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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-Q
 
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 
For the Quarterly Period Ended March 31, 2005
 
Commission File No. 000-24972
 
INKINE PHARMACEUTICAL COMPANY, INC.
(Exact name of Registrant as specified in its charter)
 
New York
 
13-3754005
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
1787 Sentry Parkway West
Building 18, Suite 440
Blue Bell, PA 19422
(Address of principal executive offices)
 
215-283-6850
(Registrant’s telephone number)
 
          Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes      No   
 
          Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).  Yes      No   
 
          At May 5, 2005, the registrant had outstanding 49,111,055 shares of common stock, par value $.0001 per share.
 
 
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INKINE PHARMACEUTICAL COMPANY, INC.
 
INDEX
 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2
Back to Index
 
PART I -- FINANCIAL INFORMATION
 
Item 1.  Financial Statements
 
INKINE PHARMACEUTICAL COMPANY, INC.
 
BALANCE SHEETS
 
(in thousands, except share and per share amounts)
 
 
 
March 31, 2005
 
December 31, 2004
 
 
 
 
 
 
 
(unaudited)
 
 
 
 
ASSETS
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
6,369
 
$
7,859
 
Short term investments
 
 
4,193
 
 
5,194
 
Accounts receivable
 
 
4,196
 
 
2,264
 
Inventory
 
 
1,905
 
 
1,445
 
Prepaid expenses and other current assets
 
 
589
 
 
255
 
 
 
 
 
Total current assets
 
 
17,252
 
 
17,017
 
               
Fixed assets
 
 
296
 
 
311
 
Deposits
 
 
26
 
 
56
 
 
 
 
 
Total assets
 
$
17,574
 
$
17,384
 
 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
Accounts payable
 
$
1,274
 
$
1,766
 
Accrued expenses
 
 
1,502
 
 
1,250
 
 
 
 
 
Total current liabilities
 
 
2,776
 
 
3,016
 
               
Shareholders’ equity:
 
 
 
 
 
 
 
Preferred stock, $0.0001 par value; authorized 5,000,000 shares; none issued and outstanding
 
 
—
 
 
—
 
Common stock, $0.0001 par value; authorized 75,000,000shares; issued 49,124,882 and 49,098,882 shares, respectively
 
 
5
 
 
5
 
Less common stock held in treasury (16,515 shares)
 
 
(37
)
 
(37
)
Additional paid-in capital
 
 
83,956
 
 
83,899
 
Deferred compensation
 
 
(615
)
 
(673
)
Unrealized loss on investments
 
 
(5
)
 
(6
)
Accumulated deficit
 
 
(68,506
)
 
(68,820
)
 
 
 
 
Total shareholders’ equity
 
 
14,798
 
 
14,368
 
 
 
 
 
Total liabilities and shareholders’ equity
 
$
17,574
 
$
17,384
 
 
 
 
 
 
See accompanying notes to unaudited financial statements.
 
3
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INKINE PHARMACEUTICAL COMPANY, INC.
 
STATEMENTS OF OPERATIONS
(unaudited)
 
(in thousands, except per share amounts)
 
 
 
Three-Months Ended March 31,
 
 
 
 
 
 
2005
 
2004
 
 
 
 
 
Product revenue
 
$
5,218
 
$
4,350
 
Other revenue
 
 
818
 
 
283
 
 
 
 
 
Revenue
 
 
6,036
 
 
4,633
 
               
Cost of goods sold
 
 
(848
)
 
(491
)
 
 
 
 
Gross profit
 
 
5,188
 
 
4,142
 
               
Cost and expenses:
 
 
 
 
 
 
 
Research and development
 
 
1,769
 
 
922
 
Sales and marketing
 
 
2,288
 
 
1,949
 
General and administrative
 
 
877
 
 
785
 
Withdrawn public offering and litigation
 
 
—
 
 
567
 
 
 
 
 
Operating expenses
 
 
4,934
 
 
4,223
 
 
 
 
 
Income (loss) from operations
 
 
254
 
 
(81
)
               
Interest income
 
 
60
 
 
10
 
Interest expense
 
 
—
 
 
(7
)
 
 
 
 
Net income (loss)
 
$
314
 
$
(78
)
 
 
 
 
Earnings per share - Basic and diluted
 
$
0.01
 
$
0.00
 
 
 
 
 
Weighted average shares outstanding:
 
 
 
 
 
 
 
Basic
 
 
49,095
 
 
48,547
 
Diluted
 
 
53,459
 
 
48,547
 
 
See accompanying notes to unaudited financial statements.
 
4
Back to Index
 
INKINE PHARMACEUTICAL COMPANY, INC.
 
STATEMENTS OF CASH FLOWS
(unaudited)
 
(in thousands)
 
 
 
Three-Months Ended March 31,
 
 
 
 
 
 
2005
 
2004
 
 
 
 
 
Operating activities:
 
 
 
 
 
 
 
Net income (loss)
 
$
314
 
$
(78
)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
 
 
 
 
 
 
 
Depreciation
 
 
31
 
 
33
 
Amortization of deferred compensation
 
 
58
 
 
8
 
Changes in operating assets and liabilities:
 
 
 
 
 
 
 
(Increase) in accounts receivable
 
 
(1,932
)
 
(1,358
)
(Increase) in inventory
 
 
(460
)
 
(700
)
(Increase) decrease in prepaid expenses and other assets
 
 
(304
)
 
188
 
Increase (decrease) in accounts payable and accrued expenses
 
 
(240
)
 
833
 
 
 
 
 
Net cash used in operating activities
 
 
(2,533
)
 
(1,074
)
               
Investing activities:
 
 
 
 
 
 
 
Purchase of short-term investments
 
 
(1,999
)
 
—  
 
Proceeds from maturities and sale of investments
 
 
3,000
 
 
—  
 
Capital expenditures
 
 
(16
)
 
(302
)
 
 
 
 
Net cash provided by (used in) investing activities
 
 
985
 
 
(302
)
               
Financing activities:
 
 
 
 
 
 
 
Proceeds from exercise of options and warrants - net of expenses
 
 
58
 
 
178
 
Repayments, net of borrowings on line of credit
 
 
—
 
 
1,000
 
 
 
 
 
Net cash provided by financing activities
 
 
58
 
 
1,178
 
               
Net decrease in cash and cash equivalents
 
 
(1,490
)
 
(198
)
               
Cash and cash equivalents - beginning of period
 
 
7,859
 
 
10,442
 
 
 
 
 
Cash and cash equivalents - end of period
 
$
6,369
 
$
10,244
 
 
 
 
 
 
See accompanying notes to unaudited financial statements.
 
5
 
INKINE PHARMACEUTICAL COMPANY, INC.
 
NOTES TO FINANCIAL STATEMENTS
(unaudited)
 
          In this Quarterly Report, “InKine,” “we,” “us” and “our” refer to InKine Pharmaceutical Company, Inc. and “Common Stock” refers to InKine’s common stock, par value $0.0001 per share.
 
1.   Organization and Business Activities
 
          We are a specialty pharmaceutical company focused on acquiring, developing and commercializing pharmaceutical products for use to diagnose and treat gastrointestinal disorders.  Our development strategy has been to acquire late-stage drug candidates with short expected time lines to commercialization. We currently market and sell two pharmaceutical products, Visicol® and IB-Stat®. We are also studying Visicol® for the treatment of constipation.  In addition to our marketed products, we are studying INKP-102 as a new generation purgative product.
 
2.   Basis of Presentation
 
          The accompanying financial statements are unaudited and have been prepared by us in accordance with accounting principles generally accepted in the United States of America.
 
          Certain information and footnote disclosures normally included in our audited annual financial statements have been condensed or omitted in our interim financial statements.  We believe that the interim financial statements reflect all adjustments (consisting of normal recurring adjustments) necessary for a fair representation of the results for the interim periods presented.
 
          The results of operations for the interim periods may not necessarily be indicative of the results of operations expected for the full year.  These interim financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2004, which are contained in our most recent Annual Report on Form 10-K.
 
3.   Use of Estimates
 
          The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date(s) of the financial statements and the reported amounts of revenues and expenses during the reporting period(s).  Actual results could differ from those estimates.
 
4.   Allowance for Sales Returns
 
          We maintain an allowance for potential future sales returns.  This allowance is evaluated on a quarterly basis based on product characteristics, wholesaler stocking patterns and prescription trends.  At March 31, 2005, we had a sales returns allowance of $81,000 that was included in accrued expenses on the balance sheet.  The following is an analysis of the sales returns allowance for the three-month period ended March 31, 2005:
 
Allowance at December 31, 2004
 
$
66,000
 
Provision for estimated sales returns
 
 
124,000
 
Actual sales returns
 
 
(109,000
)
 
 
 
Allowance at March 31, 2005
 
$
81,000
 
 
 
 
 
6
 
5.   Deferred Revenue
 
          For IB-Stat®, we recognize revenue based on prescription data.  This practice will continue until such time as data becomes available that indicates that the product has achieved adequate market acceptance and that future product returns can be reasonably estimated.  As a result, we have recorded deferred revenue of $102,000 that was included in accrued expenses on the balance sheet as of March 31, 2005. 
 
6.   Line of Credit
 
          We have a $5,000,000 line of credit with a financial institution.  Under the terms of this arrangement, we make monthly interest-only payments at a variable per annum rate of 2.20%, plus the 30-day Dealer Commercial Paper Rate, with principal due on January 31, 2006.  As collateral, we maintain cash and investments of $3,000,000 with the balance of the amount outstanding on the line of credit not to exceed 80% of our less than 90-day accounts receivable balance.  There was no outstanding balance on this line of credit at March 31, 2005.
 
7.   Withdrawn Public Offering and Preemptive Rights Class Action Litigation
 
          On March 15, 2004, we withdrew a public offering of six million shares of our common stock.  The decision to withdraw the offering was made when it came to our attention that our certificate of incorporation did not contain any provision exempting us from providing preemptive rights in connection with certain securities offerings.  On March 19, 2004, a purported class action lawsuit, naming us as the defendant, was filed in the Court of Common Pleas, Philadelphia County, on behalf of a putative class of holders of InKine equity shares who allege that they were denied certain claimed preemptive rights during the last six years.  As of March 31, 2005, we have incurred $341,000 in expenses related to the withdrawn offering and $590,000 in legal costs related to preemptive rights and the related lawsuit. To date, we have received a $500,000 payment from a third-party as reimbursement for a portion of these costs.  On October 12, 2004, we entered into an agreement with an undisclosed third-party who will fund our settlement of damages and costs incurred in connection with the class action lawsuit.  We have also entered into, and filed with the Court of Common Pleas, Philadelphia County, a settlement agreement with the class of InKine shareholders.  We do not anticipate that we or our insurance carriers will bear any costs in connection with the settlement arrangement.  Our settlement and the agreement with the undisclosed third-party is subject to a number of conditions, including final court approval.  At this time, there can be no assurance that those conditions will be met and that the settlement will receive final court approval.  Accordingly, we have recognized a $200,000 charge for the year ended December 31, 2004 for unreimbursed legal costs incurred up to our insurance deductible.
 
8.   Stock-Based Compensation
 
          We apply the intrinsic method of accounting for all stock-based employee compensation in accordance with APB No. 25, “Accounting for Stock Issued to Employees,” and related interpretations.  We record deferred compensation for option grants to employees for the amount, if any, by which the market price per share on the grant date exceeds the exercise price per share.  We generally grant our stock options with exercise prices equal to fair market value on the grant date.
 
          We have elected to adopt the disclosure only provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS No. 123), as amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” (SFAS No. 148).  The following table illustrates the effect on our net income (loss) and basic and diluted income (loss) per share if we had recorded compensation expense for the estimated fair value of our stock-based employee compensation, consistent with SFAS No. 123:
 
 
 
Three-Months Ended
 
 
 
 
 
 
March 31, 2005
 
March 31, 2004
 
 
 
 
 
Net income (loss) – as reported
 
$
314
 
$
(78
)
Deduct: Total stock-based employee compensation
 
 
(393
)
 
(482
)
 
 
 
 
Net loss – pro forma
 
$
(79
)
$
(560
)
 
 
 
 
Earnings (loss) per share:
 
 
 
 
 
 
 
Basic and diluted – as reported
 
$
0.01
 
$
0.00
 
 
 
 
 
Basic and diluted – pro forma
 
$
0.00
 
$
(0.01
)
 
 
 
 
 
7
 
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
          You should read the following discussion in conjunction with “Certain Risks Related to Our Business” and our unaudited condensed financial statements included elsewhere in this report. Some of the statements in the following discussion are forward-looking statements. See “Special Note Regarding Forward-Looking Statements.”
 
Special Note Regarding Forward-Looking Statements
 
          This report contains forward-looking statements within the meaning of Section 27A of the Securities Act, Section 21E of the Securities Exchange Act of 1934, as amended and the Private Securities Litigation Reform Act of 1995 that are subject to risks and uncertainties. You should not place undue reliance on those statements because they are subject to numerous uncertainties and factors relating to our operations and business environment, all of which are difficult to predict and many of which are beyond our control. Forward-looking statements included in this report relate to our beliefs regarding litigation exposure, our settlement and our agreement with the undisclosed third-party, our ability to market INKP-102 in the United States, our strategy with respect to in-licensing or acquiring additional pharmaceutical products or businesses, the timing and types of clinical trials we will need to conduct for our products and product candidates, our reimbursement strategy, our expectation for gross profits for Visicol for 2005, the adequacy of our financial resources, our capital expenditures for 2005, our product development expenses, our investment portfolio, market risk exposure and other statements regarding matters that are not historical facts.  These statements often include words such as “may,” “believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate” or similar expressions. These statements are based on assumptions that we have made in light of our industry experience as well as our perceptions of historical trends, current conditions, expected future developments and other factors we believe are appropriate under the circumstances. As you read and consider this report, you should understand that these statements are not guarantees of performance or results. They involve risks, uncertainties and assumptions. Although we believe that these forward-looking statements are based on reasonable assumptions, you should be aware that many factors could affect our actual financial results or results of operations and could cause actual results to differ materially from those in the forward-looking statements. These factors include but are not limited to:
 
 
•
our limited history of profitability;
 
 
 
 
•
our dependence on Visicol;
 
 
 
 
•
our ability to manage rapid growth;
 
 
 
 
•
the high cost and uncertainties relating to clinical trials;
 
 
 
 
•
market conditions and technological innovation;
 
 
 
 
•
the unpredictability of the duration and results of clinical trials and regulatory review;
 
 
 
 
•
other risks and uncertainties discussed under the caption “Certain Risks Related to Our Business” and elsewhere in this report; and
 
 
 
 
•
other risks and uncertainties as may be detailed from time to time in our public announcements and SEC filings.
 
          You should keep in mind that any forward-looking statement made by us in this report speaks only as of the date of this report.  We have no duty to, and do not intend to, update or revise the forward-looking statements in this report after the date of this report.
 
General
 
          We are a specialty pharmaceutical company focused on acquiring, developing and commercializing pharmaceutical products for use to diagnose and treat gastrointestinal disorders.  Our development strategy has been to acquire late-stage drug candidates with short expected time lines to commercialization. We currently market and sell two pharmaceutical products, Visicol® and IB-Stat®. We are also studying Visicol® for the treatment of constipation.  In addition to our marketed products, we are studying INKP-102 as a new generation purgative product.
 
8
 
 
          The following table outlines our current product pipeline, on which we have focused the majority of our research, development, marketing and sales efforts since inception. The table also sets forth the current development status of our products and product candidates in each targeted therapeutic indication:
 
Product
 
Therapeutic Indications
 
Development Status
 
 
Visicol
 
•
Colon cleansing prior to colonoscopy
 
FDA approved; marketed product
 
 
•
Constipation
 
Post-marketing study completed
 
 
 
 
 
Phase IV completed
 
 
 
 
 
 
INKP-102
(next generation purgative)
 
•
Colon cleansing prior to colonoscopy
 
Phase II completed
Phase III completed, NDA
submitted in second quarter of 2005
 
 
 
 
 
 
IB-Stat
 
•
Symptoms associated with Irritable Bowel Syndrome (IBS)
 
Marketed product
 
 
•
Reduction of bowel motility during certain diagnostic procedures
 
 
 
Critical Accounting Policies and Practices
 
          In “Cautionary Advice Regarding Disclosures about Critical Accounting Policies” (SEC Release No.33-8040, December 12, 2001), the SEC advised companies to provide more information about a company’s most critical accounting policies, i.e., the specific accounting policies that have the most impact on a company’s results and require the most difficult, subjective or complex judgments by management. We have identified the following accounting policies that may constitute “critical accounting policies,” under the guidance provided by the release:
 
 
•
Revenue recognition.  Revenue from sales of Visicol is recognized when, pursuant to Staff Accounting Bulletin No. 104, “Revenue Recognition,” all four of the following criteria are met: (i) we have persuasive evidence that an arrangement exists, (ii) the price is fixed and determinable, (iii) title has passed and (iv) collection is reasonably assured. Product demand from our customers during a given period may not correlate with prescription demand for the product in that period. As a result, we periodically evaluate inventory positions in the distribution channel. If we believe these levels are too high based on prescription demand, we may not accept purchase orders from or may not ship additional product to our customers until these levels are reduced. Provisions for sales discounts, and estimates for chargebacks, rebates and product returns are established as a reduction of product sales revenues at the time such revenues are recognized. We establish these revenue reductions as our best estimate at the time of sale based on historical experience, adjusted to reflect known changes in the factors that impact such reserves. For IB-Stat, we recognize revenue based on prescription data, net of estimated cash discounts. This practice will continue until such time data becomes available that indicates that the product has achieved adequate market acceptance and future product returns can be reasonably estimated. Revenue from service obligations is recognized when the services have been performed.  Additionally, in accordance with SAB No. 104, non-refundable, up-front payments where the Company has continuing involvement, are deferred and recognized over the estimated performance period.
 
 
 
 
•
Stock-based compensation.  It is our policy, which is consistent with most public company policies, to apply Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” to account for our stock option plans rather than Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” Had we applied SFAS No. 148, our net income for the three-month period ended March 31, 2005, would have been a net loss.  Our net loss for the three-month period ended March 31, 2004 would have been greater.
 
9
 
 
 
 
 
•
Product returns.  It is our policy to estimate and record an allowance for future product returns in connection with our sales of Visicol. We have applied a return rate to our unit sales to provide this allowance under our product return policy. This return rate is calculated based on actual return experience and our monitoring of distribution channels taking into account the expiration dating of Visicol. The product return rate is periodically updated to reflect actual experience and changes to other factors affecting future product returns.
 
 
 
 
•
Deferred taxes.  In assessing the realizability of deferred tax assets, we consider 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 the deferred tax assets is dependent upon the generation of future taxable income during the period in which those temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income and projections for future taxable income over the periods in which the deferred tax asset items are deductible. The Tax Reform Act of 1986 contains provisions that may limit the net operating loss (NOL) and research and experimentation credit carryforwards available to be used in any given year upon the occurrence of certain events, including significant changes in ownership interest. Generally, a change in ownership of a company of greater than 50% within a three-year period results in an annual limitation on that company’s ability to utilize its NOL carryforwards and tax credits from the tax periods prior to the ownership change.  We have conducted a study and based on that study we believe that we have undergone an ownership change.  We believe that the annual limitation resulting from the ownership change will not limit on an overall basis our ability to utilize our NOL carryforwards in the future if we were to generate sufficient taxable income. Our NOL carryforwards and temporary differences represent a previously unrecognized tax benefit. Recognition of these benefits requires future income.  Because the attainment of future income is uncertain, we have established a valuation allowance for the entire amount of the net deferred tax asset.
 
 
 
 
•
Contingencies.  During the year ended December 31, 2004, we have incurred costs and received reimbursement related to our withdrawn public offering and our ongoing litigation (See Note 7 of accompanying financial statements).  We recognize liabilities for loss contingencies in accordance with Statement on Financial Accounting Standards No. 5, “Accounting for Contingencies.”  This statement requires accrual by a charge to income (and disclosure) for an estimated loss from a loss contingency if two conditions are met: (a) information available prior to issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements, and (b) the amount of loss can be reasonably estimated. Gain contingencies (third-party reimbursement) are recognized when realized in accordance with Accounting Research Bulletin No. 50, “Contingencies.”
 
Results of Operations
 
          We generated net income of $314,000 or $0.01 per share for the three-months ended March 31, 2005, compared to a net loss of $78,000 or $0.00 per share for the same period a year ago.
 
          Product revenue was $5,218,000 for the three-month period ended March 31, 2005, compared to $4,350,000 for the same period a year ago.   We estimate that Visicol prescriptions grew by 27% from the same quarter a year ago. We believe the increased prescription levels are driven by the increased market awareness and acceptance of Visicol.  In addition to our product revenue, we realized $818,000 in other revenue for the three-month period ended March 31, 2005, which was mostly attributable to a milestone payment earned from Zeria Pharmaceutical Company, net of royalty payable to ALW Partnership, the inventors of Visicol.  
 
          Our gross profit was $5,188,000 and $4,142,000 for the three-month periods ended March 31, 2005 and 2004, respectively.  Gross profit as a percentage of sales for product revenue was 84% and 89% for the three-month periods ended March 31, 2005 and 2004, respectively.  The decrease in gross profit as a percentage of product sales is the result of increased royalty expense recognized along with distribution costs payable to wholesalers.  We expect that gross profit as a percent of product revenue will be approximately 84% to 86% for the 2005 year.
 
          We incurred research and development expenses of $1,769,000 for the three-month period ended March 31, 2005, compared to $922,000 for the same period a year ago.  The increase was the result of higher development costs associated with the MCC-free new generation purgative tablet, INKP-102, along with higher costs related to an increased scale of development activity.
 
10
 
 
          Sales and marketing costs of $2,288,000 were incurred for the three-month period ended March 31, 2005, compared to $1,949,000 for the same period a year ago.  The increases were a result of continued growth in the size of our sales force, along with increased marketing campaigns related to Visicol.  As of March 31, 2005, our sales force covered 48 territories with five district managers, compared to 45 territories and four district managers as of March 31, 2004.
 
          General and administrative expenses were $877,000 for the three-month period ended March 31, 2005, compared to $785,000 for the same period a year ago.  The increases were the result of higher personnel, patent and insurance costs, along with an increase in legal and accounting fees associated with compliance with the Sarbanes-Oxley Act of 2002.
 
          Interest income was $60,000 and $10,000 for the three-month period ended March 31, 2005 and 2004, respectively.  The increase in interest income was a result of increased average cash and short-term investment balances along with higher interest rates compared to the same quarter a year ago.  Interest and other expenses was minimal for the three-months ended March 31, 2005 and 2004 due to the elimination of our outstanding convertible notes, along with the decreased average line of credit borrowings.
 
Liquidity and Capital Resources
 
                At March 31, 2005, we had cash and cash equivalents of $6,369,000 and short-term investments of $4,193,000.  Short-term investments are defined as investments purchased with a maturity of more than three months, and which mature less than twelve months from the balance sheet date.  At March 31, 2005, we had no balance outstanding on our line of credit.
 
          We believe that our financial resources are adequate for our operations for at least the next 12 months.  However, from time to time we may seek additional capital to fund the possible acquisition or the in-licensing of additional products; the possible acquisition of businesses related to gastrointestinal pharmaceuticals; the marketing and, if necessary, continued development of acquired products; the development and commercialization of new indications for Visicol; research and development related to enhancements of existing products; and general corporate purposes, including working capital.
 
          Our future short and long-term capital requirements will depend on numerous factors, including continued marketplace acceptance of our products. To achieve operating profits, we, alone or with others, must successfully market and sell our products. In addition to continued marketplace acceptance of our products, other factors which cannot be quantified and many of which we cannot control will also impact our short and long-term capital requirements, including: continued commercial costs of Visicol, continued progress in our research and development activities, progress with pre-clinical studies and clinical trials, defending shareholder claims related to alleged violations of preemptive rights, prosecuting and enforcing patent claims, technological and market developments, our ability to establish product development arrangements, the cost of manufacturing development, effective marketing activities and arrangements, and licensing or acquisition activity.
 
          We are currently developing INKP-102 for cleansing the colon prior to colonoscopy, continuing to study the use of Visicol for constipation and continuing to market and sell Visicol and IB-Stat to distributors and drug store chains. During 2005, we expect to spend up to $3,400,000 on INKP-102 and $10,000,000 on Visicol sales and marketing costs. These activities will be funded by our current cash balance and future product sales. If product sales fall short of current expectations or other factors negatively impact our cash balance, we may seek to obtain additional funds through equity or debt financing, collaborative or other arrangements with corporate partners, and from other sources. We may not be able to obtain any additional financing on terms acceptable to us, if at all. If adequate additional funds are not available when required, we may have to delay, scale-back or eliminate our research, drug discovery or development activities or other aspects of our operations.  Our business could be materially and adversely affected as a result.
 
          Net Cash Used in Operating Activities.  Our net use of cash from operating activities for the three-month period ended March 31, 2005 resulted primarily from our increased working capital.  Specifically, our accounts receivable and inventory balances increased compared to year-end as a result of the timing of customer payment of receivable balances and production of inventory for future sales to customers.  Additionally, we incurred increased research and development expenditures associated with our product candidates, including clinical development and manufacturing costs for INKP-102, sales and marketing costs related to Visicol, compensation of our employees and other administrative costs.
 
11
 
 
 
          Net Cash Provided by (Used in) Investing Activities.  Cash provided by investing activities for the three-month period ended March 31, 2005 resulted from the proceeds of the maturities of short-term investments, net of purchases.  Cash used in investing activities related to the purchase of computer equipment. 
 
          Net Cash Provided By Financing Activities.  Cash provided by financing activities for the three-month period ended March 31, 2005 related to net proceeds from the exercise of stock options.  We have no immediate plans, arrangements, commitments or understandings to raise capital and issue stock.  From time to time however, we consider various methods to raise capital in light of our expansion strategies, product opportunities and market conditions.
 
Research and Development Programs
 
          We currently have two significant research and development projects relating to Visicol and INKP-102.
 
          Visicol.  We have focused our Visicol research and development on cleansing of the colon prior to colonoscopy and are presently marketing Visicol for that indication.  In addition, we have performed studies for Visicol’s use in treating patients with constipation.  The current status of these projects is as follows: (i) for cleansing of colon prior to colonoscopy, the FDA has approved both our NDA as well as our SNDA for a reduced MCC formulation and (ii) for treating constipation, we have completed a post marketing study and a Phase IV study.  As of March 31, 2005 we have incurred total costs of approximately $11,744,000 in connection with our Visicol research and development.  During the quarter ended March 31, 2005, we did not incur costs attributable to Visicol.
 
          INKP-102.  During 2003, we developed INKP-102, a next generation purgative for cleansing the colon prior to colonoscopy.  Clinical batches of this new product have been manufactured and formulated to yield smaller tablets that may be easier to ingest. Additionally, the new product does not contain any MCC, which is a common inert, but highly insoluble, substance. We have completed the Phase II and Phase III studies.  We have submitted our NDA for FDA approval of this new product using alternative dosing regimens that utilize fewer tablets.  As of March 31, 2005, we have incurred total costs of approximately $4,514,000 in connection with our INKP-102 research and development.  During the quarter ended March 31, 2005, we incurred an aggregate of $1,769,000 in research and development expenses, approximately $1,322,000 of which was attributable to INKP-102.
 
          Indirect Costs.  In addition to the direct costs related to the development of our products and product candidates, we incurred indirect non-technology specific overhead costs.  These expenses include the salaries and administrative costs of managing our research and development projects, which for the quarter ended March 31, 2005, equaled approximately $447,000.
 
Recently Issued Accounting Pronouncements
 
          In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment”, a revision to SFAS No. 123, “Accounting for Stock-Based Compensation.” This statement supercedes APB No. 25, “Accounting for Stock Issued to Employees,” and its related implementation guidance. This statement establishes standards for the accounting for which an entity exchanges its equity instruments for goods or services. This statement also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. This statement requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost shall be recognized over the period during which an employee is required to provide service in exchange for the award – the requisite service period (vesting period). The grant-date fair value of employee share options will be estimated using option-pricing models adjusted for the unique characteristics of those instruments. This statement is effective as of the beginning of the first annual reporting period that begins after June 15, 2005. We are currently evaluating various implementation standards of SFAS No. 123R, including adoption methods and option pricing methodology. Based on the assumptions used in determining disclosure in accordance with SFAS No. 148, our net income for the three-months ended March 31, 2005 would have been a net loss of approximately $79,000 and our net loss for the same period a year ago, would have been approximately $560,000 had we adopted the provisions of SFAS No. 123R.
 
12
 
 
Certain Risks Related to Our Business
 
Risks related to our operations
 
If we do not maintain our profitability or if we incur losses in the future, then the value of our common stock is likely to fall.
 
          Our first sale of Visicol occurred in January 2001 and our first sale of IB-Stat occurred in June 2002. We have a significant accumulated deficit and have incurred losses and negative cash flow from operations in each year from our inception on July 1, 1993 through December 31, 2003. We achieved profitability and positive cash flow from operations for the first time for the year ended December 31, 2004 and were profitable for the three-months ended March 31, 2005, however, Visicol, INKP-102 and IB-Stat are in various stages of marketing or development and require significant research, development and testing and we may not continue to be profitable. Visicol provides substantially all of our revenues. Our continued success and growth is primarily dependent on the performance of Visicol and secondarily on our ability to acquire or develop new products. If we are unsuccessful in achieving increased revenues through the sale of Visicol or through the sale of newly acquired or developed products, we will not be able to operate profitably in the future. Our common stock is likely to decrease in value if we fail to maintain profits or if the market believes that we are unable to maintain profits.
 
Our success and revenue currently depend on Visicol and if we do not continue to successfully market Visicol, our revenue might not grow, which could cause our stock price to decline.
 
          We market sodium phosphate tablets in the United States under the brand name Visicol, and if approved by the FDA, we intend to market INKP-102 in the United States. Our prospects over the next three to five years are substantially dependent on the successful commercialization of Visicol and INKP-102. We expect to engage in expensive advertising, educational programs and other means to market our current and future products. The degree of market acceptance of our products among physicians, patients, healthcare payors and the medical community will depend upon a number of factors including:
 
 
•
demonstration of their clinical efficacy and safety;
 
 
 
 
•
successful introduction for new indications;
 
 
 
 
•
their cost-effectiveness;
 
 
 
 
•
their potential advantages over alternative treatment methods;
 
 
 
 
•
new product introductions by our competitors;
 
 
 
 
•
the marketing and distribution support they receive; and
 
 
 
 
•
reimbursement policies of government and third-party payors.
 
          Virtually all of our revenue to date has come from Visicol. Our ability to increase revenue in the future will depend in part on our success in in-licensing or acquiring additional pharmaceutical products. We currently intend to in-license or acquire pharmaceutical products that have been developed beyond the initial discovery phase and for which late-stage human clinical data is already available or that have already received regulatory approval. These kinds of pharmaceutical products might not be available to us on attractive terms or at all. To the extent we acquire rights to additional products, we might incur significant additional expense in connection with the development and, if approved by the FDA, marketing of these products.
 
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Failure to manage our growth could increase our expenses faster than our revenue.
 
          We have experienced significant growth in the number of our employees and the scope of our operations.  Since the May 2002 re-launch of Visicol in the United States, we have grown from 13 employees on May 31, 2002 to approximately 74 on March 31, 2005. This growth has placed a significant strain on our management and operations. Our continued growth might place further strains on our management and operations. Our ability to manage growth effectively will depend upon our ability to broaden our management team and our ability to attract, hire and retain skilled employees. Our success will also depend on the ability of our officers and key employees to continue to implement and improve our operational, management information and financial control systems and to expand, train and manage our employee base.
 
If we make any acquisitions, we will incur a variety of costs and might never successfully integrate the acquired product or business into ours.
 
          We might attempt to acquire products or businesses that we believe are a strategic complement to our business model. We might encounter operating difficulties and expenditures relating to integrating an acquired product or business. These acquisitions might require significant management attention that would otherwise be available for ongoing development of our business. In addition, we might never realize the anticipated benefits of any acquisition. We might also make dilutive issuances of equity securities, incur debt or experience a decrease in cash available for our operations, or incur contingent liabilities and/or amortization expenses relating to goodwill and other intangible assets, in connection with future acquisitions.
 
If third-party payors do not provide coverage or reimburse patients for our products, then some patients may be unable or unwilling to purchase our products and we will achieve less revenue from product sales.
 
          Successful sales of our products in the United States and other countries depend on the availability of adequate reimbursement from the government, managed care organizations and private insurance plans. Pharmaceutical companies often rely on reimbursement from third parties as the basis for the sales of their products. In the pharmaceutical industry, unlike other consumer product industries, insurance companies, including managed care organizations, often pay drug stores directly for part of the cost of covered pharmaceutical products. In fact, the majority of prescription drugs prescribed to patients are ultimately paid for at the retail level by these organizations and not by the patient. These organizations provide for reimbursement only after considering a number of factors, including product features such as safety, medical necessity, cost and the experimental nature of the product. We plan to spend significant amounts of time and other resources to obtain reimbursement for our products. The organizations that provide reimbursement routinely limit reimbursement and attempt to exert significant pressure on medical suppliers to provide rebates to help offset the cost of covered medication. Visicol and IB-Stat are premium priced compared to their competitors and we have not specifically contracted with any third party to date to give rebates for their use. We do not know what impact, if any at all, this will have on the coverage of Visicol or IB-Stat by these third party payors, particularly if Visicol continues to gain market share, thus increasing the cost to third party payors.
 
If we do not have adequate insurance for product liability claims, then we may be subject to significant expenses relating to these claims.
 
          We are subject to significant product liability risks relating to the sale, manufacturing and further testing of the products on the market and the ones we are developing. These risks include:
 
 
•
our products could cause undesirable side effects or injury;
 
 
 
 
•
our product candidate could cause undesirable side effects or injury during clinical trials; and
 
 
 
 
•
we may agree to reimburse others that incur liability relating to our products and product candidate.
 
          We currently maintain insurance for product liability claims in the amount of $10,000,000 per occurrence and $10,000,000 in the aggregate. We have no way of knowing if these amounts will be adequate to cover any product liability claims filed against us. If we do not or cannot maintain adequate insurance coverage, we may incur a significant liability if a product liability claim arises. Moreover, actual or alleged undesirable side effects or injuries related to our products or product candidate may interfere with the commercialization of our products and the development of our product candidate.
 
14
 
 
If we do not develop and maintain relationships with manufacturers, then we may not successfully manufacture and sell our products.
 
          We do not possess the capabilities, resources or facilities to manufacture Visicol, INKP-102 or IB-Stat. We must contract with manufacturers to produce Visicol, INKP-102 and IB-Stat according to government regulations. Our future development and delivery of our marketed products and our product candidate depends on the timely, profitable and competitive performance of these manufacturers. A limited number of manufacturers exist which are capable of manufacturing our marketed products and our product candidate. We may fail to contract with the necessary manufacturers or we may contract with manufacturers on terms that may not be entirely acceptable to us. Our manufacturers must obtain FDA approval for their manufacturing processes, and we have no control over this approval process.
 
          We have contracted with Mallinckrodt, Inc. to supply us with active pharmaceutical ingredients for Visicol. A significant portion of the Visicol tablet is monobasic and dibasic sodium phosphate. Mallinckrodt has agreed to supply these ingredients in a manner that meets FDA requirements. The FDA has approved the manufacturing process for these active ingredients, but the Drug Master File for the sodium phosphate is only for one location at Mallinckrodt. If this location were to shut down for any reason, a delay in the delivery of our active pharmaceutical ingredients would occur and could impact future sales of Visicol.
 
          We have contracted with Pharmaceutical Manufacturing Research Services, Inc. (PMRS), a manufacturing development company, to supply commercial quantities of Visicol in a manner that meets FDA requirements. Our contract with PMRS will expire at the end of 2005. The FDA has approved the manufacturing processes of PMRS. Any failure by PMRS to maintain compliance with FDA standards could result in its loss of “approved status” and could significantly harm our business since we do not have an approved secondary manufacturer for Visicol.
 
          We have contracted with Cardinal Health Packaging Services to package Visicol in a manner that meets FDA requirements. The FDA has approved this facility for the packaging of Visicol. In the event that Cardinal Health Packaging Services were unable to package Visicol for us, the FDA has also approved Fisher Clinical Services, Inc. for packaging of Visicol.  Any failure by our packagers to maintain compliance with FDA standards could result in a supply interruption, which could significantly harm our business
 
          We are currently working with Wellspring Pharmaceutical Corporation (Wellspring) to manufacture and package INKP-102 in a manner that meets FDA requirements. The FDA has not yet approved the manufacturing processes and facility for packaging at Wellspring. If the FDA does not approve the manufacturing processes and facility for packaging at Wellspring we will not be able to market and sell INKP-102.
 
If the owners of technology licensed to us terminate our license agreement, then these owners could prevent us from developing, manufacturing or selling the product covered by this license.
 
          Our license with the ALW Partnership, entered into February 1997, which covers Visicol and INKP-102, may be terminated by the licensor if we fail to pay, commencing in February 2003, minimum royalties of $100,000 per year whether or not any sales have occurred.  In addition, our rights under the ALW License will no longer be exclusive, and the minimum royalty payment will no longer be due (although decreased actual royalty payments will be due) if there is no valid or enforceable patent on Visicol, INKP-102 or any other product under the ALW License. 
 
If we cannot develop and market our products as rapidly or cost-effectively as our competitors, then we will not be able to maintain our operations at a profit.
 
          We have products that compete in two very competitive segments of the pharmaceutical industry. Our products and product candidate include: (i) purgative and laxative agents for cleansing the colon or relieving constipation, which includes Visicol and, if approved, INKP-102; and (ii) antispasmodics, which include IB-Stat.  We are likely to encounter significant competition with respect to Visicol, INKP-102, if approved, and IB-Stat, including such competitors as:
 
 
•
Braintree Laboratories, Inc., Schwarz Pharma Inc., C.B. Fleet Company, Inc. and Novartis Pharmaceuticals Corporation with respect to Visicol and INKP-102, and
 
 
 
 
•
Schwarz Pharma Inc., Eli Lily and Company and Bedford Laboratories with respect to IB-Stat.
 
15
 
          Most of these entities have substantially greater financial, technical, manufacturing, sales, marketing, distribution and other resources. The financial strength of competitors is particularly important in the pharmaceutical industry, where technological innovations occur rapidly. These technological innovations can dramatically affect the price and effectiveness of a product line and can render a competing product line obsolete. Our competitors that have strong financial resources may develop competitive products that are cheaper and more effective than our products. These competitive products may render our products unmarketable or non-competitive. Even if our competitors do not develop better and more cost effective products, they may manufacture and market their products more successfully than us. Therefore, our competitors may capture all or a large segment of our market, severely restricting our ability to maintain a profitable level of product sales.
 
If we are unable to protect our intellectual property, then our competitors may develop similar products that could render our products obsolete.
 
          Our success depends, in part, on our ability to develop and maintain a strong patent position for our products and technologies both in the United States and other countries. As with most biotechnology and pharmaceutical companies, our patent position is highly uncertain and involves complex legal and factual questions. Without patent and other protections, other companies could offer substantially identical products for sale without incurring the sizeable development and testing costs that we have incurred. Our ability to recoup these expenditures and realize profits upon sale of product could be diminished.
 
          In 1997, the U.S. Patent and Trademark Office issued a patent covering the use of Visicol for inducing purgation of the colon. Patents claiming the use of Visicol to induce purgation of the colon have been granted in Europe and Canada. In December 2000, the U.S. Patent and Trademark Office issued to us a patent for numerous solid-dose colonic purgative agents.  A similar patent has also been granted in Canada.
 
          In 2004, we filed a U.S. patent application for a new generation of purgative products. The invention covers several highly soluble colonic purgative formulations in solid dosage forms that can be used to soften stool, promote laxation and/or induce complete purgation. There is no assurance that this patent will issue.
 
          IB-Stat is not patentable.
 
          We have pending foreign applications, and intend to apply for additional foreign patents. Competitors could challenge or develop around the patents, or the scope of the patents may not be adequate to protect the patented product from competitors. The commercial success of our products will also depend upon our ability to make sure the products do not infringe on patents issued to competitors.
 
          Our employees or scientific consultants may develop inventions or processes independently that may be related to our products. These employees or consultants could claim ownership of these inventions or processes, and these claims could succeed. We may need to enter into protracted and costly litigation to enforce or determine the scope of our proprietary rights.
 
Claims by others that we infringe their intellectual property could be costly to us.
 
          Our patent or other proprietary rights related to our products might conflict with the current or future intellectual property rights of others. We have not conducted a search to determine if there are any other patents that could cover Visicol and  INKP-102. Litigation or patent interference proceedings, either of which could result in substantial cost to us, might be necessary to defend any patents to which we have rights and our other proprietary rights or to determine the scope and validity of other parties’ proprietary rights. The defense of patent and intellectual property claims is both costly and time-consuming, even if the outcome is favorable to us. Any adverse outcome could subject us to significant liabilities to third parties, require disputed rights to be licensed from third parties or require us to cease selling our product. We might not be able to obtain a license to any third-party technology that we require to conduct our business, or, if obtainable, that technology might not be available at a reasonable cost.
 
Our actual financial results might vary from what we anticipate.
 
          Our actual financial results might vary from what we anticipate, and these variations could be material. Our annual and quarterly reports contain various forecasts. These forecasts reflect numerous assumptions concerning our anticipated future performance and with respect to the prevailing market and economic conditions that are beyond our control and which might not turn out to have been correct. Although we believe that the assumptions underlying the projections are reasonable, actual results could be materially different. Our revenues and expenses are subject to numerous risks and uncertainties. Financial results that are weaker than expectations may cause a significant and sudden decline in our stock price.
 
16
 
 
Risks related to regulatory matters
 
Regulatory approval of our products is time-consuming, expensive and uncertain, and could result in unexpectedly high expenses and delay our ability to sell our products.
 
          Development, manufacture and marketing of our products are subject to extensive regulation by governmental authorities in the United States and other countries. This regulation could require us to incur significant unexpected expenses or delay or limit our ability to sell our products. Our clinical studies of Visicol for constipation, INKP-102 for colon cleansing prior to colonoscopy, or any other product or product candidate might be delayed or halted for various reasons, including:
 
 
•
the drug is not effective;
 
 
 
 
•
patients experience severe side effects during treatment;
 
 
 
 
•
patients do not enroll in the studies at the rate we expect;
 
 
 
 
•
drug supplies are not sufficient to treat the patients in the studies;
 
 
 
 
•
we decide to modify the drug during testing; or
 
 
 
 
•
we do not have adequate funds to continue the testing.
 
          If the FDA approves new indications for Visicol, its approval will be limited to those indications for which the product has been shown to be safe and effective, as demonstrated to the FDA’s satisfaction through clinical studies. Approval might entail ongoing requirements for post-marketing studies. Even if we obtain regulatory approval, labeling and promotional activities are subject to continual scrutiny by the FDA, the Office of the Proprietor General and state regulatory agencies and, in some circumstances, the Federal Trade Commission. FDA enforcement policy prohibits the marketing of approved products for unapproved, or off-label, uses. Marketing an approved product for a new use requires a separate approval by the FDA. These regulations and the FDA’s interpretation of them might impair our ability to effectively market our products.
 
          If we do not maintain required approvals from the government, then we may not successfully manufacture, market or sell our marketed products.
 
FDA manufacturing approval
 
          The FDA requires pharmaceutical companies to include detailed manufacturing information in an NDA. The FDA has mandated that all manufacturing facilities and processes comply with good manufacturing practices, commonly known as GMP. GMP is a body of federal regulations and guidelines that govern the manufacture of drugs for human use. For example, all manufacturers must pass manufacturing plant inspections and provide detailed records of manufacturing processes. Among other things, drug manufacturers must demonstrate that:
 
 
•
the drug product can be consistently manufactured at the same quality standard;
 
 
 
 
•
the drug product is stable over time; and
 
 
 
 
•
the level of chemical impurities in the drug product is under a designated level.
 
          The FDA has inspected the manufacturing facilities for Visicol and IB-Stat. The FDA may still, however, prevent us from continuing to market Visicol or IB-Stat if we:
 
 
•
do not continue to consistently manufacture appropriate amounts of Visicol and IB-Stat; or
 
 
 
 
•
cannot continue to repeat the manufacturing process used to manufacture the validation batches of Visicol.
 
17
 
          Since we currently have only one approved manufacturer of Visicol and one manufacturer for IB-Stat, if we are unable to manufacture our products at those manufacturers our financial results could be negatively impacted.
 
FDA oversight after product approval
 
          After the FDA approves a product, the FDA continues to regulate the product. In particular, the FDA may require post-marketing testing and surveillance to monitor the effects of our marketed products or may require drug label changes, which could hinder the marketability of our marketed products. In addition, the FDA may place conditions on our marketed products that could restrict the sale or use of our products.
 
          Both Visicol and IB-Stat are products used in highly competitive diagnostic and disease indications where substitution of competitive products is common.  Although both products have a good safety profile and history, any negative change in our safety labeling could adversely affect the sale of our products.
 
The FDA could prevent us from marketing IB-Stat.
 
          IB-Stat is the combination of a marketed drug (hyoscyamine sulfate) and a widely used delivery system. Hyoscyamine sulfate was a marketed product prior to 1962. Although we have not obtained FDA approval for IB-Stat, the FDA allows certain products that were marketed prior to 1962 to continue to be marketed without an approved NDA. There is no guarantee that the FDA will continue to allow hyoscyamine sulfate or any other pre-1962 marketed products to continue to be marketed. In addition, the FDA could determine that hyoscyamine sulfate is unsafe or that additional data needs to be submitted to the FDA in order to determine the drug’s safety and efficacy. The FDA could also determine that IB-Stat is not similar enough to the pre-1962 marketed hyoscyamine sulfate, and as a result cannot be marketed without an FDA approved NDA.
 
If we do not obtain required approvals from the government, then we may not successfully market or sell our product candidates.
 
          The FDA requires multiple stages of tests, known as Phase I, II and III clinical trials, on most pharmaceutical products. In addition, the FDA must confirm that drug manufacturers comply with applicable federal regulations. The process to obtain government approval of a pharmaceutical product takes many years and requires substantial resources.
 
          The FDA may delay or halt the clinical development of our product candidates at any stage, or may deny us approval to market a product. If the FDA takes any of these adverse actions, we may delay or stop the development of a product or may be unable to sell the product.   The process of obtaining FDA approval is expensive, time-consuming and often filled with unexpected hurdles. Even if we receive approval of a product candidate, the FDA may limit and restrict the drug’s use and may subject our products to continuous review. If we fail to comply with any applicable regulatory requirement, the FDA could impose penalties on us, including:
 
 
•
warning letters;
 
 
 
 
•
fines;
 
 
 
 
•
withdrawal of regulatory approval;
 
 
 
 
•
product recalls and suspensions;
 
 
 
 
•
operating restrictions;
 
 
 
 
•
injunctions; and/or
 
 
 
 
•
civil penalties and criminal prosecution.
 
          Certain of the foregoing penalties could have an immediate negative financial impact on our business, significantly harm our reputation, have a material adverse effect on our business operations and significantly reduce our future sales and profits.
 
18
 
          We are developing INKP-102 as a compound for colon cleansing prior to colonoscopy.  We have completed our Phase II and Phase III studies and applied for FDA approval in the second quarter of 2005. We may never receive FDA approval for INKP-102 and without FDA approval, we cannot market or sell INKP-102.
 
Risks related to our common stock outstanding
 
If the holders of our outstanding options and warrants exercise them and subsequently sell the common stock they receive upon exercise, the market price of our common stock may drop.
 
          At March 31, 2005, we had approximately 8,944,000 options and warrants outstanding. Options and warrants give the holder the right to purchase shares of our common stock in the future for a predetermined price which may or may not be below the current market value of our common stock at the time the option or warrant is exercised. In addition, as of March 31, 2005, we had an additional 2,144,000 options available for issuance to employees and consultants, pursuant to our option plans. To date, option and warrant holders have exercised approximately 10,768,000 options and warrants in the aggregate at prices ranging from $0.50 to $5.56. The exercise of these outstanding warrants and options and the sale of the related shares may cause our common stock price to drop. 
 
If our common stock continues to be volatile and thinly traded, our shareholders may not be able to sell their shares when desired.
 
          The market price of our common stock, similar to other public pharmaceutical or biotechnology companies, has been volatile and may remain volatile for the foreseeable future. Our shareholders may not be able to sell their shares when they desire because the stock price is highly volatile and the stock is not widely traded. For example, as of March 31, 2005, the number of our shares theoretically available for sale in any one day was approximately 49,108,000 shares and our average daily trading volume for the twelve-month period ended March 31, 2005 was approximately 242,000 shares. If our stock continues to trade thinly, our shareholders may not be able to sell their shares when desired.
 
If our settlement agreement with the class of InKine shareholders who have purportedly been denied preemptive rights does not settle or reach final judgment for damages, or our agreement with a third-party to fund the agreed upon settlement are insufficient to cover the amount of any settlement payment or judgment for damages, then the market price of our common stock may drop.
 
          On March 15, 2004, we withdrew a public offering of six million shares of our common stock.  The decision to withdraw the offering was made when it came to our attention that our certificate of incorporation did not contain any provision exempting us from providing preemptive rights in connection with certain securities offerings.  On March 19, 2004, a purported class action lawsuit, naming us as the defendant, was filed in the Court of Common Pleas, Philadelphia County, on behalf of a putative class of holders of InKine equity shares who allege that they were denied certain claimed preemptive rights during the last six years.  As of March 31, 2005, we have incurred $341,000 in expenses related to the withdrawn offering and $590,000 in legal costs related to preemptive rights and the related lawsuit. To date, we have received a $500,000 payment from a third-party as reimbursement for a portion of these costs.  On October 12, 2004, we entered into an agreement with an undisclosed third-party who will fund our settlement of damages and costs incurred in connection with the class action lawsuit.  We have also entered into, and filed with the Court of Common Pleas, Philadelphia County, a settlement agreement with the class of InKine shareholders.  We do not anticipate that we or our insurance carriers will bear any costs in connection with the settlement arrangement.  Our settlement and the agreement with the undisclosed third-party is subject to a number of conditions, including final court approval.  At this time, there can be no assurance that those conditions will be met and that the settlement will receive final court approval.  Accordingly, we have recognized a $200,000 charge for the year ended December 31, 2004 for unreimbursed legal costs incurred up to our insurance deductible.
 
Item 3.  Quantitative and Qualitative Disclosures About Market Risks
 
          We are exposed to market risk associated with changes in interest rates on our line of credit and certain investments. We do not manage the risk of fluctuations in interest rates associated with the line of credit, as it is a short-term borrowing with a maturity date in 2006. The interest rate on our line of credit has fluctuated from 4.51% to 5.00% over the past three-months. There was no outstanding balance on this line of credit at March 31, 2005.
 
19
 
          Typically, a substantial portion of our assets are investment grade debt instruments such as direct obligations of the U.S. Treasury, securities of federal agencies which carry the direct or implied guarantee of the U.S. government and bank certificates of deposit. The market value of such investments fluctuates with current market interest rates. In general, as rates increase, the market value of a debt instrument is expected to decrease. The opposite is also true. To minimize such market risk, we have in the past and, to the extent possible, will continue in the future, to hold such debt instruments to maturity at which time the debt instrument will be redeemed at its stated or face value. Due to the short duration and nature of these instruments, we do not believe that we have a material exposure to interest rate risk related to our investment portfolio.
 
          We do not anticipate any material changes in our primary market risk exposure in 2005. We do not hold or issue any derivatives.
 
Item 4.  Controls and Procedures
 
          Evaluation of disclosure controls and procedures.  Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report.  Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report have been designed and are functioning effectively to provide reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.  We believe that a controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.
 
          Changes in internal controls.  No change in our internal control over financial reporting occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
PART II -- OTHER INFORMATION
 
Item 1.  Legal Proceedings.
 
          On March 15, 2004, we withdrew a public offering of six million shares of our common stock.  The decision to withdraw the offering was made when it came to our attention that our certificate of incorporation did not contain any provision exempting us from providing preemptive rights in connection with certain securities offerings.  On March 19, 2004, a purported class action lawsuit, naming us as the defendant, was filed in the Court of Common Pleas, Philadelphia County, on behalf of a putative class of holders of InKine equity shares who allege that they were denied certain claimed preemptive rights during the last six years.  As of March 31, 2005, we have incurred $341,000 in expenses related to the withdrawn offering and $590,000 in legal costs related to preemptive rights and the related lawsuit. To date, we have received a $500,000 payment from a third-party as reimbursement for a portion of these costs.  On October 12, 2004, we entered into an agreement with an undisclosed third-party who will fund our settlement of damages and costs incurred in connection with the class action lawsuit.  We have also entered into, and filed with the Court of Common Pleas, Philadelphia County, a settlement agreement with the class of InKine shareholders.  We do not anticipate that we or our insurance carriers will bear any costs in connection with the settlement arrangement.  Our settlement and the agreement with the undisclosed third-party is subject to a number of conditions, including final court approval.  At this time, there can be no assurance that those conditions will be met and that the settlement will receive final court approval.  Accordingly, we have recognized a $200,000 charge for the year ended December 31, 2004 for unreimbursed legal costs incurred up to our insurance deductible.
 
Item 2.  Changes in Securities and Use of Proceeds.
 
          None.
 
20
 
Item 6.  Exhibits.
 
 
(a)
Exhibits.
 
 
 
 
 
31.1* Chief Executive Officer Certification pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
 
 
31.2* Chief Financial Officer Certification pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
 
 
32.1* Chief Executive Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
 
 
32.2* Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
 
 
* Filed herewith.
 
 
 
 
21
 
Signatures
 
          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.
 
 
INKINE PHARMACEUTICAL
 
COMPANY, INC.
 
 
 
 
 
 
Date: May 5, 2005
By:
LEONARD S. JACOB M.D.,PH.D.
 
 
 
 
Leonard S. Jacob, M.D., Ph.D.
 
 
Chairman of the Board and
 
 
Chief Executive Officer
 
 
 
 
 
 
Date: May 5, 2005
By:
ROBERT F. APPLE
 
 
 
 
Robert F. Apple
 
 
Chief Operating and Financial Officer,
 
 
(Authorized Officer and Principal
 
 
Financial Officer)
 
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Exhibits Index
 
31.1* Chief Executive Officer Certification pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
31.2* Chief Financial Officer Certification pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
32.1* Chief Executive Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
32.2* Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
* Filed herewith.
 
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