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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 March 31, 2005
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 incorporation or organization) (I.R.S. Employer Identification No.)
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 May 6, 2005, the registrant had 93,816,548 outstanding Common Shares and
11,760,585 outstanding Stock Options.
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QLT INC.
QUARTERLY REPORT ON FORM 10-Q
MARCH 31, 2005
TABLE OF CONTENTS
ITEM PART I - FINANCIAL INFORMATION PAGE
- ---- ----
1. FINANCIAL STATEMENTS.............................................................................. 1
Unaudited Consolidated Balance Sheets as of March 31, 2005 and December 31, 2004................ 1
Unaudited Consolidated Statements of Income for the three months ended
March 31, 2005 and March 31, 2004............................................................... 2
Unaudited Consolidated Statements of Cash Flows for the three months ended
March 31, 2005 and March 31, 2004............................................................... 3
Unaudited Consolidated Statement of Changes in Shareholders' Equity and Comprehensive
Income for the three months ended March 31, 2005................................................ 4
Notes to the Consolidated Financial Statements.................................................. 5
2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS............. 26
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK........................................ 36
4. CONTROLS AND PROCEDURES............................................................................ 36
PART II - OTHER INFORMATION
1. LEGAL PROCEEDINGS................................................................................. 37
2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS....................................... 38
3. DEFAULTS UPON SENIOR SECURITIES................................................................... 38
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................................... 38
5. OTHER INFORMATION................................................................................. 38
6. EXHIBITS.......................................................................................... 39
PART I - FINANCIAL INFORMATION
- --------------------------------------------------------------------------------
ITEM 1. FINANCIAL STATEMENTS
QLT INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands of U.S. dollars) MARCH 31, 2005 DECEMBER 31, 2004
- ------------------------------ -------------- -----------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 192,164 $ 277,087
Short-term investment securities 215,837 102,765
Accounts receivable 57,664 56,600
Inventories (Note 3) 41,313 45,899
Current portion of deferred income tax assets 2,291 4,753
Other (Note 4) 14,661 13,521
---------- ----------
523,930 500,625
PROPERTY, PLANT AND EQUIPMENT 80,793 81,674
DEFERRED INCOME TAX ASSETS 5,501 6,926
INTANGIBLES, NET (NOTE 5) 120,101 119,600
GOODWILL 402,518 402,518
OTHER LONG-TERM ASSETS 4,439 4,906
---------- ----------
$1,137,282 $1,116,249
========== ==========
LIABILITIES
CURRENT LIABILITIES
Accounts payable $ 8,336 $ 12,993
Accrued restructuring charge (Note 7) 424 -
Accrued liabilities (Note 6) 16,660 19,528
Current portion of deferred revenue 5,116 2,278
--------- ---------
30,536 34,799
DEFERRED INCOME TAX LIABILITIES 53,022 52,171
DEFERRED REVENUE 3,572 -
LONG-TERM DEBT 172,500 172,500
---------- ----------
259,630 259,470
---------- ----------
CONTINGENCIES (NOTE 13)
SHAREHOLDERS' EQUITY
SHARE CAPITAL (NOTE 8)
Authorized
500,000,000 common shares without par value
5,000,000 first preference shares without par value, issuable in series
Issued and outstanding
Common shares 875,839 848,498
March 31, 2005 - 93,403,359 shares
December 31, 2004 - 92,021,572 shares
ADDITIONAL PAID IN CAPITAL 71,843 92,193
ACCUMULATED DEFICIT (158,538) (173,794)
ACCUMULATED OTHER COMPREHENSIVE INCOME 88,508 89,882
---------- ----------
877,652 856,779
---------- ----------
$1,137,282 $1,116,249
========== ==========
1
QLT INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three months ended
March 31,
--------------------------
(In thousands of U.S. dollars except per share information) 2005 2004
- ----------------------------------------------------------- ------- -------
REVENUES
Net product revenue (Note 9) $57,146 $40,519
Net royalties 3,708 -
Contract research and development (Note 10) 3,036 792
Licensing and milestones 125 -
------- -------
64,015 41,311
------- -------
COSTS AND EXPENSES
Cost of sales 14,490 6,922
Research and development 16,436 9,410
Selling, general and administrative 5,389 4,781
Depreciation 1,734 809
Amortization of intangibles 1,871 -
Restructuring 2,515 -
------- -------
42,435 21,922
------- -------
OPERATING INCOME 21,580 19,389
INVESTMENT AND OTHER INCOME (EXPENSE)
Net foreign exchange gains 584 276
Interest income 2,549 2,482
Interest expense (1,598) (1,528)
------- -------
1,535 1,230
------- -------
INCOME BEFORE INCOME TAXES 23,115 20,619
PROVISION FOR INCOME TAXES (7,859) (6,990)
------- -------
INCOME BEFORE EXTRAORDINARY GAIN $15,256 $13,629
------- -------
EXTRAORDINARY GAIN - 10,393
======= =======
NET INCOME $15,256 $24,022
======= =======
BASIC NET INCOME PER COMMON SHARE
Income before extraordinary gain $ 0.16 $ 0.20
Extraordinary gain - 0.15
------- -------
Net income $ 0.16 $ 0.35
------- -------
DILUTED NET INCOME PER COMMON SHARE
Income before extraordinary gain $ 0.16 $ 0.19
Extraordinary gain - 0.15
------- -------
Net income $ 0.16 $ 0.34
------- -------
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING (THOUSANDS)
Basic 93,325 69,276
Diluted 94,874 69,911
------- -------
2
QLT INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three months ended
March 31,
----------------------
(In thousands of U.S. dollars except per share information) 2005 2004
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 15,256 $ 24,022
Adjustments to reconcile net income to net cash from
operating activities
Amortization of intangibles 1,871 --
Depreciation 1,734 809
Amortization of deferred financing expenses 281 239
Unrealized foreign exchange losses 1,543 2,088
Extraordinary gain -- (10,393)
Deferred income taxes 5,306 6,990
Changes in non-cash operating assets and liabilities
Accounts receivable (7,191) (3,870)
Inventories 4,357 (1,646)
Other current assets (991) 5,643
Accounts payable 494 (911)
Accrued restructuring charge 418 --
Other accrued liabilities (3,839) (8,893)
Deferred revenue 6,398 (1,728)
--------- ---------
25,637 12,350
--------- ---------
CASH USED IN INVESTING ACTIVITIES
Short-term investment securities (110,608) (9,220)
Purchase of property, plant and equipment (2,075) (3,169)
Purchase costs related to Atrix Laboratories, Inc. (1,210) --
Purchase of Kinetek Pharmaceuticals, Inc., net of cash acquired -- (2,316)
--------- ---------
(113,893) (14,705)
--------- ---------
CASH PROVIDED BY FINANCING ACTIVITIES
Long-term debt (net) -- (71)
Issuance of common shares 7,017 11,696
--------- ---------
7,017 11,625
--------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS (3,684) (2,180)
--------- ---------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (84,923) 7,090
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 277,087 262,408
--------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 192,164 $ 269,498
========= =========
SUPPLEMENTARY CASH FLOW INFORMATION:
Interest paid: $ 2,744 $ 3,019
Income taxes paid: 2,568 --
--------- ---------
3
QLT INC.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
Accumulated
Common Shares Additional Other Total
----------------------- Paid-in Comprehensive Accumulated Comprehensive Shareholders'
Shares Amount Capital Income Deficit Income Equity
---------- ---------- ---------- ------------- ----------- ------------- -------------
(All amounts except share and per share information are expressed in thousands of U.S. dollars)
BALANCE AT DECEMBER 31, 2003 68,892,027 $ 395,627 $ -- $ 45,828 $ (8,084) -- $ 433,371
Shares issued for the
acquisition of Atrix
Laboratories, Inc. 22,283,826 436,094 -- -- -- -- 436,094
Assumption of stock options
and warrant on the acquisition
of Atrix Laboratories, Inc. -- -- 93,896 -- -- -- 93,896
Exercise of stock options at
prices ranging from CAD $12.10
to CAD $34.75 per share and
U.S.$5.29 to U.S.$14.23 per
share 845,719 16,777 (1,703) -- -- -- 15,074
OTHER COMPREHENSIVE LOSS:
Cumulative translation
adjustment from application of
U.S. dollar reporting -- -- -- 44,168 $ 44,168 44,168
Unrealized (loss) on available
for sale securities -- -- -- (114) -- (114) (114)
Net loss -- -- -- -- (165,709) (165,709) (165,709)
----------
Comprehensive loss -- -- -- -- -- $ (121,655) --
---------- ---------- ---------- ---------- ---------- ---------- ----------
BALANCE AT DECEMBER 31, 2004 92,021,572 $ 848,498 $ 92,193 $ 89,882(1) $ (173,794) -- $ 856,779
Exercise of stock options at
prices ranging from CAD $17.33
to CAD $20.10 per share and
U.S. $12.19 to U.S. $17.02 per
share 381,787 7,747 (4,146) -- -- -- 3,601
Exercise of warrant at $3.39
U.S. per share 1,000,000 19,594 (16,204) -- -- -- 3,390
OTHER COMPREHENSIVE INCOME:
Cumulative translation
adjustment from application of
U.S. dollar reporting -- -- -- (1,348) -- $ (1,348) (1,348)
Unrealized (loss) on available
for sale securities -- -- -- (26) -- (26) (26)
Net income -- -- -- -- 15,256 15,256 15,256
----------
Comprehensive income -- -- -- -- -- $ 13,882 --
---------- ---------- ---------- ---------- ---------- ---------- ----------
BALANCE AT MARCH 31, 2005 93,403,359 $ 875,839 $ 71,843 $ 88,508(1) $ (158,538) -- $ 877,652
========== ========== ========== ========== ========== ========== ==========
- ------------
(1) At December 31, 2004 and March 31, 2005, our accumulated other
comprehensive income is related almost entirely to cumulative translation
adjustments from the application of U.S. dollar reporting with an
insignificant amount due to unrealized loss on available for sale
securities.
4
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business
We are a global biopharmaceutical company dedicated to the discovery,
development and commercialization of innovative therapies in the fields of
ophthalmology, dermatology, oncology and urology.
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 2004 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 March 31, 2005, and for all
periods presented, have been made. Interim results are not necessarily
indicative of results for a full year.
Principles of Consolidation
These consolidated financial statements include the accounts of QLT Inc. and its
subsidiaries, all of which are wholly owned. The principal subsidiary included
in our consolidated financial statements is QLT USA, Inc., incorporated in the
U.S.. All significant intercompany transactions have been eliminated.
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
We use the U.S. dollar as our reporting currency, while the Canadian dollar is
the functional currency for the parent company and the U.S. dollar is the
functional currency for our U.S. subsidiary. Our consolidated financial
statements 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. Revenues and expenses are translated at a weighted average
rate of exchange for the respective years. 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 (loss).
Cash, Cash Equivalents and Short-term Investment Securities
Cash equivalents include highly liquid investments with insignificant interest
rate risk and original maturities of three months or less at the date of
purchase. Short-term investment securities consist of the following: (a)
investment-grade interest bearing instruments with maturities between three
months and one year at the date of purchase; and (b) auction rate securities,
with auction reset periods less than 12 months, classified as available-for-sale
securities. We report available-for-sale investments at fair value as of each
balance sheet date and include any unrealized holding gains and losses in
shareholders' equity. Due to the short-term maturity of these financial
instruments, all short-term investments are carried at cost plus accrued
interest which approximates their fair value.
We had previously classified auction rate securities as cash and cash
equivalents because of the short duration of their reset periods. These
securities have been reclassified as short-term investment securities to conform
with the current
5
period's presentation. As a result of this reclassification, our December 31,
2004 cash and cash equivalents decreased by $89.0 million to $277.1 million and
correspondingly, our short-term investment securities increased by $89.0 million
to $102.8 million. This reclassification has no impact on previously reported
results of operations or financial covenants and does not affect the reported
cash flows from operating or financing activities for the three months ended
March 31, 2004.
Long-lived and Intangible Assets
Occasionally we incur costs to purchase and construct property, plant and
equipment. The treatment of costs to purchase or construct these assets depends
on the nature of the costs and the stage of construction. Costs incurred in the
initial design and evaluation phase, such as the cost of performing feasibility
studies and evaluating alternatives, are charged to expense. Costs incurred in
the committed project planning and design phase, and in the construction and
installation phase, are capitalized as part of the cost of the asset. We stop
capitalizing costs when an asset is substantially complete and ready for its
intended use. Since 2003, we have been depreciating plant and equipment using
the straight-line method over their estimated economic lives, which range from
3-40 years. Determining the economic lives of plant and equipment requires us to
make significant judgments that can materially impact our operating results.
In accounting for acquisitions, we allocate the purchase price to the fair value
of the acquired tangible and intangible assets, including in-process research
and development, or IPR&D. We generally estimate the value of acquired tangible
and intangible assets and IPR&D using a discounted cash flow model, which
requires us to make assumptions and estimates about, among other things: the
time and investment that is required to develop products and technologies; our
ability to develop and commercialize products before our competitors develop and
commercialize products for the same indications; the amount of revenue to be
derived from the products; and appropriate discount rates to use in the
analysis. Use of different estimates and judgments could yield materially
different results in our analysis, and could result in materially different
asset values and IPR&D charges.
We periodically evaluate our long-lived assets for potential impairment under
SFAS No. 144, Accounting for the Impairment or Disposal of Long-lived Assets. We
perform these evaluations whenever events or changes in circumstances suggest
that the carrying amount of an asset or group of assets is not recoverable. If
impairment recognition criteria in SFAS No. 144 have been met, we charge
impairments of the long-lived assets to operations.
As of March 31, 2005, there was approximately $402.5 million of goodwill and
approximately $120.1 million of net acquired intangibles on our consolidated
balance sheet. We amortize acquired intangible assets using the straight-line
method over their estimated economic lives, which range from 16 to 17 years.
Determining the economic lives of acquired intangible assets requires us to make
significant judgments and estimates, and can materially impact our operating
results.
Goodwill Impairment
In accordance with Statement of Financial Accounting Standard, or SFAS No. 142,
Goodwill and Other Intangibles, we are required to perform impairment tests
annually or whenever events or changes in circumstances suggest that the
carrying value of an asset may not be recoverable. Assumptions and estimates
were made at the time of acquisition of Atrix Laboratories Inc. (Note 2 -
"Business Combinations") specifically regarding product development, market
conditions and cash flows that were used to determine the valuation of goodwill
and intangibles. Impairment tests in future periods may result in changes in
forecasts and estimates from those used at the acquisition date, resulting in
impairment charges.
Revenue Recognition
Net Product Revenue
Our net product revenues are primarily derived from sales of Visudyne and
Eligard.
With respect to Visudyne, under the terms of our collaborative agreement with
Novartis Ophthalmics, a division of Novartis Pharma AG, we are responsible for
Visudyne manufacturing and product supply and Novartis Ophthalmics is
responsible for marketing and distribution of Visudyne. Our agreement with
Novartis Ophthalmics provides that the calculation of total revenue from 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 us (See
Note 9 - "Net Product Revenue"). We recognize 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
sales of Visudyne, this occurs upon "sell through" of Visudyne to the end
customers.
6
With respect to Eligard, under the terms of our collaborative agreements with
our marketing partners, we are responsible for the manufacture of Eligard and
receive from our marketing partners an agreed upon sales price upon shipment to
them. (We also earn royalties from certain marketing partners based upon their
sales of Eligard products to end customers, which royalties were reported as net
royalty revenue.) We recognize net sales revenue from product sales when
persuasive evidence of an arrangement exists, product is shipped and title is
transferred to our marketing partners, collectibility is reasonably assured and
the price is fixed or determinable. Our Eligard marketing partners are
responsible for all products after shipment from our facility. Under this
calculation of revenue, we recognize net product revenue from Eligard at the
time of shipment to our marketing partners.
We do not offer rebates or discounts and have not experienced any material
product returns; accordingly, we do not provide an allowance for rebates,
discounts, and returns.
Net Royalties
We recognize net royalties when product is shipped by certain marketing partners
to end customers based on royalty rates and formulas specified in our agreements
with them. Generally, royalties are based on estimated net product sales (gross
sales less discounts, allowances and other items) based on information supplied
to us by our marketing partners.
Contract Research and Development
Contract research and development revenues consist of non-refundable research
and development funding under collaborative agreements with our various
strategic partners. Contract research and development funding generally
compensates us for discovery, preclinical and clinical expenses related to the
collaborative development programs for certain products and product candidates,
and is recognized as revenue at the time research and development activities are
performed under the terms of the collaborative agreements. For fixed price
contracts, we recognize contract research and development revenue over the term
of the agreement, which is consistent with the pattern of work performed.
Amounts received under the collaborative agreements are non-refundable even if
the research and development efforts performed by us do not eventually result in
a commercial product. Contract research and development revenues earned in
excess of payments received are classified as contract research and development
receivables and payments received in advance of revenue recognition are recorded
as deferred revenue. (See Note 10 - "Contract Research and Development".)
Licensing and Milestones
We have licensing agreements that generally provide for non-refundable license
fees and/or milestone payments. The licensing agreements typically require a
non-refundable license fee and allow our partners to sell our proprietary
products in a defined territory for a defined period. Non-refundable license
fees are initially reported as deferred revenue and recognized as licensing
revenue over the remaining contractual term or as covered by patent protection,
whichever is earlier, using the straight-line method or until the agreement is
terminated. A milestone payment is a payment made by a partner to us upon the
achievement of a pre-determined event, as defined in the applicable agreement.
Milestone payments are initially reported as deferred revenue and subsequently
recognized using the straight-line method over the remaining contractual term or
the remaining period covered by patent protection, whichever is earlier. No
milestone revenue is recognized until we have completed the required
milestone-related services as set forth in licensing agreements.
Cost of Sales
Visudyne cost of sales, consisting of expenses related to the production of bulk
Visudyne and royalty expense on Visudyne sales, are charged against earnings in
the period that Novartis Ophthalmics sells to third parties. Cost of sales
related to the production of various Eligard, generic dermatology, and dental
products are charged against earnings in the period of the related product sale
to our marketing partners. We utilize 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, various Eligard, generic dermatology, and dental
products and involve costs associated with activities such as quality
inspection, quality assurance, supply chain management, safety and regulatory.
Overhead expenses are allocated to inventory at various stages of the
manufacturing process under a standard costing system, and eventually to cost of
sales as the related products are sold to our marketing partners or, in the case
of Visudyne, by Novartis Ophthalmics to third parties. We record a provision for
the non-completion of product inventory based on our history of batch completion
and provide a reserve for
7
obsolescence of our Eligard inventory and component materials based on our
periodic evaluation of potential obsolete inventory.
Stock-Based Compensation
As allowed by SFAS 123, Accounting for Stock-based Compensation, or SFAS 123, we
apply Accounting Principles Board, or 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. We have 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 per common
share had we recognized stock-based compensation using a fair value based
accounting method:
Three months Three months
(In thousands of U.S. dollars except ended March 31, ended March 31,
per share information) 2005 2004
(Unaudited)
- ---------------------------------------- --------------- ---------------
Net income
As reported $ 15,256 $ 24,022
Add: Employee stock option expense -- --
Less: Additional stock-based compensation
expense under the fair value method (2,214) (3,270)
-------- --------
Pro forma $ 13,042 $ 20,752
======== ========
Basic net income per common share
As reported $ 0.16 $ 0.35
Pro forma 0.14 0.30
-------- --------
Diluted net income per share
As reported $ 0.16 $ 0.34
Pro forma 0.14 0.30
-------- --------
The pro forma amounts may not be representative of future disclosures since the
estimated fair value of stock options is amortized to expense over the vesting
period and additional options may be granted in future periods.
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. We use
projected data for expected volatility and expected life of our stock options
based upon historical and other economic data trended into future years. Because
our 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 may not provide a realistic measure of the fair value of our
employee stock options.
The weighted average fair value of stock options granted for the three months
ended March 31, 2005 was CAD $4.78 and U.S. $4.00 whereas the fair value of
stock options granted in the three months ended March 31, 2004 was valued at CAD
$9.19. We used the Black-Scholes option pricing model to estimate the value of
the options at each grant date, using the following weighted value average
assumptions:
Three months ended Three months ended
March 31, 2005 March 31, 2004
------------------ ------------------
Annualized volatility 46.7% 56.6%
Risk-free interest rate 3.4% 2.9%
Expected life (years) 2.5 2.5
In March 2005, our Board of Directors approved a Directors' Deferred Share Unit
Plan (the "DDSU Plan") for non-employee directors. Under the DDSU Plan, at the
discretion of the Board of Directors, non-employee directors can receive all or
a percentage of the equity-based compensation in the form of deferred share
units ("DSU's"), each of which has a value equal to the closing price of QLT's
common shares on the Toronto Stock Exchange on the date of
8
grant. A DSU is convertible into cash only (no shares are issued), and can only
be converted after the non-employee director ceases to be a member of the Board.
The DSU's will vest monthly over 36 months from the date of grant. The value of
a DSU, when converted to cash, will be equivalent to the market value of a QLT
common share at the time the conversion takes place. The obligations are accrued
on a graded vesting basis and represent the market value of QLT's common shares.
The obligations are revalued each reporting period based on the changes in the
graded vested amount of options outstanding and changes in the market value of
QLT's common shares, and recorded as compensation expense.
Research and Development
Research and development costs consist of direct and indirect expenditures,
including a reasonable allocation of overhead expenses, associated with our
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 income taxes.
Legal Proceedings
We are involved in a number of legal actions, the outcomes of which are not
within our complete control and may not be known for prolonged periods of time.
In these legal actions, the claimants seek damages, as well as other relief,
which, if granted, would require significant expenditures. We record a liability
in the consolidated financial statements for these actions when a loss is known
or considered probable and the amount can be reasonably estimated. If the loss
is not probable or cannot be reasonably estimated, a liability is not recorded
in the consolidated financial statements. Our material legal proceedings are
discussed in Note 13 to the consolidated financial statements.
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,
warrants and convertible debt. In addition, the related interest and
amortization of deferred financing fees on convertible debt, when dilutive, (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:
9
(In thousands of U.S. dollars, except per share data) Three months ended Three months ended
(Unaudited) March 31, 2005 March 31, 2004
- ----------------------------------------------------- ------------------ ------------------
Numerator:
Income before extraordinary gain $ 15,256 $ 13,629
Extraordinary gain -- 10,393
-------- --------
Net income $ 15,256 $ 24,022
Effect of dilutive securities:
Convertible senior notes - interest expense -- --
-------- --------
Adjusted income $ 15,256 $ 24,022
======== ========
Denominator: (thousands)
Weighted average common shares outstanding 93,325 69,276
Effect of dilutive securities:
Stock options 1,549 635
Warrant -- --
Convertible senior notes -- --
-------- --------
Diluted potential common shares 1,549 635
-------- --------
Diluted weighted average common shares outstanding 94,874 69,911
======== ========
Basic net income per common share
Income before extraordinary gain $ 0.16 $ 0.20
Extraordinary gain -- 0.15
-------- --------
Net income $ 0.16 $ 0.35
======== ========
Diluted net income per common share
Income before extraordinary gain $ 0.16 $ 0.19
Extraordinary gain -- 0.15
-------- --------
Net income $ 0.16 $ 0.34
======== ========
Excluded from the calculation of diluted net income per common share for the
three months ended March 31, 2005 were 9,692,637 shares related to the
conversion of the $ 172.5 million 3% convertible senior notes and 6,694,156
shares related to stock options because their effect was anti-dilutive. For the
three months ended March 31, 2004, excluded from the calculation of diluted net
income per common share were 9,692,637 shares related to the conversion of the $
172.5 million 3% convertible senior notes and 5,513,243 shares related to 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. Previously, the
potential dilutive effect of the conversion feature was excluded from diluted
earnings per share until the contingent feature was met. Issue No. 04-08 results
in contingently convertible debt instruments being included in diluted earnings
per share computations regardless of whether the 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 has resulted in our diluted
earnings per share calculation including the dilutive effect of contingently
convertible debt when the effect is dilutive. Prior period diluted earnings per
share amounts presented for comparative purposes have not been restated to
conform to this consensus, because the effect of approximately 9,692,637 shares
related to the conversion of the $172.5 million 3% convertible senior notes was
anti-dilutive.
In November 2004, the FASB issued SFAS 151, Inventory Costs an amendment of ARB
No. 43, Chapter 4. This Statement amends the guidance in ARB No.43, Chapter 4,
"Inventory Pricing," to clarify that abnormal amounts of idle facility expense,
freight, handling costs, and wasted material (spoilage) be treated as current
period charges. In addition, this Statement requires that the allocation of
fixed production overheads to the costs of conversion be based on the normal
capacity of the production facilities during periods of below normal production.
Our consolidated financial statements comply with the requirements of SFAS No.
151.
In December 2004, FASB issued SFAS 123, Revised Share-Based Payment, or SFAS
123R. The statement eliminates the alternative to account for stock-based
compensation using APB 25 and requires such transactions be recognized as
compensation expense in the statement of earnings based on their fair values on
the date of the grant, with the compensation expense recognized over the period
in which a grantee is required to provide service in exchange for the stock
award. In April 2005, the United States Securities and Exchange Commission
amended the date for compliance
10
with SFAS 123R to be the first interim period of the first fiscal year
beginning on or after June 15, 2005. We intend to adopt this statement on
January 1, 2006 using a modified prospective application. As such, the
compensation expense recognition provisions will apply to new awards and to any
awards modified, repurchased or cancelled after the adoption date. Additionally,
for any unvested awards outstanding at the adoption date, we will recognize
compensation expense over the remaining vesting period.
We have begun, but have not yet completed, evaluating the impact of adopting
SFAS 123R on our results of operations. We currently determine the fair value of
stock-based compensation using a Black-Scholes option pricing model. In
connection with evaluating the impact of adopting SFAS 123R, we are also
considering the potential implementation of different valuation models to
determine the fair value of stock-based compensation, although no decision has
yet been made. However, we do believe the adoption of SFAS 123R may have a
material impact on our results of operations, regardless of the valuation
technique used.
2. BUSINESS COMBINATIONS
ACQUISITION OF ATRIX LABORATORIES, INC.
In November 2004, we completed our acquisition of Atrix Laboratories, Inc., or
Atrix, a biopharmaceutical company focused on advanced drug delivery. Each
outstanding share of Atrix common stock was converted into one QLT Inc. common
share and $14.61 in cash. In addition, each option to purchase Atrix common
stock that was outstanding at the closing of the acquisition was assumed by us.
The results of operations of Atrix were 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 aggregate consideration for the acquisition of Atrix was $870.5 million,
which included $325.6 million in cash, acquisition related expenditures of $15.0
million, and the issuance of 22.3 million common shares of QLT Inc. In
connection with the acquisition, we also assumed all of the outstanding options
and warrants to purchase Atrix common shares and exchanged them for options to
purchase our common shares. The total consideration paid for Atrix, including
acquisition costs, was allocated based on management's preliminary assessment as
to the estimated fair values on the acquisition date. This preliminary
assessment is subject to change upon the final determination of the fair value
of the assets acquired and liabilities assumed.
ACQUISITION OF KINETEK PHARMACEUTICALS, INC.
On March 31, 2004, we acquired all the outstanding shares of Kinetek
Pharmaceuticals, Inc., or Kinetek, a privately held biopharmaceutical company
based in Vancouver, British Columbia that focused on discovery and development
of new targets and therapies. The results of operations of Kinetek were 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. We paid an aggregate cash purchase price of
$2.4 million, which included acquisition related expenditures of $0.1 million.
The extraordinary gain of $10.4 million 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 us. On July 1,
2004, Kinetek was amalgamated with QLT and ceased to exist as a separate legal
entity.
3. INVENTORIES
(In thousands of U.S. dollars) March 31, 2005 December 31, 2004
- ------------------------------------------------- -------------- -----------------
(Unaudited)
Raw materials and supplies $ 13,917 $ 14,340
Work-in-process 26,306 30,864
Finished goods 3,092 2,152
Provision for obsolete inventory (47) --
Provision for non-completion of product inventory (1,955) (1,457)
-------- --------
$ 41,313 $ 45,899
======== ========
11
We record 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 March 31,2005, we incurred charges to the
provision for non-completion of $0.4 million.
4. OTHER CURRENT ASSETS
(In thousands of U.S. dollars) March 31, 2005 December 31, 2004
- ---------------------------------------------------------- -------------- -----------------
(Unaudited)
Visudyne inventory in transit held by Novartis Ophthalmics $ 7,769 $ 8,981
Foreign exchange contracts 1,290 1,874
Prepaid expenses and other 5,602 2,666
-------- --------
$ 14,661 $ 13,521
======== ========
Inventory in transit comprises finished goods that have been shipped to and are
held by Novartis Ophthalmics. Under the terms of our collaborative agreement,
upon delivery of inventory to Novartis Ophthalmics, we are entitled to an
advance equal to our 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.
5. INTANGIBLES, NET
Intangible assets subject to amortization consisted of the following:
March 31, 2005 December 31, 2004
-------------- -----------------
Accumulated Net Book Net Book
(In thousands of U.S. dollars) Cost Amortization Value Value
- ------------------------------- -------- ------------ -------- --------
(Unaudited)
Developed technology, net $114,753 $ 2,482 $112,271 $111,653
Trademark 8,000 170 7,830 7,947
-------- -------- -------- --------
$122,753 $ 2,652 $120,101 $119,600
======== ======== ======== ========
Developed technology, net consisted of the portion of the purchase price from
the acquisition of Atrix which related to FDA-approved products comprising
certain Eligard, dermatology and dental products, net of estimated legal fees to
defend the technology. Developed technology is being amortized on a
straight-line basis over its estimated useful live of 16 years.
Trademark consists of the portion of the purchase price from the acquisition of
Atrix which relates to the Eligard trademark. The Eligard trademark is being
amortized on a straight-line basis over its estimated useful live of 17 years.
Our expected annual amortization related to our intangible assets for the next
five years is approximately $8.0 million per year.
12
6. ACCRUED LIABILITIES
(In thousands of U.S. dollars) March 31, 2005 December 31, 2004
- ----------------------------- -------------- -----------------
(Unaudited)
Royalties $ 2,737 $ 3,158
Compensation 6,298 7,633
Marketing partners 3,041 2,992
Foreign exchange contracts 159 2,222
Atrix acquisition costs 239 714
Interest 377 1,745
Inventory in transit 2,043 -
Other 1,766 1,064
-------- --------
$ 16,660 $ 19,528
======== ========
7. RESTRUCTURING CHARGE
In the three months ended March 31, 2005, we restructured our operations
following the acquisition of Atrix. We reduced our overall headcount by over 50
people. We provided affected employees with severance and support to assist with
outplacement. As a result, we recorded a $2.5 million restructuring charge in
the three months ended March 31, 2005 related to severance and termination
costs. We expect to complete final activities associated with the restructuring
in 2005. The details are as follows:
Remaining
accrual at
Restructuring March 31,
(In thousands of U. S. dollars) charge Cash paid 2005
- ------------------------------------------ ------------- --------- ----------
(Unaudited)
Severance and termination benefits accrued $ 2,347 $(2,036) $ 311
Other related expenses accrued 168 (55) 113
------- ------- -------
$ 2,515 $(2,091) $ 424
======= ======= =======
8. SHARE CAPITAL
(a) Share Buy-Back Program
On April 28, 2005, we announced a share buy-back program pursuant to which
we may purchase up to $50 million of our common shares over a two-year
period. The share purchases would be made as a normal course issuer bid.
All purchases would be effected in the open market through the facilities
of The Toronto Stock Exchange and the NASDAQ Stock Market, in accordance
with all regulatory requirements. During the one-year period commencing May
4, 2005, we may purchase for cancellation up to 4,690,752 common shares,
being 5% of the number of common shares outstanding. The actual number of
common shares which may be purchased and the timing of any such purchases
will be determined by management.
(b) Directors' Deferred Share Unit Plan
In March 2005, our Board of Directors approved a DDSU Plan for non-employee
directors. Under the DDSU Plan, at the discretion of the Board of
Directors, non-employee directors can receive all or a percentage of the
equity-based compensation in the form of DSU's, each of which has a value
equal to the closing price of QLT's common shares on the Toronto Stock
Exchange on the date of grant. A DSU is convertible into cash only (no
shares are issued), and can only be converted after the non-employee
director ceases to be a member of the Board. The DSU's will vest monthly
over 36 months from the date of grant. The value of a DSU, when converted
to cash, will be equivalent to the market value of a QLT common share at
the time the conversion takes place. Under the DDSU Plan, in March 2005,
non-employee directors of the Board were granted a total of 67,500 DSU's.
The grant of DSU's in 2005 was made in lieu of the annual stock option
grant to non-employee directors.
(c) Stock Options
13
Stock option activity with respect to our 1998 Plan and 2000 Plan is
presented below:
Exercise Price
(In Canadian dollars) Number of Options Per Share Range
-------------------------------- ----------------- ---------------
Outstanding at December 31, 2004 6,430,398 $12.10 - 108.60
From January 1 to March 31, 2005
Granted 804,200 $15.02 - 20.75
Exercised (13,110) $17.33 - 20.10
Cancelled (910,321) $12.10 - 108.60
--------- ---------------
Outstanding at March 31, 2005 6,311,167 $12.10 - 108.60
--------- ---------------
Stock option activity with respect to all other Company option plans is
presented below:
Exercise Price
(In U.S. dollars) Number of Options Per Share Range
-------------------------------- ----------------- ---------------
Outstanding at December 31, 2004 5,970,865 $ 2.63 - 17.82
Granted 332,500 $12.37 - 12.37
Exercised (368,677) $ 2.89 - 16.22
Cancelled -- --
--------- --------------
Outstanding at March 31, 2005 5,934,688 $ 2.63 - 17.82
--------- --------------
Additional information relating to stock options outstanding under the 1998
Plan and the 2000 Plan as of March 31, 2005, is presented below:
(In Canadian dollars) Options Outstanding Options Exercisable
--------------------- ------------------------------------------- ---------------------------
Weighted
Average
Weighted Remaining Weighted
Number of Average Contractual Number of Average
Price Range Options Exercise Price Life (Years) Options Exercise Price
--------------- --------- -------------- ------------ --------- --------------
Under $17.50 1,549,528 $ 14.27 3.97 490,097 $ 13.49
$17.51 - $25.00 764,177 22.20 2.34 670,397 22.37
$25.01 - $37.50 1,618,426 32.23 2.70 1,073,716 31.99
$37.51 - $50.00 1,680,669 39.43 1.15 1,680,669 39.43
Over $50.00 698,367 105.87 0.35 694,867 106.00
--------- ---------
6,311,167 4,609,746
========= =========
Additional information relating to stock options outstanding under all
other Company option plans as of March 31, 2005, is presented below:
14
(In U.S. dollars) Options Outstanding Options Exercisable
----------------- ------------------------------------------- ---------------------------
Weighted
Average
Weighted Remaining Weighted
Number of Average Contractual Number of Average
Price Range Options Exercise Price Life (Years) Options Exercise Price
----------------- --------- -------------- ------------ --------- --------------
Under $5.00 342,299 $ 3.53 5.69 342,299 $3.53
$5.01 - $7.50 457,780 5.68 4.99 457,780 5.68
$7.51 - $10.00 1,328,177 8.71 7.04 1,328,177 8.71
$10.01 - $12.50 1,177,991 11.80 6.84 845,491 11.58
$12.51 - $15.00 695,924 13.53 7.36 695,924 13.53
$15.01 - $17.82 1,932,517 16.28 9.10 1,932,517 16.28
--------- ---------
5,934,688 5,602,188
========= =========
(d) Warrant
As part of our acquisition of Atrix, on November 19, 2004 we assumed an
outstanding warrant entitling the holder to purchase up to 1,000,000 of our
common shares at a net exercise price of $3.39 per share. The warrant was
exercised during the three months ended March 31, 2005.
9. NET PRODUCT REVENUE
Net product revenue was determined as follows:
Three months ended Three months ended
(In thousands of U.S. dollars) March 31, 2005 March 31, 2004
--------------------------------------------------------- ------------------ ------------------
(Unaudited)
Visudyne(R) sales by Novartis Ophthalmics $ 123,744 $ 101,056
Less: Marketing and distribution costs (32,583) (29,279)
Less: Inventory costs (6,312) (5,261)
Less: Royalties (2,754) (2,262)
--------- ---------
$ 82,095 $ 64,254
========= =========
QLT share of remaining revenue on final sales by Novartis
Ophthalmics (50%) $ 41,048 $ 32,127
Add: Inventory costs reimbursed to QLT 5,072 4,555
Add: Royalties reimbursed to QLT 2,699 2,240
Add: Other costs reimbursed to QLT 1,132 1,597
--------- ---------
Revenue from Visudyne(R) as reported by QLT $ 49,951 $ 40,519
Net product revenue from Eligard(R) and other products 7,195 --
--------- ---------
$ 57,146 $ 40,519
========= =========
For the three months ended March 31, 2005, approximately 41% (three months ended
March 31, 2004 - 45%) of total Visudyne sales were in the U.S., with Europe and
other markets responsible for the remaining 59% (three months ended March 1,
2004 - 55%).
As a result of our acquisition of Atrix in November 2004, our net product
revenue for the three months ended March 31, 2005 included $ 7.2 million of
revenue from Eligard and other products.
10. CONTRACT RESEARCH AND DEVELOPMENT
We received non-refundable research and development funding from our strategic
partners, which was recorded as contract research and development revenue.
Details of our contract research and development revenue were as follows:
15
Three months ended Three months ended
(In thousands of U.S. dollars) March 31, 2005 March 31, 2004
----------------------------------------- ------------------ ------------------
(Unaudited)
Visudyne(R) ocular programs $ 467 $ 792
Eligard(R) programs 486 --
Aczone(TM) dermatology programs 1,213 --
Others 870 --
------- -------
Contract research and development revenue $ 3,036 $ 792
======= =======
11. FINANCIAL INSTRUMENTS AND CONCENTRATION OF CREDIT RISK
As at March 31, 2005 and December 31, 2004, the carrying amounts for our cash
and cash equivalents, short-term investment securities, accounts receivable, and
accounts payable approximated fair value due to the short-term maturity of these
financial instruments. Our investment in common shares of Diomed Holdings Inc.
is carried at fair value based on quoted market prices. Our long-term debt
comprises $172.5 million aggregate principal amount of convertible senior notes
and had a fair value of $172.3 million as of March 31, 2005 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.
With respect to the concentration of credit risk, our accounts receivable, as at
March 31, 2005 and December 31, 2004, comprised primarily aggregate amounts
owing from Novartis Ophthalmics.
We purchase goods and services primarily in Canadian ("CAD") and U.S. dollars
("USD"), and earn most of our revenues in U.S. dollars and Euros ("EUR"). We
enter into foreign exchange contracts to manage exposure to currency rate
fluctuations related to our expected future net income (primarily in U.S.
dollars and Euros) and cash flows (in U.S. dollars and Swiss francs ("CHF")). We
are exposed to credit risk in the event of non-performance by counterparties in
connection with these foreign exchange contracts. We mitigate this risk by
transacting with a diverse group of financially sound counterparties and,
accordingly, do 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 March 31, 2005, was approximately $1.3
million, which was included in our results of operations. At March 31, 2005, we
have outstanding forward foreign currency contracts as noted below.
Maturity Period Quantity (millions) Average Price
- ------------------------------------------ --------------- ------------------- ---------------
U.S. / Canadian dollar option-dated
forward contracts 2005 - 2006 USD 78.8 1.21260 per USD
Swiss franc / Canadian dollar option-dated
forward contracts 2005 - 2006 CHF 115.4 1.04708 per CHF
Canadian dollar / Swiss franc average rate
forward contracts 2005 CAD 13.4 1.04402 per CHF
Canadian dollar/ U.S. dollar average rate
forward contracts 2005 CAD 119.1 1.21307 per USD
Australian dollar (AUD) / Swiss franc
average rate forward contracts 2005 AUD 5.9 0.87123 per AUD
Euro / Swiss franc average rate
forward contracts 2005 EUR 34.3 1.53220 per EUR
U.S. dollar / Swiss franc average rate
forward contracts 2005 USD 3.2 1.16038 per USD
Great Britain pound (GBP) / Swiss franc
average rate forward contracts 2005 GBP 2.9 2.15783 per GBP
Japanese yen (JPY) / Swiss franc
average rate forward contracts 2005 JPY 403.9 0.01135 per JPY
----------- --------- ---------------
16
12. SEGMENTED INFORMATION
Details of our revenues by product category are as follows:
Revenues
Three months ended
March 31,
-------------------------
(In thousands of U.S. dollars) 2005 2004
- --------------------------------- -------- --------
(Unaudited)
Net product revenue and royalties
Visudyne(R) $ 49,951 $ 40,519
Eligard(R) 9,061 --
Generic dermatology products 1,175 --
Dental products 667 --
Contract research and development 3,036 792
Licensing and milestones 125 --
-------- --------
$ 64,015 $ 41,311
======== ========
Details of our revenues and property, plant and equipment by geographic segments
are as follows:
Revenues(1)
Three months ended
March 31,
-------------------------
(In thousands of U.S. dollars) 2005 2004
- ----------------------------- -------- --------
(Unaudited)
U.S. $ 34,702 $ 21,803
Europe 20,692 15,761
Canada 3,570 2,120
Other 5,051 1,627
-------- --------
$ 64,015 $ 41,311
======== ========
Property, plant and equipment
March 31, December 31,
(In thousands of U.S. dollars) 2005 2004
- ----------------------------- --------- ------------
(Unaudited)
Canada $ 53,641 $ 54,152
U.S. 27,152 27,523
-------- --------
$ 80,793 $ 81,674
======== ========
- ------------
(1) Revenues are attributable to a geographic segment based on the location of:
(a) the customer, for net product revenue and royalties; and (b) the head
office of the collaborative partner, in the case of revenues from contract
research and development and collaborative arrangements.
13. CONTINGENCIES
(A) TAP LITIGATION
In 2003, TAP Pharmaceutical Products, Inc., Takeda Chemical Industries Ltd.
and Wako Pure Chemical Industries, Ltd. filed suit against us, in a U.S.
federal court in the Northern District of Illinois Eastern Division,
alleging that the Eligard(R) delivery system infringes a
17
patent (U.S. Patent No.4,728,721) licensed to TAP Pharmaceuticals by the
two other plaintiffs. The patent expires on May 1, 2006. In March 2004, the
court granted our motion to stay the patent infringement suit, pending the
outcome of re-examination of the patent-in-suit by the U.S. Patent and
Trademark Office. The plaintiffs filed a motion seeking reconsideration of
the stay order, but the motion was denied. TAP Pharmaceuticals requested
that it be allowed to file a motion for preliminary injunction, and the
court denied that request. The court lifted the stay on November 16, 2004
following the conclusion of the re-examination proceedings. The judge has
not yet set a trial date. If this lawsuit is not resolved in our favor, we
may be enjoined from selling some or all of our Eligard(R) products until
the patent expires in 2006, and/or may be required to pay financial
damages, which could be substantial.
On June 21, 2004, Takeda Chemical Industries Ltd., Wako Pure Chemical
Industries, Ltd. and Takeda Pharma GmbH filed a Request for Issuance of a
Provisional Injunction against MediGene AG and Yamanouchi Pharma GmbH in
the Regional Court Hamburg, the Federal Republic of Germany. The request
alleged that MediGene AG and Yamanouchi Pharma GmbH infringe a German
patent, EP 0 202 065, and sought an injunction preventing defendants from
producing, offering putting on the market or using, or importing or
possessing for these purposes, in the Federal Republic of Germany a solvent
for preparing an injectable solution containing a polymer claimed in EP 0
202 065. On July 26, 2004, the Court denied the plaintiff's request for a
Provisional Injunction.
On June 28, 2004, Takeda Chemical Industries Ltd., Wako Pure Chemical
Industries, Ltd. and Takeda GmbH (collectively referred to as the
"Plaintiffs") filed a complaint in the Regional Court Dusseldorf, the
Federal Republic of Germany, against MediGene AG and Yamanouchi Pharma GmbH
alleging infringement of the same patent. Previously, on June 1, 2004,
MediGene AG filed an action in the Federal Patent Court in Munich, Germany
seeking the nullification of the patent that is the subject of the June 28,
2004 complaint. On April 20, 2005 the Federal Patent Court ruled that all
of the claims asserted by the Plaintiffs in the infringement suit are null
and void in Germany on the grounds of lack of novelty. The Plaintiffs have
a right of appeal from this decision. The Regional Court Dusseldorf has
stayed the infringement action in view of the Federal Patent Court's
decision.
(B) PATENT LITIGATION WITH MEEI
The First MEEI Lawsuit
In April 2000, Massachusetts Eye and Ear Infirmary ("MEEI") filed a civil
suit against us in the United States District Court (the "Court") for the
District of Massachusetts 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, we moved for summary judgement against MEEI on all eight counts of
MEEI's complaint in Civil Action No. 00-10783-JLT. The Court granted all of
our summary motions, dismissing all of MEEI's claims. With respect to our
counterclaim requesting correction of inventorship of the '349 patent to
add an additional MGH inventor, the Court stayed the claim pending the
outcome of the lawsuit described below.
MEEI appealed the decision of the Court to the U.S. District Court of
Appeals. On February 18, 2005 the Court of Appeals issued its ruling,
upholding the dismissal of five of MEEI's eight claims, and remanding three
claims to trial on the basis that they should not have been determined on
summary judgment. On March 4, 2005, we petitioned the Court of Appeals for
a panel rehearing and a rehearing en banc by the full court. On April 7,
2005, the Court issued an order allowing our petition for panel rehearing
in part and denying it in part. Our petition for rehearing en banc was
denied without prejudice to refiling after the panel's decision on the
rehearing.
The Second MEEI Lawsuit
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 Patent in issue in the first suit 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 us and Novartis Ophthalmics, Inc. (now Novartis Ophthalmics, a
division of Novartis Pharma AG) in the United States District Court for the
District of Massachusetts alleging infringement of the '303 Patent (Civil
Action No. 01-10747-EFH). The suit seeks damages and injunctive relief for
patent infringement and unjust enrichment. We have answered the complaint,
denying its material allegations and raising a number of affirmative
defenses, and have
18
asserted counterclaims against MEEI and the two MEEI researchers who are
named as inventors on the '303 patent.
In April 2003, we 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 our motion in May of 2003.
In January 2005, the Court ordered in our favour in one of our
counterclaims and declared that the inventorship of the '303 patent be
corrected to add QLT as joint inventors. That ruling gives us` the right to
exploit the patent in issue. MEEI has a right to appeal the Court's ruling.
The final outcomes of these disputes are not presently determinable or
estimable and there can be no assurance that the matters will be finally
resolved in our favor. If the lawsuits are not resolved in our favor, we
might be obliged to pay damages, or an additional royalty or damages for
access to the inventions covered by claims in issued U.S. patents, and
might be subject to such equitable relief as a court may determine (which
could include an injunction) a remedy combining some or all of those
remedies foregoing.
19
14. RECONCILIATION FROM U.S. GAAP TO CANADIAN GAAP
Canadian securities regulations allow issuers that are required to file reports
with the United States Securities & Exchange Commission, or SEC, upon meeting
certain conditions, to satisfy their Canadian continuous disclosure obligations
by using financial statements prepared in accordance with U.S. GAAP.
Accordingly, for interim periods in fiscal 2005 and 2006, we will include in the
notes to our consolidated financial statements a reconciliation highlighting the
material differences between our financial statements prepared in accordance
with U.S. GAAP as compared to financial statements prepared in accordance with
accounting principles generally accepted in Canada ("Canadian GAAP"). Subsequent
to 2006, no further interim reconciliation will be required under current
Canadian securities regulations. Prior to 2005, we prepared interim financial
statements (with accompanying notes) and Management's Discussion and Analysis -
Canadian Supplement in accordance with Canadian GAAP, all of which were
presented as a separate report and filed with the relevant Canadian securities
regulators in compliance with our Canadian continuous disclosure obligations.
Our consolidated financial statements have been prepared in accordance with U.S.
GAAP and the accounting rules and regulations of the SEC which differ in certain
material respects from those principles and practices that we would have
followed had our consolidated financial statements been prepared in accordance
with Canadian GAAP. The following is a reconciliation of our net income as
reported in U.S. GAAP and our net income computed in accordance with Canadian
GAAP for the three months ended March 31, 2005 and 2004.
Three months ended
March 31,
--------------------------------
(In thousands of U.S. dollars, except per share amounts) 2005 2004
------------ ------------
Net income, U.S. GAAP $ 15,256 $ 24,022
Stock based compensation charge (a) (2,214) (3,270)
Amortization of in-process research and development (b) (3,471) -
FIT recovery on amortization of in-process research and development (b) 1,319 -
Implied interest on convertible debt (c) (1,782) (1,641)
Unrealized gain (loss) on convertible debt (c) 331 215
Provision for income taxes on above items (d) (59) 611
------------ ------------
Net income, Canadian GAAP $ 9,380 19,937
Basic net income per common share, Canadian GAAP
Income before extraordinary gain $ 0.10 $ 0.14
Extraordinary gain - 0.15
------------ ------------
Net income $ 0.10 $ 0.29
Diluted net income per common share
Income before extraordinary gain $ 0.10 $ 0.14
Extraordinary gain - 0.15
------------ ------------
Net income $ 0.10 0.29
Weighted average number of common shares outstanding (in thousands)
Basic 93,325 69,276
Diluted 94,788 69,681
The following is a reconciliation of our balance sheet information as reported
in U.S. GAAP and our balance sheet information computed in accordance with
Canadian GAAP as of March 31, 2005 and December 31, 2004.
20
(In thousands of United States dollars) March 31, 2005 December 31, 2004
-------------- -----------------
Total assets under U.S. GAAP $ 1,137,282 $ 1,116,249
Short-term investments 27 11
Future income tax assets (d) 581 -
Intangibles, net (b) 230,948 234,419
Goodwill (b) 89,680 89,680
Other long-term assets (e) 144 133
------------ ------------
Total assets under Canadian GAAP $ 1,458,662 $ 1,440,492
------------ ------------
Total liabilities under U.S. GAAP $ 259,630 259,470
Future income tax liabilities (b), (d) 87,760 88,433
Long-term debt (c) (22,791) (24,439)
------------ ------------
Total liabilities under Canadian GAAP $ 324,599 323,464
------------ ------------
Total shareholders' equity under U.S. GAAP $ 877,652 $ 856,779
Common shares (a), (f), (g) (2,452) (2,518)
Contributed surplus (a) 54,062 51,917
Equity component of convertible debt (c) 33,500 33,500
Retained earnings (deficit) (h) 166,320 172,194
Cumulative translation adjustment (i) 4,980 5,156
------------ ------------
Total shareholder's equity under Canadian GAAP $ 1,134,062 $ 1,117,028
------------ ------------
(a) Effective January 1, 2004, we adopted the fair value method of accounting
for all employee and non-employee stock-based compensation for Canadian
GAAP purposes. We adopted this new Canadian GAAP accounting standard on a
retroactive basis, without restatement of prior periods. Compensation
expense is recorded for stock options issued to employees using the fair
value method. We calculate the fair value of stock options issued and
amortize the fair value to stock compensation expense over the vesting
period, and adjust the amortization for stock option forfeitures and
cancellations. Under U.S. GAAP, we have adopted the disclosure only
provision of SFAS 123 for stock options granted to employees and directors.
(b) Under Canadian GAAP, acquired in-process research and development ("IPR&D")
projects are recorded as an intangible asset and amortized over their
useful life. On November 19, 2004, we acquired IPR&D of $236.0 million
through the acquisition of Atrix Laboratories, Inc. Accordingly, this
amount was capitalized for Canadian GAAP purposes and is being amortized
using the straight-line method over its useful life of seventeen years. As
a result of book-tax basis differences attributable to IPR&D, an additional
deferred tax liability of $89.7 million has been recorded. During the
quarter ended March 31, 2004, the future income tax liability was adjusted
by $1.3 million for Canadian GAAP purposes to reflect the reduction in the
temporary difference due to the amortization of the IPR&D. Under U.S. GAAP,
IPR&D are expensed at time of acquisition.
(c) In 2003, we completed a private placement of $172.5 million aggregate
principal amount of convertible senior notes. Under Canadian GAAP, an
amount of $33.5 million, representing the estimated value of the right of
conversion, was allocated to the shareholders' equity as the equity
component of the convertible debt. Furthermore, with bifurcation, accretion
expense is recorded as interest expense under Canadian GAAP. Under U.S.
GAAP, bifurcation of debt is not required. In addition, foreign exchange
gains/losses are calculated for the full face value of the debt under U.S.
GAAP, and calculated only on the liability component under Canadian GAAP.
(d) The differences between Canadian GAAP and U.S. GAAP assets and liabilities
resulted in different deferred tax assets and deferred tax liabilities
under the respective GAAP's. Furthermore, investment tax credits are
calculated using different formulas for Canadian and U.S. GAAP purposes due
to different forecasted earnings under the respective GAAP's.
(e) We hold certain investments which under Canadian GAAP are recorded at
historical costs adjusted for permanent impairment. Under U.S. GAAP they
are recorded as available-for-sale securities. Such securities are required
to be marked to market, with unrealized holding gains and losses recorded
in other comprehensive income.
21
(f) Under Canadian GAAP, beneficial conversion features attached to certain
historical preferred shares were not included in share capital. Under U.S.
GAAP, in prior years, a beneficial conversion feature attached to certain
preferred shares was accreted as a return to the preferred shareholders.
This resulted in an increase in the stated amount of historical share
capital.
(g) In 2000 and 2001, we accelerated the vesting of certain employee stock
options as part of their severance. Under U.S. GAAP we recorded
compensation expense and additional paid in capital in shareholders' equity
equal to the intrinsic value of the options and under Canadian GAAP there
was no charge recorded.
(h) Certain adjustments to retained earnings are required to account for the
accumulated historical differences between Canadian GAAP and U.S. GAAP.
(i) The cumulative translation adjustment resulting from the translation of our
Canadian functional currency financial statements into U.S. dollar for
reporting purposes differs between Canadian GAAP and U.S. GAAP due to the
difference in the value of our assets and liabilities under the respective
GAAPs.
22
The following presents the conversion of the Company's unaudited consolidated
comparative financial statements from Canadian GAAP to U.S. GAAP:
QLT INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands of U.S. dollars) MARCH 31, 2005 DECEMBER 31, 2004 DECEMBER 31, 2004
-------------- ----------------- -------------------
(US GAAP) (US GAAP) Comparative as
previously reported
(Canadian GAAP)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 192,164 $ 277,087 $ 277,087
Short-term investment securities 215,837 102,765 102,776
Accounts receivable 57,664 56,600 56,600
Inventories 41,313 45,899 45,899
Current portion of deferred/future income tax assets 2,291 4,753 4,753
Other 14,661 13,521 13,521
----------- ----------- -----------
523,930 500,625 500,636
PROPERTY, PLANT AND EQUIPMENT 80,793 81,674 81,674
DEFERRED/FUTURE INCOME TAX ASSETS 5,501 6,926 6,926
INTANGIBLES, NET 120,101 119,600 354,019
GOODWILL 402,518 402,518 492,198
OTHER LONG-TERM ASSETS 4,439 4,906 5,039
----------- ----------- -----------
$ 1,137,282 $ 1,116,249 $ 1,440,492
=========== =========== ===========
LIABILITIES
CURRENT LIABILITIES
Accounts payable $ 8,336 $ 12,993 $ 12,993
Accrued restructuring charge 424 - -
Accrued liabilities 16,660 19,528 19,528
Current portion of deferred revenue 5,116 2,278 2,278
----------- ----------- -----------
30,536 34,799 34,799
DEFERRED/FUTURE INCOME TAX LIABILITIES 53,022 52,171 140,604
DEFERRED REVENUE 3,572 - -
LONG-TERM DEBT 172,500 172,500 148,061
----------- ----------- -----------
259,630 259,470 323,464
----------- ----------- -----------
SHAREHOLDERS' EQUITY
SHARE CAPITAL
Authorized
500,000,000 common shares without par value
5,000,000 first preference shares without par
value, issuable in series
Issued and outstanding
Common shares 875,839 848,498 845,980
March 31, 2005 - 93,403,359 shares
December 31, 2004 - 92,021,572 shares
ADDITIONAL PAID IN CAPITAL/CONTRIBUTED SURPLUS 71,843 92,193 144,110
EQUITY COMPONENT OF CONVERTIBLE DEBT - - 33,500
ACCUMULATED DEFICIT (158,538) (173,794) (1,600)
ACCUMULATED OTHER COMPREHENSIVE INCOME/
CUMULATIVE TRANSLATION ADJUSTMENTS 88,508 89,882 95,038
----------- ----------- -----------
877,652 856,779 1,117,028
----------- ----------- -----------
$ 1,137,282 $ 1,116,249 $ 1,440,492
=========== =========== ===========
23
QLT INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
THREE MONTHS ENDED MARCH 31,
---------------------------------------------------------
(In thousands of U.S. dollars except per share information) 2005 2004 2004
----------- ----------- -------------------
(US GAAP) (US GAAP) Comparatives as
previously reported
(Canadian GAAP)
REVENUES
Net product revenue $ 57,146 $ 40,519 $ 40,519
Net royalties 3,708 - -
Contract research and development 3,036 792 792
Licensing and milestones 125 - -
----------- ----------- -----------
64,015 41,311 41,311
----------- ----------- -----------
COSTS AND EXPENSES
Cost of sales 14,490 6,922 6,922
Research and development 16,436 9,410 11,497
Selling, general and administrative 5,389 4,781 5,254
Depreciation 1,734 809 809
Amortization of intangibles 1,871 - -
Restructuring 2,515 - -
----------- ----------- -----------
42,435 21,922 24,482
----------- ----------- -----------
OPERATING INCOME 21,580 19,389 16,829
INVESTMENT AND OTHER INCOME (EXPENSE)
Net foreign exchange gains 584 276 491
Interest income 2,549 2,482 2,482
Interest expense (1,598) (1,528) (3,169)
----------- ----------- -----------
1,535 1,230 (196)
----------- ----------- -----------
INCOME BEFORE INCOME TAXES 23,115 20,619 16,633
PROVISION FOR INCOME TAXES (7,859) (6,990) (7,089)
----------- ----------- -----------
INCOME BEFORE EXTRAORDINARY GAIN $ 15,256 $ 13,629 $ 9,544
----------- ----------- -----------
EXTRAORDINARY GAIN - 10,393 10,393
----------- ----------- -----------
NET INCOME $ 15,256 $ 24,022 $ 19,937
=========== =========== ===========
BASIC NET INCOME PER COMMON SHARE
Income before extraordinary gain $ 0.16 $ 0.20 $ 0.14
Extraordinary gain - 0.15 0.15
----------- ----------- -----------
Net income $ 0.16 $ 0.35 $ 0.29
----------- ----------- -----------
DILUTED NET INCOME PER COMMON SHARE
Income before extraordinary gain $ 0.16 $ 0.19 $ 0.14
Extraordinary gain - 0.15 0.15
----------- ----------- -----------
Net income $ 0.16 $ 0.34 $ 0.29
----------- ----------- -----------
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING
(THOUSANDS)
Basic 93,325 69,276 69,276
Diluted 94,874 69,911 69,681
----------- ----------- -----------
24
QLT INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
THREE MONTHS ENDED MARCH 31,
(In thousands of U.S. dollars except per share information) 2005 2004 2004
- ----------------------------------------------------------- --------- --------- -------------------
(US GAAP) (US GAAP) Comparatives as
previously reported
(Canadian GAAP)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 15,256 $ 24,022 $ 19,937
Adjustments to reconcile net income to net cash from
operating activities
Amortization of intangibles 1,871 - -
Depreciation 1,734 809 809
Stock-based comparison - - 3,270
Amortization of deferred financing expenses 281 239 239
Implied interest on convertible debt - - 1,641
Unrealized foreign exchange losses 1,543 2,088 1,872
Extraordinary gain - (10,393) (10,393)
Deferred/Future income taxes 5,306 6,990 7,090
Benefit of investment tax credits included in
operating expenses - - (710)
Changes in non-cash operating assets and liabilities
Accounts receivable (7,191) (3,870) (3,870)
Inventories 4,357 (1,646) (1,646)
Other current assets (991) 5,643 5,643
Accounts payable 494 (911) (911)
Accrued restructuring charge 418 - -
Other accrued liabilities (3,839) (8,893) (8,893)
Deferred revenue 6,398 (1,728) (1,728)
--------- -------- --------
25,637 12,350 12,350
--------- -------- --------
CASH USED IN INVESTING ACTIVITIES
Short-term investment securities (110,608) (9,220) (9,220)
Purchase of property, plant and equipment (2,075) (3,169) (3,169)
Purchase costs related to Atrix Laboratories, Inc. (1,210) - -
Purchase of Kinetek Pharmaceuticals, Inc., net of cash acquired - (2,316) (2,316)
--------- -------- --------
(113,893) (14,705) (14,705)
--------- -------- --------
CASH PROVIDED BY FINANCING ACTIVITIES
Long-term debt (net) - (71) (71)
Issuance of common shares 7,017 11,696 11,696
--------- -------- --------
7,017 11,625 11,625
--------- -------- --------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS (3,684) (2,180) (2,180)
--------- -------- --------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (84,923) 7,090 7,090
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 277,087 262,408 262,408
--------- -------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 192,164 $269,498 $269,498
========= ======== ========
SUPPLEMENTARY CASH FLOW INFORMATION:
Interest paid: $ 2,744 $ 3,019 $ 3,019
Income taxes paid: 2,568 - -
--------- -------- --------
25
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 our audited consolidated financial statements and
notes thereto included as part of our 2004 Annual Report on Form 10-K. All
amounts following are expressed in U.S. dollars unless otherwise indicated.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report contains forward-looking statements within the meaning of
the United States Private Securities Litigation Reform Act of 1995 which are
based on our current expectations and projections. Words such as "anticipate",
"project", "expect", "forecast", "outlook", "plan", "intend", "estimate",
"should", "may", "assume", "continue", and variations of such words or similar
expressions are intended to identify our forward-looking statements.
Forward-looking statements include, but are not limited to, those in which we
state:
o projections as to whether we will have adequate resources to fund our
future operating requirement;
o our expectation as to our tax position in 2005;
o our expectations regarding the pending patent-related litigation
against us;
and all other statements in which we project or predict future results or
events.
We caution that actual outcomes and results may differ materially from those
expressed in our forward-looking statements because such statements are
predictions only and they are subject to a number of important risk factors and
uncertainties. Risk factors and uncertainties which could cause actual results
to differ from what is expressed or implied by our forward-looking statements
are described in more detail in our most recent Annual Report on Form 10-K under
the headings: "Business -- "Risk Factors", "Legal Proceedings", "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the "Notes to the Consolidated Financial Statements". We encourage you to read
those descriptions carefully. We caution investors not to place undue reliance
on the forward-looking statements contained in this report. These statements,
like all statements in this report, speak only as of the date of this report,
unless an earlier date is indicated, and, except as required by law and the
rules and regulations of the SEC and Canadian regulatory authorities, we
undertake no obligation to update or revise the statements.
OVERVIEW
We are a global biopharmaceutical company dedicated to the discovery,
development and commercialization of innovative therapies in the fields of
ophthalmology, dermatology, oncology and urology. Our company was formed in 1981
under the laws of the Province of British Columbia, Canada.
Our first commercial product was in the field of photodynamic therapy, or PDT,
which uses photosensitizers (light activated drugs) in the treatment of disease.
Our most significant commercial product, Visudyne(R), utilizes PDT to treat the
eye disease known as wet-form age related macular degeneration, or wet AMD, the
leading cause of blindness in people over 55 in North America and Europe.
Visudyne is commercially available in more than 70 countries, including the
U.S., Canada, Japan and the European Union countries, for the treatment of a
form of wet AMD known as predominantly classic subfoveal choroidal
neovascularization, or CNV, and in over 40 countries for the form of wet AMD
known as occult subfoveal CNV. Visudyne is reimbursed in the U.S. by the Centers
for Medicare & Medicaid Services for certain patients with the occult and
minimally classic forms of wet AMD. It is also approved in more than 55
countries, including the U.S., Canada and the European Union countries, for the
treatment of subfoveal CNV due to pathologic myopia (severe near-sightedness).
In some countries (including the U.S. and Canada) Visudyne is also approved for
presumed ocular histoplasmosis or other macular diseases. QLT developed and
commercializes Visudyne through a contractual alliance with Novartis Ophthalmics
(a division of Novartis Pharma AG).
In November 2004, we acquired Atrix Laboratories, Inc., a Fort Collins, Colorado
based biopharmaceutical company focused on advanced drug delivery, for which we
paid aggregate consideration of $870.5 million, in cash and equity. With our
acquisition of Atrix (now our wholly owned subsidiary QLT USA, Inc.) we have
expanded and diversified our portfolio of approved products, products in
development or under regulatory review, and proprietary technologies.
26
In addition to our lead commercial product Visudyne, as a result of the Atrix
acquisition, we now market, through commercial partners, the Eligard(R) group of
products for the treatment of prostate cancer, a line of dermatology products
and a line of dental products. The Eligard product line includes four different
commercial formulations of our Atrigel(R) technology combined with leuprolide
acetate for the treatment of prostate cancer. The U.S. Food and Drug
Administration, or FDA, has approved all four products: Eligard 7.5-mg
(one-month), Eligard 22.5-mg (three-month), Eligard 30.0-mg (four-month) and
Eligard 45.0-mg (six-month). The Eligard 7.5-mg and Eligard 22.5-mg products are
also approved in a number of other countries, including most European countries,
Canada, Australia and a number of Latin American countries.
Our newly acquired portfolio of dermatology products consists of both
proprietary and generic products that are commercialized, under regulatory
review, or in various stages of development. Our lead proprietary dermatology
product, Aczone(TM), is currently undergoing regulatory review; a new drug
application, or NDA, was filed with the FDA for Aczone in the third quarter of
2004. Our generic dermatology business, which is part of a 50/50 joint venture
with Sandoz, Inc., currently comprises six marketed products and five under
regulatory review.
Our efforts to increase our portfolio of marketed products are ongoing. We have
a number of product candidates in our development pipeline in addition to Aczone
including another photosensitizer, lemuteporfin (which we used to call QLT0074),
currently being studied in the treatment of benign prostatic hyperplasia, or
BPH, the most common prostatic disease. We carry out research and pre-clinical
projects, in fields such as ophthalmology, dermatology, and oncology. We also
carry out contract research and development work on product candidates of third
parties from which we can potentially derive royalty revenue upon
commercialization.
ACQUISITION OF ATRIX LABORATORIES, INC.
On November 19, 2004, we completed our acquisition of Atrix Laboratories, Inc.,
or Atrix, a biopharmaceutical company focused on advanced drug delivery. Each
outstanding share of Atrix common stock was converted into the right to receive
one QLT Inc. common share and $14.61 in cash. In addition, each option to
purchase Atrix common stock that was outstanding at the closing of the
acquisition was assumed by QLT in accordance with the Agreement and Plan of
Merger dated June 14, 2004 among QLT and Atrix. The results of operations of
Atrix were 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.
We paid aggregate consideration of $870.5 million ($325.6 million in cash,
$436.1 million in common shares, $93.9 million in other equity, and $15.0
million in acquisition related expenditures) for the Atrix business. We
allocated the total consideration for Atrix, including acquisition costs, based
on our preliminary assessment as to the estimated fair values on the acquisition
date. Our preliminary assessment is subject to change upon the final
determination of the fair value of the assets acquired and liabilities assumed.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
In preparing our consolidated financial statements, we are required to make
certain estimates, judgements and assumptions that we believe 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, allocation of overhead expenses to research and development,
determination of fair value of assets and liabilities acquired in the purchase
business combinations, and provisions for taxes and contingencies. The
significant accounting policies which we believe are the most critical to aid in
fully understanding and evaluating our reported financial results include those
which follow:
Reporting Currency and Foreign Currency Translation
We use the U.S. dollar as our reporting currency, while the Canadian dollar is
the functional currency for the parent company and the U.S. dollar is the
functional currency for the U.S. subsidiary. Our consolidated financial
statements 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. Revenues and expenses are translated at a weighted average
rate of exchange for the respective years. Translation
27
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 (loss). As of March 31, 2005, our
accumulated other comprehensive income totalled $88.5 million.
Revenue Recognition
Net Product Revenue
Our net product revenues are primarily derived from sales of Visudyne and
Eligard.
With respect to Visudyne, under the terms of our collaborative agreement with
Novartis Ophthalmics we are responsible for Visudyne manufacturing and product
supply and Novartis Ophthalmics is responsible for marketing and distribution of
Visudyne. Our 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 us (See Note 9 - Net Product Revenues). We recognize
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 revenue noted above, this occurs upon "sell through" of
Visudyne to the end customers. Our revenue from Visudyne will fluctuate
dependent upon Novartis Ophthalmics' ability to market and distribute the
Visudyne to end customers.
With respect to Eligard, under the terms of our collaborative agreements with
our marketing partners, we are responsible for the manufacture of Eligard and
receive from our marketing partners an agreed upon sales price upon shipment to
them. (We also earn royalties from certain marketing partners based upon their
sales of Eligard products to end customers, which royalties are included in net
royalty revenue.) We recognize net revenue from product sales when persuasive
evidence of an arrangement exists, product is shipped and title is transferred
to our marketing partners, collectibility is reasonably assured and the price is
fixed or determinable. Our net product revenue from Eligard will fluctuate
dependent upon our ability to deliver Eligard products to our marketing
partners. Our Eligard marketing partners are responsible for all products after
shipment from our facility. Under this calculation of revenue, we recognize net
product revenue from Eligard at the time of shipment to our marketing partners.
We do not offer rebates or discounts and have not experienced any material
product returns; accordingly, we do not provide an allowance for rebates,
discounts, and returns.
Net Royalties
We recognize net royalties when product is shipped by certain of our marketing
partners to end customers based on royalty rates and formulas specified in our
agreements with them. Generally, royalties are based on estimated net product
sales (gross sales less discounts, allowances and other items) based on
information supplied to us by our marketing partners.
Contract Research and Development
Contract research and development revenues consist of non-refundable research
and development funding under collaborative agreements with our various
strategic partners. Contract research and development funding generally
compensates us for discovery, preclinical and clinical expenses related to
collaborative development programs for certain products and product candidates,
and is recognized as revenue at the time research and development activities are
performed under the terms of the collaborative agreements. For fixed price
contracts we recognize contract research and development revenue over the term
of the agreement, which is consistent with the pattern of work performed.
Amounts received under the collaborative agreements are non-refundable even if
the research and development efforts performed by us do not eventually result in
a commercial product. Contract research and development revenues earned in
excess of payments received are classified as contract research and development
receivables and payments received in advance of revenue recognition are recorded
as deferred revenue. (See Note 10 - Contract Research and Development.)
Licensing and milestones
We have licensing agreements that generally provide for non-refundable license
fees and/or milestone payments. The licensing agreements typically require a
non-refundable license fee and allow our partners to sell our proprietary
products in a defined territory for a defined period. A milestone payment is a
payment made by a partner to us upon achievement of a pre-determined event, as
defined in the applicable agreement. Non-refundable license fees and
28
milestone payments are initially reported as deferred revenue and recognized as
revenue over the remaining contractual term or as covered by patent protection,
which ever is earlier, using the straight-line method or until the agreement is
terminated. No milestone revenue is recognized until we have completed the
required milestone-related services as set forth in licensing agreements.
Cost of Sales
Visudyne cost of sales, consisting of expenses related to the production of bulk
Visudyne and royalty expense on Visudyne sales, are charged against earnings in
the period that Novartis Ophthalmics sells to third parties. Cost of sales
related to the production of various Eligard, generic dermatology, and dental
products are charged against earnings in the period of the related product sale
to our marketing partners. We utilize 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. Our standard costs are estimated based on management's best estimate
of annual production volumes and material costs. Overhead expenses comprise
direct and indirect support activities related to the manufacture of bulk
Visudyne, various Eligard, generic dermatology, and dental products and involve
costs associated with activities such as quality inspection, quality assurance,
supply chain management, safety and regulatory. Overhead expenses are allocated
to inventory at various stages of the manufacturing process under a standard
costing system, and eventually to cost of sales as the related products are sold
to our marketing partners or in the case of Visudyne, by Novartis Ophthalmics to
third parties. While we believe our standard costs are reliable, actual
production costs and volume changes may impact inventory, cost of sales, and the
absorption of production overheads. For Visudyne, we record a provision for the
non-completion of product inventory based on our 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. We estimate our non-completion rate based on past production and adjust
our provision quarterly based on actual production volume. A batch failure may
utilize a significant portion of the provision as a single completed batch
currently costs between $0.6 million and $1.1 million, depending on the stage of
production. We provide a reserve for obsolescence of our Eligard inventory and
component materials based on our periodic evaluation of potential obsolete
inventory.
Stock-based Compensation
As allowed by the provisions of SFAS 123, Accounting for Stock-based
Compensation, or SFAS 123, we apply Accounting Principles Board, Opinion No. 25,
or APB 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 option pricing 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. We have adopted
the disclosure only provision for stock-based compensation for stock options
granted to employees and directors, consistent with SFAS 123. If we had adopted
a fair value based method for stock-based compensation under SFAS 123, the
impact on our net income per common share would have been as described in Note 1
in "Notes to the Consolidated Financial Statements".
In December 2004, the Financial Accounting Standards Board, or FASB, issued SFAS
123 Revised, Share-Based Payment, or SFAS 123R. The statement eliminates the
alternative to account for stock-based compensation using APB 25 and requires
such transactions be recognized as compensation expense in the statement of
earnings based on their fair values on the date of the grant, with the
compensation expense recognized over the period in which a grantee is required
to provide service in exchange for the stock award. We intend to adopt this
statement on January 1, 2006 using a modified prospective application as defined
in SFAS 123R. As such, the compensation expense recognition provisions will
apply to new awards and to any awards modified, repurchased or cancelled after
the adoption date. Additionally, for any unvested awards outstanding at the
adoption date, we will recognize compensation expense over the remaining vesting
period.
Research and Development
Research and development costs consist of direct and indirect expenditures,
including a reasonable allocation of overhead expenses, associated with our
various research and development programs. Overhead expenses comprise general
and administrative support provided to the research and development programs and
involve costs associated
29
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 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 also 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 income
taxes. The realization of our deferred tax assets is primarily dependent on
generating sufficient taxable income prior to expiration of any loss carry
forward balance. A valuation allowance is provided when it is more likely than
not that a deferred tax asset may not be realized.
Legal Proceedings
We are involved in a number of legal actions, the outcomes of which are not
within our complete control and may not be known for prolonged periods of time.
In these legal actions, the claimants seek damages, as well as other relief,
which, if granted, would require significant expenditures. We record a liability
in the consolidated financial statements for these actions when a loss is known
or considered probable and the amount can be reasonably estimated. If the loss
is not probable or cannot be reasonably estimated, a liability is not recorded
in the consolidated financial statements. Our potentially material legal
proceedings are discussed in Note 13 to the consolidated financial statements.
As of March 31, 2005, no reserve has been established related to these
proceedings.
Long-lived and Intangible Assets
Occasionally we incur costs to purchase and construct property, plant and
equipment. The treatment of costs to purchase or construct these assets depends
on the nature of the costs and the stage of construction. Costs incurred in the
initial design and evaluation phase, such as the cost of performing feasibility
studies and evaluating alternatives are charged to expense. Costs incurred in
the committed project planning and design phase, and in the construction and
installation phase, are capitalized as part of the cost of the asset. We stop
capitalizing costs when an asset is substantially complete and ready for its
intended use. Since 2003, we have been depreciating plant and equipment using
the straight-line method over their estimated economic lives, which range from
3-40 years. Determining the economic lives of plant and equipment requires us to
make significant judgments that can materially impact our operating results.
In accounting for acquisitions, we allocate the purchase price to the fair value
of the acquired tangible and intangible assets, including in-process research
and development, or IPR&D. We generally estimate the value of acquired
intangible assets and IPR&D using a discounted cash flow model, which requires
us to make assumptions and estimates about, among other things: the time and
investment that is required to develop products and technologies; our ability to
develop and commercialize products before our competitors develop and
commercialize products for the same indications; the amount of revenue to be
derived from the products; and appropriate discount rates to use in the
analysis. Use of different estimates and judgments could yield materially
different results in our analysis, and could result in materially different
asset values and IPR&D charges.
As of March 31, 2005, there were approximately $402.5 million of goodwill and
approximately $120.1 million of net acquired intangibles on our consolidated
balance sheet. We amortize acquired intangible assets using the straight-line
method over their estimated economic lives, which range from 16 to 17 years.
Determining the economic lives of acquired intangible assets requires us to make
significant judgments and estimates and can materially impact our operating
results.
Impairment of Goodwill
In accordance with SFAS 142, Goodwill and Other Intangibles, we are required to
perform impairment tests annually or whenever events or changes in circumstances
suggest that the carrying value of an asset may not be recoverable. Assumptions
and estimates were made at the time of acquisition of Atrix specifically
regarding product development, market conditions and cash flows that were used
to determine the valuation of goodwill and intangibles. When we perform
impairment tests in future periods, the possibility exists that changes in
forecasts and estimates from those used at the acquisition date could result in
impairment charges.
30
Recently Issued Accounting Standards
In September 2004, the Emerging Issues Task Force, or 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. Previously, the potential dilutive effect of the
conversion feature was excluded from diluted earnings per share until the
contingent feature was met. Issue No. 04-08 results in contingently convertible
debt instruments being included in diluted earnings per share computations
regardless of whether the 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 has resulted in our diluted earnings per share
calculation including the dilutive effect of contingently convertible debt when
the effect is dilutive. Prior period diluted earnings per share amounts
presented for comparative purposes have been restated to conform to this method.
In November 2004, FASB issued SFAS 151, Inventory Costs an amendment of ARB No.
43, Chapter 4. This Statement amends the guidance in ARB No.43, Chapter 4,
"Inventory Pricing," to clarify that abnormal amounts of idle facility expense,
freight, handling costs, and wasted material (spoilage) be treated as current
period charges. In addition, this Statement requires that allocation of fixed
production overheads to the costs of conversion be based on the normal capacity
of the production facilities during periods of below normal production. Our
consolidated financial statements comply with the requirements of SFAS No. 151.
In December 2004, FASB issued SFAS 123 Revised, Share-Based Payment, or SFAS
123R. This statement eliminates the alternative to account for stock-based
compensation using APB 25 and requires such transactions be recognized as
compensation expense in the statement of earnings based on their fair values on
the date of the grant, with the compensation expense recognized over the period
in which a grantee is required to provide service in exchange for the stock
award. In April 2005, the United States Securities and Exchange Commission
amended the date for compliance with SFAS 123R to be the first interim period of
the first fiscal year beginning on or after June 15, 2005. We intend to adopt
this statement on January 1, 2006 using a modified prospective application. As
such, the compensation expense recognition provisions will apply to new awards
and to any awards modified, repurchased or cancelled after the adoption date.
Additionally, for any unvested awards outstanding at the adoption date, we will
recognize compensation expense over the remaining vesting period.
We have begun, but have not yet completed, evaluating the impact of adopting
SFAS 123R on our results of operations. We currently determine the fair value of
stock-based compensation using a Black-Scholes option pricing model for pro
forma purposes. In connection with evaluating the impact of adopting SFAS 123R,
we are also considering the potential implementation of different valuation
models to determine the fair value of stock-based compensation, although no
decision has yet been made. However, we believe the adoption of SFAS 123R will
have a material impact on our results of operations, regardless of the valuation
technique used.
31
RESULTS OF OPERATIONS
For the three months ended March 31, 2005, we recorded net income of $15.3
million, or $0.16 basic and diluted net income per common share. These results
compare with net income of $24.0 million, or $0.34 diluted net income per common
share, for the three months ended March 31, 2004. During the three months March
31, 2004, we recorded a $10.4 million extraordinary gain resulting from the
Kinetek acquisition. Excluding the extraordinary gain, net income increased from
$13.6 million to $15.3 million primarily as a result of strong Visudyne sales
performance.
Revenues
Net Product Revenue
Net product revenue was determined as follows:
(In thousands of U.S. dollars) Three months ended Three months ended
March 31, 2005 March 31 ,2004
------------------ ------------------
(unaudited)
Visudyne(R) sales by Novartis Ophthalmics $123,744 $101,056
Less: Marketing and distribution costs (32,583) (29,279)
Less: Inventory costs (6,312) (5,261)
Less: Royalties (2,754) (2,262)
-------- --------
$ 82,095 $ 64,254
======== ========
QLT share of remaining revenue on final sales by Novartis
Ophthalmics (50%) $ 41,048 $ 32,127
Add: Inventory costs reimbursed to QLT 5,072 4,555
Add: Royalties reimbursed to QLT 2,699 2,240
Add: Other costs reimbursed to QLT 1,132 1,597
-------- --------
Revenue from Visudyne(R) as reported by QLT $49,951 $40,519
Net product revenue from Eligard(R) and other products 7,195 -
-------- --------
$57,146 $40,519
======= =======
For the three months ended March 31, 2005, revenue from Visudyne sales of $50.0
million increased by $9.4 million (or 23%) over the three months ended March 31,
2004. The increase was primarily due to a 22% increase in Visudyne sales which
resulted from: (i) continued market growth in Europe, (ii) receipt in the second
quarter of 2004 of reimbursement for certain occult and minimally classic
lesions in the U.S., (iii) the launch in the second quarter of 2004 of Visudyne
in Japan, and (iv) favorable foreign exchange rates. In the three months ended
March 31, 2005, approximately 41% of total Visudyne sales by Novartis
Ophthalmics were in the U.S., compared to approximately 45% in the three months
ended March 31, 2004. Overall, the ratio of our share of revenue on final sales
compared to Visudyne sales was 33.2% in the three months ended March 31, 2005,
up from 31.8% in the three months ended March 31, 2004. Marketing and
distribution costs rose to $32.6 million for the three months ended March 31,
2005, compared to $29.3 million in the three months ended March 31, 2004, due
primarily to increases in advertising and promotion and sales force expenses.
As a result of our acquisition of Atrix in November 2004, our net product
revenue for the three months ended March 31, 2005 included $7.2 million from
Eligard and other products as compared to nil for the same period in 2004.
Net Royalties
As a result of our acquisition of Atrix, we have $3.7 million of net royalties
related to Eligard and other products for the three months ended March 31, 2005,
as compared to nil for the same period in 2004.
Contract Research and Development Revenue
32
We receive non-refundable research and development funding from Fujisawa
Healthcare, Inc., Sanofi-Aventis Group, Novartis Ophthalmics and other strategic
partners, which is recorded as contract research and development revenue. For
the three months ended March 31, 2005, contract research and development revenue
totaled $3.0 million, an increase of 283% as compared to the same period in
2004. The increase was primarily due to contract research and development
programs added as a result of the Atrix acquisition.
Costs and Expenses
Cost Of Sales
For the three months ended March 31, 2005, cost of sales increased 109% to $14.5
million compared to $6.9 million for the three months ended March 31, 2004. Cost
of sales related to revenue from Visudyne increased to $8.6 million in the three
months ended March 31, 2005, from $6.9 million in the same period in 2004, due
to the increase in Visudyne sales in the year. Cost of sales in the three months
ended March 31, 2005 also included $5.9 million related to revenue from Eligard
and other products acquired in our acquisition of Atrix.
Research And Development
Research and development, or R&D, expenditures increased 75% to $16.4 million
for the three months ended March 31, 2005, compared to $9.4 million for the
three months ended March 31, 2004. The increase was due to R&D expenses for
Eligard, Aczone, Octreotide and other projects related to the Atrix acquisition.
Selling, General And Administrative Expenses
For the three months ended March 31, 2005, selling, general and administrative,
or SG&A, expenses increased 13% to $5.4 million compared to $ 4.8 million for
the three months ended March 31, 2004. The increase was related to additional
SG&A expenses from the acquisition of Atrix. The increase was partially offset
by a higher allocation of overhead expenses to R&D associated with the various
research and development programs. SG&A expenses include certain overhead
expenses associated with the manufacture of products.
Depreciation Expense
Depreciation expense relates to the depreciation of property, plant, and
equipment. For the three months ended March 31, 2005, depreciation expense of
$1.7 million increased 114% compared to $0.8 million for the year ended March
31, 2004. The increase in depreciation is a result of the addition of property,
plant, and equipment from the Atrix acquisition.
Amortization Of Intangibles
Amortization of intangibles of $1.9 million is related to the developed
technology and trademark intangibles acquired in our acquisition of Atrix on
November 19, 2004. The estimated fair value of the trademark relates to the
Eligard trademark and the estimated fair value of developed technology relates
to existing FDA-approved products (certain Eligard, dermatology and dental
products). Developed technology and trademark intangibles are being amortized
over their expected useful lives of 16 to 17 years, respectively.
Restructuring
In the three months ended March 31, 2005, we restructured our operations
following the acquisition of Atrix. We reduced our overall headcount by over 50
people. We provided affected employees with severance and support to assist with
outplacement. As a result, we recorded a $2.5 million restructuring charge in
the three months ended March 31, 2005 related to severance and termination
costs. We estimate that the restructuring will result in annual savings of $4.1
million. We expect restructuring activities to be completed by the end of the
year.
Investment And Other Income
Net Foreign Exchange Gains (Losses)
Net foreign exchange gains comprise gains from the impact of foreign exchange
fluctuation on our cash and cash equivalents, short-term investments, derivative
financial instruments, foreign currency receivables, foreign currency
33
payables and U.S. dollar denominated long term debt. For the three months ended
March 31, 2005, we recorded net foreign exchange gains of $0.6 million versus
net foreign exchange gains of $0.3 million in the same period in 2004. The gains
in the three months ended March 31, 2005 were from gains on cash and foreign
exchange contracts offset by losses on U.S. dollar long-term debt and foreign
currency receivables and payables. (See "Liquidity and Capital Resources -
Interest and Foreign Exchange Rates".)
Details of our net foreign exchange gains (losses) were as follows:
For the three months ended
March 31,
-----------------------------
(In thousands of U.S. dollars) 2005 2004
------ ------
Cash and cash equivalents and short-term investments $1,253 $1,845
U.S. dollar long-term debt (1,239) (1,637)
Foreign exchange contracts 1,207 542
Foreign currency receivables and payables (637) (474)
------ ------
Net foreign exchange gains $ 584 $ 276
====== ======
Interest Income
For the three months ended March 31, 2005, interest income of $2.5 million was
flat compared to $2.5 million for the same period in 2004. The increase in
yields on short-term investments and increase in cash generated from operations
offset the reduction in cash due to cash payments related to the acquisition of
Atrix in November 2004. Our treasury policy is focused on minimizing risk of
loss of principal.
Interest Expense
Interest expense comprised interest accrued on the 3% convertible senior notes
issued on August 15, 2003 and amortization of deferred financing expenses
related to this placement. For the three months ended March 31, 2005 interest
expense increased to $1.6 million from $1.5 million in the same period in 2004
due to the foreign exchange effect on the amortization of deferred financing
expenses.
Extraordinary Gain
On March 31, 2004, we acquired all the outstanding shares of Kinetek
Pharmaceuticals, Inc., or Kinetek, a privately held biopharmaceutical 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
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 us.
LIQUIDITY AND CAPITAL RESOURCES
We have financed operations, product development and capital expenditures
primarily through proceeds from our commercial operations, public and private
sales of equity securities, private placement of convertible senior notes,
licensing and collaborative funding arrangements with strategic partners, and
interest income.
The primary drivers of our operating cash flows during the three months ended
March 31, 2005 were cash receipts from product sales, royalties and milestone
payments, and cash payments related to the following: R&D activities, SG&A
expenses, raw materials purchases, contract manufacturing fees for the
manufacture of Visudyne, manufacturing costs related to the production of
Eligard, interest expense related to our convertible notes and income tax
installments.
For the three months ended March 31, 2005, we generated $25.6 million of cash
from operations as opposed to $12.4 million for the same period in 2004. Higher
cash receipts from Visudyne sales ($45.5 million as opposed to $36.5 million in
the same period in 2004), Atrix related product sales, royalties, contract
research and development and licensing and milestone payments ($17.1 million as
opposed to nil in the same period in 2004), and lower foreign exchange contract
losses of $3.0 million as compared to the same period in 2004 were offset by the
payment of income tax installments of $2.6 million, and increased operating and
inventory related expenditures of $14.5 million. We began paying cash income tax
installments in the third quarter of 2004 when we start incurring liability for
cash taxes. Previously, our deferred tax assets (tax losses and other deductions
from prior periods) were sufficient to eliminate
34
cash taxes. We expect to be cash taxable in Canada (having utilized the majority
of our tax losses and other tax assets) in 2005 as well.
During the three months ended March 31, 2005, the Atrix acquisition, capital
expenditures, and an increase in short term investments accounted for the most
significant cash outlays for investing activities. In the three months ended
March 31, 2005, we used $1.2 million for purchase costs related to Atrix. We
also used $2.1 million for the purchase of property, plant and equipment,
primarily related to our pilot manufacturing facility in Vancouver.
Our cash flows from financing activities consisted primarily of cash receipts of
$7.0 million from stock option and warrant exercises.
Interest And Foreign Exchange Rates
We are exposed to market risk related to changes in interest and foreign
currency exchange rates, each of which could adversely affect the value of our
current assets and liabilities. At March 31, 2005, we had an investment
portfolio consisting of fixed interest rate securities with an average remaining
maturity of approximately 40 days. If market interest rates were to increase
immediately and uniformly by 10% of levels at March 31, 2005, the fair value of
the portfolio would decline by an immaterial amount.
At March 31, 2005, we had $408.0 million in cash, cash equivalents and
short-term investments (approximately $296.2 million denominated in U.S.
dollars) and $172.5 million of U.S. dollar-denominated debt. Of the $296.2
million U.S. dollar-denominated balance, $175.9 million was held by our Canadian
parent company, approximately offsetting our 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 our U.S. dollar-denominated cash, cash equivalents
and short-term investments would be mostly offset by the decline in the fair
value of our $172.5 million U.S. dollar denominated long-term debt, resulting in
an immaterial amount of unrealized foreign currency translation loss. As the
functional currency of the U.S. subsidiary is the U.S. dollar, the U.S.
dollar-denominated cash, cash equivalents and short-term investments holdings of
our U.S. subsidiary do not result in foreign currency gains and losses in
operations.
We had previously classified auction rate securities as cash and cash
equivalents because of the short duration of their reset periods. These
securities have been reclassified as short-term investment securities to conform
with the current period's presentation. As a result of this reclassification,
our December 31, 2004 cash and cash equivalents decreased by $89.0 million to
$277.1 million and correspondingly, our short-term investment securities
increased by $89.0 million to $102.8 million. This reclassification has no
impact on previously reported results of operations or financial covenants and
does not affect the reported cash flows from operating or financing activities
for the three months ended March 31, 2004.
We enter into foreign exchange contracts to manage exposures to currency rate
fluctuations related to our expected future net income and cash flows. The net
unrealized gain in respect of such foreign currency contracts, as at March 31,
2005, was approximately $1.3 million and was included in our results of
operations.
We purchase goods and services primarily in Canadian and U.S. dollars and earn a
significant portion of our revenues in U.S. dollars. Foreign exchange risk is
also managed by satisfying U.S. dollar denominated expenditures with U.S. dollar
cash flows or assets.
Contractual Obligations
Our material contractual obligations as of March 31, 2005 comprised our long
term debt, supply agreements with contract manufacturers, and clinical and
development agreements. We also had operating lease commitments for office space
and office equipment. Details of these contractual obligations are described in
our 2004 Annual Report on Form 10-K. There has been no material change in our
contractual obligations since December 31, 2004.
General
We believe that our available cash resources and working capital, and our cash
generating capabilities, should be more than sufficient to satisfy the funding
of product development programs and other operating and capital requirements,
including the in-licensing or acquisition of products and technologies for the
reasonably foreseeable future. The nature and form of any future in-licensing or
acquisition may have a material impact on our financial position and results of
operations. Depending on the overall structure of current and future strategic
alliances, we may have additional capital requirements related to the further
development, marketing and distribution of existing or future products.
35
Our working capital and capital requirements will depend upon numerous factors,
including: our ability to successfully execute our integration strategies
following the acquisition of Atrix; the progress of our 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 we devote to the development of manufacturing, marketing and support
capabilities; technological advances; the status of competitors; the cost of
filing, prosecuting and enforcing our patent claims and other intellectual
property rights; our ability to establish collaborative arrangements with other
organizations; and the outcome of legal proceedings.
We 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, we may seek funding from a
combination of sources, including product licensing, joint development and new
collaborative arrangements, additional equity or debt financing or from other
sources. No assurance can be given that additional funding will be available or,
if available, on terms acceptable to us. If adequate capital is not available,
our business could be materially and adversely affected.
SUBSEQUENT EVENT
On April 28, 2005, we announced a share buy-back program pursuant to which we
may purchase up to $50 million of our common shares over a two-year period. The
share purchases will be made as a normal course issuer bid. All purchases would
be effected in the open market through the facilities of The Toronto Stock
Exchange and the NASDAQ Stock Market, in accordance with regulatory
requirements. During the one-year period commencing May 4, 2005, we may purchase
for cancellation up to 4,690,752 common shares, being 5% of the number of common
shares outstanding. The actual number of common shares which may be purchased
and the timing of any such purchases will be determined by management.
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
We acquired Atrix Laboratories, Inc. (now QLT USA, Inc.) in November 2004, and
subsequently excluded this entity from our evaluation and conclusions about our
internal control over financial reporting as of December 31, 2004. Our efforts
to assess and evaluate internal control over financial reporting at QLT USA are
ongoing. Subject to that qualification, we report the following:
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.
36
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Certain of our legal proceedings are discussed below and in Note 13 to the
unaudited consolidated financial statements, "Contingencies". While we believe
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.
TAP LITIGATION
In 2003, TAP Pharmaceutical Products, Inc., Takeda Chemical Industries Ltd. and
Wako Pure Chemical Industries, Ltd. filed suit against us, in a U.S. federal
court in the Northern District of Illinois Eastern Division, alleging that the
Eligard(R) delivery system infringes a patent (U.S. Patent No.4,728,721)
licensed to TAP Pharmaceuticals by the two other plaintiffs. The patent expires
on May 1, 2006. In March 2004, the court granted our motion to stay the patent
infringement suit, pending the outcome of re-examination of the patent-in-suit
by the U.S. Patent and Trademark Office. The plaintiffs filed a motion seeking
reconsideration of the stay order, but the motion was denied. TAP
Pharmaceuticals requested that it be allowed to file a motion for preliminary
injunction, and the court denied that request. The court lifted the stay on
November 16, 2004 following the conclusion of the re-examination proceedings.
The judge has not yet set a trial date. If this lawsuit is not resolved in our
favor, we may be enjoined from selling some or all of our Eligard(R) products
until the patent expires in 2006, and/or may be required to pay financial
damages, which could be substantial.
On June 21, 2004, Takeda Chemical Industries Ltd., Wako Pure Chemical
Industries, Ltd. and Takeda Pharma GmbH filed a Request for Issuance of a
Provisional Injunction against MediGene AG and Yamanouchi Pharma GmbH in the
Regional Court Hamburg, the Federal Republic of Germany. The request alleged
that MediGene AG and Yamanouchi Pharma GmbH infringe a German patent, EP 0 202
065, and sought an injunction preventing defendants from producing, offering
putting on the market or using, or importing or possessing for these purposes,
in the Federal Republic of Germany a solvent for preparing an injectable
solution containing a polymer claimed in EP 0 202 065. On July 26, 2004, the
Court denied the plaintiff's request for a Provisional Injunction.
On June 28, 2004, Takeda Chemical Industries Ltd., Wako Pure Chemical
Industries, Ltd. and Takeda GmbH (collectively referred to as the "Plaintiffs")
filed a complaint in the Regional Court Dusseldorf, the Federal Republic of
Germany, against MediGene AG and Yamanouchi Pharma GmbH alleging infringement of
the same patent. Previously, on June 1, 2004, MediGene AG filed an action in the
Federal Patent Court in Munich, Germany seeking the nullification of the patent
that is the subject of the June 28, 2004 complaint. On April 20, 2005 the
Federal Patent Court ruled that all of the claims asserted by the Plaintiffs in
the infringement suit are null and void in Germany on the grounds of lack of
novelty. The Plaintiffs have a right of appeal from this decision. The Regional
Court Dusseldorf has stayed the infringement action in view of the Federal
Patent Court's decision.
PATENT LITIGATION WITH MEEI
The First MEEI Lawsuit
In April 2000, Massachusetts Eye and Ear Infirmary ("MEEI") filed a civil suit
against us in the United States District Court (the "Court") for the District of
Massachusetts 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, we moved for summary judgement against MEEI on all eight counts of
MEEI's complaint in Civil Action No. 00-10783-JLT. The Court granted all of our
summary motions, dismissing all of MEEI's claims. With respect to our
counterclaim requesting correction of inventorship of the '349 patent to add an
additional MGH inventor, the Court stayed the claim pending the outcome of the
lawsuit described below.
MEEI appealed the decision of the Court to the U.S. District Court of Appeals.
On February 18, 2005 the Court of Appeals issued its ruling, upholding the
dismissal of five of MEEI's eight claims, and remanding three claims to trial on
the basis that they should not have been determined on summary judgment. On
March 4, 2005, we petitioned the Court of Appeals for a panel rehearing and a
rehearing en banc by the full court. On April 7, 2005, the Court issued an
37
order allowing our petition for panel rehearing in part and denying it in part.
Our petition for rehearing en banc was denied without prejudice to refiling
after the panel's decision on the rehearing.
The Second MEEI Lawsuit
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 Patent in issue in the first suit 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 us and Novartis Ophthalmics, Inc. (now Novartis Ophthalmics, a division
of Novartis Pharma AG) in the United States District Court for the District of
Massachusetts alleging infringement of the '303 Patent (Civil Action No.
01-10747-EFH). The suit seeks damages and injunctive relief for patent
infringement and unjust enrichment. We have 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.
In April 2003, we 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 our motion in May of 2003.
In January 2005, the Court ordered in our favour in one of our counterclaims and
declared that the inventorship of the '303 patent be corrected to add QLT as
joint inventors. That ruling gives us the right to exploit the patent in issue.
MEEI has a right to appeal the Court's ruling.
The final outcomes of these disputes are not presently determinable or estimable
and there can be no assurance that the matters will be finally resolved in our
favor. If the lawsuits are not resolved in our favor, we might be obliged to pay
damages, or an additional royalty or damages for access to the inventions
covered by claims in issued U.S. patents, and might be subject to such equitable
relief as a court may determine (which could include an injunction) a remedy
combining some or all of those remedies foregoing.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On January 13, 2005, we issued 1,000,000 shares of Common Stock in
connection with the exercise of a warrant held by Elan International
Services, Ltd., which we assumed upon our acquisition of Atrix
Laboratories. The aggregate consideration for the shares was
$3,390,000. These shares were issued as private placement without
registration in reliance on Section 4(2) of the Securities Act of 1933,
as amended. Pursuant to the related registration rights agreement, we
are required to prepare and file a registration statement in respect of
such shares following the request by the holders.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
38
ITEM 6. EXHIBITS
Exhibit
Number Description
------ -----------
4.2 Amended and Restated Registration Rights Agreement;
10.32* Deferred Share Unit Plan for Non-employee Directors;
10.33* Summary of Directors Fees;
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: Cameron Nelson, Vice President, Finance 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: Cameron Nelson, Vice President, Finance and Chief
Financial Officer;
* Incorporated by reference from the Company's Form
8-K filed on March 15, 2005.
39
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: May 9, 2005 By: /s/ Paul J. Hastings
-------------------- -------------------------------------------
Paul J. Hastings
President and Chief Executive Officer
(Principal Executive Officer)
Date: May 9, 2005 By: /s/ Cameron Nelson
-------------------- -------------------------------------------
Cameron Nelson
Vice President Finance and Chief
Financial Officer
(Principal Financial and Accounting
Officer)
40
EXHIBIT INDEX
Exhibit
Number Description
- ------- -----------
4.2 Amended and Restated Registration Rights Agreement;
10.32* Deferred Share Unit Plan for Non-employee Directors;
10.33* Summary of Directors Fees;
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: Cameron Nelson, Vice President, Finance 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: Cameron Nelson, Vice President, Finance and Chief Financial
Officer;
* Incorporated by reference from the Company's Form 8-K filed on March 15,
2005.
41