This summary highlights select contents of this prospectus, and may not contain all of the information that you should consider before investing in our common stock. This summary should be read together with the more detailed information found elsewhere in this prospectus, including “Risk factors” and our consolidated financial statements and related notes beginning on page F-1. References in this prospectus to “Cumberland,” “we,” “us” and “our” refer to Cumberland Pharmaceuticals Inc. and our consolidated subsidiaries, unless the context indicates otherwise.

 

OUR COMPANY

 

We are a profitable and growing specialty pharmaceutical company focused on the acquisition, development and commercialization of branded prescription products. Our primary target markets are hospital acute care and gastroenterology, which are characterized by relatively concentrated physician prescriber bases that we believe can be penetrated effectively by relatively small, targeted sales forces. In June 2009, we received FDA approval for Caldolor, our lead product for use in the hospital market. In addition to Caldolor, we market and sell Acetadote and Kristalose through our dedicated hospital and gastroenterology sales forces, which together comprise 66 sales representatives and managers as of July 1, 2009. For the years 2006, 2007 and 2008, our net revenue was $17.8 million, $28.1 million and $35.1 million, respectively, and our net income was $4.4 million, $4.0 million and $4.8 million, respectively.

 

Since our inception in 1999, we have successfully funded the acquisition and development of our product portfolio with limited external investment, while maintaining profitable operations over the past five years. Unlike many emerging pharmaceutical and biotechnology companies, we have established both product development and commercialization capabilities, and believe our organizational structure can be expanded efficiently to accommodate our expected growth. Our management team consists of pharmaceutical industry veterans experienced in business development, clinical and regulatory affairs, and sales and marketing.

 

OUR PRODUCTS

 

Our key products include:

 

 

Caldolor, our intravenous formulation of ibuprofen, is the first injectable product approved in the United States for the treatment of both pain and fever. To support Caldolor’s regulatory approval, we completed a comprehensive clinical program, which culminated in an NDA filing in December 2008. We received FDA approval to market Caldolor in the United States in June 2009. We plan to promote Caldolor in the United States through a dedicated hospital sales force of 77 experienced representatives and managers and internationally through alliances with marketing partners. We are currently preparing for the commercial launch of Caldolor in the United States, which we expect to initiate in the fourth quarter of 2009. We believe Caldolor represents our most significant market opportunity to date.

 

According to IMS Health, the U.S. market for injectable analgesics, or pain relievers, exceeded $332 million, or 681 million units, in 2008. This market consists primarily of generic opioids and the non-steroidal anti-inflammatory drug ketorolac. Despite having a poor safety profile, usage of ketorolac has grown from approximately 38 million units in 2004, or 5% of the market, to approximately 46 million units in 2008, or 7% of the market, according to IMS Health. Injectable opioids such as morphine and meperidine accounted for approximately 635 million units sold in 2008. While opioids are widely used for acute pain management, they are associated with a variety of side effects including

 

 

 

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sedation, nausea, vomiting, headache, cognitive impairment and respiratory depression. Based on the results of our clinical studies to date, we believe Caldolor represents a potentially safer alternative to ketorolac, the only non-opioid injectable pain relief drug available in the U.S. Caldolor is the only approved injectable treatment for fever in the U.S.

 

Acetadote is the only intravenous formulation of N-acetylcysteine, or NAC, approved in the U.S. for the treatment of acetaminophen poisoning. Though safe at recommended doses, acetaminophen can cause liver damage with excessive use. Acetaminophen overdose is the most common cause of acute liver failure in adults in the U.S. According to the American Association of Poison Control Centers’ National Poison Data System, acetaminophen was the leading cause of toxic drug ingestions reported to poison control centers in the U.S. in 2007.

 

NAC is accepted worldwide as the standard of care for treating acetaminophen overdose, which is well-documented and is supported by a 2005 article in volume 17 of Current Opinion in Pediatrics. Until our 2004 launch of Acetadote, the only FDA-approved form of NAC available in the U.S. was an oral preparation. Medical literature suggests that, for a number of patients, IV treatment is the only reasonable route of administration due to nausea and vomiting associated with the administration of oral NAC for acetaminophen overdose. Sales of Acetadote have increased consistently since we launched the product in June 2004. According to Wolters Kluwer Health Source^tm Pharmaceutical Audit Suite, Acetadote sales to hospitals grew 33% from 2007 to 2008. Total sales to hospitals in 2008 were $24.3 million. We believe that we can continue to expand market share, and that our Acetadote sales and marketing platform should help facilitate the anticipated launch of Caldolor.

 

Kristalose, a prescription laxative product, is a crystalline form of lactulose designed to enhance patient acceptance and compliance. Based on data from IMS Health, the U.S. prescription laxative market has grown rapidly over the past few years, increasing from approximately $269 million in 2004 to $344 million in 2008, representing a compound annual growth rate of 6%. Wholesaler sales of Kristalose to pharmacies were $9.4 million in 2008. In April 2006, we acquired exclusive U.S. commercialization rights to Kristalose, subsequently assembling a dedicated field sales force and re-launching the product in September 2006 under the Cumberland brand. We believe that we can increase market share for Kristalose given its many positive, competitive attributes including better taste, consistency, ease of use and cost relative to competing products.

 

Early-stage product candidates.  Our pre-clinical product candidates are being developed by Cumberland Emerging Technologies, Inc., or CET, our 85%-owned subsidiary. CET collaborates with leading research institutions to identify and advance the development of promising pre-clinical product candidates within our target segments. Current CET projects include an improved treatment for fluid buildup in the lungs of cancer patients, an anti-infective for treating fungal infections in immuno-compromised patients and a novel treatment to reduce or eliminate asthmatic reaction in pediatric patients.

 

OUR COMPETITIVE STRENGTHS

 

We believe our key competitive strengths include the following:

 

 

 

 

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OUR STRATEGY

 

Our objective is to develop, acquire and commercialize branded pharmaceutical products for specialty physician market segments. Our strategy to achieve this objective includes the following key elements:

 

 

RISKS AFFECTING US

 

Our business is subject to numerous risks that could prevent us from successfully implementing our business strategy. These and other risks are discussed further in the section entitled “Risk factors” immediately following this prospectus summary, and include the following:

 

 

CORPORATE INFORMATION

 

We were incorporated in Tennessee in 1999. Our principal executive offices are located at 2525 West End Avenue, Suite 950, Nashville, Tennessee 37203, and our telephone number is (615) 255-0068. Our website address is www.cumberlandpharma.com. The information on, or accessible through, our website is not part of this prospectus.

 

 

 

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The offering

 

 

Common stock to be outstanding after this offering is based on 12,091,191 shares outstanding as of March 31, 2009 and excludes:

 

 

Fully diluted common stock to be outstanding after this offering represents the sum of the 17,091,191 shares to be outstanding after this offering, 6,550 shares of unvested restricted stock and the 7,276,205 shares of common stock issuable upon exercise of options and warrants outstanding as of March 31, 2009 of which we have received notice that 4,377,090 options will be exercised immediately prior to this offering pursuant to the Option Transaction. The number of outstanding options and warrants is reduced by the 889,907 shares of common stock that could theoretically be repurchased with the approximately $15.1 million in aggregate exercise price of such options and warrants at a repurchase price equal to the public offering price listed on the cover of this prospectus.

 

Unless otherwise indicated, the share information in this prospectus is as of March 31, 2009 and has been adjusted to reflect or assume the following:

 

 

 

 

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														Three Months
		Years Ended December 31,												Ended March 31,
Statement of income data:		2006				2007				2008				2008				2009
		(in thousands, except per share data)
														(unaudited)
Net revenues:
Acetadote		$	10,722			$	18,817			$	25,439			$	5,799			$	7,133
Kristalose			6,511				9,013				9,469				2,478				2,229
Other(1)			582				234				167				26				43
Total net revenues(2)		$	17,815			$	28,064			$	35,075			$	8,304			$	9,405
Operating income		$	2,224			$	6,725			$	7,282			$	1,794			$	2,117
Net income before income taxes			1,708				6,469				7,310				1,762				2,037
Net income attributable to common shareholders			4,404				4,044				4,766				1,395				1,218
Earnings per share attributable to common shareholders—basic		$	0.45			$	0.40			$	0.47			$	0.14			$	0.12
Earnings per share attributable to common shareholders—diluted		$	0.27			$	0.24			$	0.29			$	0.09			$	0.08
Pro forma earnings per share attributable to common shareholders—basic										$	0.41							$	0.10
Pro forma earnings per share attributable to common shareholders—diluted										$	0.29							$	0.08
Weighted-average shares outstanding—basic			9,797				10,032				10,143				10,094				10,321
Weighted-average shares outstanding—diluted			16,454				16,582				16,540				16,412				16,127
Pro forma weighted-average shares outstanding—basic											11,768								11,947
Pro forma weighted-average shares outstanding—diluted											16,540								16,127

		As of March 31, 2009
										Pro Forma
Balance sheet data:		Actual				Pro Forma				as Adjusted(3)
		(in thousands)
		(unaudited)
Cash and cash equivalents		$	10,072			$	10,072			$	81,056
Working capital			11,262				11,262				83,079
Total assets			30,986				30,986				101,969
Total long-term debt and other long-term obligations (including current portion)(4)			7,261				7,261				3,094
Convertible preferred stock			2,604				—				—
Retained earnings			2,669				2,669				2,669
Total equity			18,452				18,452				93,602

(1)		Includes revenue from products we are no longer selling, revenue reduction for promotional costs to a wholesaler, grant revenue and other miscellaneous revenue.
(2)		The sum of the individual amounts may not agree due to rounding.

(3)		These amounts exclude adjustments related to the Option Transaction as described in the section entitled “Certain relationships and related party transactions.” If these adjustments were included and if the shares to be repurchased in the first quarter of 2010 were repurchased on March 31, 2009 at the public offering price listed on the cover of this prospectus, then as of March 31, 2009:

	Ø	Cash and cash equivalents would have been $72,218. The adjustments include proceeds from the new term debt of $18.0 million less the payment of approximately $1.0 million of the employer’s portion of payroll-related taxes less the payment of approximately $24.6 million to repurchase shares of common stock to cover the optionee’s minimum statutory tax liability at the time of exercise less the payment of approximately $1.3 million to repurchase shares of common stock in the first quarter of 2010;
	Ø	Working capital would have been $72,742. The adjustments include proceeds from the new term debt of $18.0 million less the amount classified as a current liability of $1.5 million less the payment of approximately $1.0 million of the employer’s portion of payroll-related taxes less the payment of approximately $24.6 million to repurchase shares to cover the optionee’s minimum statutory tax liability at the time of exercise less the payment of approximately $1.3 million to repurchase shares of common stock in the first quarter of 2010;
	Ø	Total assets would have been $118,608. The adjustments include proceeds from the new term debt of $18.0 million plus the expected creation of approximately $25.5 in deferred tax assets resulting from the exercise of the stock options less the payment of approximately $1.0 million of the employer’s portion of payroll-related taxes less the payment of approximately $24.6 million to repurchase shares to cover the optionee’s minimum statutory tax liability at the time of exercise less the payment of approximately $1.3 million to repurchase shares of common stock in the first quarter of 2010;
	Ø	Total long-term debt and other long-term obligations (including current portion) would have been $21,094. The adjustments include $18.0 million of new term debt; and
	Ø	Total equity would have been $92,241. The adjustments include the expected creation of approximately $25.5 million in deferred tax assets (increase in equity) resulting from the exercise of the stock options less the employer’s payroll-related expense of approximately $1.0 million less the payment of approximately $24.6 million to repurchase shares to cover the optionee’s minimum statutory tax liability at the time of exercise less the payment of approximately $1.3 million to repurchase shares of common stock in the first quarter of 2010. These amounts exclude the effect of payment of the exercise price of approximately $2.4 million which may be settled in cash or tender of 140,788 shares (based on the public offering price listed on the cover of this prospectus).

(4)		In connection with this offering, we will use part of the proceeds to repay approximately $4.2 million of the term loan with Bank of America. As of March 31, 2009, the term loan balance was $5.0 million. Subsequent to March 31, 2009, we have paid approximately $0.8 million of the term loan during the normal course of business.

 

 

 

6

 

Investing in our common stock involves a high degree of risk. You should carefully consider the following risks, together with all of the other information included in this prospectus, before investing in our common stock. If any of the following risks were to occur, our business, financial condition and results of operations could be materially and adversely affected. In that case, the trading price of our common stock could decline, and you might lose all or part of your investment.

 

RISKS RELATED TO OUR BUSINESS

 

The commercial launch of Caldolor is subject to many internal and external challenges and if we cannot overcome these challenges in a timely manner, our future revenues and profits could be materially and adversely impacted.

 

We are dependent on Caldolor for a substantial portion of our future growth. While Caldolor was approved by the U.S. Food and Drug Administration, or FDA, in June 2009, we have not commercialized Caldolor in any jurisdiction. The successful commercial launch of Caldolor is dependent on our ability to coordinate large-scale supply, distribution, marketing, sales and education efforts. We cannot assure you that we will be able to successfully commercialize Caldolor on our current timeline or at all.

 

Internally, the successful launch of Caldolor will depend on our ability to recruit, train and retain a qualified sales force, to equip our sales force with effective supportive materials, to target appropriate markets and to accurately price Caldolor. As of July 1, 2009, our hospital sales force was comprised of 30 representatives and managers, but none of these has ever sold Caldolor before. We are planning, and have begun, to add additional representatives to be able to effectively launch Caldolor. In addition, as Caldolor is a newly marketed drug, our sales force will need to be sufficiently trained, credible and persuasive in order to convince physicians and pharmacists in target markets to use Caldolor. Finally, we will need to train our sales force to ensure that a consistent and appropriate message about Caldolor is being delivered to physicians and pharmacists. If we are unable to add enough new sales force representatives, if we are unable to add sufficiently qualified representatives, or if we are not able to effectively train our sales force, our ability to successfully launch Caldolor could be jeopardized. We must also equip our sales force with effective materials, including clinical papers, sales literature and formulary kits, to help them inform and educate physicians and pharmacists about the benefits and risks of Caldolor as well as the proper administration of the drug. If we are unable to provide our sales force with convincing supportive materials, they may not be able to sell Caldolor in sufficient quantities or at all. We must also ensure that we maximize our sales efforts for Caldolor by targeting the right hospitals across the U.S. Any failure in sales force coverage could limit our ability to generate market acceptance for Caldolor and ultimately, the successful commercialization of the drug. Finally, we must set a price for Caldolor that hospitals and other purchasers will be willing to pay, but that will also generate sufficient profits. If we set a price for Caldolor that hospitals consider too high, we may need to subsequently reduce the price for Caldolor. If we set the initial price for Caldolor too low, we may not generate adequate profits and may not be able to raise the price of the drug in the future.

 

In addition to the extensive internal efforts required, the successful launch of Caldolor will require the assistance of many third-parties, including physicians, pharmacists, hospital pharmacy and therapeutics committees, or P&T committees, suppliers and distributors, all of whom we have little or no control over. We expect Caldolor to be administered primarily to hospitalized patients who are unable to receive oral therapies for the treatment of pain or fever. Before we can attempt to sell Caldolor in hospitals, Caldolor must be approved for addition to a hospital’s formulary list by the hospital’s P&T committee. A hospital’s P&T committee generally governs all matters pertaining to the use of medications within the institution, including review of medication formulary data and recommendations

 

 

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Risk factors

 

 

of drugs to the medical staff. We cannot guarantee that we will be successful in getting the approvals we need from enough P&T committees to be able to optimize hospital sales of Caldolor. Even if we obtain hospital approval for Caldolor, we must still convince individual hospital physicians to prescribe Caldolor repeatedly for its commercialization to be successful. Because Caldolor is a new drug with little track record, any mistakes made in the timely supply of Caldolor, education about how to properly administer Caldolor or any unexpected side effects that develop from use of the drug, particularly early in product launch, may lead physicians to not accept Caldolor as a viable treatment alternative. Similar to physicians, our ability to sell Caldolor to pharmacists will depend on price and education efforts, and the lack of a track record for Caldolor could magnify any delays in delivery or side effects of the drug and prevent widespread pharmacist acceptance of Caldolor.

 

The FDA has approved Caldolor as a treatment for the reduction of pain and fever in adults in the U.S. and any attempt by us to expand the potential market for Caldolor is subject to limitations.

 

The FDA approved Caldolor for the treatment of pain and fever in adults in the U.S. In its June 2009 approval letter, the FDA required us to conduct two additional Phase IV pediatric studies by 2011 and 2012, respectively. If the results of these Phase IV clinical studies are not favorable, we may not be able to expand the market for Caldolor to children ages 1-16. We may also experience delays associated with these required Phase IV clinical studies potentially resulting from, among other factors, difficulty enrolling pediatric patients. Such delays could impact our ability to obtain an additional six months of FDA exclusivity.

 

In addition, we have only obtained regulatory approval to market Caldolor in the U.S. In foreign jurisdictions such as Canada and Australia we have licensed the right to market Caldolor to third parties. These third parties are responsible for seeking regulatory approval for Caldolor in their respective jurisdictions. We have no control over these third parties and cannot be sure that marketing approval for Caldolor will ever be obtained outside the U.S.

 

Sales of Acetadote and Kristalose currently generate almost all of our revenues. An adverse development regarding either of these products could have a material and adverse impact on our future revenues and profitability.

 

A number of factors may impact the effectiveness of our marketing and sales activities and the demand for our products, including:

 

 

 

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Risk factors

 

 

 

If demand for either Acetadote or Kristalose weakens, our revenues and profitability will likely decline.

 

Known adverse effects of our marketed products are documented in product labeling, including the product package inserts, medical information disclosed to medical professionals, and all marketing related materials. No unforeseen or serious adverse effects outside of those specified in current product labeling have been directly attributed to our approved products. The most frequently reported adverse events attributed to Acetadote include rash, urticaria (hives) and pruritus (itching), and anaphylactoid reactions. The most frequently reported adverse events attributed to Kristalose, and reported to us, include flatulence and nausea.

 

If any manufacturer we rely upon fails to produce our products and product candidates in the amounts we require on a timely basis, or fails to comply with stringent regulations applicable to pharmaceutical drug manufacturers, we may face delays in the commercialization of Caldolor, or may be unable to meet demand for the product supplied by the manufacturer and may lose potential revenues.

 

We do not manufacture any of our products or product candidates, and we do not currently plan to develop any capacity to do so. Our dependence upon third parties for the manufacture of products could adversely affect our profit margins or our ability to develop and deliver products on a timely and competitive basis. If for any reason we are unable to obtain or retain third-party manufacturers on commercially acceptable terms, we may not be able to sell our products as planned. Furthermore, if we encounter delays or difficulties with contract manufacturers in producing our products, the distribution, marketing and subsequent sales of these products could be adversely affected. As Caldolor is a new product, the effect of any delays or failure to deliver could be magnified due to the lack of a track record for Caldolor with physicians and pharmacists. In either event, we may choose to or need to seek an alternative source of supply for, or abandon, a product line or sell a product line on unsatisfactory terms. We have agreements with Bioniche Teoranta, or Bioniche, and with Bayer Healthcare, LLC, or Bayer, for the manufacture and supply of Acetadote. Our agreement with Bioniche requires us to purchase minimum amounts of Acetadote.

 

We also have minimum purchase obligations under our Kristalose supply agreement with Inalco S.p.A. and Inalco Biochemicals, Inc., or collectively Inalco. If our purchase obligations exceed demand for our products, we may be forced to either breach our contract with that manufacturer or purchase a supply of the product that we may be unable to sell. Our contract with Bioniche extends until 2011, and our contract with Inalco extends until 2021.

 

Caldolor is manufactured at Hospira Australia Pty. Ltd.’s facility in Australia and Bayer’s facility in Kansas. Acetadote is manufactured primarily at a facility in Ireland and Bayer’s manufacturing plant in Kansas is an alternative manufacturing source for Acetadote. The active pharmaceutical ingredient for Kristalose is manufactured at a single facility in Italy. If any one of these facilities is damaged or destroyed, or if local conditions result in a work stoppage, we could suffer an inability to meet demand for our products. Kristalose is manufactured through a complex process involving trade secrets of the manufacturer; therefore, it would be particularly difficult to find a new manufacturer of Kristalose on an expedited basis. As a result of these factors, our ability to manufacture Kristalose may be substantially impaired if the manufacturer is unable or unwilling to supply sufficient quantities of the product.

 

 

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Risk factors

 

 

 

In addition, all manufacturers of our products and product candidates must comply with current good manufacturing practices, referred to as cGMP, enforced by the FDA through its facilities inspection program. These requirements include quality control, quality assurance and the maintenance of records and documentation. Manufacturers of our product candidates may be unable to comply with cGMP requirements and with other FDA, state and foreign regulatory requirements. We have no control over our manufacturers’ compliance with these regulations and standards. If our third-party manufacturers do not comply with these requirements, we could be subject to:

 

 

If we are unable to maintain and build an effective sales and marketing infrastructure, we will not be able to commercialize and grow our products and product candidates successfully.

 

As we grow, we may not be able to secure sales personnel or organizations that are adequate in number or expertise to successfully market and sell our products. For example, in connection with the commercial launch of Caldolor, we expect we will need to add approximately 47 new hospital sales representatives, and we may not be able to hire these representatives in accordance with our timeline. This risk would be accentuated if we acquire products in areas outside of acute care/emergency medicine and gastroenterology, since our sales forces specialize in these areas. If we are unable to expand our sales and marketing capability or any other capabilities necessary to commercialize our products and product candidates, we will need to contract with third parties to market and sell our products. If we are unable to establish and maintain adequate sales and marketing capabilities:

 

 

We are dependent on a variety of other third parties. If these third parties fail to perform as we expect, our operations could be disrupted and our financial results could suffer.

 

We have a relatively small internal infrastructure. We rely on a variety of third parties, other than our third-party manufacturers, to help us operate our business. Other third parties on which we rely include:

 

 

If these third parties do not continue to provide services to us, or collaborate with us, we might not be able to obtain others who can serve these functions. This could disrupt our business operations, delay market launch of Caldolor or any future product candidate, increase our operating expenses or otherwise adversely affect our operating results.

 

 

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Risk factors

 

 

 

Competitive pressures could reduce our revenues and profits.

 

The pharmaceutical industry is intensely competitive. Our strategy is to target differentiated products in specialized markets. However, this strategy does not relieve us from competitive pressures, and can entail distinct competitive risks. For example, a new entrant into a smaller market could have a disproportionately large impact on others in the market. In addition, certain of our competitors do not aggressively promote their products in our markets. A relatively modest increase in promotional activity in our markets could result in large shifts in market share, adversely affecting us.

 

Kristalose competes in the U.S. with several other prescription laxative products, including Amitiza^®, which is marketed by Sucampo Pharmaceuticals Inc. and Takeda Pharmaceutical Company Limited. We have an exclusive patent license that gives us limited protection against direct competition for Kristalose. Acetadote competes domestically with several orally administered prescription products for treating acetaminophen overdose. We are aware of products under development which could compete with Caldolor, including an intravenous acetaminophen product for which Cadence Pharmaceuticals Inc. recently submitted a new drug application to the FDA and for which the FDA granted a priority review.

 

Our competitors may sell or develop drugs that are more effective and useful and less costly than ours, and they may be more successful in manufacturing and marketing their products. Many of our competitors have significantly greater financial and marketing resources than we do. Additional competitors may enter our markets.

 

The pharmaceutical industry is characterized by constant and significant investment in new product development, which can result in rapid technological change. The introduction of new products could substantially reduce our market share or render our products obsolete. The selling prices of pharmaceutical products tend to decline as competition increases, through new product introduction or otherwise, which could reduce our revenues and profitability.

 

Governmental and private health care payors have recently emphasized substitution of branded pharmaceuticals with less expensive generic equivalents. An increase in the sales of generic pharmaceutical products could result in a decrease in our revenues. While there are no generic equivalents competing with Caldolor, Acetadote or Kristalose at this time, in the future we could face generic competition.

 

Our future growth depends on our ability to identify and acquire rights to products. If we do not successfully identify and acquire rights to products and successfully integrate them into our operations, our growth opportunities would be limited.

 

We acquired rights to Caldolor, Acetadote and Kristalose. Our business strategy is to continue to acquire rights to FDA-approved products as well as pharmaceutical product candidates in the late stages of development. We do not plan to conduct basic research or pre-clinical product development, except to the extent of our investment in CET. We have limited resources to acquire third-party products, businesses and technologies and integrate them into our current infrastructure. Many acquisition opportunities involve competition among several potential purchasers including large multi-national pharmaceutical companies and other competitors that have access to greater financial resources than we do. In addition, our bank credit agreement requires that we obtain the consent of the bank prior to making acquisitions unless the acquisitions meet certain criteria. See “Management’s discussion and analysis of financial condition and results of operations — Liquidity and capital resources.”

 

With future acquisitions, we may face financial and operational risks and uncertainties, including:

 

 

 

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Risk factors

 

 

 

We are not precluded from engaging in a large acquisition in the future, including an acquisition that entails the investment of substantially all of the proceeds from this offering. While large acquisitions potentially present large opportunities, they also could magnify the risks identified above. As of the date of this prospectus, we have no commitments or agreements regarding any potential acquisitions.

 

We may not be able to engage in future product acquisitions, and those we do complete may not be beneficial to us in the long term.

 

If governmental or third-party payors do not provide adequate reimbursement for our products, our revenue and prospects for continued profitability will be limited.

 

Our financial success depends, in part, on the availability of adequate reimbursement from third-party healthcare payors. Such third-party payors include governmental health programs such as Medicare and Medicaid, managed care providers and private health insurers. Third-party payors are increasingly challenging the pricing of medical products and services, while governments continue to propose and pass legislation designed to reduce the cost of healthcare. Adoption of such legislation could further limit reimbursement for pharmaceuticals. For example, in December 2003, Congress enacted a limited prescription drug benefit for Medicare beneficiaries in the Medicare Prescription Drug, Improvement, and Modernization Act of 2003. Under this program, drug prices for certain prescription drugs are negotiated by drug plans, with the goal to lower costs for Medicare beneficiaries. Future cost control initiatives could decrease the price that we would receive for any products, which would limit our revenue and profitability. In addition, legislation and regulations affecting the pricing of pharmaceuticals might change.

 

Reimbursement practices of third-party payors might preclude us from achieving market acceptance for our products or maintaining price levels sufficient to realize an appropriate return on our investment in product acquisition and development. If we cannot obtain adequate reimbursement levels, our business, financial condition and results of operations would be materially and adversely affected.

 

“Formulary” practices of third-party payors could adversely affect our competitive position.

 

Many managed health care organizations are now controlling the pharmaceutical products listed on their formulary lists. The benefit of having products listed on these formulary lists creates competition among pharmaceutical companies which, in turn, has created a trend of downward pricing pressure in our industry. In addition, many managed care organizations are pursuing various ways to reduce pharmaceutical costs and are considering formulary contracts primarily with those pharmaceutical companies that can offer a full line of products for a given therapy sector or disease state. Our products might not be included on the formulary lists of managed care organizations, and downward pricing pressure in our industry generally could negatively impact our operations.

 

 

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Risk factors

 

 

 

Continued consolidation of distributor networks in the pharmaceutical industry as well as increases in retailer concentration may limit our ability to profitably sell our products.

 

We sell most of our products to large pharmaceutical wholesalers, who in turn sell to, thereby supplying, hospitals and retail pharmacies. The distribution network for pharmaceutical products has become increasingly consolidated in recent years. Today, three large wholesalers control most of the market. Further consolidation among, or any financial difficulties of, pharmaceutical wholesalers or retailers could result in the combination or elimination of warehouses, which could cause product returns to us. In addition, further consolidation or financial difficulties could also cause our customers to reduce the amounts of our products that they purchase, which would materially and adversely affect our business, financial condition and results of operations.

 

Our CET joint initiative may not result in our gaining access to commercially viable products.

 

Our CET joint initiative with Vanderbilt University and Tennessee Technology Development Corporation is designed to help us investigate, in a cost-effective manner, early-stage products and technologies. However, we may never gain access to commercially viable products from CET for a variety of reasons, including:

 

 

The size of our organization and our activities are growing, and we may experience difficulties in managing growth.

 

As of July 1, 2009, we had 59 full-time employees, which includes 30 hospital sales force representatives and managers. In connection with the commercial launch of Caldolor, we expect to add an additional 47 hospital sales force representatives. We may need to continue to expand our managerial, operational, financial and other resources in order to increase our marketing efforts with regard to our currently marketed products, continue our business development and product development activities and commercialize our product candidates. We have experienced, and may continue to experience, rapid growth in the scope of our operations in connection with the commercial launch of new products, including Caldolor. Our financial performance will depend, in part, on our ability to manage any such growth effectively. Our management, personnel, systems and facilities currently in place may not be adequate to support this future growth.

 

 

13

 

Risk factors

 

 

 

We depend on our key personnel, the loss of whom would adversely affect our operations. If we fail to attract and retain the talent required for our business, our business will be materially harmed.

 

We are a relatively small company, and we depend to a great extent on principal members of our management and scientific staff. If we lose the services of any key personnel, in particular, A.J. Kazimi, our Chief Executive Officer, it could have a material adverse effect on our business prospects. We currently have a key man life insurance policy covering the life of Mr. Kazimi. We have entered into agreements with each of our employees that contain restrictive covenants relating to non-competition and non-solicitation of our customers and suppliers for one year after termination of employment. Nevertheless, each of our officers and key employees may terminate his or her employment at any time without notice and without cause or good reason, and so as a practical matter these agreements do not guarantee the continued service of these employees. Our success depends on our ability to attract and retain highly qualified scientific, technical and managerial personnel and research partners. Competition among pharmaceutical companies for qualified employees is intense, and we may not be able to retain existing personnel or attract and retain qualified staff in the future. If we experience difficulties in hiring and retaining personnel in key positions, we could suffer from delays in product development, loss of customers and sales and diversion of management resources, which could adversely affect operating results.

 

We face potential product liability exposure, and if successful claims are brought against us, we may incur substantial liability for a product or product candidate and may have to limit its commercialization.

 

We face an inherent risk of product liability lawsuits related to the testing of our product candidates and the commercial sale of our products. An individual may bring a liability claim against us if one of our product candidates or products causes, or appears to have caused, an injury. If we cannot successfully defend ourselves against the product liability claim, we may incur substantial liabilities. Liability claims may result in:

 

 

We are highly dependent upon medical and patient perceptions of us and the safety and quality of our products. We could be adversely affected if we or our products are subject to negative publicity. We could also be adversely affected if any of our products or any similar products sold by other companies prove to be, or are asserted to be, harmful to patients. Also, because of our dependence upon medical and patient perceptions, any adverse publicity associated with illness or other adverse effects resulting from the use or misuse of our products or any similar products sold by other companies could have a material adverse impact on our results of operations.

 

We have product liability insurance that covers our clinical trials and the marketing and sale of our products up to a $10 million annual aggregate limit, subject to specified deductibles. Our current or future insurance coverage may prove insufficient to cover any liability claims brought against us.

 

 

14

 

Risk factors

 

 

Because of the increasing costs of insurance coverage, we may not be able to maintain insurance coverage at a reasonable cost or obtain insurance coverage that will be adequate to satisfy any liability that may arise.

 

We have never paid cash dividends on our capital stock, and we do not anticipate paying any cash dividends in the foreseeable future.

 

We have never paid cash dividends on our capital stock. We do not anticipate paying cash dividends to our shareholders in the foreseeable future. The availability of funds for distributions to shareholders will depend substantially on our earnings. Furthermore, our loan agreement places certain restrictions on payment of dividends. Even if we become able to pay dividends in the future, we expect that we would retain such earnings to enhance capital and/or reduce long-term debt.

 

RISKS RELATING TO GOVERNMENT REGULATION

 

We are subject to stringent government regulation. All of our products face regulatory challenges.

 

Virtually all aspects of our business activities are regulated by government agencies. The manufacturing, processing, formulation, packaging, labeling, distribution, promotion and sampling, and advertising of our products, and disposal of waste products arising from such activities, are subject to governmental regulation. These activities are regulated by one or more of the FDA, the Federal Trade Commission, or the FTC, the Consumer Product Safety Commission, the U.S. Department of Agriculture and the U.S. Environmental Protection Agency, or the EPA, as well as by comparable agencies in foreign countries. These activities are also regulated by various agencies of the states and localities in which our products are sold. For more information, see “Business—Government Regulation.”

 

Like all pharmaceutical manufacturers, we are subject to regulation by the FDA under the authority of the Federal Food, Drug and Cosmetic Act, or the FDC Act. All “new drugs” must be the subject of an FDA-approved new drug application, or NDA, before they may be marketed in the U.S. The FDA has the authority to withdraw existing NDA approvals and to review the regulatory status of products marketed under the enforcement policy. The FDA may require an approved NDA for any drug product marketed under the enforcement policy if new information reveals questions about the drug’s safety and effectiveness. All drugs must be manufactured in conformity with cGMP, and drug products subject to an approved NDA must be manufactured, processed, packaged, held and labeled in accordance with information contained in the NDA. Since we rely on third parties to manufacture our products, cGMP requirements directly affect our third party manufacturers and indirectly affect us. The manufacturing facilities of our third-party manufacturers are continually subject to inspection by such governmental agencies, and manufacturing operations could be interrupted or halted in any such facilities if such inspections prove unsatisfactory. Our third-party manufacturers are subject to periodic inspection by the FDA to assure such compliance.

 

Pharmaceutical products must be distributed, sampled and promoted in accordance with FDA requirements. The FDA also regulates the advertising of prescription drugs. The FDA has the authority to request post-approval commitments that can be time-consuming and expensive to comply with.

 

Under the FDC Act, the federal government has extensive enforcement powers over the activities of pharmaceutical manufacturers to ensure compliance with FDA regulations. Those powers include, but are not limited to, the authority to initiate court action to seize unapproved or non-complying products, to enjoin non-complying activities, to halt manufacturing operations that are not in compliance with cGMP, and to seek civil monetary and criminal penalties. The initiation of any of these enforcement

 

 

15

 

Risk factors

 

 

activities, including the restriction or prohibition on sales of our products, could materially adversely affect our business, financial condition and results of operations.

 

Any change in the FDA’s enforcement policy could have a material adverse effect on our business, financial condition and results of operations.

 

We cannot determine what effect changes in regulations or statutes or legal interpretation, when and if promulgated or enacted, may have on our business in the future. Such changes could, among other things, require:

 

 

Such changes, or new legislation, could have a material adverse effect on our business, financial condition and results of operations.

 

RISKS RELATING TO INTELLECTUAL PROPERTY

 

Our strategy to secure and extend marketing exclusivity or patent rights may provide only limited protection from competition.

 

We seek to secure and extend marketing exclusivity for our products through a variety of means, including FDA exclusivity and patent rights. Acetadote has been designated as an “orphan drug” and is indicated to prevent or lessen hepatic (liver) injury when administered intravenously within eight to ten hours after ingesting quantities of acetaminophen that are potentially toxic to the liver. The FDA is authorized to grant orphan drug designation to drugs intended to treat a rare disease or condition. If a product that has orphan drug designation subsequently receives the first FDA approval for the disease for which it has such designation, the product is entitled to orphan drug exclusivity, which means that the FDA may not approve any other applications to market another drug using the same active ingredients for the same indication, except in very limited circumstances, for seven years. To this extent, Acetadote is protected until 2011 against competition from another drug using the same active ingredient to treat the same indication. Orphan drug marketing exclusivity does not, however, protect a drug from competition by a different drug marketed for the same indications.

 

We do not have “composition of matter” or “use” patents for our marketed products. We do have a U.S. patent, No. 6,727,286 for Caldolor, and some related international patents, which are directed to ibuprofen solution formulations, methods of making the same, and methods of using the same, and which are related to our formulation and manufacture of Caldolor. Additionally, the active ingredient in Caldolor—ibuprofen—is in the public domain, and if a competitor were to develop a sufficiently distinct formulation, it could develop and seek FDA approval for an ibuprofen product that competes with Caldolor. Upon receipt of FDA approval in June 2009, we received three-years of marketing exclusivity for Caldolor.

 

Kristalose is manufactured under a contract with Inalco, which owns U.S. Patent No. 5,480,491, related to the manufacture of Kristalose. This patent is not directed to the composition or use of Kristalose and does not prevent a competitor from developing a formulation and developing and seeking FDA approval for a product that competes with Kristalose.

 

 

16

 

Risk factors

 

 

 

While we consider patent protection when evaluating product acquisition opportunities, any products we acquire in the future may not have significant patent protection. Neither the U.S. Patent and Trademark Office nor the courts have a consistent policy regarding the breadth of claims allowed or the degree of protection afforded under many pharmaceutical patents. Patent applications in the U.S. and many foreign jurisdictions are typically not published until 18 months following the filing date of the first related application, and in some cases not at all. In addition, publication of discoveries in scientific literature often lags significantly behind actual discoveries. Therefore, neither we nor our licensors can be certain that we or they were the first to make the inventions claimed in our issued patents or pending patent applications, or that we or they were the first to file for protection of the inventions set forth in these patent applications. In addition, changes in either patent laws or in interpretations of patent laws in the U.S. and other countries may diminish the value of our intellectual property or narrow the scope of our patent protection. Furthermore, our competitors may independently develop similar technologies or duplicate technology developed by us in a manner that does not infringe our patents or other intellectual property. As a result of these factors, our patent rights may not provide any commercially valuable protection from competing products.

 

If we are unable to protect the confidentiality of our proprietary information and know-how, the value of our technology and products could be adversely affected.

 

In addition to patents, we rely upon trade secrets, unpatented proprietary know-how and continuing technological innovation where we do not believe patent protection is appropriate or attainable. For example, the manufacturing process for Kristalose involves substantial trade secrets and proprietary know-how. We have entered into confidentiality agreements with certain key employees and consultants pursuant to which such employees and consultants must assign to us any inventions relating to our business if made by them while they are our employees, as well as certain confidentiality agreements relating to the acquisition of rights to products. Confidentiality agreements can be breached, though, and we might not have adequate remedies for any breach. Also, others could acquire or independently develop similar technology.

 

We depend on our licensors for the maintenance and enforcement of our intellectual property and have limited, if any, control over the amount or timing of resources that our licensors devote on our behalf.

 

When we license products, we often depend on our licensors to protect the proprietary rights covering those products. We have limited, if any, control over the amount or timing of resources that our licensors devote on our behalf or the priority they place on maintaining patent or other rights and prosecuting patent applications to our advantage. While any such licensor is expected to be under contractual obligations to us to diligently prosecute its patent applications and allow us the opportunity to consult, review and comment on patent office communications, we cannot be sure that it will perform as required. If a licensor does not perform and if we do not assume the maintenance of the licensed patents in sufficient time to make required payments or filings with the appropriate governmental agencies, we risk losing the benefit of all or some of those patent rights.

 

If the use of our technology conflicts with the intellectual property rights of third parties, we may incur substantial liabilities, and we may be unable to commercialize products based on this technology in a profitable manner or at all.

 

Third parties, including our competitors, could have or acquire patent rights that they could enforce against us. In addition, we may be subject to claims from others that we are misappropriating their trade secrets or confidential proprietary information. If our products conflict with the intellectual

 

 

17

 

Risk factors

 

 

property rights of others, they could bring legal action against us or our licensors, licensees, manufacturers, customers or collaborators. If we were found to be infringing a patent or other intellectual property rights held by a third party, we could be forced to seek a license to use the patented or otherwise protected technology. We might not be able to obtain such a license on terms acceptable to us or at all. If an infringement or misappropriation legal action were to be brought against us or our licensors, we would incur substantial costs in defending the action. If such a dispute were to be resolved against us, we could be subject to significant damages, and the manufacturing or sale of one or more of our products could be enjoined.

 

We may be involved in lawsuits to protect or enforce our patents or the patents of our collaborators or licensors, which could be expensive and time consuming.

 

Competitors may infringe our patents or the patents of our collaborators or licensors. To counter infringement or unauthorized use, we may be required to file infringement claims, which can be expensive and time-consuming. In addition, in an infringement proceeding, a court may decide that a patent of ours is not valid or is unenforceable, or may refuse to stop the other party from using the technology at issue on the grounds that our patents do not cover the technology in question. An adverse result in any litigation or defense proceeding could put one or more of our patents at risk of being invalidated or interpreted narrowly and could put our patent applications at risk of not issuing.

 

Interference proceedings brought by the U.S. Patent and Trademark Office may be necessary to determine the priority of inventions with respect to our patent applications or those of our collaborators or licensors. Litigation or interference proceedings may fail and, even if successful, may result in substantial costs and distract our management. We may not be able, alone or with our collaborators and licensors, to prevent misappropriation of our proprietary rights, particularly in countries where the laws may not protect such rights as fully as in the U.S.

 

Furthermore, because of the substantial amount of discovery required in connection with intellectual property litigation, some of our confidential information could be disclosed during this type of litigation. In addition, there could be public announcements of the results of hearings, motions or other interim proceedings or developments. If securities analysts or investors perceive these results to be negative, it could have a substantial adverse effect on the price of our common stock.

 

If we breach any of the agreements under which we license rights to our products and product candidates from others, we could lose the ability to continue commercialization of our products and development and commercialization of our product candidates.

 

We have exclusive licenses for the marketing and sale of certain products and may acquire additional licenses. Such licenses may terminate prior to expiration if we breach our obligations under the license agreement related to these pharmaceutical products. For example, the licenses may terminate if we fail to meet specified quality control standards, including cGMP with respect to the products, or commit a material breach of other terms and conditions of the licenses. Such early termination could have a material adverse effect on our business, financial condition and results of operations.

 

Our agreement with Inalco appoints us as the exclusive marketer, seller and distributor of Kristalose in the U.S. Either we or Inalco may terminate this agreement upon the breach of any material provision of the agreement if the breach is not cured within 45 days following written notice. If our agreement with Inalco were terminated, we would lose our right to continue commercialization of Kristalose in the U.S.

 

Under an agreement between us and Vanderbilt University, we have received certain clinical data to support regulatory approval for Caldolor. Either we or Vanderbilt may terminate this agreement upon substantial breach of the agreement if the breach is not cured within 45 days following written notice. If

 

 

18

 

Risk factors

 

 

our agreement with Vanderbilt were terminated, we would lose our right to use the data, and this loss might hinder our ability to commercialize Caldolor in accordance with our plans.

 

RISKS RELATED TO OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Our operating results are likely to fluctuate from period to period.

 

We are a relatively new company seeking to capture significant growth. While our revenues and operating income have increased over time, we anticipate that there may be fluctuations in our future operating results. Potential causes of future fluctuations in our operating results may include:

 

 

See also “Management’s discussion and analysis of financial condition and results of operations — Liquidity and capital resources.” Fluctuation in operating results, particularly if not anticipated by investors and other members of the financial community, could add to volatility in our stock price.

 

Our focus on acquisitions as a growth strategy has created a large amount of intangible assets whose amortization could negatively affect our results of operations.

 

Our total assets include intangible assets related to our acquisitions. As of March 31, 2009, intangible assets relating to product and data acquisitions represented approximately 27% of our total assets. We may never realize the value of these assets. Generally accepted accounting principles require that we evaluate on a regular basis whether events and circumstances have occurred that indicate that all or a portion of the carrying amount of the asset may no longer be recoverable, in which case we would write down the value of the asset and take a corresponding charge to earnings. Any determination requiring the write-off of a significant portion of unamortized intangible assets would adversely affect our results of operations.

 

We may need additional funding and may be unable to raise capital when needed, which could force us to delay, reduce or eliminate our product development or commercialization and marketing efforts.

 

We may need to raise additional funds in order to meet the capital requirements of running our business and acquiring and developing new pharmaceutical products. If we require additional funding, we may seek to sell common stock or other equity or equity-linked securities, which could result in dilution to purchasers of common stock in this offering. We may also seek to raise capital through a debt financing, which would result in ongoing debt-service payments and increased interest expense. Any financings would also likely involve operational and financial restrictions being imposed on us. We might also seek to sell assets or rights in one or more commercial products or product development programs. Additional capital might not be available to us when we need it on acceptable terms or at all. If we are unable to raise additional capital when needed, we could be forced to scale back our operations to conserve cash.

 

 

19

 

Risk factors

 

 

 

We have a relatively short history of profitability and may not be able to sustain or increase our net income levels.

 

We were incorporated in 1999 and incurred operating losses until 2004. We recorded our first year of profitability in 2004 and have remained profitable in each of 2005, 2006, 2007 and 2008. As of March 31, 2009, we had retained earnings of $2.7 million, representing the amount by which our historical profits have exceeded our historical losses. We may not be able to maintain or improve our current levels of revenue or net income. In such event, investors are likely to lose confidence in our ability to grow, and our stock price would suffer.

 

RISKS RELATED TO THIS OFFERING AND AN INVESTMENT IN OUR STOCK

 

As a new investor, you will experience immediate and substantial dilution in the net tangible book value of your shares.

 

The initial public offering price of our common stock in this offering is considerably more than the net tangible book value per share of our outstanding common stock. Investors purchasing shares of common stock in this offering will pay a price that substantially exceeds the value of our tangible assets after subtracting liabilities. As a result, investors in this offering will:

 

 

These percentages do not give effect to the exercise of options and warrants to purchase up to an aggregate of 7,276,205 shares of common stock or the vesting of 6,550 shares of restricted stock, of which we have received notice that 4,377,090 options will be exercised immediately prior to this offering. See “Dilution.”

 

We may conduct substantial additional equity offerings or issue equity as consideration in an acquisition or otherwise. These future equity issuances, together with the exercise of outstanding options or warrants, could result in future dilution to investors.

 

The market price of our common stock may fluctuate substantially.

 

The initial public offering price for the shares of our common stock sold in this offering has been determined by negotiation between the representatives of the underwriters and us. This price may not reflect the market price of our common stock following this offering. The price of our common stock may decline. In addition, the market price of our common stock is likely to be highly volatile and may fluctuate substantially.

 

The realization of any of the risks described in these “Risk factors” could have a dramatic and material adverse impact on the market price of our common stock. In addition, securities class action litigation has often been instituted against companies whose securities have experienced periods of volatility in market price. Any such securities litigation brought against us could result in substantial costs and a diversion of management’s attention and resources, which could negatively impact our business, operating results and financial condition.

 

 

20

 

Risk factors

 

 

 

We will incur increased costs as a result of operating as a public company, and our management will be required to devote additional time to new compliance initiatives.

 

We will incur increased costs as a result of operating as a public company, and our management will be required to devote additional time to new compliance initiatives. As a public company, we will incur legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, as well as rules subsequently implemented by the SEC and Nasdaq, have imposed various requirements on public companies, including requiring establishment and maintenance of effective disclosure and financial controls and changes in corporate governance practices. These rules and regulations will increase our legal and financial compliance costs and will render some activities more time-consuming and costly.

 

The Sarbanes-Oxley Act will require, among other things, that we maintain effective internal controls for financial reporting and disclosure controls and procedures. In particular, we must perform system and process evaluation and testing of our internal controls over financial reporting to allow management and our independent registered public accounting firm to report on the effectiveness of our internal controls over financial reporting, beginning with our Annual Report on Form 10-K for the fiscal year ending December 31, 2010, as required by Section 404 of the Sarbanes-Oxley Act. Our testing, or the subsequent testing by our independent registered public accounting firm, may reveal deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses.

 

Our compliance with Section 404 will require that we incur substantial accounting expense and expend significant management efforts. Moreover, if we are not able to comply with the requirements of Section 404 in a timely manner, or if we or our independent registered public accounting firm identifies deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses, the market price of our stock could decline and we could be subject to sanctions or investigations by Nasdaq, the SEC or other regulatory authorities, which would require additional financial and management resources.

 

There may not be a viable public market for our common stock.

 

Prior to this offering, there has been no public market for our common stock, and a regular trading market might not develop or continue after this offering. Moreover, the market price of our common stock might decline below the initial public offering price.

 

We will have broad discretion in how we use the proceeds of this offering, and we may not use these proceeds effectively, which could affect our results of operations and cause our stock price to decline.

 

We will have broad discretion over the use of proceeds from this offering. We intend to use the net proceeds from this offering to acquire new products and product candidates, to fund continued development of Caldolor as well as other research, marketing and development activities, and to fund working capital, capital expenditures, reduction of bank debt and other general corporate purposes. We have no present agreements with respect to any such product acquisitions. We will have considerable discretion in the application of the net proceeds, and you will not have the opportunity, as part of your investment decision, to assess whether the proceeds are being used appropriately. The net proceeds may be used for purposes that do not increase our operating results or market value. Until the net proceeds are used, they may be placed in investments that do not produce significant income or that lose value.

 

Future sales of our common stock may depress our stock price.

 

Sales of a substantial number of shares of our common stock in the public market after this offering or the perception that these sales may occur could cause the market price of our common stock to decline.

 

 

21

 

Risk factors

 

 

In addition, the sale of these shares in the public market could impair our ability to raise capital through the sale of additional common or preferred stock. After this offering, we will have 17,091,191 shares of common stock outstanding. Of these shares, all shares sold in the offering, other than shares, if any, purchased by our affiliates, will be freely tradable.

 

Some provisions of our third amended and restated charter, bylaws, credit facility and Tennessee law may inhibit potential acquisition bids that you may consider favorable.

 

Our corporate documents contain provisions that may enable our board of directors to resist a change in control of our company even if a change in control were to be considered favorable by you and other shareholders. These provisions include:

 

 

These and other provisions contained in our third amended and restated charter and bylaws could delay or discourage transactions involving an actual or potential change in control of us or our management, including transactions in which our shareholders might otherwise receive a premium for their shares over then current prices, and may limit the ability of shareholders to remove our current management or approve transactions that our shareholders may deem to be in their best interests and, therefore, could adversely affect the price of our common stock.

 

Under our bank credit agreement, it is an event of default if any person or entity obtains ownership or control, in one or a series of transactions, of more than 30% of our common stock or 30% of the voting power entitled to vote in the election of members of our board of directors.

 

In addition, we are subject to control share acquisitions provisions and affiliated transaction provision of the Tennessee Business Corporation Act, the applications of which may have the effect of delaying or preventing a merger, takeover or other change in control of us and therefore could discourage attempts to acquire our company. For more information, see “Description of capital stock—Anti-takeover effects of Tennessee law and provisions of our charter and bylaws.”

 

Some of our shareholders have registration rights, which could impair our ability to raise capital or involve us in disputes.

 

Holders of our preferred stock have rights to be included in registration statements we file with the U.S. SEC. These rights could interfere with our ability to raise capital. To the extent that these rights might have applied to this offering, we have obtained waivers from preferred holders for all but approximately 1% of our shares to be outstanding after this offering. We do not believe that these rights apply to this offering, although the non-waiving parties might claim otherwise.

 

 

22

 

Statements in this prospectus that are not historical factual statements are “forward-looking statements.” Forward-looking statements include, among other things, statements regarding our intent, belief or expectations, and can be identified by the use of terminology such as “may,” “will,” “expect,” “believe,” “intend,” “plan,” “estimate,” “should,” “seek,” “anticipate” and other comparable terms or the negative thereof. In addition, we, through our senior management, from time to time make forward-looking oral and written public statements concerning our expected future operations and other developments. While forward-looking statements reflect our good-faith beliefs and best judgment based upon current information, they are not guarantees of future performance and are subject to known and unknown risks and uncertainties, including those mentioned in “Risk factors,” “Management’s discussion and analysis of financial condition and results of operations” and elsewhere in this prospectus. Actual results may differ materially from the expectations contained in the forward-looking statements as a result of various factors. Such factors include, without limitation:

 

 

 

23

 

We estimate that the net proceeds to us from the sale of the 5,000,000 shares of common stock offered hereby will be approximately $75.2 million after deducting underwriting discounts and commissions and estimated offering expenses payable by us. If the underwriters exercise their over-allotment option in full, we estimate that our net proceeds will be approximately $87.0 million.

 

We plan to use the net proceeds from this offering principally for acquisitions of product candidates, new products, intellectual property rights to products or companies that complement our business. We actively seek out acquisitions in the markets in which we have developed our sales forces—hospital acute care and gastroenterology. We concentrate our efforts on products that are in the late stages of development or that are currently marketed. We do not currently have a letter of intent or definitive purchase agreement for any potential target. We may undertake one large acquisition, utilizing substantially all of the net proceeds from this offering, or we may engage in one or more smaller acquisitions. It is also possible that we do not identify and complete any acquisitions. Our bank credit agreement requires that we obtain the consent of the bank prior to making acquisitions unless the acquisitions meet certain criteria. See “Management’s discussion and analysis of financial condition and results of operations — Liquidity and capital resources.”

 

Subject to the foregoing, we currently expect to use our net proceeds from this offering as follows:

 

 

The expected uses of net proceeds of this offering represent our current intentions based upon our present plans and business conditions. As of the date of this prospectus, we cannot specify with certainty all of the particular uses for the net proceeds to be received upon completion of this offering. Accordingly, our management will have broad discretion in the application of the net proceeds, and you will be relying on the judgment of our management regarding the application of the proceeds of this offering.

 

The amounts we actually expend for the above-specified purposes may vary depending on a number of factors, including the extent of our success in identifying and completing acquisitions, changes in our business strategy, the amount of our future revenues and expenses and our future cash flow. If our

 

 

24

 

Use of proceeds

 

 

future revenues or cash flow are less than we currently anticipate, we may need to support our ongoing business operations with net proceeds from this offering that we would otherwise use to support acquisitions and other methods of growth.

 

Until we use the net proceeds from this offering for the above purposes, we intend to invest the funds in short-term, investment-grade, interest-bearing securities as directed by our investment policy. Our goals with respect to the investment of these net proceeds are capital preservation and liquidity so that such funds are readily available.

 

We expect to use approximately $4.2 million of the net proceeds of this offering to repay our outstanding borrowings under a recently amended term loan agreement with Bank of America. Effective July 2009, we amended our debt agreement with Bank of America to provide for $18.0 million in term debt and a $4.0 million revolving credit facility.

 

We expect to draw down on our amended debt agreement with Bank of America in the third quarter of 2009 in connection with the Option Transaction as described in the section titled “Certain relationships and related party transactions”. We expect to use the proceeds from the term debt to pay in part the minimum statutory tax withholding requirements of approximately $24.6 million due upon completion of the Option Transaction. The consideration for that payment will be the transfer to us of 1,445,074 shares of our common stock. In connection with the Option Transaction, we expect to generate a deferred tax asset of approximately $25.5 million to offset future tax liabilities.

 

We have not declared or paid any cash dividends on our common stock and do not anticipate paying cash dividends on our common stock for the foreseeable future. We currently intend to retain any future earnings for use in the operation of our business and to fund future growth. The payment of dividends by us on our common or preferred stock is limited by our loan agreement with Bank of America. Any future decision to declare and pay dividends will be at the sole discretion of our board of directors.

 

 

25

 

The following table sets forth our capitalization as of March 31, 2009:

 

 

You should read the following table in conjunction with our consolidated financial statements and related notes and “Management’s discussion and analysis of financial condition and results of operations” appearing elsewhere in this prospectus.

 

 

 

 

26

 

Capitalization

 

 

 

 

 

 

 

27

 

Our net tangible book value as of March 31, 2009 was $10.7 million, or $1.02 per share. Net tangible book value per share represents the amount of our total tangible assets less total liabilities, divided by the total number of shares of common stock outstanding. Our pro forma net tangible book value per share as of March 31, 2009 was $0.89. Pro forma net tangible book value per share gives effect to the conversion of all of our preferred stock into 1,625,498 shares of our common stock, which will occur upon completion of this offering.

 

After giving further effect to the sale by us of 5,000,000 shares of common stock in this offering, and after taking into account the automatic conversion of our preferred stock upon completion of this offering, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value as of March 31, 2009 would have been approximately $85.9 million, or approximately $5.02 per share. This amount represents an immediate increase in pro forma net tangible book value of $4.13 per share to our existing shareholders and an immediate dilution in pro forma net tangible book value of approximately $11.98 per share to new investors purchasing shares of common stock in this offering. We determine dilution by subtracting the pro forma as adjusted net tangible book value per share after this offering from the amount of cash that a new investor paid for a share of common stock.

 

The following table illustrates this dilution on a per share basis:

 

 

In addition, the above discussion and table do not account for the vesting of 6,550 shares of restricted stock or the exercise of stock options and warrants after March 31, 2009. As of March 31, 2009, we had outstanding options to purchase a total of 7,207,247 shares of common stock at a weighted-average exercise price of $2.04 per share and outstanding warrants to purchase a total of 68,958 shares of common stock at a weighted-average exercise price of $6.17 per share. If all such options and warrants had been exercised and the restricted stock had vested as of March 31, 2009, pro forma as adjusted net tangible book value per share, exclusive of the expected future tax benefit (deferred tax asset) of approximately $33.5 million arising from the exercise of certain options, would have been $4.14 per share, and dilution to new investors would have been $12.86 per share. We have received notice that, upon the closing of this offering, in connection with the Option Transaction as described in the section “Certain relationships and related party transactions”, certain holders will exercise options to purchase 4,377,090 of these shares for which a holder will use a net-share settlement providing for him to use 1,445,074 shares acquired upon exercise to satisfy the minimum statutory withholding requirements of approximately $24.6 million.

 

 

28

 

Dilution

 

 

 

The following table summarizes, as of March 31, 2009, the differences between the number of shares purchased from us, the total consideration paid to us and the average price per share that existing shareholders and new investors paid. The table gives effect to the conversion of all of our outstanding preferred stock into 1,625,498 shares of common stock, which will occur upon completion of this offering.

 

 

Assuming that the 6,550 shares of restricted stock had vested, that all options and warrants outstanding as of March 31, 2009 had been exercised for 7,276,205 shares of common stock, and the aggregate exercise price of approximately $15.1 million had been applied to repurchase 889,907 shares of common stock (at a repurchase price equal to the public offering price listed on the cover of this prospectus), new investors would have purchased 21.3% of our shares of common stock outstanding after this offering.

 

The discussion and tables above assume no exercise of the underwriters’ over-allotment option. If the underwriters’ over-allotment option is exercised in full (but assuming no exercise of outstanding options or warrants or vesting of restricted stock), the number of shares of common stock held by existing shareholders would be reduced to 67.8% of the total number of shares of common stock to be outstanding after this offering, and the number of shares of common stock held by investors participating in this offering would be 32.2% of the total number of shares of common stock to be outstanding after this offering.

 

 

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The selected consolidated financial data set forth below should be read in conjunction with the consolidated financial statements and related notes and “Management’s discussion and analysis of financial condition and results of operation” and other financial information appearing elsewhere in this prospectus. The consolidated statement of income data for the years ended December 31, 2006, 2007 and 2008 and consolidated balance sheet data as of December 31, 2007 and 2008 are derived from consolidated financial statements audited by KPMG LLP and are included elsewhere in this prospectus. The consolidated statements of income data for the years ended December 31, 2004 and 2005 and the consolidated balance sheet data as of December 31, 2004, 2005 and 2006 have been derived from our audited consolidated financial statements that do not appear in this prospectus. The consolidated statements of income data for the three months ended March 31, 2008 and 2009 and the consolidated balance sheet data as of March 31, 2009 have been derived from our unaudited financial statements which are included elsewhere in this prospectus. Our unaudited consolidated financial statements include, in the opinion of management, all adjustments consisting of only normal recurring adjustments necessary for a fair presentation of these statements. The historical results are not necessarily indicative of the results to be expected for any future periods.

 

 

 

30

 

Selected consolidated financial data

 

 

 

 

 

 

 

31

 

The following discussion and analysis of our financial position and results of operations should be read together with our audited consolidated financial statements and related notes appearing elsewhere in this prospectus. This discussion and analysis may contain forward-looking statements that involve risks and uncertainties. You should review the “Risk factors” section of this prospectus for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements described in the following discussion and analysis.

 

OVERVIEW

 

We are a specialty pharmaceutical company focused on the acquisition, development and commercialization of branded, prescription products. We are building our product portfolio primarily by acquiring rights to FDA-approved and late-stage development products and marketing them to specialty physician segments. Our primary target markets are hospital acute care and gastroenterology. Our current portfolio consists of two products marketed in the United States and one product recently approved by the FDA.

 

We pursued the development of Acetadote for the treatment of acetaminophen poisoning and acquired rights to clinical data to support its approval. Approval of the product was obtained in January 2004 and we began to market Acetadote in the second quarter of 2004 and launched the product with a dedicated hospital sales force. In March 2006, we received approval from the FDA for the use of Acetadote in pediatric patients.

 

We gained access to marketed gastroenterology products by negotiating co-promotion agreements with the original developers of these products. These agreements allowed us to enter the gastroenterology market with minimal up-front costs and limited ongoing operating risk. In 2005, we made a strategic decision to de-emphasize our reliance on co-promotion agreements as a primary growth driver. In April 2006, we acquired exclusive commercial rights in the U.S. to Kristalose, a gastroenterology product we had previously co-promoted under an arrangement with Bertek Pharmaceuticals Inc., a subsidiary of Mylan Laboratories Inc. In September 2006, we re-launched Kristalose under the Cumberland brand with a dedicated field sales force targeting gastroenterologists and other high prescribers of laxative products.

 

Our research and development expenses have continued to grow because of our program to develop Caldolor. We completed the clinical program for Caldolor intended to support regulatory approval in 2008 and received that approval in June 2009. We expect research and development expenses to continue to be significant as we continue clinical work related to Caldolor and other products.

 

We have funded our operations with private equity capital of approximately $14 million since our inception in 1999. We have supplemented this equity funding by re-investing our profits and utilizing our credit facilities in order to support our operations.

 

Prior to 2007, our sales forces were contracted to us by a third party. In January 2007, we brought the hospital sales force in-house via our wholly-owned subsidiary, Cumberland Pharma Sales Corp. We continue to outsource the dedicated gastroenterology sales force. All expenses associated with the sales forces are included in selling and marketing expense.

 

In 2000, we formed CET with Vanderbilt University and Tennessee Technology Development Corporation to identify early-stage drug development activities. CET partners with universities and other research organizations to advance promising, early-stage product candidates through the development process and on to commercialization.

 

 

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Management’s discussion and analysis of financial condition and results of operations

 

 

Our operating results have fluctuated in the past and are likely to fluctuate in the future. These fluctuations can result from competitive factors, new product acquisitions or introductions, the nature, scope and results of our research and development programs, pursuit of our growth strategy and other factors. As a result of these fluctuations, our historical financial results are not necessarily indicative of future results.

 

We were incorporated in 1999 and have been headquartered in Nashville, Tennessee since inception.

 

CRITICAL ACCOUNTING POLICIES AND SIGNIFICANT JUDGMENTS AND ESTIMATES

 

Accounting Estimates and Judgments

 

The preparation of the consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. We base our estimates on past experience and on other factors we deem reasonable given the circumstances. Past results help form the basis of our judgments about the carrying value of assets and liabilities that are not determined from other sources. Actual results could differ from these estimates. These estimates, judgments and assumptions are most critical with respect to our accounting for revenue recognition, provision for income taxes, stock-based compensation, research and development accounting, and intangible assets.

 

As of March 31, 2009, we have capitalized $3.5 million of costs associated with our initial public offering in accordance with SEC Staff Accounting Bulletin Topic 5A. If events or circumstances were to change, we may be required to expense these costs in a future period.

 

Revenue Recognition

 

We recognize revenue in accordance with the SEC’s Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, as amended by Staff Accounting Bulletin No. 104 (together, SAB 101), and Statement of Financial Accounting Standards No. 48, Revenue Recognition When Right of Return Exists (SFAS 48).

 

Our revenue is derived primarily from the product sales of Acetadote and Kristalose. Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed and determinable and collectability is probable. Delivery is considered to have occurred upon either shipment of the product or arrival at its destination based on the shipping terms of the transaction. When these conditions are satisfied, we recognize gross product revenue, which is the price we charge generally to our wholesalers for a particular product.

 

Our net product revenue reflects the reduction of gross product revenue at the time of initial sales recognition for estimated accounts receivable allowances for chargebacks, discounts and damaged product as well as provisions for sales related accruals of rebates, product returns and administrative fees and fee for services. Our financial statements reflect accounts receivable allowances of $0.1 million, $0.1 million and $0.1 million as of December 31, 2007 and 2008 and March 31, 2009, respectively, for chargebacks, discounts and allowances for product damaged in shipment. We had accrued liabilities of $0.7 million, $1.0 million and $1.3 million as of December 31, 2007 and 2008 and March 31, 2009, respectively, for rebates, product returns, service fees, and administrative fees.

 

 

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The following table reflects our sales-related accrual activity:

 

 

The allowances for chargebacks, discounts, and damaged products and sales related accruals for rebates and product returns are determined on a product-by-product analysis and are established by management as our best estimate at the time of sale based on each product’s historical experience, adjusted to reflect known changes in the factors that impact such allowances and accruals. Additionally, these allowances and accruals are established based on the contractual terms with customers; analysis of historical levels of discounts, returns, chargebacks and rebates; communication with customers, and purchased information about the rate of prescriptions being written and the level of inventory remaining in the distribution channel, if known; as well as expectations about the market for each product, including any anticipated introduction of competitive products.

 

The allowances for chargebacks and accruals for rebates and product returns are the most significant estimates used in the recognition of our revenue from product sales. Of the accounts receivable allowances and our sales related accruals, our accrual for rebates and product returns represent the majority of the balance. Sales related accrued liabilities totaled $0.7 million, $1.0 million and $1.3 million as of December 31, 2007 and 2008 and March 31, 2009, respectively. Of these amounts, our estimated liability for rebates represented $0.3 million, $0.1 million and $0.2 million, respectively, while our accrual for product returns totaled $0.3 million, $0.6 million and $0.7 million, respectively. If the actual amount of cash discounts, chargebacks, rebates, and product returns differ from the amounts estimated by management, material differences may result from the amount of our revenue recognized from product sales. A change in our rebate estimate of one percentage point would have impacted net sales by approximately $96,000 and $102,000 for the years ended December 31, 2007 and 2008, respectively. A change in our product return estimate of one percentage point would have impacted net sales by $302,000 and $377,000 for the years ended December 31, 2007 and 2008, respectively. Our product returns for expired product are not tracked against specific periods. Any expired product return would be from a prior period, given the shelf-life of the products.

 

From January 2006 through part of April 2006, we recorded contract sales revenue which was based on co-promotion agreements primarily with Bertek Pharmaceuticals Inc., for the sales of Kristalose. Co-promotion fees were calculated based on a percent of gross sales or similar calculation. Contract sales revenue is included in net revenues.

 

 

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Management’s discussion and analysis of financial condition and results of operations

 

 

In 2005, we allowed customers to purchase additional product prior to a scheduled price increase. Revenue for shipments of these purchases was recognized in accordance with our stated revenue recognition policy. As a general rule, effective January 1, 2006, we no longer offer these or any other type of incentive purchases to our customers. We occasionally make an exception to this policy, when we offer odd-lot quantities at a slightly reduced price or when a customer opens a new facility and requests special terms on their initial purchase. To date, we believe these types of transactions have not been material. Moreover, when we offer special terms, we review the transaction against our revenue recognition policy for proper treatment. If we determine such transactions become material, we will disclose the impact in the notes to our financial statements.

 

While we do not have regular access to our customers’ inventory levels, we review each order from all of our customers. To the extent that an order reflects more than a normal purchasing pattern, management discusses the order with the customer prior to agreeing to process the order.

 

Other income, which is included in net revenues, includes rental and grant income. Other income was less than one percent of net revenues in 2008.

 

Income Taxes

 

We provide for deferred taxes using the asset and liability approach. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to operating loss and tax credit carry-forwards and differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Our principal differences are related to the timing of deductibility of certain items such as depreciation, amortization, and expense for options issued to nonemployees. Deferred tax assets and liabilities are measured using management’s estimate of tax rates expected to apply to taxable income in the years in which management believes those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

 

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. In order to fully utilize the deferred tax asset of $1.5 million as of December 31, 2008, we will need to generate future taxable income of approximately $7.2 million prior to the expiration of the net operating loss carry-forwards in 2023.

 

Stock-Based Compensation

 

We determine our share value on a contemporaneous basis when we issue shares of common stock and options to purchase shares of our common stock. Our board of directors establishes a share value of the common stock based on a recommendation by management and its assessment of several factors, including:

 

 

 

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Management’s discussion and analysis of financial condition and results of operations

 

 

 

In preparing its recommendation for our board, our management analyzes our revenue and expense projections, along with financial assumptions (including anticipation of future events). We have historically estimated a range for the value of our company as an enterprise, based on multiples of revenues, EBITDA, and earnings. We then adjust the range of enterprise values for cash and debt in order to determine the range of equity values of our company. We divide the equity values by the total number of common shares outstanding or subject to issuance upon the exercise or conversion of all outstanding options, warrants, and shares of preferred stock to establish the per share price range. In allocating equity value to preferred and common shares, we consider the features of common and preferred shares, recognizing that dividend and voting rights are the same for each and that the primary difference is a liquidation preference of $3.25 per share for preferred shares. After considering the range of values in December 2008, we determined that the equity value of our company was approximately $254 million. In the event of liquidation, aggregate preferential payments to holders of our preferred stock would be less than $2.7 million. We have evaluated the preference related to these potential payments and determined that its value is not material in relation to our company’s overall equity value or on a per share basis. In recommending a specific price within the range of values, management makes subjective judgments based upon its current assessment of our historical and projected performance, general market conditions, and similar subjective criteria that management deems appropriate. All valuation analyses are performed contemporaneously. Most recently in December 2008, Morgan Joseph & Co. Inc., acting in connection with its role as our financial advisor, assisted management in preparing its valuation analysis for board review.

 

Prior to January 1, 2006, we applied the intrinsic-value-based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations including FIN No. 44, Accounting for Certain Transactions Involving Stock Compensation — an interpretation of APB Opinion No. 25, to account for our stock options issued under the 1999 Stock Option Plan. Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, and SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure, an amendment of FASB Statement No. 123, established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based compensation plans. As permitted by then-existing accounting standards, we elected to continue to apply the intrinsic-value-based method of accounting described above, and adopted only the disclosure requirements of SFAS No. 123, as amended for options issued to employees. We applied the fair-value method prescribed by SFAS 123 for options issued to nonemployees.

 

Effective January 1, 2006, we adopted SFAS No. 123(R), Share-Based Payments, which revises SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS 123(R) requires that all share-based payment transactions with employees be recognized in the financial statements based on their fair value and recognized as compensation expense over the vesting period. We adopted SFAS 123(R) effective January 1, 2006, prospectively for new equity awards issued subsequent to December 31, 2005, or existing awards that were modified, repurchased, or cancelled subsequent to the adoption of SFAS 123(R).

 

The 1999 Stock Option Plan was superseded and replaced by the 2007 Long-Term Incentive Compensation Plan (the 2007 Plan) and 2007 Directors’ Incentive Plan (the Directors’ Plan). The terms

 

 

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Management’s discussion and analysis of financial condition and results of operations

 

 

of the awards granted under the 1999 Stock Option Plan were not impacted by the implementation of the new plans.

 

Information on employee and non-employee stock options granted in 2007, 2008 and 2009 is summarized as follows:

 

 

 

 

The fair value of employee options granted during 2007, 2008 and 2009 were estimated using the Black-Scholes option-pricing model and the following assumptions:

 

 

The fair value of non-employee options granted during 2007, 2008 and 2009, were estimated using the Black-Scholes option-pricing model and the following assumptions:

 

 

For employee stock option grants, the weighted-average expected option terms for 2007, 2008 and 2009 represent the application of the simplified method as defined in SEC Staff Accounting Bulletin (SAB) No. 107 issued in March 2005, as amended by SAB 110 issued in December 2007. The simplified method defines the expected life as the average of the contractual term of the option and the weighted-average vesting period for the option. For non-employee stock option grants, the expected option terms for 2007, 2008 and 2009 represent the contractual term.

 

We estimated volatility for 2007, 2008 and 2009 in accordance with SAB No. 107. As there has been no public market for our common stock prior to this offering, and therefore, a lack of company-specific historical or implied volatility data, we have determined the share-price volatility based on an analysis of certain publicly-traded companies that we consider to be our peers. The comparable peer companies used for our estimated volatility are publicly-traded companies with operations which we believe to be similar to ours. When identifying companies as peers, we consider such characteristics as the type of

 

 

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Management’s discussion and analysis of financial condition and results of operations

 

 

industry, size and/or type of product(s), research and/or product development capabilities, and stock-based transactions. We intend to continue to consistently estimate our volatility in this manner until sufficient historical information regarding the volatility of our own shares becomes available, or circumstances change such that the identified entities are no longer similar to us. In this latter case, we would utilize other similar entities whose share prices are publicly available.

 

As of March 31, 2009, we had approximately $1.6 million of unrecognized share-based compensation expense related to unvested option awards. Additionally, as of March 31, 2009, we had outstanding vested options to purchase 6,836,332 shares of our common stock and unvested options to purchase 370,915 shares of our common stock. Furthermore, as of March 31, 2009, we had 68,958 warrants outstanding to purchase shares of our common stock.

 

Research and Development

 

We account for research and development costs and accrue expenses based on estimates of work performed, patient enrollment, or fixed-fee-for-services. As work is performed and/or invoices are received, we adjust our estimates and accruals. To date, our accruals have been within our estimates.

 

Total research and development costs are a function of studies being conducted and will increase or decrease, depending on the level of activity in any particular year.

 

Intangible Assets

 

Intangible assets include license agreements, product rights, and other identifiable intangible assets. We assess the impairment of identifiable intangible assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. In determining the recoverability of our intangible assets, we must make assumptions regarding estimated future cash flows and other factors. If the estimated undiscounted future cash flows do not exceed the carrying value of the intangible assets, we must determine the fair value of the intangible assets. If the fair value of the intangible assets is less than the carrying value, an impairment loss will be recognized in an amount equal to the difference.

 

 

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Management’s discussion and analysis of financial condition and results of operations

 

 

RESULTS OF OPERATIONS

 

The following table sets forth, for the periods indicated, certain items from our statement of operations expressed as a percentage of net revenues, as well as the period-to-period change in these items.

 

 

 

 

Description of operating accounts

 

Net revenues consist of net product revenue, revenue from co-promotion agreements, and other revenue. Net product revenue consists primarily of gross revenue less discounts and allowances, such as cash discounts, rebates, chargebacks, and returns. Revenue from co-promotion agreements includes product promotion fees. Other income includes rental and grant income.

 

Cost of products sold consists principally of the cost to acquire each unit of product sold. Cost of products sold also includes expense associated with the write-off of slow moving or expired product.

 

Selling and marketing expense consists primarily of expense relating to the promotion, distribution and sale of products, including royalty expense, salaries and related costs.

 

Research and development expense consists primarily of clinical trial expenses, salary and wages and related costs of materials and supplies, and certain activities of third-party providers participating in our clinical studies.

 

General and administrative expense includes finance and accounting expenses, executive expenses, office expenses, and business development expenses, including salaries and related costs.

 

Amortization of product license rights resulted from our acquisition of the exclusive U.S. commercialization rights to Kristalose.

 

Interest income consists primarily of interest income earned on cash deposits.

 

 

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Interest expense consists primarily of interest incurred on debt and other long-term obligations.

 

Income tax benefit in 2006 consists primarily of the realization of our deferred tax assets less taxes incurred on income. Income tax expense in 2007 and 2008 consists primarily of current and deferred income taxes on our taxable income for financial reporting purposes.

 

Three months ended March 31, 2009 compared to the three months ended March 31, 2008

 

Net revenues.  Net revenues for the three months ended March 31, 2009 totaled approximately $9.4 million, representing an increase of approximately $1.1 million, or 13%, over the same period in 2008. The increase in net revenues is primarily due to increased sales of Acetadote as we continued to gain market share and expand our target markets. Net revenues related to Kristalose decreased $0.2 million during the first quarter of 2009 as compared to the same period in 2008. The decrease in volume was primarily due to lower orders from a wholesaler as they implemented a new inventory ordering system.

 

For the three months ended March 31, 2009, gross sales were reduced by approximately $1.0 million, of which approximately $0.2 million related to cash discounts, approximately $0.3 million related to damaged and expired product returns, approximately $0.3 million related to fee-for-services and approximately $0.2 million related to rebates. For the three months ended March 31, 2008, gross sales were reduced by approximately $0.6 million, of which approximately $0.2 million related to cash discounts and approximately $0.3 million related to damaged and expired product returns.

 

Cost of products sold.  Cost of products sold for the three months ended March 31, 2009 totaled approximately $0.7 million, representing a decrease of approximately $22,000, or 3%, over the same period in 2008. As a percentage of net revenues, cost of products sold decreased from 9.1% of net revenues for the three months ended March 31, 2008 to 7.8% of net revenues for the three months ended March 31, 2009. The decrease in cost of products sold, in dollars, is directly related to the strengthening of the U.S. dollar for inventory purchases during the three months ended March 31, 2009 as compared to the same period in 2008. The decrease in cost of products sold as a percentage of net revenues was primarily due to a change in the sales mix and the strengthening of the U.S. dollar.

 

Selling and marketing.  Selling and marketing expense for the three months ended March 31, 2009 totaled approximately $4.1 million, representing an increase of approximately $0.8 million, or 23%, over the same period in 2008. Of the increase, approximately $0.4 million related to the expansion of our sales forces and approximately $0.3 million related to new marketing campaigns for our products. We expect selling and marketing expense to increase in the second half of 2009 as we expand our sales force for the launch of Caldolor.

 

Research and development.  Research and development expense for the three months ended March 31, 2009 totaled approximately $0.8 million, representing a decrease of approximately $0.3 million, or 31%, over the same period in 2008. The decrease was primarily due to fewer clinical studies for our products in the first quarter of 2009 as compared to the same period in 2008.

 

General and administrative.  General and administrative expense for the three months ended March 31, 2009 totaled approximately $1.4 million, representing an increase of approximately $0.4 million, or 33%, over the same period in 2008. The increase is primarily due to increased payroll tax expense of $0.1 million, increased stock compensation expense of $0.1 million and increased legal and audit-related fees of $0.1 million.

 

Income tax expense.  Income tax expense for the three months ended March 31, 2009 totaled approximately $0.8 million, representing an increase of approximately $0.5 million, or 126%, over the same period in 2008. As a percentage of net income before income taxes, income tax expense increased

 

 

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Management’s discussion and analysis of financial condition and results of operations

 

 

from 20.8% for the three months ended March 31, 2008 to 40.8% for the three months ended March 31, 2009. The increase was primarily due to the recognition in the first quarter of 2008 of approximately $0.4 million of previously unrecognized tax benefits.

 

Year ended December 31, 2008 compared to year ended December 31, 2007

 

Net revenues.  Net revenues for 2008 totaled $35.1 million, representing an increase of $7.0 million, or 25%, over the same period in 2007. Of this increase, approximately $6.6 million related to Acetadote and $0.5 million related to Kristalose. Increases were partially offset by lower grant revenue in 2008. The increase in revenues for Acetadote and Kristalose was primarily due to increased volume as our products continued to grow in our target markets.

 

Gross product sales were reduced by $2.8 million and $2.4 million in 2008 and 2007, respectively. In 2008, this reduction included $1.1 million for damaged and expired product returns, $0.7 million for cash discounts, $0.7 million related to fee-for-service costs and $0.3 million for estimated rebates, chargebacks and discounts related to Kristalose. For 2007 this reduction included $1.1 million for damaged and expired product returns, $0.6 million for cash discounts, $0.4 million related to fee-for-service costs and $0.2 million for estimated rebates, chargebacks and discounts related to Kristalose.

 

Cost of products sold.  Cost of products sold totaled $3.0 million, representing an increase of $0.4 million, or 14%, over cost of products sold in 2007 of $2.7 million. Of this increase, approximately $0.3 million related to Acetadote and $0.1 million related to Kristalose. As a percentage of net revenues, cost of products sold decreased from 9.5% in 2007 to 8.7% for 2008. The decrease in cost of products sold, as a percentage of net revenues, was due to a shift in the sales mix between the periods.

 

Selling and marketing.  Selling and marketing expense for 2008 totaled $14.4 million, representing an increase of $4.3 million, or 43%, over 2007. Selling and marketing expense as a percentage of net revenue was 41.0% and 35.8% in 2008 and 2007, respectively. The increase was primarily due to $3.1 million for the expansion and ongoing costs of our sales forces as we continue to grow our products in our target markets and expand our territories. We also incurred an increase of $0.4 million in advertising expense primarily associated with a new marketing campaign for Kristalose and $0.4 million of additional royalty expense. We anticipate selling and marketing expenses to continue to increase as we expand both sales forces as well as our product lines.

 

Research and development.  Research and development expense for 2008 totaled $4.4 million, representing an increase of $0.7 million, or 20%, over 2007. The increase was primarily due to $1.2 million expended for the application fee associated with regulatory approval of one of our products, and was offset by a decrease in clinical studies and supplies expense as we completed development activity intended to support regulatory approval of that product.

 

General and administrative.  General and administrative expense for 2008 totaled $5.1 million, representing an increase of $1 million, or 24%, over general and administrative expenses in 2007 of $4.1 million. The increase was primarily due to increased rent expense as we acquired additional office space, increased business development expense as we evaluated potential acquisition candidates and agreements and increased salary and related expenses, including share-based compensation, due to personnel additions.

 

Interest income.  Interest income totaled $0.2 million for 2008, representing a decrease of $0.1 million, or 37%, over 2007. The decrease was primarily due to lower interest rates and lower cash balance requirements due to the repayment of our remaining product license right obligation in April 2008.

 

Interest expense.  Interest expense totaled $0.2 million for 2008, representing a decrease of $0.4 million, or 67%, over 2007. The decrease was primarily due to lower outstanding debt during

 

 

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2008 as compared to 2007. In April 2008, we amended our agreement to pay the remaining obligation related to the purchase of the product license right, resulting in lower interest expense in 2008 associated with this obligation.

 

Income tax expense.  Income tax expense for 2008 totaled $2.5 million, representing a decrease of $0.1 million, or 5%, over 2007. As a percentage of net income before income taxes, income tax expense decreased from 37.5% for 2007 to 34.8% for 2008. The decrease in the tax rate was primarily due to the recognition in 2008 of previously unrecognized tax benefits associated with the reversal of our FIN 48 reserve.

 

Year ended December 31, 2007 compared to year ended December 31, 2006

 

Net revenues.  Net revenues in 2007 totaled $28.1 million, representing an increase of $10.2 million, or 57.5%, over 2006. Of this increase, $8.1 million was attributable to increased sales of Acetadote, and $2.8 million was attributable to increased sales of Kristalose. These increases were partially offset by a $0.6 million decrease in co-promotion and other revenue. In April 2006, we entered into an agreement to acquire the exclusive U.S. commercial rights to Kristalose and began recording revenue based on shipments of the product. Prior to April 2006, we co-promoted Kristalose and recorded a co-promotion fee based on a percentage of the product’s sales. The increase in sales of Acetadote was primarily due to increased market share in our target area for the treatment of acetaminophen toxicity, a one-time sale to an international customer for $0.9 million and the impact of additional sales representatives. Other income in 2006 was primarily comprised of co-promotion fees related to Kristalose and grant related activity.

 

Gross product sales were reduced by $2.4 million and $2.1 million in 2007 and 2006, respectively. In 2007, this reduction included $1.1 million for damaged and expired product returns, $0.6 million for cash discounts, $0.4 million related to fee-for-service costs and $0.2 million for estimated rebates, chargebacks, and discounts related to Kristalose. For 2006, this reduction included $0.7 million related to damaged and expired product returns, $0.3 million related to cash discounts, $0.2 million related to fee-for-service costs and $1.0 million related to estimated rebates, chargebacks, and discounts related to Kristalose.

 

Cost of products sold.  Cost of products sold totaled approximately $2.7 million in 2007, representing an increase of approximately $0.3 million, or 11%, over cost of products sold in 2006 of approximately $2.4 million. Of the increase, approximately 52% related to Acetadote and 48% related to Kristalose. Cost of products sold as a percentage of net revenues decreased from 13.5% in 2006 to 9.5% in 2007. The decrease in the cost of products sold as a percentage of net revenue was due to the shift in the sales mix. Acetadote cost of products sold as a percentage of Acetadote net revenue was not materially different between 2007 and 2006.

 

Selling and marketing.  Selling and marketing expense totaled approximately $10.1 million in 2007, representing an increase of approximately $2.7 million, or 37%, over selling and marketing expense in 2006. Selling and marketing expense as a percentage of net revenue was 35.8% and 41.2% in 2007 and 2006, respectively. The dollar increase was primarily due to $2.0 million in additional costs related to the new sales force created to promote Kristalose. Additionally, we incurred approximately $0.7 million of increased royalty expense, of which $0.4 million related to Acetadote and $0.3 million related to Kristalose. We anticipate selling and marketing expense will grow as we expand both sales forces as well as our product lines.

 

Research and development.  Research and development expense for 2007 totaled approximately $3.7 million, representing an approximate $1.5 million, or 65%, increase over research and development expense in 2006 of approximately $2.2 million. The increase was primarily due to the increased clinical studies in 2007 as we worked towards completing the studies of Caldolor. We expect

 

 

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research and development expense in 2008 to remain consistent with 2007 expense, and expect to include the NDA filing fee for Caldolor.

 

General and administrative.  General and administrative expense totaled $4.1 million in 2007, representing a $1.1 million, or 38%, increase over general and administrative expense in 2006 of $3.0 million. General and administrative expense as a percentage of net revenue was 14.7% and 16.8% in 2007 and 2006, respectively. The dollar increase was primarily due to increased personnel expense of $0.5 million, increased stock compensation expense of $0.3 million, increased audit fees of $0.2 million, and increased rent of $0.1 million.

 

Amortization of product license rights.  Amortization of product licensing rights increased $0.2 million in 2007 as compared to 2006. The increase was due to recording twelve months of expense in 2007 compared to recording nine months in 2006 as the licensing rights were not acquired until April 2006. We expect to incur annual amortization expense relating to these product license rights through March 2021.

 

Interest income.  Interest income in 2007 totaled $0.4 million, representing a $0.2 million, or 84%, increase over interest income in 2006 of $0.2 million. The increase in interest income was due to larger cash equivalent balances in 2007 as compared to 2006.

 

Interest expense.  Interest expense totaled $0.6 million in 2007 as compared to $0.7 million in 2006. The decrease in interest expense in 2007 was due to lower outstanding term debt balances during 2007 as compared to 2006.

 

Income tax expense.  Income tax expense totaled $2.4 million in 2007 as compared to an income tax benefit of $2.7 million in 2006. The income tax expense in 2007 was primarily due to current and deferred income taxes on our taxable income for financial reporting purposes. In 2006, the income tax benefit was primarily due to the reversal of our deferred tax asset valuation allowance after determining that it was more likely than not that we would realize the benefits of the deferred tax asset.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Our primary sources of liquidity are cash flows provided by our operations and our borrowings. We believe that our internally generated cash flows and amounts available under our debt agreements will be adequate to service existing debt, finance internal growth and fund capital expenditures.

 

As of March 31, 2009, cash and cash equivalents was $10.1 million, working capital was $11.3 million and our current ratio (current assets to current liabilities) was 2.77 to 1. Management expects funds for our operating and capital requirements will be provided by continuing operations, existing cash balances, and availability under our credit facilities. As of March 31, 2009, we had an additional $5.7 million available to us on our line of credit. Upon completion of this offering, we expect to have substantial proceeds.

 

In connection with the Option Transaction as described in the section titled “Certain relationships and related party transactions”, effective July 2009, we amended our debt agreement with Bank of America to provide for $18.0 million in term debt and a $4.0 million revolving credit facility. We expect to use the proceeds from the term debt to pay in part the minimum statutory tax withholding requirements of approximately $24.6 million due from an option holder who has submitted notice that prior to or at the pricing of this offering, he is exercising options to purchase shares of our common stock. The consideration for that payment will be the transfer to us of 1,445,074 shares of our common stock of the option holder. In connection with the Option Transaction, we expect to generate a deferred tax asset of approximately $25.5 million to offset future tax liabilities. The aggregate exercise price of the options is approximately $2.4 million for which payment may be satisfied using cash or 140,788 shares

 

 

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(using the public offering price listed on the cover of this prospectus). The aggregate exercise price will be satisfied by the tendering of shares, resulting in no cash proceeds to us.

 

The following table summarizes our net changes in cash and cash equivalents for the years ended December 31, 2006, 2007 and 2008 and three months ended March 31, 2008 and 2009: