10-Q 1 e10-q.txt FORM 10-Q FOR QUARTERLY PERIOD ENDED JUNE 30, 2000 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. COMMISSION FILE NUMBER 0-23641 ALLERGAN SPECIALTY THERAPEUTICS, INC. A DELAWARE CORPORATION IRS EMPLOYER IDENTIFICATION 33-0779207 2525 DUPONT DRIVE, IRVINE, CALIFORNIA 92612 TELEPHONE NUMBER 714/246-4500 Indicate by a check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. (1) X yes no --- --- (2) X yes no --- --- Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date. As of August 4, 2000, there were 3,272,690 shares of callable Class A common stock outstanding, and 1,000 shares of Class B common stock outstanding. 2 ALLERGAN SPECIALTY THERAPEUTICS, INC. FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2000 INDEX Page ------ PART I - FINANCIAL INFORMATION ITEM 1 - FINANCIAL STATEMENTS Condensed Statements of Operations 3 Condensed Balance Sheets 4 Condensed Statements of Cash Flows 5 Notes to Condensed Financial Statements 6-8 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 9-10 ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 11 CERTAIN FACTORS AND TRENDS AFFECTING ALLERGAN SPECIALTY THERAPEUTICS, INC. AND ITS BUSINESSES 12-15 PART II - OTHER INFORMATION ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 16 ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K 16 Signature 17 Exhibits 2 3 PART I - FINANCIAL INFORMATION Allergan Specialty Therapeutics, Inc. (a development stage company) Condensed Statements of Operations (unaudited) (In thousands, except share data)

See accompanying notes to condensed financial statements. 3 4 Allergan Specialty Therapeutics, Inc. (a development stage company) Condensed Balance Sheets (unaudited) (In thousands, except share data)

See accompanying notes to condensed financial statements. 4 5 Allergan Specialty Therapeutics, Inc. (a development stage company) Condensed Statements of Cash Flows (unaudited) (In thousands)

See accompanying notes to condensed financial statements. 5 6 Allergan Specialty Therapeutics, Inc. Notes to Condensed Financial Statements 1. Basis of Presentation and Significant Accounting Policies Allergan Specialty Therapeutics, Inc. ("ASTI" or "the Company") was incorporated in Delaware on November 12, 1997 and commenced operations on March 10, 1998. ASTI was formed for the purpose of conducting research and development of potential human pharmaceutical products, and to commercialize such products, most likely through licensing to Allergan, Inc. (Allergan). The Company is subject to risks associated with development stage companies. All of the Company's efforts to date have been limited to obtaining capital and conducting research and development. The Company does not yet generate any revenues from product sales or royalties. Research and development is performed by Allergan and the costs incurred are reimbursed by ASTI. In the opinion of management, the accompanying unaudited financial statements contain all adjustments (consisting only of normal recurring accruals) necessary to present fairly the financial information contained therein. These statements do not include all disclosures required by generally accepted accounting principles. The results of operations for the six month period ended June 30, 2000 and for the period from inception to June 30, 2000 are not necessarily indicative of the results to be expected for the year ending December 31, 2000. Use of estimates The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Per share information Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share," (EPS) requires calculations for "basic earnings per share" including only actual weighted shares outstanding and "diluted earnings per share" including the effect of any common equivalent shares or other items that are dilutive. The Company has no common equivalent shares or other items that are dilutive. The reconciliations of the numerators and denominators of the basic and diluted loss per share computations for the six month periods ended June 30, 2000 and 1999 and for the period from inception to June 30, 1999 are as follows: 6 7 Allergan Specialty Therapeutics, Inc. Notes to Condensed Financial Statements 1. Basis of Presentation and Significant Accounting Policies (Continued)

2. Comprehensive Income (Loss) SFAS No. 130, "Reporting Comprehensive Income," established standards for reporting comprehensive income and its components. Other comprehensive income (loss) for the quarters and six months ended June 30, 2000 and 1999 were comprised of unrealized gains (losses) on investments. Other comprehensive income (loss) for the quarters and six month periods ended June 30, 2000 and 1999 and for the period from inception to June 30, 2000 are as follows:

7 8 Allergan Specialty Therapeutics, Inc. Notes to Condensed Financial Statements 2. Comprehensive Income (Loss) (Continued)

8 9 ALLERGAN SPECIALTY THERAPEUTICS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE QUARTER ENDED JUNE 30, 2000 This Quarterly Report on Form 10-Q may contain certain projections, estimates and other forward-looking statements that involve a number of risks and uncertainties. While this outlook represents management's current judgment on the future direction of the business, such risks and uncertainties could cause actual results to differ materially from any future performance suggested below. The Company undertakes no obligation to release publicly the results of any revisions to these forward-looking statements to reflect events or circumstances arising after the date hereof. The following should be read in conjunction with the section entitled "--Risks and Uncertainties" included in the Company's annual report on Form 10-K for the year ended December 31, 1999 and the Company's Financial Statements and notes thereto in Item 1 above. RESULTS OF OPERATIONS Net interest and investment income earned on investments were $861,000 and $1,942,000 for the quarters ended June 30, 2000 and 1999, respectively, and $1,841,000 and $4,092,000 for the six month periods ended June 30, 2000 and 1999, respectively. ASTI earned investment income of $17,094,000 for the period from inception through June 30, 2000. Interest and investment income were earned subsequent to March 10, 1998, the date Allergan contributed $200 million to ASTI. In the future, as ASTI's funds are used pursuant to the R&D Agreement and to pay the Technology Fee pursuant to the Technology Agreement, lower cash balances will be available for investment and therefore interest and investment income is expected to decrease. Research and development expenses were $14,066,000 and $11,957,000 for the quarters ended June 30, 2000 and 1999, respectively, and $30,006,000 and $22,646,000 for the six month periods ended June 30, 2000 and 1999, respectively. Research and development expenses were $115,092,000 for the period from inception through June 30, 2000. ASTI has paid technology fees of $825,000 and $1,675,000 to Allergan during the quarters ended June 30, 2000 and 1999, respectively, and $1,650,000 and $3,350,000 for the six month periods ended June 30, 2000 and 1999, respectively. ASTI has paid technology fees of $18,962,000 for the period from inception to June 30, 2000. Provision for taxes were $344,000 and $874,000 for the quarters ended June 30, 2000 and 1999, respectively and $796,000 and $1,475,000 for the six month periods ended June 30, 2000 and 1999, respectively. Provision for taxes for the period from inception through June 30, 2000 was $7,326,000. ASTI expects to have taxable income as a result of the requirement to capitalize technology fees and its election to capitalize research and development expenses for tax purposes. The results of operations of ASTI are expected to reflect primarily interest and investment income on the funds contributed by Allergan, and research and development expenses related to development of ASTI Products and the Technology Fee. ASTI's net loss for the quarters ended June 30, 2000 and 1999 were $15,099,000 or $4.61 per share and $12,191,000 or $3.72 per share, respectively. 9 10 Allergan Specialty Therapeutics, Inc. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE QUARTER ENDED JUNE 30, 2000 (Continued) RESULTS OF OPERATIONS (Continued) For the six month periods ended June 30, 2000 and 1999, ASTI's net losses were $32,262,000 or $9.85 per share and $22,990,000 or $7.02 per share, respectively. ASTI's net loss for the period from inception through June 30, 2000 was $121,876,000 or $37.23 per share. ASTI is expected to continue to record significant net losses in future periods, as expenses under its agreements with Allergan are expected to continue to exceed investment income. LIQUIDITY AND CAPITAL RESOURCES On March 9, 1998, Allergan contributed $200 million in cash to ASTI in exchange for all of the issued and outstanding shares of callable Class A Common Stock of ASTI. On March 10, 1998, Allergan distributed the Class A shares to holders of Allergan common stock and ASTI commenced operations. The funds contributed by Allergan, plus investment income earned thereon, will be used primarily to fund the research and development of ASTI Products and to conduct related activities. Funds not immediately required for research and development activities will be invested in investment grade securities. At June 30, 2000, ASTI had $74,013,000 in investments. The Company invests its excess cash in money market funds, equity securities and debt instruments of financial institutions and corporations with strong credit ratings. The Company has established guidelines with respect to diversification and maturities in order to maintain safety and liquidity of its investment portfolio. Additionally, ASTI classifies all investments as available-for-sale securities with net unrealized holding gains or losses as a component of other comprehensive income. ASTI liquidates investments to pay for operating expenses as needed. At the time of its formation, ASTI was projected to spend its funds over a five-year period. The Board of Directors of ASTI recently approved a research and development plan for the year ending December 31, 2000 which, if executed in its entirety, would represent an acceleration in spending on ASTI's research and development programs. This potential accelerated spending is the result of the acceptance by ASTI of more research and development projects as well as more rapid research and development of compounds than anticipated at the time of ASTI's formation. ASTI anticipates the acceleration of spending could result in the use of substantially all of the funds available for research and development remaining in ASTI in the first half of 2001. Pursuant to ASTI's Restated Certificate of Incorporation and Allergan's rights as the sole holder of all of the ASTI Class B Common Stock, Allergan has certain rights (but no obligation) to purchase all of the ASTI Class A Common Stock. Allergan's purchase rights, which expire if not exercised by the 90th day after the date on which Allergan receives notice that the amount of cash and marketable securities held by ASTI is less than $15 million, are summarized in ASTI's Prospectus dated March 6, 1998. 10 11 ALLERGAN SPECIALTY THERAPEUTICS, INC. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ASTI does not use derivative financial instruments in its non-trading investment portfolio. The Company's primary investment objective is preservation of capital in order to fund research and development of potential pharmaceutical products incurred pursuant to the Company's agreement with Allergan, Inc. As such, the Company invests its excess cash in investment grade securities consisting of money market funds, equity securities and debt instruments. Interest and investment income earned on the Company's investment portfolio is most sensitive to fluctuations in the general level of U.S. interest rates. The Company mitigates interest rate risk by a program of diversification so that exposure to risks relating to a single security or investment manager is minimal. Further, the Company invests in money market funds and debt instruments with varying maturity dates to correspond to anticipated research and development expenses. These securities typically bear minimal credit risk and ASTI has not experienced any losses on its investments to date due to credit risk. The Company's investments in equity securities, which are subject to price risk, are generally invested in companies that have a history of paying dividends. The Company addresses price risk by a program of diversification so that exposure to risks relating to a single security is minimal. 11 12 ALLERGAN SPECIALTY THERAPEUTICS, INC. CERTAIN FACTORS AND TRENDS AFFECTING ASTI AND ITS BUSINESSES The Company believes that certain statements made by the Company in this report and in other reports and statements released by the Company constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, such as comments which express the Company's opinions about trends and factors which may impact future operating results. Disclosures which use words such as the Company "believes," "anticipates," "expects" and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from expectations. Any such forward-looking statements, whether made in this report or elsewhere, should be considered in context with the various disclosures made by the Company in its press releases and publicly filed reports such as the Company's Annual Report on Form 10-K for the year ended December 31, 1999, which disclosures are incorporated herein by this reference. In addition to those risks identified elsewhere in this report on Form 10-Q and those risks described in the Company's press releases and publicly filed reports, the Company's business and results of operations are subject to other risks, including the following risk factors: o ASTI commenced operations in 1998 and is subject to the risks inherent in the establishment of a new business enterprise in the biotechnology industry. ASTI will incur substantial losses for several years due to the long-term nature of the research and development of pharmaceutical products through clinical testing and the regulatory process, which losses may never be recovered. o There can be no assurance that the ASTI Board of Directors will continue the funding of the research and development of all of the current ASTI Products or Pre-Selection Work, or that any ASTI Products can be successfully researched, developed and/or commercialized within the anticipated cost estimates or time frames, if at all. Certain of the ASTI Products are at critical stages of research and development, and technical and clinical outcomes are impossible to predict. Because of the long-range nature of any pharmaceutical product research and development plan, research and development of a particular product or project could accelerate, slow down or be discontinued, and other unforeseen events could occur, all of which would significantly affect the timing and amount of ASTI's expenditures on a particular product, or in total. As a result, estimates of costs and timing of research and development programs and for the use of Available Funds may not be accurate. o All ASTI Products, Developed Technology Products and Pre-Selection Products will require FDA clearance before such products may be lawfully marketed in the United States. Applications for FDA clearance must be based on costly and extensive clinical trials designed to demonstrate safety and efficacy. Clearance to market such products will also be required from corresponding regulatory authorities in foreign countries before such products may be marketed in those countries. There can be no assurance that the necessary regulatory clearances and approvals will be obtained in a timely fashion or, if obtained, that such clearances and approvals will not be revoked or withdrawn. 12 13 Allergan Specialty Therapeutics, Inc. CERTAIN FACTORS AND TRENDS AFFECTING ASTI AND ITS BUSINESSES (Continued) o Allergan has contributed $200 million in cash to ASTI. Allergan has no obligation to contribute additional funds to ASTI, and, to the best of ASTI's knowledge, has no present intention to do so. For the foreseeable future, ASTI's only ongoing source of revenue will be investment income and certain milestone payments. There can be no assurance that ASTI will have sufficient funds to complete the research and development of any or all of the ASTI Products. o Allergan is not obligated to exercise the License Option for any ASTI Product or to exercise the Purchase Option, and Allergan will exercise any such option only if it is in Allergan's best interest to do so. The timing of the exercise of the Purchase Option is within Allergan's sole discretion. The timing of the exercise of the License Option with respect to any Licensed Product is also within Allergan's sole discretion and thereafter research, development and funding of any such product will be controlled by Allergan. o ASTI Products, Developed Technology Products and Pre-Selection Products are likely to face competition from other therapies for the same indications. Competitors potentially include any of the world's pharmaceutical and biotechnology companies. A number of companies have developed and are developing competing technologies and products. o Patent protection generally has been important in the pharmaceutical industry. Therefore, ASTI's financial success may depend in part upon Allergan obtaining patent protection for the technologies incorporated in ASTI Products. Allergan will determine which patent applications to pursue, and the expense of obtaining and maintaining patents covering Developed Technology will be paid by ASTI during the term of the Research and Development Agreement. However, there can be no assurance that patents will be issued covering any products, or that any existing patents or patents issued in the future will be of commercial benefit. In addition, it is impossible to anticipate the breadth or degree of protection that any such patents will afford, and there can be no assurance that any such patents will not be successfully challenged in the future. If Allergan is unsuccessful in obtaining or preserving patent protection, or if any products rely on unpatented proprietary technology, there can be no assurance that others will not commercialize products substantially identical to such products. Patents have been issued to third parties covering various therapeutic agents, products and technologies. There can be no assurance that any ASTI Products, Developed Technology Products or Pre-Selection Products will not infringe patents held by third parties. In such event, licenses from such third parties would be required, or their patents would have to be designed around. There can be no assurance that such licenses would be available or that they would be available on commercially attractive terms, or that any necessary redesign could be successfully completed. 13 14 Allergan Specialty Therapeutics, Inc. CERTAIN FACTORS AND TRENDS AFFECTING ASTI AND ITS BUSINESSES (Continued) Allergan licenses certain intellectual property from third parties which it will sublicense to ASTI pursuant to the Technology License Agreement. Under the terms of certain of its license agreements, Allergan may be obligated to exercise diligence and make certain royalty and milestone payments as well as incur costs related to filing and prosecuting the underlying patents. Each agreement is terminable by either party upon notice if the other party defaults in its obligations. Should Allergan default under any of its agreements, Allergan and therefore ASTI may lose their rights to market and sell products based upon such licensed technology. In addition, there can be no assurance that Allergan's licensors will meet their obligations to Allergan pursuant to such licenses. In such event, ASTI's results of operations and business prospects would be materially and adversely affected. o Because Allergan may develop and/or market products (including Developed Technology Products and Pre-Selection Products) for its own account, independent of ASTI, that compete directly with ASTI Products, Allergan and ASTI may have conflicting interests with respect to certain products and/or certain markets. In addition, ASTI Products, Developed Technology Products and Pre-Selection Products may compete with one another. Allergan Technology excludes, and ASTI will have no rights with respect to, any topical formulation of Tazarotene. Allergan is currently marketing a topical formulation of Tazarotene for the treatment of psoriasis and acne in the United States and Canada under the brand name "Tazorac" and outside of the United States and Canada under the brand name "Zorac." o The terms of the Allergan/ASTI Agreements and ASTI's Restated Certificate of Incorporation were not determined on an arm's-length basis and certain terms may limit ASTI's activities and its market value. ASTI's Restated Certificate of Incorporation prohibits ASTI from taking or permitting any action that might impair Allergan's rights under the Purchase Option. Prior to the expiration of the Purchase Option, ASTI may not, without the consent of the holders of ASTI Class B Common Stock, merge or liquidate, or sell, lease, exchange, transfer or dispose of any substantial assets, or amend its Restated Certificate of Incorporation to alter the Purchase Option, ASTI's authorized capitalization, or the provisions of the Restated Certificate of Incorporation governing ASTI's Board of Directors. Because Allergan owns all of the outstanding Class B Common Stock, Allergan is able to influence significantly or control the outcome of any of the foregoing actions requiring approval by the Class B stockholders of ASTI. The ability of Allergan to significantly influence or control such matters, together with the provisions of ASTI's Restated Certificate of Incorporation eliminating the right of the ASTI stockholders to call special meetings of stockholders, could affect the liquidity of the ASTI Shares and have an adverse effect on the price of the ASTI Shares, and may have the effect of delaying or preventing a change in control of ASTI, including transactions in which stockholders might otherwise receive a premium for their shares over the current market price. Neither the terms of the ASTI/Allergan Agreements nor ASTI's Restated 14 15 Allergan Specialty Therapeutics, Inc. CERTAIN FACTORS AND TRENDS AFFECTING ASTI AND ITS BUSINESSES (Continued) Certificate of Incorporation prohibit Allergan from transferring its ASTI Class B Common Stock. The special rights accorded to the holder or holders of the ASTI Class B Common Stock will expire upon expiration of the Purchase Option. So long as the Purchase Option is exercisable, the market value of the ASTI Shares will be limited by the Purchase Option exercise price. The Purchase Option exercise price was not determined on an arm's-length basis. The Purchase Option exercise price was determined by Allergan, giving consideration to the structure of the Distribution, ASTI's planned business, the Allergan/ASTI Agreements, advice given by Merrill Lynch, Pierce, Fenner & Smith Incorporated, and such other factors as Allergan deemed appropriate. The existence of the Purchase Option and Allergan's rights as holder of the ASTI Class B Common Stock may inhibit ASTI's ability to raise capital. Additional capital raised by ASTI, if any, would most likely reduce the per share proceeds available to holders of ASTI Shares if the Purchase Option were exercised. The existence of the Purchase Option and Allergan's rights as the holder of the ASTI Class B Common Stock may inhibit a change of control and may make an investment in ASTI Shares less attractive to certain potential stockholders, which could adversely affect the liquidity and market value of ASTI Shares. If Allergan exercises its License Option for any ASTI Product, Allergan will have the right to commercialize the product with third parties on such terms as Allergan deems appropriate. In such event, payments from Allergan to ASTI with respect to the ASTI Products will be based solely on sublicensing revenues received from such third parties. o Each of the current executive officers of ASTI is employed by or retained as a consultant to Allergan and receives compensation solely from Allergan, which may further contribute to Allergan's ability to influence significantly or control the outcome of actions taken by ASTI. o ASTI has granted Allergan the License Option, which is exercisable on a product-by-product and country-by-country basis. During the term of the License Option for each ASTI Product, ASTI will not be able to license such ASTI Product to any party other than Allergan. Furthermore, ASTI may perform research with respect to product candidates which become ASTI Products only if recommended by Allergan and accepted by ASTI. In particular, Allergan performs Pre-Selection Work with respect to various product candidates. If such product candidates do not become ASTI Products, ASTI will have no rights with respect thereto except the right to receive limited royalties from Allergan on commercial sales of such products, if any. 15 16 Allergan Specialty Therapeutics, Inc. PART II - OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders The annual meeting of stockholders of the registrant was held on April 28, 2000. At such meeting, five directors, constituting the entire Board of Directors, were re-elected to serve on the Board of Directors until the next annual meeting of stockholders. The names of the persons elected as directors are: William C. Shepherd Lester J. Kaplan, Ph.D. Alan J. Lewis, Ph.D. Gary L. Neil, Ph.D. Marvin E. Rosenthale, Ph.D. The only other matter considered by the stockholders at the annual meeting was ratification of the selection of KPMG LLP as independent auditors of the registrant for the fiscal year ended December 31, 2000. The holders of the Class B Common Stock, voting as a class, were entitled to elect one director, and the holders of the Class A Common Stock, voting as a class, were entitled to elect four directors. The holders of both Class A and Class B Common Stock voted together as a single class on all other matters. In the election of directors, Lester J. Kaplan, Ph.D. received 1,000 votes of the Class B Common Stock, representing 100% of the issued and outstanding shares of such class. The holders of the Class A Common Stock voted as follows: Broker Election of Directors For Withheld Non-Votes --------------------- --- -------- --------- William C. Shepherd 2,721,175 3,437 0 Alan J. Lewis, Ph.D. 2,720,137 4,475 0 Gary L. Neil, Ph.D. 2,721,285 3,327 0 Marvin E. Rosenthale, Ph.D. 2,720,112 4,500 0 With respect to the ratification of KPMG LLP as independent auditors for the year ending December 31, 2000, the Class A and Class B shares voted together as a single class, as follows: Broker For Against Abstain Non-Votes --- ------- ------- --------- 2,723,456 668 1,488 0 Item 6. Exhibits and Reports on Form 8-K - Exhibits (numbered in accordance with Item 601 of Regulation S-K) 27.1 -- Financial Data Schedule - Reports on Form 8-K. None. 16 17 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: August 11, 2000 ALLERGAN SPECIALTY THERAPEUTICS, INC. /s/ James M. Hindman ------------------------------------- James M. Hindman Chief Financial Officer and Duly Authorized Officer 17 18 EXHIBIT INDEX EXHIBIT NUMBER DESCRIPTION ------- ----------- 27.1 Financial Data Schedule

ALLERGAN SPECIALTY THERAPEUTICS INC 10-Q