QUIGLEY CORPORATION (QGLY)

[mjm2005]

http://biz.yahoo.com/e/050803/qgly10-q.html

Form 10-Q for QUIGLEY CORP

3-Aug-2005

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

In addition to historical information, this Report contains forward-looking statements. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in these forward-looking statements. Factors that might cause such a difference include, but are not limited to, management of growth, competition, pricing pressures on the Company's products, industry growth and general economic conditions. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's opinions only as of the date hereof. The Company undertakes no obligation to revise or publicly release the results of any revision to these forward-looking statements.

CERTAIN RISK FACTORS

The Quigley Corporation makes no representation that the United States Food and Drug Administration ("FDA") or any other regulatory agency will grant an Investigational New Drug or take any other action to allow its formulations to be studied or marketed. Furthermore, no claim is made that potential medicine discussed herein is safe, effective, or approved by the Food and Drug Administration. Additionally, data that demonstrates activity or effectiveness in animals or in vitro tests do not necessarily mean such formula test compound, referenced herein, will be effective in humans. Safety and effectiveness in humans will have to be demonstrated by means of adequate and well controlled clinical studies before the clinical significance of the formula test compound is known. Readers should carefully review the risk factors described in other sections of the filing as well as in other documents the Company files from time to time with the Securities and Exchange Commission ("SEC").

OVERVIEW

The Company, headquartered in Doylestown, Pennsylvania, is a leading manufacturer, marketer and distributor of a diversified range of homeopathic and health products which comprise the Cold Remedy, Health and Wellness and Contract Manufacturing segments. The Company is also involved in the research and development of potential prescription products that comprise the Ethical Pharmaceutical segment.

The Company's business is the manufacture and distribution of cold remedy products to the consumer through the over-the-counter marketplace together with the sale of proprietary health and wellness products through its direct selling subsidiary. One of the Company's key products in its Cold Remedy segment is Cold-Eeze(R), a zinc gluconate glycine product proven in two double-blind clinical studies to reduce the duration and severity of the common cold symptoms by nearly half. Cold-Eeze(R) is now an established product in the health care and cold remedy market. Effective October 1, 2004, the Company acquired substantially all of the assets of JoEl, Inc., the previous manufacturer of the Cold-Eeze(R) lozenge product. This manufacturing entity, now called Quigley Manufacturing Inc. ("QMI"), a wholly owned subsidiary of the Company, will continue to produce lozenge product along with performing such operational tasks as warehousing and shipping the Company's Cold-Eeze(R) products. In addition, QMI produces a variety of hard and organic candy for sale to third party customers in addition to performing contract manufacturing activities for non-related entities. The Cold-Eeze(R) products reported a strong sales performance in the first six months of 2005 as a result of a prolonged cough/cold season, increased consumer demand and increased household penetration. The presence of QMI in 2005 contributed net sales of $2,376,319 in the six month period.

Darius International Inc. ("Darius"), the Health and Wellness segment, a wholly owned subsidiary of the Company, was formed in January 2000 to introduce new products to the marketplace through a network of independent distributors. Darius is a direct selling organization specializing in proprietary health and wellness products. The formation of Darius has provided diversification to the Company in both the method of product distribution and the broader range of products available to the marketplace, serving as a balance to the seasonal revenue cycles of the Cold-Eeze(R) branded products. This segment's 2005 net sales decreased over the comparable 2004 six month period due to a decline in the number of active domestic independent representatives; however, international sales activity improved in the 2005 period.

In January 2001, the Company formed an Ethical Pharmaceutical segment, Quigley Pharma Inc. ("Pharma"), that is under the direction of its Executive Vice President and Chairman of its Medical Advisory Committee. Pharma was formed for the purpose of developing naturally derived prescription drugs, cosmeceuticals, and dietary supplements. Pharma is currently undergoing research and development activity in compliance with regulatory requirements. The Company is in the initial stages of what may be a lengthy process to develop these patent applications into commercial products.

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Future revenues, costs, margins, and profits will continue to be influenced by the Company's ability to maintain its manufacturing availability and capacity together with its marketing and distribution capabilities and the requirements associated with the development of Pharma's potential prescription drugs in order to continue to compete on a national and international level. The continued expansion of Darius is dependent on the Company retaining existing independent representatives and recruiting additional active representatives both internationally and within the United States, continued conformity with government regulations, a reliable information technology system capable of supporting continued growth and continued reliable sources for product and materials to satisfy consumer demand.

COLD REMEDY

Cold-Eeze(R), a zinc gluconate glycine formulation (ZIGG(TM)), is an over-the-counter consumer product used to reduce the duration and severity of the common cold and is currently sold in lozenge, sugar-free tablet and gum form. During 2003, the Company launched a Kidz-EEZE(TM) Sore Throat Pops product.

In May 1992, the Company entered into an exclusive agreement for worldwide representation, manufacturing and marketing of Cold-Eeze(R) products in the United States. A randomized double-blind placebo-controlled study, conducted at Dartmouth College of Health Science, Hanover, New Hampshire, concluded that the lozenge formulation treatment, initiated within 48 hours of symptom onset, resulted in a significant reduction in the total duration of the common cold.

On May 22, 1992, "ZINC AND THE COMMON COLD, A CONTROLLED CLINICAL STUDY," was published in England in the "Journal of International Medical Research," Volume 20, Number 3, Pages 234-246. According to this publication, (a) flavorings used in other Zinc lozenge products (citrate, tartrate, separate, orotate, picolinate, mannitol or sorbitol) render the Zinc inactive and unavailable to the patient's nasal passages, mouth and throat where cold symptoms have to be treated, (b) this patented formulation delivers approximately 93% of the active Zinc to the mucosal surfaces and (c) the patient has the same sequence of symptoms as in the absence of treatment but goes through the phases at an accelerated rate and with reduced symptom severity.

On July 15, 1996, results of a new randomized double-blind placebo-controlled study on the common cold, which commenced at the CLEVELAND CLINIC FOUNDATION on October 3, 1994 were published. The study called "ZINC GLUCONATE LOZENGES FOR TREATING THE COMMON COLD" was completed and published in THE ANNALS OF INTERNAL MEDICINE - VOL. 125 NO. 2. Using a 13.3mg lozenge (almost half the strength of the lozenge used in the Dartmouth Study), the result still showed a 42% reduction in the duration of common cold symptoms.

In April 2002, the Company announced the statistical results of a retrospective clinical adolescent study at the Heritage School facility in Provo, Utah that suggests that Cold-Eeze(R) is also an effective means of preventing the common cold and statistically (a) lessens the number of colds an individual suffers per year, reducing the median from 1.5 to zero and (b) reduces the use of antibiotics for respiratory illnesses from 39.3% to 3.0% when Cold-Eeze(R) is administered as a first-line treatment approach to the common cold.

In April 2002, the Company was assigned a Patent Application which was filed with the Patent Office of the United States Commerce Department for the use of Cold-Eeze(R) as a prophylactic for cold prevention. The new patent application follows the results of the adolescent study at the Heritage School facility.

In May 2003, the Company announced the findings of a prospective study, conducted at the Heritage School facility in Provo, Utah, in which 178 children, ages 12 to 18 years, were given Cold-Eeze(R) lozenges both symptomatically and prophylactically from October 5, 2001 to May 30, 2002. The study found a 54% reduction in the most frequently observed cold duration. Those subjects not receiving treatment most frequently experienced symptom duration of 11 days compared with 5 days when Cold-Eeze(R) lozenges were administered, a reduction of 6 days.

The business of the Company is subject to federal and state laws and regulations adopted for the health and safety of users of the Company's products. Cold-Eeze(R) is a homeopathic remedy that is subject to regulations by various federal, state and local agencies, including the FDA and the Homeopathic Pharmacopoeia of the United States.

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HEALTH AND WELLNESS

Darius, through Innerlight Inc., its wholly owned subsidiary, is a direct selling company specializing in the development and distribution of proprietary health and wellness products, including herbal vitamins and dietary supplements for the human condition, primarily within the United States and since the second quarter of 2003, internationally.

The continued success of this segment is dependent, among other things, on the Company's ability:

o To maintain existing independent representatives and recruit additional successful independent representatives. Additionally, the loss of key high-level distributors could negatively impact future growth and revenues;

o To continue to develop and make available new and desirable products at an acceptable cost;

o To maintain safe and reliable multiple-location sources for product and materials;

o To maintain a reliable information technology system and internet capability. The Company has expended significant resources on systems enhancements in the past and will continue to do so to ensure prompt customer response times, business continuity and reliable reporting capabilities. Any interruption to computer systems for an extended period of time could be harmful to the business;

o To execute conformity with various federal, state and local regulatory agencies both within the United States and abroad. With the growth of international business, difficulties with foreign regulatory requirements could have a significant negative impact on future growth. Any inquiries from government authorities relating to the Company's business and compliance with laws and regulations could be harmful to the Company;

o To compete with larger more mature organizations operating within the same market and to remain competitive in terms of product relevance and business opportunity;

o To successfully implement methods for progressing the direct selling philosophy internationally; and

o To plan strategically for general economic conditions.

Any or all of the above risks could result in significant reductions in revenues and profitability of the Health and Wellness segment.

CONTRACT MANUFACTURING

From October 1, 2004, this manufacturing entity, QMI, a wholly owned subsidiary of the Company, has continued to produce lozenge product along with performing such operational tasks as warehousing and shipping the Company's Cold-Eeze(R) products. In addition to that function, QMI produces a variety of hard and organic candy for sale to third party customers in addition to performing contract manufacturing activities for non-related entities. QMI is an FDA-approved facility.

ETHICAL PHARMACEUTICAL

Pharma's current activity is the development of naturally-derived prescription drugs with the goal to improve the quality of life and health of those in need through scientific research and development. Research and development will focus on the identification, isolation and direct use of active medicinal substances. One aspect of Pharma's research will focus on the combination of isolated active constituents and whole plant components. The search for new natural sources of medicinal substances will focus not only on world plants, fungi, and other natural substances, but also on an intense investigation into traditional medicinals and historic therapeutics.

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The pre-clinical development, clinical trials, product manufacturing and marketing of Pharma's potential new products are subject to federal and state regulation in the United States and other countries. Obtaining FDA regulatory approval for these pharmaceutical products can require substantial resources and take several years. The length of this process depends on the type, complexity and novelty of the product and the nature of the disease or other indications to be treated. If the Company cannot obtain regulatory approval of these new products in a timely manner or if the patents are not granted or if the patents are subsequently challenged, these possible events could have a material effect on the business and financial condition of the Company. The strength of the Company's patent position may be important to its long-term success. There can be no assurance that these patents and patent applications will effectively protect the Company's products from duplication by others.

The areas of focus are:

o A Patent (No. 6,555,573 B2) entitled "Method and Composition for the Topical Treatment of Diabetic Neuropathy." The patent extends through March 27, 2021.

o A Patent (No. 6,592,896 B2) entitled "Medicinal Composition and Method of Using It" (for Treatment of Sialorrhea and other Disorders) for a product to relieve sialorrhea (drooling) in patients suffering from Amyotrophic Lateral Sclerosis (ALS), otherwise known as Lou Gehrig's Disease. The patent extends through August 6, 2021.

o A Patent (No. 6,596,313 B2) entitled "Nutritional Supplement and Method of Using It" for a product to relieve sialorrhea (drooling) in patients suffering from Amyotrophic Lateral Sclerosis (ALS), otherwise known as Lou Gehrig's Disease. The patent extends through April 15, 2022.

o A Patent (No. 6,753,325 B2) entitled "Composition and Method for Prevention, Reduction and Treatment of Radiation Dermatitis," a composition for preventing, reducing or treating radiation dermatitis. The patent extends through November 5, 2021.

o A Patent (No. 6,827,945 B2) entitled "Nutritional Supplement and Method of Using It" for a method of treating at least one symptom of arthritis. The patent extends through April 22, 2023.

o In September 2002, the Company filed a foreign patent application entitled "Method and Composition for the Topical Treatment of Diabetic Neuropathy" in Europe and other foreign markets.

In April 2002, the Company initiated a Phase II Proof of Concept Study in France for treatment of diabetic neuropathy, which was concluded in 2003. In April 2003, the Company announced that an independently monitored analysis of the Phase II Proof of Concept Study concluded that subjects using this formulation had 67% of their symptoms improve, suggesting efficacy. In March 2004, the Company announced that it had completed its first meeting at the FDA prior to submitting the Company's Investigational New Drug ("IND") application for the relief of symptoms of diabetic symmetrical peripheral neuropathy. The FDA's pre-IND meeting programs are designed to provide sponsors with advance guidance and input on drug development programs.

In September 2003, the Company announced its intention to file for permission to study its patent pending potential treatment for psoriasis and other skin disorders. Continued testing will therefore have to be conducted under an IND application following positive preliminary results.

In December 2003, the Company announced positive test results of a preliminary independent in vitro study indicating that a test compound of the Company previously tested on the Influenza virus showed "significant virucidal activity against a strain of the Severe Acute Respiratory Syndrome (SARS) virus." In January 2004 the Company announced that it intends to conduct two further studies. The first study is intended to repeat the previously announced results, which demonstrated the compound to be 100 percent effective in preventing non-infected ferrets in close proximity to an infected ferret from becoming infected with the Influenza A virus. The second study is a dose ranging study on the test compound. Upon dosage determination and confirmation results from this forthcoming animal model study, a human proof of concept study using a virus challenge with Influenza A virus in a quarantine unit can be the next step. In January 2004, the Company also reported that its compound has shown virucidal and virustatic activity against the strain 3B of the Human Immunodeficiency Virus Type 1 (HIV-1) in an in-vitro study.

In January 2004, a broad anti-viral compound was determined to be effective in in-vitro and in-vivo studies for applications such as Influenza A&B, SARS, and Herpes Simplex 1, and since this Sialorrhea formulation is a derivative compound of the anti-viral formulation, ongoing testing for this Sialorrhea compound is being reconsidered and probably will be discontinued.

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In April 2004, the Company announced the results of a preliminary, pre-clinical animal study which measured the effect of its proprietary patent applied for formulation against ionizing (nuclear) radiation. This study determined that parenteral (injection) administration of the study compound was protective against the effects of a lethal, whole body ionizing radiation dose in a mouse model. This compound is being investigated to potentially reduce the effects of radiation exposure on humans.

EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS

In May 2005, the Financial Accounting Standards Board ("FASB") issued Statement 154, "ACCOUNTING CHANGES AND ERROR CORRECTIONS, A REPLACEMENT OF APB OPINION NO. 20 AND FASB STATEMENT NO. 3." The standard requires retrospective application to prior periods' financial statements of a voluntary change in accounting principle unless it is deemed impracticable. The standard states that a change in method of depreciation, amortization or depletion for long-lived, non-financial assets be accounted for as a change in accounting estimate that is affected by a change in accounting principle. The standard is effective for accounting changes and corrections of errors made occurring in fiscal years beginning after December 15, 2005. The adoption of Statement of Financial Accounting Standards ("SFAS") No. 154 is not expected to have a material impact on the Company's financial position or results of operations.

In December 2004, the FASB issued Statement 153,"EXCHANGES OF NONMONETARY ASSETS, AN AMENDMENT OF APB OPINION NO.29." The standard is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged and eliminates the exception under APB Opinion No. 29 for an exchange of similar productive assets and replaces it with an exception for exchanges of nonmonetary assets that do not have commercial substance. The standard is effective for nonmonetary exchanges occurring in fiscal periods beginning after June 15, 2005. The adoption of SFAS No. 153 is not expected to have a material impact on the Company's financial position or results of operations.

In December 2004, the FASB issued Statement 123 (revised 2004),"SHARE-BASED PAYMENT." The standard eliminates the disclosure-only election under the prior SFAS 123 and requires the recognition of compensation expense for stock options and other forms of equity compensation based on the fair value of the instruments on the date of grant. The standard is effective for fiscal years beginning after June 15, 2005.

CRITICAL ACCOUNTING POLICIES

As previously described, the Company is engaged in the development, manufacturing, and marketing of health and homeopathic products that are being offered to the general public and is also involved in the research and development of potential prescription products. Certain key accounting policies that may affect the results of the Company are the timing of revenue recognition and sales incentives, particularly co-operative advertising; the classification of royalties and commissions; the classification of advertising expenses; and the fact that all research and development costs are expensed as incurred. Note 1, Organization and Business, describes the Company's other significant accounting policies.

REVENUE RECOGNITION

Sales are recognized at the time ownership is transferred to the customer, which for the Cold Remedy segment is the time the shipment is received by the customer and for both the Health and Wellness segment and the Contract Manufacturing segment, when the product is shipped to the customer. Sales returns and allowances are provided for in the period that the related sales are recorded. Provisions for these reserves are based on historical experience. The 2005 and 2004 reserve balances include a returns provision at June 30, 2005 and December 31, 2004 of approximately $344,000 and $626,000, respectively, in the event of future product returns following the discontinuation of the Cold-Eeze(R) Cold Remedy Nasal Spray product in September 2004.

ADVERTISING

Advertising costs are expensed within the period in which they are utilized. Advertising expense is comprised of media advertising, presented as part of sales and marketing expense; co-operative advertising, which is accounted for as a deduction from sales; and bonus product, which is accounted for as part of cost of sales. Advertising costs incurred for the three month periods ended June 30, 2005 and 2004 were $812,497 and $289,638, respectively; the six month costs for the periods ended June 30, 2005 and 2004 were $2,507,330 and $1,589,755, respectively. Included in prepaid expenses and other current assets was $59,016 and $41,375 at June 30, 2005 and December 31, 2004, respectively, relating to prepaid advertising expenses.

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RESEARCH AND DEVELOPMENT

Research and development costs are charged to operations in the period incurred. Expenditures for the three month periods ended June 30, 2005 and 2004 were $840,659 and $820,847, respectively; the six month costs for the periods ended June 30, 2005 and 2004 were $1,908,962 and $1,767,849, respectively. Principally, research and development costs are related to Pharma's study activities and costs associated with Cold-Eeze(R) products.

RESULTS OF OPERATIONS

THREE MONTHS ENDED JUNE 30, 2005 COMPARED WITH THREE MONTHS ENDED JUNE 30, 2004

Net sales for the three month period ended June 30, 2005 were $8,844,173, reflecting an increase of $1,942,991 over the net sales of $6,901,182 for the comparable three month period ended June 30, 2004. The Cold Remedy segment reported net sales in the 2005 period of $2,140,905, an increase of $570,824, or 36.4%, over the comparable 2004 period of $1,570,081. The Health and Wellness segment reported net sales in the 2005 period of $5,337,573, an increase of $6,472, or 0.1%, over the net sales of $5,331,101 for the comparable 2004 period. The Contract Manufacturing segment reported net sales of $1,365,695 in the 2005 period with no comparable amount in the 2004 period as this segment commenced business as a part of The Quigley Corporation on October 1, 2004.

Net sales of the Cold Remedy segment were favorably affected by the prolonged nature of the recent cold season, increased consumer demand and increased household penetration. In addition, the Company continued to generate increased sales and greater market penetration for the Cold-Eeze(R) products due to continued product support and promotion.

The Health and Wellness segment's net sales decreased in the 2005 period as a result of a decline in the number of active domestic independent representatives. This decline was partially offset by an increase in European sales of 39.7% over the 2004 comparable period.

Cost of sales as a percentage of net sales for the three months ended June 30, 2005 was 65.7% compared to 59.8% for the comparable 2004 period, an increase of 5.9%. This increase was primarily due to the provision for obsolete product and the lower gross profit margin attributable to the contract manufacturing segment.

Sales and marketing expense for the three month period ended June 30, 2005 were $1,066,759, an increase of $232,285 over the comparable 2004 period amount of $834,474. The increase was primarily due to increased media advertising in the 2005 period in support of the Cold-Eeze(R) products and increased costs associated with sales growth.

General and administration costs for the three month period ended June 30, 2005 was $2,986,507 compared to $2,054,741 during the 2004 period, an increase of $931,766 between the periods. The increase in 2005 was primarily due to increased payroll costs for the period and 2005 costs associated with the contract manufacturing segment for which there are no comparable 2004 costs as this segment commenced business as a part of the Company on October 1, 2004.

Research and development costs during the three months ended June 30, 2005 were $840,659 compared to $820,847 during the 2004 comparable period, reflecting an increase in 2005 of $19,812, primarily as a result of increased Pharma segment costs and reduced study activity related to the Cold-Eeze(R) products.

SIX MONTHS ENDED JUNE 30, 2005 COMPARED WITH SIX MONTHS ENDED JUNE 30, 2004

Net sales for the six month period ended June 30, 2005 were $20,597,443, reflecting an increase of $4,090,644 over the net sales of $16,506,799 for the comparable six month period ended June 30, 2004. The Cold Remedy segment reported net sales in 2005 of $7,887,546, an increase of $2,203,873, or 38.8%, over the comparable 2004 period of $5,683,673. The Health and Wellness segment reported net sales in 2005 of $10,333,578, a reduction of $489,548, or 4.5%, over the net sales of $10,823,126 for the comparable 2004 period. The Contract Manufacturing segment reported net sales of $2,376,319 in the 2005 period with no comparable amount in the 2004 period as this segment commenced business as a part of The Quigley Corporation on October 1, 2004.

Net sales of the Cold Remedy segment were favorably affected by the prolonged nature of the recent cold season, increased consumer demand and increased . .