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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTIONS 13 OR 15 (D) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004
COMMISSION FILE NUMBER: 0-24249
PDI, INC.
---------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 22-2919486
- ---------------------------------- -----------------------
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
SADDLE RIVER EXECUTIVE CENTRE
1 ROUTE 17 SOUTH
SADDLE RIVER, NJ 07458
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (201) 258-8450
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE
(TITLE OF CLASS)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO __
-
INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO
ITEM 405 OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED,
TO THE BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION
STATEMENTS INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY
AMENDMENT TO THIS FORM 10-K. __
INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS
DEFINED IN RULE 12B-2 IN THE
ACT.) YES X NO __
-
THE AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD BY NON-AFFILIATES OF
THE REGISTRANT AS OF JUNE 30, 2004 WAS APPROXIMATELY $273,333,083.*
THE NUMBER OF SHARES OUTSTANDING OF THE REGISTRANT'S COMMON STOCK, $.01
PAR VALUE, AS OF MARCH 4, 2005 WAS 14,735,415 SHARES.
DOCUMENTS INCORPORATED BY REFERENCE
CERTAIN INFORMATION REQUIRED BY PART III OF THIS REPORT, (ITEMS 10, 11,
12, 13 AND 14), IS INCORPORATED HEREIN BY REFERENCE FROM THE REGISTRANT'S
DEFINITIVE PROXY STATEMENT RELATING TO THE ANNUAL MEETING OF SHAREHOLDERS TO BE
HELD IN 2005, WHICH DEFINITIVE PROXY STATEMENT SHALL BE FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION WITHIN 120 DAYS AFTER THE END OF THE FISCAL
YEAR TO WHICH THIS REPORT RELATES.
- ------------------
* Excludes the Common Stock held by executive officers, directors and
stockholders whose ownership exceeds 5% of the Common Stock outstanding at June
30, 2004. This calculation does not reflect a determination that such persons
are affiliates for any other purposes.
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PDI, INC.
FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page
PART I.........................................................................3
Item 1. Business........................................................3
Item 2. Properties.....................................................17
Item 3. Legal Proceedings..............................................18
Item 4. Submission of Matters to a Vote of Security Holders............19
PART II.......................................................................20
Item 5. Market for our Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities......................20
Item 6. Selected Financial Data........................................20
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................21
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.....40
Item 8. Financial Statements and Supplementary Data....................40
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosures......................................40
Item 9A. Controls and Procedures........................................40
Item 9B. Other Information..............................................40
PART III......................................................................41
Item 10. Directors and Executive Officers...............................41
Item 11. Executive Compensation.........................................41
Item 12. Security Ownership of Certain Beneficial Owners
and Management....................................41
Item 13. Certain Relationship and Related Transactions..................41
Item 14. Principal Accounting Fees and Services.........................41
PART IV.......................................................................42
Item 15. Exhibits and Financial Statement Schedules.....................42
FORWARD LOOKING STATEMENT INFORMATION
VARIOUS STATEMENTS MADE IN THIS ANNUAL REPORT ON FORM 10-K ARE
"FORWARD-LOOKING STATEMENTS" (WITHIN THE MEANING OF THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995) REGARDING THE PLANS AND OBJECTIVES OF MANAGEMENT
FOR FUTURE OPERATIONS. THESE STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS,
UNCERTAINTIES AND OTHER FACTORS THAT MAY CAUSE OUR ACTUAL RESULTS, PERFORMANCE
OR ACHIEVEMENTS TO BE MATERIALLY DIFFERENT FROM ANY FUTURE RESULTS, PERFORMANCE
OR ACHIEVEMENTS EXPRESSED OR IMPLIED BY THESE FORWARD-LOOKING STATEMENTS. THE
FORWARD-LOOKING STATEMENTS INCLUDED IN THIS REPORT ARE BASED ON CURRENT
EXPECTATIONS THAT INVOLVE NUMEROUS RISKS AND UNCERTAINTIES. OUR PLANS AND
OBJECTIVES ARE BASED, IN PART, ON ASSUMPTIONS INVOLVING JUDGMENTS ABOUT, AMONG
OTHER THINGS, FUTURE ECONOMIC, COMPETITIVE AND MARKET CONDITIONS AND FUTURE
BUSINESS DECISIONS, ALL OF WHICH ARE DIFFICULT OR IMPOSSIBLE TO PREDICT
ACCURATELY AND MANY OF WHICH ARE BEYOND OUR CONTROL. ALTHOUGH WE BELIEVE THAT
OUR ASSUMPTIONS UNDERLYING THE FORWARD-LOOKING STATEMENTS ARE REASONABLE, ANY OF
THESE ASSUMPTIONS COULD PROVE INACCURATE AND, THEREFORE, WE CANNOT ASSURE YOU
THAT THE FORWARD-LOOKING STATEMENTS INCLUDED IN THIS REPORT WILL PROVE TO BE
ACCURATE. IN LIGHT OF THE SIGNIFICANT UNCERTAINTIES INHERENT IN THE
FORWARD-LOOKING STATEMENTS INCLUDED IN THIS REPORT, THE INCLUSION OF THESE
STATEMENTS SHOULD NOT BE INTERPRETED BY ANYONE THAT OUR OBJECTIVES AND PLANS
WILL BE ACHIEVED. FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY
AND ADVERSELY FROM THOSE EXPRESSED OR IMPLIED BY FORWARD-LOOKING STATEMENTS
INCLUDE, BUT ARE NOT LIMITED TO, THE FACTORS, RISKS AND UNCERTAINTIES (I)
IDENTIFIED OR DISCUSSED HEREIN, (II) SET FORTH UNDER THE HEADINGS "BUSINESS" AND
"RISK FACTORS" IN PART I, ITEM 1; "LEGAL PROCEEDINGS" IN PART I, ITEM 3; AND
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS" IN PART II, ITEM 7, OF THIS ANNUAL REPORT ON FORM 10-K, AND (III)
SET FORTH IN THE COMPANY'S PERIODIC REPORTS ON AMENDED ANNUAL REPORT FORM
10-K/A, QUARTERLY REPORT ON FORM 10-Q, AMENDED QUARTERLY REPORTS ON 10-Q/A,
CURRENT REPORTS ON FORM 8-K AND CURRENT REPORTS ON FORM 8-K/A AS FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION (SEC) SINCE JANUARY 1, 2004. WE UNDERTAKE NO
OBLIGATION TO REVISE OR UPDATE PUBLICLY ANY FORWARD-LOOKING STATEMENTS FOR ANY
REASON.
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PART 1
ITEM 1. BUSINESS
SUMMARY OF BUSINESS
We are a diversified sales and marketing services company serving the
biopharmaceutical and medical devices and diagnostics (MD&D) industries.
We create and execute sales and marketing programs intended to improve the
profitability of biopharmaceutical and MD&D products. We do this by working with
companies who recognize our ability to add value to their products and maximize
their sales performance. We have a variety of agreement types that we enter into
with our clients. In these agreements, we leverage our experience in sales,
medical education and marketing research to help our partners and clients meet
strategic and financial objectives.
We have assembled our commercial capabilities through organic growth,
acquisitions, and internal expansion. These capabilities can be applied on a
stand-alone or integrated basis. This flexibility enables us to provide a wide
range of marketing and promotional options that can benefit many different
products throughout the various stages of their life cycles.
It is important for us to form strong relationships with companies within
the biopharmaceutical and MD&D industries. Our focus is to achieve operational
excellence that delivers the desired product sales results.
We are among the leaders in outsourced sales and marketing services in the
U.S. We have designed and implemented programs for many of the major
pharmaceutical companies serving the U.S. market. Our clients include
AstraZeneca PLC (AstraZeneca), GlaxoSmithKline PLC (GSK), Novartis
Pharmaceutical Corporation (Novartis), Pfizer Inc. (Pfizer) and Sanofi-Aventis,
AG (Sanofi-Aventis) as well as many small and specialty pharmaceutical
companies. Our relationships are built on consistent performance and program
results.
Our clients engage us on a contractual basis to design and implement
promotional programs for both prescription and over-the-counter products. The
programs are designed to increase product sales and are tailored to meet the
specific needs of the product and the client. These services are provided
predominantly on a fee for service basis. Occasionally, there is an opportunity
for us to earn incentives if we meet or exceed predetermined performance
targets. Contracts may also be terminated for cause, or we may incur specific
penalties if we fail to meet stated performance benchmarks.
REPORTING SEGMENTS AND OPERATING GROUPS
During the fourth quarter of 2004 as a result of our acquisition of
Pharmakon we restructured certain management responsibilities and changed our
internal financial reporting. As a result of these changes, we determined that
our reporting segments were required to be amended. Accordingly, we now report
under the following three segments: Sales Services, Marketing Services and PDI
Products Group (PPG).
SALES SERVICES
This segment includes dedicated teams, shared teams, MD&D contract sales
and MD&D InServe clinical teams. This segment, which focuses on product
detailing and clinical education, represented 91.2% of consolidated revenue for
the year ended December 31, 2004.
Product detailing involves a representative meeting face-to-face with
targeted physicians and other healthcare decision makers to provide a technical
review of the product being promoted. Contract sales teams can be deployed on
either a dedicated or shared basis.
o Dedicated Teams
---------------
A dedicated contract sales team works exclusively on behalf of one client
and often carries the business cards of the client. The sales team is customized
to meet the specifications of our client with respect to representative profile,
physician targeting, product training, incentive compensation plans, integration
with clients' in-house sales forces, call reporting platform and data
integration. Without adding permanent personnel, the client gets a high quality,
industry-standard sales team comparable to its internal sales force.
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o Shared Teams
------------
Our shared sales teams sell multiple brands from different pharmaceutical
companies. Using these teams, we make a face-to-face selling resource available
to those clients that want an alternative to a dedicated team. PDI Shared Sales
is a leading provider of these detailing programs in the U.S. Since costs are
shared among various companies, these programs may be less expensive for the
client than programs involving a dedicated sales force. With a shared sales
team, the client still gets targeted coverage of its physician audience within
the representatives' geographic territories.
o MD&D Contract Sales
-------------------
We also provide contract sales services within the MD&D market. We
leveraged our knowledge from years of providing sales forces to the
pharmaceutical industry and applied it to our MD&D business. As a result, we now
offer the provision of contract sales forces as one of the services that we
market to the MD&D industry to assist our clients in improving product sales.
o MD&D Clinical Teams
-------------------
Our MD&D Clinical Teams group provides an array of sales and marketing
services to the MD&D industry. Its core service is the provision of clinical
after sales support teams. Our clinical after sales support teams employ nurses,
medical technologists, and other clinicians who train and provide hands-on
clinical education and after sales support to the medical staff of hospitals and
clinics that recently purchased our clients' equipment. Our activities maximize
product utilization and customer satisfaction for the medical practitioners,
while simultaneously enabling our clients' sales forces to continue their
selling activities instead of in-servicing the equipment.
MARKETING SERVICES
This segment, which includes PDI Education and Communications (PDI
Edcomm), Pharmakon, and TVG Marketing Research and Consulting, represented 8.0%
of consolidated revenue for 2004.
PDI Edcomm provides medical education and promotional communications to
the biopharmaceutical and MD&D industries. Using an expert-driven, customized
approach, we provide our clients with integrated advocacy development,
accredited continuing medical education (CME), promotions, publication services
and interactive sales initiatives to generate incremental value for products.
We create custom designed programs focusing on optimizing the informed use
of our clients' products. Our services are executed through a customized,
integrated plan that can be leveraged across the product's entire life cycle. We
can meet a wide range of objectives, including advocacy during pre-launch,
communicating disease state awareness, supporting a product launch, helping an
under-performing brand, fending off new competition, and expanding market
leadership.
Pharmakon's emphasis is on the creation, design and implementation of
interactive peer persuasion programs. In the last five years, Pharmakon has
conducted over 20,000 peer persuasion programs with more than 250,000
participants. Pharmakon's peer programs can be designed as promotional, CME or
marketing research/advisory programs. We acquired Pharmakon in August 2004.
Each marketing program can be offered through a number of different venues,
including: teleconferences, dinner meetings, "lunch and learns," and web casts.
Within each of our programs, we offer a number of services including strategic
design, tactical execution, technology support, moderator services and thought
leader management.
TVG Marketing Research and Consulting employs leading edge, in some
instances proprietary, research methodologies. We provide qualitative and
quantitative marketing research to pharmaceutical companies with respect to
healthcare providers, patients and managed care customers in the U.S. and
globally. We offer a full range of pharmaceutical marketing research services,
including studies to identify the most impactful business strategy, profile,
positioning, message, execution, implementation and post implementation for a
product. Our marketing research model improves the knowledge clients obtain
about how physicians and other healthcare professionals will likely react to
products.
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We utilize a systematic approach to pharmaceutical marketing research.
Recognizing that every marketing need, and therefore every marketing research
solution, is unique, we have developed our marketing model to help identify the
work that needs to be done in order to identify critical paths to marketing
goals. At each step of the marketing model we can offer proven research
techniques, proprietary methodologies and customized study designs to address
specific product needs.
In addition to conducting marketing research, we have trained several
thousand industry professionals at our public seminars. Our professional
development seminars focus on key marketing processes and issues.
PDI PRODUCTS GROUP (PPG)
The goal of the PPG segment has been to source biopharmaceutical products
in the U.S. through licensing, copromotion, acquisition or integrated
commercialization services arrangements. This segment represented 0.8% of
consolidated revenue for 2004.
Notwithstanding the fact that we are shifting our strategy to deemphasize
the PPG Segment and focus on our service businesses and that we had only
approximately $2.9 million in revenue from the PPG segment of our business in
2004, we may continue to review opportunities which may include copromotion,
distribution arrangements, as well as licensing and brand ownership of products.
Revenue in 2004 was due to royalty payments received from Novartis from the
Lotensin(R) agreement completed at the end of 2003. See complete discussion
below in the "Examples of Significant Contracts." We do not anticipate any
revenue for 2005 from the PPG segment at this time.
HISTORY
We commenced operations as a contract sales organization in 1987. From
1990 to 1995, contract sales became accepted in the pharmaceutical industry as a
tactical solution for a lower cost, high quality sales team. The representatives
were principally flextime. We were paid per call and there was little, if any,
risk sharing.
The expansion of pharmaceutical field forces in general and the acceptance
of contract sales by the industry were two main drivers that fueled our high
growth from 1996 to 2000. Our representatives were principally full-time
employees, and we provided a compensation package that was competitive with
those of the major pharmaceutical companies in order to attract higher quality
personnel and become a better provider of contract sales services.
We completed our initial public offering in May 1998. In May 1999, we
acquired TVG, Inc. (TVG) which gave us one of the leading marketing research
groups in the U.S. and a scientifically focused medical education capability,
which we now refer to as PDI Education and Communication. The addition of TVG
provided us with incremental growth potential as a result of the additional
capabilities they provide.
In August 1999, we added a shared sales capability through the acquisition
of ProtoCall, Inc. (ProtoCall), now PDI Shared Sales. This addition provided us
with a lower cost product offering and increased business opportunities with
existing and new clients. This offering also supplemented our dedicated sales
force capacity.
In September 2001, we acquired InServe Support Solutions (InServe) which
provides clinical after sales support to the MD&D industry. InServe employs
nurses, medical technologists, and other clinicians who train healthcare
practitioners with respect to medical equipment. InServe informs and supports
the end users of medical equipment, with the objective of increasing
satisfaction and utilization of the equipment. The client benefits by reducing
the time its sales representatives spend on training and service, increasing the
time available for sales activity.
In June 2000, we established LifeCycle Ventures, Inc. (LCV) to support our
agreements that require marketing and other commercial capabilities. Our initial
strategy, in response to the market dynamics at the time, was to identify
under-promoted brands within pharmaceutical companies' product portfolios and
put a focused promotional effort behind them, increasing product performance. In
the fourth quarter of 2000, we entered into an exclusive sales, marketing and
distribution contract with GSK in support of Ceftin(R).
From 2001 through 2003, we continued to identify late stage pharmaceutical
products that could benefit from focused sales and marketing efforts. Many
companies had products within their portfolios that were under-promoted and that
could potentially benefit from focused sales and marketing efforts. As the
dynamics within the industry changed, affected by mergers and acquisitions, a
slowdown in the approval of new products, and increased generic availability of
once large brands, the willingness of pharmaceutical companies to relinquish
commercial control of
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products decreased. During this period, we entered into a number of copromotion
agreements. In 2001, we entered into an agreement with Eli Lilly and Company
(Eli Lilly) to copromote Evista(R) in the U.S. In the fourth quarter of 2002, we
entered into two licensing arrangements, one with Xylos Corporation (Xylos) and
one with Cellegy Pharmaceuticals, Inc. (Cellegy). The Xylos arrangement was for
the sales, marketing and distribution rights for the XCell(R) wound care
products. The Cellegy agreement was for exclusive North American rights for
Fortigel(TM), a testosterone gel product. Please refer to the subsection below
under "Contracts" entitled "EXAMPLES OF SIGNIFICANT CONTRACTS" for a detailed
description of these contractual arrangements.
CORPORATE STRATEGY
We are a diversified sales and marketing service business, serving the
biopharmaceutical and MD&D industries. We intend to increase the value of our
company by investing in the businesses we currently have and to increase our
service offerings by internal development or through acquisitions.
CONTRACTS
Our contracts are nearly all fee for service. They may contain operational
benchmarks, such as a minimum amount of activity within a specified amount of
time. These contracts can include incentive payments that can be earned if our
activities generate results that meet or exceed performance targets. Contracts
may be terminated for cause or we may incur specific penalties if we fail to
meet stated performance benchmarks.
SALES SERVICES
The majority of our revenue is generated by contracts for dedicated sales
teams. These contracts are generally for terms of one to three years and may be
renewed or extended. The majority of these contracts, however, are terminable by
the client for any reason upon 30 to 90 days' notice. These contracts often, but
not always, provide for termination payments by the client upon termination
without cause. While such termination may result in the imposition of penalties
on the client, these penalties may not act as an adequate deterrent to the
termination of any contract. In addition, these penalties may not offset the
revenue we could have earned under the contract or the costs we may incur as a
result of its termination. The loss or termination of a large contract or the
loss of multiple contracts could have a material adverse effect on our business,
financial condition and results of operations.
MARKETING SERVICES
Our marketing services contracts generally are for projects lasting from
three to six months. The contracts are terminable by the client and typically
provide for termination payments in the event they are terminated by the client
without cause. Termination payments include payment for all work completed to
date, plus the cost of any nonrefundable commitments made on behalf of the
client. Due to the typical size of these contracts, it is unlikely the loss or
termination of any individual contract would have a material adverse effect on
our business, financial condition and results of operations.
PPG
The contracts within the PPG segment have been performance based or fee
for service and some required sales, marketing and distribution of product. In
performance based contracts, we provide and finance a portion, if not all, of
the commercial activities in support of a brand in return for a percentage of
product sales. An important performance parameter was normally the level of
sales or prescriptions attained by the product during the period of our
marketing or promotional responsibility, and in some cases, for periods after
our promotional activities have ended.
EXAMPLES OF SIGNIFICANT CONTRACTS
In the fourth quarter of 2000, we entered into a performance based
contract with GSK. Our agreement with GSK was in support of Ceftin and was an
exclusive sales, marketing and distribution contract. The agreement had a
five-year term, but was cancelable by either party without cause on 120 days'
notice. The agreement was terminated by mutual consent, effective February 28,
2002, due to the unexpected loss of patent exclusivity for Ceftin.
In May 2001, we entered into a copromotion agreement with Novartis for the
U.S. sales, marketing and promotion rights for Lotensin, and Lotensin HCT(R).
Another product, Lotrel(R), was promoted by the same sales force under the same
agreement, but was a fee-for-service arrangement. On May 20, 2002, that
agreement was
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replaced by two separate agreements, one for Lotensin and another one for
Lotrel, Diovan(R) and Diovan HCT(R). Both agreements ran through December 31,
2003; however, the Lotrel-Diovan agreement was renewed on December 24, 2003 for
an additional one year period. In February 2004, we were notified by Novartis of
its intent to terminate the Lotrel-Diovan agreement without cause, effective
March 16, 2004. We continued to be compensated under the terms of the agreement
through the effective termination date. The Lotensin agreement called for us to
provide promotion, selling, marketing and brand management for Lotensin. In
exchange, we were entitled to receive a percentage of product revenue based on
certain total prescription (TRx) objectives above specified contractual
baselines. Even though the Lotensin agreement ended December 31, 2003, we
received royalty payments on the sales of Lotensin through December 31, 2004.
In October 2001, we entered into an agreement with Eli Lilly to copromote
Evista in the U.S. Under this agreement, we were entitled to be compensated
based upon net sales achieved above a predetermined level. In the event these
predetermined net sales levels were not achieved, we would not receive any
revenue to offset expenses incurred. During 2002, it became apparent that the
net sales levels likely to be achieved would not be sufficient to recoup our
expenses. In November 2002, we agreed with Eli Lilly to terminate the Evista
copromotion agreement effective December 31, 2002.
In October 2002, we entered into an agreement with Xylos for the exclusive
U.S. commercialization rights to the XCell line of wound care products. On
January 2, 2004, we exercised our contractual right to terminate the agreement
on 135 days' notice to Xylos, since sales of XCell were not sufficient to
sustain our role as commercialization partner for the product. Our promotional
activities in support of the brand concluded in January 2004, and the agreement
was terminated effective May 16, 2004. In 2002, we had acquired $1.0 million of
preferred stock of Xylos and in 2004, we loaned $500,000 to Xylos. As discussed
on page 24, we determined our $1.0 million investment and $500,000 short-term
loan to Xylos were impaired as of December 31, 2004 and both were written down
to zero.
On December 31, 2002, we entered into an exclusive licensing agreement
with Cellegy (the Cellegy Licensing Agreement) for the exclusive North American
rights for the testosterone gel product, Fortigel. The agreement is in effect
for the commercial life of the product. Cellegy submitted a New Drug Application
(NDA) for the hypogonadism indication to the U.S. Food and Drug Administration
(FDA) in June 2002. In July 2003, Cellegy received a letter from the FDA
rejecting its NDA for Fortigel. Cellegy has told us that, in the first quarter
of 2005, it received FDA approval for the protocol parameters for a new Phase 3
study proposed by Cellegy to the FDA. We do not know when, or even whether,
Cellegy will conduct such a new Phase 3 Study, and we cannot predict with any
certainty whether the FDA will ultimately approve Fortigel for sale in the U.S.
Under the terms of the agreement, we paid Cellegy a $15.0 million initial
licensing fee on December 31, 2002. This payment was made prior to FDA approval
and since there is no alternative future use of the licensed rights, we expensed
the $15.0 million payment in December 2002, when incurred. This amount was
recorded in other selling, general and administrative expenses in the December
31, 2002 consolidated statements of operations. Pursuant to the terms of the
Cellegy Licensing Agreement, we will be required to pay Cellegy a $10.0 million
incremental license fee milestone payment upon Fortigel's receipt of all
approvals required by the FDA (if such approvals are obtained) to promote, sell
and distribute the product in the U.S. This incremental milestone license fee,
if incurred, will be recorded as an intangible asset and amortized over its
estimated useful life, as then determined, which is not expected to exceed the
life of the patent. Royalty payments to Cellegy over the term of the commercial
life of the product will range from 20% to 30% of net sales. On December 12,
2003, we instituted an action against Cellegy in the U.S. District Court for the
Southern District of New York seeking to rescind the Cellegy Licensing Agreement
on the grounds that it was procured by fraud. We are seeking return of the $15.0
million license fee we paid plus additional damages caused by Cellegy's conduct.
See Item 3 - "Legal Proceedings" for additional information.
SIGNIFICANT CUSTOMERS
Our significant customers are discussed in Note 12 to the consolidated
financial statements included elsewhere in this report.
MARKETING
Our marketing efforts target the biopharmaceutical and MD&D industries.
Companies with large product portfolios have been the most likely customers for
the services and solutions we provide, but we also frequently serve smaller,
emerging companies. Our marketing efforts are designed to reach the senior
sales, marketing and business development personnel within these companies, with
the goal of informing them of the value we can bring to their
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products. Our tactical plan usually includes advertising in trade publications,
direct mail campaigns, presence at industry seminars and a direct selling
effort. We have a dedicated team of business development specialists who work
within our business units to identify needs within the biopharmaceutical and
MD&D industries which we can address. A multi-disciplinary team of senior
managers reviews possible business opportunities as identified by the business
development team and determines strategies and negotiation positions to contract
for the most attractive business opportunities.
COMPETITION
There are relatively few barriers to entry into the businesses in which we
operate and, as the industry continues to evolve, new competitors are likely to
emerge. We compete on the basis of such factors as reputation, service quality,
management experience, performance record, customer satisfaction, ability to
respond to specific client needs, integration skills and price. We believe we
compete effectively with respect to each of these factors. Increased competition
may lead to price and other forms of competition that could have a material
adverse effect on our business, financial condition and results of operations.
The competition includes in-house sales and marketing departments of
biopharmaceutical and MD&D companies, as well as other contract sales
organizations (CSOs), medical education providers and marketing research
companies. Companies that compete with us from the perspective of having
diversified service offerings include Innovex (a subsidiary of Quintiles
Transnational), Ventiv Health, Publicis Selling Solutions and Cardinal Health,
Inc.
GOVERNMENT AND INDUSTRY REGULATION
The healthcare sector is heavily regulated by both government and
industry. Various laws, regulations and guidelines established by government,
industry and professional bodies affect, among other matters, the approval,
provision, licensing, labeling, marketing, promotion, price, sale and
reimbursement of healthcare services and products, including pharmaceutical and
MD&D products. The federal government has extensive enforcement powers over the
activities of pharmaceutical manufacturers, including authority to withdraw
product approvals, commence actions to seize and prohibit the sale of unapproved
or non-complying products, to halt manufacturing operations that are not in
compliance with good manufacturing practices, and to impose or seek injunctions,
voluntary recalls, and civil monetary and criminal penalties. These restrictions
or prohibitions on sales or withdrawal of approval of products marketed by us
could have a material adverse effect on our business, financial condition and
results of operations.
The Food, Drug and Cosmetic Act, as supplemented by various other
statutes, regulates, among other matters, the approval, labeling, advertising,
promotion, sale and distribution of drugs, including the practice of providing
product samples to physicians. Under this statute, the FDA regulates all
promotional activities involving prescription drugs. The distribution of
pharmaceutical products is also governed by the Prescription Drug Marketing Act
(PDMA), which regulates these activities at both the federal and state level.
The PDMA imposes extensive licensing, personnel record keeping, packaging,
quantity, labeling, product handling and facility storage and security
requirements intended to prevent the sale of pharmaceutical product samples or
other diversions. Under the PDMA and its implementing regulations, states are
permitted to require registration of manufacturers and distributors who provide
pharmaceutical products even if such manufacturers or distributors have no place
of business within the state. States are also permitted to adopt regulations
limiting the distribution of product samples to licensed practitioners and
require extensive record keeping and labeling of such samples for tracing
purposes. The sale or distribution of pharmaceutical products is also governed
by the Federal Trade Commission Act.
Some of the services that we currently perform or that we may provide in
the future may also be affected by various guidelines established by industry
and professional organizations. For example, ethical guidelines established by
the American Medical Association (AMA) govern, among other matters, the receipt
by physicians of gifts from health-related entities. These guidelines govern
honoraria and other items of economic value which AMA member physicians may
receive, directly or indirectly, from pharmaceutical companies. Similar
guidelines and policies have been adopted by other professional and industry
organizations, such as Pharmaceutical Research and Manufacturers of America, an
industry trade group.
There are also numerous federal and state laws pertaining to healthcare
fraud and abuse. In particular, certain federal and state laws prohibit
manufacturers, suppliers and providers from offering, giving or receiving
kickbacks or other remuneration in connection with ordering or recommending the
purchase or rental of healthcare items and services. The federal anti-kickback
statute imposes both civil and criminal penalties for, among other things,
offering
8
or paying any remuneration to induce someone to refer patients to, or to
purchase, lease or order (or arrange for or recommend the purchase, lease or
order of) any item or service for which payment may be made by Medicare or other
federally-funded state healthcare programs (E.G., Medicaid). This statute also
prohibits soliciting or receiving any remuneration in exchange for engaging in
any of these activities. The prohibition applies whether the remuneration is
provided directly or indirectly, overtly or covertly, in cash or in kind.
Violations of the statute can result in numerous sanctions, including criminal
fines, imprisonment and exclusion from participation in the Medicare and
Medicaid programs.
Several states also have referral, fee splitting and other similar laws
that may restrict the payment or receipt of remuneration in connection with the
purchase or rental of medical equipment and supplies. State laws vary in scope
and have been infrequently interpreted by courts and regulatory agencies, but
may apply to all healthcare items or services, regardless of whether Medicare or
Medicaid funds are involved.
The FDA regulates the drug development process in the U.S. This impacts
products we may develop, license or acquire, including, for example, the Cellegy
licensed product. These regulations affect all aspects of the research programs
conducted on unapproved products in the U.S., including manufacturing of the
drug substance and drug product, preliminary pharmacology and toxicology
evaluation, and all exposure of human subjects or patients. This human testing
is performed under an Investigational New Drug Exemption (IND). When sufficient
evidence of efficacy and safety is available to enable unrestricted commercial
distribution, an NDA is submitted under the regulations. The NDA is a
comprehensive filing that includes, among other things, the results of all
Chemistry, Manufacturing and Controls preclinical and clinical studies. The
FDA's review of this application results in a decision on the approval or
non-approval of the drug. Approved drugs may be marketed in the U.S.
post-approval, however, the NDA regulations require continuing monitoring and
reporting on the safety of the approved product in the general patient
population.
We cannot determine what effect changes in regulations or statutes or
legal interpretations, when and if established or enacted, may have on our
business in the future. Changes could require, among other things, changes to
manufacturing methods, expanded or different labeling, the recall, replacement
or discontinuance of certain products, additional record keeping or expanded
documentation of the properties of certain products and scientific
substantiation. Further, we may experience delays in the regulatory approval of
products we license or acquire. Such changes, or new legislation, or delays
could have a material adverse effect on our business, financial condition and
results of operations. Our failure, or the failure of our clients and/or the
partners, to comply with, or any change in, the applicable regulatory
requirements or professional organization or industry guidelines or regulatory
delays could, among other things, limit or prohibit us or our clients from
conducting business activities as presently conducted or proposed to be
conducted, result in adverse publicity, increase the costs of regulatory
compliance or result in monetary fines or other penalties. Any of these
occurrences could have a material adverse effect on our business, financial
condition and results of operations.
RISK FACTORS
In addition to the other information provided in our reports, you should
carefully consider the following factors in evaluating our business, operations
and financial condition. Additional risks and uncertainties not presently known
to us, that we currently deem immaterial or that are similar to those faced by
other companies in our industry or business in general, such as competitive
conditions, may also impair our business operations. The occurrence of any of
the following risks could have a material adverse effect on our business,
financial condition and results of operations.
OUR SERVICE BUSINESSES DEPEND ON EXPENDITURES BY COMPANIES IN THE LIFE SCIENCES
INDUSTRIES.
Our service revenues depend on promotional, marketing and sales
expenditures by companies in the life sciences industries, including the
pharmaceutical, MD&D and biotechnology industries. Promotional, marketing and
sales expenditures by pharmaceutical manufacturers have in the past been, and
could in the future be, negatively impacted by, among other things, governmental
reform or private market initiatives intended to reduce the cost of
pharmaceutical products or by governmental, medical association or
pharmaceutical industry initiatives designed to regulate the manner in which
pharmaceutical manufacturers promote their products. Furthermore, the trend in
the life sciences industries toward consolidation may result in a reduction in
overall sales and marketing expenditures and, potentially, a reduction in the
use of contract sales and marketing services providers.
9
CHANGES IN OUTSOURCING TRENDS IN THE PHARMACEUTICAL AND BIOTECHNOLOGY INDUSTRIES
COULD MATERIALLY ADVERSELY AFFECT OUR BUSINESS, FINANCIAL CONDITION, RESULTS OF
OPERATIONS AND GROWTH RATE.
Our business and growth depend in large part on demand from the
pharmaceutical and life sciences industries for outsourced marketing and sales
services. The practice of many companies in these industries has been to hire
outside organizations like us to conduct large sales and marketing projects.
However, companies may elect to perform these services internally for a variety
of reasons, including the rate of new product development and FDA approval of
those products, number of sales representatives employed internally in relation
to demand for or the need to promote new and existing products, and competition
from other suppliers. If these industries reduce their tendency to outsource
these projects, our business, financial condition, results of operations and
growth rate could be materially adversely affected.
MOST OF OUR SERVICE REVENUE IS DERIVED FROM A LIMITED NUMBER OF CLIENTS, THE
LOSS OF ANY ONE OF WHICH COULD ADVERSELY AFFECT OUR BUSINESS.
Our revenue and profitability depend to a great extent on our
relationships with a limited number of large pharmaceutical companies. In 2004,
we had two major clients that accounted for approximately 42.0% and 21.0%,
respectively, or a total of approximately 63.0% of our service revenue. In 2003,
our two major clients accounted for a total of approximately 66.5%, of our
service revenue. We are likely to continue to experience a high degree of client
concentration, particularly if there is further consolidation within the
pharmaceutical industry. The loss or a significant reduction of business from
any of our major clients could have a material adverse effect on our business,
financial condition and results of operations. For example, in December 2004, we
announced a reduction in the aggregate number of representatives that we
deployed for AstraZeneca. This reduction is expected to decrease revenue
generated from AstraZeneca in 2005 by approximately $60.0 million compared to
revenues generated in 2004.
PRODUCT LIABILITY CLAIMS COULD HARM OUR BUSINESS.
We could face substantial product liability claims in the event any of the
pharmaceutical and medical device products we market now or in the future are
alleged to cause negative reactions or adverse side effects or in the event any
of these products causes injury, is alleged to be unsuitable for its intended
purpose or is alleged to be otherwise defective. For example, we have been named
in numerous lawsuits as a result of our detailing of Baycol(R) on behalf of
Bayer Corporation (Bayer). Product liability claims, regardless of their merits,
could be costly and divert management's attention, or adversely affect our
reputation and the demand for our products. Although we currently have product
liability insurance in the aggregate amount of $10.0 million, we cannot assure
you that our insurance will be sufficient to cover fully all potential claims.
Also, adequate insurance coverage might not be available in the future at
acceptable costs, if at all.
IF WE DO NOT MEET PERFORMANCE GOALS SET IN OUR INCENTIVE-BASED AND REVENUE
SHARING ARRANGEMENTS, OUR PROFITS COULD SUFFER.
We sometimes enter into incentive-based and revenue sharing arrangements
with pharmaceutical companies. Under incentive-based arrangements, we are
typically paid a fixed fee and, in addition, have an opportunity to increase our
earnings based on the market performance of the products being detailed in
relation to targeted sales volumes, sales force performance metrics or a
combination thereof. Additionally, certain of our service contracts may contain
penalty provisions pursuant to which our fees may be significantly reduced if we
do not meet certain performance metrics, for example number and timing of sales
calls, physician reach, territory vacancies and/or sales representative
turnover. Under revenue sharing arrangements, our compensation is based on the
market performance of the products being detailed, usually expressed as a
percentage of product sales. These types of arrangements transfer some market
risk from our clients to us. In addition, these arrangements can result in
variability in revenue and earnings due to seasonality of product usage, changes
in market share, new product introductions, overall promotional efforts and
other market related factors. As an example, in October 2001, we entered into an
agreement with Eli Lilly to copromote Evista in the U.S. under which we were to
receive payments once product net sales exceeded a pre-determined baseline. The
net sales of Evista were insufficient for us to achieve our revenue and profit
goals and as a result we incurred an operating loss for 2002 of $35.1 million on
this contract, consisting of $28.9 million from operating activities and $6.2
million in unused sales force capacity. This contract was terminated effective
December 31, 2002.
10
OUR SERVICE CONTRACTS ARE GENERALLY SHORT-TERM AGREEMENTS AND ARE CANCELABLE AT
ANY TIME, WHICH MAY RESULT IN LOST REVENUE AND ADDITIONAL COSTS AND EXPENSES.
Our service contracts are generally for a term of one to three years
(certain of our operating entities have contracts of shorter duration) and many
may be terminated by the client at any time for any reason. Additionally,
certain of our clients have the ability to significantly reduce the number of
representatives we deploy on their behalf. For example, as discussed above, as a
result of the reduction in the number of representatives we deployed for
AstraZeneca and the early termination of our fee for service contract
arrangement with Novartis, we expect to generate approximately $60.0 million
less revenue from our AstraZeneca relationship in 2005 than we realized in 2004,
and $28.9 million of originally anticipated revenue associated with the Novartis
contract in 2004 was not realized. The termination or significant reduction of a
contract by one of our major clients not only results in lost revenue, but also
may cause us to incur additional costs and expenses. All of our sales
representatives are employees rather than independent contractors. Accordingly,
when a contract is significantly reduced or terminated, unless we can
immediately transfer the related sales force to a new program, we must either
continue to compensate those employees, without realizing any related revenue,
or terminate their employment. If we terminate their employment, we may incur
significant expenses relating to their termination. The loss, termination or
significant reduction of a large contract or the loss of multiple contracts
could have a material adverse effect on our business, financial condition and
results of operations.
WE MAY MAKE ACQUISITIONS IN THE FUTURE WHICH MAY LEAD TO DISRUPTIONS TO OUR
ONGOING BUSINESS.
Historically, we have made a number of acquisitions and will continue to
review new acquisition opportunities. If we are unable to successfully integrate
an acquired company, the acquisition could lead to disruptions to our business.
The success of an acquisition will depend upon, among other things, our ability
to:
o assimilate the operations and services or products of the acquired company;
o integrate new personnel due to the acquisition;
o retain and motivate key employees;
o retain customers; and
o minimize the diversion of management's attention from other business
concerns.
In the event that the operations of an acquired business do not meet our
performance expectations, we may have to restructure the acquired business or
write-off the value of some or all of the assets of the acquired business,
including goodwill and other intangible assets identified at time of
acquisition.
WE AND TWO OF OUR OFFICERS ARE DEFENDANTS IN A CLASS ACTION SHAREHOLDER LAWSUIT
WHICH COULD DIVERT OUR TIME AND ATTENTION FROM MORE PRODUCTIVE ACTIVITIES.
Beginning on January 24, 2002, several purported class action complaints
were filed in the U.S. District Court for the District of New Jersey, against us
and certain of our officers on behalf of persons who purchased our common stock
during the period between May 22, 2001 and August 12, 2002. On May 23, 2002 the
court consolidated these suits into a single class action lawsuit. We believe
that meritorious defenses exist to the allegations asserted in this lawsuit and
we intend to vigorously defend this action. Although we currently maintain
director and officer liability insurance coverage, there is no assurance that we
will continue to maintain such coverage or that any such coverage will be
adequate to offset potential damages.
OUR FAILURE, OR THAT OF OUR CLIENTS, TO COMPLY WITH APPLICABLE HEALTHCARE
REGULATIONS COULD LIMIT, PROHIBIT OR OTHERWISE ADVERSELY IMPACT OUR BUSINESS
ACTIVITIES.
Various laws, regulations and guidelines established by government,
industry and professional bodies affect, among other matters, the provision of,
licensing, labeling, marketing, promotion, sale and distribution of healthcare
services and products, including pharmaceutical and MD&D products. In
particular, the healthcare industry is governed by various federal and state
laws pertaining to healthcare fraud and abuse, including prohibitions on the
payment or acceptance of kickbacks or other remuneration in return for the
purchase or lease of products that are paid for by Medicare or Medicaid.
Sanctions for violating these laws include civil and criminal fines and
penalties and possible exclusion from Medicare, Medicaid and other federal or
state healthcare programs. Although we believe our current business arrangements
do not violate these federal and state fraud and abuse laws, we cannot be
certain that our business practices will not be challenged under these laws in
the future or that a challenge would not have a material adverse effect on our
business, financial condition and results of operations. Our failure, or the
failure of our
11
clients, to comply with these laws, regulations and guidelines, or any change in
these laws, regulations and guidelines may, among other things, limit or
prohibit our business activities or those of our clients, subject us or our
clients to adverse publicity, increase the cost of regulatory compliance and
insurance coverage or subject us or our clients to monetary fines or other
penalties.
OUR INDUSTRY IS HIGHLY COMPETITIVE AND OUR FAILURE TO ADDRESS COMPETITIVE
DEVELOPMENTS PROMPTLY WILL LIMIT OUR ABILITY TO RETAIN AND INCREASE OUR MARKET
SHARE.
Our primary competitors for sales and marketing services include in-house
sales and marketing departments of pharmaceutical companies, other CSOs and
medical education and marketing research providers. There are relatively few
barriers to entry in the businesses in which we compete and, as the industry
continues to evolve, new competitors are likely to emerge. Many of our current
and potential competitors are larger than we are and have substantially greater
capital, personnel and other resources than we have. Increased competition may
lead to competitive practices that could have a material adverse effect on our
market share, our ability to source new business opportunities, our business,
financial condition and results of operations.
OUR STOCK PRICE IS VOLATILE AND COULD BE FURTHER AFFECTED BY EVENTS NOT WITHIN
OUR CONTROL. IN 2004, OUR STOCK TRADED AT A LOW OF $18.94 AND A HIGH OF $33.23.
IN 2003, OUR STOCK TRADED AT A LOW OF $6.86 AND A HIGH OF $31.71.
The market for our common stock is volatile. The trading price of our
common stock has been and will continue to be subject to:
o volatility in the trading markets generally;
o significant fluctuations in our quarterly operating results;
o announcements regarding our business or the business of our competitors;
o industry developments;
o regulatory developments;
o changes in revenue mix;
o changes in revenue and revenue growth rates for us and for our industry as a
whole; and
o statements or changes in opinions, ratings or earnings estimates made by
brokerage firms or industry analysts relating to the markets in which we
operate or expect to operate.
OUR QUARTERLY REVENUES AND OPERATING RESULTS MAY VARY, WHICH MAY CAUSE THE PRICE
OF OUR COMMON STOCK TO FLUCTUATE.
Our quarterly operating results may vary as a result of a number of
factors, including:
o the commencement, delay, cancellation or completion of programs;
o regulatory developments;
o uncertainty related to compensation based on achieving performance
benchmarks;
o the mix of services provided;
o the mix of programs -- i.e., contract sales, medical education, marketing
research;
o the timing and amount of expenses for implementing new programs and services
and acquiring license rights for products;
o the accuracy of estimates of resources required for ongoing programs;
o the timing and integration of acquisitions;
o changes in regulations related to pharmaceutical companies; and
o general economic conditions.
In addition, in the case of revenue related to service contracts, we
recognize revenue as services are performed, while program costs, other than
training costs, are expensed as incurred. As a result, during the first two to
three months of a new contract, we may incur substantial expenses associated
with implementing that new program without recognizing any revenue under that
contract. This could have a material adverse impact on our operating results and
the price of our common stock for the quarters in which these expenses are
incurred. For these and other reasons, we believe that quarterly comparisons of
our financial results are not necessarily meaningful and should not be relied
upon as an indication of future performance. Fluctuations in quarterly results
could materially adversely affect the market price of our common stock in a
manner unrelated to our long-term operating performance.
12
WE MAY REQUIRE ADDITIONAL FUNDS IN ORDER TO IMPLEMENT OUR EVOLVING BUSINESS
MODEL.
We may require additional funds in order to:
o pursue other business opportunities or meet future operating requirements;
o develop incremental marketing and sales capabilities;
o acquire other services businesses;
o license or acquire additional pharmaceutical or medical device products or
technologies; and/or
o pursue regulatory approvals.
We may seek additional funding through public or private equity or debt
financing or other arrangements with collaborative partners. If we raise
additional funds by issuing equity securities, further dilution to existing
stockholders may result. In addition, as a condition to providing us with
additional funds, future investors may demand, and may be granted, rights
superior to those of existing stockholders. We cannot be sure, however, that
additional financing will be available from any of these sources or, if
available, will be available on acceptable or affordable terms. If adequate
additional funds are not available, we may be required to delay, reduce the
scope of, or eliminate one or more of our growth strategies.
IF WE ARE UNABLE TO ATTRACT KEY EMPLOYEES AND CONSULTANTS, WE MAY BE UNABLE TO
SUPPORT THE GROWTH OF OUR BUSINESS.
Successful execution of our business strategy depends, in large part, on
our ability to attract and retain qualified management, marketing and other
personnel with the skills and qualifications necessary to fully execute our
programs and strategy. Competition for personnel among companies in the
pharmaceutical industry is intense and we cannot assure you that we will be able
to continue to attract or retain the personnel necessary to support the growth
of our business.
OUR BUSINESS MAY SUFFER IF WE FAIL TO ATTRACT AND RETAIN QUALIFIED SALES
REPRESENTATIVES.
The success and growth of our business depends on our ability to attract
and retain qualified pharmaceutical sales representatives. There is intense
competition for pharmaceutical sales representatives from CSOs and
pharmaceutical companies. On occasion, our clients have hired the sales
representatives that we trained to detail their products. We cannot be certain
that we can continue to attract and retain qualified personnel. If we cannot
attract and retain qualified sales personnel, we will not be able to expand our
teams business and our ability to perform under our existing contracts will be
impaired.
OUR BUSINESS WILL SUFFER IF WE LOSE CERTAIN KEY MANAGEMENT PERSONNEL.
The success of our business also depends on our ability to attract and
retain qualified senior management, and financial and administrative personnel
who are in high demand and who often have multiple employment options.
Currently, we depend on a number of our senior executives, including Charles T.
Saldarini, our chief executive officer and vice chairman of our board of
directors, Steven K. Budd, our president, global sales and marketing services,
and Bernard C. Boyle, our chief financial officer. The loss of the services of
any one or more of these executives could have a material adverse effect on our
business, financial condition and results of operations. Except for a $5 million
key-man life insurance policy on the life of Mr. Saldarini and a $3 million
policy on the life of Mr. Budd and life insurance policies on two other
executives, we do not maintain and do not contemplate obtaining insurance
policies on any of our employees.
OUR CONTROLLING STOCKHOLDER CONTINUES TO HAVE EFFECTIVE CONTROL OF US, WHICH
COULD DELAY OR PREVENT A CHANGE IN CORPORATE CONTROL THAT MAY OTHERWISE BE
BENEFICIAL TO OUR STOCKHOLDERS.
John P. Dugan, our chairman, beneficially owns approximately 33.0% of our
outstanding common stock. As a result, Mr. Dugan will be able to exercise
substantial control over the election of all of our directors, and to determine
the outcome of most corporate actions requiring stockholder approval, including
a merger with or into another company, the sale of all or substantially all of
our assets and amendments to our certificate of incorporation.
WE HAVE ANTI-TAKEOVER DEFENSES THAT COULD DELAY OR PREVENT AN ACQUISITION AND
COULD ADVERSELY AFFECT THE PRICE OF OUR COMMON STOCK.
13
Our certificate of incorporation and bylaws include provisions, such as
providing for three classes of directors, which are intended to enhance the
likelihood of continuity and stability in the composition of our board of
directors. These provisions may make it more difficult to remove our directors
and management and may adversely affect the price of our common stock. In
addition, our certificate of incorporation authorizes the issuance of "blank
check" preferred stock. This provision could have the effect of delaying,
deterring or preventing a future takeover or a change in control, unless the
takeover or change in control is approved by our board of directors, even though
the transaction might offer our stockholders an opportunity to sell their shares
at a price above the current market price.
RISK FACTORS MORE CLOSELY ASSOCIATED WITH THE PPG SEGMENT OF OUR BUSINESS:
WE MAY CONTINUE TO REVIEW OPPORTUNITIES FOR THE PPG SEGMENT OF OUR BUSINESS,
WHICH MAY INCLUDE COPROMOTION AND EXCLUSIVE DISTRIBUTION ARRANGEMENTS, AS WELL
AS LICENSING AND BRAND OWNERSHIP OF PRODUCTS. WE CANNOT ASSURE YOU THAT WE CAN
SUCCESSFULLY DEVELOP THIS BUSINESS.
Notwithstanding the fact that we had only approximately $2.9 million in
revenue from the PPG segment of our business in 2004, we may continue to review
opportunities which may include copromotion, distribution arrangements, as well
as licensing and brand ownership of products. These types of arrangements can
significantly increase our operating expenditures in the short-term. Typically,
these agreements require significant "upfront" payments, minimum purchase
requirements, minimum royalty payments, payments to third parties for
production, inventory maintenance and control, distribution services and
accounts receivable administration, as well as sales and marketing expenditures.
In addition, particularly where we license or acquire products before they are
approved for commercial use, we may be required to incur significant expense to
gain the required regulatory approvals. As a result, our working capital balance
and cash flow position could be materially and adversely affected until the
products in question become commercially viable, if ever. The risks that we face
in developing the PPG segment of our business may increase in proportion with:
o the number and types of products covered by these types of
agreements;
o the applicable stage of the drug regulatory process of the products
at the time we enter into these agreements; and
o our control over the manufacturing, distribution and marketing
processes.
In December 2002, we acquired from Cellegy the exclusive right to market
and sell Fortigel, a transdermal testosterone gel for the treatment of male
hypogonadism in the U.S., Puerto Rico, Mexico and Canada. While we have entered
into copromotion and exclusive distribution arrangements in the past, the
Cellegy License Agreement was our first licensing arrangement. We paid an
initial $15.0 million license fee and another $10.0 million incremental license
fee milestone payment is due after the product has all FDA approvals (if such
approvals are obtained) required to promote, sell and distribute the product in
the U.S. If the drug is approved, in addition to paying Cellegy a royalty based
on net sales, all of the costs associated with manufacturing the drug,
distributing it, as well as sales and marketing expenditures would be our
obligation. If additional testing is required after the drug is approved for
sale in the U.S., the costs associated with those tests are our obligation as
well. Furthermore, if we want to sell the drug in Mexico and Canada, we must
fund the regulatory process in those countries.
In July 2003, Cellegy received a letter from the FDA rejecting its NDA for
Fortigel. In December 2003, we filed a lawsuit against Cellegy as we believed
they fraudulently induced us to enter the Cellegy License Agreement and for
breaching certain obligations under the Cellegy License Agreement. (See the Risk
Factor describing the Cellegy litigation in this section, below.) Cellegy has
told us that, in the first quarter of 2005, it received FDA approval for the
protocol parameters for a new Phase 3 study proposed by Cellegy to the FDA. We
do not know when, or even whether Cellegy will conduct such a new Phase 3 Study,
and we cannot predict with any certainty whether the FDA will ultimately approve
Fortigel for sale in the U.S.
WE ARE INVOLVED IN LAWSUITS WITH CELLEGY CONCERNING THE CELLEGY LICENSE
AGREEMENT.
On December 12, 2003, we filed a complaint against Cellegy in the U.S.
District Court for the Southern District of New York. The complaint alleges that
Cellegy fraudulently induced us to enter into a license agreement regarding
Fortigel on December 31, 2002. The complaint also alleges claims for
misrepresentation and breach of contract related to the Cellegy License
Agreement. In the complaint, we seek, among other things, rescission of the
Cellegy License Agreement and return of the $15.0 million we paid Cellegy. After
we filed this lawsuit, also on December 12, 2003, Cellegy filed a complaint
against us in the U.S. District Court for the Northern District of California.
Cellegy's complaint seeks a declaration that Cellegy did not fraudulently induce
us to enter the Cellegy
14
License Agreement and that Cellegy has not breached its obligations under the
Cellegy License Agreement. We are unable to predict the ultimate outcome of
these lawsuits. The trial is scheduled to commence during the second quarter of
2005. Material legal expense has been and is expected to continue to be incurred
in connection with this lawsuit; however, at this time we are not able to
estimate the magnitude of the expense. See Item 3 - Legal Proceedings.
WE RELY ON THIRD PARTIES TO MANUFACTURE ALL OF OUR PRODUCTS AND SUPPLY RAW
MATERIALS. OUR DEPENDENCE ON THESE THIRD PARTIES MAY RESULT IN UNFORESEEN DELAYS
OR OTHER PROBLEMS BEYOND OUR CONTROL, WHICH COULD HAVE A MATERIAL ADVERSE EFFECT
ON OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS AND OUR
REPUTATION.
We do not manufacture any products and expect to continue to depend on
third parties to provide us with sufficient quantities of products to meet
demand. As a result, we cannot assure you that we will always have a sufficient
supply of products on hand to satisfy demand or that the products we do have
will meet our specifications. This risk is more acute in those situations where
we have no control over the manufacturers. For example, the Cellegy License
Agreement obligates us to purchase all quantities of the product from PanGeo
Pharma Inc. (PanGeo), a third-party manufacturer with which we have no
contractual relationship and to which Cellegy has granted exclusive
manufacturing rights. If there are any problems with this contract manufacturer,
the supply of product could be temporarily halted until either PanGeo is able to
get their facilities back on-line or we are able to source another supplier for
the product. This manufacturing shutdown could have a material impact on the
future demand for the product and thus could have a material adverse effect on
our business, financial condition and results of operations. Even if third-party
manufacturers comply with the terms of their supply arrangements, we cannot be
certain that supply interruptions will not occur or that our inventory will
always be adequate. Numerous factors could cause interruptions in the supply of
our finished products, including shortages in raw materials, strikes and
transportation difficulties. Any disruption in the supply of raw materials or an
increase in the cost of raw materials to our supplier could have a significant
effect on its ability to supply us with products.
In addition, manufacturers of products requiring FDA approval are required
to comply with FDA mandated standards, referred to as good manufacturing
practices, relating not only to the manufacturing process but to record-keeping
and quality control activities as well. Furthermore, they must pass a
pre-approval inspection of manufacturing facilities by the FDA and foreign
authorities before obtaining marketing approval, and are subject to periodic
inspection by the FDA and corresponding foreign regulatory authorities under
reciprocal agreements with the FDA. These inspections may result in compliance
issues that could prevent or delay marketing approval or require significant
expenditures on corrective measures.
If for any reason we are unable to obtain or retain our relationships with
third-party manufacturers on commercially acceptable terms, or if we encounter
delays or difficulties with contract manufacturers in producing or packaging our
products, the distribution, marketing and subsequent sales of these products
would be adversely affected, and we may have to seek alternative sources of
supply. We cannot assure you that we will be able to maintain our existing
manufacturing relationships or enter into new ones on commercially acceptable
terms, if at all.
OUR LICENSE AGREEMENTS MAY REQUIRE US TO MAKE MINIMUM PAYMENTS TO THE LICENSOR,
REGARDLESS OF THE REVENUE DERIVED UNDER THE LICENSE, WHICH COULD FURTHER STRAIN
OUR WORKING CAPITAL AND CASH FLOW POSITION. IN ADDITION, THESE AGREEMENTS MAY BE
NONEXCLUSIVE OR MAY CONDITION EXCLUSIVITY ON MINIMUM SALES LEVELS.
Under the Cellegy License Agreement, we are required to make certain
minimum royalty payments to Cellegy once the product is approved by the FDA,
assuming such an approval occurs. If the Cellegy product fails to gain market
acceptance, we would still be required to make these minimum royalty payments.
This would likely have a material adverse effect on our business, financial
condition and results of operations. In addition, the Cellegy License Agreement
requires us to satisfy certain minimum net sales requirements. If we fail to
satisfy these minimum net sales requirements, under certain circumstances
Cellegy may, at its option, convert our exclusive license to a nonexclusive
license. This could mean that we would face increased competition from third
parties with respect to the marketing and sale of the product.
WE MAY BE UNABLE TO SECURE OR ENFORCE ADEQUATE INTELLECTUAL PROPERTY RIGHTS TO
PROTECT THE PRODUCTS OR TECHNOLOGIES WE ACQUIRE, LICENSE OR DEVELOP.
Our ability to successfully commercialize newly branded products or
technologies depends on our ability to secure and enforce intellectual property
rights, generally patents, and we may be unable to do so. To obtain patent
protection, we must be able to successfully persuade the U.S. Patent and
Trademark Office and its foreign
15
counterparts to issue patents on a timely basis and possibly in the face of
third-party challenges. Even if we are granted a patent, our rights may later be
challenged or circumvented by third parties. Likewise, a third-party may
challenge our trademarks or, alternatively, use a confusingly similar trademark.
The issuance of a patent is not conclusive as to its validity or enforceability
and the patent life is limited. In addition, from time to time, we might receive
notices from third parties regarding patent claims against us. These types of
claims, with or without merit, could be time-consuming to defend, result in
costly litigation, divert management's attention and resources, and cause us to
incur significant expenses. As a result of litigation over intellectual property
rights, we may be required to stop selling a product, obtain a license from the
owner to sell the product in question or use the relevant intellectual property,
which we may not be able to obtain on favorable terms, if at all, or modify a
product to avoid using the relevant intellectual property. A successful claim of
infringement against us could have a material adverse effect on our business,
financial condition and results of operations.
THE REGULATORY APPROVAL PROCESS IS EXPENSIVE, TIME CONSUMING AND UNCERTAIN AND
MAY PREVENT US FROM OBTAINING REQUIRED APPROVALS FOR THE COMMERCIALIZATION OF
DRUGS AND PRODUCTS THAT WE LICENSE OR ACQUIRE.
In those potential situations where we license or acquire ownership of
drugs or other medical or diagnostic equipment, the product in question may not
yet be approved for sale to the public, in which case we may have the obligation
to obtain the required regulatory approvals. The research, testing,
manufacturing and marketing of drugs and other medical and diagnostic devices is
heavily regulated in the U.S. and other countries. The regulatory clearance
process typically takes many years and is extremely expensive. Despite the time
and expense expended, regulatory clearance is never guaranteed. The FDA can
delay, limit or deny approval of a drug for many reasons, including:
o safety or efficacy;
o inconsistent or inconclusive data or test results;
o failure to demonstrate compliance with the FDA's good manufacturing
practices; or
o changes in the approval process or new regulations.
THE FDA CONTINUES TO REGULATE THE SALE AND MARKETING OF DRUGS AND MEDICAL AND
DIAGNOSTIC DEVICES EVEN AFTER THEY HAVE BEEN APPROVED FOR SALE TO THE PUBLIC.
COMPLYING WITH THESE REGULATIONS MAY BE COSTLY AND OUR FAILURE TO COMPLY COULD
LIMIT OUR ABILITY TO CONTINUE MARKETING AND DISTRIBUTING THESE PRODUCTS.
Even after drugs have been approved for sale, the FDA continues to
regulate their sale. These post-approval regulatory requirements may require
further testing and/or clinical studies, and may limit our ability to market and
distribute the product or may limit the use of the product. Under the Cellegy
License Agreement, we are responsible for all post-approval regulatory
compliance. If we fail to comply with the regulatory requirements of the FDA, we
may be subject to one or more of the following administrative or judicially
imposed sanctions:
o warning letters;
o civil penalties;
o criminal penalties;
o injunctions;
o product seizure or detention;
o product recalls;
o total or partial suspension of production; and
o FDA refusal to approve pending NDAs, or supplements to approved NDAs.
FDA APPROVAL DOES NOT GUARANTEE COMMERCIAL SUCCESS. IF WE FAIL TO SUCCESSFULLY
COMMERCIALIZE OUR PRODUCTS, OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF
OPERATIONS COULD BE MATERIALLY AND ADVERSELY AFFECTED.
Even if a product is approved for sale to the general public, its
commercial success will depend on our marketing efforts and acceptance by the
general public. The commercial success of any drug or medical or diagnostic
device depends on a number of factors, including:
o demonstration of clinical efficacy and safety;
o cost;
o reimbursement policies of large third-party payors;
o competitive products;
16
o convenience and ease of administration;
o potential advantages over alternative treatment methods;
o marketing and distribution support; and
o successfully creating and sustaining demand.
We cannot assure you that any of our future products will achieve
commercial success, regardless of how effective they may be.
CONSOLIDATION OF THE WHOLESALE DISTRIBUTION NETWORK FOR PHARMACEUTICAL PRODUCTS
COULD ADVERSELY IMPACT THE TERMS AND CONDITIONS OF OUR PRODUCT SALES.
The distribution network for pharmaceutical products has recently
experienced significant consolidation among wholesalers and chain stores. As a
result, a few large wholesale distributors control a significant share of the
market and we have less ability to negotiate price, return policies and other
terms and related provisions of the sale. If our distribution of products
expands, some of these wholesalers and distributors may account for a
significant portion of our product sales. Our inability to negotiate favorable
terms and conditions for product sales to those wholesalers could have a
material adverse effect on our business, financial condition and results of
operations.
FAILURE TO OBTAIN ADEQUATE REIMBURSEMENT COULD LIMIT OUR ABILITY TO MARKET
PRODUCTS.
Our ability to commercialize products, including licensed or acquired
products, will depend in part on the reimbursements, if any, obtained from
third-party payors such as government health administration authorities, private
health insurers, managed care programs and other organizations. Third-party
payors are increasingly attempting to contain healthcare costs by limiting both
coverage and the level of reimbursement for pharmaceutical products and medical
devices. Cost control initiatives could decrease the price that we would receive
for products and affect our ability to commercialize any product. Third-party
payors also tend to discourage use of branded products when generic substitutes
are available. As a result, reimbursement may not be available to enable us to
maintain price levels sufficient to realize an appropriate return on our
investment in product acquisition and development. If adequate reimbursement
levels for either newly approved or branded products are not provided, our
business, financial condition and results of operations could be materially and
adversely affected.
EMPLOYEES
As of December 31, 2004, we had 3,140 employees. Included in that amount
are 130 part-time field representatives employed by InServe, the number of which
varies from time to time based on project demand. We are not party to a
collective bargaining agreement with a labor union. We believe that our
relations with our employees are good.
AVAILABLE INFORMATION
Our website address is www.pdi-inc.com. We are not including the
information contained on our website as part or, or incorporating it by
reference into, this annual report on Form 10-K. We make available free of
charge through our website our annual report on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K, and all amendments to those reports as
soon as reasonably practicable after such material is electronically filed with
or furnished to the SEC.
The public may read and copy any materials we file with the SEC at the
SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549.
The public may obtain information on the operation of the Public Reference Room
by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that
contains reports, proxy and information statements, and other information
regarding issuers such as us that file electronically with the SEC. The website
address is www.sec.gov.
ITEM 2. PROPERTIES
FACILITIES
Our corporate headquarters are located in Saddle River, New Jersey, in an
84,000 square foot facility. The lease runs for a term of approximately 12
years, which began in July 2004.
17
TVG currently operates out of a 48,000 square foot facility in Fort
Washington, Pennsylvania, under a lease that expires in the third quarter of
2005. In the third quarter of 2005, TVG will be moving to a 37,700 square foot
facility in Upper Dublin, Pennsylvania. The lease runs for a term of
approximately 12 years, which commenced January 2005.
InServe operates out of a 9,100 square foot facility in Novato,
California, under a lease that expires in the second quarter of 2005. We will
not be renewing the lease in Novato as operations will have been moved to the
corporate headquarters in New Jersey.
Pharmakon operates out of a 6,700 square foot facility in Schaumburg,
Illinois, under a lease that expires in February 2010.
The office containing ProtoCall's Shared Sales operations was closed and
those operations were transferred to corporate headquarters in New Jersey from
Cincinnati, Ohio, in early 2003. The Ohio facility is approximately 11,000
square feet of space and was rented to a sub-tenant in early 2003 through the
end of the lease which expires in April 2005.
We believe that our current and recently leased facilities are adequate
for our current and foreseeable operations and that suitable additional space
will be available if needed.
ITEM 3. LEGAL PROCEEDINGS
SECURITIES LITIGATION
In January and February 2002, we, our chief executive officer and our
chief financial officer were served with three complaints that were filed in the
United States District Court for the District of New Jersey alleging violations
of the Securities Exchange Act of 1934 (the 1934 Act). These complaints were
brought as purported shareholder class actions under Sections 10(b) and 20(a) of
the 1934 Act and Rule 10b-5 established thereunder. On May 23, 2002, the Court
consolidated all three lawsuits into a single action entitled In re PDI
Securities Litigation, Master File No. 02-CV-0211, and appointed lead plaintiffs
(Lead Plaintiffs) and Lead Plaintiffs' counsel. On or about December 13, 2002,
the Lead Plaintiffs filed a second consolidated and amended complaint (the
Consolidated and Amended Complaint), which superseded their earlier complaints.
The Consolidated and Amended Complaint names us, our chief executive
officer and our chief financial officer as defendants; purports to state claims
against us on behalf of all persons who purchased our common stock between May
22, 2001 and August 12, 2002; and seeks money damages in unspecified amounts and
litigation expenses including attorneys' and experts' fees. The essence of the
allegations in the Consolidated and Amended Complaint is that we intentionally
or recklessly made false or misleading public statements and omissions
concerning our financial condition and prospects with respect to our marketing
of Ceftin in connection with the October 2000 distribution agreement with GSK,
our marketing of Lotensin in connection with the May 2001 distribution agreement
with Novartis, as well as our marketing of Evista in connection with the October
2001 distribution agreement with Eli Lilly.
In February 2003, we filed a motion to dismiss the Consolidated and
Amended Complaint. We believe that the allegations in this purported securities
class action are without merit and we intend to defend the action vigorously.
BAYER-BAYCOL LITIGATION
We have been named as a defendant in numerous lawsuits, including two
class action matters, alleging claims arising from the use of Baycol, a
prescription cholesterol-lowering medication. Baycol was distributed, promoted
and sold by Bayer in the U.S. through early August 2001, at which time Bayer
voluntarily withdrew Baycol from the U.S. market. Bayer retained certain
companies, such as us, to provide detailing services on its behalf pursuant to
contract sales force agreements. We may be named in additional similar lawsuits.
To date, we have defended these actions vigorously and have asserted a
contractual right of defense and indemnification against Bayer for all costs and
expenses we incur relating to these proceedings. In February 2003, we entered
into a joint defense and indemnification agreement with Bayer, pursuant to which
Bayer has agreed to assume substantially all of our defense costs in pending and
prospective proceedings and to indemnify us in these lawsuits, subject to
certain limited exceptions. Further, Bayer agreed to reimburse us for all
reasonable costs and expenses incurred to date in defending these proceedings.
As of December 31, 2004, Bayer has reimbursed us for approximately $1.6 million
in legal
18
expenses, the majority of which was received in 2003 and was reflected as a
credit within selling, general and administrative expense. No amounts have been
received in 2004.
AUXILIUM PHARMACEUTICALS LITIGATION
On January 6, 2003, we were named as a defendant in a lawsuit filed by
Auxilium Pharmaceuticals, Inc. (Auxilium), in the Pennsylvania Court of Common
Pleas, Montgomery County. Auxilium was seeking monetary damages and injunctive
relief, including preliminary injunctive relief, based on several claims related
to our alleged breaches of a contract sales force agreement entered into by the
parties on November 20, 2002, and claims that we were misappropriating trade
secrets in connection with the Cellegy License Agreement.
On May 8, 2003, we entered into a settlement and mutual release agreement
with Auxilium (Settlement Agreement), by which the lawsuit and all related
counter claims were dropped without any admission of wrongdoing by either party.
The settlement terms included a cash payment which was paid upon execution of
the Settlement Agreement as well as certain other additional expenses. We
recorded a $2.1 million charge in the first quarter of 2003 related to this
settlement. Pursuant to the Settlement Agreement, we also agreed that we would
(a) not sell, ship, distribute or transfer any Fortigel product to any
wholesalers, chain drug stores, pharmacies or hospitals prior to November 1,
2003, and (b) pay Auxilium an additional amount per prescription to be
determined based upon a specified formula, in the event any prescriptions were
filled for Fortigel prior to January 26, 2004. As discussed above, in July 2003,
Cellegy received a letter from the FDA rejecting its NDA for Fortigel. We have
not paid and will not pay any additional amount to Auxilium as set forth in
clause (b) above since Fortigel was not approved by the FDA prior to January 26,
2004. We do not believe that the terms of the Settlement Agreement will have any
material impact on the success of our commercialization of Fortigel if, or when,
the FDA approves it.
CELLEGY PHARMACEUTICALS LITIGATION
On December 12, 2003, we filed a complaint against Cellegy in the U.S.
District Court for the Southern District of New York. The complaint alleges that
Cellegy fraudulently induced us to enter into the Cellegy License Agreement
regarding Fortigel on December 31, 2002. The complaint also alleges claims for
misrepresentation and breach of contract related to the Cellegy License
Agreement. In the complaint, we seek, among other things, rescission of the
Cellegy License Agreement and return of the $15.0 million we paid Cellegy. After
we filed this lawsuit, also on December 12, 2003, Cellegy filed a complaint
against us in the U.S. District Court for the Northern District of California.
Cellegy's complaint seeks a declaration that Cellegy did not fraudulently induce
us to enter the Cellegy License Agreement and that Cellegy has not breached its
obligations under the Cellegy License Agreement. We filed an answer to Cellegy's
complaint on June 18, 2004, in which we make the same allegations and claims for
relief as we do in our New York action, and we also allege Cellegy violated
California unfair competition law. By order dated April 23, 2004, our lawsuit
was transferred to the Northern District of California where it may be
consolidated with Cellegy's action. We are unable to predict the ultimate
outcome of these lawsuits. The trial is scheduled to commence during the second
quarter of 2005. Material legal expense has been and is expected to continue to
be incurred in connection with this lawsuit; however, at this time we are not
able to estimate the magnitude of the expense.
OTHER LEGAL PROCEEDINGS
We are currently a party to other legal proceedings incidental to our
business. While management currently believes that the ultimate outcome of these
proceedings, individually and in the aggregate, will not have a material adverse
effect on our business, financial condition and results of operations,
litigation is subject to inherent uncertainties. Were we to settle a proceeding
for a material amount or were an unfavorable ruling to occur, there exists the
possibility of a material adverse impact on our business, financial condition
and results of operations.
No amounts have been accrued for losses under any of the above mentioned
matters, other than for the Auxilium litigation settlement reserve, as no other
amounts are considered probable or reasonably estimable at this time. Legal fees
are expensed as incurred.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
19
PART II
ITEM 5. MARKET FOR OUR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES.
Our common stock is traded on the Nasdaq National Market under the symbol
"PDII." The following table sets forth, for each of the periods indicated, the
range of high and low closing sales prices for the common stock as reported by
the Nasdaq National Market.
High Low
---- ---
2004
----
First quarter.......................................... 31.770 23.290
Second quarter......................................... 32.060 24.400
Third quarter.......................................... 29.980 21.600
Fourth quarter ........................................ 31.550 21.780
2003
----
First quarter.......................................... 12.650 7.100
Second quarter......................................... 12.600 7.350
Third quarter.......................................... 26.810 10.330
Fourth quarter ........................................ 30.870 20.250
There were 379 shareholders of record of PDI common shares as of February
24, 2005.
EQUITY COMPENSATION PLAN INFORMATION
YEAR ENDED DECEMBER 31, 2004
Number of securities
remaining available for
Number of securities Weighted-average future issuance under
to be issued upon exercise price of equity compensation
exercise of outstanding plans (excluding
outstanding options, options, warrants securities reflected in
Plan Category warrants and rights and rights column (a))
- ------------------------------------- ----------------------- -------------------- --------------------------
(a) (b)
Equity compensation plans
approved by security holders
(2004 Stock Award and
Incentive Plan, 2000 Omnibus
Incentive Compensation Plan,
and 1998 Stock Option Plan) ..... 1,343,745 $27.86 1,230,563
Equity compensation plans not
approved by security
holders(1).................... -- -- --
======================= ==================== ==========================
Total............................ 1,343,745 $27.86 1,230,563
======================= ==================== ==========================
(1) The Company does not have any equity compensation plans which have not been approved by security holders.
DIVIDEND POLICY
We have not paid any dividends and do not intend to pay any dividends in
the foreseeable future. Future earnings, if any, will be used to finance the
future growth of our business. Future dividends, if any, will be determined by
our board of directors.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data set forth below as of and for
the years ended December 31, 2004, 2003, 2002, 2001, and 2000 are derived from
our audited consolidated financial statements and the accompanying notes.
Consolidated balance sheets at December 31, 2004 and 2003 and consolidated
statements of operations, stockholders' equity and cash flows for the three
years ended December 31, 2004, 2003 and 2002 and the related notes are included
elsewhere in this Annual Report on Form 10-K and have been audited by
PricewaterhouseCoopers LLP, Independent
20
Registered Public Accounting Firm. The selected financial data set forth below
should be read together with, and are qualified by reference to, "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
our audited consolidated financial statements and related notes appearing
elsewhere in this report.
STATEMENT OF OPERATIONS DATA:
Years Ended December 31,
-----------------------------------------------------------------
2004 2003 2002 2001 2000
---------- ---------- ---------- ---------- ----------
(in thousands, except per share data)
Revenue
Service .................................................... $ 365,965 $ 356,143 $ 301,437 $ 301,447 $ 338,038
Product, net ............................................... (1,521) (11,613) 6,438 415,314 101,008
---------- ---------- ---------- ---------- ----------
Total revenue ............................................ 364,444 344,530 307,875 716,761 439,046
---------- ---------- ---------- ---------- ----------
Cost of goods and services
Program expenses ........................................... 265,360 254,162 278,002 252,349 257,526
Cost of goods sold ......................................... 254 1,287 -- 328,629 68,997
---------- ---------- ---------- ---------- ----------
Total cost of goods and services ......................... 265,614 255,449 278,002 580,978 326,523
---------- ---------- ---------- ---------- ----------
Gross profit ................................................. 98,830 89,081 29,873 135,783 112,523
Operating expenses
Compensation expense ....................................... 34,325 36,901 32,670 39,263 32,820
Other selling, general and administrative expenses ......... 29,314 30,347 44,163 83,815 38,827
Restructuring and other related expenses ................... -- 143 3,215 -- --
Litigation settlement ...................................... -- 2,100 -- -- --
---------- ---------- ---------- ---------- ----------
Total operating expenses ................................. 63,639 69,491 80,048 123,078 71,647
---------- ---------- ---------- ---------- ----------
Operating income (loss) ...................................... 35,191 19,590 (50,175) 12,705 40,876
Other income, net ............................................ 779 1,073 1,967 2,275 4,864
---------- ---------- ---------- ---------- ----------
Income (loss) before provision (benefit) for income taxes .... 35,970 20,663 (48,208) 14,980 45,740
Provision (benefit) for income taxes ......................... 14,838 8,405 (17,447) 8,626 18,712
---------- ---------- ---------- ---------- ----------
Net income (loss) ............................................ $ 21,132 $ 12,258 $ (30,761) $ 6,354 $ 27,028
========== ========== ========== ========== ==========
Basic net income (loss) per share(1) ......................... $ 1.45 $ 0.86 $ (2.19) $ 0.46 $ 2.00
========== ========== ========== ========== ==========
Diluted net income (loss) per share(1) ....................... $ 1.42 $ 0.85 $ (2.19) $ 0.45 $ 1.96
========== ========== ========== ========== ==========
Basic weighted average number of shares outstanding(1) ....... 14,564 14,231 14,033 13,886 13,503
========== ========== ========== ========== ==========
Diluted weighted average number of shares outstanding(1) ..... 14,893 14,431 14,033 14,113 13,773
========== ========== ========== ========== ==========
BALANCE SHEET DATA:
As of December 31,
-----------------------------------------------------------------
2004 2003 2002 2001 2000
---------- ---------- ---------- ---------- ----------
(in thousands)
Cash and cash equivalents .................................... $ 96,367 $ 113,288 $ 66,827 $ 160,043 $ 109,000
Working capital .............................................. 96,156 100,009 81,854 113,685 120,720
Total assets ................................................. 224,705 219,623 190,939 302,671 270,225
Total long-term debt ......................................... -- -- -- -- --
Stockholders' equity ......................................... 165,425 138,488 123,211 150,935 138,110
- ----------
(1) See Note 9 to our audited consolidated financial statements included
elsewhere in this report for a description of the computation of basic
and diluted weighted average number of shares outstanding for 2004, 2003
and 2002.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
We make forward-looking statements that involve risks, uncertainties, and
assumptions in this report. Actual results may differ materially from those
anticipated in these forward-looking statements as a result of various factors,
including, but not limited to, those presented under "Forward-Looking Statement
Information" on page 2.
The following Management's Discussion and Analysis of Financial Condition
and Results of Operations should be read in conjunction with our consolidated
financial statements and the related notes appearing elsewhere in this report.
21
OVERVIEW
We are a diversified sales and marketing services company serving the
biopharmaceutical and MD&D industries. We create and execute sales and marketing
programs intended to improve the profitability of pharmaceutical and MD&D
products. We do this by working with companies who own the intellectual property
rights to these products and recognize our ability to add value to these
products and maximize their sales performance. We have a variety of agreement
types that we enter into with our clients, from fee for service arrangements to
arrangements which involve risk-sharing and incentive based provisions.
DESCRIPTION OF REPORTING SEGMENTS AND NATURE OF CONTRACTS
During the fourth quarter of 2004, as a result of our acquisition of
Pharmakon (as described in Note 5 to the consolidated financial statements) we
restructured certain management responsibilities and changed our internal
financial reporting. As a result of these changes we determined that our
reporting segments were required to be amended. Accordingly, we now report under
the following three segments:
o SALES SERVICES:
o DEDICATED CONTRACT SALES (CSO);
o SHARED CONTRACT SALES;
o MEDICAL DEVICES AND DIAGNOSTICS (MD&D) CONTRACT SALES TEAMS; AND
o CLINICAL SALES TEAMS (INSERVE)
o MARKETING SERVICES:
o EDUCATION AND COMMUNICATION (EDCOMM);
o PHARMAKON; AND
o TVG MARKETING RESEARCH AND CONSULTING (TVG)
o PDI PRODUCTS GROUP (PPG)
An analysis of these reporting segments and their results of operations
is contained in Note 23 to the consolidated financial statements found elsewhere
in this report and in the CONSOLIDATED RESULTS OF OPERATIONS discussion below.
SALES SERVICES
Given the customized nature of our business, we utilize a variety of
contract structures. Historically, most of our product detailing contracts have
been fee for service, i.e., the client pays a fee for a specified package of
services. These contracts typically include operational benchmarks, such as a
minimum number of sales representatives or a minimum number of calls. Also, our
contracts might have a lower base fee offset by built-in incentives we can earn
based on our performance. In these situations, we have the opportunity to earn
additional fees, as incentives, based on attaining performance benchmarks.
Our product detailing contracts generally are for terms of one to three
years and may be renewed or extended. However, the majority of these contracts
are terminable by the client for any reason on 30 to 90 days' notice. These
contracts often, but not always, provide for termination payments in the event
they are terminated by the client without cause. While the cancellation of a
contract by a client without cause may result in the imposition of penalties on
the client, these penalties may not act as an adequate deterrent to the
termination of any contract. In addition, we cannot assure you that these
penalties will offset either the revenue we could have earned under the contract
or the costs we may incur as a result of its termination. The loss, termination
or significant reduction of a large contract or the loss of multiple contracts
could have a material adverse effect on our business, financial condition and
results of operations. For example, in December 2004, we announced a reduction
in the aggregate number of representatives that we deployed for AstraZeneca.
This reduction is expected to decrease revenue generated from AstraZeneca in
2005 by approximately $60.0 million versus revenues generated in 2004. Contracts
may also be terminated for cause or we may incur specific penalties if we fail
to meet stated performance benchmarks.
We also provide a contract sales offering within the MD&D market. We
leveraged our knowledge from years of providing sales forces to the
pharmaceutical industry and applied it to the MD&D market. As a result, we now
offer the provision of contract sales forces as one of the services that we
market to the MD&D industry to assist our clients in improving their product
sales.
22
Our clinical sales teams employ nurses, medical technologists, and other
clinicians who train and provide hands-on clinical education and after sales
support to the medical staff of hospitals and clinics that recently purchased
our clients' equipment. Our activities maximize product utilization and customer
satisfaction for the medical practitioners, while simultaneously enabling our
clients' sales forces to continue their selling activities instead of
in-servicing the equipment they had recently sold.
MARKETING SERVICES
Our marketing services contracts generally are for projects lasting from
three to six months. The contracts are typically terminable by the client and
provide for termination payments in the event they are terminated without cause.
Termination payments include payment for all work completed to date, plus the
cost of any nonrefundable commitments made on behalf of the client. Due to the
usual size of the projects, it is unlikely the loss or termination of any
individual medical education or marketing research contract would have a
material adverse effect on our business, financial condition or results of
operations.
PDI PRODUCTS GROUP (PPG)
We are shifting our strategy to deemphasize the PPG segment and focus on
the service businesses. However, we may continue to review opportunities which
may include copromotion, distribution arrangements, as well as licensing and
brand ownership of products.
The contracts within the PPG segment can be either performance based or
fee for service and may require sales, marketing and distribution of product. In
performance based contracts, we provide and finance a portion, if not all, of
the commercial activities in support of a brand in return for a percentage of
product sales. An important performance parameter is normally the level of sales
or prescriptions attained by the product during the period of our marketing or
promotional responsibility, and in some cases, for periods after our promotional
activities have ended.
In the fourth quarter of 2000, we entered into a performance based
contract with GSK. Our agreement with GSK was in support of Ceftin and was an
exclusive sales, marketing and distribution contract. The agreement had a
five-year term, but was cancelable by either party without cause on 120 days'
notice. The agreement was terminated by mutual consent, effective February 28,
2002, due to the unexpected entry of a competitive generic product.
In May 2001, we entered into a copromotion agreement with Novartis for
the U.S. sales, marketing and promotion rights for Lotensin, and Lotensin HCT.
Another product, Lotrel, was promoted by the same sales force under the same
agreement, but was a fee for service arrangement. That agreement ran through
December 31, 2003. On May 20, 2002, that agreement was replaced by two separate
agreements, one for Lotensin and another one for Lotrel, Diovan and Diovan HCT.
Both agreements ran through December 31, 2003; however, the Lotrel-Diovan
agreement was renewed on December 24, 2003 for an additional one year period. In
February 2004, we were notified by Novartis of its intent to terminate the
Lotrel-Diovan agreement without cause, effective March 16, 2004 and, as a
result, $28.9 million of anticipated revenue associated with the Lotrel-Diovan
agreement in 2004 was not realized. We continued to be compensated under the
terms of the agreement through the effective termination date. Even though the
Lotensin agreement ended December 31, 2003, we were still entitled to receive
royalty payments on the sales of Lotensin through December 31, 2004. The
Lotensin agreement stipulated that we were to provide promotion, selling,
marketing and brand management for Lotensin. In exchange, we were entitled to
receive a percentage of product revenue based on certain TRx objectives above
specified contractual baselines. The revenue resulting from the efforts of the
Novartis sales force responsible for Lotrel-Diovan was classified in the sales
and marketing services segment in 2003 (defined in 2003 as a combination of the
current sales services and marketing services segments) instead of the PPG
segment, where it was classified in 2002, due to the fact that there was a
change in the terms of the Lotensin agreement. During 2002, we were reliant on
the attainment of performance incentives, whereas in 2003 this contract was
basically a fixed fee arrangement.
In October 2001, we entered into an agreement with Eli Lilly to copromote
Evista in the U.S. Under this agreement, we were entitled to be compensated
based upon net sales achieved above a predetermined level. In the event these
predetermined net sales levels were not achieved, we would not receive any
revenue to offset expenses incurred. During 2002, it became apparent that the
net sales levels likely to be achieved would not be sufficient to recoup our
expenses. In November 2002, we agreed with Eli Lilly to terminate the Evista
copromotion agreement effective December 31, 2002.
23
In October 2002, our MD&D products unit partnered with Xylos for the
exclusive U.S. commercialization rights to XCell line of wound care products. We
became the exclusive commercialization partner for the sales, marketing and
distribution of the product line in the U.S. On January 2, 2004, we exercised
our contractual right to terminate the agreement on 135 days' notice to Xylos
since sales of XCell were not sufficient to sustain our role as
commercialization partner for the product. Our promotional activities in support
of the brand concluded in January 2004 and the agreement was terminated
effective May 16, 2004. We provided short-term loans to Xylos of $250,000 in
February 2004 and $250,000 in April 2004, totaling $500,000. As a result of
continuing operating losses incurred by Xylos as well as recent negative
developments regarding their inability to obtain appropriate financing, we
concluded during the fourth quarter of 2004 that both the investment and the
recoverability of the loan were impaired as of December 31, 2004. As a result,
the $1.0 million investment was written down to zero in the fourth quarter of
2004 and the $500,000 loan was fully reserved for during the fourth quarter as
well.
On December 31, 2002, we entered into an exclusive licensing agreement
with Cellegy for the exclusive North American rights for Fortigel, a
testosterone gel product. The agreement is in effect for the commercial life of
the product. Cellegy submitted an NDA for the hypogonadism indication to the FDA
in June 2002. In July 2003, Cellegy received a letter from the FDA rejecting its
NDA for Fortigel. Cellegy has told us that, in the first quarter of 2005, it
received FDA approval for the protocol parameters for a new Phase 3 study
proposed by Cellegy to the FDA. We do not know when, or even whether, Cellegy
will conduct such a new Phase 3 Study, and we cannot predict with any certainty
whether the FDA will ultimately approve Fortigel for sale in the U.S. Under the
terms of the agreement, we paid Cellegy a $15.0 million initial licensing fee on
December 31, 2002. This payment was made prior to FDA approval and since there
is no alternative future use of the licensed rights, we expensed the $15.0
million payment in December 2002, when incurred. This amount was recorded in
other selling, general and administrative expenses in the December 31, 2002
consolidated statements of operations. Pursuant to the terms of the Cellegy
License Agreement, we will be required to pay Cellegy a $10.0 million
incremental license fee milestone payment upon Fortigel's receipt of all
approvals required by the FDA (if such approvals are obtained) to promote, sell
and distribute the product in the U.S. This incremental milestone license fee,
if incurred, will be recorded as an intangible asset and amortized over its
estimated useful life, as then determined, which is not expected to exceed the
life of the patent. Royalty payments to Cellegy over the term of the commercial
life of the product will range from 20% to 30% of net sales.
On December 12, 2003, we instituted an action against Cellegy in the U.S.
District Court for the Southern District of New York seeking to rescind the
Cellegy License Agreement on the grounds that it was procured by fraud. We are
seeking return of the license fee we paid on December 31, 2002 of $15.0 million
plus additional damages caused by Cellegy's conduct.
CRITICAL ACCOUNTING POLICIES AND THE USE OF ESTIMATES
USE OF ESTIMATES
----------------
We prepare our financial statements in accordance with generally accepted
accounting principles (GAAP). The preparation of financial statements in
conformity with GAAP requires the use of estimates and assumptions that affect
the reported amounts of assets and liabilities, including disclosure of
contingent assets and liabilities, at the date of the financial statements and
the reported amounts of revenue and expenses during the reporting period. Our
critical accounting policies are those that are most important to our financial
condition and results and that require the most significant judgments on the
part of our management in their application. Some of those judgments can be
subjective and complex. In many instances, we could have reasonably used
different accounting estimates, and in other instances changes in the accounting
estimates are reasonably likely to occur from period to period. Accordingly,
actual results could differ significantly from the estimates made by management.
Management considers an accounting estimate to be critical if:
o it requires assumptions to be made that were uncertain at the time the
estimate was made; and
o changes in the estimate are reasonably likely to occur from period to
period as new information becomes available, or
o use of different estimates that we reasonably could have used in the
current period could have a material effect on our consolidated
results of any one period, or
o the time period over which the uncertainties are resolved could be
extensive.
To the extent that there are material differences between these estimates
and actual results, our future financial statement presentation of our financial
condition and results of operations will be affected.
24
We continually evaluate the accounting policies and estimates we use to
prepare the consolidated financial statements. In cases where management
estimates are used, they are based on historical experience, information from
third-party professionals and various other assumptions believed to be
reasonable. We refer to accounting estimates of this type as "critical
accounting policies," which are discussed further below. Management has
discussed the development and selection of these critical accounting policies
with the Audit Committee. In addition, there are other items within our
financial statements that require estimation, but are not deemed critical as
based on the criteria above. Changes in estimates used in these and other items
could have a material impact on our consolidated results of operations in any
one period.
CRITICAL ACCOUNTING POLICIES
----------------------------
We must ensure that our financial statements are properly stated in
accordance with GAAP. In many cases, the accounting treatment of a particular
transaction is specifically dictated by GAAP and does not require management's
judgment in its application, while in other cases, management's judgment is
required in selecting among available alternative accounting standards that
allow different accounting treatment for similar transactions (e.g.,
depreciation methodology, accounting changes). We believe that the following
accounting policies are critical to understanding our historical and future
performance, as these policies relate to the more significant areas involving
management's judgments and estimates: revenue recognition; loans and investments
in privately held entities; income taxes; goodwill, intangibles and other
long-lived assets; incentive compensation; and contingencies.
For a summary of our significant accounting policies, see Note 1 to the
consolidated financial statements.
REVENUE RECOGNITION
Service revenue
---------------
Service revenue is earned primarily by performing product detailing
programs and other marketing and promotional services under contracts. Revenue
is recognized as the services are performed and the right to receive payment for
the services is assured. Revenue is recognized net of any potential penalties
until the performance criteria relating to the penalties have been achieved.
Performance incentives, as well as termination payments, are recognized as
revenue in the period earned and when payment of the bonus, incentive or other
payment is assured. Under performance based contracts, revenue is recognized
when the performance based parameters are achieved.
Product revenue
---------------
Product revenue is recognized when products are shipped and title is
transferred to the customer. For product sales, provision is made at the time of
sale for all estimated rebates, discounts and product returns and allowances.
Although we have had significant product sales in recent years, we no longer
plan to emphasize the types of contracts and agreements that would entail
product sales.
LOANS AND INVESTMENTS IN PRIVATELY HELD ENTITIES
As discussed in Note 7 to the consolidated financial statements, our
loans and investments in privately held entities are accounted for under either
the cost or equity method, whichever is appropriate for the particular
investment. The appropriate method is determined by our ability to exercise
significant influence over the investee, through either quantity of voting stock
or other means. If we were to determine that our accounting treatment for our
investments should change from the cost to the equity method, in accordance with
APB No. 18, "EQUITY METHOD OF ACCOUNTING FOR INVESTMENTS IN COMMON STOCK," we
would retroactively restate our previously issued financial statements as if we
had always accounted for the investment under the equity method.
We assess our loans and investments in privately held entities on a
quarterly basis for impairment and propriety of current accounting treatment.
This quarterly review includes discussions with senior management of the
investee, and evaluations of, among other things, the investee's progress
against its business plan, its customer base, the market condition of the
overall industry of the investee, historical and projected financial
performance, expected cash needs and recent funding events. Our assessments of
value are highly subjective given that these companies may be at an early stage
of development and rely regularly on their investors for cash infusions.
Consequently, if we determine based on the above factors that the loans are not
collectible and/or investments are other than temporarily impaired, we will
record a loss on our investments which may be material to the period in which
the adjustment is recorded. For the years ended December 31, 2004, 2003 and
2002, we recorded write-downs of these loans and investments of $1.5 million,
zero, and approximately $379,000, respectively.
25
INCOME TAXES
In accordance with the provisions of SFAS No. 109, "ACCOUNTING FOR INCOME
TAXES," we account for income taxes using the asset and liability method. This
method requires recognition of deferred tax assets and liabilities for expected
future tax consequences of temporary differences that currently exist between
tax bases and financial reporting bases of our assets and liabilities based on
enacted tax laws and rates. A valuation allowance is established, when
necessary, to reduce the deferred income tax assets that are not more likely
than not to be realized.
We operate in multiple tax jurisdictions and provide taxes in each
jurisdiction where we conduct business and are subject to taxation.
We have established estimated liabilities for federal and state income
tax exposures that arise and meet the criteria for accrual under SFAS No. 5,
"ACCOUNTING FOR CONTINGENCIES" (SFAS 5). These accruals represent accounting
estimates that are subject to inherent uncertainties associated with the tax
audit process. We adjust these accruals as facts and circumstances change, such
as the progress of a tax audit. We believe that any potential audit adjustments
will not have a material adverse effect on our financial condition or liquidity.
However, any adjustments made may be material to our consolidated results of
operations of a reporting period.
GOODWILL, INTANGIBLES AND OTHER LONG-LIVED ASSETS
We account for our purchases of acquired companies in accordance with SFAS
No. 141, "BUSINESS COMBINATIONS" (SFAS 141) and account for the related acquired
intangible assets in accordance with SFAS No. 142, "GOODWILL AND OTHER
INTANGIBLE ASSETS" (SFAS 142). In connection with our acquisitions, we have
historically obtained a valuation from an independent specialist that assists in
the identification of any specific intangibles and provides assistance in our
determination of an estimated value and useful life for each. Identified
intangible assets are assigned a value, generally as estimated in the valuation,
and amortized over the estimated life. In accordance with SFAS 141, we allocate
the cost of the acquired companies to the identifiable tangible and intangible
assets and liabilities acquired, with the remaining amount being classified as
goodwill. Since the entities we have acquired do not have significant tangible
assets, a significant portion of the purchase price has been allocated to
intangible assets and goodwill. See Note 21 for more information about goodwill
and other identified intangible assets associated with our acquisitions.
We test goodwill for impairment at the reporting unit level at least
annually and more frequently upon the occurrence of certain events, as defined
by SFAS 142. Goodwill has been assigned to the reporting units to which the
value of the goodwill relates. Goodwill is tested for impairment annually on
December 31 in a two-step process. First, for each reporting unit containing
goodwill, we must determine if the carrying amount exceeds the fair value based
on a discounted future cash flows model, which would indicate that goodwill may
be impaired. Because of the complexity of assumptions and judgment used in
estimating the future cash flows expected from a reporting unit(s), the
appropriate discount rate and other significant assumptions used to determine
the fair value of the unit(s), there is significant risk that the actual
reporting unit's fair value will vary from the original estimate. If we were to
determine that goodwill may be impaired, we would then compare the implied fair
value of the goodwill, as defined by SFAS 142, to its carrying amount to
determine the impairment loss, if any. We performed the required annual
impairment tests for each of the three years ended December 31, 2004, 2003 and
2002 and determined that no impairment existed.
We evaluate all of our long-lived assets (primarily property and
equipment and intangible assets other than goodwill) for impairment in
accordance with the provisions of SFAS No. 144, "ACCOUNTING FOR THE IMPAIRMENT
OR DISPOSAL OF LONG-LIVED ASSETS" (SFAS 144). SFAS 144 requires that long-lived
assets and intangible assets other than goodwill be evaluated for impairment
whenever events or changes in circumstances indicate that the carrying value of
an asset may not be recoverable based on expected undiscounted cash flows
attributable to that asset. Because of the complexity of assumptions and
judgment used in estimating the value and life of the identified other
intangible assets resulting from our acquisitions, there is significant risk
that their actual value and life may vary from the original estimate. We
periodically evaluate whether events and circumstances have occurred that
indicate the carrying amount of intangibles may warrant revision or may not be
recoverable. We may determine that an intangible asset has diminished or has no
remaining value prior to it being fully amortized. In this instance, in
accordance with SFAS 144, we would be required to record a charge to earnings to
account for the impairment of the asset which may have a material adverse effect
on our results of operations for the current period.
26
While we do not currently believe any of our long-lived assets are
impaired, and we do not anticipate an impairment in the near term, if a change
in circumstances were to occur requiring an assessment of impairment, we would
be required to evaluate whether the future undiscounted cash flows related to
the asset will be greater than its carrying value at the time of the impairment
test. While our cash flow assumptions are consistent with the plans and
estimates we are using to manage our operations, there is significant judgment
in determining the cash flows attributable to our intangible assets over their
respective estimated useful lives. If such an evaluation resulted in the
identification of an impairment of any of our long-lived assets, such impairment
would be recorded in the period we determine the impairment has occurred.
INCENTIVE COMPENSATION
We have various incentive compensation programs that are funded based on
one or more of the following targets:
o Annual consolidated net income
o Business unit operating income
o Individual contract milestone achievements
o Individual performance goals
All of the incentive programs feature a discretionary component, and
incentives based on annual consolidated net income or business unit operating
income are subject to approval by the board of directors. Quarterly reviews are
made for any changes in the facts and circumstances underlying the estimates for
accrual of these incentives; changes in these estimates could be material from
quarter to quarter depending on the current and projected results of operations
and field performance on the programs. In making changes to our estimates, we
conform to the guidance contained in APB No. 20, "ACCOUNTING CHANGES," which
outlines the methods that companies may use to record accounting changes, which
includes changes in estimates, among other items.
CONTINGENCIES
In the normal course of business, we are subject to various
contingencies. Contingencies are recorded in the consolidated financial
statements when it is probable that a liability will be incurred and the amount
of the loss can be reasonably estimated, or otherwise disclosed, in accordance
with SFAS 5. Litigation outcomes are not within our complete control, are often
very difficult to predict and often are resolved over long periods of time. For
a discussion of legal contingencies, please refer to Note 19 to the consolidated
financial statements.
CONSOLIDATED RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, selected
statement of operations data as a percentage of revenue. The trends illustrated
in this table may not be indicative of future operating results.
27
Years Ended December 31,
-------------------------------------------------
OPERATING DATA 2004 2003 2002 2001 2000
------ ------ ------ ------ ------
Revenue
Service 100.4% 103.4% 97.9% 42.1% 77.0%
Product, net (0.4) (3.4) 2.1 57.9 23.0
------ ------ ------ ------ ------
Total revenue 100.0 100.0 100.0 100.0 100.0
------ ------ ------ ------ ------
Cost of goods and services
Program expenses 72.8 73.8 90.3 35.3 58.6
Cost of goods sold 0.1 0.4 -- 45.8 15.8
------ ------ ------ ------ ------
Total cost of goods and services 72.9 74.2 90.3 81.1 74.4
------ ------ ------ ------ ------
Gross profit 27.1 25.8 9.7 18.9 25.6
Operating expenses
Compensation expense 9.4 10.7 10.6 5.5 7.5
Other selling, general and administrative
expenses 8.0 8.8 14.3 11.7 8.8
Restructuring and other related expenses -- 0.1 1.0 -- --
Litigation settlement -- 0.6 -- -- --
------ ------ ------ ------ ------
Total operating expenses 17.4 20.2 25.9 17.2 16.3
------ ------ ------ ------ ------
Operating income (loss) 9.7 5.7 (16.2) 1.7 9.3
Other income, net 0.2 0.3 0.6 0.3 1.1
------ ------ ------ ------ ------
Income (loss) before provision (benefit)
for income taxes 9.9 6.0 (15.6) 2.0 10.4
Provision (benefit) for income taxes 4.1 2.4 (5.6) 1.2 4.3
------ ------ ------ ------ ------
Net income (loss) 5.8% 3.6% (10.0)% 0.8% 6.1%
====== ====== ====== ====== ======
COMPARISON OF 2004 AND 2003
REVENUE (IN THOUSANDS)
- -------------------------------------------------------------------
2004 2003 Inc/(Dec) % Inc/(Dec)
- -------------------------------------------------------------------
Sales services $332,431 $271,210 $ 61,221 22.6%
Marketing services 29,057 29,436 (379) (1.3)%
PPG 2,956 43,884 (40,928) (93.3)%
- -------------------------------------------------------------------
TOTAL $364,444 $344,530 $ 19,914 5.8%
- -------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------
Service Product
- ------------------------------------------------------------------- ----------------------------------------------
2004 2003 Inc/(Dec) % Inc/(Dec) 2004 2003 Inc/(Dec) % Inc/(Dec)
- ------------------------------------------------------------------- ----------------------------------------------
Sales services $332,431 $271,210 $ 61,221 22.6% $ -- $ -- $ -- 0.0%
Marketing services 29,057 29,436 (379) (1.3)% -- -- -- 0.0%
PPG 4,477 55,497 (51,020) (91.9)% (1,521) (11,613) 10,092 **
- ------------------------------------------------------------------- ----------------------------------------------
TOTAL $365,965 $356,143 $ 9,822 2.8% $(1,521) $(11,613) $10,092 **
- ------------------------------------------------------------------- ----------------------------------------------
REVENUE. Total revenue for 2004 was $364.4 million, an increase of $19.9
million or 5.8% from revenue of $344.5 million for 2003. Service revenue was
$366.0 million in 2004, an increase of $9.8 million or 2.8% from the $356.1
million recorded in 2003. Product net revenue for 2004 was negative $1.5 million
primarily as a result of a $1.7 million increase in the Ceftin reserve; this
increase was mainly attributable to the changes in estimate related to the
allowance for sales returns recorded on previous Ceftin sales. (Please see Note
3 to the consolidated financial statements.)
28
The sales services segment generated $332.4 million in revenue for 2004,
an increase of $61.2 million over 2003. This increase in revenue is mainly
attributable to three dedicated CSO contracts, all of which commenced in the
second half of 2003 and were active for the full year in 2004.
The marketing services segment generated $29.1 million in revenue in
2004, a slight decrease of $379,000 from the comparable prior year period. The
EdComm unit's revenue for 2004 declined on a year-over-year basis mainly due to
the decrease in services provided to one major client. Revenue generated by
Pharmakon, which was acquired on August 31, 2004, almost completely offset the
decline in revenue from the EdComm unit.
The PPG segment generated net revenue of $2.9 million in 2004, which
consisted of $4.4 million in service revenue offset by negative product revenue
of $1.5 million. The service revenue of $4.4 million was generated almost
entirely by revenue from Lotensin royalties; the negative product revenue of
$1.5 million was primarily related to the increase in the Ceftin sales returns
reserve. As our responsibility to accept product returns ended December 31,
2004, no further increases to this reserve are likely. We will, however,
continue to pay these returns during 2005. In 2003, the PPG segment had service
revenue of $55.5 million almost entirely from Lotensin and this was offset by
negative product revenue of $11.6 million which was mainly attributable to the
$12.0 million increase in the Ceftin reserve. The Lotensin contract was
effectively completed December 31, 2003, but we continued to earn Lotensin
royalties through December 31, 2004.
COST OF GOODS AND SERVICES (IN THOUSANDS)
- -------------------------------------------------------------------
2004 2003 Inc/(Dec) % Inc/(Dec)
- -------------------------------------------------------------------
Sales services $249,131 $201,059 $ 48,072 23.9%
Marketing services 16,352 15,674 678 4.3%
PPG 131 38,716 (38,585) (99.7)%
- -------------------------------------------------------------------
TOTAL $265,614 $255,449 $ 10,165 4.0%
- -------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------
Service Product
- ------------------------------------------------------------------- ----------------------------------------------
2004 2003 Inc/(Dec) % Inc/(Dec) 2004 2003 Inc/(Dec) % Inc/(Dec)
- ------------------------------------------------------------------- ----------------------------------------------
Sales services $249,131 $201,059 $ 48,072 23.9% $ -- $ -- $ -- 0.0%
Marketing services 16,352 15,674 678 4.3% -- -- -- 0.0%
PPG (123) 37,429 (37,552) (100.3)% 254 1,287 (1,033) (80.3)%
- ------------------------------------------------------------------- ----------------------------------------------
TOTAL $265,360 $254,162 $ 11,198 4.4% $ 254 $ 1,287 $(1,033) (80.3)%
- ------------------------------------------------------------------- ----------------------------------------------
COSTS OF GOODS AND SERVICES, AND GROSS PROFIT. Cost of goods and services
for 2004 was $265.6 million, which was $10.2 million or 4.0% more than cost of
goods and services of $255.4 million for 2003.
o During 2004 the gross profit percentage was 27.1% compared to 25.8% in
the comparable prior year period.
o The gross profit margins were similar in 2004 and 2003 for each of the
segments, and
o The service revenue gross profit percentages were 27.5% and 28.6% for
2004 and 2003, respectively.
The sales services segment had gross profit of $83.3 million in 2004,
with a gross profit percentage of 25.1%; during 2003 this segment had gross
profit of $70.2 million and a gross profit percentage of 25.9%. The increase in
gross profit is mainly attributable to three dedicated CSO contracts, all of
which commenced in the second half of 2003, and which were active for the full
year in 2004.
The marketing services segment earned gross profit of $12.7 million and
$13.8 million for 2004 and 2003, respectively. The gross percentage declined
slightly from 46.8% in 2003 to 43.7% in 2004. The decrease in gross profit
attributable to the marketing services is due primarily to the decline in
revenue from EdComm on a year over year basis. The acquisition of Pharmakon in
August 2004 partially offset this decline.
29
The PPG segment had $2.8 million in gross profit for 2004 compared to
$5.2 million in 2003. The decrease in PPG gross profit is attributable to the
Lotensin contract ending December 31, 2003.
(NOTE: COMPENSATION AND OTHER SG&A EXPENSE AMOUNTS FOR EACH SEGMENT
CONTAIN ALLOCATED CORPORATE OVERHEAD.)
- --------------------------------------------------------------------------------
COMPENSATION EXPENSE (IN THOUSANDS)
- --------------------------------------------------------------------------------
% of % of % Inc/
2004 revenue 2003 revenue Inc/(Dec) (Dec)
- --------------------------------------------------------------------------------
Sales services $25,022 7.5% $17,573 6.5% $ 7,449 42.4%
Marketing services 7,367 25.4% 7,463 25.4% (96) (1.3)%
PPG 1,936 65.5% 11,865 27.0% (9,929) (83.7)%
================================================================================
TOTAL $34,325 9.4% $36,901 10.7% $(2,576) (7.0)%
- --------------------------------------------------------------------------------
COMPENSATION EXPENSE. Compensation expense for 2004 was $34.3 million, a
decrease of $2.6 million or 7.0% less than the $36.9 million for the comparable
prior year period. This decrease can be primarily attributed to an overall
decrease in the amount of incentive compensation in 2004. As a percentage of
total revenue, compensation expense decreased to 9.4% for 2004 from 10.7% for
2003. Compensation expense for the sales services segment increased $7.4 million
or 42.4%. Conversely, the compensation expense associated with the PPG segment
decreased by $9.9 million or 83.7%. The changes in both the sales services and
PPG segments reflect the changes in how management's time and effort was being
concentrated on a year-over-year basis. Compensation expense associated with the
marketing services segment remained virtually the same, decreasing by 1.3%
overall.
- --------------------------------------------------------------------------------
OTHER SG&A
(IN THOUSANDS)
- --------------------------------------------------------------------------------
% of % of % Inc/
2004 revenue 2003 revenue Inc/(Dec) (Dec)
- --------------------------------------------------------------------------------
Sales services $24,260 7.3% $16,267 6.0% $ 7,993 49.1%
Marketing services 3,803 13.1% 2,622 8.9% 1,181 45.0%
PPG 1,250 42.3% 11,458 26.1% (10,208) (89.1)%
================================================================================
TOTAL $29,313 8.0% $30,347 8.8% $(1,034) (3.4)%
- --------------------------------------------------------------------------------
OTHER SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Total other SG&A
expenses were $29.3 million in 2004, versus $30.3 million in 2003. Even though
total other SG&A for 2004 did decrease overall, included is $500,000 in bad debt
expense associated with the write off of the Xylos loan discussed previously,
which was recorded in the fourth quarter of 2004. As a percent to revenue, other
SG&A expenses decreased slightly to 8.0% in 2004 from 8.8% in 2003. Other SG&A
expenses associated with the sales services segment increased $8.0 million or
49.1%. In the PPG segment, other SG&A decreased by $10.2 million or 89.1% as the
majority of management's time and efforts as well as the associated resources
were concentrated on the other two segments. Other SG&A for the marketing
services segment increased by $1.2 million or 45.3%. This increase is partially
attributable to the Pharmakon acquisition and the amortization expense
associated with the acquisition.
RESTRUCTURING AND LITIGATION SETTLEMENT EXPENSES. There were no expenses
incurred in 2004 in these categories. In 2003, approximately $143,000 of net
restructuring expense and $2.1 million for the Auxilium legal settlement were
recorded in SG&A.
- --------------------------------------------------------------------------------
OPERATING INCOME (LOSS)
(IN THOUSANDS)
- --------------------------------------------------------------------------------
% Inc/
2004 % of rev 2003 % of rev Inc/(Dec) (Dec)
- --------------------------------------------------------------------------------
Sales services $34,018 10.2% $34,891 12.9% $ (873) (2.51)%
Marketing services 1,535 5.3% 3,567 12.1% (2,032) (56.95)%
PPG (362) -12.2% (18,868) -43.0% 18,506 **
================================================================================
TOTAL $35,191 9.7% $19,590 5.7% $15,601 79.64%
- --------------------------------------------------------------------------------
30
OPERATING INCOME. There was operating income for 2004 of $35.2 million,
compared to operating income of $19.6 million in 2003, an increase of $15.6
million. This increase can be mainly attributed to the negative impact in 2003
of the $12.0 million increase to the Ceftin sales returns reserve (the 2004
Ceftin sales returns impact was approximately $1.7 million). As a percentage of
revenue from the sales services segment, operating income for that segment
decreased to 10.2% for 2004, from 12.9% for 2003. This decrease as a percent to
revenue can be attributed to the increased amount of SG&A being absorbed by this
segment in 2004. There was operating income in 2004 for the marketing services
segment of $1.5 million compared to operating income of $3.6 million in the
comparable prior year period. This can be attributed to the decreased
contribution from the EdComm division, partially offset by the income from
Pharmakon. There was an operating loss for the PPG segment for 2004 of $362,000
that was primarily attributable to the increase in the Ceftin returns reserve of
$1.7 million. In 2003, the PPG segment had an operating loss of $18.9 million
primarily attributable to the $12.0 million adjustment to the Ceftin sales
returns accrual and the losses associated with the Xylos product launch, and the
slower than anticipated sales of that product.
OTHER INCOME, NET. Other income, net, for 2004 and 2003 was approximately
$780,000 and $1.1 million, respectively. For 2004, other income, net, was
comprised primarily of interest income of $1.8 million, partially offset by the
loss on the preferred stock investment in Xylos (see Note 7) of $1.0 million.
For 2003, other income, net, was primarily comprised of interest income. The
increase in interest income is primarily attributed to higher interest rates in
2004, and larger average cash balances in 2004.
PROVISION FOR INCOME TAXES. We recorded a provision for income taxes of
$14.8 million for 2004, compared to $8.4 million in 2003. Our overall effective
tax rate was 41.3% and 40.7% for 2004 and 2003, respectively. The increase in
the 2004 effective rate is primarily due to a valuation allowance associated
with the capital loss carryforward that resulted from the Xylos investment
write-off since management believes it is more likely than not that the deferred
tax asset will not be realized.
NET INCOME. There was net income for 2004 of $21.1 million, compared to
net income of $12.3 million for 2003 due to the factors discussed above.
COMPARISON OF 2003 AND 2002
REVENUE (IN THOUSANDS)
- -----------------------------------------------------------------
% Inc/
2003 2002 Inc/(Dec) (Dec)
- -----------------------------------------------------------------
Sales services $271,210 $185,386 $ 85,824 46.3%
Marketing services 29,436 26,284 3,152 12.0%
PPG 43,884 96,205 (52,321) (54.4)%
- -----------------------------------------------------------------
TOTAL $344,530 $307,875 $ 36,655 11.9%
- -----------------------------------------------------------------
- ----------------------------------------------------------------- ---------------------------------------------
Service Product
- ----------------------------------------------------------------- ---------------------------------------------
% Inc/ % Inc/
2003 2002 Inc/(Dec) (Dec) 2003 2002 Inc/(Dec) (Dec)
- ----------------------------------------------------------------- ---------------------------------------------
Sales services $271,210 $185,386 $ 85,824 46.3% $ -- $ -- $ -- 0.0%
Marketing services 29,436 26,284 3,152 12.0% -- -- -- 0.0%
PPG 55,497 89,767 (34,270) (38.2)% (11,613) 6,438 (18,051) **
- ----------------------------------------------------------------- ---------------------------------------------
TOTAL $356,143 $301,437 $ 54,706 18.2% $(11,613) $ 6,438 $(18,051) **
- ----------------------------------------------------------------- ---------------------------------------------
REVENUE, NET. Total net revenue for 2003 was $344.5 million, 11.9% more
than revenue of $307.9 million for the prior year period. Service revenue was
$356.1 million in 2003, an increase of $54.7 million or 18.2% from the $301.4
million recorded in 2002. This increase is mainly attributable to the addition
of three significant dedicated CSO contracts in July 2003, as well as the
performance on the Lotensin contract. Product net revenue for 2003 was negative
$11.6 million as a result of a $12.0 million increase in the Ceftin sales
returns accrual which was recorded in the fourth quarter of 2003; this increase
was attributable to the changes in estimates related to the allowance for sales
returns recorded on previous Ceftin sales. (Please see Note 3 to the
consolidated financial statements.) This was partially offset by Xylos net
product sales of approximately $387,000 in 2003.
31
The sales services segment had $271.2 million in revenue for 2003, an
increase of $85.8 million over 2002. This increase was attributable to the three
new dedicated CSO contracts mentioned previously, and the reclassification of
the Lotrel-Diovan revenues due to the renegotiation of our Novartis contract in
May 2002. The Novartis sales force responsible for Lotrel-Diovan was classified
in the sales and marketing services segment in 2003 (defined in 2003 as a
combination of the current sales services and marketing services segments)
instead of the PPG segment (where it was classified in 2002). During 2002, we
were reliant on the attainment of performance incentives, whereas in 2003, this
contract was basically a fixed fee arrangement.
The marketing services segment had $29.4 million in revenue in 2003, an
increase of $3.2 million over 2002. This increase was attributable to the
improved performance of the EdComm division in 2003. This division benefited
from a significant increase in revenue from one of its largest clients in 2003.
The PPG segment had service revenue of $55.5 million in 2003, mainly
attributable to the results of the Lotensin contract. Lotensin prescription
levels remained relatively stable throughout the year, which resulted in our
earning additional revenue under the terms of the agreement. The decrease of
$34.3 million in 2003 from the comparable prior year period can be primarily
attributed to the Lotrel-Diovan revenue reclassification discussed above. The
negative product revenue of $11.6 million compares to $6.4 million in revenue to
2002. The negative product revenue in 2003 was mainly attributable to the $12.0
million increase in the Ceftin sales returns accrual discussed above.
COST OF GOODS AND SERVICES (IN THOUSANDS)
- -----------------------------------------------------------------
% Inc/
2003 2002 Inc/(Dec) (Dec)
- -----------------------------------------------------------------
Sales services $201,059 $149,305 $ 51,754 34.7%
Marketing services 15,674 13,718 1,956 14.3%
PPG 38,716 114,979 (76,263) (66.3)%
- -----------------------------------------------------------------
TOTAL $255,449 $278,002 $(22,553) (8.1)%
- -----------------------------------------------------------------
- ----------------------------------------------------------------- ---------------------------------------------
Service Product
- ----------------------------------------------------------------- ---------------------------------------------
%Inc/ % Inc/
2003 2002 Inc/(Dec) (Dec) 2003 2002 Inc/(Dec) (Dec)
- ----------------------------------------------------------------- ---------------------------------------------
Sales services $201,059 $149,305 $ 51,754 34.7% $ -- $ -- $ -- 0.0%
Marketing services 15,674 13,718 1,956 14.3% -- -- -- 0.0%
PPG 37,429 114,979 (77,550) (67.5)% 1,287 -- 1,287 0.0%
- ----------------------------------------------------------------- ---------------------------------------------
TOTAL $254,162 $278,002 $(23,840) (8.6)% $ 1,287 $ -- $ 1,287 0.0%
- ----------------------------------------------------------------- ---------------------------------------------
COSTS OF GOODS AND SERVICES. Cost of goods and services for 2003 was
$255.5 million, which was $22.5 million or 8.1% less than cost of goods and
services of $278.0 million for 2002. During 2003 the gross profit percentage was
25.8% compared to 9.7% in the comparable prior year period. The gross profit
attributable to service revenue was $102.0 million in 2003 versus $23.4 million
in 2002, an increase of 335.9%. As discussed in Note 2, during 2002, it became
apparent that the net sales levels likely to be achieved under the terms of the
Evista contract would not be sufficient to recoup our expenses. In November
2002, we agreed with Eli Lilly to terminate the Evista copromotion agreement
effective December 31, 2002. A $34.7 million negative gross profit was
recognized under this contract for the year ended December 31, 2002. Excluding
the effect of the Evista contract, the gross profit percentage for 2002 would
have been 21.0%.
The sales services segment had gross profit of $70.2 million with a gross
profit percentage of 25.9%, a substantial increase over the $36.1 million gross
profit and 19.5% gross profit percentage achieved in 2002, primarily due to the
three new significant contracts entered into in 2003. Generally, the gross
profit percentage achieved in 2003 was slightly higher than our historical gross
profit percentages and was attributable to the greater efficiencies achieved in
the performance of our contractual obligations for most service units.
32
The marketing services segment earned a gross profit of $13.8 million and
$12.6 million for the 2003 and 2002, respectively. The increase in gross profit
of $1.2 million is primarily attributable to the increased revenue in the EdComm
division.
The PPG segment had $5.2 million in gross profit for 2003 compared to
negative gross profit of $18.8 million in 2002. Excluding the $12.0 million
effect of the increase in the Ceftin accrual for sales returns, the contracts
within PPG contributed $17.2 million in gross profit with a gross profit
percentage of 30.7%. Excluding the Evista contract, in 2002 total PPG would have
earned a positive gross profit of $16.0 million and a gross profit percentage of
16.6%; the Evista contract was terminated as of December 31, 2002. The increase
in gross profit percentage excluding these items from an adjusted 16.6% to an
adjusted 30.7% resulted from our success on the Lotensin program. Lotensin
prescription levels remained relatively stable throughout the year, which
resulted in our earning additional revenue under the terms of the agreement.
(NOTE: COMPENSATION AND OTHER SG&A EXPENSE AMOUNTS FOR EACH SEGMENT
CONTAIN ALLOCATED CORPORATE OVERHEAD.)
- --------------------------------------------------------------------------------
COMPENSATION EXPENSE (EXCLUDING RESTRUCTURING EXPENSE)
(IN THOUSANDS)
- --------------------------------------------------------------------------------
% of % of % Inc/
2003 revenue 2002 revenue Inc/(Dec) (Dec)
- --------------------------------------------------------------------------------
Sales Services $17,573 6.5% $13,509 7.3% $ 4,064 30.1%
Marketing Services 7,463 25.4% 8,798 33.5% (1,335) (15.2)%
PPG 11,865 27.0% 10,363 10.8% 1,502 14.5%
- --------------------------------------------------------------------------------
TOTAL $36,901 10.7% $32,670 10.6% $ 4,231 13.0%
- --------------------------------------------------------------------------------
COMPENSATION EXPENSE. Compensation expense for 2003 was $36.9 million,
an increase of $4.2 million or 13.0% more than the $32.7 million for the
comparable prior year period. This increase can be attributed to a $7.1 million
increase in incentive compensation in 2003, which resulted from the improved
performance of most business units in 2003. This increase in incentive
compensation was partially offset by savings attributable to the reduced
headcount associated with our 2002 restructuring initiative. As a percentage of
total revenue, compensation expense increased slightly to 10.7% for 2003 from
10.6% for 2002. Compensation expense as a percent of revenue for the sales
services and marketing services segments decreased but increased for the PPG
segment. The increase in expense, as a percent of revenue for the PPG segment,
reflects the investment of additional management effort during 2003 toward our
investigation of opportunities for licensing or acquiring products for that
segment.
- --------------------------------------------------------------------------------
OTHER SG&A (EXCLUDING RESTRUCTURING EXPENSE AND LITIGATION EXPENSE)
(IN THOUSANDS)
- --------------------------------------------------------------------------------
% of % of % Inc/
2003 revenue 2002 revenue Inc/(Dec) (Dec)
- --------------------------------------------------------------------------------
Sales Services $16,267 6.0% $15,477 7.3% $ 790 5.1%
Marketing Services 2,622 8.9% 2,986 11.4% (364) (12.2)%
PPG 11,458 26.1% 25,700 26.7% (14,242) (55.4)%
- --------------------------------------------------------------------------------
TOTAL $30,347 8.8% $44,163 14.3% $(13,816) (31.3)%
- --------------------------------------------------------------------------------
Less: Cellegy
licensing fee -- -- 15,000 15.6% (15,000) (100.0)%
- --------------------------------------------------------------------------------
ADJUSTED TOTAL $30,347 8.8% $29,163 9.5% $ 1,193 4.1%
- --------------------------------------------------------------------------------
OTHER SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Total other SG&A
expenses were $30.3 million for 2003, which represented 8.8% of revenues. Other
selling, general and administrative expenses were $44.2 million in 2002, which
included the $15.0 million payment for the initial licensing fee associated with
the Cellegy License Agreement. Excluding the $15.0 million Cellegy license fee
payment we incurred in 2002, other SG&A increased year over year by
approximately $1.2 million or 4.1%, however it decreased as a percentage of
revenue.
RESTRUCTURING AND OTHER RELATED EXPENSES. During the year ended December
31, 2002, we accrued $6.3 million in restructuring and other related expenses in
connection with our decision to consolidate operations to create efficiencies.
33
During the year ended December 31, 2003, we recognized a net reduction in
the restructuring accrual of $197,000, of which $143,000 was recorded as
additional expense in SG&A and $340,000 was recorded as a credit to program
expenses consistent with the original recording of the restructuring charges.
As of December 31, 2003, the restructuring accrual was $744,000,
consisting of remaining severance and lease payments. All restructuring
activities associated with this accrual are substantially complete. The
restructuring accrual and related activities are discussed more fully in the
"RESTRUCTURING AND OTHER RELATED EXPENSES" section of this MD&A.
LITIGATION SETTLEMENT. On May 8, 2003, we entered into a settlement
agreement with Auxilium. We recorded a $2.1 million charge in the first quarter
of 2003 which included a cash payment paid upon execution of the settlement
agreement and other additional expenses that were required as part of the
settlement. Please see Note 19 to the consolidated financial statements for
additional information.
-------------------------------------------------------------------------
OPERATING INCOME (LOSS)
(IN THOUSANDS)
-------------------------------------------------------------------------
2003 2002 Inc/(Dec)
-------------------------------------------------------------------------
Sales Services $ 34,891 $ 4,745 $30,146
Marketing Services 3,567 290 3,277
PPG (18,868) (55,210) 36,342
-------------------------------------------------------------------------
TOTAL $ 19,590 $(50,175) $69,765
-------------------------------------------------------------------------
OPERATING INCOME (LOSS). There was operating income for 2003 of $19.6
million, compared to an operating loss of $50.2 million in 2002. The 2002 period
operating loss was primarily the result of the $35.1 million operating loss
generated by the Evista contract and $15.0 million in licensing fee expenses
associated with the Cellegy License Agreement. Operating income for 2003 for the
sales services segment was $34.9 million, or 635.3% more than sales services
operating income for 2002 of $4.7 million. As a percentage of revenue from the
sales services segment, operating income for that segment increased to 12.9% for
2003, from 2.6% in 2002. There was an operating loss for the PPG segment for
2003 of $18.9 million which was attributable to the $12.0 million adjustment to
the Ceftin sales return accrual in 2003 and the losses associated with the Xylos
product launch, and the slower than anticipated sales of the Xylos product. This
compares to an operating loss of $55.2 million in 2002, most of which was
attributable to the Evista contract loss and the Cellegy initial licensing fee
discussed above. There was operating income for 2003 for the marketing services
segment of $3.6 million compared to operating income of approximately $290,000
in the prior period. This can be attributed to the increased contribution from
the EdComm division.
OTHER INCOME, NET. Other income, net, for 2003 and 2002 was $1.1 million
and $2.0 million, respectively. For 2003, other income, net, was comprised
primarily of interest income. For 2002, other income, net, was primarily
comprised of $2.5 million in other income and net interest income, which was
partially offset by losses on minority investments and disposal of assets of
$0.5 million. The reduction in other income, net, in 2003 is primarily due to
lower interest rates in 2003.
PROVISION (BENEFIT) FOR INCOME TAXES. There was an income tax provision
of $8.4 million for 2003, compared to an income tax benefit of $17.4 million for
2002, which consisted of Federal and state corporate income taxes. The effective
tax rate for 2003 was 40.7%, compared to an effective tax benefit rate of 36.2%
for 2002. During 2002, the benefit rate was lower than the target rate of 41% to
42% as a result of the effect of recording a valuation allowance
34
against certain state NOL carryforwards, for which it was determined that it was
not more likely than not that the benefit from the net operating losses would be
realized. The effective tax rate for 2003 was lower than the target rate of 41%
to 42% due to reductions in certain non-deductible costs and a decrease in the
state effective tax rate resulting from changes in state tax apportionment
factors and an increase in the number of filing jurisdictions required as a
result of changes in our operations. The tax benefit from the reversal of the
state valuation allowance was offset by a decrease in the value of our net state
deferred tax asset resulting from the decrease in our overall state effective
tax rate.
NET INCOME (LOSS). There was net income for 2003 of $12.3 million,
compared to a net loss of $30.8 million for 2002 due to the factors discussed
above.
RESTRUCTURING AND OTHER RELATED EXPENSES
During the third quarter of 2002, we adopted a restructuring plan, the
objectives of which were to consolidate operations in order to enhance operating
efficiencies (the 2002 Restructuring Plan). This plan was primarily in response
to the recognition that the infrastructure that supported certain business units
was larger than required. We originally estimated that the restructuring would
result in annualized SG&A savings of approximately $14.0 million, based on the
level of SG&A spending at the time we initiated the restructuring. However,
these savings have been partially offset by incremental SG&A expenses we have
incurred in subsequent periods as we have been successful in expanding our
business platforms for our segments. Substantially all of the restructuring
activities were completed by December 31, 2003, except for remaining lease
payments and severance payouts.
In connection with this plan, we originally estimated that we would incur
total restructuring expenses of approximately $5.4 million, other non-recurring
expenses of $0.1 million, and accelerated depreciation of $0.8 million.
Excluding $0.1 million, all of these expenses were recognized in 2002. The $0.1
million recognized in 2003 consisted of $0.4 million in additional expense
incurred for severance and other exit costs partially offset by the receipt of
$0.3 million for subletting the Cincinnati, Ohio facility.
The primary items comprising the $5.4 million in restructuring expenses
were $3.7 million in severance expense consisting of cash and non-cash
termination payments to employees in connection with their involuntary
termination and $1.7 million in other restructuring exit costs relating to
leased facilities and other contractual obligations.
During the year ended December 31, 2003, we recognized a net reduction in
the restructuring accrual of $197,000, of which $143,000 was recorded as
additional expense in SG&A and $340,000 was recorded as a credit to program
expenses consistent with the original recording of the restructuring charges.
For the year ended December 31, 2004, there were no such adjustments.
The accrual for restructuring and exit costs totaled approximately
$161,000 at December 31, 2004, and is recorded in current liabilities on the
accompanying balance sheet.
A roll forward of the activity for the 2002 Restructuring Plan is as
follows:
BALANCE AT BALANCE AT
DECEMBER 31, DECEMBER 31,
(IN THOUSANDS) 2003 ADJUSTMENTS PAYMENTS 2004
Administrative severance $ 285 $ - $(272) $ 13
Exit costs 459 - (311) 148
------ ----- ----- -------
744 - (583) 161
------ ----- ----- -------
Sales force severance -- -- -- --
------ ----- ----- -------
TOTAL $ 744 $ -- $(583) $ 161
====== ===== ===== =======
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2004, we had cash and cash equivalents and short-term
investments of approximately $109.5 million and working capital of $96.2
million, compared to cash and cash equivalents and short-term investments of
approximately $113.3 million and working capital of approximately $100.0 million
at December 31, 2003.
35
For the year ended December 31, 2004, net cash provided by operating
activities was $27.5 million, compared to $41.6 million net cash provided by
operating activities in 2003. The main components of cash provided by operating
activities during 2004 were:
o net income of $21.1 million;
o decrease in the net deferred tax asset of $9.2 million;
o depreciation and other non-cash expense of $5.9 million which
included:
o bad debt expense of $683,000, which includes the $500,000
associated with the write off of the Xylos loan in the fourth
quarter of 2004,
o stock compensation expense of $1.2 million,
o non-cash rent expense of $954,000; we were exempt from paying
rent for the period July through December 2004 on the new
facility under the terms of the lease,
o amortization of intangible assets of approximately $1.0 million,
o loss on disposal or sale of assets of approximately $622,000,
each of which was charged to SG&A,
offset by a net cash decrease in "other changes in assets and
liabilities" of $13.3 million.
The net changes in the "Other changes in assets and liabilities" section
of the consolidated statement of cash flows may fluctuate depending on a number
of factors, including the number and size of programs, contract terms and other
timing issues; these variations may change in size and direction with each
reporting period. A major net cash outflow in 2004 has been net payments of
$18.5 million to reimburse customers for returns of Ceftin product.
As of December 31, 2004, we had $3.4 million of unbilled costs and
accrued profits on contracts in progress. When services are performed in advance
of billing, the value of such services is recorded as unbilled costs and accrued
profits on contracts in progress. Normally all unbilled costs and accrued
profits are earned and billed within 12 months from the end of the respective
period. As of December 31, 2004, we had $6.9 million of unearned contract
revenue. When we bill clients for services before they have been completed,
billed amounts are recorded as unearned contract revenue, and are recorded as
income when earned.
During 2004, we continued to hold a $1.0 million investment of preferred
stock of Xylos. In addition we provided short-term loans to Xylos in February
2004 and April 2004 totaling $500,000. As a result of continuing operating
losses incurred by Xylos as well as recent negative developments regarding their
inability to obtain appropriate financing, we concluded during the fourth
quarter of 2004 that both the investment and the recoverability of the loan were
impaired as of December 31, 2004. As a result, the $1.0 million investment was
written down to zero in the fourth quarter of 2004 and the $500,000 loan was
fully reserved for during the fourth quarter as well.
For the year ended December 31, 2004, net cash used in investing
activities was $48.3 million. The main components consisted of the following:
o Approximately $11.7 million used primarily in the purchase of a
laddered portfolio of investment grade debt instruments such as
obligations of the U.S. Treasury and U.S. Federal Government agencies;
municipal bonds; and commercial paper. We are focused on preserving
capital, maintaining liquidity, and maximizing returns in accordance
with our investment criteria.
o Capital expenditures for the year ended December 31, 2004 were $8.1
million, primarily comprised of purchases related to the move to our
new corporate headquarters which occurred in July of 2004. The lease
at our new location, which replaces our expiring leases, is for
approximately 84,000 square feet and has a duration of approximately
12 years at market rates. There was approximately $1.8 million in
capital expenditures for the year ended December 31, 2003. For both
periods, all capital expenditures were funded out of available cash.
o Cash disbursed for the Pharmakon acquisition for the year ended
December 31, 2004, was approximately $28.4 million.
On August 31, 2004, we acquired substantially all of the assets of
Pharmakon, LLC ("Pharmakon") in a transaction treated as an asset acquisition
for tax purposes. The acquisition has been accounted for as a purchase, subject
to the provisions of Statement of Financial Accounting Standards (SFAS) No. 141.
We made payments to the members of Pharmakon, LLC at closing of $27.4 million,
of which $1.5 million was deposited into an escrow account, and assumed
approximately $2.6 million in net liabilities. As of December 31, 2004 we still
hold $1.0
36
million in the escrow account which is recorded in other assets on our balance
sheet and will paid out during 2005 subject to certain working capital
adjustments. Approximately $1.1 million in direct costs of the acquisition were
also capitalized. Based upon the attainment of annual profit targets agreed upon
at the date of acquisition, the members of Pharmakon, LLC will receive
approximately $1.5 million in additional payments in March 2005 for the year
ended December 31, 2004. Additionally, the members of Pharmakon, LLC can still
earn up to an additional $6.7 million in cash based upon achievement of certain
annual profit targets through December 2006. In connection with this
transaction, we recorded $12.7 million in goodwill and $18.9 million in other
identifiable intangibles.
In May 2004, we entered into a loan agreement with TMX Interactive, Inc.
(TMX), a provider of sales force effectiveness technology. Pursuant to the loan
agreement, we provided TMX with a term loan facility of $500,000 and a
convertible loan facility of $500,000, each of which are due to be repaid on
November 26, 2005. In connection with the convertible loan facility, we have the
right to convert all, or, in multiples of $100,000, any part of the convertible
note into common stock of TMX. Although TMX experienced losses in 2004, we
continue to believe that, based on current prospects and activities at TMX, our
loans are not impaired and the amounts are recoverable as of December 31, 2004.
However, if TMX continues to experience losses and is not able to generate
sufficient cash flows through operations and financing, we may determine that we
will be unable to recover our loans and would have to reserve for them at that
time.
For the year ended December 31, 2004, net cash provided by financing
activities of approximately $3.9 million was due to the net proceeds received
from the exercise of stock options and the employee stock purchase plan.
Our revenue and profitability depend to a great extent on our
relationships with a limited number of large pharmaceutical companies. For the
year ended December 31, 2004, we had two major clients that accounted for
approximately 42.0% and 21.0%, respectively, or a total of 63.0% of our service
revenue. We are likely to continue to experience a high degree of client
concentration, particularly if there is further consolidation within the
pharmaceutical industry. The loss or a significant reduction of business from
any of our major clients, or a decrease in demand for our services, could have a
material adverse effect on our business, financial condition and results of
operations. For example, in December 2004, we announced a reduction in the
aggregate number of representatives that we deployed for AstraZeneca. This
reduction is expected to decrease revenue generated from AstraZeneca in 2005 by
approximately $60.0 million versus revenues generated in 2004.
Under the Cellegy License Agreement, we will be required to pay Cellegy a
$10.0 million incremental license fee milestone payment upon Fortigel's receipt
of all approvals required by the FDA to promote, sell and distribute the product
in the U.S. (if such approvals are obtained). Upon payment, this incremental
milestone license fee will be recorded as an intangible asset and amortized over
the estimated commercial life of the product, as then determined. This payment
will be funded, when due, out of cash flows provided by operations and existing
cash balances. In addition, under the Cellegy License Agreement, we would be
required to pay Cellegy royalty payments ranging from 20% to 30% of net sales,
including minimum royalty payments, if and when complete FDA approval is
received. The initial 10-month Prescription Drug User Fee Act (PDUFA) date for
the product was April 5, 2003. In March 2003, Cellegy was notified by the FDA
that the PDUFA date had been revised to July 3, 2003. On July 3, 2003, Cellegy
was notified by the FDA that Fortigel was not approved. Cellegy has told us
that, in the first quarter of 2005, it received FDA approval for the protocol
parameters for a new Phase 3 study proposed by Cellegy to the PDA. We do not
know when, or even whether, Cellegy will conduct such a new Phase 3 study, and
we cannot predict with any certainty whether the FDA will ultimately approve
Fortigel for sale in the U.S. Management believes that it will not be required
to pay Cellegy the $10.0 million incremental license fee milestone payment in
2005, and it is unclear at this point when or if Cellegy will get Fortigel
approved by the FDA which would trigger our obligation to pay $10.0 million to
Cellegy.
On December 12, 2003, we filed a complaint against Cellegy in the U.S.
District Court for the Southern District of New York. The complaint alleges that
Cellegy fraudulently induced us to enter into the Cellegy License Agreement with
Cellegy regarding Fortigel on December 31, 2002. The complaint also alleges
claims for misrepresentation and breach of contract related to the Cellegy
License Agreement. In the complaint, we seek, among other things, rescission of
the license agreement and return of the $15.0 million we paid Cellegy. After we
filed this lawsuit, also on December 12, 2003, Cellegy filed a complaint against
us in the U.S. District Court for the Northern District of California. Cellegy's
complaint seeks a declaration that Cellegy did not fraudulently induce us to
enter the Cellegy License Agreement and that Cellegy has not breached its
obligations under the Cellegy License Agreement. We filed an answer to Cellegy's
complaint on June 18, 2004, in which we make the same allegations and claims for
relief as we do in our New York action, and we also allege Cellegy violated
California unfair competition law. By order dated April 23, 2004 our lawsuit was
transferred to the Northern District of California where it may be consolidated
with Cellegy's action. We are unable to predict the ultimate outcome of these
lawsuits.
37
The trial is scheduled to commence during the second quarter of 2005. Material
legal expense has been and is expected to continue to be incurred in connection
with this lawsuit; however, at this time we are not able to estimate the
magnitude of the expense.
We believe that our existing cash balances and expected cash flows
generated from operations will be sufficient to meet our operating and capital
requirements for the next 12 months. We continue to evaluate and review
financing opportunities and acquisition candidates in the ordinary course of
business.
CONTRACTUAL OBLIGATIONS
As of December 31, 2004, the aggregate minimum future rental payments
required by non-cancelable operating leases with initial or remaining lease
terms exceeding one year are as follows:
2005 2006 2007 2008 2009 TOTAL
------- ------ ------ ------ ------ --------
(in thousands)
Operating leases
Minimum lease payments $ 3,799 $3,232 $3,042 $3,130 $3,189 $ 16,392
Less minimum sublease rentals (34) -- -- -- -- (34)
-------------------------------------------------------------
Net minimum lease payments $ 3,765 $3,232 $3,042 $3,130 $3,189 $ 16,358
=============================================================
OFF-BALANCE SHEET ARRANGEMENTS
As of December 31, 2004, we had no off-balance sheet arrangements.
QUARTERLY OPERATING RESULTS
Our results of operations have varied, and are expected to continue to
vary, from quarter to quarter. These fluctuations result from a number of
factors including, among other things, the timing of commencement, completion or
cancellation of major programs. In the future, our revenue may also fluctuate as
a result of a number of additional factors, including the types of products we
market and sell, delays or costs associated with acquisitions, government
regulatory initiatives and conditions in the healthcare industry generally.
Revenue, generally, is recognized as services are performed and products are
shipped. Program costs, other than training costs, are expensed as incurred. As
a result, we may incur substantial expenses associated with staffing a new
detailing program during the first two to three months of a contract without
recognizing any revenue under that contract. This could have an adverse impact
on our operating results for the quarters in which those expenses are incurred.
Revenue related to performance incentives is recognized in the period when the
performance based parameters are achieved. A significant portion of this revenue
could be recognized in the fourth quarter of a year. Costs of goods sold are
expensed when products are shipped. For milestone payments associated with
licensing agreements, amounts paid before the underlying product has obtained
regulatory approval and which have no alternate use are expensed as incurred,
whereas payments post-approval are capitalized and amortized over the economic
life of the product or agreement. We believe that because of these fluctuations,
quarterly comparisons of our financial results cannot be relied upon as an
indication of future performance.
38
The following tables set forth quarterly operating results for the eight
quarters ended December 31, 2004:
QUARTER ENDED
---------------------------------------------------------------------------------------
Mar 31, Jun 30, Sep 30, Dec 31, Mar 31, Jun 30, Sep 30, Dec 31,
2004 2004 2004 2004 2003 2003 2003 2003
------- -------- -------- -------- -------- ------- ------- ---------
(in thousands except per share data)
(unaudited)
Revenue
Service .............................. $92,547 $ 92,519 $ 92,525 $ 88,299 $ 73,099 $77,543 $94,470 $ 111,031
Product, net ......................... 101 (1,131) (3) (487) 34 82 81 (11,810)
------- -------- -------- -------- -------- ------- ------- ---------
Total revenue ...................... 92,648 91,388 92,522 87,812 73,133 77,625 94,551 99,221
------- -------- -------- -------- -------- ------- ------- ---------
Cost of goods and services
Program expenses ..................... 65,988 69,483 68,127 61,690 55,469 56,673 70,085 71,935
Cost of goods sold ................... 145 89 10 10 62 83 952 190
------- -------- -------- -------- -------- ------- ------- ---------
Total cost of goods and services ... 66,133 69,572 68,137 61,700 55,531 56,756 71,037 72,125
------- -------- -------- -------- -------- ------- ------- ---------
Gross profit ........................... 26,515 21,816 24,385 26,112 17,602 20,869 23,514 27,096
Operating expenses
Compensation expense ................. 10,216 7,924 8,409 7,776 8,874 9,123 9,297 9,607
Other selling, general and
administrative expenses ............ 6,490 5,657 6,941 10,224 5,833 7,206 7,676 9,632
Restructuring and other
related expenses ................... -- -- -- -- (270) -- -- 413
Litigation settlement ................ -- -- -- -- 2,100 -- -- --
------- -------- -------- -------- -------- ------- ------- ---------
Total operating expenses ........... 16,706 13,581 15,350 18,000 16,537 16,329 16,973 19,652
------- -------- -------- -------- -------- ------- ------- ---------
Operating income ....................... 9,809 8,235 9,035 8,112 1,065 4,540 6,541 7,444
Other income (expense) net ............. 318 313 231 (82) 269 226 246 332
------- -------- -------- -------- -------- ------- ------- ---------
Income before provision for taxes ...... 10,127 8,548 9,266 8,030 1,334 4,766 6,787 7,776
Provision for income taxes ............. 4,152 3,505 3,799 3,383 556 1,954 2,605 3,290
------- -------- -------- -------- -------- ------- ------- ---------
Net income ............................. $ 5,975 $ 5,043 $ 5,467 $ 4,647 $ 778 $ 2,812 $ 4,182 $ 4,486
======= ======== ======== ======== ======== ======= ======= =========
Basic net income per share ............. $ 0.41 $ 0.35 $ 0.37 $ 0.32 $ 0.05 $ 0.20 $ 0.29 $ 0.31
======= ======== ======== ======== ======== ======= ======= =========
Diluted net income per share ........... $ 0.40 $ 0.34 $ 0.37 $ 0.31 $ 0.05 $ 0.20 $ 0.29 $ 0.31
======= ======== ======== ======== ======== ======= ======= =========
Weighted average number of shares:
Basic .............................. 14,461 14,533 14,621 14,641 14,166 14,188 14,252 14,320
======= ======== ======== ======== ======== ======= ======= =========
Diluted ............................ 14,767 14,918 14,933 14,922 14,237 14,266 14,543 14,677
======= ======== ======== ======== ======== ======= ======= =========
NOTE: FOR 2003, THE SUM OF THE QUARTERLY BASIC NET INCOME PER SHARE AMOUNTS DOES
NOT EQUAL THE ANNUAL BASIC NET INCOME PER SHARE DUE TO ROUNDING.
EFFECT OF NEW ACCOUNTING PRONOUNCEMENTS
In November 2004, the FASB issued SFAS No. 151, "INVENTORY COSTS," (SFAS
151) which clarifies the accounting for abnormal amounts of idle facility
expense, freight, handling costs, and wasted material (spoilage) by requiring
these items to be recognized as current-period charges. SFAS 151 is effective
for inventory costs incurred during fiscal years beginning after June 15, 2005,
with earlier application permitted. The adoption of SFAS 151 is not expected to
have a material impact on our business, financial condition and results of
operations.
In December 2004, the FASB issued SFAS No. 153, "EXCHANGES OF MONETARY
ASSETS," (SFAS 153) which addresses the measurement of exchanges of nonmonetary
assets and eliminates the exception from fair value measurement for nonmonetary
exchanges of similar productive assets and replaces it with an exception for
exchanges that do not have commercial substance. SFAS 153 is effective for
nonmonetary asset exchanges occurring in fiscal periods beginning after June 15,
2005, with earlier application permitted. The adoption of SFAS 153 is not
expected to have a material impact on our business, financial condition and
results of operations.
In December 2004, the FASB issued a revision of SFAS No. 123, "STATEMENT
OF FINANCIAL ACCOUNTING STANDARDS NO. 123 (REVISED 2004)," (SFAS 123R) which
requires that the cost resulting from all share-based payment transactions be
recognized in the financial statements. This Statement establishes fair value as
the measurement objective in accounting for share-based payment arrangements and
requires all entities to apply a fair-value-based measurement method in
accounting for share-based payment transactions with employees except for equity
instruments held by employee share ownership plans. This Statement is effective
as of the beginning of the first interim or annual reporting period that begins
after June 15, 2005, and we expect to adopt this standard using the modified
prospective method. The adoption of SFAS 123R may have a material effect on our
business, financial condition and results of operations, depending on the number
of options granted in the future.
39
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our financial statements and the required financial statement schedule
are included herein beginning on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None.
ITEM 9A. CONTROLS AND PROCEDURES
CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING DURING THE MOST RECENT
QUARTER
As described in Note 1B to the consolidated financial statements in our
Amended Annual Report on Form 10-K/A for the year ended December 31, 2003 and
our Amended Quarterly Reports on Form 10-Q/A for the periods ended March 31,
2004 and June 30, 2004, during 2004, the Company had a restatement due to the
non-application of EITF 01-14, "INCOME STATEMENT CHARACTERIZATION OF
REIMBURSEMENTS RECEIVED FOR OUT-OF-POCKET EXPENSES INCURRED", from the first
quarter of 2002 through June 30, 2004. We became aware of the applicability of
EITF 01-14 to the Company in September 2004. As a result of this restatement, we
determined that a material weakness existed in our disclosure controls regarding
the selection and application of GAAP and preparation of our consolidated
financial statements through June 30, 2004.
Beginning in September 2004, we have taken a series of steps designed to
improve the control processes regarding the selection and application of GAAP
and preparation and review of our consolidated financial statements.
Specifically, key personnel involved in our financial reporting processes have
enhanced the process through which authoritative guidance is monitored on a
regular basis. Review of both authoritative guidance and industry practices is
conducted in order to ensure that all new guidance is being complied with in the
preparation of our financial statements, related disclosures and periodic
filings with the SEC. As of December 31, 2004, we have completed the remediation
of our disclosure controls regarding the selection and application of GAAP and
preparation of our consolidated financial statements and have concluded that a
material weakness no longer exists.
CONCLUSION REGARDING THE EFFECTIVENESS OF DISCLOSURE CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
conducted an evaluation of our disclosure controls and procedures, as such term
is defined under Rule 13a-15(e) promulgated under the 1934 Act. Based on this
evaluation, our principal executive officer and our principal financial officer
concluded that our disclosure controls and procedures were effective as of the
end of the period covered by this annual report.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate
internal control over financial reporting, as such term is defined in 1934 Act
Rules 13a-15(f). Under the supervision and with the participation of our
management, including our principal executive officer and principal financial
officer, we conducted an evaluation of the effectiveness of our internal control
over financial reporting based on the framework in INTERNAL CONTROL - INTEGRATED
FRAMEWORK issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Based on our evaluation under the framework in INTERNAL CONTROL --
INTEGRATED FRAMEWORK, our management concluded that our internal control over
financial reporting was effective as of December 31, 2004. We have excluded the
Pharmakon business from our assessment of internal control over financial
reporting since the business was acquired in an asset purchase in August 2004.
The Pharmakon business' total assets and total revenues represent 2.1% and 1.3%,
respectively, of the related consolidated financial statement amounts as of and
for the year ended December 31, 2004.
Our management's assessment of the effectiveness of our internal control
over financial reporting as of December 31, 2004 has been audited by
PricewaterhouseCoopers LLP, an independent registered public accounting firm, as
stated in their report which is included herein.
ITEM 9B. OTHER INFORMATION
None.
40
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information relating to directors and executive officers of the
registrant that is responsive to Item 11 of Form 10-K will be included in our
Proxy Statement in connection with our 2005 annual meeting of stockholders and
such information is incorporated by reference herein.
CODE OF CONDUCT
We have adopted a code of conduct that applies to our principal executive
officer, principal financial officer and other persons performing similar
functions, as well as all of our other employees and directors. This code of
conduct is posted on our website at www.pdi-inc.com.
ITEM 11. EXECUTIVE COMPENSATION
Information relating to executive compensation that is responsive to Item
11 of Form 10-K will be included in our Proxy Statement in connection with our
2005 annual meeting of stockholders and such information is incorporated by
reference herein.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information relating to security ownership of certain beneficial owners
and management that is responsive to Item 12 of Form 10-K will be included in
our Proxy Statement in connection with our 2005 annual meeting of stockholders
and such information is incorporated by reference herein.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information relating to certain relationships and related transactions
that is responsive to Item 13 of Form 10-K will be included in our Proxy
Statement in connection with our 2005 annual meeting of stockholders and such
information is incorporated by reference herein.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Information relating to principal accounting fees and services that is
responsive to Item 14 of Form 10-K will be included in our Proxy Statement in
connection with our 2005 annual meeting of stockholders and such information is
incorporated by reference herein.
41
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this report:
(1) FINANCIAL STATEMENTS - See Index to Financial Statements on
page F-1 of this report.
(2) FINANCIAL STATEMENT SCHEDULE
Schedule II: Valuation and Qualifying Accounts
Schedules not listed above have been omitted because they are not
required by the instructions or are inapplicable.
(3) EXHIBITS
Exhibit
No. Description
3.1 Certificate of Incorporation of PDI, Inc.(1)
3.2 By-Laws of PDI, Inc.(1)
3.3 Certificate of Amendment of Certificate of Incorporation of PDI,
Inc.(4)
4.1 Specimen Certificate Representing the Common Stock(1)
10.1 Form of 1998 Stock Option Plan(1)
10.2 Form of 2000 Omnibus Incentive Compensation Plan(2)
10.4 Form of Employment Agreement between the Company and Charles T.
Saldarini(4)
10.5 Agreement between the Company and John P. Dugan(1)
10.6 Form of Amended and Restated Employment Agreement between the
Company and Steven K. Budd(4)
10.7 Form of Amended and Restated Employment Agreement between the
Company and Bernard C. Boyle(4)
10.8 Form of Employment Agreement between the Company and Christopher
Tama(5)
10.9 Form of Amended and Restated Employment Agreement between the
Company and Stephen Cotugno(4)
10.10 Form of Employment Agreement between the Company and Beth
Jacobson(5)
10.11 Form of Employment Agreement between the Company and Alan
Rubino(7)
10.12 Form of Loan Agreement between the Company and Steven K. Budd(3)
10.13 Exclusive License Agreement between the Company and Cellegy
Pharmaceuticals, Inc.(5)(6)
10.14 Saddle River Executive Centre Lease, as amended(7)
10.15 2004 Stock Award and Incentive Plan(8)
14.1 Code of Conduct(7)
21.1 Subsidiaries of the Registrant(4)
23.1 Consent of PricewaterhouseCoopers LLP*
31.1 Certification of Chief Executive Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002*
42
31.2 Certification of Chief Financial Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002*
32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C.
Section 1350, as adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002*
32.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C.
Section 1350, as adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002*
- ----------
* Filed herewith
(1) Filed as an exhibit to our Registration Statement on Form S-1
(File No 333-46321), and incorporated herein by reference.
(2) Filed as an Exhibit to our definitive proxy statement dated May
10, 2000, and incorporated herein by reference.
(3) Filed as an exhibit to our Annual Report on Form 10-K for the year
ended December 31, 1999, and incorporated herein by reference.
(4) Filed as an exhibit to our Annual Report on Form 10-K for the year
ended December 31, 2001, and incorporated herein by reference.
(5) Filed as an exhibit to our Annual Report on Form 10-K for the year
ended December 31, 2002, and incorporated herein by reference.
(6) The Securities and Exchange Commission granted the Registrant's
application for confidential treatment, pursuant to Rule 24b-2
under the Exchange Act, of certain portions of this exhibit. These
portions of the exhibit have been redacted from the exhibit as
filed.
(7) Filed as an exhibit to our Annual Report on Form 10-K for the year
ended December 31, 2003, and incorporated herein by reference.
(8) Filed as an Exhibit to our definitive proxy statement dated April
28, 2004, and incorporated herein by reference.
43
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this Form 10-K
to be signed on its behalf by the undersigned, thereunto duly authorized, on the
14th day of March, 2005.
PDI, INC.
/s/ Charles T. Saldarini
-----------------------------------
Charles T. Saldarini,
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this Form 10-K has been signed by the following persons on behalf of
the Registrant and in the capacities indicated and on the 14th day of March,
2005.
Signature Title
/s/ John P. Dugan Chairman of the Board of Directors
- ----------------------------
John P. Dugan
Vice Chairman of the Board of Directors
/s/ Charles T. Saldarini and Chief Executive Officer
- ----------------------------
Charles T. Saldarini
Chief Financial Officer and Treasurer
/s/ Bernard C. Boyle (principal accounting and financial officer)
- ----------------------------
Bernard C. Boyle
/s/ John M. Pietruski Director
- ----------------------------
John M. Pietruski
/s/ Jan Martens Vecsi Director
- ----------------------------
Jan Martens Vecsi
/s/ Frank Ryan Director
- ----------------------------
Frank Ryan
/s/ Larry Ellberger Director
- ----------------------------
Larry Ellberger
/s/ John C. Federspiel Director
- ----------------------------
John Federspiel
/s/ Dr. Joseph T. Curti Director
- ----------------------------
Dr. Joseph T. Curti
/s/ Stephen J. Sullivan Director
- ----------------------------
Stephen J. Sullivan
44
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
Page
PDI, INC
Report of Independent Registered Public Accounting Firm F-2
Consolidated Balance Sheets F-3
Consolidated Statements of Operations F-4
Consolidated Statements of Cash Flows F-5
Consolidated Statements of Stockholders' Equity F-6
Notes to Consolidated Financial Statements F-7
Schedule II. Valuation and Qualifying Accounts F-28
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To Board of Directors and
Stockholders of PDI, Inc.:
We have completed an integrated audit of PDI, Inc.'s 2004 consolidated financial
statements and of its internal control over financial reporting as of December
31, 2004 and audits of its 2003 and 2002 consolidated financial statements in
accordance with the standards of the Public Company Accounting Oversight Board
(United States). Our opinions, based on our audits, are presented below.
CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
In our opinion, the consolidated financial statements listed in the index
appearing under Item 15(a)(1) present fairly, in all material respects, the
financial position of PDI, Inc. and its subsidiaries (the "Company") at December
31, 2004 and December 31, 2003, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 2004 in
conformity with accounting principles generally accepted in the United States of
America. In addition, in our opinion, the financial statement schedule listed in
the index appearing under Item 15(a)(2) presents fairly, in all material
respects, the information set forth therein when read in conjunction with the
related consolidated financial statements. These financial statements and
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits. We conducted our audits of
these statements in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit of financial statements
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
INTERNAL CONTROL OVER FINANCIAL REPORTING
Also, in our opinion, management's assessment, included in Management's Report
on Internal Control Over Financial Reporting appearing under Item 9A, that the
Company maintained effective internal control over financial reporting as of
December 31, 2004 based on criteria established in INTERNAL CONTROL - INTEGRATED
FRAMEWORK issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), is fairly stated, in all material respects, based on those
criteria. Furthermore, in our opinion, the Company maintained, in all material
respects, effective internal control over financial reporting as of December 31,
2004, based on criteria established in INTERNAL CONTROL - INTEGRATED FRAMEWORK
issued by the COSO. The Company's management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting. Our
responsibility is to express opinions on management's assessment and on the
effectiveness of the Company's internal control over financial reporting based
on our audit. We conducted our audit of internal control over financial
reporting in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. An audit of internal control over financial reporting includes
obtaining an understanding of internal control over financial reporting,
evaluating management's assessment, testing and evaluating the design and
operating effectiveness of internal control, and performing such other
procedures as we consider necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
As described in Management's Report on Internal Control over Financial
Reporting, management has excluded the Pharmakon business (Pharmakon) from its
assessment of internal control over financial reporting as of December 31, 2004
because it was acquired by the Company in a purchase business combination during
2004. We have also excluded Pharmakon from our audit of internal control over
financial reporting. Pharmakon's total assets and total revenues represent 2.1%
and 1.3%, respectively, of the related consolidated financial statement amounts
as of and for the year ended December 31, 2004.
/s/ PricewaterhouseCoopers LLP
Florham Park, New Jersey
March 11, 2005
F-2
PDI, INC.
CONSOLIDATED BALANCE SHEETS
December 31,
2004 2003
--------- ---------
ASSETS (in thousands)
Current assets:
Cash and cash equivalents ........................................... $ 96,367 $ 113,288
Short-term investments .............................................. 13,131 1,344
Inventory, net of obsolescence reserve of $0 and $818 as of
December 31, 2004 and 2003, respectively ........................... -- 43
Accounts receivable, net of allowance for doubtful accounts of
$74 and $749 as of December 31, 2004 and 2003, respectively ....... 26,662 40,885
Unbilled costs and accrued profits on contracts in progress ......... 3,393 4,041
Deferred training ................................................... 740 1,643
Other current assets ................................................ 11,818 8,847
Deferred tax asset .................................................. 3,325 11,053
--------- ---------
Total current assets .................................................. 155,436 181,144
Property and equipment, net .......................................... 17,170 14,494
Deferred tax asset .................................................. 5,832 7,304
Goodwill ............................................................ 23,791 11,132
Other intangible assets ............................................. 19,548 1,648
Other long-term assets .............................................. 2,928 3,901
--------- ---------
Total assets .......................................................... $ 224,705 $ 219,623
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable .................................................... $ 7,217 $ 8,689
Accrued rebates, sales discounts and returns ........................ 4,316 22,811
Accrued incentives .................................................. 16,282 20,486
Accrued salaries and wages .......................................... 8,414 9,031
Unearned contract revenue ........................................... 6,924 3,604
Restructuring accruals .............................................. 161 744
Other accrued expenses .............................................. 15,966 15,770
--------- ---------
Total current liabilities ............................................. 59,280 81,135
--------- ---------
Long-term liabilities ................................................. -- --
--------- ---------
Total liabilities ..................................................... $ 59,280 $ 81,135
--------- ---------
Commitments and Contingencies
Stockholders' equity:
Preferred stock, $.01 par value; 5,000,000 shares authorized,
no shares issued and outstanding .................................. $ -- $ --
Common stock, $.01 par value; 100,000,000 shares authorized;
shares issued and outstanding, 2004 - 14,665,945;
2003 - 14,387,126; restricted $.01 par value; shares issued
and outstanding, 2004- 154,554; 2003 - 136,178 .................... 148 145
Additional paid-in capital ............................................ 116,737 109,531
Retained earnings ..................................................... 50,637 29,505
Accumulated other comprehensive income ................................ 76 25
Unamortized compensation costs ........................................ (2,063) (608)
Treasury stock, at cost: 5,000 shares at December 31, 2004 and 2003 ... (110) (110)
--------- ---------
Total stockholders' equity ............................................ $ 165,425 $ 138,488
--------- ---------
Total liabilities & stockholders' equity .............................. $ 224,705 $ 219,623
========= =========
The accompanying notes are an integral part of
these consolidated financial statements
F-3
PDI, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For The Years Ended December 31,
----------------------------------
2004 2003 2002
-------- -------- --------
(in thousands, except for per share data)
Revenue
Service ............................................... $365,965 $356,143 $301,437
Product, net .......................................... (1,521) (11,613) 6,438
-------- -------- --------
Total revenue ....................................... 364,444 344,530 307,875
-------- -------- --------
Cost of goods and services
Program expenses (including related party amounts
of $180, $983 and $516 for the periods ended
December 31, 2004, 2003 and 2002, respectively) ..... 265,360 254,162 278,002
Cost of goods sold .................................... 254 1,287 --
-------- -------- --------
Total cost of goods and services .................... 265,614 255,449 278,002
-------- -------- --------
Gross profit ............................................ 98,830 89,081 29,873
Operating expenses
Compensation expense .................................. 34,325 36,901 32,670
Other selling, general and administrative expenses .... 29,314 30,347 44,163
Restructuring and other related expenses .............. -- 143 3,215
Litigation settlement ................................. -- 2,100 --
-------- -------- --------
Total operating expenses ............................ 63,639 69,491 80,048
-------- -------- --------
Operating income (loss) ................................. 35,191 19,590 (50,175)
Other income, net ....................................... 779 1,073 1,967
-------- -------- --------
Income (loss) before provision (benefit) for taxes ...... 35,970 20,663 (48,208)
Provision (benefit) for income taxes .................... 14,838 8,405 (17,447)
-------- -------- --------
Net income (loss) ....................................... $ 21,132 $ 12,258 $(30,761)
======== ======== ========
Basic net income (loss) per share ....................... $ 1.45 $ 0.86 $ (2.19)
======== ======== ========
Diluted net income (loss) per share ..................... $ 1.42 $ 0.85 $ (2.19)
======== ======== ========
Basic weighted average number of shares outstanding ..... 14,564 14,231 14,033
======== ======== ========
Diluted weighted average number of shares outstanding ... 14,893 14,431 14,033
======== ======== ========
The accompanying notes are an integral part of
these consolidated financial statements
F-4
PDI, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For The Years Ended December 31,
----------------------------------
2004 2003 2002
-------- -------- --------
(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) from operations .................................. $ 21,132 $ 12,258 $(30,761)
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization ................................ 5,916 6,243 7,374
Loss on disposal of asset .................................... 622 -- --
Stock compensation costs ..................................... 1,232 554 443
Deferred taxes, net .......................................... 9,199 (3,117) 8,501
Reserve for inventory obsolescence and bad debt .............. 683 1,939 (2,080)
Loss on other investments .................................... 1,000 -- 379
Other changes in assets and liabilities, net of acquisitions:
Decrease (increase) in accounts receivable ................... 15,807 (1,277) 13,991
Decrease (increase) in inventory ............................. 43 (216) (203)
Decrease (increase) in unbilled costs ........................ 648 (681) 3,538
Decrease (increase) in deferred training ..................... 903 (537) 4,463
(Increase) decrease in other current assets .................. (936) 14,813 (15,559)
(Increase) decrease in other long-term assets ................ (28) (2,052) 4,385
(Decrease) increase in accounts payable ...................... (3,439) 3,316 (4,119)
(Decrease) increase in accrued rebates, sales discounts
and returns ............................................... (18,495) 6,311 (51,903)
(Decrease) increase in accrued contract losses ............... -- -- (12,256)
(Decrease) increase in accrued liabilities ................... (3,867) 11,957 (10,398)
Increase (decrease) in unearned contract revenue ............. 507 (5,869) (1,404)
(Decrease) increase in other current liabilities ............. (1,362) 1,943 (3,371)
(Decrease) in restructuring liability ........................ (583) (3,954) --
-------- -------- --------
Net cash provided by (used in) operating activities ................ 28,982 41,631 (88,980)
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Sales (net) of short-term investments ........................ -- 4,614 1,532
Purchases (net) of short-term investments .................... (11,736) -- --
Investments in Xylos, TMX, and iPhysician Net ................ (1,500) -- (1,379)
Purchase of property and equipment ........................... (8,104) (1,829) (4,012)
Cash paid for acquisition, including acquisition costs ....... (28,443) -- (2,735)
-------- -------- --------
Net cash (used in) provided by investing activities ................ (49,783) 2,785 (6,594)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from employee stock purchase plan
and the exercise of stock options .......................... 3,880 2,045 2,358
-------- -------- --------
Net cash provided by financing activities .......................... 3,880 2,045 2,358
-------- -------- --------
Net (decrease) increase in cash and cash equivalents ............... (16,921) 46,461 (93,216)
Cash and cash equivalents - beginning .............................. 113,288 66,827 160,043
-------- -------- --------
Cash and cash equivalents - ending ................................. $ 96,367 $113,288 $ 66,827
======== ======== ========
Cash paid for interest ............................................. $ 3 $ 25 $ 33
======== ======== ========
Cash paid for taxes ................................................ $ 7,389 $ 9,619 $ 4,827
======== ======== ========
The accompanying notes are an integral part of
these consolidated financial statements
F-5
PDI, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
ACCUMULATED
OTHER
COMMON STOCK TREASURY STOCK COMPRE- UNAMORTIZED
-------------- --------------- ADDITIONAL HENSIVE COMPEN-
PAID IN RETAINED INCOME SATION
SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS (LOSS) COSTS TOTAL
------ ------ ------ ------ --------- -------- ------ ------- --------
Balance - December 31, 2001 13,983 $ 140 5 $ (110) $ 103,711 $ 48,008 $ (79) $ (735) $150,935
====== ====== ====== ====== ========= ======== ====== ======= ========
Net loss for the year ended
December 31, 2002 (30,761) (30,761)
Unrealized investment holding
losses, net of tax (21) (21)
--------
Comprehensive income (30,782)
Issuance of common stock 190 2 2,239 2,241
Issuance of employees'
restricted common stock 29 593 593
Exercise of common
stock options 8 130 130
Amortization of deferred
compensation costs 443 443
Deferred compensation costs (349) (349)
------ ------ ------ ------ --------- -------- ------ ------- --------
Balance - December 31, 2002 14,210 $ 142 5 $ (110) $ 106,673 $ 17,247 $ (100) $ (641) $123,211
====== ====== ====== ====== ========= ======== ====== ======= ========
Net income for the year ended
December 31, 2003 12,258 12,258
Unrealized investment holding
gains, net of tax 125 125
--------
Comprehensive income 12,383
Issuance of common stock 143 1 1,326 1,327
Issuance of employees'
restricted common stock 129 1 814 815
Exercise of common
stock options 41 1 526 527
Tax benefit of nonqualified
option exercise 192 192
Amortization of deferred
compensation costs 554 554
Deferred compensation costs (521) (521)
------ ------ ------ ------ --------- -------- ------ ------- --------
Balance - December 31, 2003 14,523 $ 145 5 $ (110) $ 109,531 $ 29,505 $ 25 $ (608) $138,488
====== ====== ====== ====== ========= ======== ====== ======= ========
Net income for the year ended
December 31, 2004 21,132 21,132
Unrealized investment holding
gains, net of tax 51 51
--------
Comprehensive income 21,824
Issuance of common stock 68 1 1,511 1,512
Issuance of employees'
restricted common stock 98 1 2,626 2,627
Forfeitures of restricted stock (14) (174) 137 (37)
Exercise of common stock options 145 1 2,369 2,370
Tax benefit of option exercise 641 641
Acceleration of stock
option vesting 233 233
Amortization of deferred
compensation costs 1,035 1,035
Deferred compensation costs (2,627) (2,627)
------ ------ ------ ------ --------- -------- ------ ------- --------
Balance - December 31, 2004 14,820 $ 148 5 $ (110) $ 116,737 $ 50,637 $ 76 $(2,063) $165,425
====== ====== ====== ====== ========= ======== ====== ======= ========
The accompanying notes are an integral part of
these consolidated financial statements
F-6
PDI, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS
PDI, Inc. (PDI and, together with its wholly owned subsidiaries, the
Company) is a healthcare sales and marketing company serving the
biopharmaceutical and medical devices and diagnostics (MD&D) industries. See
Note 23 for segment information.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include accounts of PDI and its
wholly owned subsidiaries TVG, Inc. (TVG), ProtoCall, Inc. (ProtoCall), InServe
Support Solutions, Inc. (InServe), and PDI Investment Company, Inc. (PDII). All
significant intercompany balances and transactions have been eliminated in
consolidation.
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles (GAAP) requires the Company to make
estimates and assumptions that affect the amounts reported in the financial
statements. Actual results could differ from those estimates. Significant
estimates include incentives earned or penalties incurred on contracts, accrued
incentives payable to employees, valuation allowances related to deferred taxes,
insurance loss accruals, bad debt reserves, fair value of assets, and sales
returns.
REVENUE RECOGNITION AND ASSOCIATED COSTS
The paragraphs that follow describe the guidelines that the Company
adheres to in accordance with GAAP when recognizing revenue and cost of goods
and services in financial statements. In accordance with GAAP, service revenue
and product revenue and their respective direct costs have been shown separately
on the income statement.
Historically, the Company has derived a significant portion of its
service revenue from a limited number of clients. Concentration of business in
the pharmaceutical services industry is common and the industry continues to
consolidate. As a result, the Company is likely to continue to experience
significant client concentration in future periods. For the years ended December
31, 2004, 2003 and 2002, the Company's two largest clients, who each
individually represented 10% or more of its service revenue, accounted for
approximately 63.0%, 66.5% and 61.9%, respectively, of its service revenue.
Service revenue and program expenses
------------------------------------
Service revenue is earned primarily by performing product detailing
programs and other marketing and promotional services under contracts. Revenue
is recognized as the services are performed and the right to receive payment for
the services is assured. Revenue is recognized net of any potential penalties
until the performance criteria relating to the penalties have been achieved.
Performance incentives, as well as termination payments, are recognized as
revenue in the period earned and when payment of the bonus, incentive or other
payment is assured. Under performance based contracts, revenue is recognized
when the performance based parameters are achieved.
Program expenses consist primarily of the costs associated with executing
product detailing programs, performance based contracts or other sales and
marketing services identified in the contract. Program expenses include
personnel costs and other costs associated with executing a product detailing or
other marketing or promotional program, as well as the initial direct costs
associated with staffing a product detailing program. Such costs include, but
are not limited to, facility rental fees, honoraria and travel expenses, sample
expenses and other promotional expenses. Personnel costs, which constitute the
largest portion of program expenses, include all labor related costs, such as
salaries, bonuses, fringe benefits and payroll taxes for the sales
representatives and sales managers and professional staff who are directly
responsible for executing a particular program. Initial direct program costs are
those costs associated with initiating a product detailing program, such as
recruiting, hiring, and training the sales representatives who staff a
particular product detailing program. All personnel costs and initial direct
program costs, other than training costs, are expensed as incurred for service
offerings. Product detailing, marketing and promotional expenses related to the
detailing of products the Company distributes are recorded as a selling expense
and are included in other selling, general and administrative expenses in the
consolidated statements of operations.
F-7
PDI, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Reimbursable Out-of-Pocket Expenses
-----------------------------------
Reimbursable out-of-pocket expenses include those relating to travel and
out-of pocket expenses and other similar costs, for which the Company is
reimbursed at cost from its clients. In accordance with the requirements of
Emerging Issues Task Force No. 01-14, "INCOME STATEMENT CHARACTERIZATION OF
REIMBURSEMENTS RECEIVED FOR OUT-OF-POCKET EXPENSES INCURRED" (EITF 01-14),
reimbursements received for out-of-pocket expenses incurred are characterized as
revenue and an identical amount is included as cost of goods and services in the
consolidated statements of operations. For the years ended December 31, 2004,
2003 and 2002, reimbursable out-of-pocket expenses were $22.8 million, $27.1
million and $23.9 million, respectively.
Training Costs
--------------
Training costs include the costs of training the sales representatives
and managers on a particular product detailing program so that they are
qualified to properly perform the services specified in the related contract.
For all contracts, training costs are deferred and amortized on a straight-line
basis over the shorter of the life of the contract to which they relate or 12
months. When the Company receives a specific contract payment from a client upon
commencement of a product detailing program expressly to compensate the Company
for recruiting, hiring and training services associated with staffing that
program, such payment is deferred and recognized as revenue in the same period
that the recruiting and hiring expenses are incurred and amortization of the
deferred training is expensed. When the Company does not receive a specific
contract payment for training, all revenue is deferred and recognized over the
life of the contract.
Product revenue and cost of goods sold
--------------------------------------
Product revenue is recognized when products are shipped and title is
transferred to the customer. Product revenue for the years ended December 31,
2004 and 2003 were negative, primarily from the adjustments to the Ceftin sales
returns reserve, as discussed in Note 3 to the consolidated financial
statements, net of the sale of the Xylos wound care products. Product revenue
recognized in prior periods was related to the Ceftin contract which was
terminated by mutual consent in February 2002.
Cost of goods sold includes all expenses for product distribution costs,
acquisition and manufacturing costs of the product sold.
ESTIMATES FOR ACCRUED REBATES, SALES DISCOUNTS AND RETURNS
For product sales, provision is made at the time of sale for all
discounts and estimated sales allowances. As is common in the pharmaceutical
industry, customers who purchased the Company's Ceftin product were permitted to
return unused product, after approval from the Company, up to six months before,
and one year after the expiration date for the product, but no later than
December 31, 2004. The products sold by the Company prior to the Ceftin
agreement termination date of February 28, 2002 had expiration dates through
June 2004. As discussed in Note 3 to the consolidated financial statements,
there were $1.7 million and $12.0 million adjustments for changes in estimates
to the Ceftin returns reserve in 2004 and 2003, respectively. These adjustments
were recorded as a reduction to revenue consistent with the initial recognition
of the returns allowance and resulted in the Company reporting net negative
product revenue in 2004 and 2003. As the Company's responsibility to accept
product returns ended December 31, 2004, no further increases to this reserve
are likely. The Company will, however, continue to pay these returns during
2005. Additionally, certain customers were eligible for price rebates or
discounts, offered as an incentive to increase sales volume and achieve
favorable formulary status, on the basis of volume of purchases or increases in
the product's market share over a specified period, and certain customers are
credited with chargebacks on the basis of their resales to end-use customers,
such as HMO's, which contracted with the Company for quantity discounts.
Furthermore, the Company is obligated to issue rebates under the federally
administered Medicaid program. In each instance the Company has the historical
data and access to other information, including the total demand for the drug it
distributes, its market share, the recent or pending introduction of new drugs
or generic competition, the inventory practices of the Company's customers and
the resales by its customers to end-users having contracts with the Company,
necessary to reasonably estimate the amount of such returns or allowances, and
record reserves for such returns or allowances at the time of sale as a
reduction of revenue. The actual payment of these rebates varies depending on
the program and can take several calendar quarters before final settlement. Any
adjustments for changes in estimates are recorded through revenue in that
period.
F-8
PDI, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
UNBILLED COSTS AND ACCRUED PROFITS AND UNEARNED CONTRACT REVENUE
In general, contractual provisions, including predetermined payment
schedules or submission of appropriate billing detail, establish the
prerequisites for billings. Unbilled costs and accrued profits arise when
services have been rendered and payment is assured but clients have not been
billed. These amounts are classified as a current asset. Normally, in the case
of detailing contracts, the clients agree to pay the Company a portion of the
fee due under a contract in advance of performance of services because of large
recruiting and employee development costs associated with the beginning of a
contract. The excess of amounts billed over revenue recognized represents
unearned contract revenue, which is classified as a current liability.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of unrestricted cash accounts, highly
liquid investment instruments and certificates of deposit with an original
maturity of three months or less at the date of purchase.
INVESTMENTS
The Company accounts for certain investments under Statement of Financial
Accounting Standards (SFAS) No. 115, "ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT
AND EQUITY SECURITIES" (SFAS 115). Available-for-sale investments are valued at
fair market value based on quoted market values, with the resulting adjustments,
net of deferred taxes, reported as a separate component of stockholders' equity
as accumulated other comprehensive income (loss). For the purposes of
determining gross realized gains and losses, the cost of securities sold is
based upon specific identification. The Company's other short-term investments
consist of a laddered portfolio of investment grade debt instruments such as
obligations of the U.S. Treasury and U.S. Federal Government agencies; municipal
bonds; and commercial paper. Because the Company's management has the intention
and ability to hold these securities to maturity, the investments are accounted
for as HELD-TO-MATURITY debt securities under the guidance of SFAS 115 and are
stated at amortized cost, which approximates fair value.
LOANS AND INVESTMENTS IN PRIVATELY HELD ENTITIES
As discussed in Note 7 to the consolidated financial statements, the
Company's loans and investments in privately held entities are accounted for
under either the cost or equity method, whichever is appropriate for the
particular investment, and are included in other assets. The appropriate method
is determined by the Company's ability to exercise significant influence over
the investee, through either quantity of voting stock or other means. If the
Company was to determine that its accounting treatment for these investments
should change from the cost to the equity method, in accordance with APB No. 18,
"EQUITY METHOD OF ACCOUNTING FOR INVESTMENTS IN COMMON STOCK," the Company would
retroactively restate its previously issued financial statements as if the
Company had always accounted for the investment under the equity method.
The Company assesses its loans and investments in privately held entities
on a quarterly basis for impairment and propriety of current accounting
treatment. This quarterly review includes discussions with senior management of
the investee, and evaluations of, among other things, the investee's progress
against its business plan, its customer base, the market condition of the
overall industry of the investee, historical and projected financial
performance, expected cash needs and recent funding events. The Company's
assessments of value are highly subjective given that these companies may be at
an early stage of development and rely regularly on their investors for cash
infusions. Consequently, if the Company determines based on the above factors
that the loans are not collectible and/or investments are other than temporarily
impaired, the Company will record a loss on its investments which may be
material to the period in which the adjustment is recorded. For the years ended
December 31, 2004, 2003 and 2002, the Company recorded write-downs of these
loans and investments of $1.5 million, zero, and approximately $379,000,
respectively.
INVENTORY
Inventory is valued at the lower of cost or market value. Cost is
determined using the first in, first out costing method. Inventory consists
entirely of finished goods and is recorded net of a provision for obsolescence.
The Company had no inventory as of December 31, 2004.
REALIZABILITY OF CARRYING VALUE OF LONG-LIVED ASSETS
The Company reviews the recoverability of long-lived assets and
finite-lived intangible assets when circumstances indicate that the carrying
amount of assets may not be recoverable. This evaluation is based on various
analyses including cash flow projections. In the event cash flow projections
indicate an impairment, the Company would record an impairment based on the fair
value of the assets at the date of the impairment. No impairments of long-lived
assets were recorded in 2004, 2003, or 2002; however, the Company disposed of or
sold assets in 2004, primarily related to the move of the company's headquarters
in July 2004, resulting in a loss on disposal or sale of approximately $622,000.
RECEIVABLES AND ALLOWANCE FOR DOUBTFUL ACCOUNTS
Trade accounts receivable are recorded at the invoiced amount and do not bear
interest. The allowance for doubtful accounts is the Company's best estimate of
the amount of probable credit losses in its existing accounts receivable. The
Company determines the allowance based on historical write-off experience. The
Company reviews its allowance for doubtful accounts monthly. Past due balances
over 90 days and over a specified amount are reviewed individually for
collectibility. Account balances are charged off against the allowance when the
Company feels it is probable the receivable will not be recovered. Additionally,
the Company has other receivables from Xylos Corporation (Xylos), TMX
Interactive, Inc. (TMX), and a related party, which are included in other
current and long-term assets, respectively. See Notes 7 and 16 for more
information. The Company does not have any off balance sheet credit exposure
related to its customers.
Total receivables consist of the following at December 31, 2004 and 2003
(amounts in thousands):
2004 2003
---- ----
Trade $ 26,736 $ 41,634
Employee 75 150
Other 1,694 501
-------- --------
Total receivables $ 28,505 $ 42,285
======== ========
The allowance for doubtful accounts was approximately $574,000 and
$749,000 as of December 31, 2004 and 2003, respectively and includes amounts
recorded for both accounts receivable and other receivables.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost less accumulated depreciation.
Depreciation is computed using the straight-line method, based on estimated
useful lives of seven to ten years for furniture and fixtures, three to five
years for office equipment and computer equipment, and seven years for computer
software. Leasehold improvements are amortized over the shorter of the estimated
service lives or the terms of the related leases. Repairs and maintenance are
charged to expense as incurred. Upon disposition, the asset and related
accumulated depreciation are removed from the related accounts and any gains or
losses are reflected in operations. Purchased computer software is capitalized
and amortized over the software's useful life, unless the amounts are immaterial
in which case the Company expenses it immediately. Internally developed software
is also capitalized and amortized over its useful life in accordance with of the
American Institute of Certified Public Accountants' (AICPA) Statement of
Position (SOP) 98-1 "ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE DEVELOPED OR
OBTAINED FOR INTERNAL USE."
F-9
PDI, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill is evaluated for impairment on at least an annual basis. The
Company has established reporting units for purposes of testing goodwill for
impairment. The tests involve determining the fair market value of each of the
reporting units with which the goodwill was associated and comparing the
estimated fair market value of each of the reporting units with its carrying
amount. Goodwill has been assigned to the reporting units to which the value of
the goodwill relates. The Company evaluates goodwill and other intangible assets
at least on an annual basis and whenever events and changes in circumstances
suggest that the carrying amount may not be recoverable based on the estimated
future cash flows. The Company performed the required annual impairment tests in
the fourth quarters of 2004, 2003 and 2002 and determined that no impairment
existed during any of the comparative periods.
STOCK-BASED COMPENSATION
As of December 31, 2004, the Company has three stock-based employee
compensation plans described more fully in Note 20. SFAS No. 123, "ACCOUNTING
FOR STOCK-BASED COMPENSATION" allows companies a choice of measuring employee
stock-based compensation expense based on either the fair value method of
accounting or the intrinsic value approach under the Accounting Pronouncement
Board (APB) Opinion No. 25, "ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES." The
Company accounts for those plans under the recognition and measurement
principles of APB Opinion No. 25 and related Interpretations. During 2004, the
Company accelerated the vesting of stock option grants and restricted stock
grants for certain employees which resulted in total compensation of
approximately $275,000. Other than the expense mentioned above, no stock
option-based employee compensation cost is reflected in net income, as all
options granted under those plans had an exercise price equal to the market
value of the underlying common stock on the date of the grant. Certain employees
receive restricted common stock, the amortization of which is reflected in net
income. The following table illustrates the effect on net income and earnings
per share if the Company had applied the fair value recognition provisions of
SFAS No. 123 to stock-based employee compensation.
As of December 31,
2004 2003 2002
-------- -------- --------
(in thousands, except per share data)
Net income (loss), as reported $ 21,132 $ 12,258 $(30,761)
Add: Stock-based employee compensation
expense included in reported net income
(loss), net of related tax effects 721 368 283
Deduct: Total stock-based employee
compensation expense determined under
fair value based methods for all awards,
net of related tax effects (3,946) (6,133) (8,137)
-------- -------- --------
Pro forma net income (loss) $ 17,907 $ 6,493 $(38,615)
======== ======== ========
Earnings (loss) per share
Basic--as reported $ 1.45 $ 0.86 $ (2.19)
======== ======== ========
Basic--pro forma $ 1.23 $ 0.46 $ (2.75)
======== ======== ========
Diluted--as reported $ 1.42 $ 0.85 $ (2.19)
======== ======== ========
Diluted--pro forma $ 1.20 $ 0.45 $ (2.75)
======== ======== ========
Compensation cost for the determination of Pro forma net income (loss)
and related per share amounts were estimated using the Black Scholes option
pricing model, with the following assumptions: (i) risk free interest rate of
3.63%, 4.49% and 5.01% at December 31, 2004, 2003 and 2002, respectively; (ii)
expected life of five years for 2004, 2003 and 2002; (iii) expected dividends -
$0 for 2004, 2003 and 2002; and (iv) volatility of 100% for 2004, 2003, and
2002. The weighted average fair value of options granted during 2004, 2003 and
2002 was $19.26, $11.23 and $14.92, respectively.
ADVERTISING
The Company recognizes advertising costs as incurred. The total amounts
charged to advertising expense were approximately $230,000, $555,000 and
$259,000 for the years ended December 31, 2004, 2003 and 2002, respectively.
F-10
PDI, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
INCOME TAXES
In accordance with the provisions of SFAS No. 109, "ACCOUNTING FOR INCOME
TAXES," the Company accounts for income taxes using the asset and liability
method. This method requires recognition of deferred tax assets and liabilities
for expected future tax consequences of temporary differences that currently
exist between tax bases and financial reporting bases of our assets and
liabilities based on enacted tax laws and rates. A valuation allowance is
established, when necessary, to reduce the deferred income tax assets that are
not more likely than not to be realized.
The Company operates in multiple tax jurisdictions and provides taxes in
each jurisdiction where the Company conducts business and is subject to
taxation.
The Company has established estimated liabilities for federal and state
income tax exposures that arise and meet the criteria for accrual under SFAS No.
5, "ACCOUNTING FOR CONTINGENCIES" (SFAS 5). These accruals represent accounting
estimates that are subject to inherent uncertainties associated with the tax
audit process. The Company adjusts these accruals as facts and circumstances
change, such as the progress of a tax audit. The Company believes that any
potential audit adjustments will not have a material adverse effect on its
financial condition or liquidity. However, any adjustments made may be material
to the Company's consolidated results of operations of a reporting period.
LICENSE FEES
Costs related to the acquisition or licensing of products that have not
yet received regulatory approval to be marketed, and that have no alternative
future uses, are expensed as incurred, while costs incurred post-approval are
capitalized and amortized over the shorter of the estimated economic life of the
underlying product or the term of the license agreement. See Note 2.
RECLASSIFICATIONS
Certain reclassifications have been made to conform prior periods'
information to the current year presentation.
NEW ACCOUNTING PRONOUNCEMENTS
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs," (SFAS
151) which clarifies the accounting for abnormal amounts of idle facility
expense, freight, handling costs, and wasted material (spoilage) by requiring
these items to be recognized as current-period charges. SFAS No. 151 is
effective for inventory costs incurred during fiscal years beginning after June
15, 2005, with earlier application permitted. The adoption of SFAS No. 151 is
not expected to have a material impact on the Company's financial condition and
results of operations.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Monetary
Assets," (SFAS 153) which addresses the measurement of exchanges of nonmonetary
assets and eliminates the exception from fair value measurement for nonmonetary
exchanges of similar productive assets and replaces it with an exception for
exchanges that do not have commercial substance. SFAS No. 153 is effective for
nonmonetary asset exchanges occurring in fiscal periods beginning after June 15,
2005, with earlier application permitted. The adoption of SFAS No. 153 is not
expected to have a material impact on the Company's financial condition and
results of operations.
In December 2004, the FASB issued a revision of SFAS No. 123, "Statement
of Financial Accounting Standards No. 123 (revised 2004)," (SFAS 123R) which
requires that the cost resulting from all share-based payment transactions be
recognized in the financial statements. This Statement establishes fair value as
the measurement objective in accounting for share-based payment arrangements and
requires all entities to apply a fair-value-based measurement method in
accounting for share-based payment transactions with employees except for equity
instruments held by employee share ownership plans. This Statement is effective
as of the beginning of the first interim or annual reporting period that begins
after June 15, 2005, and the Company expects to adopt this standard using the
modified prospective method. The adoption of SFAS 123R may have a material
effect on the Company's financial condition and results of operations.
2. PERFORMANCE BASED CONTRACTS
In May 2001, the Company entered into a copromotion agreement with
Novartis Pharmaceuticals Corporation (Novartis) for the U.S. sales, marketing
and promotion rights for Lotensin(R), and Lotensin HCT(R). Another product,
Lotrel, was promoted by the same sales force under the same agreement, but was a
fee for service arrangement. On May 20, 2002, this agreement was replaced by two
separate agreements, one for Lotensin and one for Lotrel-Diovan through the
addition of Diovan(R) and Diovan HCT(R). Both of these agreements ended December
31, 2003; however, the Lotrel-Diovan agreement was renewed on December 24, 2003
for an additional one year period. In February 2004, the Company was notified by
Novartis of its intent to terminate the Lotrel-Diovan agreement, without cause,
effective March 16, 2004. The Company was compensated under the terms of the
agreement through the effective termination date. Even though the Lotensin
agreement ended December 31, 2003, the Company also was entitled to receive
royalty payments on the sales of Lotensin through December 31, 2004.
F-11
PDI, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
In October 2002, the Company entered into an agreement with Xylos for the
exclusive U.S. commercialization rights to the XCell line of wound care
products. Pursuant to this agreement, the Company had certain minimum purchase
requirements. The minimum purchase requirement for the calendar year 2003 was
$750,000, which was met. The minimum purchase requirement for each subsequent
calendar year was to be based on the aggregate dollar volume of sales of
products during the 12-month period ending with September of the prior year, but
in no event less than $750,000. The Company did have the right to terminate the
agreement with 135 days' notice to Xylos, beginning January 1, 2004. The Company
began selling the Xylos products in January 2003; however, sales were
significantly slower than anticipated and actual 2003 sales did not meet the
Company's forecasts. Based on these sales results, the Company concluded that
sales of XCell were not sufficient enough to sustain the Company's continued
role as commercialization partner for the product and therefore, on January 2,
2004, the Company exercised its contractual right to terminate the agreement on
135 days' notice to Xylos. The Company's promotional activities in support of
the brand concluded in January 2004, and the agreement was terminated effective
May 16, 2004. The Company recorded a reserve for potential excess inventory
during 2003. In 2002, the Company had acquired $1.0 million of preferred stock
of Xylos and in 2004, the Company loaned $500,000 to Xylos. As discussed in Note
7, the Company determined its $1.0 million investment and $500,000 short-term
loan to Xylos were impaired as of December 31, 2004 and both were written down
to zero.
On December 31, 2002, the Company entered into an exclusive licensing
agreement (the Cellegy License Agreement) with Cellegy Pharmaceuticals, Inc.
(Cellegy) for the exclusive North American rights for Fortigel(TM), a
testosterone gel product. The agreement is in effect for the commercial life of
the product. Cellegy submitted a New Drug Application (NDA) for the hypogonadism
indication to the U.S. Food and Drug Administration (FDA) in June 2002. In July
2003, Cellegy received a letter from the FDA rejecting its NDA for Fortigel.
Cellegy has told us that, in the first quarter of 2005, it received FDA approval
for the protocol parameters for a new Phase 3 study proposed by Cellegy to the
FDA. The Company does not know when, or even whether Cellegy will conduct such a
new Phase 3 Study, and the Company cannot predict with any certainty whether the
FDA will ultimately approve Fortigel for sale in the U.S. Under the terms of the
agreement, the Company paid Cellegy a $15.0 million initial licensing fee on
December 31, 2002. This nonrefundable payment was made prior to FDA approval
and, since there is no alternative future use of the licensed rights, the $15.0
million payment was expensed by the Company in December 2002, when incurred.
This amount was recorded in other selling, general, and administrative expenses
in the December 31, 2002 consolidated statements of operations. Pursuant to the
terms of the Cellegy License Agreement, the Company will be required to pay
Cellegy a $10.0 million incremental license fee milestone payment upon
Fortigel's receipt of all approvals required by the FDA (if such approvals are
obtained) to promote, sell and distribute the product in the U.S. This
incremental milestone license fee, if incurred, will be recorded as an
intangible asset and amortized over its estimated useful life, as then
determined, which is not expected to exceed the life of the patent. Royalty
payments to Cellegy over the term of the commercial life of the product would
range from 20% to 30% of net sales.
Evista
------
In October 2001, the Company entered into an agreement with Eli Lilly and
Company (Eli Lilly) to copromote Evista(R) in the U.S. Under the terms of the
agreement, the Company provided sales representatives to copromote Evista to
physicians in the U.S. The Company's sales representatives supplemented the Eli
Lilly sales force promoting Evista. Under this agreement, the Company was
entitled to be compensated based on net sales achieved by the product above a
predetermined level. The agreement did not provide for the reimbursement of
expenses the Company incurred.
The Eli Lilly arrangement was a performance based contract. The Company
was required to commit a certain level of spending for promotional and selling
activities, including, but not limited to, providing sales representatives. The
sales force assigned to Evista was at times used to promote other products in
addition to Evista, including products covered by other Company copromotion
arrangements, which partially offset the costs of the sales force. The Company's
compensation for Evista was determined based upon a percentage of net factory
sales of Evista above contractual baselines. To the extent that such baselines
were not exceeded, the Company received no revenue.
Based upon management's assessment of the future performance potential of
the Evista brand, on November 11, 2002, the Company and Eli Lilly mutually
agreed to terminate the agreement as of December 31, 2002. The Company accrued a
contract loss of $7.8 million as of September 30, 2002 representing the
anticipated future loss expected to be incurred by the Company to fulfill its
contractual obligations under the Evista agreement. There was no remaining
accrual as of December 31, 2002 as the Company had no further obligations due to
the termination of the agreement. An operating loss of $35.1 million was
recognized under this agreement for the year ended December 31, 2002.
F-12
3. CEFTIN CONTRACT TERMINATION
In October 2000, the Company entered into an agreement (the Ceftin
Agreement) with GlaxoSmithKline (GSK) for the exclusive U.S. sales, marketing
and distribution rights for Ceftin(R) Tablets and Ceftin(R) for Oral Suspension,
two dosage forms of a cephalosporin antibiotic, which agreement was terminated
in February 2002 by mutual agreement of the parties. The Ceftin Agreement had a
five-year term but was cancelable by either party without cause on 120 days'
notice. From October 2000 through February 2002, the Company marketed Ceftin to
physicians and sold the products primarily to wholesale drug distributors,
retail chains and managed care providers.
On August 21, 2001, the U.S. Court of Appeals overturned a preliminary
injunction granted by the New Jersey District Court to GSK, which subsequently
allowed for the entry of a generic competitor to Ceftin immediately upon
approval by the FDA. The affected Ceftin patent had previously been scheduled to
run through July 2003. The generic version of Ceftin was approved by the FDA in
February 2002 and it began to be manufactured in late March 2002. As a result of
this U.S. Court of Appeals decision and its impact on future sales, in the third
quarter of 2001 the Company recorded a charge to cost of goods sold and a
related reserve of $24.0 million representing the anticipated future loss to be
incurred by the Company under the Ceftin Agreement as of September 30, 2001. The
recorded loss was calculated as the excess of estimated costs that the Company
was contractually obligated to incur to complete its obligations under the
Ceftin Agreement, over the remaining estimated gross profits to be earned under
the Ceftin Agreement from selling the inventory. These costs primarily consisted
of amounts paid to GSK to reduce purchase commitments, estimated committed sales
force expenses, selling and marketing costs through the effective date of the
termination, distribution costs, and fees to terminate existing arrangements.
The Ceftin Agreement was terminated by the Company and GSK under a mutual
termination agreement entered into in December 2001. GSK resumed exclusive
rights to Ceftin after the effective date of the termination of the Ceftin
Agreement, and the Company believes that GSK currently sells Ceftin under its
own label code.
Pursuant to the termination agreement, the Company agreed to perform
marketing and distribution services through February 28, 2002. As is common in
the pharmaceutical industry, customers who purchased the Company's Ceftin
product were permitted to return unused product, after approval from the
Company, up to six months before and one year after the expiration date for the
product, but no later than December 31, 2004. The products sold by the Company
prior to the Ceftin Agreement termination date of February 28, 2002 had
expiration dates through June 2004. The Company also maintained responsibility
for processing and payment of certain sales rebates through December 31, 2004.
The Company's Ceftin sales aggregated approximately $628 million during the term
of the Ceftin Agreement.
As of December 31, 2002, the Company had accrued reserves of
approximately $16.5 million related to Ceftin sales. Of this accrual, $11.0
million related to return reserves and $5.5 million related to sales rebates
accruals. On an ongoing basis, the Company assesses its reserve for product
returns by: analyzing historical sales and return patterns; monitoring
prescription data for branded Ceftin; monitoring inventory withdrawals by the
wholesalers and retailers for branded Ceftin; inquiring about inventory levels
and potential product returns with the wholesaler companies; and estimating
demand for the product. During the third quarter of 2003, the Company made a
$5.5 million payment to settle its estimated remaining sales rebate liabilities,
and concluded based on its returns reserve review process, which included a
review of prescription and withdrawal data for branded Ceftin as well as
information communicated to the Company by the wholesalers, that the remaining
$11.0 million reserve for returns was adequate as of September 30, 2003.
In the fourth quarter of 2003, the Company determined, based primarily
upon new information obtained from its wholesalers as part of its ongoing
reserve review process, that significant amounts of inventory, incremental to
that previously reported by the wholesalers, were being held by them in
inventory. The Company believed that this resulted, in part, from the sale by
the wholesalers of Ceftin product not supplied by the Company and acquired by
the wholesalers subsequent to the mutual termination of the Ceftin Agreement.
Based upon that information, the Company increased its returns reserve $12.0
million to a total reserve of $22.8 million in the fourth quarter of 2003.
On March 31, 2004, the Company signed an agreement and waiver with a
large wholesaler by which the Company agreed to pay that wholesaler $10.0
million, and purchase $2.5 million worth of services from that wholesaler by
March 31, 2006, in exchange for that wholesaler waiving, to the fullest extent
permitted by law, all rights with respect to any additional returns of Ceftin to
the Company. The Company made the payment on April 5, 2004. In 2004 the Company
increased its return reserve by approximately $1.7 million based primarily upon
new information obtained from the wholesalers as part of the Company's ongoing
reserve review process.
F-13
PDI, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
The Company's reserve of $4.3 million at December 31, 2004 reflects the
Company's estimated liability for all identified product that the Company has
accepted for return by all the remaining wholesalers. The reserve has been
calculated based on, with respect to wholesalers, reimbursing the wholesalers at
the amount that they purchased the product from the Company. The reserve as
recorded by the Company is its best estimate based on its understanding of its
obligations. The reserve also includes a liability of $2.5 million for services
to be purchased by the Company from a large wholesaler which the Company was
able to negotiate in lieu of cash payments as described above. Subsequent to
that negotiation, the Company entered into an agreement with this large
wholesaler and certain of its affiliates pursuant to which the Company will
provide $2.5 million of product detailing services for such affiliates in lieu
of purchasing services from the wholesaler. The Company has continued to assess
the adequacy of its reserves until the Company's obligations for processing any
returned products ceased on December 31, 2004.
4. REPURCHASE PROGRAM
On September 21, 2001, the Company announced that its Board of Directors
(the Board) had unanimously authorized management to repurchase up to $7.5
million of its Common Stock. Subject to availability, the transactions may be
made from time to time in the open market or directly from stockholders at
prevailing market prices that the Company deems appropriate. In October 2001,
5,000 shares were repurchased in an open market transaction for a total of
$110,000. No further purchases have been made through December 31, 2004.
5. ACQUISITION
On August 31, 2004, the Company acquired substantially all of the assets
of Pharmakon, LLC, in a transaction treated as an asset acquisition for tax
purposes. The acquisition has been accounted for as a purchase, subject to the
provisions of SFAS No. 141, "BUSINESS COMBINATIONS" (SFAS 141). The Company made
payments to the members of Pharmakon at closing of $27.4 million, of which $1.5
million was deposited into an escrow account, and assumed approximately $2.6
million in net liabilities. Approximately $1.1 million in direct costs of the
acquisition were also capitalized. Based upon the attainment of annual profit
targets agreed upon at the date of acquisition, the members of Pharmakon, LLC
will receive approximately $1.5 million in additional payments in March 2005 for
the year ended December 31, 2004. The Company has determined that this
consideration meets the requirements to be capitalized as additional investment,
rather than expensed as compensation. This amount was recorded as a current
liability as of December 31, 2004, with a corresponding amount recorded to
goodwill. Additionally, the members of Pharmakon, LLC can still earn up to an
additional $6.7 million in cash based upon achievement of certain annual profit
targets through December 2006. In connection with this transaction, the Company
recorded $12.7 million in goodwill and $18.9 million in other identifiable
intangibles.
Pharmakon is a healthcare communications company focused on the marketing
of ethical pharmaceutical and biotechnology products. A primary reason for the
acquisition of Pharmakon was the advancement of the Company's goal to expand its
presence in the growing and heavily outsourced medical education market.
Pharmakon's emphasis is on the creation, design and implementation of
interactive peer persuasion programs. The successful integration of Pharmakon
and PDI would allow both companies to leverage their account relationships and
cross sell their services.
The following unaudited pro forma consolidated results of operations for
the years ended December 31, 2004, 2003, and 2002 assume that the Company and
Pharmakon had been combined as of the beginning of the periods presented. The
pro forma results include estimates and assumptions which management believes
are reasonable. However, pro forma results are not necessarily indicative of the
results that would have occurred if the acquisition had been consummated as of
the dates indicated, nor are they necessarily indicative of future operating
results.
F-14
PDI, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Year ended December 31,
---------------------------------------
2004 2003 2002
----------- ----------- ---------
(in thousands, except for per share data)
(unaudited)
Revenue - pro forma $ 377,577 $ 361,687 $ 324,731
=========== =========== =========
Net income (loss) - pro forma $ 22,842 $ 14,713 $ (29,657)
=========== =========== =========
Pro forma earnings (loss) per share $ 1.53 $ 1.02 $ (2.11)
=========== =========== =========
6. SHORT-TERM INVESTMENTS
At December 31, 2004, short-term investments were $13.1 million,
including approximately $1.6 million of investments classified as
available-for-sale securities. At December 31, 2003, short-term investments were
$1.3 million, including approximately $1.1 million of investments classified as
available-for-sale securities.
Excluding investments classified as available-for-sale securities,
short-term investments at December 31, 2004 consist of a laddered portfolio of
investment grade debt instruments such as obligations of the U.S. Treasury and
U.S. Federal Government agencies; municipal bonds; and commercial paper. At
December 31, 2004, the weighted average maturity date for these short-term
investments is 8.3 months. Because the Company's management has the intention
and ability to hold these securities to maturity, the investments are accounted
for as HELD-TO-MATURITY debt securities under the guidance of SFAS 115,
"ACCOUNTING FOR CERTAIN INVESTMENTS IN EQUITY AND DEBT SECURITIES", and are
stated at amortized cost, which approximates fair value.
The unrealized after-tax gain/(loss) on the available-for-sale securities
is included as a separate component of stockholders' equity as accumulated other
comprehensive income (loss).
7. OTHER INVESTMENTS
In October 2002, the Company acquired $1.0 million of preferred stock of
Xylos. The Company recorded its investment in Xylos under the cost method and
its ownership interest in Xylos is less than five percent. As discussed in Note
2, the Company served in 2003 as the exclusive distributor of the Xylos XCell
product line, but on January 2, 2004, the Company terminated that arrangement
effective May 16, 2004. In addition, the Company provided short term loans in
totaling $500,000 in the first half of 2004. As a result of continuing operating
losses incurred by Xylos as well as recent negative developments regarding its
inability to obtain appropriate financing, the Company concluded during the
fourth quarter of 2004 that both the investment and the recoverability of the
loan were impaired as of December 31, 2004. As a result, the $1.0 million
investment was written down to zero in the fourth quarter of 2004 and the
$500,000 loan was fully reserved for during the fourth quarter as well.
In May 2004, the Company entered into a loan agreement with TMX, a
provider of sales force effectiveness technology. Pursuant to the loan
agreement, the Company provided TMX with a term loan facility of $500,000 and a
convertible loan facility of $500,000, each of which are due to be repaid on
November 26, 2005. In connection with the convertible loan facility, the Company
has the right to convert all, or, in multiples of $100,000, any part of the
convertible note into common stock of TMX. Although TMX experienced losses in
2004, the Company continues to believe that, based on current prospects and
activities at TMX, its loans are not impaired and the amounts are recoverable as
of December 31, 2004. However, if TMX continues to experience losses and is not
able to generate sufficient cash flows through operations and financing, the
Company may determine that it will be unable to recover its loans and would have
to reserve for them at that time.
The Company has an investment in the preferred stock of iPhysicianNet,
Inc. (iPhysicianNet) that is accounted for under the equity method; however,
recognition of losses by the Company was suspended in 2000 after the Company's
investment was reduced to zero. During 2002, additional investments of $379,000
were made by the Company. Due to the continuing losses of iPhysicianNet, the
2002 investments were immediately expensed rather than recorded as an asset. The
Company does not have, nor has it ever had, any commitments to provide future
financing to iPhysicianNet. No investments were made by the Company in
iPhysicianNet during 2003 or 2004 and no losses were recorded in either year due
to the suspension of losses mentioned above because the investment has been
previously reduced to zero. The Company's ownership interest in iPhysicianNet is
less than five percent. The Company was informed by iPhysicianNet that they
ceased operations effective August 1, 2003, and they subsequently filed for
bankruptcy protection.
F-15
PDI, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
8. INVENTORY
At December 31, 2004 and December 31, 2003, the Company had zero and
approximately $43,000, respectively, in finished goods inventory, net of
reserves, relating to the products that were being marketed and distributed in
accordance with the Xylos agreement. As discussed in Note 2, on January 2, 2004,
the Company gave notice of termination of its agreement with Xylos, effective
May 16, 2004, and discontinued sales of the Xylos wound care products after the
effective date. In the third quarter of 2003, as a result of the continued lower
than anticipated Xylos product sales, management recorded a reserve of $835,000
to reduce the value of the XCell inventory to its estimated net realizable
value.
9. HISTORICAL BASIC AND DILUTED NET INCOME/(LOSS) PER SHARE
Historical basic and diluted net income/(loss) per share is calculated
based on the requirements of SFAS No. 128, "Earnings Per Share."
A reconciliation of the number of shares used in the calculation of basic
and diluted earnings per share for the years ended December 31, 2004, 2003 and
2002 is as follows:
Years Ended December 31,
------------------------------
2004 2003 2002
------ ------ ------
(in thousands)
Basic weighted average number of
common shares outstanding .................... 14,564 14,231 14,033
Dilutive effect of stock options and
restricted shares ............................ 329 200 --
------ ------ ------
Diluted weighted average number of
common shares outstanding .................... 14,893 14,431 14,033
====== ====== ======
Outstanding options at December 31, 2004 to purchase 409,182 shares of
common stock with exercise prices of $27.00 to $93.75 were not included in the
2004 computation of historical and pro forma diluted net income per share
because to do so would have been antidilutive. Outstanding options at December
31, 2003 to purchase 380,493 shares of common stock with exercise prices of
$27.00 to $93.75 were not included in the 2003 computation of historical and pro
forma diluted net income per share because to do so would have been
antidilutive. Outstanding options at December 31, 2002 to purchase 1,514,297
shares of common stock with exercise prices of $5.21 to $98.70 per share were
not included in the 2002 computation of historical and pro forma diluted net
income per share because to do so would have been antidilutive, as a result of
the Company's net loss in 2002.
10. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following as of December 31, 2004
and 2003:
December 31,
2004 2003
-------- --------
(in thousands)
Furniture and fixtures ............................... $ 3,942 $ 3,288
Office equipment ..................................... 3,787 3,204
Computer equipment ................................... 5,727 13,494
Computer software .................................... 13,674 13,685
Leasehold improvements ............................... 4,565 1,905
-------- --------
Total property and equipment ......................... 31,695 35,576
Less accumulated depreciation and amortization ..... (14,525) (21,082)
-------- --------
Property and equipment, net .......................... $ 17,170 $ 14,494
======== ========
Depreciation expense was approximately $4.9 million, $5.6 million, and $6.8
million, for the years ended December 31, 2004, 2003 and 2002, respectively.
F-16
PDI, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
11. OPERATING LEASES
The Company leases facilities, automobiles and certain equipment under
agreements classified as operating leases which expire at various dates through
2017. Lease expense under these agreements for the years ended December 31,
2004, 2003 and 2002 was approximately $24.4 million, $21.3 million, and $26.1
million, respectively, of which $21.2 million in 2004, $18.0 million in 2003,
and $21.2 million in 2002 related to automobiles leased for employees for a term
of one-year from the date of delivery.
As of December 31, 2004, the aggregate minimum future rental payments
required by non-cancelable operating leases with initial or remaining lease
terms exceeding one year are as follows:
2005 2006 2007 2008 2009 TOTAL
------ ------ ------ ------ ------ -------
(in thousands)
Operating leases
Minimum lease payments $3,799 $3,232 $3,042 $3,130 $3,189 $16,392
Less minimum sublease rentals (34) -- -- -- -- (34)
------ ------ ------ ------ ------ -------
Net minimum lease payments $3,765 $3,232 $3,042 $3,130 $3,189 $16,358
====== ====== ====== ====== ====== =======
12. SIGNIFICANT CUSTOMERS
During 2004, 2003 and 2002 the Company had several significant customers
for which it provided services under specific contractual arrangements. The
following sets forth the net service revenue generated by customers who
accounted for more than 10% of the Company's revenue during each of the periods
presented.
Years Ended December 31,
-------------------------------
Customers 2004 2003 2002
--------- -------- -------- -------
(in thousands)
A ...................... $153,801 $118,713 $96,456
B ...................... 76,744 -- --
C ...................... -- 118,291 90,238
For each of the years ended December 31, 2004, 2003 and 2002, the Company
had two large clients, who each individually represented 10% or more of its
service revenue; these clients accounted for in the aggregate, approximately
63.0%, 66.5% and 61.9%, respectively, of its service revenue.
At December 31, 2004 and 2003, two customers represented 55.0% and 69.2%,
respectively, of the aggregate of outstanding service accounts receivable and
unbilled services. The loss of any one of the foregoing customers could have a
material adverse effect on the Company's business, financial position, results
of operations and cash flows.
13. RELATED PARTY TRANSACTIONS
The Company purchases certain print advertising for initial recruitment
of representatives through a company that is wholly-owned by family members of
the Company's largest stockholder. The amounts charged to the Company for these
purchases totaled approximately $180,000, $983,000, and $516,000, for the years
ended December 31, 2004, 2003 and 2002. We are no longer using this company as
of December 31, 2004.
14. INCOME TAXES
The provision (benefit) for income taxes for the years ended December 31,
2004, 2003 and 2002 are summarized as follows:
F-17
PDI, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
2004 2003 2002
------- -------- --------
(in thousands)
Current:
Federal ................................ $ 3,709 $ 10,308 $(26,972)
State .................................. 1,930 1,181 1,024
------- -------- --------
Total current .......................... 5,639 11,489 (25,948)
------- -------- --------
Deferred:
Federal ................................ 8,039 (3,856) 10,249
State .................................. 1,160 772 (1,748)
------- -------- --------
Total deferred ......................... 9,199 (3,084) 8,501
------- -------- --------
Provision (benefit) for income taxes ...... $14,838 $ 8,405 $(17,447)
======= ======== ========
A reconciliation of the difference between the Federal statutory tax
rates and the Company's effective tax rate is as follows:
2004 2003 2002
------- -------- -------
Federal statutory rate .................... 35.0% 35.0% (35.0)%
State income tax effect, net of Federal benefit 5.6 6.1 (1.1)
Meals and entertainment ................... 0.2 0.3 0.8
Federal valuation allowance ............... 0.9 -- 0.3
Other ..................................... (0.4) (0.7) (1.2)
------- -------- -------
Effective tax rate ........................ 41.3% 40.7% (36.2)%
======= ======== =======
The tax effects of significant items comprising the Company's deferred
tax assets and (liabilities) as of December 31, 2004 and 2003 are as follows:
2004 2003
-------- --------
Deferred tax assets (liabilities) -- current
Allowances and reserves $ 2,604 $ 9,938
Inventory -- 312
Compensation 635 762
Other 86 41
-------- --------
$ 3,325 $ 11,053
-------- --------
Deferred tax assets (liabilities) -- non current
Property, plant and equipment $ (3,676) $ (2,457)
State net operating loss carryforwards 1,356 1,427
State taxes 1,652 1,296
Intangible assets (433) (126)
Equity investment 2,204 1,882
Self insurance and other reserves 1,185 1,466
Contract costs 5,748 5,698
Valuation allowance on deferred tax assets (2,204) (1,882)
-------- --------
$ 5,832 $ 7,304
-------- --------
Net deferred tax asset $ 9,157 $ 18,357
======== ========
At December 31, 2004 and 2003, the Company had a valuation allowance of
$2,204,287 and $1,881,851, respectively, related to the Company's equity
investments. The increase in the current year relates to a valuation allowance
established associated with the write off of the Xylos investment discussed in
Note 7. Prior to 2003, the Company also had a valuation allowance for certain
state NOL carryforwards. At December 31, 2003, the Company reduced the valuation
allowance by $1,059,310 related to the state NOL carryforwards because the
Company determined that it was more likely than not that these assets would be
realized due to the improved operating results of the Company.
The Company performs an analysis each year to determine whether the
Company's expected future income will more likely than not be sufficient to
realize the recorded deferred tax assets. At December 31, 2004, the Company had
approximately $26.0 million of state NOL carryforwards which will begin to
expire in 2010.
15. PREFERRED STOCK
The Company's Board is authorized to issue, from time to time, up to
5,000,000 shares of preferred stock in one or more series. The Board is
authorized to fix the rights and designation of each series, including dividend
rights and rates, conversion rights, voting rights, redemption terms and prices,
liquidation preferences and
F-18
PDI, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
the number of shares of each series. As of December 31, 2004 and 2003, there
were no issued and outstanding shares of preferred stock.
16. LOANS TO STOCKHOLDERS/OFFICERS
In November 1998, the Company agreed to lend $250,000 to an executive
officer of which $100,000 was funded in November 1998, and the remaining
$150,000 was funded in February 1999. This amount was recorded in other
long-term assets. Such loan is payable on December 31, 2008 and bears interest
at a rate of 5.5% per annum, payable quarterly in arrears. In April 2004 and
February 2003, $75,000 and $100,000 payments, respectively, were made against
this loan, leaving a balance of $75,000 as of December 31, 2004.
17. RETIREMENT PLANS
Effective January 1, 2004, the Company's PDI, Inc. 401(k) Plan (the PDI
Plan) provided all "Safe Harbor Eligible" plan participants with Company
matching contributions (Safe Harbor Matching Contributions) in accordance with
the formula described below:
o Employee contributions of 1% to 3% of base salary will be matched
100%; and
o Employee contributions which exceed 3% but do not exceed 5% will be
matched 50%.
Employees must meet all Safe Harbor Matching Contributions eligibility
requirements as defined in the Plan in order to participate. Employees' account
balances derived from the Safe Harbor Matching Contributions will be immediately
vested. In addition, the Company can make discretionary contributions to the
Plan. There will continue to be no option for employees to invest any of their
401(k) funds in the Company's common stock. The Company's total contribution
expense related to the Company's 401(k) plans for 2004, 2003 and 2002 was
approximately $1.6 million, $905,000, and $1.7 million, respectively.
During 2003, the Company restructured its qualified profit sharing plans
with 401(k) features. Effective January 1, 2003, the Company's InServe 401(k)
Plan (the Inserve Plan) was frozen, and participants in the Inserve Plan began
to participate in the PDI Plan. Under the terms of the PDI Plan, the Company was
committed to make mandatory cash contributions in an amount equal to the
employee contributions up to a maximum of 2% of each participating employee's
annual base wages. There was no option for employees to invest any of their
401(k) funds in the Company's common stock.
18. DEFERRED COMPENSATION ARRANGEMENTS
Beginning in 2000, the Company established a deferred compensation
arrangement whereby a portion of certain employees' salaries is withheld and
placed in a Rabbi Trust. The plan permits the employees to diversify these
assets through a variety of investment options. The Company adopted the
provisions of EITF No. 97-14 "ACCOUNTING FOR DEFERRED COMPENSATION ARRANGEMENT
WHERE AMOUNTS ARE EARNED AND HELD IN A RABBI TRUST AND INVESTED" which requires
the Company to consolidate into its financial statements the net assets of the
trust. The deferred compensation obligation has been classified as a current
liability and is adjusted, with the corresponding charge or credit to
compensation expense, to reflect changes in fair value of the amounts owed to
the employee. The assets in the trust are classified as available-for-sale. In
2004 and 2003, the market value of the investments increased by $57,000 and
$42,000, respectively, and was recorded as a debit to compensation expense.
There was a credit to compensation expense due to a decrease of the market value
of the investments of approximately $95,000 in 2002. The total value of the
Rabbi Trust was approximately $1.6 million and $1.1 million at December 31, 2004
and 2003, respectively.
In 2000, the Company established a Long-term Incentive Compensation Plan
whereby certain employees are required to take a portion of their bonus
compensation in the form of restricted Common Stock. The restricted shares vest
on the third anniversary of the grant date and are subject to accelerated
vesting and forfeiture under certain circumstances. The Company recorded
deferred compensation costs of approximately $2.6 million, zero, and $593,000
during 2004, 2003 and 2002, respectively, which are being amortized over a
three-year vesting period. The unamortized compensation costs have been
classified as a separate component of stockholders' equity.
19. COMMITMENTS AND CONTINGENCIES
Due to the nature of the business in which the Company is engaged, such
as product detailing and distribution of products, it could be exposed to
certain risks. Such risks include, among others, risk of liability for personal
injury
F-19
PDI, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
or death to persons using products the Company promotes or distributes. There
can be no assurance that substantial claims or liabilities will not arise in the
future because of the nature of the Company's business activities and recent
increases in litigation related to healthcare products, including
pharmaceuticals, increases this risk. The Company seeks to reduce its potential
liability under its service agreements through measures such as contractual
indemnification provisions with clients (the scope of which may vary from client
to client, and the performances of which are not secured) and insurance. The
Company could, however, also be held liable for errors and omissions of its
employees in connection with the services it performs that are outside the scope
of any indemnity or insurance policy. The Company could be materially adversely
affected if it was required to pay damages or incur defense costs in connection
with a claim that is outside the scope of an indemnification agreement; if the
indemnity, although applicable, is not performed in accordance with its terms;
or if the Company's liability exceeds the amount of applicable insurance or
indemnity.
SECURITIES LITIGATION
In January and February 2002, the Company, its chief executive officer
and its chief financial officer were served with three complaints that were
filed in the United States District Court for the District of New Jersey
alleging violations of the Securities Exchange Act of 1934 (the 1934 Act). These
complaints were brought as purported shareholder class actions under Sections
10(b) and 20(a) of the 1934 Act and Rule 10b-5 established thereunder. On May
23, 2002, the Court consolidated all three lawsuits into a single action
entitled In re PDI Securities Litigation, Master File No. 02-CV-0211, and
appointed lead plaintiffs (Lead Plaintiffs) and Lead Plaintiffs' counsel. On or
about December 13, 2002, the Lead Plaintiffs filed a second consolidated and
amended complaint (the Consolidated and Amended Complaint), which superseded
their earlier complaints.
The Consolidated and Amended Complaint names the Company, its chief
executive officer and its chief financial officer as defendants; purports to
state claims against the Company on behalf of all persons who purchased the
Company's Common Stock between May 22, 2001 and August 12, 2002; and seeks money
damages in unspecified amounts and litigation expenses including attorneys' and
experts' fees. The essence of the allegations in the Consolidated and Amended
Complaint is that the Company intentionally or recklessly made false or
misleading public statements and omissions concerning its financial condition
and prospects with respect to its marketing of Ceftin in connection with the
October 2000 distribution agreement with GSK, its marketing of Lotensin in
connection with the May 2001 distribution agreement with Novartis, as well as
its marketing of Evista in connection with the October 2001 distribution
agreement with Eli Lilly.
In February 2003, the Company filed a motion to dismiss the Consolidated
and Amended Complaint. That motion is fully submitted to the court for its
decision. The Company believes that the allegations in this purported securities
class action are without merit and intends to defend the action vigorously.
BAYER-BAYCOL LITIGATION
The Company has been named as a defendant in numerous lawsuits, including
two class action matters, alleging claims arising from the use of Baycol(R), a
prescription cholesterol-lowering medication. Baycol was distributed, promoted
and sold by Bayer Corporation (Bayer) in the United States through early August
2001, at which time Bayer voluntarily withdrew Baycol from the United States
market. Bayer retained certain companies, such as the Company, to provide
detailing services on its behalf pursuant to contract sales force agreements.
The Company may be named in additional similar lawsuits. To date, the Company
has defended these actions vigorously and has asserted a contractual right of
indemnification against Bayer for all costs and expenses the Company incurs
relating to these proceedings. In February 2003, the Company entered into a
joint defense and indemnification agreement with Bayer, pursuant to which Bayer
has agreed to assume substantially all of the Company's defense costs in pending
and prospective proceedings and to indemnify the Company in these lawsuits,
subject to certain limited exceptions. Further, Bayer agreed to reimburse the
Company for all reasonable costs and expenses incurred to date in defending
these proceedings. As of December 31, 2004, Bayer has reimbursed the Company for
approximately $1.6 million in legal expenses, the majority of which was received
in 2003 and was reflected as a credit within selling, general and administrative
expense. No amounts have been received in 2004.
AUXILIUM PHARMACEUTICALS LITIGATION
On January 6, 2003, the Company was named as a defendant in a lawsuit
filed by Auxilium Pharmaceuticals, Inc. (Auxilium), in the Pennsylvania Court of
Common Pleas, Montgomery County. Auxilium was seeking monetary damages and
injunctive relief, including preliminary injunctive relief, based on several
claims related to the
F-20
PDI, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Company's alleged breaches of a contract sales force agreement entered into by
the parties on November 20, 2002, and claims that the Company was
misappropriating trade secrets in connection with the Cellegy License Agreement.
On May 8, 2003, the Company entered into a settlement and mutual release
agreement with Auxilium (Settlement Agreement), by which the lawsuit and all
related counter claims were dropped without any admission of wrongdoing by
either party. The settlement terms included a cash payment which was paid upon
execution of the Settlement Agreement as well as certain other additional
expenses. The Company recorded a $2.1 million charge in the first quarter of
2003 related to this settlement. Pursuant to the Settlement Agreement, the
Company also agreed that it would (a) not sell, ship, distribute or transfer any
Fortigel product to any wholesalers, chain drug stores, pharmacies or hospitals
prior to November 1, 2003, and (b) pay Auxilium an additional amount per
prescription to be determined based upon a specified formula, in the event any
prescriptions were filled for Fortigel prior to January 26, 2004. As discussed
above, in July 2003, Cellegy received a letter from the FDA rejecting its NDA
for Fortigel. The Company has not paid and will not pay any additional amount to
Auxilium as set forth in clause (b) above since Fortigel was not approved by the
FDA prior to January 26, 2004. The Company does not believe that the terms of
the Settlement Agreement will have any material impact on the success of its
commercialization of Fortigel if, or when, the FDA approves it.
CELLEGY PHARMACEUTICALS LITIGATION
On December 12, 2003, the Company filed a complaint against Cellegy in
the U.S. District Court for the Southern District of New York. The complaint
alleges that Cellegy fraudulently induced the Company to enter into a license
agreement with Cellegy regarding Fortigel on December 31, 2002. The complaint
also alleges claims for misrepresentation and breach of contract related to the
Cellegy License Agreement. In the complaint, the Company seeks, among other
things, rescission of the Cellegy License Agreement and return of the $15.0
million it paid Cellegy. After the Company filed this lawsuit, also on December
12, 2003, Cellegy filed a complaint against the Company in the U.S. District
Court for the Northern District of California. Cellegy's complaint seeks a
declaration that Cellegy did not fraudulently induce the Company to enter the
Cellegy License Agreement and that Cellegy has not breached its obligations
under the Cellegy License Agreement. The Company is unable to predict the
ultimate outcome of these lawsuits. The trial is scheduled to commence during
the second quarter of 2005. Material legal expense has been and is expected to
continue to be incurred in connection with this lawsuit; however, at this time
the Company is not able to estimate the magnitude of the expense.
OTHER LEGAL PROCEEDINGS
The Company is currently a party to other legal proceedings incidental to
its business. While the Company currently believes that the ultimate outcome of
these proceedings individually, and in the aggregate, will not have a material
adverse effect on its consolidated financial statements, litigation is subject
to inherent uncertainties. Were the Company to settle a proceeding for a
material amount or were an unfavorable ruling to occur, there exists the
possibility of a material adverse effect on the Company's business, financial
condition and results of operations.
No material amounts have been accrued for losses under any of the above
mentioned matters, other than for the Auxilium litigation settlement reserve, as
no amounts are considered probable or reasonably estimable at this time. Legal
fees are expensed as incurred.
Other than the foregoing, the Company is not currently a defendant in any
material pending litigation and it is not aware of any material threatened
litigation.
20. STOCK-BASED COMPENSATION
In June 2004, the Board and the shareholders approved the PDI, Inc. 2004
Stock Award and Incentive Plan (the 2004 Plan). The 2004 Plan replaced the 2000
Omnibus Incentive Compensation Plan (the 2000 Plan) and the 1998 Stock Option
Plan (the 1998 Plan). The 2004 Plan reserved an additional 893,916 shares for
new awards as well as combined the remaining shares available under the old
plans. The maximum number of shares as to which awards or options may at any
time be granted under the 2004 Plan is approximately 2.9 million shares.
Eligible participants under the 2004 Plan include officers and other employees
of the Company, members of the Board and outside consultants, as specified under
the 2004 Plan and designated by the Compensation Committee of the Board. Unless
earlier terminated by action of the Board, the 2004 Plan will remain in effect
until such time as no stock remains available for delivery under the 2004 Plan
and the Company has no further rights or obligations under the 2004 Plan with
respect to outstanding awards under the 2004 plan. No participant may be granted
more than the annual limit of 400,000 shares plus the amount of the
participant's unused annual limit relating
F-21
PDI, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
to share-based awards as of the close of the previous year, subject to
adjustment for splits and other extraordinary corporate events.
In May 2000 the Board approved the 2000 Plan. The purpose of the 2000
Plan was to provide a flexible framework to permit the Board to develop and
implement a variety of stock-based incentive compensation programs based on the
changing needs of the Company, its competitive market and the regulatory
climate. The maximum number of shares as to which awards or options could be
granted under the 2000 Plan was 2.2 million shares. Eligible participants under
the 2000 Plan included officers and other employees of the Company, members of
the Board and outside consultants, as specified under the 2000 Plan and
designated by the Compensation Committee of the Board. The right to grant Awards
under the 2000 Plan was to terminate 10 years after the date the 2000 Plan was
adopted. No Participant could be granted, in the aggregate, more than 100,000
shares of Company common stock from all awards under the 2000 Plan.
In March 1998, the Board approved the 1998 Plan which reserved for
issuance up to 750,000 shares of the Company's common stock, pursuant to which
officers, directors and key employees of the Company and consultants to the
Company were eligible to receive incentive and/or non-qualified stock options.
The 1998 Plan, which had an initial term of ten years from the date of its
adoption, was administered by a committee designated by the Board. The selection
of participants, allotment of shares, determination of price and other
conditions relating to the purchase of options was determined by the committee,
in its sole discretion. Incentive stock options granted under the 1998 Plan are
exercisable for a period of up to 10 years from the date of grant at an exercise
price which is not less than the fair market value of the common stock on the
date of the grant, except that the term of an incentive stock option granted
under the 1998 Plan to a shareholder owning more than 10% of the outstanding
common stock may not exceed five years and its exercise price may not be less
than 110% of the fair market value of the common stock on the date of the grant.
Options granted to members of the Board vest a third upon date of grant
and then a third over the next two years. All other options granted vest a third
each year over a three-year period. During 2004, the Company accelerated the
vesting of stock option grants and restricted stock grants for certain employees
which resulted in total compensation of approximately $275,000 for the year
ended December 31, 2004. The Board has approved the acceleration of the
Company's unvested underwater options. The maximum number of options to be
accelerated is 520,000 and the weighted average exercise price is $25.46.
At December 31, 2004, options for an aggregate of 1,343,745 shares were
outstanding under the Company's stock option plans and options to purchase
520,946 shares of common stock had been exercised since its inception.
The activity for the 2004, 2000, and 1998 Plans during the years ended
December 31, 2004, 2003 and 2002 is set forth in the table below:
2004 2003 2002
--------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
---------- -------- ---------- -------- ---------- --------
Outstanding at beginning of year 1,037,599 $27.33 1,514,297 $39.23 1,125,313 $53.60
Granted 520,000 25.46 115,303 16.13 596,812 14.81
Exercised (144,686) 16.38 (42,373) 13.06 (6,520) 16.00
Terminated (69,168) 15.10 (549,628) 58.86 (201,308) 49.91
---------- ------ ---------- ------ ---------- ------
Outstanding at end of year 1,343,745 $27.86 1,037,599 $27.33 1,514,297 $39.23
========== ====== ========== ====== ========== ======
Options exercisable at end of year 691,798 $32.58 608,811 $31.87 611,871 $46.04
========== ====== ========== ====== ========== ======
The following table summarizes information about stock options
outstanding at December 31, 2004:
F-22
PDI, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Options Outstanding Options Exercisable
- --------------------------------------------------------------------------------
Remaining
Number of weighted Weighted Number of Weighted
Exercise price options contractual exercise options exercise
per share outstanding life (years) price exercisable price
- --------------------------------------------------------------------------------
$ 5.21 - $ 9.15 44,334 7.9 $ 6.69 27,332 $ 7.28
$14.16 - $18.38 411,035 6.8 15.88 277,757 15.84
$21.10 - $31.62 691,137 8.3 25.76 189,470 27.06
$59.50 149,289 6.1 59.50 149,289 59.50
$80.00 - $93.75 47,950 6.2 82.02 47,950 82.02
---------------------------------- ----------------------
1,343,745 7.5 $27.86 691,798 $32.58
================================== ======================
In March 2003, the Company initiated an option exchange program pursuant
to which eligible employees, which excluded certain members of senior
management, were offered an opportunity to exchange an aggregate of 357,885
outstanding stock options with exercise prices of $30.00 and above for either
cash or shares of restricted stock, depending upon the number of options held by
an eligible employee. The offer exchange period expired on May 12, 2003.
Approximately 310,403 shares of common stock underlying eligible options were
tendered by eligible employees and accepted by the Company. This number
represents approximately 87% of the total shares of common stock underlying
eligible options. A total of approximately 120 eligible participants elected to
exchange an aggregate of approximately 59,870 shares of common stock under
eligible options and received cash in the aggregate amount of approximately
$67,000 (which amount includes applicable withholding taxes). A total of
approximately 145 eligible participants elected to exchange an aggregate of
approximately 250,533 shares of common stock underlying eligible options in
exchange for an aggregate of approximately 49,850 shares of restricted stock.
All tendered options have been canceled and are eligible for re-issuance under
the Company's option plans. The restricted stock is subject to three-year cliff
vesting and is being amortized on a straight-line basis over that three-year
period. The shares are subject to forfeiture upon termination of employment
other than in the event of the recipient's death or disability. The total
compensation expense related to the option exchange program was approximately
$96,000 in 2004 and $178,000 in 2003.
Approximately 47,500 options, which were offered to, but did not
participate in, the option exchange program, are subject to variable accounting.
As such, the Company may record compensation expense if the market price of the
Company's common stock exceeds the exercise price of the non-tendered options
until these options are terminated, exercised or forfeited. The non-tendered
options have exercise prices ranging from $59.50 to $80.00 and a remaining life
of 5.8 to 6.1 years.
21. GOODWILL AND INTANGIBLE ASSETS
Goodwill is evaluated for impairment on at least an annual basis. The
Company has established reporting units for purposes of testing goodwill for
impairment. Goodwill has been assigned to the reporting units to which the value
of the goodwill relates. The Company performed the required annual impairment
tests in the fourth quarter of 2004, 2003 and 2002 and determined that no
impairments existed during any of these periods. These tests involved
determining the fair market value of each of the reporting units with which the
goodwill was associated and comparing the estimated fair market value of each of
the reporting units with its carrying amount. The Company's goodwill, which is
not subject to amortization, totaled $23.8 million and $11.1 million as of
December 31, 2004 and December 31, 2003, respectively. Goodwill attributable to
the InServe acquisition is $7.8 million. If the businesses related to the
Inserve goodwill do not achieve forecasted revenue and profitability targets in
the near term, some or all of this goodwill may become impaired.
As a result of the acquisition of Pharmakon (discussed in Note 5), there
was an additional $12.7 million added to the carrying amount of goodwill in
2004. The Company has determined that no event has occurred since the
acquisition date that would indicate impairment of the goodwill associated with
the Pharmakon acquisition.
F-23
PDI, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Sales Marketing
services services PPG Total
-------- --------- -------- -------
Balance as of January 1, 2003 $11,132 $ -- $ -- $11,132
Amortization -- -- -- --
Goodwill additions -- -- -- --
------- ------- -------- -------
Balance as of December 31, 2003 $11,132 $ -- $ -- $11,132
======= ======= ======== =======
Balance as of January 1, 2004 $11,132 $ -- $ -- $11,132
Amortization -- -- -- --
Goodwill additions -- 12,659 -- 12,659
------- ------- -------- -------
Balance as of December 31, 2004 $11,132 $12,659 $ -- $23,791
======= ======= ======== =======
All identifiable intangible assets recorded as of December 31, 2004 are
being amortized on a straight-line basis over the lives of the intangibles which
range from 5 to 15 years. The weighted average amortization period for all of
the identifiable intangible assets is approximately 13.9 years.
As of December 31, 2004 As of December 31, 2003
--------------------------------- -------------------------------
Carrying Accumulated Carrying Accumulated
Amount Amortization Net Amount Amortization Net
--------------------------------- -------------------------------
Covenant not to compete $ 1,826 $1,126 $ 700 $1,686 $ 780 $ 906
Customer relationships 17,508 1,163 16,345 1,208 559 649
Corporate tradename 2,672 169 2,503 172 79 93
------- ------ ------- ------ ------ ------
Total $22,006 $2,458 $19,548 $3,066 $1,418 $1,648
======= ====== ======= ====== ====== ======
Amortization expense for the years ended December 31, 2004, 2003 and 2002
was approximately $1.0 million, $613,000, and $613,000, respectively. Estimated
amortization expense for the next five years is as follows:
2005 $ 1,895
=======
2006 1,703
=======
2007 1,281
=======
2008 1,281
=======
2009 1,272
=======
22. RESTRUCTURING AND OTHER RELATED EXPENSES
During the third quarter of 2002, the Company adopted a restructuring
plan, the objectives of which were to consolidate operations in order to enhance
operating efficiencies (the 2002 Restructuring Plan). This plan was primarily in
response to the general decrease in demand within the Company's markets for the
sales and marketing services segment (defined in 2004 as a combination of the
current sales services and marketing services segments), and the recognition
that the infrastructure that supported these business units was larger than
required. The Company originally estimated that the restructuring would result
in annualized SG&A savings of approximately $14.0 million, based on the level of
SG&A spending at the time it initiated the restructuring. However, these savings
have been partially offset by incremental SG&A expenses the Company has incurred
in subsequent periods as the Company has been successful in expanding its
business platforms for its segments. Substantially all of the restructuring
activities have been completed as of December 31, 2004, except for the remaining
lease payments.
In connection with this plan, the Company originally estimated that it
would incur total restructuring expenses of approximately $5.4 million, other
non-recurring expenses of approximately $0.1 million, and accelerated
depreciation of approximately $0.8 million. Excluding $0.1 million, all of these
expenses were recognized in 2002. The $0.1 million recognized in 2003 consisted
of $0.4 million in additional expense incurred for severance and other exit
costs partially offset by the receipt of $0.3 million for subletting the
Cincinnati, Ohio facility.
The primary items comprising the $5.4 million in restructuring expenses
were $3.7 million in severance expense consisting of cash and non-cash
termination payments to employees in connection with their involuntary
termination, and $1.7 million in other restructuring exit costs relating to
leased facilities and other contractual obligations.
F-24
PDI, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
During the year ended December 31, 2003, the Company recognized a net
reduction in the restructuring accrual of $197,000, of which $143,000 was
recorded as additional expense in SG&A and $340,000 was recorded as a credit to
program expenses consistent with the original recording of the restructuring
changes. For the year ended December 31, 2004, there were no such adjustments.
The accrual for restructuring and exit costs totaled approximately
$161,000 at December 31, 2004, and is recorded in current liabilities on the
consolidated balance sheet.
A roll forward of the activity for the 2002 Restructuring Plan is as
follows:
BALANCE AT BALANCE AT
DECEMBER 31, DECEMBER 31,
(IN THOUSANDS) 2003 ADJUSTMENTS PAYMENTS 2004
- ------------------------ ------------ ----------- -------- ------------
Administrative severance $ 285 $ -- $ (272) $ 13
Exit costs 459 -- (311) 148
----- ----- ------ -------
744 -- (583) 161
----- ----- ------ -------
Sales force severance -- -- -- --
----- ----- ------ -------
TOTAL $ 744 $ -- $ (583) $ 161
===== ===== ====== =======
23. SEGMENT INFORMATION
During the fourth quarter of 2004, as a result of the Company's
acquisition of Pharmakon, the Company restructured certain management
responsibilities and changed its internal financial reporting. As a result of
these changes the Company determined that its reporting segments were required
to be amended. Accordingly, the Company now reports under the following three
segments:
o Sales services segment - includes the Company's dedicated, shared
and MD&D CSO units and the Company's MD&D clinical teams. This
segment uses teams to deliver services to a wide base; they have
similar long-term average gross margins, contract terms, types of
clients and regulatory environments. One segment manager oversees
the operations of all of these units and regularly discusses the
results of operations, forecasts and activities of this segment
with the chief operating decision maker;
o Marketing services segment - includes the Company's marketing
research and medical education and communication services. This
segment is project driven; the units comprising it have a large
number of smaller contracts, share similar gross margins, have
similar clients, and have low barriers to entry for competition.
There are many discrete offerings within this segment, including:
accredited continuing medical education (CME), content development
for CME, promotional medical education, marketing research and
communications. One segment manager oversees the operations of all
of these units and regularly discusses the results of operations,
forecasts and activities of this segment with the chief operating
decision maker; and
o PDI products group (PPG) - includes revenues earned through the
Company's licensing and copromotion of pharmaceutical and MD&D
products. One segment manager oversees the operations of all of
this unit and regularly discusses the results of operations,
forecasts and activities of this segment with the chief operating
decision maker.
F-25
PDI, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
All segments have changed since the Company's December 31, 2003 financial
presentation. The segment information from prior periods has been reclassified
to conform to the current period's presentation.
The accounting policies of the segments are described in Note 1.
Corporate charges are allocated to each of the operating segments on the basis
of total salary costs. Corporate charges include corporate headquarter costs and
certain depreciation expense. Certain corporate capital expenditures have not
been allocated from the sales services segment to the other operating segments
since it is impracticable to do so.
For the Year
Ended December 31,
-----------------------------------
2004 2003 2002
--------- --------- ---------
(in thousands)
Revenue
Sales services ........................ $ 332,431 $ 271,210 $ 185,386
Marketing services .................... 29,057 29,436 26,284
PPG ................................... 2,956 43,884 96,205
--------- --------- ---------
Total ............................. $ 364,444 $ 344,530 $ 307,875
========= ========= =========
Income (loss) from operations
Sales services ........................ $ 64,737 $ 48,891 $ 14,096
Marketing services .................... 3,122 4,493 1,083
PPG ................................... (169) (16,403) (48,821)
Corporate charges ..................... (32,499) (17,391) (16,533)
--------- --------- ---------
Total ............................. $ 35,191 $ 19,590 $ (50,175)
========= ========= =========
Corporate allocations
Sales services ........................ $ (30,719) $ (14,000) $ (9,351)
Marketing services .................... (1,587) (926) (793)
PPG ................................... (193) (2,465) (6,389)
Corporate charges ..................... 32,499 17,391 16,533
--------- --------- ---------
Total ............................... $ -- $ -- $ --
========= ========= =========
Income (loss) from operations,
less corporate allocations
Sales services ........................ $ 34,018 $ 34,891 $ 4,745
Marketing services .................... 1,535 3,567 290
PPG ................................... (362) (18,868) (55,210)
Corporate charges ..................... -- -- --
--------- --------- ---------
Total ............................... $ 35,191 $ 19,590 $ (50,175)
========= ========= =========
Reconciliation of income (loss) from
operations to income (loss) before
provision for income taxes
Total income (loss) from operations
for operating groups ................ $ 35,191 $ 19,590 $ (50,175)
Other income, net .................... 779 1,073 1,967
--------- --------- ---------
Income (loss) before provision
for income taxes .................. $ 35,970 $ 20,663 $ (48,208)
========= ========= =========
Capital expenditures
Sales services ........................ $ 7,671 $ 1,750 $ 3,397
Marketing services .................... 433 54 398
PPG ................................... -- 25 217
--------- --------- ---------
Total ............................. $ 8,104 $ 1,829 $ 4,012
========= ========= =========
Depreciation expense
Sales services ........................ $ 4,222 $ 3,935 $ 3,896
Marketing services .................... 627 522 587
PPG ................................... 27 1,173 2,277
--------- --------- ---------
Total ............................. $ 4,876 $ 5,630 $ 6,760
========= ========= =========
F-26
PDI, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
For the Year
Ended December 31,
-----------------------------------
2004 2003 2002
--------- --------- ---------
(in thousands)
Total Assets
Sales services ........................ $ 179,754 $ 151,768
Marketing services .................... 44,516 10,949
PPG ................................... 435 56,906
--------- ---------
Total ............................. $ 224,705 $ 219,623
========= =========
F-27
SCHEDULE II
PDI, INC.
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 2002, 2003 AND 2004
BALANCE AT ADDITIONS (1) BALANCE AT
BEGINNING CHARGED TO DEDUCTIONS END
DESCRIPTION OF PERIOD OPERATIONS OTHER OF PERIOD
----------- ----------- ------------ -----------
Against trade and note receivables--
Year ended December 31, 2002
Allowance for doubtful accounts ........................ $ 3,692,047 $ 366,125 $ (2,994,695) $ 1,063,477
Year ended December 31, 2003
Allowance for doubtful accounts ........................ 1,063,477 1,526,626 (1,840,762) 749,341
Year ended December 31, 2004
Allowance for doubtful accounts ........................ $ 749,341 $ 1,154,903 $ (1,330,660) $ 573,584
Against taxes--
Year ended December 31, 2002
Tax valuation allowance ................................ $ 1,808,046 $ 1,133,115 $ -- $ 2,941,161
Year ended December 31, 2003
Tax valuation allowance ................................ 2,941,161 -- (1,059,310) 1,881,851
Year ended December 31, 2004
Tax valuation allowance ................................ $ 1,881,851 $ 322,436 $ -- $ 2,204,287
Against inventory--
Year ended December 31, 2002
Inventory valuation allowance .......................... $ -- $ -- $ -- $ --
Year ended December 31, 2003
Inventory valuation allowance .......................... -- 835,448 (17,583) 817,865
Year ended December 31, 2004
Inventory valuation allowance .......................... $ 817,865 $ -- $ (817,865) $ --
Against product rebates, sales discounts and returns--
Year ended December 31, 2002
Accrued product rebates, sales discounts and returns ... $68,402,828 $25,446,424 $(77,349,392) $16,499,861
Year ended December 31, 2003
Accrued product rebates, sales discounts and returns ... 16,499,861 12,000,000 (5,689,035) 22,810,826
Year ended December 31, 2004
Accrued product rebates, sales discounts and returns ... $22,810,826 $ 1,676,000 $(20,171,058) $ 4,315,768
- ------------
(1) Includes payments and actual write offs, as well as changes in estimates
in the reserves and the impact of acquisitions.
F-28