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Article by DailyStocks_admin    (06-17-08 08:25 AM)

The Daily China Business Stock for 06/17/2008 is PSDV

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Our Business

We are a global drug delivery company committed to the biomedical sector and the development of therapeutic delivery products. Retisert ® is approved by the U.S. Food and Drug Administration (“FDA”) for the treatment of posterior uveitis. Vitrasert ® is FDA approved for the treatment of AIDS-related CMV retinitis. The Company has licensed the technologies underlying both of these products to Bausch & Lomb Incorporated. The technology underlying the Medidur™ for diabetic macular edema (“DME”) product candidate using fluocinolone acetonide (“Medidur FA for DME”) is licensed to Alimera Sciences and is in Phase III clinical trials. The Company has a worldwide collaborative research and license agreement with Pfizer for certain of the Company’s technologies, including the technology underlying Medidur, in certain ophthalmic applications.

We own the rights to develop and commercialize a novel-porous biomaterial composed of nanostructured elemental silicon, known as BioSilicon™, which has potential applications in drug delivery, wound healing, orthopedics and tissue engineering. The most advanced BioSilicon product, BrachySil™, delivers phosphorus-32, a beta-emitting radioactive isotope shown to shrink tumors, directly to solid tumors. We recently completed a Phase IIa clinical trial of BrachySil™ for the treatment of pancreatic cancer and expect to shortly begin a Phase IIb dose-ranging clinical trial.

BioSilicon™, BrachySil™ and Medidur™ are our trademarks. Retisert ® and Vitrasert ® are Bausch & Lomb’s trademarks.

Summary of Critical Accounting Policies

We prepare our consolidated financial statements in accordance with U.S. GAAP. In preparing these financial statements, we make certain estimates, judgments and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. These estimates, judgments and assumptions, which management believes are reasonable under the circumstances and are based upon the information available at the time, cannot be made with certainty. These estimates, judgments and assumptions may change as new events occur or as additional information is obtained, and actual results may differ from these estimates under different assumptions or conditions. While there are a number of accounting policies, methods and estimates affecting our financial statements as described in Note 2 to the accompanying unaudited condensed consolidated financial statements, management has identified certain of these accounting policies to be critical to aid in a full understanding and evaluation of our financial condition and results of operations. A critical accounting policy is one that is both material to the presentation of our financial statements and requires us to make subjective or complex judgments that could have a material effect on our financial condition and results of operations. We believe the following critical accounting policies, and our procedures relating to these policies, require more significant judgments and estimates in the preparation of our consolidated financial statements.

Revenue Recognition for License Agreements

The Company has entered into collaborative license and development arrangements with strategic partners for the development and commercialization of products utilizing the Company’s technologies. The terms of these agreements typically include multiple deliverables by the Company (for example, license rights, providing research and development services and manufacturing of clinical materials) in exchange for consideration to the Company of some combination of non-refundable license fees, funding of research and development activities, payments based upon achievement of clinical development milestones and royalties in the form of a designated percentage of product sales or profits. The Company follows the provisions of the Securities and Exchange Commission’s Staff Accounting Bulletin (“SAB”) No. 101 (“SAB 101”), “ Revenue Recognition in Financial Statements ”, as amended by SAB No. 104 (“SAB 104”), “ Revenue Recognition ”, and Emerging Issues Task Force (“EITF”) Issue No. 00-21 (“EITF 00-21”) , “ Accounting for Revenue Arrangements with Multiple Deliverables ”. With the exception of royalties, these types of consideration are classified as collaborative research and development revenue in the Company’s statements of operations when revenue recognition is appropriate.

Non-refundable license fees are recognized as revenue when the Company has a contractual right to receive such payment, the contract price is fixed or determinable, the collection of the resulting receivable is reasonably assured and the Company has no further performance obligations under the license agreement. Multiple element arrangements, such as license and development arrangements, are analyzed to determine whether the deliverables can be separated or whether they must be accounted for as a single unit of accounting in accordance with EITF 00-21. The Company recognizes up-front license payments as revenue upon delivery of the license only if the license has stand-alone value and the fair value of the undelivered performance obligations can be determined. If the fair value of the undelivered performance obligations can be determined, such obligations would then be accounted for separately as performed. If the license is considered to either (i) not have stand-alone value or (ii) have stand-alone value but the fair value of any of the undelivered performance obligations cannot be determined, the arrangement would then be accounted for as a single unit of accounting.

For arrangements that are accounted for as a single unit of accounting, total payments under the arrangement, excluding royalties and payments contingent upon achievement of substantive milestones, are recognized as revenue on a straight-line basis over the period the Company expects to complete its performance obligations. The cumulative amount of revenue earned is limited to the cumulative amount of payments received as of the period ending date.

If the Company cannot reasonably estimate when its performance obligation either ceases or becomes inconsequential, then revenue is deferred until the Company can reasonably estimate when the performance obligation ceases or becomes inconsequential. Revenue is then recognized over the remaining estimated period of performance. Deferred revenue amounts are classified as current liabilities to the extent that revenue is expected to be recognized within one year.

Significant management judgment is required in determining the level of effort required under an arrangement and the period over which the Company is expected to complete its performance obligations under an arrangement.

Amended and Restated Collaboration Agreement with Alimera Sciences, Inc.

As discussed in Note 4 to the accompanying unaudited condensed consolidated financial statements, we entered into an amended collaboration agreement with Alimera on March 14, 2008. The terms and conditions of this amendment required an assessment of the expected term of the agreement and our obligations thereunder. Pursuant to EITF 00-21, we evaluated the Company’s obligations under the amended agreement and concluded that, since each deliverable did not have a determinable fair value to the licensee on a standalone basis, such deliverables represented a single unit of accounting. The Company further determined that all of its consequential development obligations under the amended agreement would cease no later than December 31, 2009. Accordingly, commencing on the effective date of the amended agreement, the Company will amortize the aggregate $18.3 million deferred revenue balance that existed at that date on a straight-line basis over the 21.5 month performance period. The $18.3 million deferred revenue balance consisted of (i) a $12.0 million payment received upon the execution of the amended agreement; (ii) cancellation of approximately $5.7 million of accrued development costs, including related penalties and accrued interest, owed by the Company to Alimera as of March 14, 2008; and (iii) an additional $650,000 of previously received but unamortized milestone payments.

All future payments received from Alimera during the designated performance period will be recognized as revenue using the cumulative catch-up method. Under this method, the portion of any such payment represented by the time elapsed from the amendment effective date to the payment date as a percentage of the 21.5 month performance period will be recognized immediately as revenue, with the remainder amortized on a straight-line basis over the remaining performance period. All payments received from Alimera following the end of the performance period will be recognized as revenue when earned.

Pfizer Collaborative Research and License Agreement

On April 3, 2007, the Company and Pfizer, Inc. entered into a Collaborative Research and License Agreement (the “Pfizer Agreement”) which superseded a prior research agreement dated December 22, 2006. Under the Pfizer Agreement, the parties have implemented a joint research program aimed at developing ophthalmic products using the Company’s Durasert drug delivery technology. In addition to potential development and sales related milestone payments, Pfizer will pay the Company $500,000 per quarter, commencing in calendar year 2008, in consideration of the Company’s costs in performing the research program, and continuing until the commencement of a Phase III clinical trial for the first licensed product candidate or until the agreement is earlier terminated. Pfizer made the first $500,000 research payment in February 2008.

The two Pfizer agreements have been combined for accounting purposes and, following an evaluation of the multiple deliverables in accordance with the provisions of EITF 00-21, the Company concluded that there was a single unit of accounting. The Company is currently evaluating the deliverables and other obligations under the Pfizer Agreement and, as a result, all payments received to date from Pfizer totaling $1.25 million have been recorded as deferred revenue.

Intrinsiq License Agreement

On January 17, 2008, the Company and Intrinsiq entered into an agreement pursuant to which Intrinsiq acquired an exclusive license to develop and commercialize nutraceutical and food science applications of BioSilicon, and certain related assets, for $1,230,000. Intrinsiq paid $500,000 at closing and agreed to make additional payments totaling $730,000 through January 2009. In addition, subject to its unilateral right to terminate the license upon 90 days prior written notice, Intrinsiq will be obligated to pay the Company minimum royalties of $3.95 million over five years, of which the first $500,000 payment is due 18 months after the closing.

The Company is required to spend approximately $460,000 to expand the Company’s BioSilicon manufacturing capacity and is obligated to enter into a supply agreement with Intrinsiq. The Company does not believe that the agreement to execute a supply agreement has standalone value to Intrinsiq. Therefore, until the supply agreement is executed, the Company is unable to estimate the period of its performance obligations under the license agreement. The aggregate total of $1.2 million, consisting of cash received and contractual amounts due from Intrinsiq, has been recorded as deferred revenue at March 31, 2008, and will not be subject to revenue recognition until the Company can determine the end date of its performance obligations.

Intangible Assets and Goodwill

Intangible assets acquired in a business combination

All potential intangible assets acquired in a business combination are identified and recognized separately from goodwill where they satisfy the definition of an intangible asset and their fair value can be measured reliably.

In connection with our acquisition of CDS referred in Note 2 of our unaudited condensed consolidated financial statements, we determined that the portion of the CDS purchase price allocation assigned to Medidur met the definition of in-process research and development, or IPR&D, as the product was in Phase III clinical trials, had not been approved by the FDA and did not have alternative future use other than the indications for which it was in development. As such, the value assigned to Medidur was immediately expensed on the acquisition date in accordance with FASB Interpretation No. 4, Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase Method.

The portion of the purchase price allocation assigned to Retisert, which was a commercially available product approved for sale by the FDA at the date of the CDS acquisition, is subject to amortization over the estimated useful life of the intangible asset. We evaluated several pertinent factors to determine an appropriate useful life. These included:


•

the Retisert for Uveitis patents will be further commercialized as we advance other development programs using these patents for similar drug delivery devices for other eye diseases;


•

the acquired intellectual property is not related to another asset or asset group that could limit its life;


•

the acquired patents have a legal expiration of 12 to 15 years from the date of acquisition and we are unaware of any regulatory or contractual provisions that would limits their lives;

•

the potential for product obsolescence as a result of competition and the financial limitations on our product development capabilities; and


•

the minimal expected costs of ongoing patent maintenance.

On the basis of these and other considerations, our judgment was that the acquired patents had an estimated useful life of 12 years from the date of acquisition.

Goodwill

Goodwill arising on consolidation consists of the excess of the cost of the acquisition over our interest in the fair value of the identifiable assets and liabilities at the date of acquisition. The excess of the purchase price over the fair value of the assets and liabilities of CDS acquired on December 30, 2005, $30.5 million, was recorded as purchased goodwill and is subject to testing for impairment on at least an annual basis. In applying impairment testing, our judgment was that the consolidated entity is the deemed reporting unit. In making this determination we considered that (1) we operate in one business segment, the biotechnology sector; and (2) our executive management assesses operating performance and reviews financial statements predominantly at the consolidated level.

The Company is required to test for goodwill impairment on an annual basis (June 30 of each year) and whenever events or changes in circumstances indicate that the carrying value may no longer be recoverable. For the analysis at June 30, 2007, the cash flow projections were based on the expectations and forecasts of management covering a 10.5 year period (the remaining estimated useful life of the Company’s patents) and applying a discount rate equal to a weighted average cost of capital for the Company of approximately 17.5%. Management believes the estimated useful life to be a reasonable period to consider based on the nature of the industry and the often long product development cycles prior to commercialization. Cash flows were estimated based on current numbers of patients diagnosed with the condition which the Company’s products are developed to treat, with growth rates based on generally expected trends, ranging between 0% and 4% per annum. Management considers such growth rates to be reasonable. Market penetration rates were developed based on currently available sales results and on management’s future expectations and range from between 0.4% to 12%. Management considers the market penetration rates applied to be reasonable based on the unmet need of the conditions for which the Company’s products are being developed to treat. Development costs were estimated based on historical costs and on management’s development plans currently in place, with general and administrative costs assumed to grow at the rate of 5% per annum after the three year period for which detailed cost budgets were prepared by management.

Impairment of Intangible Assets

The Company reviews its intangible assets for impairment whenever events or other changes in circumstances indicate that the carrying value of an asset may no longer be recoverable. At December 31, 2006 and at June 30, 2007, the Company identified triggering events that required in-depth assessment of the recoverability of the carrying value of its Retisert and BrachySil intangible assets. The valuation assessment required detailed analysis of projected future cash inflows and cash outflows associated with each intangible asset. These projections required the application of numerous judgments. In the case of Retisert, a commercialized product with two years of sales history, these judgments and estimates included market penetration rates, estimated market growth, potential impact of new technologies under development, penetration rate for re-implants and appropriate weighted average cost of capital rate to discount the future cash flows. In the case of BrachySil, a product candidate then in Phase IIa clinical trial, other estimates included the cost and duration of later stage clinical trials, timing of regulatory approval and the probability of a collaboration agreement with a third party.

At June 30, 2007, the Company recorded an impairment write-down of $45.3 million in connection with its Retisert patents. No impairment write-downs were required at December 31, 2006.

If the actual cash flows are significantly different from the projected amounts, the Company may be required to record additional impairment write-downs against the $37.8 million of carrying value of its intangible assets at March 31, 2008.

Accounting for Convertible Notes

The Company financed its activities partially through the issuance of convertible notes with detachable warrants in November 2005 and September 2006 to institutional investors. These compound instruments require analysis of their component parts and appropriate classification as liabilities and equity. We concluded that the note holder conversion option was an embedded derivative that required bifurcation and classification as a derivative liability subject to fair value adjustment through the consolidated statements of operations. The fair value of the embedded derivative was estimated using the Binomial Tree Model, taking into account assumptions as to share price volatility, dividend yield and market interest rates for a comparable non-convertible debt instrument.

The initial carrying value of a convertible note liability is determined by first subtracting from the gross proceeds the relative fair value of any equity component and then subtracting the fair value of any compound embedded derivatives. The effective interest method is used to amortize to finance costs the debt discount over the expected life of the financial liability, or such shorter period as may be deemed appropriate. Debt issue costs are recorded as an asset and similarly amortized to finance costs over the life of the financial liability.

During the year ended June 30, 2007, the Company entered into multiple amendments of the terms of the Sandell convertible note. For each amendment, the Company estimated the present value of the future cash flows of the amended note, including cash and non-cash consideration, against that of the pre-amendment note. If the resulting present values reflected a change of greater than 10%, the pre-amendment note was accounted for as an extinguishment of debt and the issuance of a new compound debt instrument. Alternatively, if the resulting present values reflected a change of less than 10%, the amendment was treated as a modification of the original debt instrument. As more fully described in Note 6 of the accompanying unaudited condensed consolidated financial statements, during the nine months ended March 31, 2007, the Company entered into three amendments of its Sandell convertible note, two of which resulted in extinguishment of the prior debt instrument and one of which was treated as a debt modification.

Results of Operations

Three Months Ended March 31, 2008 Compared to Three Months Ended March 31, 2007.

Revenue

Revenue increased by $173,000, or 47%, to $542,000 for the three months ended March 31, 2008 from $369,000 for the three months ended March 31, 2007. The increase was primarily attributable to $426,000 of revenue recognized in connection with the amended collaboration agreement with Alimera consummated on March 14, 2008, partially offset by a $220,000 decrease in royalty income payable to the Company by Bausch & Lomb on its sales of Retisert.

The Company recorded approximately $18.3 million of deferred revenue at the effective date of the Alimera amendment (see Note 4 of the unaudited condensed consolidated financial statements), which will be recognized to revenue ratably over the performance period through December 2009, or approximately $2.5 million per quarter. Additional consideration received by the Company pursuant to the Alimera agreement prior to December 31, 2009 will also be recognized ratably over the performance period, including immediate revenue recognition for the pro rata period from the effective date to the date of receipt.

Pursuant to a June 2005 advance royalty agreement, Bausch & Lomb has retained (a) 50% of Retisert royalties otherwise payable to the Company through June 30, 2007 and (b) 100% of Retisert royalties otherwise payable to the Company subsequent to June 30, 2007. Subsequent to March 31, 2008, Bausch & Lomb is entitled to retain an additional $3.3 million of future Retisert royalties otherwise payable to the Company. Accordingly we currently do not expect to receive any Retisert royalty income from Bausch & Lomb through at least the fiscal year ending June 30, 2009.

Royalties retained by Bausch & Lomb pursuant to the advance royalty agreement which would otherwise have been payable to the Company for the three months ended March 31, 2008 were $371,000. This was a 20% decrease from $461,000 paid or otherwise payable to the Company in the same quarter a year earlier and a 31% decrease from $541,000 otherwise payable to the Company in the immediately preceding quarter.

Research and Development

Research and development decreased by approximately $1.5 million, or 30%, to approximately $3.6 million for the three months ended March 31, 2008 from approximately $5.2 million for the three months ended March 31, 2007. This decrease was primarily attributable to the following factors:


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a decrease of approximately $1.1 million in amortization of intangible assets due to the effect of the $45.3 million asset impairment write-down at June 30, 2007 related to our Retisert patents; and


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a decrease of approximately $600,000 in our U.K. and Singapore-based operating expenses as a result of (i) personnel reductions in the U.K. which were implemented as cost reduction measures and (ii) reduced depreciation expense; which were partially offset by


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an increase of approximately $200,000 in development costs related to the Phase III clinical trial of the Medidur FA for DME product candidate through the March 14, 2008 effective date of the Company’s amended collaboration agreement with Alimera.

Development costs related to the Phase III clinical trial of the Medidur FA for DME product candidate, which totaled approximately $1.2 million for the three months ended March 31, 2008, will not be incurred in future periods pursuant to the terms of the amended collaboration agreement with Alimera.

Selling, General and Administrative

Selling, general and administrative costs increased by approximately $1.5 million, or 72%, to approximately $3.5 million for the three months ended March 31, 2008 from approximately $2.1 million for the three months ended March 31, 2007. This increase was primarily attributable to the following factors:


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an increase of approximately $1.0 million in legal fees, primarily related to (a) the Company’s proposal to reincorporate in the United States and (b) collaboration agreements; and


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an increase of approximately $275,000 in share-based payments expense, primarily due to the effect of prior year period forfeitures.

Change in Fair Value of Derivative

Change in fair value of derivative represented income of approximately $1.2 million for the three months ended March 31, 2008 compared to expense of approximately $6.7 million for the three months ended March 31, 2007.

For the three months ended March 31, 2008, the change in fair value of derivative was related to warrants issued in financing transactions denominated in A$ and resulted in income of approximately $1.2 million primarily due to a decrease in the market price of our ordinary shares during that period. These derivative liabilities will be subject to future revaluation through expiration, or earlier exercise, of the underlying warrants. Several factors, primarily decreases or increases in the Company’s ordinary share price, will result in income or expense amounts, respectively, to be recorded in future periods.

For the three months ended March 31, 2007, the change in fair value of derivative consisted of (a) approximately $4.5 million of expense related to the embedded conversion features of our convertible notes, which were redeemed in full prior to June 30, 2007 and (b) approximately $2.2 million of expense related to warrants issued in financing transactions denominated in A$. The expense amounts were primarily attributable to an increase in the market price of our ordinary shares during that period.

Interest Income

Interest income increased by approximately $59,000, or 95%, to $121,000 for the three months ended March 31, 2008 from $62,000 for the three months ended March 31, 2007. This increase was attributable to (i) interest earned on cash equivalent balances resulting from the July 2007 share issue as described in Note 3 of our unaudited condensed consolidated financial statements and (ii) interest accrued on the $1.5 million note receivable due April 2008 in connection with the April 2007 sale of our former subsidiary, AION Diagnostics Limited, the principal and interest of which has not been paid and is overdue (see Note 11 to the accompanying unaudited condensed consolidated financial statements).

Interest and Finance Costs

Interest and finance costs were $206,000 for the three months ended March 31, 2008 compared to approximately $2.0 million for the three months ended March 31, 2007. The decrease in interest and finance costs of approximately $1.8 million was primarily attributable to the absence in the current period of (i) approximately $370,000 of interest expense and approximately $1.3 million of amortization of debt discount and issue costs in connection with convertible notes which were subsequently redeemed prior to June 30, 2007 and (ii) approximately $147,000 of registration rights delay penalties. As of June 30, 2007, all required registration statements had been filed and declared effective by the SEC. In addition, for the three months ended March 31, 2008 and 2007, we accrued approximately $205,000 and $150,000 of interest expense, respectively, on the portion of shared Medidur FA for DME product candidate development costs that we elected not to pay. In connection with the amended collaboration agreement with Alimera, the total development costs, including associated penalties and accrued interest, owed by the Company to Alimera were cancelled. The Company does not expect to incur any interest and finance costs for the remainder of the fiscal year ending June 30, 2008.

Deferred Income Tax Benefit

Deferred income tax benefit decreased to $15,000 for the three months ended March 31, 2008 from $3.5 million for the three months ended March 31, 2007. The primary reason for the smaller benefit in the current period is that since June 30, 2007 valuation allowances have been required to offset essentially all net operating loss carryforwards created during the current period, which was not the case for the earlier period. The limitation on the ability to record deferred tax assets since June 30, 2007 was primarily attributable to the significant impairment write-down (and resulting decrease in the deferred tax liabilities) recorded in June 2007 related to the Retisert patents.


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