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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NO. 0-17082
QLT INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
BRITISH COLUMBIA, CANADA N/A
- ----------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
887 GREAT NORTHERN WAY, VANCOUVER, B.C., CANADA V5T 4T5
- -------------------------------------------------- ----------------
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (604) 707-7000
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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
As of November 4, 2004, the registrant had 69,600,592 outstanding Common Shares
and 6,486,180 outstanding Stock Options.
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QLT INC.
QUARTERLY REPORT ON FORM 10-Q
SEPTEMBER 30, 2004
TABLE OF CONTENTS
ITEM PAGE
- ---- ----
PART I - FINANCIAL INFORMATION
1. FINANCIAL STATEMENTS...................................................................................... 1
Unaudited Consolidated Balance Sheets as of
September 30, 2004 and December 31, 2003............................................................... 1
Unaudited Consolidated Statements of Income for the three months and nine months ended
September 30, 2004 and September 30, 2003.............................................................. 2
Unaudited Consolidated Statements of Cash Flows for the three months and nine months ended
September 30, 2004 and September 30, 2003.............................................................. 3
Unaudited Consolidated Statement of Changes in Shareholders' Equity and Comprehensive
Income for the three months and nine months ended September 30, 2004................................... 4
Notes to the Consolidated Financial Statements......................................................... 5
2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS....................................................................... 18
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK................................................ 25
4. CONTROLS AND PROCEDURES................................................................................... 25
PART II - OTHER INFORMATION
1. LEGAL PROCEEDINGS......................................................................................... 26
2. UNREGISTERED SALES OF EQUITY SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES........ 28
3. DEFAULTS UPON SENIOR SECURITIES........................................................................... 28
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS....................................................... 28
5. OTHER INFORMATION......................................................................................... 28
6. EXHIBITS.................................................................................................. 28
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
QLT INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands of United States dollars) SEPTEMBER 30, 2004 December 31, 2003
- --------------------------------------------- ------------------ -----------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 524,115 $ 262,408
Short-term investment securities 36,832 233,022
Accounts receivable (Note 5) 44,893 35,395
Inventories (Note 6) 28,531 26,808
Deferred income tax assets 5,798 11,801
Other (Note 7) 12,882 16,150
----------- -------------
653,051 585,584
PROPERTY AND EQUIPMENT 51,395 43,262
OTHER LONG-TERM ASSETS (Note 8) 7,365 5,876
----------- -------------
$ 711,811 $ 634,722
=========== =============
LIABILITIES
CURRENT LIABILITIES
Accounts payable $ 7,898 $ 8,683
Other accrued liabilities (Note 9) 8,554 13,574
Deferred revenue 4,587 6,594
----------- -------------
21,039 28,851
LONG-TERM DEBT 172,500 172,500
----------- -------------
193,539 201,351
----------- -------------
CONTINGENCIES (Note 15)
SHAREHOLDERS' EQUITY
SHARE CAPITAL (Note 10)
Authorized
500,000,000 common shares without par value
Issued and outstanding
Common shares 409,482 395,627
September 30, 2004 - 69,599,190
December 31, 2003 - 68,892,027
ACCUMULATED OTHER COMPREHENSIVE INCOME 61,467 45,828
RETAINED EARNINGS (DEFICIT) 47,323 (8,084)
----------- -------------
518,272 433,371
----------- -------------
$ 711,811 $ 634,722
=========== =============
See accompanying notes to the consolidated financial statements.
1
QLT INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three months ended Nine months ended
September 30, September 30,
(In thousands of United States dollars, except per share information) 2004 2003 2004 2003
- --------------------------------------------------------------------- -------- -------- --------- ---------
REVENUES
Revenue from Visudyne(R) (Note 11) $ 45,704 $ 37,158 $ 129,359 $ 103,767
Contract research and development (Note 12) 849 1,124 2,904 3,495
-------- -------- --------- ---------
46,553 38,282 132,263 107,262
-------- -------- --------- ---------
COSTS AND EXPENSES
Cost of sales 7,946 6,211 22,318 17,681
Research and development 12,200 9,684 32,867 32,646
Selling, general and administrative 2,966 3,653 11,354 10,118
Depreciation 802 825 2,527 2,266
Restructuring (recovery) - - - (394)
-------- -------- --------- ---------
23,914 20,373 69,066 62,317
-------- -------- --------- ---------
OPERATING INCOME 22,639 17,909 63,197 44,945
INVESTMENT AND OTHER INCOME
Net foreign exchange (losses) gains (317) 406 297 3,320
Interest income 2,620 2,443 7,370 6,087
Interest expense (1,583) (773) (4,659) (773)
Other gains 1,912 1,813 1,912 1,813
-------- -------- --------- ---------
2,632 3,889 4,920 10,447
-------- -------- --------- ---------
INCOME BEFORE INCOME TAXES 25,271 21,798 68,117 55,392
PROVISION FOR INCOME TAXES (8,570) (8,649) (23,103) (19,545)
-------- -------- --------- ---------
INCOME BEFORE EXTRAORDINARY GAIN $ 16,701 $ 13,149 $ 45,014 $ 35,847
-------- -------- --------- ---------
EXTRAORDINARY GAIN (NOTE 3) - - 10,393 -
======== ======== ========= =========
NET INCOME $ 16,701 $ 13,149 $ 55,407 $ 35,847
======== ======== ========= =========
BASIC NET INCOME PER COMMON SHARE
Income before extraordinary gain $ 0.24 $ 0.19 $ 0.65 $ 0.52
Extraordinary gain - - 0.15 -
-------- -------- --------- ---------
Net income $ 0.24 $ 0.19 $ 0.80 $ 0.52
-------- -------- --------- ---------
DILUTED NET INCOME PER COMMON SHARE
Income before extraordinary gain $ 0.24 $ 0.19 $ 0.64 $ 0.52
Extraordinary gain - - 0.15 -
-------- -------- --------- ---------
Net income $ 0.24 $ 0.19 $ 0.79 $ 0.52
-------- -------- --------- ---------
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING (IN THOUSANDS)
Basic 69,594 68,837 69,482 68,686
Diluted 69,925 69,196 70,044 68,882
-------- -------- --------- ---------
See accompanying notes to the consolidated financial statements. Visudyne(R) is
a trademark of Novartis Pharma AG
2
QLT INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three months ended Nine months ended
September 30, September 30,
-------------------- -----------------------
(In thousands of United States dollars) 2004 2003 2004 2003
- --------------------------------------------------------------- -------- --------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 16,701 $ 13,149 $ 55,407 $ 35,847
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation 802 825 2,527 2,266
Amortization of deferred financial expenses 267 122 770 122
Unrealized foreign exchange (gain) loss (5,282) (159) 2,669 1,939
Extraordinary gain - - (10,393) -
Deferred income taxes 5,490 8,649 18,315 19,545
Restructuring (recovery) - - - (394)
Changes in non-cash operating assets and liabilities
Account receivable (705) (935) (8,786) 94
Inventories (3,650) (791) (1,086) (1,083)
Other assets 1,243 7,310 3,982 3,093
Accounts payable 1,835 (1,759) (1,481) (4,080)
Income taxes payable (1,775) - (67) -
Accrued restructuring charge - (432) - (2,437)
Other accrued liabilities (1,002) 2,623 (4,874) 2,607
Deferred revenue (178) (1,800) (2,094) (6,398)
-------- --------- --------- ---------
13,746 26,802 54,889 51,121
-------- --------- --------- ---------
CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES
Short-term investment securities 286,798 (137,636) 192,041 (139,328)
Purchase of property and equipment (2,476) (1,284) (9,381) (3,495)
Other long-term assets (1,416) - (2,134) -
Purchase of Kinetek Pharmaceuticals, Inc., net of cash
acquired - - (2,316) -
-------- --------- --------- ---------
282,906 (138,920) 178,210 (142,823)
-------- --------- --------- ---------
CASH PROVIDED BY FINANCING ACTIVITIES
Long-term debt (net) (18) 167,748 (123) 167,748
Issuance of common shares 186 833 13,958 3,472
-------- --------- --------- ---------
168 168,581 13,835 171,220
-------- --------- --------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS 22,355 836 14,773 21,504
-------- --------- --------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS 319,175 57,299 261,707 101,022
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 204,940 171,861 262,408 128,138
-------- --------- --------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $524,115 $ 229,160 $ 524,115 $ 229,160
======== ========= ========= =========
SUPPLEMENTARY CASH FLOW INFORMATION:
Interest paid $ 2,730 $ 114 $ 5,879 $ 365
Income taxes paid 5,806 - 5,806 -
See accompanying notes to the consolidated financial statements.
3
QLT INC.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY AND COMPREHENSIVE
INCOME
(Unaudited)
Accumulated
Common Shares Other Total
--------------------- Comprehensive Accumulated Comprehensive Shareholders'
Shares Amount Income Deficit Income Equity
---------- --------- ------------- ----------- ------------- -------------
(All amounts except share and per share information are expressed in thousands of United States dollars)
Balance at December 31, 2003 68,892,027 $ 395,627 $ 45,828 $ (8,084) $ - $ 433,371
Exercise of stock options at
prices ranging from CAD $12.10
to CAD $31.40 per share 609,161 11,602 - - - 11,602
Other comprehensive income:
Cumulative translation adjustment
from application of U.S. dollar
reporting - - (3,816) - (3,816) (3,816)
Unrealized loss on available for
sale securities - - (99) - (99) (99)
Net income - - - 24,022 24,022 24,022
-------------
Comprehensive income - - - - $ 20,107 -
---------- --------- -------- -------- ------------- ---------
Balance at March 31, 2004 69,501,188 $ 407,229 $ 41,913 $ 15,938 - $ 465,079
---------- --------- -------- -------- ------------- ---------
Exercise of stock options at prices
ranging from CAD $ 12.10 to CAD
$34.75 per share 81,129 2,067 - - - 2,067
Other comprehensive income:
Cumulative translation adjustment
from application of U.S. dollar
reporting - - (7,897) - (7,897) (7,897)
Unrealized loss on available for sale
securities - - (31) - (31) (31)
Net income - - - 14,684 14,684 14,684
-------------
Comprehensive income - - - - $ 6,756 -
---------- --------- -------- -------- ------------- ---------
Balance at June 30, 2004 69,582,317 $ 409,296 $ 33,985 $ 30,622 - $ 473,903
---------- --------- -------- -------- ------------- ---------
Exercise of stock options at prices
ranging from CAD $ 12.10 to CAD
$23.50 per share 16,873 186 - - - 186
Other comprehensive income:
Cumulative translation adjustment
from application of U.S. dollar
reporting - - 27,530 - 27,530 27,530
Unrealized loss on available for
sale securities - - (48) - (48) (48)
Net income - - - 16,701 16,701 16,701
-------------
Comprehensive income - - - - $ 44,183 -
---------- --------- -------- -------- ------------- ---------
BALANCE AT SEPTEMBER 30, 2004 69,599,190 $ 409,482 $ 61,467 $ 47,323 - $ 518,272
========== ========= ======== ======== ============= =========
See accompanying notes to the consolidated financial statements.
4
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Information as at and for the three and nine month periods ended September 30,
2004 and September 30, 2003 is unaudited.)
QLT Inc. (the "Company" or "QLT") is a global bio-pharmaceutical company
dedicated to the discovery, development and commercialization of
innovative therapies to treat eye diseases, cancer, dermatological and
urological conditions. The Company, as the first developer of an approved
photodynamic therapy ("PDT") pharmaceutical product, is considered a
pioneer in the field of PDT. PDT is a minimally invasive medical procedure
utilizing photosensitizers (light-activated drugs) to treat a range of
diseases associated with rapidly growing tissue.
1. BASIS OF PRESENTATION
These unaudited consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United
States and pursuant to the rules and regulations of the United States
Securities and Exchange Commission for the presentation of interim
financial information. Accordingly, certain information and footnote
disclosures normally included in financial statements prepared in
accordance with United States generally accepted accounting principles
have been condensed, or omitted, pursuant to such rules and regulations.
These financial statements do not include all disclosures required for
annual financial statements and should be read in conjunction with the
Company's audited consolidated financial statements and notes thereto
included as part of the Company's 2003 Annual Report on Form 10-K. All
amounts are expressed in United States dollars unless otherwise noted.
In the opinion of management, all adjustments (including reclassifications
and normal recurring adjustments) necessary to present fairly the
financial position, results of operations and cash flows at September 30,
2004, and for all periods presented, have been made. Interim results are
not necessarily indicative of results for a full year.
2. PRINCIPLES OF CONSOLIDATION
These consolidated financial statements include the accounts of the
Company and its subsidiaries. All significant intercompany transactions
have been eliminated.
3. BUSINESS COMBINATION
On March 31, 2004, the Company acquired all the outstanding shares of
Kinetek Pharmaceuticals, Inc. ("Kinetek"), a privately held
bio-pharmaceutical company based in Vancouver, British Columbia that
focused on discovery and development of new targets and therapies. The
results of operations of Kinetek are included in the consolidated
statement of operations since the acquisition date, and the related assets
and liabilities were recorded based upon their respective fair values at
the date of acquisition. The Company paid an aggregate cash purchase price
of $2.4 million, which included acquisition related expenditures of $0.1
million. The extraordinary gain resulting from this acquisition related to
the estimated fair value of net assets acquired, including the recognition
of certain tax assets, in excess of the total consideration paid by the
Company.
(In thousands of United States dollars)
---------------------------------------
Purchase price $ 2,447
Current assets acquired (including cash of $0.1 million) 13,137
Property and equipment acquired 604
Current liabilities assumed (901)
--------
Extraordinary gain $ 10,393
========
On July 1, 2004, Kinetek was amalgamated with the Company and ceased to
exist as a separate legal entity.
5
4. SIGNIFICANT ACCOUNTING POLICIES
In the opinion of management, the following are the most significant
accounting policies used in preparing these financial statements.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
the disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenue and expenses
during the reporting periods presented. Significant estimates are used
for, but not limited to, provisions for non-completion of inventory,
assessment of the net realizable value of long-lived assets, accruals for
contract manufacturing and research and development agreements, allocation
of costs to manufacturing under a standard costing system, allocation of
overhead expenses to research and development, determination of fair value
of assets and liabilities acquired in purchase business combinations, and
provisions for taxes and contingencies. Actual results may differ from
estimates made by management.
Reporting Currency and Foreign Currency Translation
The Company uses the U.S. dollar as its reporting currency while retaining
the Canadian dollar as its functional currency. The consolidated financial
statements of the Company are translated into U.S. dollars using the
current rate method. Assets and liabilities are translated at the rate of
exchange prevailing at the balance sheet date. Shareholders' equity is
translated at the applicable historical rates. Revenue and expenses are
translated at a weighted average rate of exchange for the respective
periods. Translation gains and losses are included as part of the
cumulative foreign currency translation adjustment which is reported as a
component of shareholders' equity under accumulated other comprehensive
income.
Property and Equipment
During the first quarter of 2003, the Company reviewed its intended use of
property and equipment and adopted the straight-line method for all newly
acquired or constructed property and equipment beginning in 2003. The
Company retains the declining balance method for all property and
equipment acquired prior to 2003.
Property and equipment are recorded at cost and amortized as follows:
Methods Rates Methods Years
----------------- ----- ------------- -----
Buildings Declining balance 4%
Office furnishings, fixtures and other Declining balance 20% or Straight-line 5
Research and commercial manufacturing equipment and
computer operating system Declining balance 20% or Straight-line 5
Computer hardware Declining balance 30% or Straight-line 3
Revenue Recognition
Under the terms of the Company's collaborative agreement with Novartis
Ophthalmics, a division of Novartis Pharma AG ("Novartis Ophthalmics"),
the Company is responsible for manufacturing and product supply and
Novartis Ophthalmics is responsible for sales, marketing and distribution
of Visudyne. The Company's agreement with Novartis Ophthalmics provides
that the calculation of total revenue from the sale of Visudyne be
comprised of three components: (1) an advance on the cost of inventory
sold to Novartis Ophthalmics, (2) an amount equal to 50% of the profit
that Novartis Ophthalmics derives from the sale of Visudyne to end-users,
and (3) the reimbursement of other specified costs incurred and paid for
by the Company (See Note 11 - Revenue from Visudyne). The Company
recognizes revenue from the sale of Visudyne when persuasive evidence of
an arrangement exists, delivery to Novartis Ophthalmics has occurred, the
end selling price of Visudyne is fixed or determinable, and collectibility
is reasonably assured. Under the calculation of total revenues noted
above, this occurs upon "sell through" to the end customers.
Contract research and development revenues consist of non-refundable
research and development funding under collaborative agreements with the
Company's strategic partners. Contract research and development funding
generally compensates the Company for discovery, preclinical and clinical
expenses related to the collaborative development programs for certain
products and product candidates of the Company, and is recognized as
revenue at the time research and development activities are performed
under the terms of the collaborative agreements. Amounts received under
the collaborative agreements are non-refundable even if the research and
development efforts performed by the Company do not eventually result in a
commercial product. Contract research and development revenues earned in
6
excess of payments received are classified as contract research and
development receivables. (See Note 5 - Accounts Receivable and Note 12 -
Contract Research and Development.)
The Company does not offer rebates or discounts and has not experienced
any material product returns; accordingly, the Company does not provide an
allowance for rebates, discounts, and returns.
Cost of Sales
Cost of sales, consisting of expenses related to the production of bulk
Visudyne sold to Novartis Ophthalmics and royalties on Visudyne sales, are
charged against earnings in the period of the related product sale by
Novartis Ophthalmics to third parties. The Company utilizes a standard
costing system, which includes a reasonable allocation of overhead
expenses, to account for inventory and cost of sales with adjustments
being made periodically to reflect current conditions. Overhead expenses
comprise direct and indirect support activities related to the manufacture
of bulk Visudyne and involve costs associated with activities such as
quality inspection, quality assurance, supply chain management, safety and
regulatory. Overhead expenses are allocated to inventory during each stage
of the manufacturing process under the standard costing system, and
eventually to cost of sales as the related products are sold by Novartis
Ophthalmics to third parties. The Company records a provision for the
non-completion of product inventory based on its history of batch
completion.
Stock-Based Compensation
As allowed by SFAS No. 123 "Accounting for Stock-based Compensation"
("SFAS 123"), the Company applies Accounting Principles Board ("APB")
Opinion No. 25 and related interpretations in the accounting for employee
stock option plans. SFAS 123 requires that all stock-based awards made to
non-employees be measured and recognized using a fair value based method.
The standard encourages the use of a fair value based method for all
awards granted to employees, but only requires the use of a fair value
based method for direct awards of stock, stock appreciation rights, and
awards that call for settlement in cash or other assets. Awards that an
entity has the ability to settle in stock are recorded as equity, whereas
awards that the entity is required to or has a practice of settling in
cash are recorded as liabilities. The Company has adopted the disclosure
only provision for stock options granted to employees and directors, as
permitted by SFAS 123.
The following pro forma financial information presents the net income and
net income per common share had the Company recognized stock-based
compensation using a fair value based accounting method:
Three months ended Nine months ended
-------------------------------- -------------------------------
(In thousands except per share information) September 30, September 30, September 30, September 30,
(Unaudited) 2004 2003 2004 2003
- -------------------------------------------------- ------------- ------------- ------------- -------------
Net Income
As reported $ 16,701 $ 13,149 $ 55,407 $ 35,847
Less: Additional employee compensation expense
under the fair value method (2,509) (4,330) (8,748) (14,715)
-------- -------- -------- --------
Pro forma $ 14,192 $ 8,819 $ 46,659 $ 21,132
-------- -------- -------- --------
Basic net income per common share
As reported $ 0.24 $ 0.19 $ 0.80 $ 0.52
Pro forma $ 0.20 $ 0.13 $ 0.67 $ 0.31
-------- -------- -------- --------
Diluted net income per share
As reported $ 0.24 $ 0.19 $ 0.79 $ 0.52
Pro forma $ 0.20 $ 0.13 $ 0.67 $ 0.31
-------- -------- -------- --------
The pro forma amounts may not be representative of future disclosures
because the estimated fair value of stock options is amortized to expense
over the vesting period and additional options may be granted in future
years.
The Black-Scholes option pricing model was developed for use in estimating
the value of traded options that have no vesting restrictions and are
fully transferable. In addition, option pricing models require the input
of highly subjective assumptions including the expected stock price
volatility. The Company uses projected data for expected volatility and
expected life of its stock options based upon historical and other
economic data trended into future years. Because the Company's employee
stock options have characteristics significantly different from those of
traded options, and because changes in the subjective input assumptions
can materially affect the estimate, in management's opinion, the existing
valuation models do not provide a reliable measure of the fair value of
the Company's employee stock options.
7
The weighted average fair value of stock options granted in the three
months and nine months periods ended September 30, 2004 were $5.53 and
$8.87 whereas the fair value of stock options granted in the three and
nine month periods ended September 30, 2003 were $5.45 and $4.36. The
Company used the Black-Scholes option pricing model to estimate the value
of the options at each grant date, under the following weighted average
assumptions:
Three months ended Nine months ended
--------------------------------- ---------------------------------
September 30, September 30, September 30, September 30,
2004 2003 2004 2003
------------- ------------- ------------- -------------
Annualized Volatility 50.9% 63.4% 55.9% 72.8%
Risk-free Interest Rate 3.6% 3.3% 2.9% 4.1%
Expected Life (Years) 2.5 2.5 2.5 2.5
Research and Development
Research and development costs consist of direct and indirect
expenditures, including a reasonable allocation of overhead expenses,
associated with the Company's various research and development programs.
Overhead expenses comprise general and administrative support provided to
the research and development programs and involve costs associated with
support activities such as facility maintenance, utilities, office
services, information technology, legal, accounting and human resources.
Research and development costs are expensed as incurred. Patent
application, filing and defense costs are expensed as incurred.
Income Taxes
Income taxes are reported using the asset and liability method, whereby
deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective
tax bases, and operating loss and tax credit carry forwards, using
applicable enacted tax rates. An increase or decrease in these tax rates
will increase or decrease the carrying value of the deferred net tax
assets resulting in an increase or decrease to net income. A valuation
allowance is provided when it is more likely than not that a deferred tax
asset may not be realized. Investment tax credits are included as part of
the provision for (recovery of) income taxes.
Net Income Per Common Share
Basic net income per common share is computed using the weighted average
number of common shares outstanding during the period. Diluted net income
per common share is computed in accordance with the treasury stock method
and "if converted" method, as applicable, which uses the weighted average
number of common shares outstanding during the period and also includes
the dilutive effect of potentially issuable common stock from outstanding
stock options and convertible debt. In addition, the related interest and
amortization of deferred financing fees on convertible debt (net of tax)
are added back to income, since these would not be paid or incurred if the
convertible senior notes were converted into common shares.
The following table sets out the computation of basic and diluted net
income per common share:
8
Three months ended Nine months ended
(In thousands, except per share data) September 30, September 30, September 30, September 30,
(Unaudited) 2004 2003 2004 2003
- ------------------------------------- ------------- ------------- ------------- -------------
Numerator:
Income before extraordinary gain $ 16,701 $ 13,149 $ 45,014 $ 35,847
Extraordinary gain - - 10,393 -
-------- -------- -------- --------
Net Income $ 16,701 $ 13,149 $ 55,407 $ 35,847
Denominator:
Weighted-average common shares outstanding 69,594 68,837 69,482 68,686
Effect of dilutive securities:
Stock options 331 359 562 196
-------- -------- -------- --------
Diluted weighted-average common shares outstanding 69,925 69,196 70,044 68,882
======== ======== ======== ========
Basic net income per common share
Income before extraordinary gain $ 0.24 $ 0.19 $ 0.65 $ 0.52
Extraordinary gain - - 0.15 -
-------- -------- -------- --------
Net income $ 0.24 $ 0.19 $ 0.80 $ 0.52
======== ======== ======== ========
Diluted net income per common share
Income before extraordinary gain $ 0.24 $ 0.19 $ 0.64 $ 0.52
Extraordinary gain - - 0.15 -
-------- -------- -------- --------
Net income $ 0.24 $ 0.19 $ 0.79 $ 0.52
======== ======== ======== ========
The effect of approximately 9,692,637 shares related to the assumed
conversion of the $172.5 million 3% convertible senior notes has been
excluded in the computation of diluted earnings per share for the three
and nine month periods ended September 30, 2004 as the convertibles senior
notes did not meet the test for conversion. In addition, also excluded
from the calculation of diluted net income per common share for the three
and nine month periods ended September 30, 2004 were 5,496,914 and
4,999,647 shares, respectively, (in the three and nine month periods ended
September 30, 2003 the amounts excluded were 6,244,678 and 6,444,678
shares, respectively) of common stock from stock options because their
effect was anti-dilutive.
Recently Issued Accounting Standards
In September 2004, the EITF reached a consensus on Issue No. 04-08, The
Effect of Contingently Convertible Debt on Diluted Earnings per Share.
Issue No. 04-08 addresses the issue of when the dilutive effect of
contingently convertible debt instruments should be included in diluted
earnings per share. Presently, the potential dilutive effect of the
conversion feature is excluded from diluted earnings per share until the
contingent feature is met. Issue No. 04-08 will result in contingently
convertible debt instruments being included in diluted earnings per share
computations regardless of whether contingent features are met. The
provisions of Issue No. 04-08 apply to reporting periods ending after
December 15, 2004. The adoption of Issue No. 04-08 will result in the
Company's diluted earnings per share calculation including convertible
debt regardless of whether contingent features are met when Issue No.
04-08 becomes applicable. Prior period earnings per share amounts
presented for comparative purposes will be restated to conform to this
consensus when Issue No. 04-08 becomes applicable.
9
5. ACCOUNTS RECEIVABLE
(In thousands of United States Dollars) September 30, 2004 December 31, 2003
- --------------------------------------- ------------------ -----------------
(Unaudited)
Visudyne(R) $ 41,831 $34,035
Contract research and development 875 1,032
Foreign exchange contracts 179 -
Trade and other 2,008 328
-------- -------
$ 44,893 $35,395
-------- -------
Accounts receivable - Visudyne represents amounts due from Novartis
Ophthalmics and consists of the Company's 50% share of pre-tax profit on
sales of Visudyne and reimbursement of specified royalty and other costs.
The Company has not, in the past, experienced bad debts. Based on this
history and because the Company's accounts receivable consists primarily
of receivables from its strategic partner, Novartis Ophthalmics, the
Company does not provide an allowance for doubtful accounts.
6. INVENTORIES
(In thousands of United States dollars) September 30, 2004 December 31, 2003
- --------------------------------------- ------------------ -----------------
(Unaudited)
Raw materials and supplies $ 849 $ 2,066
Work-in-process 28,242 24,660
Finished goods 69 82
Provision for non-completion of product inventory (629) -
-------- --------
$ 28,531 $ 26,808
-------- --------
The Company records a provision for non-completion of product inventory to
provide for the potential failure of inventory batches in production to
pass quality inspection. During the three months ended September 30, 2004,
the Company incurred a batch non-completion resulting in a charge to the
reserve for non-completion of $1.5 million. The Company has not
experienced finished goods inventory spoilage to date. Based on this
history, inventory turnover, and expected sales, the Company believes
that, at this time, the risk of inventory obsolescence is negligible.
Accordingly, the Company has not established any reserve for obsolescence.
7. OTHER CURRENT ASSETS
(In thousands of United States dollars) September 30, 2004 December 31, 2003
- --------------------------------------- ------------------ -----------------
(Unaudited)
Inventory in transit held by Novartis Ophthalmics $ 8,408 $ 10,122
Foreign exchange contracts 1,490 4,447
Prepaid expenses and other 2,984 1,581
-------- --------
$ 12,882 $ 16,150
-------- --------
Inventory in transit comprises finished goods that have been shipped to
and are held by Novartis Ophthalmics. Under the terms of the Company's
collaborative agreement, upon delivery of inventory to Novartis
Ophthalmics, the Company is entitled to an advance equal to the Company's
cost of inventory. The inventory in transit is also included in deferred
revenue at cost, and will be recognized as revenue in the period of the
related product sale and delivery by Novartis Ophthalmics to third
parties, where collection is reasonably assured.
Foreign exchange contracts consist of unrealized gains on foreign currency
derivative financial instruments.
10
8. OTHER LONG-TERM ASSETS
(In thousands of United States dollars) September 30, 2004 December 31, 2003
- --------------------------------------- ------------------ -----------------
(Unaudited)
Deferred financing expenses $ 4,238 $ 4,784
Deferred Atrix acquisition expenses 2,389 -
Diomed Holdings, Inc. 64 244
Other 674 848
-------- --------
$ 7,365 $ 5,876
-------- --------
Deferred financing expenses represent debt issue costs related to the
convertible senior notes, net of amortization. Deferred financing expenses
are being amortized over 5 years commencing August 2003. Deferred Atrix
acquisition expenses represent the direct incremental costs incurred to
September 30, 2004 in relation to the Agreement and Plan of Merger entered
into with Atrix Laboratories, Inc. on June 14, 2004. (See Note 16 -
Proposed Merger with Atrix Laboratories, Inc.). The long-term investment
in Diomed Holdings, Inc. represents the restricted Class A Convertible
Preferred Stock the Company received as consideration for the sale of the
Company's Optiguide fiber optic business to Diomed Holdings, Inc. and was
converted to Diomed Holdings, Inc. common shares during 2003. Other
long-term investments consist principally of long-term employee loans
which are non-interest bearing with terms ranging from one to five years,
and which will be forgiven if certain conditions are met.
9. OTHER ACCRUED LIABILITIES
(In thousands of United States dollars) September 30, 2004 December 31, 2003
- --------------------------------------- ------------------ -----------------
(Unaudited)
Royalties $ 2,600 $ 2,470
Compensation 5,167 5,325
Foreign Exchange Contracts - 3,589
Interest 439 2,132
Other 348 58
-------- --------
$ 8,554 $ 13,574
-------- --------
11
10. SHARE CAPITAL
On August 12, 2004, the share buy-back program announced by the Company on
August 11, 2003 expired. Under that program the Company had the ability to
purchase a maximum of 5,000,000 common shares in the open market through
the facilities of the Toronto Stock Exchange and the Nasdaq National
Market, in accordance with all regulatory requirements, during the period
from August 13, 2003 until August 12, 2004. The Company did not purchase
any of its common shares under the program.
Stock option activity with respect to all of the Company's stock option
plans is presented below:
Weighted
Number of Exercise Price Range Average
(In Canadian dollars) Shares Per Share Exercise Price
- ------------------------------------- --------- -------------------- --------------
Outstanding at December 31, 2003 7,236,624 $ 12.10 - $ 108.60 $ 47.82
From January 1 to September 30, 2004:
Granted 950,200 $ 21.04 - $ 32.85 $ 32.00
Exercised (707,163) $ 12.10 - $ 34.75 $ 26.10
Cancelled (973,020) $ 12.10 - $ 108.60 $ 48.69
--------- -------------------- --------
Outstanding at September 30, 2004 6,506,641 $ 12.10 - $ 108.60 $ 47.74
========= ==================== ========
Additional information relating to stock options outstanding as of
September 30, 2004 is presented below:
(In Canadian dollars) Options Outstanding Options Exercisable
- ---------------------------- ----------------------- ---------------------
Weighted
Weighted Average Weighted
Average Remaining Average
Exercise Number of Exercise Contractual Number of Exercise
Price Range Shares Price Life (Years) Shares Price
- --------------- --------- -------- ----------- --------- --------
Under $17.50 799,227 $ 13.49 3.47 354,621 $ 13.50
$17.51 - $25.00 765,059 $ 22.25 2.78 544,085 $ 22.42
$25.01 - $37.50 1,691,672 $ 32.26 3.20 951,167 $ 31.93
$37.51 - $50.00 1,712,419 $ 39.44 1.64 1,642,974 $ 39.50
Over $50.00 1,538,264 $ 104.47 0.62 1,534,764 $ 104.53
--------- ---------
6,506,641 5,027,611
========= =========
11. REVENUE FROM VISUDYNE(R)
Under the terms of the Company's collaborative agreement with Novartis
Ophthalmics, the Company is responsible for manufacturing and product
supply and Novartis Ophthalmics is responsible for marketing and
distribution of Visudyne.
The Company's revenue from the sales of Visudyne was determined as
follows:
12
Three months ended Nine months ended
September 30, September 30,
(In thousands of United States dollars) 2004 2003 2004 2003
- --------------------------------------- ------------ ------------ ------------ ------------
(Unaudited)
Visudyne(R) sales by Novartis Ophthalmics $ 113,954 $ 89,822 $ 324,350 $ 261,082
Less: Marketing and distribution costs (31,452) (24,933) (94,088) (78,457)
Less: Inventory costs (7,020) (5,483) (19,502) (15,821)
Less: Royalties (2,578) (2,009) (7,302) (5,919)
------------ ------------ ------------ ------------
$ 72,904 $ 57,397 $ 203,458 $ 160,885
============ ============ ============ ============
QLT share of remaining revenue on final sale by
Novartis Ophthalmics (50%) $ 36,452 $ 28,699 $ 101,729 $ 80,442
Add: Inventory costs reimbursed to QLT 5,530 4,430 15,853 12,563
Add: Royalties reimbursed to QLT 2,575 2,005 7,272 5,795
Add: Other costs reimbursed to QLT 1,147 2,024 4,505 4,966
------------ ------------ ------------ ------------
Revenue from Visudyne(R) as reported by QLT $ 45,704 $ 37,158 $ 129,359 $ 103,767
============ ============ ============ ============
For the three months ended September 30, 2004 approximately 50% of total
Visudyne sales by Novartis Ophthalmics were in the United States, with
Europe and other markets responsible for the remaining 50%. For the same
period in 2003, approximately 52% of total Visudyne sales by Novartis
Ophthalmics were in the United States, with Europe and other markets
responsible for the remaining 48%.
For the nine months ended September 30, 2004 approximately 47% of total
Visudyne sales by Novartis Ophthalmics were in the United States, with
Europe and other markets responsible for the remaining 53%. For the same
period in 2003, approximately 51% of total Visudyne sales by Novartis
Ophthalmics were in the United States, with Europe and other markets
responsible for the remaining 49%.
12. CONTRACT RESEARCH AND DEVELOPMENT
The Company received non-refundable research and development funding from
Novartis Ophthalmics and Xenova Limited which was recorded as contract
research and development revenue. Details of the Company's contract
research and development revenue are as follows:
Three months ended Nine months ended
September 30, September 30,
(In thousands of United States dollars) 2004 2003 2004 2003
- --------------------------------------- ---------- ---------- ---------- ----------
(Unaudited)
Visudyne(R) ocular programs $ 849 $ 626 $ 2,904 $ 1,397
Multiple basal cell carcinoma program - 8 - 1,062
Others - 490 - 1,036
---------- ---------- ---------- ----------
Contract research & development revenue $ 849 $ 1,124 $ 2,904 $ 3,495
========== ========== ========== ==========
13. FINANCIAL INSTRUMENTS AND CONCENTRATION OF CREDIT RISK
As at September 30, 2004 and December 31, 2003, the carrying amounts for
the Company's cash and cash equivalents, short-term investment securities,
accounts receivable, accounts payable, and other accrued liabilities
approximated fair value due to the short-term maturity of these financial
instruments. The Company's investment in common shares of Diomed Holdings
Inc. is carried at fair value based on quoted market prices. The Company's
long-term debt comprises $172.5 million aggregate principal amount of
convertible senior notes due in 2023 and has a fair value of $213.0
million as of September 30, 2004 as valued by an independent investment
bank. These notes are not listed on any securities exchange or included in
any automated quotation system. The quoted bid and ask prices may not be
reliable as the amounts cannot be independently verified and not all
trades are reflected.
13
With respect to the concentration of credit risk, the Company's accounts
receivables, as at September 30, 2004 and December 31, 2003, comprise
primarily aggregate amounts owing from Novartis Ophthalmics.
The Company purchases goods and services primarily in both Canadian (CAD)
and U.S. dollars (USD), and earns most of its revenues in U.S. dollars and
Euros (EUR). The Company enters into foreign exchange contracts to manage
exposure to currency rate fluctuations related to its expected future net
income (primarily in U.S. dollars and Euros) and cash flows (in U.S.
dollars and Swiss francs (CHF)). The Company is exposed to credit risk in
the event of non-performance by counterparties in connection with these
foreign exchange contracts. The Company mitigates this risk by transacting
with a diverse group of financially sound counterparties and, accordingly,
does not anticipate loss for non-performance. Foreign exchange risk is
also managed by satisfying foreign denominated expenditures with cash
flows or assets denominated in the same currency. The net unrealized gain
in respect of such foreign currency contracts, as at September 30, 2004,
was approximately $1.5 million, which was included in the Company's
results of operations. At September 30, 2004, the Company has outstanding
forward foreign currency contracts as noted below.
Maturity Period Quantity (millions) Average Price
--------------- ------------------- ---------------
U.S. / Canadian dollar option-dated forward
contracts 2004 - 2005 USD 44.3 1.30758 per USD
Swiss Franc / Canadian dollar option-dated
forward contracts 2004 - 2005 CHF 43.6 1.05040 per CHF
Canadian dollar / Swiss Franc average rate
forward contract 2004 CAD 4.1 1.05130 per CHF
Canadian / U.S. dollar average rate forward
contracts 2004 CAD 39.1 1.30728 per USD
Australian dollar (AUD) / Swiss Franc
average rate forward contract 2004 AUD 1.9 0.91280 per AUD
Euro / Swiss Franc average rate forward
contract 2004 EUR 9.3 1.54350 per EUR
U.S. dollar / Swiss Franc average rate
forward contract 2004 USD 1.2 1.23700 per USD
14
14. SEGMENTED INFORMATION
Details of revenues and property and equipment by geographic segments are
as follows:
Revenues(1)
Three months ended Nine months ended
September 30, September 30,
(In thousands of United States dollars) 2004 2003 2004 2003
- --------------------------------------- ---------- ---------- ---------- ----------
(Unaudited)
United States $ 25,625 $ 23,128 $ 72,377 $ 63,979
Europe 15,658 12,054 47,644 34,730
Canada 2,659 1,874 7,041 5,344
Other 2,611 1,226 5,200 3,209
---------- ---------- ---------- ----------
$ 46,553 $ 38,282 $ 132,263 $ 107,262
========== ========== ========== ==========
Property and equipment
September 30, December 31,
(In thousands of United States dollars) 2004 2003
- --------------------------------------- ------------- ------------
(Unaudited)
Canada $ 50,886 $ 42,687
United States 509 575
---------- ----------
$ 51,395 $ 43,262
---------- ----------
(1) Revenues are attributable to a geographic segment based on location of
the customer for revenue from Visudyne and royalties on product sales,
and location of the head office of the funding entity in the case of
revenue from contract research and development and collaborative
arrangements.
15. CONTINGENCIES
(a) Patent Litigation with MEEI
First lawsuit brought by MEEI
In April 2000, Massachusetts Eye and Ear Infirmary ("MEEI") filed a civil suit
complaint against the Company in the United States District Court for the
District of Massachusetts (the "Court") seeking to establish exclusive rights
for MEEI as the owner of certain inventions relating to the use of verteporfin
as the photoactive agent in the treatment of certain eye diseases including AMD.
In 2002, QLT moved for summary judgment against MEEI on all counts of MEEI's
complaint. The Court granted QLT's motions, thus dismissing all of MEEI's claims
in the lawsuit. Final judgment of dismissal was entered in April 2003. In May
2003, MEEI filed a notice of appeal, and QLT filed a notice of cross-appeal with
respect to a contested discovery order entered by the district court. Oral
argument on the appeal and cross-appeal was heard in August of 2004. These
appeals are pending before the Court of Appeal for the First Circuit.
The lawsuit relates, in part, to an ongoing dispute involving U.S. Patent No.
5,798,349 (the " '349 Patent") which was issued in 1998 to the Company, MEEI and
Massachusetts General Hospital ("MGH") as co-owners. The complaint alleged
breach of contract, misappropriation of trade secrets, conversion,
misrepresentation, unjust enrichment, unfair trade practices and related claims
and asked that the Court: (i) declare MEEI the owner of certain inventions
claimed in the '349 Patent; (ii) enjoin the Company from infringement of those
claims or any action that would diminish the validity or value of such claims;
(iii) declare that the Company breached an agreement with MEEI to share
equitably in any proceeds derived as a result of collaboration leading to the
'349 Patent; (iv) impose a constructive trust upon the Company for any benefit
that the Company has or will derive as a result of the '349 Patent; and (v)
award MEEI monetary relief for misappropriation of trade secrets in an amount
equal to the greater of MEEI's damages or the Company's profits from any such
misappropriation, and double or treble damages under Massachusetts law.
QLT's counterclaim in this lawsuit requesting correction of inventorship of the
`349 patent to add an additional MGH inventor, was stayed by the Court pending
the outcome of the second MEEI lawsuit described below. QLT voluntarily
dismissed the remainder of its counterclaims in the first lawsuit without
prejudice in April 2003.
15
Second lawsuit brought by MEEI
In May 2001, the United States Patent Office issued United States Patent No.
6,225,303 (the "'303 Patent") to MEEI. The `303 Patent is derived from the same
patent family as the '349 Patent and claims a method of treating unwanted
choroidal neovasculature in a shortened treatment time using verteporfin. The
patent application which led to the issuance of the `303 patent was filed and
prosecuted by attorneys for MEEI and, in contrast to the '349 patent, named only
MEEI researchers as inventors.
The same day the `303 patent was issued, MEEI commenced a second civil suit
against the Company and Novartis Ophthalmics in the same Court alleging
infringement of the `303 Patent. In the second suit MEEI seeks damages and
injunctive relief for patent infringement and unjust enrichment. The Company has
answered the complaint, denying its material allegations and raising a number of
affirmative defenses, and has asserted counterclaims against MEEI and the two
MEEI researchers who are named as inventors on the `303 patent.
The Company's counterclaim seeks to correct inventorship of the `303 patent by
adding QLT and MGH researchers as joint inventors and asks the court to declare
that QLT and MGH are co-owners of the `303 patent. The counterclaim also
requests a declaration that QLT does not infringe, induce infringement, or
contribute to infringement of the `303 patent, asserting, among other reasons,
that QLT and MGH are rightful co-owners of the patent and QLT has a license from
MGH of MGH's co-ownership rights under the patent. In addition, the counterclaim
seeks a declaratory judgment that the `303 patent is invalid and unenforceable
and an award of monetary damages for breach of material transfer agreements
governing MEEI's use of verteporfin, based upon MEEI's failure to notify QLT of
MEEI's intent to file the patent application that led to the issuance of the
`303 patent to MEEI.
In November 2001, MGH sought and was granted leave to intervene in the action to
protect its rights in the `303 patent. MGH's complaint in intervention, like
QLT's counterclaim, asks the court to correct inventorship of the `303 patent by
adding QLT and MGH researchers as joint inventors of the inventions claimed in
the patent and by declaring that MGH is a joint owner of those inventions.
In April 2003, QLT moved to dismiss MEEI's claim for unjust enrichment on the
grounds that this claim had been previously decided by a court. The Court
granted QLT's motion on May 28, 2003.
No trial has been scheduled in the second lawsuit, and none is expected until
2005 at the earliest.
The Company believes MEEI's claims in both lawsuits are without merit and
intends to vigorously defend against such actions and any appeals and pursue its
counterclaims. The outcomes of these disputes are not presently determinable or
estimable and there can be no assurance that the matters will be resolved in
favor of the Company. If the lawsuits are not resolved in the Company's favor,
the Company may be obliged to pay damages, to pay an additional royalty or
damages for access to the inventions covered by claims in issued U.S. patents,
may be subject to such equitable relief as a court may determine (which could
include an injunction) or may be subject to a remedy combining some or all of
the foregoing.
16. PROPOSED MERGER WITH ATRIX LABORATORIES, INC.
On June 14, 2004, the Company and Atrix Laboratories, Inc. signed a definitive
merger agreement, after unanimous approval by the board of directors of both
companies, for QLT to acquire 100% of Atrix's common stock. Atrix is a
pharmaceutical company focused on advanced drug delivery. In the transaction,
Atrix shareholders will receive one common share of QLT and $14.61 in cash for
each share of Atrix common stock. The estimated cash component of this
transaction is approximately $338 million. After the closing of the transaction,
Atrix shareholders will own approximately 25% of the combined entity and QLT
shareholders will own approximately 75%.
On July 13, 2004, the Federal Trade Commission granted early termination of the
waiting period under the Hart-Scott-Rodino Antitrust Improvements Act with
respect to the proposed merger.
On October 14, 2004, the Company's registration statement on Form S-4 filed in
connection with the proposed merger was declared effective by the United States
Securities and Exchange Commission. The proposed merger remains subject to the
approval of stockholders of QLT and Atrix. The QLT shareholder meeting will be
held at 9:00 a.m. (Pacific Time) on November 19, 2004 at QLT's head office at
887 Great Northern Way, Vancouver, British Columbia. Atrix has scheduled a
stockholder meeting at 10:00 a.m. (Mountain Time) on November 19, 2004, to be
held at The Fort Collins Marriott, 350 East Horsetooth Road, Fort Collins,
Colorado. The Company expects the merger to complete before the end of November
16
2004, assuming both companies receive the requisite stockholder approvals.
Alan Mendelson, a member of the Company's board of directors, is a senior
partner of the law firm Latham & Watkins LLP, which has provided the Company
with legal representation regarding the proposed merger. During the three and
nine month periods ended September 30, 2004, the Company incurred legal expenses
in the amount of $0.5 million and $1.0 million respectively (2003 - nominal)
payable to this law firm.
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following information should be read in conjunction with the accompanying
unaudited consolidated financial statements and notes thereto, which are
prepared in accordance with generally accepted accounting principles ("GAAP") in
the United States ("U.S.") and QLT Inc.'s (the "Company" or "QLT") audited
consolidated financial statements and notes thereto included as part of the
Company's 2003 Annual Report on Form 10-K. All amounts following are expressed
in U.S. dollars unless otherwise indicated.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
The following discussion and analysis of financial conditions and results of
operations contains forward-looking statements of the Company, within the
meaning of the Private Securities Litigation Reform Act of 1995, which involve
known and unknown risks, uncertainties and other factors which may cause our
actual results to differ materially from any future results, performance or
achievements expressed or implied by such statements. Forward-looking statements
include, but are not limited to, those with respect to: anticipated levels of
sales of Visudyne(R), including patient and physician demand for Visudyne
therapy, anticipated future operating results, anticipated timing for and
receipt of further reimbursement approvals for Visudyne therapy, the anticipated
outcome of pending patent and securities litigation against QLT, the anticipated
timing and progress of clinical trials, the anticipated timing of regulatory
submissions for expanded uses for Visudyne and for QLT's other products, the
anticipated timing and receipt of regulatory approvals for expanded uses for
Visudyne and for QLT's other products, statements regarding the intentions of
QLT to expand its pipeline through strategic product or technology acquisitions,
and statements regarding our expectations that the merger with Atrix
Laboratories, Inc. will close, our expectations as to the timing of the closing,
and our estimates of cash balances following the closing. These statements are
predictions only and actual events or results may differ materially. Factors
that could cause such actual events or our actual results to differ materially
from any future results expressed or implied by such forward-looking statements
include, but are not limited to, the ability and efforts of QLT's alliance
partner, Novartis Ophthalmics, a division of Novartis Pharma AG, to
commercialize and market Visudyne, the timing and impact of new product launches
by competitors, currency fluctuations in our primary markets may impact our
financial results, the outcome of pending patent litigation against QLT, QLT's
ability to maintain and expand its intellectual property position, the timing
and success of planned or existing clinical trials for Visudyne and QLT's other
products, the outcome of QLT's applications for regulatory approvals for
expanded uses for Visudyne, the risk that the proposed merger with Atrix
Laboratories, Inc. will not be successfully completed or that the businesses
will not be successfully integrated, the risk that, if the merger does proceed,
risk factors relating to the business or products of Atrix will impact the
combined company's results, potential acquisitions or investments in products or
technologies and the successful development or acquisition of complementary or
supplementary products or product candidates, or technologies, as well as the
risk factors described below under the heading Liquidity and Capital Resources -
General, and under "Legal Proceedings", and in the sections outlined in the
Company's most recent Annual Report on Form 10-K under "Business - Risk
Factors", "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and the "Notes to Consolidated Financial Statements", and
in the section entitled "Risk Factors" contained in the joint proxy
statement/prospectus contained in the registration statement on Form S-4 filed
in connection with the proposed Atrix merger. Forward looking statements are
based on our current expectations and QLT does not assume any obligation to
update such information to reflect later developments, except as required by
law.
OVERVIEW
The Company is a global bio-pharmaceutical company dedicated to the discovery,
development and commercialization of innovative therapies to treat eye diseases,
cancer, dermatological and urological conditions. The Company, as the first
developer of an approved photodynamic therapy ("PDT") pharmaceutical product, is
considered a pioneer in the field of PDT. PDT is a minimally invasive medical
procedure utilizing photosensitizers (light-activated drugs) to treat a range of
diseases associated with rapidly growing tissue.
Visudyne, the Company's commercial product, is a photosensitizer for the
treatment of the wet form of age-related macular degeneration ("AMD"). Wet AMD
is the leading cause of severe vision loss in people over the age of 50 in North
America and Europe. Visudyne is marketed through the Company's alliance with
Novartis Ophthalmics and together QLT and Novartis are currently investigating
the use of Visudyne in additional ophthalmologic indications to expand the
existing label. The Company is also pursuing the development of other clinical
candidates in the treatment of benign prostatic hyperplasia ("BPH"), a
progressive condition that results from the excessive benign growth of prostatic
tissue, and androgenetic alopecia (male pattern baldness).
18
In addition to the Company's own research and development programs, the Company
explores opportunities to expand its product pipeline by identifying, evaluating
and acquiring rights to potential products and technologies developed by third
parties, beyond PDT and the field of ophthalmology. The Company also intends to
continue to explore strategic collaborations or acquisitions to facilitate its
development and commercialization efforts. The nature and form of any future
in-licensing or acquisition may have a material impact on the financial
position, share capital and results of operations of the Company.
The Company operates as a single reportable segment. The Company's profitability
depends upon the commercial success of Visudyne in major markets world-wide and
the achievement of product development objectives. Key performance indicators as
viewed by the Company's management include Visudyne sales figures, the Company's
percentage profit share of Visudyne sales by Novartis Ophthalmics, net income
per common share, achievement of product development milestones, and the
obtaining of marketing approvals and reimbursement approvals in additional
jurisdictions. These performance indicators are discussed in the "Results of
Operations" section below. As of September 30, 2004 the Company had retained
earnings of $47.3 million and total shareholders' equity of $518.3 million.
Proposed Merger with Atrix Laboratories, Inc.
On June 14, 2004, the Company and Atrix Laboratories, Inc. signed a definitive
merger agreement, after unanimous approval by the board of directors of both
companies, for QLT to acquire 100% of Atrix's common stock. Atrix is a
pharmaceutical company focused on advanced drug delivery. In the transaction,
Atrix shareholders will receive one common share of QLT and $14.61 in cash for
each share of Atrix common stock. The estimated cash component of this
transaction is approximately $338 million. After the closing of the transaction,
Atrix shareholders will own approximately 25% of the combined entity and QLT
shareholders will own approximately 75%.
On July 13, 2004, the Federal Trade Commission granted early termination of the
waiting period under the Hart-Scott-Rodino Antitrust Improvements Act with
respect to the proposed merger.
On October 14, 2004, the Company's registration statement on Form S-4 filed in
connection with the proposed merger was declared effective by the United States
Securities and Exchange Commission. The proposed merger remains subject to the
approval of stockholders of QLT and Atrix. QLT has scheduled its shareholder
meeting for 9:00 a.m. (Pacific Time) on November 19, 2004, at QLT's head office
at 887 Great Northern Way, Vancouver, British Columbia. Atrix has scheduled its
stockholder meeting at 10:00 a.m. (Mountain Time) on November 19, 2004, at The
Fort Collins Marriott, 350 East Horsetooth Road, Fort Collins, Colorado. The
Company expects the merger to complete before the end of November 2004.
CRITICAL ACCOUNTING POLICIES
In preparing the Company's consolidated financial statements, management is
required to make certain estimates, judgments and assumptions that the Company
believes are reasonable based upon the information available. These estimates
and assumptions affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the periods presented. Significant estimates are used for, but
not limited to, provisions for non-completion of inventory, assessment of the
net realizable value of long-lived assets, accruals for contract manufacturing
and research and development agreements, allocation of costs to manufacturing
under a standard costing system, determination of fair value of assets and
liabilities acquired in purchase business combinations, and provisions for taxes
and contingencies. The significant accounting policies which the Company
believes are the most critical to aid in fully understanding and evaluating its
reported financial results include those which follow:
Reporting Currency and Foreign Currency Translation
The Company uses the U.S. dollar as its reporting currency while retaining the
Canadian dollar as its functional currency. The consolidated financial
statements of the Company are translated into U.S. dollars using the current
rate method. Assets and liabilities are translated at the rate of exchange
prevailing at the balance sheet date. Shareholders' equity is translated at the
applicable historical rates. Revenue and expenses are translated at a weighted
average rate of exchange for the respective periods. Translation gains and
losses are included as part of the cumulative foreign currency translation
adjustment which is reported as a component of shareholders' equity under
accumulated other comprehensive income. Fluctuations in the exchange rate
between the Canadian and U.S dollars can affect the reported value of Canadian
dollar denominated assets and liabilities on the balance sheet. The movement of
the Canadian dollar in relation to the U.S. dollar between September 30, 2004
and December 31, 2003 was a 2.7% improvement. The impact on the Company's
Canadian dollar denominated cash and short-term investments' reported value was
approximately $9.8 million higher.
19
Revenue Recognition
Under the terms of the Company's collaborative agreement with Novartis
Ophthalmics, the Company is responsible for manufacturing and product supply and
Novartis Ophthalmics is responsible for marketing and distribution of Visudyne.
The Company's agreement with Novartis Ophthalmics provides that the calculation
of total revenue for the sale of Visudyne be composed of three components: (1)
an advance on the cost of inventory sold to Novartis Ophthalmics, (2) an amount
equal to 50% of the profit that Novartis Ophthalmics derives from the sale of
Visudyne to end-users, and (3) the reimbursement of other specified costs
incurred and paid for by the Company. The Company recognizes revenue from the
sale of Visudyne when persuasive evidence of an arrangement exists, delivery to
Novartis Ophthalmics has occurred, the end selling price of Visudyne is fixed or
determinable, and collectibility is reasonably assured. The Company is able to
determine the final pricing of Visudyne only upon sell through by Novartis
Ophthalmics to the end customers. The Company's revenue from Visudyne is
impacted by the cost of producing Visudyne, the selling price of Visudyne to end
customers, Visudyne related costs incurred by Novartis Ophthalmics, and
reimbursable costs incurred by the Company.
The Company does not offer rebates or discounts and has not experienced any
material product returns; accordingly, the Company does not provide an allowance
for rebates, discounts and returns.
Cost of Sales
Cost of sales, consisting of expenses related to the production of bulk Visudyne
sold to Novartis Ophthalmics, and royalties on Visudyne sales, are charged
against earnings in the period of the related product sale by Novartis
Ophthalmics to third parties. The Company utilizes a standard costing system,
which includes a reasonable allocation of overhead expenses, to account for
inventory and cost of sales, with adjustments being made periodically to reflect
current conditions. Overhead expenses comprise direct and indirect support
activities related to the manufacture of bulk Visudyne and involve costs
associated with activities such as quality inspection, quality assurance, supply
chain management, safety and regulatory. Overhead expenses are allocated to
inventory during each stage of the manufacturing process under the standard
costing system, and eventually to cost of sales as the related products are sold
by Novartis Ophthalmics to third parties. Variances from standard can occur due
to changes in actual pricing and production volumes. While the Company believes
its standards are reliable, actual production costs and volume changes may
impact inventory, cost of sales, and the absorption of production overheads. The
Company records a provision for the non-completion of product inventory based on
its history of batch completion to provide for the potential failure of
inventory batches to pass quality inspection. The provision is calculated at
each stage of the manufacturing process. The Company estimates its
non-completion rate based on past production and adjusts its provision quarterly
based on actual production volume. A single batch failure may utilize a
significant portion of the provision as one completed batch currently costs
between $0.8 million and $1.7 million, depending on the stage of production.
Stock-Based Compensation
As allowed by SFAS No. 123 "Accounting for Stock-based Compensation" ("SFAS
123"), the Company applies Accounting Principles Board ("APB") Opinion No. 25
and related interpretations in the accounting for employee stock option plans.
SFAS 123 requires that all stock-based awards made to non-employees be measured
and recognized using a fair value based method. The standard encourages the use
of a fair value based method for all awards granted to employees, but only
requires the use of a fair value based method for direct awards of stock, stock
appreciation rights, and awards that call for settlement in cash or other
assets. Estimates of fair value are determined using the Black-Scholes model.
The use of this model requires certain assumptions regarding the volatility,
term, and risk free interest rate experienced by the holder. Awards that a
company has the ability to settle in stock are recorded as equity, whereas
awards that the entity is required to or has a practice of settling in cash are
recorded as liabilities. The Company has adopted the disclosure only provision
for stock options granted to employees and directors, consistent with SFAS 123.
Had the Company adopted a fair value based method for stock-based compensation,
the impact on the Company's net income and net income per common share is as
described in Note 4 in "Notes to the Consolidated Financial Statements".
Research and Development
Research and development costs consist of direct and indirect expenditures,
including a reasonable allocation of overhead expenses, associated with the
Company's various research and development programs. Overhead expenses comprise
general and administrative support provided to the research and development
programs and involve costs associated with support activities such as facility
maintenance, utilities, office services, information technology, legal,
accounting and human resources. Research and development costs are expensed as
incurred. Costs related to the acquisition of
20
development rights for which no alternative use exists are classified as
research and development and expensed as incurred. Patent application, filing
and defense costs are expensed as incurred.
Income Taxes
Income taxes are reported using the asset and liability method, whereby deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases, and operating
loss and tax credit carry forwards using applicable enacted tax rates. An
increase or decrease in these tax rates will increase or decrease the carrying
value of future net tax assets resulting in an increase or decrease to net
income. Income tax credits are included as part of the provision for (recovery
of) income taxes. The realization of the Company's deferred tax assets is
primarily dependent on generating sufficient taxable income prior to expiration
of any loss carry forward balance. Based on the Company's current operations and
anticipated results, the Company believes it is more likely than not to realize
its deferred tax assets. A valuation allowance is provided when it is more
likely than not that a deferred tax asset may not be realized.
RESULTS OF OPERATIONS
For the three months ended September 30, 2004, the Company recorded net income
of $16.7 million, or $0.24 diluted net income per common share. These results
compare to net income of $13.1 million, or $0.19 per common share for the three
months ended September 30, 2003. The increase in net income was primarily due to
strong Visudyne sales performance.
Net income for the nine months ended September 30, 2004 was $55.4 million, or
$0.79 diluted net income per common share, as compared to $35.8 million, or
$0.52 per common share for the nine months ended September 30, 2003. The
increase in net income for the nine months ended September 30, 2004, in
comparison to the nine months ended September 30, 2003, was primarily due to the
extraordinary gain of $10.4 million or $0.15 per common share resulting from the
Kinetek acquisition, and strong Visudyne sales performance.
Revenues
Revenue From Visudyne(R)
The Company's revenue from the sales of Visudyne was determined as follows:
Three months ended Nine months ended
September 30, September 30,
(In thousands of United States dollars) 2004 2003 2004 2003
- --------------------------------------- ---------- ---------- ---------- ----------
Visudyne(R) sales by Novartis Ophthalmics $ 113,954 $ 89,822 $ 324,350 $ 261,082
Less: Marketing and distribution costs (31,452) (24,933) (94,088) (78,457)
Less: Inventory costs (7,020) (5,483) (19,502) (15,821)
Less: Royalties (2,578) (2,009) (7,302) (5,919)
---------- ---------- ---------- ----------
72,904 57,397 203,458 160,885
========== ========== ========== ==========
QLT share of remaining revenue on final sale by
Novartis Ophthalmics (50%) $ 36,452 $ 28,699 $ 101,729 $ 80,442
Add: Inventory costs reimbursed to QLT 5,530 4,430 15,853 12,563
Add: Royalties reimbursed to QLT 2,575 2,005 7,272 5,795
Add: Other costs reimbursed to QLT 1,147 2,024 4,505 4,966
---------- ---------- ---------- ----------
Revenue from Visudyne(R) as reported by QLT 45,704 37,158 129,359 103,767
========== ========== ========== ==========
For the three months ended September 30, 2004, revenue from Visudyne increased
by 23% over the three months ended September 30, 2003. This increase was
primarily due to a 27% increase in Visudyne sales, which resulted from higher
market penetration (21%), favorable exchange rates (5%), and an increase in
average selling prices (1%).
For the nine months ended September 30, 2004, revenue from Visudyne increased by
25% over the nine months ended September 30, 2003. The increase was primarily
due to a 24% increase in Visudyne sales, which resulted from higher market
penetration (17%), favorable exchange rates (6%) and an increase in average
selling prices (1%).
21
For the three months ended September 30, 2004, approximately 50% of total
Visudyne sales by Novartis Ophthalmics were in the United States compared to
approximately 52% for the same period in 2003. Approximately 47% of total
Visudyne sales by Novartis Ophthalmics were in the United States during the nine
month period ended September 30, 2004, compared to 51% for the same period in
2003.
Contract Research and Development Revenue
The Company received non-refundable research and development funding from
Novartis Ophthalmics and Xenova Limited which was recorded as contract research
and development revenue. For the three months ended September 30, 2004, contract
research and development revenue totaled $0.8 million, a decrease of 25% as
compared to the same period in 2003. For the nine months ended September 30,
2004, contract research and development revenue totaled $2.9 million, a decrease
of 17% as compared to the same period in 2003. The decrease for both the
three-month and nine-month periods was primarily due to the elimination of
reimbursements related to the Tariquidar program, and the cessation of the
multiple basal cell carcinoma ("MBCC") program which was previously funded by
Novartis Ophthalmics, partially offset by the Company assuming a higher
proportion of activities on joint Visudyne programs.
COSTS AND EXPENSES
Cost of Sales
For the three months ended September 30, 2004, cost of sales increased 28% to
$7.9 million compared to $6.2 million for the same period in 2003. Cost of sales
for the nine months ended September 30, 2004 increased 26% to $22.3 million
compared to $17.7 million for the same period in 2003. The increase was due
primarily to the increase in Visudyne sales.
Research and Development Costs
Research and development ("R&D") expenditures increased 26% to $12.2 million for
the three months ended September 30, 2004, compared to $9.7 million for the
three months ended September 30, 2003. This increase was primarily the result of
increased spending on integrin-linked kinase ("ILK") research programs and
Lemuteporfin development programs, and timing of the allocation of overhead
expenses. For the nine months ended September 30, 2004, R&D expenditures of
$32.9 million were only $0.2 million higher compared to the same period in 2003.
Higher spending related to ILK research, Lemuteporfin development, and Visudyne
clinical trials were offset by the halting of the Phase III tariquidar trials
and cessation of the MBCC program.
Selling, General and Administrative Expenses
Selling, general and administrative ("SG&A") expenses include overhead expenses
associated with the manufacture of bulk Visudyne. For the three months ended
September 30, 2004, SG&A expenses decreased 19% to $3.0 million compared to $3.7
million for the three months ended September 30, 2003. This decrease was
primarily the result of increased absorption of direct manufacturing overheads
resulting from higher Visudyne production levels, and lower legal fees but
partially offset by higher compensation expenses and costs associated with
initiatives related to section 404 of the Sarbanes-Oxley Act. For the nine
months ended September 30, 2004, SG&A expenses increased 12% to $11.4 million
compared to $10.1 million for the same period in 2003. These increases were
primarily due to unfavorable foreign exchange impact, increased compensation and
recruitment expenses, and costs associated with initiatives related to section
404 of the Sarbanes-Oxley Act, but partially offset by increased absorption of
direct manufacturing overheads resulting from higher Visudyne production levels.
Depreciation Expense
Depreciation expense relates to the depreciation of property and equipment. For
the three months ended September 30, 2004, depreciation expense of $0.8 million
was unchanged compared to the three months ended September 30, 2003. For the
nine months ended September 30, 2004, depreciation expense increased 12% to $2.5
million compared to $2.3 million for the nine months ended September 30, 2003.
The increase was primarily due to the addition of fixed assets from the
acquisition of Kinetek as well as a computer system upgrade completed in late
2003.
22
INVESTMENT AND OTHER INCOME
Net Foreign Exchange Gains
Net foreign exchange gains comprise gains from the impact of foreign exchange
rate fluctuations on the Company's cash and short-term investments, derivative
financial instruments, foreign currency receivables, foreign currency payables
and U.S. dollar denominated long term debt. For the three months ended September
30, 2004, the Company recorded net foreign exchange losses of $0.3 million
versus net foreign exchange gains of $0.4 million in the same period of 2003.
This decrease was due to a charge of $0.4 million related to foreign exchange
options purchased to hedge the cash requirement related to the Atrix
acquisition. Net foreign exchange gains for the nine months ended September 30,
2004 were $0.3 million in comparison to $3.3 million for the same period in
2003. More stable foreign exchange rates during the nine months ended September
30, 2004 resulted in lower gains on foreign exchange contracts as compared to
the same period in 2003. Since the issuance of $172.5 million of U.S. dollar
denominated convertible senior notes in August 2003, the Company has been
targeting to hold an equivalent amount of U.S. cash to offset the impact of
fluctuations in foreign exchange rates (see Liquidity and Capital Resources -
Interest and Foreign Exchange Rates).
Details of the Company's net foreign exchange gains (losses) are as follows:
Three months ended Nine months ended
September 30, September 30,
(In thousands of United States dollars) 2004 2003 2004 2003
- --------------------------------------- ---------- ---------- ---------- ----------
Cash and cash equivalents $ (9,635) $ (5,060) $ (4,465) $ (6,625)
U.S. dollar long-term debt 9,446 5,354 4,813 5,354
Foreign exchange contracts 1,706 (303) 283 6,960
Foreign currency receivables and payables (1,834) 415 (334) (2,369)
---------- ---------- ---------- ----------
Net foreign exchange (losses) gains (317) 406 297 3,320
========== ========== ========== ==========
Interest Income
For the three months ended September 30, 2004, interest income increased 7% to
$2.6 million compared to $2.4 million for the same period in 2003. Interest
income for the nine months ended September 30, 2004 was $7.4 million compared
with $6.1 million for the same period in 2003. This increase was a result of
higher cash reserves from the convertible senior notes and internal cash
generation which more than offset lower average interest rates on investments as
compared to 2003. The Company's treasury policy is focused on minimizing risk of
loss of principal.
Interest Expense
Interest expense of $1.6 million for the three months ended September 30, 2004
and $4.7 million for the nine months ended September 30, 2004 comprised the
interest payment and accrual on the 3% convertible senior notes issued on August
15, 2003, and amortization of deferred financing expenses related to this
placement.
Other Gains
In September 2004, the Company received payment from Axcan Pharma, Inc. of CAD
$2.5 million (USD $1.9 million) for a milestone payment resulting from the
approval in Europe of Photofrin for Barrett's Esophagus. During the same period
in 2003, the Company received the same amount (CAD $2.5 million) from Axcan
Pharma, Inc. for approval in the U.S. of Photofrin for Barrett's Esophagus.
Extraordinary Gain
On March 31, 2004, the Company acquired all the outstanding shares of Kinetek
Pharmaceuticals, Inc. ("Kinetek"), a privately held bio-pharmaceutical company
based in Vancouver, British Columbia, which focused on discovery and development
of new therapies. The extraordinary gain of $10.4 million resulting from this
business acquisition related to the estimated fair value of net assets acquired.
LIQUIDITY AND CAPITAL RESOURCES
23
The Company has financed operations, product development and capital
expenditures primarily through the Company's proceeds from the commercialization
of Visudyne, public and private sales of equity securities, licensing and
collaborative funding arrangements with strategic partners, and interest income.
The primary drivers of the Company's operating cash flows are cash receipts from
Visudyne sales and cash payments related to the following: R&D activities, SG&A
expenses, raw materials purchases and contract manufacturing fees for the
manufacture of Visudyne, interest expense related to the Company's convertible
notes and income tax installments.
For the three months ended September 30, 2004, the Company generated $13.8
million cash from operations as opposed to $26.8 million for the same period in
2003. This decrease is the result of the payment of income tax installments
($5.8 million), increased level of production to replenish inventory ($3.7
million), interest payment related to the convertible notes ($2.6 million) and
higher R&D expenditures ($2.5 million). The payment of cash income tax
installments was the result of the liability for cash taxes in 2004. Previously,
the Company's deferred tax assets (tax losses and other deductions from prior
periods) were sufficient to provide for its income tax provision recognized. The
Company expects to be cash taxable (having utilized the majority of its tax
losses and other tax assets) in 2005 as well. Increased production levels and
the use of cash for replenishing inventory are consistent with the Company's
planned production volumes for 2004 and 2005. The increase in payments for
interest resulted from the timing of payments on the Company's convertible
notes. The timing of such payments affects the cash disbursements on a
semi-annual basis.
Other sources and uses of cash for the three months ended September 30, 2004 are
$0.2 million from stock option exercises, $2.5 million used in the purchase of
property and equipment, and $1.5 million used for the acquisition of Atrix
Laboratories, Inc.
For the nine months ended September 30, 2004, the Company generated $54.9
million of cash from operations as opposed to $51.1 million for the same period
in 2003. This increase is the result of higher cash receipts from Visudyne sales
($111.6 million as opposed to $ 90.8 million in 2003), offset by the payment of
income tax installments of $5.8 million, and interest payments related to the
convertible notes of $5.2 million and $4.0 million less in foreign exchange
contract gains as compared to the same period in 2003. There was no interest
payable on the convertible notes in 2003 as these notes were issued in August of
2003 with the first two scheduled interest payments occurring on March 15 and
September 15 of 2004.
Other sources and uses of cash for the nine months ended September 30, 2004 are:
receipt of $14.0 million from stock option exercises, used $9.4 million in the
purchase of property and equipment primarily related to the Company's pilot
manufacturing facility, $2.3 million used for the purchase of Kinetek
Pharmaceuticals, Inc., and $2.1 million used for the acquisition of Atrix
Laboratories, Inc..
Interest and Foreign Exchange Rates
The Company is exposed to market risk related to changes in interest and foreign
currency exchange rates, each of which could adversely affect the value of the
Company's current assets and liabilities. At September 30, 2004, the Company had
an investment portfolio consisting of fixed interest rate securities with an
average remaining maturity of approximately 25 days. If market interest rates
were to increase immediately and uniformly by 10% of levels at September 30,
2004, the fair value of the portfolio would decline by an immaterial amount.
At September 30, 2004, the Company had $560.9 million in cash and short-term
investments (approximately $174.6 million of which was denominated in U.S.
dollars) and $172.5 million of U.S. dollar denominated debt. If the U.S. dollar
were to decrease in value by 10% against the Canadian dollar, the decline in
fair value of the Company's U.S. dollar denominated cash and short-term
investments will be mostly offset by the decline in the fair value of the
Company's $172.5 million U.S. dollar denominated long-term debt, resulting in an
immaterial amount of unrealized foreign currency translation loss.
The Company uses the U.S. dollar as its reporting currency while retaining the
Canadian dollar as its functional currency. The consolidated financial
statements of the Company are translated into U.S. dollars using the current
rate method. Fluctuation in the exchange rate between the Canadian dollar and
U.S. dollar will result in translation gains and losses which are recorded as
other comprehensive income and included as part of the cumulative foreign
currency translation adjustment within shareholders' equity.
The Company enters into foreign exchange contracts to manage exposures to
currency rate fluctuations related to its expected future net income and cash
flows. The net unrealized gain in respect of such foreign currency contracts,
for the three and nine months ended September 30, 2004, was approximately $2.2
million and $1.5 million (2003 - loss of $1.3 million and gain of $4.2 million
respectively) and were included in the Company's results of operations.
24
The Company purchases goods and services primarily in Canadian and U.S. dollars
and earns a significant portion of its revenues in U.S. dollars and Euros.
Foreign exchange risk is also managed by satisfying U.S. dollar denominated
expenditures with U.S. dollar cash flows or assets.
Contractual Obligations
The Company's material contractual obligations as of September 30, 2004
comprised the Company's long term debt, Visudyne supply agreements with contract
manufacturers, and clinical and development agreements. The Company also has
operating lease commitments for office space and office equipment. Details of
these contractual obligations are described in the Company's 2003 Annual Report
on Form 10-K.
General
On June 14, 2004, the Company and Atrix Laboratories Inc. signed a definitive
merger agreement, after unanimous approval by the board of directors of both
companies, for QLT to acquire 100% of Atrix's common stock. Under the terms of
the agreement, each share of Atrix common stock will be exchanged for one QLT
common share and $14.61 in cash. The estimated cash component of this
transaction is approximately $338 million. The transaction is subject to
approval by the shareholders of both QLT and Atrix at the shareholder meetings
to be held on November 19, 2004. The Company believes that its available cash
resources and working capital are sufficient to fund this acquisition. The
Company expects that it will have combined cash balances of approximately $300
million following the acquisition and believes that these remaining cash
resources, plus working capital and its cash generating capabilities, should be
sufficient to satisfy the funding of product development programs, and other
operating and capital requirements for the reasonably foreseeable future.
The Company's working capital and capital requirements will depend upon numerous
factors, including: the ability of the Company to successfully execute its
integration strategies or achieve planned synergies following the proposed
merger with Atrix; the progress of the Company's preclinical and clinical
testing; fluctuating or increasing manufacturing requirements and R&D programs;
the timing and cost of obtaining regulatory approvals; the levels of resources
that the Company devotes to the development of manufacturing, marketing and
support capabilities; technological advances; new product launches by
competitors; the status of competition; the cost of filing, prosecuting and
enforcing the Company's patent claims and other intellectual property rights;
the ability of the Company to establish collaborative arrangements with other
organizations; and the outcome of legal proceedings.
The Company may require additional capital in the future to fund clinical and
product development costs for certain product applications or other technology
opportunities, and strategic acquisitions of products, product candidates,
technologies or other businesses. Accordingly, the Company may seek funding from
a combination of sources, including product licensing, joint development and new
collaborative arrangements, additional equity and debt financing or from other
sources. No assurance can be given that additional funding will be available or,
if available, on terms acceptable to the Company. If adequate capital is not
available, the Company's business can be materially and adversely affected.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See `Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources'.
ITEM 4. CONTROLS AND PROCEDURES
The Company maintains a set of disclosure controls and procedures designed to
ensure that information required to be disclosed in filings made pursuant to the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified and in accordance with the Securities and
Exchange Commission's rules and forms. The Company's principal executive and
financial officers have evaluated the Company's disclosure controls and
procedures as of the end of the period covered by this report and concluded that
the Company's disclosure controls and procedures were effective in ensuring that
material information relating to the Company was made known to management,
including the Chief Executive Officer and Chief Financial Officer, by others
within the Company during the period in which this report was being prepared. No
change was made to our internal controls over financial reporting in connection
with this evaluation that has materially affected, or is reasonably likely to
materially affect, such internal controls over financial reporting.
25
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Certain of the Company's legal proceedings are discussed below and in Note 13 to
the unaudited consolidated financial statements, "Contingencies". While the
Company believes these proceedings are without merit and intends to vigorously
defend against these claims, it is impossible to predict accurately or determine
the eventual outcome of these proceedings.
Patent Litigation With MEEI
First lawsuit brought by MEEI
In April 2000, Massachusetts Eye and Ear Infirmary ("MEEI") filed a civil suit
complaint against the Company in the United States District Court for the
District of Massachusetts (the "Court") seeking to establish exclusive rights
for MEEI as the owner of certain inventions relating to the use of verteporfin
as the photoactive agent in the treatment of certain eye diseases including AMD.
In 2002 QLT moved for summary judgment against MEEI on all counts of MEEI's
complaint. The Court granted QLT's motions, thus dismissing all of MEEI's claims
in the lawsuit. Final judgment of dismissal was entered in April 2003. In May
2003, MEEI filed a notice of appeal, and QLT filed a notice of cross-appeal with
respect to a contested discovery order entered by the district court. Oral
argument on the appeal and cross-appeal was heard in August 2004. These appeals
are pending before the Court of Appeal for the First Circuit.
The lawsuit relates, in part, to an ongoing dispute involving U.S. Patent No.
5,798,349 (the " '349 Patent") which was issued in 1998 to the Company, MEEI and
Massachusetts General Hospital ("MGH") as co-owners. The complaint alleged
breach of contract, misappropriation of trade secrets, conversion,
misrepresentation, unjust enrichment, unfair trade practices and related claims
and asked that the Court: (i) declare MEEI the owner of certain inventions
claimed in the '349 Patent; (ii) enjoin the Company from infringement of those
claims or any action that would diminish the validity or value of such claims;
(iii) declare that the Company breached an agreement with MEEI to share
equitably in any proceeds derived as a result of collaboration leading to the
'349 Patent; (iv) impose a constructive trust upon the Company for any benefit
that the Company has or will derive as a result of the '349 Patent; and (v)
award MEEI monetary relief for misappropriation of trade secrets in an amount
equal to the greater of MEEI's damages or the Company's profits from any such
misappropriation, and double or treble damages under Massachusetts law.
QLT's counterclaim in this lawsuit requesting correction of inventorship of the
`349 patent to add an additional MGH inventor, was stayed by the Court pending
the outcome of the second MEEI lawsuit described below. QLT voluntarily
dismissed the remainder of its counterclaims in the first lawsuit without
prejudice in April 2003.
Second lawsuit brought by MEEI
In May 2001, the United States Patent Office issued United States Patent No.
6,225,303 (the "'303 Patent") to MEEI. The `303 Patent is derived from the same
patent family as the '349 Patent and claims a method of treating unwanted
choroidal neovasculature in a shortened treatment time using verteporfin. The
patent application which led to the issuance of the `303 patent was filed and
prosecuted by attorneys for MEEI and, in contrast to the '349 patent, named only
MEEI researchers as inventors.
The same day the `303 patent was issued, MEEI commenced a second civil suit
against the Company and Novartis Ophthalmics in the same Court alleging
infringement of the `303 Patent. In the second suit MEEI seeks damages and
injunctive relief for patent infringement and unjust enrichment. The Company has
answered the complaint, denying its material allegations and raising a number of
affirmative defenses, and has asserted counterclaims against MEEI and the two
MEEI researchers who are named as inventors on the `303 patent.
The Company's counterclaim seeks to correct inventorship of the `303 patent by
adding QLT and MGH researchers as joint inventors and asks the court to declare
that QLT and MGH are co-owners of the `303 patent. The counterclaim also
requests a declaration that QLT does not infringe, induce infringement, or
contribute to infringement of the `303 patent, asserting, among other reasons,
that QLT and MGH are rightful co-owners of the patent and QLT has a license from
MGH of MGH's co-ownership rights under the patent. In addition, the counterclaim
seeks a declaratory judgment that the `303
26
patent is invalid and unenforceable and an award of monetary damages for breach
of material transfer agreements governing MEEI's use of verteporfin, based upon
MEEI's failure to notify QLT of MEEI's intent to file the patent application
that led to the issuance of the `303 patent to MEEI.
In November 2001, MGH sought and was granted leave to intervene in the action to
protect its rights in the `303 patent. MGH's complaint in intervention, like
QLT's counterclaim, asks the court to correct inventorship of the `303 patent by
adding QLT and MGH researchers as joint inventors of the inventions claimed in
the patent and by declaring that MGH is a joint owner of those inventions.
In April 2003, QLT moved to dismiss MEEI's claim for unjust enrichment on the
grounds that this claim had been previously decided by a court. The Court
granted QLT's motion on May 28, 2003.
No trial has been scheduled in the second lawsuit, and none is expected until
2005 at the earliest.
The Company believes MEEI's claims in both lawsuits are without merit and
intends to vigorously defend against such actions and any appeals and pursue its
counterclaims. The outcomes of these disputes are not presently determinable or
estimable and there can be no assurance that the matters will be resolved in
favor of the Company. If the lawsuits are not resolved in the Company's favor,
the Company may be obliged to pay damages, to pay an additional royalty or
damages for access to the inventions covered by claims in issued U.S. patents,
may be subject to such equitable relief as a court may determine (which could
include an injunction) or may be subject to a remedy combining some or all of
the foregoing.
27
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES, USE OF PROCEEDS AND ISSUER
PURCHASES OF EQUITY SECURITIES
The following table sets forth information regarding the Company's
purchases of its Common Stock on a monthly basis during the third
quarter of 2004:
Issuer Purchases of Equity Securities
Total Number of
Shares Purchased
as Part of Maximum Number of
Total Number Publicly Shares that May Yet
of Shares Average Price Announced Plans Be Purchased Under
Period Purchased Paid per Share or Programs the Plans or Programs
- ---------------------- ------------ -------------- ---------------- ---------------------
July 1, 2004 through
July 31, 2004 - - - 5,000,000
August 1, 2004 through
August 12, 2004 - - - 5,000,000
---- ----- ------ ---------
Total - - - 5,000,000
==== ===== ====== =========
On August 12, 2004, the share buy-back program announced by the Company
on August 11, 2003 expired. Under that program the Company had the
ability to purchase a maximum of 5,000,000 common shares in the open
market through the facilities of the Toronto Stock Exchange and the
Nasdaq National Market, in accordance with all regulatory requirements,
during the period from August 13, 2003 until August 12, 2004. The
Company did not purchase any of its common shares under the program.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
28
Exhibit
Number Description
------ -----------
31.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002: Paul J. Hastings, President and Chief Executive
Officer;
31.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002: Michael J. Doty, Senior Vice President and Chief
Financial Officer;
32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002: Paul J. Hastings, President and Chief Executive
Officer;
32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002: Michael J. Doty, Senior Vice President and Chief
Financial Officer;
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
QLT INC.
-------------------------------------------------
(Registrant)
Date: November 5, 2004 By: /s/ Paul J. Hastings
-------------------------------------------------
Paul J. Hastings
President and Chief Executive Officer
(Principal Executive Officer)
Date: November 5, 2004 By: /s/ Michael J. Doty
-------------------------------------------------
Michael J. Doty
Senior Vice-President and Chief Financial Officer
(Principal Financial and Accounting Officer)
29
EXHIBIT INDEX
Exhibit
Number Description
------ -----------
31.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002: Paul J. Hastings, President and Chief Executive
Officer;
31.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002: Michael J. Doty, Senior Vice President and Chief
Financial Officer;
32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002: Paul J. Hastings, President and Chief Executive
Officer;
32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002: Michael J. Doty, Senior Vice President and Chief
Financial Officer;
30