CUMBERLAND PHARMACEUTICALS INC annual report, FY2011

Cumberland Pharmaceuticals Inc. — FY2011 Form 10-K Summary

Business context and reporting period

Cumberland is a specialty pharmaceutical company focused on acquiring, developing and commercializing branded prescription products for hospital acute care and gastroenterology markets. Its marketed products were Acetadote, Caldolor and Kristalose; Hepatoren (ifetroban) was in Phase II development. This filing covers the fiscal year ended December 31, 2011, with quarterly information available for the fourth quarter.

Financial performance and key metrics

Metric	FY2011	FY2010	Change
Net revenues	$51.1 million	$45.9 million	+11.5%
Net product revenue	$50.9 million	$44.7 million	+14%
Operating income	$9.8 million	$6.5 million	+51.5%
Net income attributable to common shareholders	$5.7 million	$2.5 million	+130%
Basic and diluted EPS	$0.28	$0.12	+133%
Cash flow from operations	$8.7 million	$0.3 million	Improved substantially

Approximate operating margin was 19.3%, versus 14.2% in 2010; approximate net margin was 11.1%, versus 5.4%.
Acetadote net revenue increased to $42.5 million from $35.1 million, driven by approximately 13% volume growth, higher average selling price, market acceptance of the new formulation and a shortage of oral N-acetylcysteine.
Kristalose net revenue declined to $8.5 million from $9.5 million, primarily because of lower volume and manufacturing delays.
Caldolor generated negative net product revenue of approximately $0.1 million in 2011, compared with $0.1 million in 2010, after reserves for potential returns of the discontinued 400mg offering. Gross Caldolor revenue increased modestly.
Cost of products sold was $5.4 million, or 10.5% of net revenue, including approximately $2.0 million of inventory write-downs. Excluding the write-down, management stated that the ratio would have been approximately 6.6%.
Selling and marketing expense decreased 8% to $20.9 million; research and development expense increased 16% to $5.0 million; general and administrative expense increased 15% to $9.2 million.
Interest expense declined 75% to $0.4 million following repayment of term debt and amendment of the revolving credit facility. The effective income tax rate was 42%, compared with 54% in 2010.

Liquidity, debt and capital resources

Cash and cash equivalents were $70.6 million at December 31, 2011, compared with $65.9 million at December 31, 2010.
Working capital was $80.7 million and the current ratio was 13.2x, compared with $71.8 million and 8.8x, respectively, in 2010.
Operating cash flow of $8.7 million more than offset $0.4 million of investing outflows and $3.6 million of financing outflows, producing a $4.7 million increase in cash.
The company repaid its approximately $5.3 million term debt balance in 2011. At year-end, $4.9 million was outstanding under a revolving line of credit with up to approximately $5.1 million of additional availability.
The amended credit facility provides up to $10 million of availability, with an option to increase it to $20 million subject to conditions. It expires December 31, 2014, bears interest at LIBOR plus an applicable margin, and was priced at 2.29% at year-end.
Total long-term debt and other long-term obligations, including current portions, were $5.5 million at year-end, compared with $7.8 million in 2010.
The company repurchased approximately $4.2 million of common shares during 2011 and does not expect to pay cash dividends in the foreseeable future.

Material changes, outlook and unusual items

The FDA approved and Cumberland launched a preservative-free, next-generation Acetadote formulation in early 2011. The company received a U.S. patent notice of allowance in February 2012; upon issuance, the patent is expected to expire in August 2025.
The company acquired additional Kristalose assets from Mylan, including the trademark and FDA registration, and entered into a long-term packaging and supply arrangement. The transaction is intended to improve supply-chain control but creates royalty-like payments based on future Kristalose sales through November 2018.
Caldolor strategy shifted toward increasing utilization at hospitals that already stock the product. The 400mg vial was phased out in late 2011, with emphasis placed on the 800mg vial.
Four Caldolor studies were underway, including two pediatric studies and two adult registry studies. Hepatoren entered a Phase II dose-escalation study for hepatorenal syndrome. Management expected research and development costs to increase in 2012 as these studies progress.
The FDA issued a Complete Response Letter in December 2010 regarding the proposed Acetadote indication for non-acetaminophen acute liver failure. Cumberland remained in discussions with the FDA, but approval was not assured.
The company reported a $2.0 million inventory write-down, primarily related to potentially obsolete Caldolor inventory. Caldolor inventory had expiration dates extending through January 2015.
2011 other revenue declined because the $0.9 million federal Therapeutic Discovery Project grant recognized in 2010 was not available in 2011.
Management stated that internally generated cash flow and available credit were expected to fund existing debt service, internal growth and capital expenditures. The filing provides no formal revenue or earnings guidance.

Principal risks and contingencies

Revenue is concentrated among three wholesale customers, which represented 36%, 28% and 31% of 2011 revenue; these customers accounted for 95% of accounts receivable at year-end.
The company relies on third-party manufacturers and distributors. Kristalose depends on a single Italian active pharmaceutical ingredient supplier, while manufacturing disruptions, regulatory deficiencies or supply shortages could impair sales.
Future results depend heavily on Acetadote demand, Caldolor hospital formulary adoption and utilization, Kristalose supply stability, and successful development and approval of Hepatoren.
Acetadote sales benefited from a shortage of oral N-acetylcysteine, but management could not quantify the shortage’s contribution or predict the effect when supply normalizes.
Potential risks include product liability, recalls, adverse regulatory decisions, reimbursement and pricing pressure, generic competition, patent limitations, inventory obsolescence and impairment of acquired intangible assets.
The revolving credit facility is secured by substantially all assets and includes leverage, interest coverage and other restrictive covenants. The company was in compliance at December 31, 2011.
Total contractual obligations were reported at $12.1 million, including $4.9 million of line-of-credit borrowings, $4.4 million of operating leases and $2.6 million of purchase obligations; Kristalose sales-based payments were excluded because they could not be determined in advance.
No legal proceedings or off-balance-sheet arrangements were reported. KPMG issued unqualified opinions on the consolidated financial statements and internal control over financial reporting.

Investor verification checklist

Verify whether the Acetadote patent was ultimately issued and assess the durability of Acetadote revenue after the oral N-acetylcysteine shortage ends.
Track Caldolor gross sales, hospital formulary additions, pull-through utilization, inventory levels and the financial effect of discontinuing the 400mg vial.
Evaluate Kristalose manufacturing reliability, the Mylan packaging arrangement and the sales-based consideration payable through 2018.
Review the progress, cost and regulatory outcomes of the Caldolor pediatric studies, adult registry studies and Hepatoren Phase II program.
Monitor customer concentration, product-return and rebate accruals, and the risk of additional inventory write-downs.
Confirm outstanding revolver balances, covenant compliance, maturity terms and the company’s stated liquidity expectations for 2012.