Obagi Medical Products, Inc. (OMPI) - Description of business

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Company Description
Corporate information Dr. Zein Obagi founded WorldWide Product Distribution, Inc. in 1988. OMP Acquisition Corporation was formed as a California corporation in October 1997 to purchase substantially all of the assets and to assume the accounts payable and related operating liabilities of WorldWide Product Distribution, Inc. and subsequently changed its name to Obagi Medical Products, Inc. in December 1997. OMP, Inc. was incorporated in Delaware in November 2000 and, in January 2001, Obagi Medical Products, Inc. was merged into OMP, Inc., with OMP, Inc. as the surviving corporation. In December 2004, the stockholders of OMP, Inc. exchanged their shares of OMP, Inc. for an equal number of shares in a newly formed holding company incorporated in Delaware, Obagi Medical Products, Inc., which became the parent holding company for all existing operations. Our principal executive offices are located at 310 Golden Shore, Long Beach, California 90802 and our telephone number is (562) 628-1007. Our website address is http://www.obagi.com. Copies of our most recent Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q and our other reports filed with the Securities and Exchange Commission, or the SEC, can be obtained, free of charge as soon as reasonably practicable after such material is electronically filed with, or furnished to the SEC, by calling Ina McGuinness at Integrated Corporate Relations at (310) 954-1100, through the SEC’s website by clicking the SEC Filings link from the Investor Relations page on our website at www.obagi.com or directly from the SEC’s website at www.sec.gov. Our website and the information contained therein or connected thereto are not intended to be incorporated into this Annual Report on Form 10-K. Overview We are a specialty pharmaceutical company focused on the aesthetic and therapeutic skin health markets. We develop and commercialize prescription-based, topical skin health systems that enable physicians to treat a range of skin conditions, including pre-mature aging, photo-damage, hyperpigmentation (irregular or patchy discoloration of the skin), acne and soft tissue deficits, such as fine lines and wrinkles. Our products are designed to improve the underlying health of patients’ skin, and our clinical studies have demonstrated that the use of our Obagi Nu-Derm System results in skin that looks and acts younger and healthier. We focus our research and development activities on improving the efficacy of established prescription and over-the-counter, or OTC, therapeutic agents by enhancing the penetration of these agents across the skin barrier using proprietary technologies collectively known as Penetrating Therapeutics™. Through our own domestic sales force and foreign distribution partners, we market and sell physician-dispensed skin care systems directly to plastic surgeons, dermatologists and other physicians who are focused on aesthetic and therapeutic skin care. We are the market leader in the growing physician-dispensed skin care channel, according to an independent 2006 study by Kline & Co. Our net sales have grown from approximately $35.6 million in 2001 to approximately $78.0 million in 2006. We currently market and sell a range of systems and related products for the enhancement of skin health. Our leading product line is our Obagi Nu-Derm System. This system was launched in 1988, and since that time, we have made substantial enhancements to the system through the application of our Penetrating Therapeutics technology. We believe that our Obagi Nu-Derm System is the only clinically proven, prescription-based topical skin health system on the market that has been shown to enhance the skin’s overall health by correcting photo-damage using drugs that, by definition, work at the cellular level, resulting in a reduction of the visible signs of aging. We have further leveraged our Penetrating Therapeutics technology through the systems that we market. In 2004, we launched the Obagi-C Rx System, which we believe is the only prescription-based system that reduces the early effects of sun damage and evens skin tones through the use of Vitamin C serum combined with 4% hydroquinone. We are the sole licensee of certain Avon patents relating to this technology. In 2005, we launched Professional-C, a series of high potency antioxidant Vitamin C serums that help to counteract the effects of ultraviolet radiation and other environmental influences. Professional-C represents an improved product line with more effective skin barrier penetration replacing our Vitamin C serum offerings marketed under the Cffectives and Obagi-C brands that we introduced in 2000. In July 2006, we launched Nu-Derm Condition and Enhance targeted for use with Botox. This system provides adjunctive therapy following Botox injections, which was designed to enhance aesthetic outcomes and improve overall patient satisfaction. In October 2006, we introduced the first product in the ELASTIderm™ product line, ELASTIderm™ Eye Cream, a nighttime eye cream for treatment of skin laxity around the eye. In February 2007, we launched a second product in the ELASTIderm line for daytime use, ELASTIderm™ Eye Gel, to use along with our ELASTIderm Eye Cream, as an eye therapy system. ELASTIderm products are formulated with a patent pending bi-mineral complex, which is clinically shown to help the body’s own natural ability to increase epidermal thickness, augment hypodermal fat and increase elastin levels. In February 2007, we launched CLENZIderm M.D.™, a system of products for acne treatment featuring a novel formulation of Benzoyl Peroxide, or BPO. Our clinical studies have shown that CLENZIderm M.D. penetrates more readily into the skin follicle than current creams or gels because it is in solution form (1/100 th  - 1/1000 th  of the size of current BPO particles). We believe that our solution-based acne system is a more effective treatment for acne because a greater amount of the active ingredient, BPO, will penetrate the hair follicle to more rapidly kill P. acne bacteria. In addition, we offer tretinoin, a generic equivalent to Retin-A, which has been among the most widely used acne treatments for approximately 25 years. We currently distribute a Food and Drug Administration, or FDA, approved generic equivalent in the physician-dispensed channel under an exclusive license agreement with Triax Pharmaceuticals, LLC. We also sell the Obagi Blue Peel which has been cited by Kline & Co. as one of the most well known brands for use in physician-strength facial peel procedures. While the Obagi Blue Peel products are not dispensed for daily home use in a system and are therefore not a significant source of our revenue, they are used to aid the physician in skin peeling activities. Acceptance and awareness of the Obagi Blue Peel among physicians give it an intrinsic value as a marketing tool in driving new account growth. We believe that our products have the potential to be used in a number of applications and procedures beyond their current use. For example, our Obagi Systems may complement and enhance commonly performed cosmetic procedures, such as Botox injections, as well as shorten healing times and reduce the post-inflammatory hyperpigmentation that typically follow laser therapy and basal cell carcinoma excisions, and we are conducting clinical studies to evaluate the adjunctive use of our systems before and after these types of procedures. We expanded this initiative in 2005, and are working with physicians and physicians’ associations to evaluate the use of our Obagi Nu-Derm System in enhancing skin healing in ablative and non-ablative laser procedures. In late 2005 and through 2006, we conducted a study targeting more than 5,000 patients and supporting independent clinical research on our systems. The study entails physician and patient evaluations of skin quality on patients using our Obagi Nu-Derm System in conjunction with other cosmetic facial procedures. Based on the results of the clinical use study, in which patient outcomes have been documented for 2,697 patients, we launched new systems for use before and after commonly performed cosmetic procedures in July 2006. These systems are positioned under the Nu-Derm Condition and Enhance brand, with an initial focus on use in conjunction with Botox injections (Botox is a registered trademark of Allergan, Inc.). We are using this data to evaluate possible individual clinical studies on the use of Nu-Derm Condition and Enhance with  specific procedures. For example, in February 2007, we entered into an agreement with Syneron to perform a joint clinical use study of Nu-Derm Condition and Enhance system used as an adjunct therapy with Syneron’s energy based systems, with physicians who are experienced with Syneron’s systems, in order to evaluate the enhanced aesthetic outcomes and improved overall patient satisfaction. However, this study has not yet been undertaken and will require the cooperation of physicians not yet identified, and as such, there can be no assurance that the end results of this study will be positive. We plan to continue to build clinical support for the benefits of our systems in conditioning the skin and enhancing the outcomes of the most commonly performed cosmetic procedures, such as chemical peels, dermabrasion, and laser resurfacing, as well as the aesthetic and wound healing aspects of surgical procedures such as basal cell carcinoma excisions. We engage in an active development program using our Penetrating Therapeutics technology to enhance the efficacy of established FDA-approved and OTC active ingredients. Positive findings from completed pilot studies of these new systems may not be duplicated in the larger studies that we are currently completing, or the incidence of side effects in these larger studies may force us to reformulate our products. We will continue to seek additional market opportunities where we believe we can improve the effectiveness of existing products through the application of our Penetrating Therapeutics technology to address conditions such as fungal infections, dermatitis, psoriasis, hair loss and hair removal. We also advance our development objectives through product and license agreements with third parties. These agreements may include patent and technology licenses, product licenses and new product collaboration agreements. For example, we are developing products for the regeneration of elasticity in skin which are covered by claims contained in a patent application which we license from JR Chem LLC. The initial focus will be centered on products applied around the eyes, on the neck and on the back of the hands, where the break down in skin elasticity is most visible in aging skin. The first products to result from our collaboration with JR Chem are the products in our ELASTIderm product line. In addition, in December 2005, we entered into a product supply and collaboration agreements with Triax Pharmaceuticals, LLC for the supply of certain of its tretinoin products and to provide Obagi-branded tretinoin products in various concentrations. In the United States, we sell our systems and related products directly to physicians through our internal sales force, which as of December 31, 2006 consisted of 109 sales, marketing and education specialists, including 96 direct sales representatives and managers. Physicians dispense our products in-office, directly to their patients, a distribution method commonly referred to as the “physician-dispensed” channel. We believe that the physician-dispensed distribution model ultimately results in higher patient satisfaction because it is better suited to the provision of system-based skin care than traditional drug distribution channels. Our physician customer base consists primarily of plastic surgeons and dermatologists, but also includes an increasing number of physicians from other practice areas, such as internal medicine and obstetrics and gynecology, or OBGYN, who are adding skin care to their practices. As of December 31, 2006, we sold our products to approximately 4,400 accounts in the United States, which we believe represented over 6,000 individual practicing physicians. Based on a 2006 study by Kline & Co., an independent market research firm, we are the leading skin health company in the physician-dispensing channel, with an estimated 27% market share and nearly three times the market share of the next largest competitor. Outside the United States, we utilize distribution partners for the sale of our systems and related products. We currently have 12 distribution partners who sell our products through their own dedicated sales forces in approximately 35 countries. We also compete in the Japanese retail skin care markets through a strategic licensing agreement with Rohto Pharmaceutical Co., Ltd., or Rohto. Rohto is a Japanese pharmaceutical manufacturer and distributor. Under our agreement, Rohto is licensed to manufacture and sell a series of OTC products under the Obagi brand name, including Obagi-C (a Vitamin C based topical serum in various concentrations), in the Japanese drug store channel and we receive a royalty based upon sales of Obagi branded products in Japan by Rohto. We have other licensing arrangements in Japan to market and sell OTC product systems under the Obagi brand, both for in-office use in facial procedures, as well as for sale as a take-home product kit in the spa channel. Our net licensing revenue from skin health systems and products in Japan was approximately $4.1 million in 2006. Background Skin damage and disorders The skin is the largest organ in the body, consisting primarily of two layers: the epidermis, a thin outer layer; and the dermis, a relatively thick inner layer. The epidermis is comprised of specialized cells such as keratinocytes and melanocytes. Keratinocytes are formed in the epidermis and travel to the skin’s surface and are exfoliated, or shed off, as they die in a maturation cycle which normally takes approximately six weeks. Buildup of excess keratinocytes can result in rough, thick or dry skin. Melanocytes produce melanin, the pigment that determines skin color and protects the body from ultraviolet radiation. The dermis is comprised largely of connective tissue fibers made of collagen and elastin. Collagen is a tough, fibrous protein that helps give skin its strength and resiliency. Elastin is a tissue that helps maintain healthy skin tension and gives skin its shape, but does not readily regenerate post-puberty and degrades over time. As the elastin degrades, skin tone and elasticity become diminished, resulting in loose, sagging skin. The health and appearance of a person’s skin is impacted by a variety of intrinsic and extrinsic factors, including pre-mature aging, photo damage, hormones, stress, pollutants, diets and skin diseases. These factors cause newly created cells to be damaged which leads to an increase in the skin cell maturation cycle. The result is that skin cells are disorganized and pigment cell activity is increased. The damaged epidermal cells cause a wide variety of conditions such as mottled pigmentation (varied pigment density across the skin), melasma (skin discoloration often caused by hormonal changes such as those from pregnancy), age spots, fine lines and dry thickened sallow skin. In the dermis of extrinsic or intrinsic aged skin, the amount of new collagen and elastin produced decreases, resulting in fibers that do not support the structure and the dermis becoming thinner. As a result deep lines, wrinkles and sagging skin make the appearance of skin significantly worse. Skin health is also impacted by diseases such as acne, rosacea, dermatitis, and psoriasis. Imbalanced production of skin oils such as sebum encourages accelerated growth of microbes in the skin such as Propionibacterium acnes, or P.acne. The skin can also become host to viral or fungal infections. While these conditions and diseases are not life-threatening, they are readily apparent, sometimes disfiguring, usually chronic and can be debilitating in terms of a person’s self image and confidence. As a result, people are often highly motivated to seek treatment programs to restore the look and feel of their skin. The skin care market In 2005, the global skin care market was estimated to be $36.2 billion, of which over 62% were facial skin care products, according to Global Industry Analysts, Inc., a market research firm. Additionally, the independent research firm, Kalorama Information, estimates that from 2005 to 2010, over 70 million people in the United States alone will receive cosmetic facial procedures for which they will pay over $60 billion. We believe this reflects a growing desire and acceptance among the aging population to seek aesthetic facial products and procedures from their physicians. A key driver of this trend is the aging of the “baby boomer” segment of the U.S. population. In addition, life expectancy in the United States has extended in recent years, leading to a further increase in the average age of the country’s population. Because healthcare needs, including the treatment of skin disorders, tend to increase with age, we expect the demand for dermatologic products to continue to increase over time. In particular, women tend to demonstrate a higher motivation than men to improve their personal appearances. The number of women between the ages of 35 and 65, the primary users of our products, was estimated by the U.S. Census Bureau to have grown 35% between 1990 and 2004. With this segment’s strong desire to reduce the signs of pre-mature aging, we expect the aging female population to continue to increase the market opportunity for skin care products. Consumer demand for physician-dispensed skin care products and procedures has been steadily growing. We believe this growth is due to consumers realizing that many non-prescription consumer cosmetic products are unable to fully meet their needs. Consumers have increasingly turned to their physicians for products and simple in-office procedures that can provide better results than consumer cosmetics. For example, physician-directed cosmetic products and commonly performed cosmetic procedures such as Botox injections, laser hair removal and microdermabrasion (a cosmetic procedure that removes the outermost layer of the skin to promote skin rejuvenation), have experienced substantial growth as consumers learn that they can achieve positive cosmetic results with minimally invasive techniques. According to the American Society of Plastic Surgeons, or ASPS, the number of minimally-invasive cosmetic office procedures performed increased 72% from approximately 4.9 million in 2002 to approximately 8.4 million in 2005. This increase was led by facial procedures such as Botox, up 242% in 2005 compared to 2002, and injectable fillers, which were first measured by ASPS in 2003, and increased 990% in 2005 compared to 2003. Beyond anti-aging and aesthetic treatments, there is significant market demand for effective treatments of skin diseases such as acne, rosacea, psoriasis, and eczema (dermatitis). While a number of therapies and treatments exist for such diseases, most treatments consist of either topical applications with efficacy that is limited by their inability to cross the skin barrier effectively, or systemic (oral) applications that carry significant potential side effects. According to Kline & Co., in 2006, there were approximately 22,700 practicing dermatologists and plastic surgeons in the United States. Based on our experience with physicians who have opened accounts with us, we believe a growing number of general practice, family practice and OBGYN physicians are also dedicating resources in their practices to skin care. We believe that these physicians are responding to the rapid increase in consumer demand for non-invasive skin care treatments. Furthermore, many of these physicians are dispensing prescription and non-prescription skin care products directly to their patients. According to a 2006 Kline & Co. study, a combined number of approximately 10,100 physicians dispensed skin care products directly to their patients. Outside the United States, the physician-dispensed skin care market varies by country due to cultural differences and regulatory variations. Cultural desires for skin with lighter and more even pigmentation have created large and growing aesthetic skin care demand across the Pacific Rim countries, particularly Japan, China and Korea. European and certain South American countries such as Brazil also present large skin care markets due to the complementary growth in cosmetic procedures and willingness on the part of their consumers to spend discretionary income on aesthetic enhancements. We believe that the growth in major international markets will also be driven by cultural desires to remove skin darkening caused by exposure to sun, aging populations and a heightened awareness and acceptance of physician-dispensed products and procedures. Additionally, while physician dispensing is common in most countries, certain countries prohibit or limit the types of products that can by dispensed from the physician office, requiring physicians to either partner with a retail pharmacy or drug store, or to simply forgo dispensing. Limitations of traditional products and procedures Most of the cosmetic skin care products and procedures available today are designed to mask the effects of aging and skin disorders, rather than treat the underlying health of the skin. As a result of using these cosmetic skin care products, consumers may see temporary skin surface improvements, but underlying skin restoration often does not occur. We believe that the limitations of traditional products and procedures result primarily from the following causes: ·        The outer layer of human skin is a highly effective protective barrier against the entry of foreign particles into the body. The active agents in many competing topical products and procedures lack the ability to effectively penetrate the skin barrier, reducing their ability to improve the health of the skin at the stratum corneum, epidermis and dermis level. The most commonly used skin care products are cosmetics by definition under the U.S. Food, Drug and Cosmetic Act, or the FDCA, consisting largely of surface covers and moisturizers, which only add water to the cells on the surface of the skin, providing superficial and temporary improvement in the appearance of the skin. Moisturizers are not capable of causing the skin to generate healthy new cells to replace older, damaged ones that make up the epidermis. ·        Most traditional approaches to skin care are not comprehensive programs designed to integrate complementary products. As a result, individual products, even those that are widely used by consumers (such as facial soaps or sunscreens) are not generally designed to work together, and therefore may cause unintended side effects or reduced effectiveness when used in combination. Furthermore, the range of skin types in any given patient population is highly varied and different skin types respond differently to treatment, yet few products are capable of treating the specific needs of the individual patient’s overall skin health. The Obagi Medical Products approach We believe the effects of aging and skin disorders are best addressed not at the surface of the skin but at a deeper level, where the skin’s natural regeneration processes occur. Our Obagi Nu-Derm and Obagi-C Rx Systems improve the overall health of the skin by improving cellular processes such as collagen and elastin production, keratinocyte clearing, and melanocyte regulation, using drugs that, by definition, work at the cellular level. With improved underlying skin health, we believe a patient’s skin shows fewer signs of aging, is less susceptible to disease, and better able to combat exposure to the elements. We have developed skin care systems that we believe address the limitations of traditional skin care products and procedures, including the following: ·        Our Obagi Nu-Derm and Obagi-C Rx Systems are drug-based systems designed to penetrate below the skin’s surface to correct damage in all layers of the skin (the stratum corneum, the epidermis and the dermis) and accelerate cellular turnover. We have demonstrated in clinical studies that by enhancing the penetration of the intended active ingredient (tretinoin), more of this drug gets to the targeted tissue, improving patient outcomes. The increased penetration of a system of active ingredients triggers a therapeutic cascade that (i) pushes fresher cells to the surface faster, for smoother skin, reduced wrinkles and increased tolerance, (ii) corrects current hyperpigmentation (including freckles and age spots) and prevents the appearance of new hyperpigmentation, (iii) promotes more uniform cells at the deepest layer for better skin structure and balanced, even skin tone, (iv) helps stimulate collagen and elastin for firmer, more resilient skin, and (v) helps increase natural hydration and circulation for supple, healthy-looking skin. ·        To achieve improved skin health, our Penetrating Therapeutics technology integrate proprietary formulations of existing prescription and non-prescription skin care products into treatment programs specially designed and physician-tailored to address the unique needs of each patient’s skin. The individual products within our systems are formulated to work synergistically using our proprietary Penetrating Therapeutics technology in formulations that enhance the stability and efficacy of what are often otherwise unstable molecules. When this system of products is applied within a physician directed protocol tailored to the patient’s skin health needs, overall penetration of the active ingredient to the appropriate layer of skin is achieved, resulting in greater efficacy and improved patient outcomes. Our business strategy Our objective is to become the leading specialty pharmaceutical company dedicated to developing and commercializing systems that enable physicians to improve skin health at the cellular level. Key elements of our strategy include: ·        Leveraging the strength of our physician-dispensed marketing and distribution channel to increase market share and introduce new Obagi products.    We believe that our market-leading position in the physician-dispensed channel presents us with the opportunity to increase the market share of our existing products and to launch a range of new Obagi Systems and products. We have built long-term relationships with skin health professionals based on the success of our products during the 18 years since the first Obagi Systems and products were launched. We will continue our sales and marketing efforts aimed at helping physicians understand how our systems’ products can meet growing patient demand for effective skin care treatments, thereby generating additional sources of revenue for physician practices. Furthermore, we believe that our systems’ product offerings, and our experienced sales force, uniquely position us to benefit from growth in the number of physicians who dispense skin care products directly to their patients. According to Kline & Co., in 2006 only about 43% of the approximately 22,700 practicing plastic surgeons and dermatologists in the United States dispense professional skin care products. According to the results of a study we sponsored by Wirthlin Worldwide Company, an additional 40% of non-dispensing surveyed physicians indicated that they are considering dispensing skin care products. ·        Continuing to develop and market new indications for Obagi Systems.   We believe a significant opportunity exists to use current Obagi Systems as non-invasive adjunctive therapies to improve certain current skin care procedures, resulting in overall better patient outcomes and satisfaction. Many cosmetic procedures are limited in their ability to provide healthier skin and an overall enhanced aesthetic outcome. For example, Botox injections for cosmetic wrinkles affect mostly the forehead and have no effect on the skin’s color, hyperpigmentation, age spots, acne or the overall health of the skin. We believe patients who are treated with our Obagi Systems following Botox injections will achieve greater overall aesthetic outcomes and satisfaction, and we are conducting clinical studies to evaluate the adjunctive use of our systems before and after these types of procedures. We expanded this initiative in 2005, including working with physicians and physicians’ associations to evaluate the use of our Obagi Nu-Derm System in conjunction with these types of procedures in more than 5,000 patients. Based on the results of the study, in which patient outcomes have been documented for 2,697 of the patients, we launched new systems for use before and after commonly performed cosmetic procedures in July 2006. The systems are positioned under the Nu-Derm Condition and Enhance brand, with an initial focus on use in conjunction with Botox injections. We plan to continue to build clinical support for the benefits of our systems in conditioning the skin and enhancing the outcomes of the most commonly performed cosmetic procedures, such as chemical peels, dermabrasion, laser resurfacing and basal cell carcinoma excisions. ·        Creating additional clinically proven Obagi Systems that increase the efficacy of commonly prescribed dermatological agents in addressing new areas of skin disease.    We focus our research and development efforts on increasing the ability of FDA-allowed skin agents to penetrate the skin barrier, thereby increasing the effectiveness of such agents within the Generally Recognized As Safe, or GRAS, OTC or Drug Efficacy Study Indication, or DESI, classification as defined by the FDA. This approach accelerates the commercialization timeline and avoids the lengthy clinical development processes typically required to obtain new drug approvals. We intend to further differentiate our products and systems by supporting them with randomized and comparative clinical studies conducted by leading experts in the markets in which we are developing products. Supporting this strategy we initiated more than eighteen (18) clinical studies in 2005 and 2006 in the areas of acne and elasticity. ·        Establishing new strategic collaborations and relationships.   We intend to continue accessing new and complementary products through in-licensing, strategic collaborations and strategic acquisitions. We also intend to explore new product distribution partnerships in high growth channels such as the spa and salon channel, in which manufacturers’ sales of skin care products are estimated at over $460 million in 2006, according to Kline & Co. We plan to target new products and channels, which will expand the Obagi brand and System concept but will not compete directly with the physician-dispensed channel or products. We believe that skin health professionals will be receptive to new products we introduce under the Obagi brand name, and that the brand credibility that exists among skin health professionals will allow for more rapid trial and acceptance. This belief is supported by a 2003 study we sponsored by Wirthlin Worldwide Company of 1,000 medical professionals (primarily consisting of plastic surgeons, dermatologists, and medical skin care professionals), which found that the Obagi brand had the highest total awareness, at 97%, among leading physician-dispensed brands. ·        Continuing to expand intellectual property protection .   Our intellectual property protection is based on a combination of issued patents, patent applications, licensed patents, licensed product methods and technologies and trade secrets. As of December 31, 2006, we were the sole licensee of four patents, and have filed more than 37 additional U.S. provisional and non-provisional patent applications since the beginning of 2004. We will continue to pursue additional invention and method patents as we find new applications and improvements to our existing intellectual property. We also pursue an aggressive trademark registration policy as a means to increase brand recognition and product differentiation in the market. Our Obagi Systems and related products We currently market and sell our systems and related products to physicians for the treatment of age-related skin disorders, incorporating a range of individual prescription and non-prescription therapeutic agents, as well as cosmetic ingredients. The individual components of each system have been formulated to complement one another, enhancing the effectiveness of the system as a whole and allowing the physician to tailor the treatment program to the specific needs of the patient. The design of our systems is proprietary to us, and we are the sole licensee of U.S. patents and have patent applications for the composition of certain of the products.

System and related products

Segment/product category

Description

Applications

Launch date

Obagi Nu-Derm System

 

Skin Health / Nu-Derm

 

Comprehensive system of six products including prescription and OTC drugs

 

Fine lines, wrinkles, acne, photo damage, hyperpigmentation, melasma, laxity, skin sallowness

 

1988

Obagi-C Rx System

 

Skin Health / Vitamin C

 

Highly stable Vitamin C serum with 4% hydroquinone system; prescription-based

 

Fine lines, wrinkles, hyperpigmentation, skin sallowness

 

2004

Professional-C and Cffectives

 

Skin Health / Vitamin C

 

Highly stable Vitamin C serums; non-prescription

 

Antioxidant protection, fine lines, wrinkles, hyperpigmentation

 

2005 (1)

ELASTIderm™ System

 

Skin Health / Skin laxity

 

System of skin health products built around a novel formulation of a mineral complex; non-prescription

 

Increase elasticity and skin tone of eyes and face

 

2006

CLENZIderm M.D.™ System

 

Skin Health / Other

 

System for acne treatment built around a novel formulation of Benzoyl Peroxide, or BPO

 

Acne

 

2007

Tretinoin

 

Skin Health / Other

 

Generic equivalent of Retin-A available in the United States through an exclusive license

 

Acne

 

2002

Obagi Blue Peel System

 

Skin Health / Other

 

Topical system to aid in the application of TCA (trichloroacetic acid) chemical peels

 

Fine lines, wrinkles, hyperpigmentation

 

1988

(1)              Professional-C includes improved formulations and higher concentrations of vitamin C, and replaces our Cffectives and   Obagi-C brands that were first introduced in 2000. Obagi Nu-Derm System Our Obagi Nu-Derm System consists of a combination of six prescription and OTC drugs and adjunctive cosmetic skin care products to treat visible skin conditions such as photo damage and hyperpigmentation resulting from extrinsic damage and intrinsic changes to the skin. The Obagi Nu-Derm cosmetic skin care products include cleansers and exfoliating creams. Three of these products contain the drug hydroquinone in a 4% prescription concentration, which acts as a bleaching agent that is designed to correct skin pigmentation problems by normalizing the production of new melanin in the epidermis. Physicians also prescribe the drug tretinoin as part of the system, in various concentrations, depending on the physician’s judgment of patient need. We believe that the use of these prescription drugs, the ability of the drugs to penetrate the skin’s surface and the order of application distinguishes our Obagi Nu-Derm System from other commonly prescribed regimens. While we have designed our Obagi Nu-Derm System to include products that patients can use in a systematic treatment regimen, we also make the component products available for individual sale. We believe that physicians who dispense the Obagi Nu-Derm System generally encourage their patients to use the component products together in a systematic treatment regimen. However, we also believe that some patients elect to use the products that make up the system individually. Products that are used individually at times include the sun screen products and Obagi Nu-Derm Clear, which physicians may dispense on occasion to address localized pigmentation problems. Side effects from use of the products may include redness, mild to moderate irritation and/or excessive flaking or sloughing of the outer layers of the treated skin. Side effects generally resolve after the first 10 days of use, or in cases with certain sensitive individuals, in a few days upon discontinuance of use. In 2003, we sponsored a 301-subject, six-month, randomized, controlled, two-center, clinical use study that was independently designed and conducted by Thomas J. Stephens & Associates to compare the efficacy, side effects and tolerability of our Obagi Nu-Derm System with other commonly prescribed regimens of tretinoin, hydroquinone and OTC moisturizer. One of our minority stockholders assisted in the preparation of the study. Improvements in perioral (around the mouth) and periocular (around the eyes) fine wrinkles, facial mottled hyperpigmentation, clarity, sallowness, laxity (the appearance of loose, sagging and/or excess skin), and tactile roughness were measured. After 24 weeks of treatment, the mean changes observed with our Obagi Nu-Derm System were consistently larger than, and statistically superior to, the changes produced with the other treatment regimens. Of particular note were the changes in the perioral fine wrinkles, mottled pigmentation and laxity. While treatment with all regimens was generally well tolerated, there was a higher level of both objective and subjective irritation with the Obagi Nu-Derm System that largely resolved by the end of the study. The Obagi Nu-Derm System accounted for over 68% of our consolidated net revenues in 2006. We sell our Obagi Nu-Derm System primarily as a single-price bundle of component products. Although volumes of sales for each individual product within the system varies, we believe the majority of our sales of each component product is due to the fact that they are sold as part of the system. Clinical Study Support; Our products are designed to improve the underlying health of patients’ skin. Clinical studies conducted with our Obagi Nu-Derm System that we have sponsored have demonstrated that the use of our Obagi Nu-Derm System results in skin that looks and acts younger and healthier. Those studies include a randomized clinical study comparing four treatment groups over a 24-week period, involving 387 women with moderate photodamage assessments. The study was completed by 301 of the participating women. The study compared usage of Obagi Nu-Derm System (Group 1) versus other commonly prescribed therapies using tretinoin alone (Group 2) and hydroquinone alone (Group 3), as well as a leading facial moisturizer (Group 4). The mean changes observed in Group 1 (Obagi Nu-Derm System) were statistically significant and were consistently larger than, and statistically superior to, the changes produced with the other treatment groups, particularly with respect to perioral fine wrinkles, mottled hyperpigmentation, and laxity. Mean values for clinical grading parameters at weeks one, two, 12, 18, and 24, and ultrasound measurements at weeks 12 and 24 were compared with mean baseline values. Changes from baseline were compared among the four test groups using analysis of variance with paired comparisons. P values less than or equal to 0.05 were considered statistically significant. Mean percent change from baseline and the incidence of improvement were calculated for all attributes at each time point. Silicone replicas taken at baseline and weeks 12 and 24 and 24-week biopsy samples were referred to reference laboratories. Our clinical results provide objective and subjective support that our Obagi Nu-Derm System contributes to skin that looks and acts younger and healthier, in that the improvement in attributes related to skin tone, tissue content, skin laxity and wrinkling, are directly consistent with attributes found in comparatively younger skin. Obagi-C Rx System The Obagi-C Rx System consists of a combination of four prescription and OTC drugs and adjunctive cosmetic skin care products to treat skin conditions resulting from sun damage and the oxidative damage of free radicals. The central ingredients in the system are 4% hydroquinone, a prescription drug and Vitamin C. This combination distinguishes Obagi-C Rx from other Vitamin C based products available in the physician office. Two Obagi-C Rx System products contain this concentration of hydroquinone, which is designed to correct skin pigmentation problems by normalizing the production of new melanin in the epidermis. The Obagi-C Rx System includes cosmetic skin care cleansers and exfoliating lotions. When combined in a system, we believe hydroquinone, Vitamin C and a sunscreen provide correction of, and protection against, premature skin aging. As with the Obagi Nu-Derm System, the products that make up the Obagi-C Rx System are generally used together in a coordinated regimen by the majority of patients. Side effects from use of these products may include redness and/or mild to moderate irritation of the treated skin. Side effects generally resolve after the first 10 days of use, or in cases with certain sensitive individuals, in a few days upon discontinuance of use. We sponsored an in vitro study at the University of California, Irvine in September 2003 to evaluate the percutaneous absorption and bioavailability of our patented 10% Vitamin C and 4% hydroquinone combination product compared with the leading Vitamin C competitor, SkinCeuticals 20 Vitamin C. Our product demonstrated, with statistical significance, more Vitamin C in all layers of the skin than SkinCeuticals 20 Vitamin C serum. Obagi Professional-C The Obagi Professional-C products are a complete line of proprietary, non-prescription products, which consist of Vitamin C serums used to reduce the appearance of damage to the skin caused by ultraviolet radiation and other environmental influences. Vitamin C (L-ascorbic acid) acts as a potent antioxidant. The Obagi Professional-C line consists of a 5% serum for the area around the eyes and 10%, 15% and 20% serums for the face, neck and chest. Professional-C represents an expanded line that replaced our 5% and 10% Vitamin C serum offerings marketed under the Cffectives brand domestically, and Obagi-C brand internationally, as introduced in 2000. Obagi Professional-C products are sold individually and are used on their own, or in combination with other Obagi system products. These products are classified as cosmetics and side effects are not generally associated with their use, however certain sensitive individuals may experience mild irritation of the skin where product is applied. In addition, the product has been shown in studies we sponsored at the University of California, Irvine in September 2003 and July 2005 to penetrate all levels of skin better than SkinCeuticals 20 Vitamin C serum. Obagi ELASTIderm™ Our ELASTIderm product line consists of products for the treatment of skin laxity featuring novel mineral complexes which may help the body’s own natural ability to increase epidermal thickness, augment hypodermal fat and increase elastin levels by supplying increased local concentrations of natural mineral actives to the relevant tissue, thereby improving the elasticity and skin tone around the eyes. We believe this is the first clinically proven skin health system to aid in the regeneration of elastin, which we believe is a new and novel topical application for anti-aging. An eight-week treatment, randomized, double-blind clinical study was conducted with 33 subjects to determine the efficacy of our novel under eye elastin regeneration product. The primary endpoints were appearance in under eye skin elasticity, fine line wrinkles and moisturization. The treatment improved the appearance of the under eye skin. We believe that a more rapid improvement in elasticity is essential to earning customer compliance and repurchase. Based on clinically significant improvements in measured collagen and elastin in skin treated over the eight week period, we launched a single nighttime eye cream product under the Obagi ELASTIderm brand name in mid-October 2006. In February 2007, we launched a daytime eye gel which is the second product under the Obagi ELASTIderm brand. Tretinoin Tretinoin creams and related adjunctive acne care products are used for the topical treatment of acne in the United States. Tretinoin, the active ingredient in the prescription acne drug Retin-A, is a Vitamin A derivative and has been the primary prescription acne therapy for approximately 25 years. Topical tretinoin normalizes the growth rate of skin cells, disrupting the onset of acne. We offer FDA-approved formulations of tretinoin through an exclusive license in the physician-dispensed channel. Our Tretinoin cream line is available in concentrations of 0.1%, 0.05% and 0.025%. These products are sold individually and are used by doctors as a single therapy, in combination with Obagi Nu-Derm, or in combination with other acne therapies including but not limited to salicylic acid and clindamyacin. Side effects include excessively red, edematous, blistered, or crusted skin for certain sensitive individuals. If these effects occur, the medication should either be discontinued until the integrity of the skin is restored, or the medication should be adjusted to a level the patient can tolerate. To date, generally adverse effects have been reversible upon discontinuation of therapy. Obagi Blue Peel Obagi Blue Peel is a topical system to aid in the application of TCA chemical peels used to smooth the surface of skin, improve skin tone and color, diminish wrinkles and shrink pore sizes. Chemical peels are an in-office procedure performed either by a physician or a member of a physician’s staff, depending on the skin depth of the peel. During the procedure, acidic solutions are combined in our delivery system and applied to the face to remove the thin surface layers of aged and damaged skin. After removal, the body will naturally replace the removed skin layers with new, healthy skin cells. The Obagi Blue Peel provides for an even application and slows the penetration of the solution into the skin, allowing physicians to more accurately monitor the peel. This produces a more uniform and consistent application, which reduces the risk of complications. We believe that the Obagi Blue Peel is especially effective as a complementary treatment to our Obagi Nu-Derm System. The Obagi Blue Peel products have no known side effects in and of themselves. Patients receiving blue peel products as part of an acid peel procedure can expect to experience side effects that are associated with such procedures. Expanded applications for existing products We believe that many of our products have applications in areas beyond their current uses. For example, we are conducting studies to evaluate the adjunctive use of our systems with commonly performed cosmetic procedures such as laser therapy, Botox injections and basal cell carcinoma excisions. In July 2006, we launched our Nu-Derm Condition and Enhance System, for use primarily with Botox injections. Nu-Derm Market opportunity.    According to the American Society of Plastic Surgeons, or ASPS, the number of minimally-invasive cosmetic office procedures performed increased 72% from approximately 4.9 million in 2002 to approximately 8.4 million in 2005. This increase was led by facial procedures such as Botox, up 242% in 2005 compared to 2002, and injectable fillers, which were first measured by ASPS in 2003, and increased 990% in 2005 compared to 2003. Our Obagi Nu-Derm System restores skin to a healthier state and helps regulate skin cell functions and improve circulation. This improves the skin’s ability to constantly renew itself, repair damage, and act as an effective barrier. It also restores the skin to an active and tolerant state so that it responds better to the trauma of surgical procedures, heals faster and is less likely to exhibit an undesirable post-procedure response. Anecdotal evidence provided to us by clinicians who use our products suggests a decreased recovery period, improved rate of healing and reduction in post-inflammatory hyperpigmentation. Another proposed advantage of pre-treating patients undergoing laser resurfacing with our Obagi Nu-Derm System is that priming collagen might enhance the response to laser resurfacing, thereby improving cosmetic results. Further, our Obagi Nu-Derm System, when used as adjunctive therapy following Botox injections, has indicated the possibility of enhanced aesthetic outcomes and improved overall patient satisfaction as suggested to us anecdotally by several dermatologists and plastic surgeons and supported by our physician use study. Clinical development.    In January 2006, we initiated a large, multi-center, physician use study targeted for over 5,000 patients. This study will broadly assess the outcomes and practice patterns of our Obagi Nu-Derm System used as an adjunct therapy to a wide variety of commonly performed cosmetic procedures. To date, we have received procedure evaluations on over 2,697 of the patients. The results indicate enhanced patient outcomes and are achieved with several commonly performed cosmetic procedures including Botox and facial laser resurfacing.

Product line

Description

Applications

Launch date/target launch date

Obagi Nu-Derm Condition and Enhance for Botox

 

Line extension of Nu-Derm System designed for use after soft tissue filler injections

 

Enhances outcomes for Botox and other injectible procedures

 

2006

Obagi Nu-Derm Condition and Enhance for Laser

 

Line extension of Nu-Derm System designed for use before and after cosmetic laser procedures

 

Enhances outcomes for cosmetic laser procedures

 

2007*

Obagi Nu-Derm Condition and Enhance for Basal Cell Carcinoma (BCC)

 

Line extension of Nu-Derm System designed for use before and after BCC excision and cutterage

 

Enhances outcomes for BCC treatment procedures

 

2008*

*                     These target launch dates are forecasted on the assumption that results of our clinical studies will be favorable, which may not be the case. Obagi Nu-Derm Condition and Enhance for Botox According to ASPS, there were approximately 3.8 million Botox injections performed in 2005. Botox is a non-surgical, physician administered cosmetic treatment that can temporarily reduce moderate to severe frown lines between eye brows (glabellar lines associated with corrugator and/or procerus muscle activity) for up to four months. In order to maintain the results, a patient needs to be injected every three to four months. We are planning to conduct a 12-week multi-center, randomized, single-blind, post-market study comparing the aesthetic outcome of the application of Botox alone to the application of Botox with post treatment with our Obagi Nu-Derm System. The primary endpoints will be additive improvements in perioral and periocular fine wrinkles, facial mottled hyperpigmentation, clarity, sallowness, laxity, tactile roughness and overall patient satisfaction. We anticipate initiating this study by mid-2007 for completion prior to 2007 year-end. Obagi Nu-Derm Condition and Enhance for Laser We are evaluating and sponsoring studies to evaluate the use of Obagi Nu-Derm products in aiding skin healing in skin peel procedures and ablative laser procedures, which are procedures using lasers that work primarily by removing the top layer of the skin, while the subsequent layer is heated. These initiatives are based on anecdotal evidence, supplied by physicians who are experienced with our Obagi Nu-Derm System, that indicates the possibility of improved recovery and healing time when our Obagi Nu-Derm System is used with ablative laser procedures. We also agreed to work jointly with Syneron Medical Ltd. to conduct physician site studies using our Nu-Derm Condition and Enhance Systems in conjunction with their el ō s technology. However, these evaluations and studies have not yet been completed, and there can be no assurance that the end results will be positive. Obagi Nu-Derm Condition and Enhance for Basal Cell Carcinoma According to the American Society for Dermatologic Surgery, approximately 1.7 million procedures to treat skin cancer were performed in the United States in 2005. Basal cell carcinoma is the most common skin cancer. Electrodessication and curettage is a commonly employed treatment in which superficial skin cancers are scraped with a curette followed by electrocautery of the site in three successive cycles. Electrodessication and curettage usually leaves a scar and hypopigmented, firm, and demarcated skin. We have initiated a multi-center, randomized, single-blind, controlled study comparing the efficacy of pre-treatment and post-treatment with our Obagi Nu-Derm System with a commonly prescribed regimen of gentle cleanser and emollient on skin healing. The primary endpoint will include an improvement in healing rates, less scar formation and less hypopigmented, firm, demarcated skin. New Products and Product Lines ELASTIderm™— Anti-Aging Market opportunity.    Elastin is a protein found in the dermis which allows the skin to resume its normal shape after stretching. As skin ages, it loses its elasticity and begins to sag, particularly around the eyes, on the neck and on the hands. According to Kline & Co., in 2006, the eye, hand and neck skin care market in the spa and salon channel was estimated at over $170 million per year, comprised of products that are primarily designed to improve skin appearance through added moisturization, or building collagen in the skin. We conducted a soft-launch of an eye cream product under the Obagi ELASTIderm brand name in mid-October 2006, limited to our aesthetic sales force and targeted for existing accounts. In February 2007, we announced the formal launch of an ELASTIderm Eye Therapy system, including both the eye cream and a new eye gel product. We are also evaluating the use of future ELASTIderm products on other areas of the body which may help the body’s own natural ability to increase epidermal thickness, augment hypodermal fat and increase elastin levels by supplying increased local concentrations of natural mineral actives to the relevant tissue, thereby improving the elasticity and skin tone. These areas may include the neck, hands, full face, arms and other areas of the body. However, there can be no assurance that additional products will be successfully developed in the future. The commercial acceptance of the recently introduced product cannot yet be determined, and there can be no assurance that additional products will be successfully developed in the future.

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