SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________to _________
Commission file number: 0-19756
PROTEIN DESIGN LABS, INC.
|
|
|
|
|
|
34801 Campus Drive
Fremont, California 94555
(510) 574-1400
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ]
As of July 31, 2002, there were 89,015,493 shares of the Registrant's Common Stock outstanding.
PROTEIN DESIGN LABS, INC.
QUARTERLY REPORT ON FORM 10-Q FOR THE PERIOD ENDED JUNE 30, 2002
TABLE OF CONTENTS
| PART I. FINANCIAL INFORMATION | Page No. |
| Item 1. Financial Statements |
|
|
Consolidated Statements of Operations for the Three and Six months ended June 30, 2002 and 2001 |
|
|
Consolidated Balance Sheets at June 30, 2002 and December 31, 2001 |
|
|
Consolidated Statements of Cash Flows for the Six months ended June 30, 2002 and 2001 |
|
| Notes to Consolidated Financial Statements |
|
| Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations |
|
| Item 3. Quantitative and Qualitative Disclosures About Market Risk |
|
| PART II. OTHER INFORMATION |
|
| Item 4. Submission of Matters to a Vote of Security Holders |
|
| Item 5. Other Information - Risk Factors |
|
| Item 6. Exhibits and Reports on Form 8-K |
|
| Signatures |
|
Protein Design Labs, Nuvion and SMART are registered U.S. trademarks and the PDL logo and and Zamyl are trademarks of Protein Design Labs, Inc. Zenapax is a registered U.S. trademark of Hoffmann-La Roche Inc. All other company names and trademarks included in this Quarterly Report are trademarks, registered trademarks or trade names of their respective owners.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PROTEIN DESIGN LABS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except net income per share data)
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- --------------------
2002 2001 2002 2001
--------- --------- --------- ---------
Revenues:
Royalties $ 13,491 $ 10,462 $ 27,167 $ 20,067
License and other 1,300 2,221 1,951 9,347
--------- --------- --------- ---------
Total revenues 14,791 12,683 29,118 29,414
--------- --------- --------- ---------
Costs and expenses:
Research and development 14,774 12,207 27,961 25,879
General and administrative 4,789 4,052 8,946 7,672
--------- --------- --------- ---------
Total costs and expenses 19,563 16,259 36,907 33,551
--------- --------- --------- ---------
Operating loss (4,772) (3,576) (7,789) (4,137)
Interest income 6,455 8,966 13,593 18,405
Interest expense (2,242) (2,250) (4,482) (4,497)
--------- --------- --------- ---------
Net income (loss) $ (559) $ 3,140 $ 1,322 $ 9,771
========= ========= ========= =========
Net income per share:
Basic $ (0.01) $ 0.04 $ 0.01 $ 0.11
========= ========= ========= =========
Diluted $ (0.01) $ 0.03 $ 0.01 $ 0.11
========= ========= ========= =========
Weighted average number of shares:
Basic 88,751 87,444 88,698 87,338
========= ========= ========= =========
Diluted 88,751 93,184 91,382 92,848
========= ========= ========= =========
See accompanying notes
PROTEIN DESIGN LABS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
June 30, December 31,
2002 2001
----------- -----------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 212,786 $ 120,268
Marketable securities 425,599 530,047
Other current assets 4,196 4,144
----------- -----------
Total current assets 642,581 654,459
Property, plant and equipment, net 54,136 42,111
Convertible note receivable 30,000 30,000
Other assets 4,554 3,328
----------- -----------
Total assets $ 731,271 $ 729,898
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 882 $ 1,249
Accrued compensation 1,727 2,000
Accrued clinical trials 2,968 2,588
Accrued interest 3,071 3,071
Other accrued liabilities 2,670 3,123
Deferred revenue -- 100
Current portion of long-term debt 449 432
----------- -----------
Total current liabilities 11,767 12,563
Convertible subordinated notes 150,000 150,000
Other long-term debt 8,663 8,892
----------- -----------
Total liabilities 170,430 171,455
Stockholders' equity:
Preferred stock, par value $0.01 per
share, 10,000 shares authorized;
no shares issued and outstanding -- --
Common stock, par value $0.01 per share,
250,000 shares authorized; 88,859
and 88,499 shares issued and
outstanding at June 30, 2002
and December 31, 2001, respectively 889 885
Additional paid-in capital 626,413 624,094
Accumulated deficit (74,601) (75,923)
Accumulated other comprehensive income 8,140 9,387
----------- -----------
Total stockholders' equity 560,841 558,443
----------- -----------
Total liabilities and stockholders' equity $ 731,271 $ 729,898
=========== ===========
See accompanying notes
PROTEIN DESIGN LABS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(In thousands)
Six Months Ended
June 30,
--------------------
2002 2001
--------- ---------
Cash flows from operating activities:
Net income $ 1,322 $ 9,771
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 2,539 2,277
Amortization of convertible notes offering costs 360 361
Changes in assets and liabilities:
Interest receivable 2,873 (5,016)
Other current assets (100) (2,542)
Other assets (296) (14)
Accounts payable (367) 121
Accrued liabilities (346) (339)
Deferred revenue (100) (1,355)
--------- ---------
Total adjustments 4,563 (6,507)
--------- ---------
Net cash provided by operating activities 5,885 3,264
--------- ---------
Cash flows from investing activities:
Purchase of convertible note -- (30,000)
Purchases of marketable securities (79,954) (377,011)
Maturities of marketable securities 180,000 117,885
Purchase of property, plant and equipment (15,524) (2,796)
--------- ---------
Net cash used in investing activities 84,522 (291,922)
--------- ---------
Cash flows from financing activities:
Proceeds from issuance of capital stock,
net of issuance costs 2,323 5,376
Payments on other long-term debt (212) (197)
--------- ---------
Net cash provided by financing activities 2,111 5,179
--------- ---------
Net increase (decrease) in cash and cash equivalents 92,518 (283,479)
Cash and cash equivalents at beginning of period 120,268 421,541
--------- ---------
Cash and cash equivalents at end of period $ 212,786 $ 138,062
========= =========
Non-cash activities:
Exchange of assets for third party preferred stock $ 1,290 $ --
See accompanying notes
PROTEIN DESIGN LABS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2002
(unaudited)
1. Summary of Significant Accounting Policies
Organization and Business
Protein Design Labs, Inc. (PDL) is a biotechnology company engaged in the development of humanized antibodies to prevent or treat various disease conditions. We currently have antibodies under development for autoimmune and inflammatory conditions, asthma and cancer. We hold fundamental patents for our antibody humanization technology.
Basis of Presentation and Responsibility for Quarterly Financial Statements
The Consolidated Balance Sheet as of June 30, 2002, the Consolidated Statements of Operations for the three and six months ended June 30, 2002 and 2001 and the Consolidated Statements of Cash Flows for the six months ended June 30, 2002 and 2001 are unaudited, but include all adjustments (consisting only of normal recurring adjustments) which we consider necessary for a fair presentation of our financial position at such dates and the operating results and cash flows for those periods. Although we believe that the disclosures in our financial statements are adequate to make the information presented not misleading, certain information and footnote information normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The accompanying financial statements should be read in conjunction with our Annual Report on Form 10-K/A filed with the Securities and Exchange Commission, for the year ended December 31, 2001. The Consolidated Balance Sheet as of December 31, 2001 is derived from our audited financial statements. Results for any interim period are not necessarily indicative of results for any other interim period or for the entire year.
Reclassifications
Certain reclassifications of prior period amounts have been made to conform to the current presentation, including royalty revenue, license and other revenue and interest income.
Cash Equivalents, Marketable Securities and Concentration of Credit Risk
We consider all highly liquid investments with a maturity of three months or less at the date of purchase to be cash equivalents. Marketable securities in the Consolidated Balance Sheets includes the interest receivable associated with all marketable securities. We place our cash and marketable debt securities with high-credit-quality financial institutions and in securities of the U.S. government, U.S. government agencies and U.S. corporations and, by policy, limit the amount of credit exposure in any one financial instrument. To date, we have not experienced credit losses on investments in these instruments.
Revenue Recognition
We currently recognize three types of revenues resulting from the licensing and use of our technology, and from services we sometimes perform in connection with the licensed technology. These revenues are typically derived from our proprietary patent portfolio covering the humanization of antibodies for use in drug development and production. Revenues, and their respective treatment for financial reporting purposes, are as follows:
Upfront and License Maintenance Fees
We generally recognize revenue from upfront fees when the agreement is signed, we have completed the earnings process and we have no ongoing performance obligation with respect to the arrangement. Revenues recognized from upfront fees typically relate to patent license and patent rights agreements.
Milestone Payments
Certain agreements include milestone payments which are recognized as revenue when earned as part of a multi-element arrangement. Each element of the contract represents a separate earnings process and as such we recognize milestone amounts when the associated earnings process is complete and, to the extent the milestone amount relates to our performance obligation, when our customer confirms that we have met the requirements under the terms of the agreement. Generally, there are three types of agreements under which a customer would owe us a milestone payment:
Royalties
Under some of our agreements, we also receive royalty payments based upon our licensees' net sales of products. Generally, we receive royalty reports from such licensees' approximately one quarter in arrears; that is, generally at the end of the second month of the quarter after the licensee has sold the royalty-bearing product. We recognize royalty revenues when we can reliably estimate such amounts and collectibility is reasonably assured. Accordingly, we have adopted an accounting policy of recording the royalty revenue in the quarter it is reported to us (i.e. a one quarter lag).
Net Income (Loss) Per Share
In accordance with Financial Accounting Standards Board Statement No. 128, "Earnings Per Share" (FAS 128), basic and diluted net income per share amounts have been computed using the weighted average number of shares of common stock outstanding during the periods presented. Calculation of diluted net income per share also includes the effect of outstanding stock options, if dilutive, but does not include the effect of outstanding convertible notes because the assumed conversion of these notes would be anti-dilutive for the periods presented.
The following is a reconciliation of the numerators and denominators of the basic and diluted net income (loss) per share computations for the periods presented below:
Three Months Ended Six Months Ended
June 30, June 30,
(In thousands, except per ------------------ ------------------
share data) 2002 2001 2002 2001
-------- -------- -------- --------
Numerator:
Net income (loss) $ (559) $ 3,140 $ 1,322 $ 9,771
======== ======== ======== ========
Denominator:
Basic net income (loss) per share -
weighted-average shares 88,751 87,444 88,698 87,338
Dilutive potential common shares:
Stock options -- 5,740 2,684 5,510
-------- -------- -------- --------
Denominator for diluted net income
(loss) per share 88,751 93,184 91,382 92,848
======== ======== ======== ========
Basic net income (loss) per share $ (0.01) $ 0.04 $ 0.01 $ 0.11
======== ======== ======== ========
Diluted net income (loss) per share $ (0.01) $ 0.03 $ 0.01 $ 0.11
======== ======== ======== ========
For the three months ended June 30, 2002, 2,152,000 shares related to outstanding stock options were excluded from the diluted net loss per share computation because the inclusion of theses shares would be anti-dilutive due to the net loss in the period.
Comprehensive Income
For the three months ended June 30, 2002, total comprehensive income was $1.8 million as compared to total comprehensive income of $3.1 million for the three months ended June 30, 2001. For the six months ended June 30, 2002, total comprehensive income was $0.1 million as compared to total comprehensive income of $13.9 million for the six months ended June 30, 2001. Total comprehensive income is comprised of net income (loss) and unrealized gains and losses on our available-for-sale securities.
Management Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires the use of management's estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. For example, our cost accruals for clinical trials are based on estimates of the services received and efforts expended pursuant to contracts with numerous clinical trial centers and clinical research organizations. In the normal course of business we contract with third parties to perform various clinical trial activities in the on going development of potential drugs. The financial terms of these agreements are subject to negotiation and vary from contract to contract and may result in uneven payment flows. Payments under the contracts depend on factors such as the achievement of certain events or the successful accrual of patients or the completion of portions of the clinical trial or similar conditions. The objective of our accrual policy is to match the recording of expenses in our financial statements to the actual services received and efforts expended. As such, expenses related to each patient enrolled in a clinical trial are recognized ratably beginning upon entry into the trial and over the course of the trial. In the event of early termination of a clinical trial, we accrue an amount based on our estimate of the remaining non-cancelable obligations associated with the winding down of the clinical trial. In addition, funded research and development to third parties is expensed on a straight-line basis over the period of performance. Our estimates and assumptions could differ significantly from the amounts which may actually be incurred.
Sale of Small Molecule Group
In January 2002, we sold the assets of our small molecule group to Signature BioScience, Inc. (Signature), a privately-held detection- based drug discovery company, in exchange for 523,952 shares of Signature convertible preferred stock. The small molecule group primarily had been responsible for our chemistry, high-throughput screening and small-molecule drug discovery research efforts. The stock received was recorded at the net book value of the assets sold plus transaction costs incurred, which approximated $1.3 million. Accordingly, there was no gain or loss recorded on this transaction.
In conjunction with this sale, 12 of our former employees became employed by Signature. We may be obligated to pay up to a maximum of $320,000 in cash retention bonuses to designated key employees still employed by Signature after one year. We believe that if such amounts are paid, they will be recorded as an increase in the carrying value of the preferred stock.
Recent Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board (FASB) issued FAS 141, "Business Combinations"(FAS 141). FAS 141 supersedes APB 16, "Business Combinations," and FAS 38, "Accounting for Preacquisition Contingencies of Purchased Enterprises." FAS 141 requires the purchase method of accounting for all business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method. FAS 141 also includes guidance on the initial recognition and measurement of goodwill and other intangible assets arising from business combinations completed after June 30, 2001.
In July 2001, the FASB issued FAS 142, "Goodwill and Other Intangible Assets" (FAS 142). FAS 142 supersedes APB 17, "Intangible Assets," and requires the discontinuance of goodwill amortization. In addition, FAS 142 includes provisions regarding the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the testing for impairment of existing goodwill and other intangibles. FAS 142 is required to be applied for fiscal years beginning after December 15, 2001, with certain early adoption permitted. The adoption of FAS 142 did not have a material effect on our financial condition or results of operations.
In August 2001, the FASB issued FAS 143, "Accounting for Asset Retirement Obligations" (FAS 143). FAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long- lived assets and the associated retirement costs. The Company is in the process of assessing the effect of adopting FAS 143, which will be effective for the Company's fiscal year ending December 31, 2003.
In October 2001, the FASB issued FAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (FAS 144), which supersedes FAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of"(FAS 121). FAS 144 addresses financial accounting and reporting for the impairment of long-lived assets and for long-lived assets to be disposed of. However, FAS 144 retains the fundamental provisions of FAS 121 for: 1) recognition and measurement of the impairment of long-lived assets to be held and used; and 2) measurement of long-lived assets to be disposed of by sale. FAS 144 is effective for fiscal years beginning after December 15, 2001. The adoption of FAS 144 did not have a material effect on our financial condition or results of operations.
Stock Split
In August 2001, we announced that our Board of Directors approved a two-for-one stock split of the outstanding shares of our common stock. The stock split was effected in the form of a stock dividend. Each stockholder of record at the close of business on September 18, 2001 was entitled to receive one additional share of common stock for every share of common stock held on that date. The stock dividend resulting from the stock split was distributed by our transfer agent on October 9, 2001. The accompanying financial statements reflect the effect of this stock split.
2. Short and Long-Term Investments
We invest our excess cash balances primarily in short- term and long-term marketable debt securities. These securities are classified as available-for-sale. Available-for-sale securities are carried at fair value, with the unrealized gains and losses reported in accumulated other comprehensive income (loss) in stockholders' equity. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. The cost of securities sold is based on the specific identification method, when applicable.
The following is a summary of all available-for-sale securities. Estimated fair value is based upon quoted market prices for these or similar instruments.
Available-for-Sale-Securities
--------------------------------------------
(In thousands) Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
June 30, 2002
Securities of the U.S. Government
and its agencies maturing:
Less than 1 year $ 50,889 $ 881 $ -- $ 51,770
between 1-3 years 220,689 2,810 -- 223,499
U.S. corporate debt securities
maturing:
Less than 1 year 58,535 1,581 -- 60,116
between 1-3 years 87,346 2,868 -- 90,214
--------- ---------- ---------- ---------
Total marketable debt securities $ 417,459 $ 8,140 $ -- $ 425,599
========= ========== ========== =========
During the six months ended June 30, 2002 and 2001, there were no realized gains or losses on the sale of available-for-sale securities, as all securities liquidated prior to that date were held to maturity.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This report includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended. All statements other than statements of historical facts are "forward looking statements" for purposes of these provisions, including any projections of earnings, revenues or other financial items, any statements of the plans and objectives of management for future operations, any statements concerning proposed new products or licensing or collaborative arrangements, any statements regarding future economic conditions or performance, and any statement of assumptions underlying any of the foregoing. In some cases, forward-looking statements can be identified by the use of terminology such as "may," "will," "expects," "plans," "anticipates," estimates," "potential," or "continue" or the negative thereof or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements contained herein are reasonable, there can be no assurance that such expectations or any of the forward-looking statements will prove to be correct, and actual results could differ materially from those projected or assumed in the forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to inherent risks and uncertainties, including but not limited to the risk factors set forth below, and for the reasons described elsewhere in this report. All forward-looking statements and reasons why results may differ included in this report are made as of the date hereof, and we assume no obligation to update these forward-looking statements or reasons why actual results might differ.
OVERVIEW
In general, we have a history of operating losses and may not achieve sustained profitability. Although we have recorded small profits for the past two years, in general, our expenses have exceeded revenues. As of June 30, 2002, we had an accumulated deficit of approximately $74.6 million. Our expenses may increase because of the extensive resource commitments required to achieve regulatory approval and commercial success for any individual product. Over the next several years, we expect to incur substantial additional expenses as we continue to develop and manufacture our potential products, invest in research and improve and expand our manufacturing, marketing and sales capabilities. Since we or our collaborative partners or licensees may not be able to successfully develop additional products, obtain required regulatory approvals, manufacture products at an acceptable cost and with appropriate quality, or successfully market such products with desired margins, we may never achieve sustained profitable operations. The amount of net losses and the time required to reach sustained profitability are highly uncertain. Although we have had some profitable reporting periods, we may be unable to achieve sustained profitability.
Our commitment of resources to the continued development of our products will require significant additional funds for development. Our operating expenses may also increase as some of our earlier stage potential products move into later stage clinical development, as additional potential products are selected as clinical candidates for further development, as we invest in additional manufacturing capacity, as we defend or prosecute our patents and patent applications, and as we invest in research or acquire additional technologies, product candidates or businesses.
In the absence of substantial revenues from new corporate collaborations or patent rights or patent licensing or humanization agreements, significant royalties on sales of products licensed under our intellectual property rights, product sales or other uncertain sources of revenue, we will incur substantial operating losses.
Our revenues, expenses and operating results will likely fluctuate in future periods. Our revenues have varied in the past and will likely continue to fluctuate considerably from quarter to quarter and from year to year. As a result, our revenues in any period may not be predictive of revenues in any subsequent period. Our royalty revenues may be unpredictable and may fluctuate since they depend upon the seasonality of sales of licensed products, the existence of competing products, the marketing efforts of our licensees, potential reductions in royalties payable to us due to credits for prior payments to us, the timing of royalty reports, some of which are required quarterly and others semi-annually, our method of accounting for royalty revenues from our licensees in the period reported to us, and our ability to successfully defend and enforce our patents.
License and other revenue may also be unpredictable and may fluctuate due to the timing of payments of upfront fees, payments for manufacturing and clinical development services and payments for the achievement of milestones under new and existing collaborative, humanization, and patent licensing agreements. Revenue historically recognized under our prior agreements may not be an indicator of revenue from any future collaborations.
In addition, our expenses may be unpredictable and may fluctuate from quarter to quarter due to the timing of expenses, which may include clinical trial expenses as well as payments owed by us and to us under collaborative agreements for reimbursement of expenses and which are reported under our policy during the quarter in which such expenses are reported to us or to our collaborative partners and agreed to by us or our partners.
We receive royalty revenues on sales of the product Synagis. This product has higher sales in the fall and winter, which to date have resulted in much higher royalties recognized by us in our first and second quarters than in other quarters. The seasonality of Synagis sales could contribute to fluctuation of our royalty revenues from quarter to quarter.
In January 2002, we sold the assets of our small molecule group to Signature BioScience, Inc. (Signature), a privately-held detection- based drug discovery company, in exchange for 523,952 shares of Signature convertible preferred stock. The small molecule group primarily has been responsible for our chemistry, high-throughput screening and small-molecule drug discovery research efforts. The stock received was recorded at the net book value of the assets sold plus transaction costs incurred, which approximated $1.3 million. Accordingly, there was no gain or loss recorded on this transaction.
In conjunction with this sale, 12 of our former employees became employed by Signature. We may be obligated to pay up to a maximum of $320,000 in cash retention bonuses to designated key employees still employed by Signature after one year. We believe that if such amounts are paid, they will be recorded as an increase in the carrying value of the preferred stock.
CRITICAL ACCOUNTING POLICIES AND THE USE OF ESTIMATES
The preparation of our financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in our financial statements and accompanying notes. Actual results could differ materially from those estimates. The items in our financial statements requiring significant estimates and judgments are as follows:
We currently recognize three types of revenues resulting from the licensing and use of our technology, and from services we sometimes perform in connection with the licensed technology. These revenues are typically derived from our proprietary patent portfolio covering the humanization of antibodies for use in drug development and production. Revenues, and their respective treatment for financial reporting purposes, are as follows:
Upfront and License Maintenance Fees
We generally recognize revenue from upfront fees when the agreement is signed, we have completed the earnings process and we have no ongoing performance obligation with respect to the arrangement. Revenues recognized from upfront fees typically relate to patent license and patent rights agreements.
Milestone Payments
Certain agreements include milestone payments which are recognized as revenue when earned as part of a multi-element arrangement. Each element of the contract represents a separate earnings process and as such we recognize milestone amounts when the associated earnings process is complete and, to the extent the milestone amount relates to our performance obligation, when our customer confirms that we have met the requirements under the terms of the agreement. Generally, there are three types of agreements under which a customer would owe us a milestone payment:
Royalties
Under some of our agreements, we also receive royalty payments based upon our licensees' net sales of products. Generally, we receive royalty reports from such licensees' approximately one quarter in arrears; that is, generally at the end of the second month of the quarter after the licensee has sold the royalty-bearing product. We recognize royalty revenues when we can reliably estimate such amounts and collectibility is reasonably assured. Accordingly, we have adopted an accounting policy of recording the royalty revenue in the quarter it is reported to us (i.e. a one quarter lag).
Clinical Trial Expenses
Our cost accruals for clinical trials are based on estimates of the services received and efforts expended pursuant to contracts with numerous clinical trial centers and clinical research organizations. In the normal course of business we contract with third parties to perform various clinical trial activities in the on-going development of potential drugs. The financial terms of these agreements are subject to negotiation and variation from contract to contract and may result in uneven payment flows. Payments under the contracts depend on factors such as the achievement of certain events or the successful accrual of patients or the completion of portions of the clinical trial or similar conditions. The objective of our accrual policy is to match the recording of expenses in our financial statements to the actual services received and efforts expended. As such, expenses related to each patient enrolled in a clinical trial are recognized ratably beginning upon entry into the trial and over the course of the trial. In the event of early termination of a clinical trial, we accrue an amount based on our estimate of the remaining non-cancellable obligations associated with the winding down of the clinical trial.
RESULTS OF OPERATIONS
Three Months Ended June 30, 2002 and 2001
Revenues
The Company's total revenues for the three months ended June 30, 2002 were $14.8 million compared to $12.7 million in the second quarter of 2001. Royalty revenues recognized under agreements with Roche, Genentech, MedImmune and Wyeth were $13.5 million in the second quarter of 2002 compared to $10.5 million in the comparable period in 2001. This $3.0 million increase in royalty revenue was primarily the result of increased net sales of the products Synagis and Herceptin reported by two licensees. Royalty payments from two companies accounted for 62% and 25% of our revenues for the three months ended June 30, 2002 compared to 54% and 25% in the comparable period in 2001. License and other revenue was $1.3 million in the second quarter of 2002 compared to $2.2 million in the comparable period in 2001. License and other revenue recognized primarily consists of upfront patent licensing and patent rights fees, amortization of upfront fees associated with humanization agreements and license maintenance fees. The $0.9 million decrease in license and other revenue was primarily due to the recognition of less revenue in connection with humanization services and the recognition of fewer license maintenance fees in the second quarter of 2002 than in the second quarter of 2001.
Research and Development Expenses
Research and development expenses for the three months ended June 30, 2002 increased to $14.8 million compared with $12.2 million in the year-earlier quarter. Research and development costs include costs of personnel to support our research and development activities, costs of preclinical studies, costs of conducting our clinical trials, such as clinical investigator fees, monitoring costs, data management and drug supply costs, research and development funding provided to third parties and an allocation of facility costs. Research and development costs increased $2.6 million for the three month period ended June 30, 2002 as compared to the 2001 period primarily due to higher clinical development expenses for our major research and development projects which increased by $1.4 million, research and development funding provided to a third party and an increase in research and development personnel headcount and associated costs. We expect our research and development expenses will increase further as we advance our product candidates into later stages of development and add new product candidates.
General and Administrative Expenses
General and administrative expenses for the three months ended June 30, 2002 increased to $4.8 million from $4.1 million in the comparable period in 2001. General and administrative costs include costs of personnel, professional services, consulting and other expenses related to our administrative functions and an allocation of facility costs. General and administrative expenses increased $0.7 million for the three months ended June 30, 2002 as compared to the 2001 period primarily due to increased personnel and recruiting costs and legal costs related to our intellectual property, licensing and other contractual matters. We expect that general and administrative expenses will continue to increase as we continue to build our organization.
Interest Income and Expense
Interest income for the three months ended June 30, 2002 decreased to $6.5 million compared to $9.0 million in the 2001 period reflecting the decreased interest earned on our cash, cash equivalents and marketable securities balances primarily as a result of lower interest rates.
Interest expense for the three months ended June 30, 2002 and 2001 was essentially unchanged at $2.2 million.
Six Months Ended June 30, 2002 and 2001
Revenues
The Company's total revenues for the six months ended June 30, 2002 were $29.1 million compared to $29.4 million in the 2001 period. Royalty revenues recognized under agreements with Roche, Genentech, Medimmune and Wyeth were $27.2 million in the first six months of 2002 compared to $20.1 million in the comparable period in 2001. This $7.1 million increase in royalty revenue was primarily the result of increased net sales of the products Synagis and Herceptin reported by two licensees. Royalty payments from two companies accounted for 58% and 27% of our revenues for the six months ended June 30, 2002 compared to 45% and 18% in the 2001 period. License and other revenue was $2.0 million for the six months ended June 30, 2002 compared to $9.3 million in the comparable period in 2001. License and other revenue recognized primarily consists of upfront patent licensing and patent rights fees, milestones, amortization of upfront fees associated with humanization agreements and license maintenance fees. The $7.3 million decrease in license and other revenue was primarily due to the recognition of less revenue under patent licensing, patent rights and humanization agreements in the first six months of 2002 as compared to the first six months of 2001.
Research and Development Expenses
Research and development expenses for the six months ended June 30, 2002 increased to $28.0 million compared with $25.9 million in the year-earlier period. Research and development costs include costs of personnel to support our research and development activities, costs of preclinical studies, costs of conducting our clinical trials, such as clinical investigator fees, monitoring costs, data management and drug supply costs, research and development funding provided to third parties and an allocation of facility costs. Research and development costs increased $2.1 million for the six month period ended June 30, 2002 as compared to the 2001 period primarily due to higher research and development funding provided to a third party which increased by $1.7 million and an increase in research and development personnel headcount and associated costs. We expect our research and development expenses will increase further as we advance our product candidates' progress into later stages of development and add new product candidates.
Below is a summary of products and the related stages of development for each product in clinical development, including the research and development expenses recognized in connection with each product. The information in the column labeled "Estimated Completion of Phase" is only our estimate of the timing of completion of product development phases. The actual timing of completion of those phases could differ materially from the estimates provided in the table. For a discussion of the risks and uncertainties associated with the timing of completing a product development phase, see the "Clinical development is inherently uncertain and expense levels may fluctuate unexpectedly because we can not accurately predict the timing and level of such expenses," "If we cannot successfully complete our clinical trials, we will be unable to obtain regulatory approvals required to market our products," "Our clinical trial strategy may increase the risk of clinical trial difficulties," "If our collaborations are not successful, we may not be able to effectively develop and market some of our products," "If we do not attract and retain key employees, our business could be impaired," and "We may be unable to obtain or maintain regulatory approval for our products" sections of our Risk Factors below. For further information on our products refer to our Annual Report on Form 10-K/A filed with the Securities and Exchange Commission, for the year ended December 31, 2001.
|
(In thousands) |
Estimated |
Six Months ended |
||||
|
Phase of |
Completion |
June 30, |
||||
|
Product |
Description / Indication |
Development |
Collaborator |
of Phase |
2002 |
2001 |
|
Humanized Anti-IL-4 |
................... |
........... |
GlaxoSmithKline |
$ 1,480 |
$ 1,672 |
|
|
Asthma |
Phase IIa |
2003 |
||||
|
SMART Anti-IL-12 |
................... |
........... |
- |
1,537 |
1,160 |
|
|
Auto Immune Diseases |
Phase I |
2002 |
||||
|
SMART Anti-Gamma Interferon |
................... |
........... |
- |
5,305 |
3,134 |
|
|
Crohn's Disease |
Phase II |
2003 |
||||
|
Psoriasis |
Phase I/II |
2002 |
||||
|
Nuvion |
................... |
........... |
- |
1,307 |
3,461 |
|
|
Steroid Refractory Graft Vs. Host Disease |
Phase II |
2004 |
||||
|
Primary Graft Vs. Host Disease |
Phase I/II |
2004 |
||||
|
Ulcerative Colitis |
Phase I |
2003 |
||||
|
Remitogen |
................... |
........... |
- |
1,551 |
1,572 |
|
|
Non-Hodgkin's B-Cell Lymphoma |
Phase II |
2003 |
||||
|
Solid Tumors |
Phase I |
2003 |
||||
|
Zamyl |
................... |
........... |
- |
3,409 |
3,173 |
|
|
Acute Myloid Leukemia |
Phase III |
Completed |
||||
|
Daclizumab |
................... |
........... |
Roche |
4,022 |
4,765 |
|
|
Asthma |
Phase II |
2003 |
||||
|
Other (1) |
................... |
........... |
- |
9,350 |
6,942 |
|
|
Total Research and development costs |
$ 27,961 |
$ 25,879 |
||||
(1) No single potential product included in "other" constitutes more than 5% of the total research and development costs.
We cannot reliably estimate the overall completion dates or total costs to complete our major research and development programs. The clinical development portion of these programs spans as many as seven to ten years and any estimation of completion dates or costs to complete would be highly speculative and subjective due to the numerous risks and uncertainties associated with developing biopharmaceutical products, including intense and changing government regulation, the uncertainty of future preclinical and clinical study results and success and uncertainties associated with process development and manufacturing. These risks and uncertainties make reliably estimating overall completion dates and total costs to complete development highly speculative. For additional discussion of factors affecting overall completion dates and total costs, see the "Clinical development is inherently uncertain and expense levels may fluctuate unexpectedly because we can not accurately predict the timing and level of such expenses" section of our Risk Factors below.
General and Administrative Expenses
General and administrative expenses for the six months ended June 30, 2002 increased to $8.9 million from $7.7 million in the comparable period in 2001. General and administrative costs include costs of personnel, professional services, consulting and other expenses related to our administrative functions and an allocation of facility costs. General and administrative expenses increased $1.2 million for the six months ended June 30, 2002 as compared to the 2001 period primarily due to increased personnel costs and legal costs related to our intellectual property, licensing and other contractual matters. We expect that general and administrative expenses will continue to increase as we continue to build our organization.
Interest Income and Expense
Interest income for the six months ended June 30, 2002 decreased to $13.6 as compared to $18.4 million in the 2001 period reflecting the decreased interest earned on our cash, cash equivalents and marketable securities balances primarily as a result of lower interest rates.
Interest expense for the six months ended June 30, 2002 and 2001 was essentially unchanged at $4.5 million.
LIQUIDITY AND CAPITAL RESOURCES
To date, we have financed our operations primarily through public and private placements of equity and debt securities, revenue under agreements with third parties and interest income on invested capital. At June 30, 2002, we had cash, cash equivalents and marketable securities in the aggregate of $638.4 million, compared to $650.3 million at December 31, 2001.
Net cash provided by our operating activities for the six months ended June 30, 2002 was approximately $5.9 million compared with $3.3 million in the 2001 period. The change was primarily due to a decrease in interest receivable during the six months ended June 30, 2002 versus an increase in interest receivable for the 2001 period and a smaller increase in other current assets for the six months ended June 30, 2002 compared to the prior year period, partially offset by a decrease in net income.
Net cash provided by our investing activities for the six months ended June 30, 2002 was $84.5 million compared to net cash used in our investing activities of $291.9 million in 2001. The change in 2002 was primarily the result of maturities of marketable securities during the period as compared to our reinvestment activities associated with the purchases of short- and long- term investments in 2001.
Net cash provided by our financing activities for the six months ended June 30, 2002 was $2.1 million compared to $5.2 million in the 2001 period. The change in 2002 from 2001 was primarily the result of a decrease in the exercise of outstanding stock options.
We estimate that our existing capital resources will be sufficient to fund our current level of operations for at least the next few years. Our future capital requirements will depend on numerous factors, including, among others, interest income, royalties from sales of products by third party licensees, including Synagis, Herceptin, Zenapax and Mylotarg; our ability to enter into additional collaborative, humanization, patent license and patent rights agreements; progress of product candidates in clinical trials; the ability of our licensees to obtain regulatory approval and successfully manufacture and market products licensed under our patents; the continued or additional support by our collaborative partners or other third parties of research and development efforts and clinical trials; investment in existing and new research and development programs; time required to gain regulatory approvals; resources we devote to manufacturing facilities; our ability to obtain and retain funding from third parties under collaborative arrangements; our continued development of internal marketing and sales capabilities; the demand for our potential products, if and when approved; potential acquisitions of technology, product candidates or businesses by us; and the costs of defending or prosecuting any patent opposition or litigation necessary to protect our proprietary technology. In order to develop and commercialize our potential products we may need to raise substantial additional funds through equity or debt financings, collaborative arrangements, the use of sponsored research efforts or other means. No assurance can be given that such additional financing will be available on acceptable terms, if at all, and such financing may only be available on terms dilutive to existing stockholders.
In Fremont, California, Somerville, New Jersey, Plymouth, Minnesota and Paris, France, we occupy leased facilities under agreements that expire in 2004, 2005, 2009 and 2003, respectively. We also have leased certain office equipment under operating leases.
In September 1999, Fremont Holding L.L.C. (our wholly owned subsidiary) obtained a $10.2 million term loan to purchase our Fremont, California facilities. The loan bears interest at the rate of 7.64% per year amortized over 15 years with principal and interest payable monthly. The loan is secured by our Fremont, California facilities and is subject to the terms and covenants of the loan agreement.
In February 2000, we issued 5.50% Convertible Subordinated Notes due February 15, 2007 with a principal amount of $150 million (the Convertible Notes). The Convertible Notes are convertible at the holders' option into our common stock at a conversion price of $37.75 per share, subject to adjustment as a result of certain events. Interest on the Convertible Notes is payable semiannually in arrears on February 15 and August 15 of each year. The Convertible Notes are unsecured and are subordinated to all our existing and future Senior Indebtedness (as defined in the indenture relating to the Convertible Notes). The Convertible Notes may be redeemed at our option, in whole or in part, beginning on February 15, 2003 at the redemption prices set forth in the Convertible Notes indenture.
In May 2001, we signed a collaborative agreement with Exelixis to discover and develop humanized antibodies for the diagnosis, prevention and treatment of cancer. We agreed to provide Exelixis with $4.0 million in annual research funding for two or more years, and we purchased a $30.0 million five year note, convertible at our option after the first year of the collaboration into Exelixis common stock. Exelixis will perform certain genetic screens and other research activities intended to identify and validate targets for antibody therapeutics in oncology. We received an exclusive, worldwide license to develop antibodies against certain targets identified by Exelixis that are involved in cell growth, cell death and proliferation. Exelixis has the right to co-fund development of antibodies resulting from the collaboration. For certain antibody products we develop that Exelixis elects not to co-fund, we have agreed to make specified milestone payments and royalty payments on any product sales.
Our material contractual obligations under lease, debt and research funding agreements for the next five years, and thereafter as of June 30, 2002 are as follows:
PAYMENTS DUE BY PERIOD
-----------------------------------------------------
(In thousands) Less Than 1-3 4-5 After 5
CONTRACTUAL OBLIGATIONS (1) 1 Year Years Years Years Total
--------- --------- --------- --------- ---------
Operating leases $ 1,240 $ 2,189 $ 1,629 $ 1,269 $ 6,327
Long-term debt 1,139 2,278 2,278 8,353 14,048
Convertible debentures (2) 8,250 16,500 166,375 -- 191,125
Research funding 3,000 -- -- -- 3,000
Capital improvements 4,600 -- -- -- 4,600
--------- --------- --------- --------- ---------
Total contractual cash obligations $ 18,229 $ 20,967 $ 170,282 $ 9,622 $ 219,100
========= ========= ========= ========= =========
(1) This table does not include (a) any milestone payments which may become payable under research collaborations or license agreements as the timing and likelihood of such payments are not known, (b) any royalty payments to third parties as the amounts of such payments and / or likelihood of such payments are not known, (c) amounts that may be committed to construct our new manufacturing plant and (d) contracts that are entered into in the ordinary course of business which are not material in the aggregate in any period presented above.
(2) Our convertible debenture may be converted to common stock prior to the maturity date and therefore may not require use of our capital resources.
We are currently improving our existing manufacturing plant in Plymouth, Minnesota in order to manufacture initial commercial supplies of certain products. We currently estimate this capital project will cost approximately $10 million. In March 2002, we purchased approximately 29 acres in Brooklyn Park, Minnesota and intend to build a new commercial manufacturing plant on this property. When we implement these plans we will incur substantial costs. We expect to expend approximately $200 million over the next three years.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK
We maintain a non-trading investment portfolio of investment grade, highly liquid, debt securities which limits the amount of credit exposure to any one issue, issuer, or type of instrument. We do not use derivative financial instruments for speculative or trading purposes. We hold a $30.0 million five-year convertible note receivable we purchased from Exelixis, Inc. in May 2001. Accounting rules require the conversion feature of some convertible notes to be separated from the debt agreement in which the conversion feature is contained and accounted for as a derivative instrument, and therefore reflected in the note purchaser's financial statements based upon the fair market value of the stock into which the note is convertible. Due in part to the number of shares into which this note receivable would currently convert and the average daily trading volume of Exelixis stock, the Exelixis note is not currently considered a derivative instrument and, therefore, changes in the market value of Exelixis stock are not required to be recorded in our financial statements. However, a significant increase in the average daily trading volume of Exelixis stock, or new accounting pronouncements or regulatory rulings could require us to report the value of the Exelixis stock in our financial statements. Such a requirement could cause changes in the Exelixis stock price to contribute to fluctuation of our operating results from quarter to quarter. The securities in our investment portfolio are not leveraged and are classified as available-for-sale and therefore are subject to interest rate risk. We do not currently hedge interest rate exposure. As of June 30, 2002, there has been no material change in our interest rate exposure from that described in the Company's Annual Report on Form 10-K/A for the year ended December 31, 2001.
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's 2002 Annual Meeting of Stockholders was held on June 20, 2002 at the Company's principal offices in Fremont, California. Of the 88,757,688 shares of common stock outstanding as of the record date, 71,925,102 shares were present at the meeting or represented by proxy, representing approximately 81% of the total votes eligible to be cast.
At the meeting, the stockholders voted to re-elect the Class I members of the Company's Board of Directors as follows:
|
Nominee |
For |
Withheld |
|
George M. Gould, Esq. |
70,830,826 |
599,631 |
|
Jon S. Saxe, Esq. |
70,245,409 |
1,185,048 |
The stockholders also voted to approve the 2002 Outside Directors Stock Option Plan as follows:
|
For |
Against |
Abstentions |
|
50,908,163 |
20,257,239 |
265,054 |
Lastly, the stockholders voted to ratify the appointment of Ernst & Young LLP as the Company's independent auditors for the fiscal year ending December 31, 2002 as follows:
|
For |
Against |
Abstentions |
|
69,877,041 |
1,490,395 |
63,021 |
ITEM 5. OTHER INFORMATION - RISK FACTORS
Risk Factors
This Quarterly Report contains, in addition to historical information, forward-looking statements which involve risks and uncertainties. Our actual results may differ significantly from the results discussed in forward-looking statements. Factors that may cause such a difference include those discussed in the material set forth below and elsewhere in this document. Additional risks and uncertainties not presently known to us or that we currently see as immaterial may also impair our business. If any of these risks actually occurs, it could materially harm our business, financial condition or operating results.
We have a history of operating losses and may not achieve sustained profitability.
Although we have recorded small profits for the past two years, in general, our expenses have exceeded revenues. As of June 30, 2002, we had an accumulated deficit of approximately $74.6 million. Our expenses may increase because of the extensive resource commitments required to achieve regulatory approval and commercial success for any individual product. For example, over the next several years, we will incur substantial additional expenses as we continue to develop and manufacture our potential products, invest in research and improve and expand our manufacturing, marketing and sales capabilities. Since we or our partners or licensees may not be able to successfully develop additional products, obtain required regulatory approvals, manufacture products at an acceptable cost and with appropriate quality, or successfully market such products with desired margins, we may never achieve sustained profitable operations. The amount of net losses and the time required to reach sustained profitability are highly uncertain. We may be unable to achieve sustained profitability.
Our commitment of resources to the continued development of our products will require significant additional funds for development. Our operating expenses may also increase as:
In the absence of substantial revenues from new agreements with third party business partners, significant royalties on sales of products licensed under our intellectual property rights, product sales or other uncertain sources of revenue, we will incur substantial operating losses.
Our revenues, expenses and operating results will likely fluctuate in future periods.
Our revenues have varied in the past and will likely continue to fluctuate considerably from quarter to quarter and from year to year. As a result, our revenues in any period may not be predictive of revenues in any subsequent period. Our royalty revenues may be unpredictable and may fluctuate since they depend upon:
We receive royalty revenues on sales of the product Synagis. This product has higher sales in the fall and winter, which to date have resulted in much higher royalties paid to us in our first and second quarters than in other quarters. The seasonality of Synagis sales could contribute to fluctuation of our revenues from quarter to quarter.
License and other revenue may also be unpredictable and may fluctuate due to the timing of payments of non-recurring licensing and signing fees, payments for manufacturing and clinical development services, and payments for the achievement of milestones under new and existing agreements with third party business partners. Revenue historically recognized under our prior agreements may not be an indicator of non-royalty revenue from any future collaborations.
Our expenses may be unpredictable and may fluctuate from quarter to quarter due to the timing of expenses, including clinical trial expenses as well as payments owed by us and to us under collaborative agreements for reimbursement of expenses and which are reported under our policy during the quarter in which such expenses are reported to us or to our partners and agreed to by us or our partners.
In addition, our expenses or other operating results may fluctuate due to the accounting treatment of securities we own or may purchase or securities we have issued or may issue. In May 2002, we entered into an agreement with our Chairman of the Board under which vesting of his stock options may accelerate in certain events, and such acceleration would trigger an accounting expense. In addition, we hold a $30.0 million five-year convertible note receivable we purchased from Exelixis, Inc. in May 2001. Accounting rules require the conversion feature of some convertible notes to be separated from the debt agreement in which the conversion feature is contained and accounted for as a derivative instrument, and therefore reflected in the note purchaser's financial statements based upon the fair market value of the stock into which the note is convertible. Due in part to the number of shares into which this note receivable would currently convert and the average daily trading volume of Exelixis stock, the Exelixis note is not currently considered a derivative instrument and, therefore, changes in the market value of Exelixis stock are not required to be recorded in our financial statements. However, a significant increase in the average daily trading volume of Exelixis stock, or new accounting pronouncements or regulatory rulings could require us to report the value of the Exelixis stock in our financial statements. Such a requirement could cause changes in the Exelixis stock price to contribute to fluctuation of our operating results from quarter to quarter.
Our humanization patents are being opposed and a successful challenge could limit our future revenues.
Most of our current revenues are related to our humanization patents. At an oral hearing in March 2000, the Opposition Division of the European Patent Office decided to revoke the broad claims of our first European humanization patent. We have appealed this decision. Until our appeal is resolved, we may be limited in our ability to collect royalties or to negotiate future licensing or collaborative research and development arrangements based on this and our other humanization patents. Moreover, if our appeal is unsuccessful, our ability to collect royalties on European sales of antibodies humanized by others would depend on the scope and validity of our second European patent, whether the antibodies are manufactured in a country outside of Europe where they are covered by one of our patents, and in that case the terms of our license agreements with respect to that situation. Also, the Opposition Division's decision could encourage challenges of our related patents in other jurisdictions, including the U.S. This decision may lead some of our licensees to stop making royalty payments or lead potential licensees not to take a license, either of which might result in us initiating formal legal actions to enforce our rights under our humanization patents. In such a situation, a likely defensive strategy to our action would be to challenge our patents in that jurisdiction. During the appeals process with respect to our first European patent, if we were to commence an infringement action to enforce that patent, such an action would likely be stayed until the appeal is decided by the European Patent Office. As a result, we may not be able to successfully enforce our rights under our European or related U.S. and Japanese patents. Eight notices of opposition have been filed with respect to our second European antibody humanization patent and we have filed our response with the European Patent Office. Also, three opposition statements were filed with the Japanese Patent Office with respect to our humanization patent issued in Japan in late 1998. We received a decision from the Japanese Opposition Board in March 2001, supporting one aspect of the position of the opponents, and we filed a response in September 2001. In April 2002, the examiner issued a further Office Action maintaining the earlier decision of the Opposition Board, to which we filed an additional response in May 2002. We now await a final decision from the examiner. If the examiner maintains her earlier decision, we will have the opportunity to appeal to the Tokyo High Court. The patent will remain valid and enforceable during this appeal process. If this appeal is unsuccessful, we will then have an opportunity to appeal to the Japanese Supreme Court.
We intend to vigorously defend the European patents and the Japanese patent in these proceedings; however, we may not prevail in the opposition proceedings or any litigation contesting the validity of these patents. If our appeal with respect to our first European patent is unsuccessful or if the outcome of the other European or Japanese opposition proceedings or any litigation involving our antibody humanization patents were to be unfavorable, our ability to collect royalties on existing licensed products and to license our patents relating to humanized antibodies may be materially harmed. In addition, these proceedings or any other litigation to protect our intellectual property rights or defend against infringement claims by others could result in substantial costs and diversion of management's time and attention, which could harm our business and financial condition.
If we are unable to protect our patents and proprietary technology, we may not be able to compete successfully.
Our pending patent applications may not result in the issuance of valid patents or our issued patents may not provide competitive advantages. Also, our patent protection may not prevent others from developing competitive products using related or other technology.
A number of companies, universities and research institutions have filed patent applications or received patents in the areas of antibodies and other fields relating to our programs. Some of these applications or patents may be competitive with our applications or contain material that could prevent the issuance of patents to us or result in a significant reduction in the scope of our issued patents.
The scope, enforceability and effective term of patents can be highly uncertain and often involve complex legal and factual questions. No consistent policy has emerged regarding the breadth of claims in biotechnology patents, so that even issued patents may later be modified or revoked by the relevant patent authorities or courts. Moreover, the issuance of a patent in one country does not assure the issuance of a patent with similar claims in another country, and claim interpretation and infringement laws vary among countries, so we are unable to predict the extent of patent protection in any country.
In addition to seeking the protection of patents and licenses, we also rely upon trade secrets, know-how and continuing technological innovation which we seek to protect, in part, by confidentiality agreements with employees, consultants, suppliers and licensees. If these agreements are not honored, we might not have adequate remedies for any breach. Additionally, our trade secrets might otherwise become known or patented by our competitors.
We may require additional patent licenses in order to manufacture or sell our potential products.
Other companies, universities and research institutions may obtain patents that could limit our ability to use, import, manufacture, market or sell our products or impair our competitive position. As a result, we might be required to obtain licenses from others before we could continue using, importing, manufacturing, marketing, or selling our products. We may not be able to obtain required licenses on terms acceptable to us, if at all. If we do not obtain required licenses, we may encounter significant delays in product development while we redesign potentially infringing products or methods or may not be able to market our products at all.
Celltech has been granted a European patent covering humanized antibodies, which we have opposed. At an oral hearing in September 2000, the Opposition Division of the European Patent Office decided to revoke this patent. Celltech has appealed that decision. Also, Celltech has a second issued divisional patent in Europe, which has claims that may be broader in scope than its first European patent. In addition, Celltech has a third divisional application currently drafted with broad claims directed towards humanized antibodies. We cannot predict whether Celltech will be able to successfully appeal the decision of the Opposition Division with respect to their first European patent or whether Celltech's second European patent will be modified or revoked in any future opposition proceedings, or whether it will be able to obtain the grant of a patent from the pending divisional application with claims broad enough to generally cover humanized antibodies. Celltech has also been issued a corresponding U.S. patent that contains claims that may be considered broader in scope than their first European patent. We have entered into an agreement with Celltech providing each company with the right to obtain nonexclusive licenses for up to three antibody targets under the other company's humanization patents. Nevertheless, if our humanized antibodies were covered by Celltech's European or U.S. patents and if we were to need more than the three licenses under those patents currently available to us under the agreement, we would be required to negotiate additional licenses under those patents or to significantly alter our processes or products. We might not be able to successfully alter our processes or products to avoid conflict with these patents or to obtain the required additional licenses on commercially reasonable terms, if at all.
In addition, if the Celltech U.S. patent or any related patent applications conflict with our U.S. patents or patent applications, we may become involved in proceedings to determine which company was the first to invent the products or processes contained in the conflicting patents. These proceedings could be expensive, last several years and either prevent issuance of additional patents to us relating to humanization of antibodies or result in a significant reduction in the scope or invalidation of our patents. Any limitation would reduce our ability to negotiate or collect royalties or to negotiate future collaborative research and development agreements based on these patents.
Lonza Biologics, Inc. has a patent issued in Europe to which we do not have a license that may cover a process that we use to produce our potential products. In addition, we do not have a license to an issued U.S. patent assigned to Stanford University and Columbia University, which may cover a process we use to produce our potential products. We have been advised that an exclusive license has been previously granted to a third party, Centocor, Inc., under this patent. If our processes were covered by either of these patents, we might be required to obtain licenses or to significantly alter our processes or products. We might not be able to successfully alter our processes or products to avoid conflicts with these patents or to obtain licenses on acceptable terms.
We are also aware of issued patents that could apply to one or more of our specific products. For example, a U.S. patent recently issued to Advanced Biotherapy, Inc. has claims to the use of anti-gamma interferon antibodies to treat certain autoimmune diseases. The claims, however, do not cover treatment of either Crohn's disease or psoriasis -- the two indications currently being investigated in our SMART Anti-Gamma Interferon Antibody clinical trials. Additional examples include an issued U.S. patent to Schering Corporation that may cover our humanized anti-IL-4 antibody, and issued U.S. and European patents to Genetics Institute (now a wholly-owned subsidiary of Wyeth) that may cover our SMART Anti-IL-12 Antibody. As a result, we might be required to obtain licenses from others. We may not be able to obtain required licenses on terms acceptable to us, if at all. If we do not obtain required licenses, we may encounter significant delays in product development while we redesign potentially infringing products or methods or we may not be able to market our products at all.
Clinical development is inherently uncertain and expense levels may fluctuate unexpectedly because we cannot accurately predict the timing and level of such expenses
Our future success depends in large part upon the results of clinical trials designed to assess the safety and efficacy of our potential products, and the majority of our expenses are to support these activities. The completion rate of clinical trials depends significantly upon the rate of patient enrollment, and our expense levels will vary depending upon the rate of enrollment. In addition, the length of time necessary to complete clinical trials and submit an application for marketing and manufacturing approvals varies significantly and is difficult to predict. The expenses associated with each phase of a trial depend upon the design of the trial. The design of each phase of trials depends in part upon results of prior phases, and additional trials may be necessary or appropriate at each phase. As a result the expense associated with future phases can not predicted in advance. Further, we may determine to terminate trials in process or suspend trials. Failure to comply with extensive FDA regulations may result in unanticipated delay, suspension or cancellation of a trial or the FDA's refusal to accept test results. The FDA may also suspend our clinical trials at any time if it concludes that the participants are being exposed to unacceptable risks. As a result of these factors, we can not predict the actual expenses that we will incur with respect to trials for any of our potential products, and we expect that our expense levels will fluctuate unexpectedly in the future.
If we cannot successfully complete our clinical trials, we will be unable to obtain regulatory approvals required to market our products.
To obtain regulatory approval for the commercial sale of any of our potential products or to promote these products for expanded indications, we must demonstrate through preclinical testing and clinical trials that each product is safe and effective for use in indications for which approval is requested. We have conducted only a limited number of clinical trials to date. Moreover, we have a relatively large number of potential products in clinical development. We may not be able to successfully commence and complete all of our planned clinical trials without significant additional resources and expertise. Additionally, regulatory review of our clinical trial protocols may cause us in some cases to delay or abandon our planned clinical trials. Our potential inability to commence or continue clinical trials, to complete the clinical trials on a timely basis or to demonstrate the safety and efficacy of our potential products, further adds to the uncertainty of regulatory approval for our potential products.
Earlier clinical trials such as Phase I and II trials generally are designed to gather information to determine whether further trials are appropriate and, if so, how such trials should be designed. As a result, data gathered in these trials may indicate that the endpoints selected for these trials are not the most relevant for purposes of assessing the product or the design of future trials. Moreover, success or failure in meeting such early clinical trial endpoints may not be dispositive of whether further trials are appropriate and, if so, how such trials should be designed.
Larger or later stage clinical trials may not produce the same results as earlier trials. Many companies in the pharmaceutical and biotechnology industries, including our company, have suffered significant setbacks in clinical trials, including advanced clinical trials, even after promising results had been obtained in earlier trials. As an example, in a Phase I trial, Remitogen produced partial clinical responses in several B-cell lymphoma patients. Partial, preliminary results in a Phase II trial of Remitogen, however, did not show a similar response rate. Consequently, the dosing regimen has been amended in that trial to attempt to determine an effective dosing regimen.
Even when a drug candidate shows indications of efficacy in a clinical trial, it may be impossible to further develop or receive regulatory approval for the drug if it causes an unacceptable incidence or severity of side effects, or further development may be slowed down by the need to find dosing regimens that do not cause such side effects. For example, while Nuvion has shown biological activity in some patients in a Phase I/II trial for psoriasis, it has also caused a level of side effects that would be unacceptable in this patient population. Enrollment in this trial currently is suspended and our current plan is not to continue this trial and not to further develop Nuvion for psoriasis.
Our clinical trial strategy may increase the risk of clinical trial difficulties.
Research, preclinical testing and clinical trials may take many years to complete and the time required can vary depending on the indication being addressed and the nature of the product. We may at times elect to use aggressive clinical strategies in order to advance potential products through clinical development as rapidly as possible. For example, we may commence clinical trials without conducting preclinical animal efficacy testing where an appropriate animal efficacy testing model does not exist, or we may conduct later stage trials based on limited early stage data. As a result, we anticipate that only some of our potential products may show safety and efficacy in clinical trials and some may encounter difficulties or delays during clinical development.
We may be unable to enroll sufficient patients to complete our clinical trials.
The rate of completion of our clinical trials, and those of our collaborators, is significantly dependent upon the rate of patient enrollment. Patient enrollment is a function of many factors, including:
We may have difficulty obtaining sufficient patient enrollment or clinician support to conduct our clinical trials as planned, and we may need to expend substantial additional funds to obtain access to resources or delay or modify our plans significantly. These considerations may lead us to consider the termination of ongoing clinical trials or development of a product for a particular indication.
Our revenues from licensed technologies depend on the efforts and successes of our licensees.
In those instances where we have licensed rights to our technologies, the product development and marketing efforts and successes of our licensees will determine the amount and timing of royalties we may receive, if any. We have no assurance that any licensee will successfully complete the product development, regulatory and marketing efforts required to sell products. The success of products sold by licensees will be affected by competitive products, including potential competing therapies that are marketed by the licensee or others.
If our collaborations are not successful, we may not be able to effectively develop and market some of our products.
We have collaborative agreements, which generally relate to our collaborators' license and use of our technology to develop therapeutic products, with several pharmaceutical and other companies to develop, manufacture and market Zenapax and some of our potential products. In some cases, we are relying on our collaborative partners to manufacture such products, to conduct clinical trials, to compile and analyze the data received from these trials, to obtain regulatory approvals and, if approved, to market these licensed products. As a result, we may have little or no control over the manufacturing, development and marketing of these potential products and little or no opportunity to review clinical data prior to or following public announcement.
Our collaborative agreements can generally be terminated by our partners on short notice. A collaborator may terminate its agreement with us or separately pursue alternative products, therapeutic approaches or technologies as a means of developing treatments for the diseases targeted by us or our collaborative effort. Even if a collaborator continues its contributions to the arrangement, it may nevertheless determine not to actively pursue the development or commercialization of any resulting products. In these circumstances, our ability to pursue potential products could be severely limited.
Continued funding and participation by collaborative partners will depend on the timely achievement of our research and development objectives, the retention of key personnel performing work under those agreements and on each collaborative partner's own financial, competitive, marketing and strategic considerations. Such considerations include:
Our ability to enter into new collaborations and the willingness of our existing collaborators to continue development of our potential products depends upon, among other things, our patent position with respect to such products. If we are unable to successfully maintain our patents we may be unable to collect royalties on existing licensed products or enter into additional collaborations and agreements.
Our lack of experience in sales, marketing and distribution may hamper market introduction and acceptance of our products.
We intend to market and sell a number of our products either directly or through sales and marketing partnership arrangements with collaborative partners. To market products directly, we must either establish a marketing group and direct sales force or obtain the assistance of another company. We may not be able to establish marketing, sales and distribution capabilities or succeed in gaining market acceptance for our products. If we were to enter into co-promotion or other marketing arrangements with pharmaceutical or biotechnology companies, our revenues would be subject to the payment provisions of these arrangements and dependent on the efforts of third parties. If we were to enter into co-promotion or other marketing arrangements with collaborative partners, our revenues would be subject to the payment provisions of these arrangements and could largely depend on these partners' marketing and promotion efforts.
If we do not attract and retain key employees, our business could be impaired.
To be successful we must retain our qualified clinical, manufacturing, scientific and management personnel. In May 2002, we announced that Laurence Jay Korn, Ph.D., a co-founder of PDL and its Chief Executive Officer since 1987, relinquished his responsibilities as Chief Executive Officer. Dr. Korn continues to serve as Chairman of the Board and Douglas O. Ebersole is currently serving as our Chief Executive Officer on an interim basis. In addition, we announced in May 2002 that Daniel J. Levitt, M.D., Ph.D., President, Research and Development, resigned. We believe that existing management can operate the Company effectively while we conduct searches to fill key positions; however, if we are unsuccessful in filling these positions or retaining qualified personnel, or if the searches are prolonged, our business could be impaired. In addition, we face competition for personnel from other companies, academic institutions, government entities and other organizations.
Manufacturing difficulties could delay commercialization of our products.
Of the products that we currently have in clinical development, Hoffmann-La Roche Inc. and its affiliates (Roche) are responsible for manufacturing Zenapax, GlaxoSmithKline is responsible for manufacturing the humanized anti-IL-4 antibody and Scil Biomedicals is responsible for manufacturing the SMART Anti-L-Selectin Antibody. We are responsible for manufacturing our other products for our own development. We intend to continue to manufacture potential products for use in preclinical and clinical trials using our manufacturing facility in accordance with standard procedures that comply with appropriate regulatory standards. The manufacture of sufficient quantities of antibody products that comply with these standards is an expensive, time-consuming and complex process and is subject to a number of risks that could result in delays. We and our collaborative partners have experienced some manufacturing difficulties. Product supply interruptions could significantly delay clinical development of our potential products, reduce third party or clinical researcher interest and support of proposed clinical trials, and possibly delay commercialization and sales of these products. Manufacturing difficulties can even interrupt the supply of marketed products, thereby reducing revenues and risking loss of market share. For example, in December 1999, Roche received a warning letter from the FDA regarding deficiencies in the manufacture of various products. Although the letter primarily related to products other than Zenapax, Roche has also experienced difficulties in the manufacture of Zenapax leading to interruptions in supply. If future manufacturing difficulties arise and are not corrected in a timely manner, Zenapax supplies could be interrupted, which could cause a delay or termination of our clinical trials of Zenapax in autoimmune disease and could force Roche to withdraw Zenapax from the market temporarily or permanently, resulting in loss of revenue to us. These occurrences could impair our competitive position.
We do not have experience in manufacturing commercial supplies of our potential products, nor do we currently have sufficient facilities to manufacture our potential products on a commercial scale. To obtain regulatory approvals and to create capacity to produce our products for commercial sale at an acceptable cost, we will need to improve and expand our existing manufacturing capabilities. We are currently improving our existing manufacturing plant in order to manufacture initial commercial supplies of certain products. Our ability to file for, and to obtain, regulatory approvals for such products, as well as the timing of such filings, will depend on our ability to successfully improve our existing manufacturing plant. We may be unable to do so, or to obtain regulatory approval or to successfully produce commercial supplies on a timely basis. Failure to do so could delay commercialization of our products.
In addition, we plan to construct a new commercial manufacturing plant. When we implement these plans we will incur substantial costs. Any construction or other delays could impair our ability to obtain necessary regulatory approvals and to produce adequate commercial supplies of our potential products on a timely basis. Failure to do so could delay commercialization of some of our products and could impair our competitive position.
Our revenue may be adversely affected by competition and rapid technological change.
Potential competitors have developed and are developing human and humanized antibodies or other compounds for treating autoimmune and inflammatory diseases, transplantation, asthma and cancers. In addition, a number of academic and commercial organizations are actively pursuing similar technologies, and several companies have developed or may develop technologies that may compete with our SMART antibody technology. Competitors may succeed in more rapidly developing and marketing technologies and products that are more effective than our products or that would render our products or technology obsolete or noncompetitive. Our collaborative partners may also independently develop products that are competitive with products that we have licensed to them. This could reduce our revenues under our agreements with these partners.
Any product that we or our collaborative partners succeed in developing and for which regulatory approval is obtained must then compete for market acceptance and market share. The relative speed with which we and our collaborative partners can develop products, complete the clinical testing and approval processes, and supply commercial quantities of the products to the market compared to competitive companies will affect market success. In addition, the amount of marketing and sales resources and the effectiveness of the marketing used with respect to a product will affect its marketing success. For example, Novartis, which has a significant marketing and sales force directed to the transplantation market, has received approval to market Simulect, a product competitive with Zenapax, in the U.S. and Europe. In May 2001, Novartis acquired a significant interest in Roche. We cannot predict the impact, if any, that this relationship may have on Roche's efforts to market Zenapax.
We may be unable to obtain or maintain regulatory approval for our products.
All of our products in development are subject to risks associated with applicable government regulations. The manufacturing, testing and marketing of our products are subject to regulation by numerous governmental authorities in the U.S. and other countries. In the U.S., pharmaceutical products are subject to rigorous FDA regulation. Additionally, other federal, state and local regulations govern the manufacture, testing, clinical and nonclinical studies to assess safety and efficacy, approval, advertising and promotion of pharmaceutical products. The process of obtaining approval for a new pharmaceutical product or for additional therapeutic indications within this regulatory framework requires a number of years and the expenditure of substantial resources. Companies in the pharmaceutical and biotechnology industries, including us, have suffered significant setbacks in various stages of clinical trials, even in advanced clinical trials after promising results had been obtained in earlier trials.
In addition to the requirement for FDA approval of each pharmaceutical product, each pharmaceutical product manufacturing facility must be registered with, and approved by, the FDA. The manufacturing and quality control procedures must conform to rigorous guidelines in order to receive FDA approval. Pharmaceutical product manufacturing establishments are subject to inspections by the FDA and local authorities as well as inspections by authorities of other countries. To supply pharmaceutical products for use in the U.S., foreign manufacturing establishments must comply with these FDA approved guidelines. These foreign manufacturing establishments are subject to periodic inspection by the FDA or by corresponding regulatory agencies in these countries under reciprocal agreements with the FDA. Moreover, pharmaceutical product manufacturing facilities may also be regulated by state, local and other authorities.
For the marketing of pharmaceutical products outside the U.S., we and our collaborative partners are subject to foreign regulatory requirements and, if the particular product is manufactured in the U.S., FDA and other U.S. export provisions. Requirements relating to the manufacturing, conduct of clinical trials, product licensing, promotion, pricing and reimbursement vary widely in different countries. Difficulties or unanticipated costs or price controls may be encountered by us or our licensees or marketing partners in our respective efforts to secure necessary governmental approvals. This could delay or prevent us, our licensees or our marketing partners from marketing potential pharmaceutical products.
Both before and after approval is obtained, a biologic pharmaceutical product, its manufacturer and the holder of the BLA for the pharmaceutical product are subject to comprehensive regulatory oversight. The FDA may deny a BLA if applicable regulatory criteria are not satisfied. Moreover, even if regulatory approval is granted, such approval may be subject to limitations on the indicated uses for which the pharmaceutical product may be marketed. Further, regulatory approvals may be withdrawn if compliance with regulatory standards is not maintained or if problems with the pharmaceutical product occur following approval. In addition, under a BLA, the manufacturer continues to be subject to facility inspection and the applicant must assume responsibility for compliance with applicable pharmaceutical product and establishment standards. Violations of regulatory requirements at any stage may result in various adverse consequences, which may include, among other adverse actions, withdrawal of the previously approved pharmaceutical product or regulatory approvals and/or the imposition of criminal penalties against the manufacturer and/or BLA holder.
Manufacturing changes may result in delays in obtaining regulatory approval or marketing for our products.
Manufacturing of antibodies for use as therapeutics in compliance with regulatory requirements is complex, time-consuming and expensive. If we make changes in the manufacturing process, we may be required to demonstrate to the FDA and corresponding foreign authorities that the changes have not caused the resulting drug material to differ significantly from the drug material previously produced. This is particularly important if we want to rely on results of prior preclinical studies and clinical trials performed using the previously produced drug material. Depending upon the type and degree of differences between the newer and older drug material, we may be required to conduct additional animal studies or human clinical trials to demonstrate that the newly produced drug material is sufficiently similar to the previously produced drug material. We have made manufacturing changes and are likely to make additional manufacturing changes for the production of our products currently in clinical development. These manufacturing changes could result in delays in development or regulatory approvals or in reduction or interruption of commercial sales and could impair our competitive position.
Our business may be harmed if we cannot obtain sufficient quantities of raw materials.
We depend on outside vendors for the supply of raw materials used to produce our product candidates. Once a supplier's materials have been selected for use in our manufacturing process, the supplier in effect becomes a sole or limited source of that raw material due to regulatory compliance procedures. If the third party suppliers were to cease production or otherwise fail to supply us with quality raw materials and we were unable to contract on acceptable terms for these services with alternative suppliers, our ability to produce our products and to conduct preclinical testing and clinical trials of product candidates would be adversely affected. This could impair our competitive position.
We may be subject to product liability claims, and our insurance coverage may not be adequate to cover these claims.
We face an inherent business risk of exposure to product liability claims in the event that the use of products during research and development efforts or after commercialization results in adverse effects. This risk will exist even with respect to any products that receive regulatory approval for commercial sale. While we have obtained liability insurance for our products, it may not be sufficient to satisfy any liability that may arise. Also, adequate insurance coverage may not be available in the future at acceptable cost, if at all.
We may incur significant costs in order to comply with environmental regulations or to defend claims arising from accidents involving the use of hazardous materials.
We are subject to federal, state and local laws and regulations governing the use, discharge, handling and disposal of materials and wastes used in our operations. As a result, we may be required to incur significant costs to comply with these laws and regulations. We cannot eliminate the risk of accidental contamination or injury from these materials. In the event of such an accident, we could be held liable for any resulting damages and incur liabilities which exceed our resources. In addition, we cannot predict the extent of the adverse effect on our business or the financial and other costs that might result from any new government requirements arising out of future legislative, administrative or judicial actions.
Changes in the U.S. and international health care industry could adversely affect our revenues.
The U.S. and international health care industry is subject to changing political, economic and regulatory influences that may significantly affect the purchasing practices and pricing of pharmaceuticals. Cost containment measures, whether instituted by health care providers or imposed by government health administration regulators or new regulations, could result in greater selectivity in the purchase of drugs. As a result, third-party payors may challenge the price and cost effectiveness of our products. In addition, in many major markets outside the U.S., pricing approval is required before sales can commence. As a result, significant uncertainty exists as to the reimbursement status of approved health care products.
We may not be able to obtain or maintain our desired price for our products. Our products may not be considered cost effective relative to alternative therapies. As a result, adequate third-party reimbursement may not be available to enable us to maintain prices sufficient to realize an appropriate return on our investment in product development. Also, the trend towards managed health care in the U.S. and the concurrent growth of organizations such as health maintenance organizations, as well as legislative proposals to reform health care or reduce government insurance programs, may all result in lower prices, reduced reimbursement levels and diminished markets for our products. These factors will also affect the products that are marketed by our collaborative partners.
Our common stock price is volatile and an investment in our company could decline in value.
Market prices for securities of biotechnology companies, including ourselves, have been highly volatile so that investment in our securities involves substantial risk. Additionally, the stock market from time to time has experienced significant price and volume fluctuations that may be unrelated to the operating performance of particular companies. The following are some of the factors that may have a significant effect on the market price of our common stock:
If any of these factors causes us to fail to meet the expectations of securities analysts or investors, or if adverse conditions prevail or are perceived to prevail with respect to our business, the price of the common stock would likely drop significantly. A significant drop in the price of a company's common stock often leads to the filing of securities class action litigation against the company. This type of litigation against us could result in substantial costs and a diversion of management's attention and resources.
Legislative actions, higher insurance cost and potential new accounting pronouncements are likely to impact our future financial position and results of operations.
There have been regulatory changes, including the Sarbanes Oxley Act, and there may be potential new accounting pronouncements or regulatory rulings which will have an impact on our future financial position and results of operations. The Sarbanes Oxley Act and other rule changes and proposed legislative initiatives following the Enron bankruptcy are likely to increase general and administrative costs. In addition, insurers are likely to increase rates as a result of high claims rates over the past year and our rates for our various insurance policies are likely to increase. Further, proposed initiatives could result in changes in accounting rules, including legislative and other proposals to account for employee stock options as an expense. These and other potential changes could materially increase the expenses we report under generally accepted accounting principles, and adversely affect our operating results.
The Securities and Exchange Commission (SEC) staff has commented on our 2001 Form 10-K filing, including commenting on the timing of recognition of a portion of our revenue, and we cannot be certain of the outcome of this review.
In May 2002, we received a letter from the staff of the SEC (the Staff) in which the Staff commented with regard to our 2001 Form 10-K filing with the SEC. We believe this letter was the result of the SEC's efforts to review on a regular basis filings by registered companies. We have discussed the comments with the Staff, and believe we have resolved substantially all of the comments to the Staff's satisfaction. However, in July 2002 we received an additional letter from the Staff regarding what we believe is the only remaining outstanding issue in the review. The comment concerns the timing of recognition of revenue associated with non-refundable upfront fees we receive under patent license and patent rights agreements and maintenance fees we receive under patent license agreements. Such payments are not our primary source of revenue, and accounted for approximately 10% of our revenue in fiscal 2001.
We have no continuing performance obligations relating to these payments. As we believe that the earnings process for these payments is complete when such amounts are received or collection is reasonably assured, we believe our accounting for these as revenue at that time is appropriate under generally accepted accounting principles (GAAP). See "Revenue Recognition" in our footnotes to our consolidated financial statements for a full description of how we account for various types of revenue we receive, including upfront payments.
Of our total revenue of $44.4 million in 2001, $3.7 million was recognized from upfront payments under patent rights agreements; $1.0 million was recognized from an upfront payment under a patent license agreement in that period. None of our revenue for the first six months of 2002 was attributable to such upfront payments.
The SEC's comment letter indicates the Staff questions whether these up-front payments should be recognized over a period of time, or at a future time. We believe the Staff has not had the opportunity to fully review the information we have provided and that when it has done so, they will agree that our method of accounting for these payments is appropriate. However, because the Staff's review process is not yet complete, it is possible that the SEC will come to a different conclusion, and that we may need to agree to use a different method of accounting for these payments going forward, and possibly revise our prior consolidated financial statements to reflect a different method of accounting. We believe this outcome is unlikely. Further, the Staff has not indicated what the alternative timing or period for recognition for such amounts might be.
As a result, we cannot be certain of the outcome of this discussion with the Staff or precisely what the resulting consequence might be, if any. However, as an example of the possible result of this review, if the SEC were to disagree with our accounting, the result as to fiscal 2001 would be to reduce our $44.4 million in revenue by some or all of the $4.7 million in upfront fees we recognized in that period, and to spread that revenue over future periods. If periods prior to 2001 were revised, some of the payments from those prior periods might be recognized in 2001. Our revenue for the first six months of 2002 does not include any upfront fees, so our revenue for that period would not be reduced, but might increase somewhat as a result of recognizing upfront payments from 2001, or prior years, over a period of time.
The Staff also inquired about the timing of recognition of what we refer to as "maintenance" fees. These are annual payments due to us under patent license agreements if our licensees desire to continue to hold the licenses we have granted, and are recognized by us upon receipt. The Staff may believe that these annual payments should be recognized ratably over four quarters, instead of upon receipt. We recognized $1.9 million in maintenance fees in 2001, and $1.3 million in the first half of 2002. If it were determined to recognize these on a quarterly basis, our quarterly results might be different, but we do not believe our annual results would be meaningfully affected.
While we respect the Staff's comments and are working cooperatively with the Staff to resolve this issue, we believe that once the Staff understands that nature of these transactions, they will concur that our accounting is proper, and the issue will be resolved. However, as discussion of the issue is in process we cannot be certain of the outcome. Further, we do not believe the SEC has reached a specific conclusion of what the alternative methods or periods for recognizing these amounts revenue might be.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
|
10.1 |
2002 Outside Directors Plan together with Form of Nonqualified Stock Option Agreement |
|
10.2 |
Form of Notice of Grant of Stock Option under the 1999 Stock Option Plan |
|
10.3 |
Form of Notice of Grant of Stock Option under the 1999 Nonstatutory Plan |
|
10.4 |
Special Compensation and Continued Employment Agreement by and between the Company and Dr. Laurence J. Korn dated May 1, 2002 |
|
10.5 |
Stock Option Agreement by and between the Company and Mr. Douglas O. Ebersole dated April 25, 2002 |
|
10.6 |
Notice of Grant of Stock Option by and between the Company and Mr. Douglas O. Ebersole dated April 25, 2002 |
|
99.1 |
906 Certification for acting Chief Executive Officer |
|
99.2 |
906 Certification for Principal Accounting Officer |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its be half by the undersigned thereunto duly authorized.
Dated: August 14, 2002
| PROTEIN DESIGN LABS, INC. |
| (Registrant) |
| By: | /s/ Douglas O. Ebersole |
|
| |
| Douglas O. Ebersole | |
| Chief Executive Officer | |
| (Principal Executive Officer) |
| By: | /s/ Robert Kirkman |
|
| |
| Robert Kirkman | |
| Vice President, Business Development and Corporate Communications | |
| (Principal Accounting Officer) |