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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
Commission file number 0-15190
OSI Pharmaceuticals, Inc.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 13-3159796
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
58 South Service Road, Suite 110, Melville, New York 11747
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
631-962-2000
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report.)
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 [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
At January 31, 2004 the registrant had outstanding 38,978,070 shares of common
stock, $.01 par value.
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONTENTS
Page No.
PART I. FINANCIAL INFORMATION........................................ 2
Item 1. FINANCIAL STATEMENTS.......................................... 2
Consolidated Balance Sheets
- December 31, 2003 (Unaudited) and September 30, 2003..... 2
Consolidated Statements Of Operations
-Three Months Ended December 31, 2003 and 2002 (Unaudited). 3
Consolidated Statements Of Cash Flows
- Three Months Ended December 31, 2003 and 2002 (Unaudited) 4
Notes to Consolidated Financial Statements................. 5
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS........................... 11
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK................................................... 22
Item 4. CONTROLS AND PROCEDURES....................................... 23
PART II. OTHER INFORMATION........................................... 25
Item 1. LEGAL PROCEEDINGS............................................ 25
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.................... 25
Item 3. DEFAULTS UPON SENIOR SECURITIES.............................. 25
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.......... 25
Item 5. OTHER INFORMATION............................................ 25
Item 6. EXHIBITS AND REPORTS ON FORM 8-K............................. 25
SIGNATURES............................................................ 27
INDEX TO EXHIBITS..................................................... 28
i
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT PER SHARE DATA)
DECEMBER 31, SEPTEMBER 30,
2003 2003
---- ----
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents........................... $114,238 $202,519
Investment securities............................... 236,815 174,057
Restricted investment securities - short-term....... 12,818 12,758
Receivables, including amounts due from related
parties of $74 at September 30, 2003............. 10,033 10,121
Inventory........................................... 3,506 3,616
Interest receivable................................. 1,532 1,533
Prepaid expenses and other current assets........... 6,089 9,847
-------- --------
Total current assets.......................... 385,031 414,451
-------- --------
Restricted investment securities - long-term........... 14,883 14,813
Property, equipment and leasehold improvements - net... 44,088 44,977
Debt issuance costs - net.............................. 9,237 9,488
Goodwill............................................... 38,981 38,810
Other intangible assets - net.......................... 61,325 66,145
Other assets........................................... 2,850 2,818
-------- --------
$556,395 $591,502
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses, including
amounts due to related parties of
$11,948 and $6,875 at December 31, 2003 and
September 30, 2003, respectively.............. $ 32,933 $ 29,013
Unearned revenue - current; including amounts
received in advance from related parties
of $5,000 as of December 31, 2003 and
September 30, 2003............................... 5,907 5,779
Loans and capital leases payable - current.......... 37 61
-------- --------
Total current liabilities..................... 38,877 34,853
-------- --------
Other liabilities:
Deferred rent expense - long term................... 2,213 2,179
Unearned revenue - long-term, including amounts
received in advance from related parties
of $1,250 as of September 30, 2003............... -- 1,250
Convertible senior subordinated notes and capital
leases payable - long-term........................ 310,003 310,008
Contingent value rights............................. 22,047 22,047
Accrued postretirement benefit cost................. 3,283 3,108
-------- --------
Total liabilities............................. 376,423 373,445
-------- --------
Stockholders' equity:
Preferred stock, $.01 par value; 5,000 shares
authorized; no shares issued at
December 31, 2003 and September 30, 2003......... -- --
Common stock, $.01 par value; 200,000 shares
authorized, 40,374 and 40,298 shares issued
at December 31, 2003 and September 30, 2003,
respectively.................................... 404 403
Additional paid-in capital.......................... 748,350 747,737
Deferred compensation............................... (85) (216)
Accumulated deficit................................. (545,713) (505,580)
Accumulated other comprehensive income.............. 2,467 1,164
-------- --------
205,423 243,508
Less: treasury stock, at cost; 1,443 shares at
December 31, 2003 and September 30, 2003............ (25,451) (25,451)
-------- --------
Total stockholders' equity.................... 179,972 218,057
-------- --------
$556,395 $591,502
======== ========
See accompanying notes to consolidated financial statements.
2
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS EXCEPT PER SHARE DATA)
THREE MONTHS ENDED
DECEMBER 31,
------------------
2003 2002
---- ----
Revenues:
Sales commissions and product sales .............. $ 10,141 $ --
License and other revenues, including $1,250 from
related parties in 2003 and 2002 ............... 1,250 1,490
Collaborative program revenues, including $2,010
from related parties in 2002 ................... -- 2,982
-------- --------
11,391 4,472
-------- --------
Expenses:
Cost of product sales ............................ 110 --
Research and development ......................... 24,105 28,223
Selling, general and administrative .............. 20,820 7,500
Amortization of intangibles ...................... 4,838 54
-------- --------
49,873 35,777
======== ========
Loss from operations ......................... (38,482) (31,305)
Other income (expense):
Investment income -- net ......................... 1,487 2,669
Interest expense ................................. (2,820) (1,607)
Other income (expense) -- net ................... (318) 143
-------- --------
Net loss ........................................... $(40,133) $(30,100)
======== ========
Weighted average shares of common
stock outstanding................................. 38,884 36,414
======== ========
Basic and diluted net loss per common share ........ $ (1.03) $ (0.83)
======== ========
See accompanying notes to consolidated financial statements.
3
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
THREE MONTHS ENDED
DECEMBER 31
-------------------
2003 2002
---- ----
Cash flow from operating activities:
Net loss ............................................................. $ (40,133) $ (30,100)
Adjustments to reconcile net loss to net cash
used in operating activities:
Gain on sale of investments ....................................... (9) (345)
Loss on sale and disposals of equipment ........................... 9 --
Depreciation and amortization ..................................... 8,123 3,015
Non-cash compensation charges ..................................... 185 101
Changes in assets and liabilities:
Receivables .................................................... 88 2,029
Inventory ...................................................... 110 --
Prepaid expenses and other current assets ...................... 3,868 (352)
Other assets ................................................... 16 25
Accounts payable and accrued expenses .......................... 3,748 (675)
Unearned revenue ............................................... (1,122) (3,419)
Accrued postretirement benefit cost ............................ 174 174
--------- ---------
Net cash used in operating activities ................................... (24,943) (29,547)
--------- ---------
Cash flows from investing activities:
Purchases of investments (restricted and unrestricted) ............... (119,031) (127,078)
Maturities and sales of investments (restricted and unrestricted) .... 56,110 126,658
Net additions to property, equipment and leasehold improvements ...... (941) (821)
Additions to compound library assets ................................. (126) (45)
Investments in privately-owned companies ............................. -- (50)
--------- ---------
Net cash used in investing activities ................................... (63,988) (1,336)
--------- ---------
Cash flows from financing activities:
Proceeds from the exercise of stock options, stock warrants, and other 560 256
Debt issuance costs .................................................. (17) --
Payments on loans and capital leases payable ......................... (30) (128)
--------- ---------
Net cash provided by financing activities ............................... 513 128
--------- ---------
Net decrease in cash and cash equivalents ............................... (88,418) (30,755)
Effect of exchange rate changes on cash and cash equivalents ............ 137 (13)
Cash and cash equivalents at beginning of year .......................... 202,519 152,578
--------- ---------
Cash and cash equivalents at end of period .............................. $ 114,238 $ 121,810
========= =========
Non-cash activities:
Issuance of common stock to employees ................................ $ 60 $ 91
========= =========
Cash paid for interest ............................................... $ 1 $ 7
========= =========
See accompanying notes to consolidated financial statements.
4
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In this Quarterly Report on Form 10-Q, "OSI," "our company," "we," "us,"
and "our" refer to OSI Pharmaceuticals, Inc. and subsidiaries.
(1) Basis of Presentation
In the opinion of management, the accompanying unaudited consolidated
financial statements have been prepared in accordance with U.S. generally
accepted accounting principles ("GAAP") for interim financial information and
with the instructions to Rule 10-01 of Regulation S-X. Accordingly, they do not
include all of the information and footnotes required by GAAP for complete
financial statements. In the opinion of management, all adjustments (consisting
of only normal recurring accruals) considered necessary for a fair presentation
have been included. Operating results and cash flows for the three months ended
December 31, 2003 are not necessarily indicative of the results that may be
expected for the fiscal year ending September 30, 2004. For further information,
refer to the consolidated financial statements and footnotes thereto included in
our Annual Report on Form 10-K (the "Form 10-K") for the fiscal year ended
September 30, 2003.
(2) Revenue Recognition
Sales commissions represent commissions earned on the sales of the drug,
Novantrone(R) (mitoxantrone for injection concentrate), in the United States for
oncology indications (see note 4). Sales commissions are recognized on net
oncology sales in the period the sales occur based on the estimated split
between oncology sales and multiple sclerosis sales, as determined on a
quarterly basis by an external third party. The split between oncology and
multiple sclerosis sales is subject to further adjustment based on our review
and the final review by the external party, in the subsequent quarter. Based on
past experience, we do not believe these adjustments, if any, are significant to
the consolidated financial statements.
Product sales represent sales of Gelclair(R) Bioadherent Oral Gel
("Gelclair(R)") in accordance with an exclusive distribution agreement with
Helsinn Healthcare S.A. ("Helsinn"), which allows us to market and distribute
Gelclair(R) in North America. In accordance with SFAS No. 48, "Revenue
Recognition When Right of Return Exists," given the limited sales history of
Gelclair(R), we at this time defer the recognition of revenue on product
shipments of Gelclair(R) to wholesale customers until such time as the product
is sold from the wholesale customer to the retail and non-retail outlets. For
each reporting period, we monitor shipments from wholesale customers to
pharmacies and hospitals, and wholesale customer reorder history based on data
from an external third party. The related cost of the product shipped to
wholesale customers that has not been recognized as revenue has been reflected
as inventory subject to return (see note 7). The unearned revenue related to
shipments of Gelclair(R) to wholesale customers was $907,000 and $779,000 as of
December 31, 2003 and September 30, 2003, respectively, and is included in
unearned revenue-current on the accompanying consolidated balance sheets.
5
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
We account for upfront nonrefundable technology access and other upfront
fees over the term of the related research and development collaboration period
in accordance with the guidance provided in the Securities and Exchange
Commission's Staff Accounting Bulletin No. 104, "Revenue Recognition." We
received a total of $25.0 million in upfront fees from Genentech, Inc.
("Genentech") and Roche ("Roche") in January 2001 which is being recognized on a
straight-line basis evenly over the expected four-year term of our required
research and development efforts under the terms of a Tripartite Agreement with
Genentech and Roche.
(3) Stock Options
We follow the provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation." The provisions of SFAS No. 123 allow us to either expense the
estimated fair value of stock options or to continue to follow the intrinsic
value method set forth in Accounting Principles Board ("APB") Opinion No. 25
"Accounting for Stock Issued to Employees," but disclose the pro forma effect on
net income (loss) had the fair value of the options been expensed. We have
elected to continue to apply APB No. 25 in accounting for stock options issued
to employees.
Stock option grants are generally set at the closing price of our common
stock on the date of grant and the number of shares to be granted under the
option are fixed at that point in time. Therefore, under the principles of APB
No. 25, we do not recognize compensation expense associated with the grant of
stock options. Pro forma information regarding net loss and net loss per share
shown below was determined as if we had accounted for our employee stock options
and shares sold under our stock purchase plan under the fair value method of
SFAS No. 123.
The weighted average fair value per stock option granted was $14.71 for
the three months ended December 31, 2003 and $8.89 for the three months ended
December 31, 2002. The fair value of the options was estimated at the date of
grant using a Black-Scholes option pricing model with the following assumptions:
THREE MONTHS ENDED
DECEMBER 31,
----------------
2003 2002
---- ----
Risk-free interest rate ........................ 2.42% 2.04%
Dividend yield ................................. 0% 0%
Volatility factors of expected market
price of our common stock .................... 76.81% 85.27%
Weighted-average expected life of option
(years) ........................................ 3 3
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized over the options' vesting periods. Our pro forma
information for the three months ended December 31, 2003 and 2002 is as follows
(in thousands, except per share information):
6
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
THREE MONTHS ENDED
DECEMBER 31,
----------------------------
2003 2002
---- ----
Net loss.......................................... $ (40,133) $ (30,100)
Compensation cost determined under fair value
method.......................................... (5,640) (4,678)
---------- ----------
Pro forma net loss................................ $ (45,773) $ (34,778)
========== ==========
Basic and diluted net loss per common share:
Net loss........................................ $ (1.03) $ (0.83)
Compensation cost............................... (0.15) (0.13)
---------- ----------
Pro forma net loss................................ $ (1.18) $ (0.96)
========== ==========
(4) Co-Promotion Agreement
On March 11, 2003, we entered into the Co-Promotion Agreement with an
affiliate of Serono S.A. ("Serono") to market and promote Novantrone(R) for
approved oncology indications in the United States through December 2017. The
purchase price and related professional fees, net of related amortization, are
included in other intangible assets in the accompanying consolidated balance
sheets as of December 31, 2003 and September 30, 2003 and are being amortized on
a straight-line basis through expiration of the Novantrone(R) patent in April
2006. Under the terms of the agreement, we will also pay quarterly maintenance
fees to Serono until the later of the expiration of the last valid patent claim
or the first generic date, as defined in the agreement. Such maintenance fees
will be expensed as incurred. We receive commissions on net sales of the product
in the United States for oncology indications. Sales commissions totaled $9.8
million for the three months ended December 31, 2003.
(5) Acquisition
On June 12, 2003, we completed our acquisition of Cell Pathways, Inc.
("Cell Pathways") pursuant to the terms of an Agreement and Plan of Merger dated
February 7, 2003. The acquisition was accounted for under the purchase method of
accounting.
The assets purchased and liabilities assumed by us included: (a) two drug
candidates in clinical development, Aptosyn(R) (exisulind) and OSI-461, and the
related technology platform and patent estate; (b) exclusive distribution rights
to the marketed product, Gelclair(R), in North America; (c) rights to Cell
Pathways' leased facility in Horsham, Pennsylvania, as well as leasehold
improvements and certain equipment; (d) inventory; and (e) certain other assets
and liabilities. Gelclair(R) is a bioadherent oral gel that provides relief for
the treatment of pain associated with oral mucositis, a debilitating side effect
often seen in patients undergoing chemotherapy or radiation treatment. We have
an exclusive distribution agreement with Helsinn Healthcare, S.A., which allows
us to market and distribute Gelclair(R) in North America (United States, Canada
and Mexico) through January 2012. We have a marketing agreement with John O.
Butler Company ("Butler"), under which Butler markets Gelclair(R) to the dental
market within the United States and will market in Canada if and when
Gelclair(R) is approved for marketing in Canada.
7
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(6) Restricted Assets
In September 2003, in connection with the issuance of convertible senior
subordinated notes, we pledged $14.2 million of U.S. government securities
("Restricted Investment Securities") with maturities at various dates through
August 2006. In February 2002, in connection with the issuance of convertible
senior subordinated notes, we pledged $22.9 million of Restricted Investment
Securities with maturities at various dates through November 2004. Upon
maturity, the proceeds of the Restricted Investment Securities will be
sufficient to pay the first six scheduled interest payments on the respective
convertible senior subordinated notes when due. We consider our Restricted
Investment Securities to be held-to-maturity securities, as defined by SFAS No.
115, "Accounting for Certain Investments in Debt and Equity Securities." These
securities are reported at their amortized cost, which includes the direct costs
to acquire the securities plus the amortization of any discount or premium, and
accrued interest earned on the securities.
With respect to our facility leases in Horsham, Pennsylvania and Oxford,
England, we have outstanding letters of credit issued by a commercial bank. The
irrevocable letter of credit for our Horsham, Pennsylvania facility expires
annually on September 22nd with a final expiration date of September 22, 2008.
This letter of credit is for $400,000 of which the full amount was available at
December 31, 2003. The irrevocable letter of credit for our Oxford, England
facility expires annually on September 27th with a final expiration date of
September 27, 2007. This letter of credit is for $2.5 million, of which the full
amount was available on December 31, 2003. The collateral for these letters of
credit are maintained in a restricted investment account. Included in cash and
cash equivalents and investments securities as of December 31, 2003 is $48,000
and $3.4 million, respectively, relating to restricted cash and investments to
secure these letters of credit. Included in cash and cash equivalents and
investment securities as of September 30, 2003 is $35,000 and $3.4 million,
respectively, relating to restricted cash and investments to secure these
letters of credit.
(7) Inventory
Inventory is comprised solely of Gelclair(R) and is stated at the lower of
cost or market, as determined using the first-in, first-out method. Inventory at
December 31, 2003 and September 30, 2003, consisted of the following (in
thousands):
DECEMBER 31, SEPTEMBER 30,
2003 2003
---- ----
Finished goods on hand .... $3,217 $3,358
Inventory subject to return 289 258
------ ------
$3,506 $3,616
====== ======
Inventory subject to return represents the amount of Gelclair(R) shipped
to wholesale customers which has not been recognized as revenue (see note 2).
8
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(8) Comprehensive Income (Loss)
Comprehensive loss for the three months ended December 31, 2003 and 2002
was as follows (in thousands):
THREE MONTHS ENDED
DECEMBER 31,
------------------------
2003 2002
---- ----
Net loss..................................... $(40,133) $(30,100)
Other comprehensive income (loss):
Foreign currency translation adjustments ... 1,336 659
Unrealized holding losses arising during
period .................................... (24) (66)
Less: Reclassification adjustment for
gains realized in net loss .............. (9) (348)
------- --------
1,303 245
------- --------
Total comprehensive loss..................... $(38,830) $(29,855)
======= ========
The components of accumulated other comprehensive income were as follows
(in thousands):
DECEMBER 31, SEPTEMBER 30,
2003 2003
---- ----
Cumulative foreign currency translation
adjustment ........................................ $2,166 $830
Unrealized gains on available-for-sale
securities ........................................ 301 334
------ ------
Accumulated other comprehensive income........ $2,467 $1,164
====== ======
(9) Net Loss per Common Share
A reconciliation between the numerators and the denominators of the basic
and diluted net loss per share computation is as follows (in thousands except
per share data):
THREE MONTHS ENDED
DECEMBER 31,
-------------------------
2003 2002
---- ----
Net loss available for common stockholders . $ (40,133) $(30,100)
========= ========
Weighted average common shares ............. 38,884 36,414
Effect of common share equivalents ......... -- --
--------- --------
Weighted average common and potential
common shares outstanding ................. 38,884 36,414
========= ========
Basic loss per share ....................... $ (1.03) $ (0.83)
========= ========
Diluted loss per share ..................... $ (1.03) $ (0.83)
========= ========
Basic and diluted net loss per share is computed by dividing the net loss
by the weighted average number of common shares outstanding during the period.
If the three months ended December 31, 2003 and 2002 had resulted in net income
and had the common share equivalents for the 4% convertible senior subordinated
notes (3,200,000 shares) issued in February 2002 and the 3.25% convertible
senior subordinated notes (2,998,800 shares) issued in September 2003
9
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
been dilutive, interest expense related to the notes would have been added back
to net income to calculate diluted earnings per share. The related interest
expense of these notes for the three months ended December 31, 2003 and 2002
totaled $2.8 million and $1.6 million, respectively. Common share equivalents
(convertible senior subordinated notes, stock options and warrants) and
contingent shares pursuant to the contingent value rights are not included since
their effect would be anti-dilutive. Such common share equivalents (convertible
senior subordinated notes, stock options and warrants) and contingent shares
amounted to 7,326,597 and 1,584,973, respectively, for the three months ended
December 31, 2003. Such common share equivalents (convertible senior
subordinated notes and stock options) amounted to 4,102,186 for the three months
ended December 31, 2002.
(10) Goodwill and Other Intangible Assets
The carrying amount of goodwill as of December 31, 2003 of $39.0 million
includes a $171,000 effect from foreign currency exchange rate fluctuations
during the three-month period ended December 31, 2003. We completed our annual
impairment review of goodwill during the first quarter of fiscal 2004 and
determined that no impairment charge was required.
The components of other intangible assets are as follows:
DECEMBER 31, 2003 SEPTEMBER 30, 2003
------------------------------- -------------------------------
NET NET
CARRYING ACCUMULATED BOOK CARRYING ACCUMULATED BOOK
AMOUNT AMORTIZATION VALUE AMOUNT AMORTIZATION VALUE
-------- ------------ ------- -------- ------------ -------
Novantrone(R) ............... $46,009 $(11,814) $34,195 $46,009 $(8,084) $37,925
Gelclair(R) ................. 28,957 (1,827) 27,130 28,957 (984) 27,973
License to compound libraries 795 (795) -- 740 (493) 247
------- -------- ------- ------- ------- -------
Total ....................... $75,761 $(14,436) $61,325 $75,706 $(9,561) $66,145
======= ======== ======= ======= ======= =======
In the first quarter of fiscal 2004, we made the decision not to renew our
research agreement with British Biotech plc and as a result recorded an
impairment loss relating to the license for compound libraries of $217,000.
Amortization expense for these intangible assets for the three months ended
December 31, 2003 and 2002 was $4.8 million and $54,000, respectively.
Amortization expense is estimated to be $13.7 million for the remainder of
fiscal 2004, $18.3 million in fiscal 2005, $11.5 million in fiscal 2006, $3.4
million in fiscal 2007 and $3.4 million in fiscal 2008.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THREE MONTHS ENDED DECEMBER 31, 2003 AND 2002
OVERVIEW
We are a leading biotechnology company focused on the discovery,
development and commercialization of high-quality oncology products that both
extend life and improve the quality-of-life for cancer patients worldwide. We
have established a balanced pipeline of oncology drug candidates that includes
both novel mechanism based, targeted therapies in the areas of signal
transduction and apoptosis and next-generation cytotoxic chemotherapy agents. We
also market and promote Novantrone(R) (mitoxantrone concentrate for injection)
for approved oncology indications in the United States and market and distribute
Gelclair(R) Bioadherent Oral Gel in North America.
Our clinical pipeline consists of multiple drug candidates in various
stages of clinical development. Our most prominent drug candidate, Tarceva(TM)
(erlotinib HC1), is a small molecule inhibitor of the epidermal growth factor
receptor, or HER1/EGFR. The protein product of the HER1/EGFR gene is a receptor
tyrosine kinase that is over-expressed or mutated in many major solid tumors
including lung and pancreatic cancers. The HER1/EGFR gene is also amplified in
certain tumors including glioblastoma multiforme, an aggressive form of brain
cancer. We believe HER1/EGFR inhibitors represent an exciting new class of
relatively safe and well tolerated anti-cancer agents that may have utility in
treating a wide range of cancer patients. Tarceva(TM) is an oral once-a-day
small molecule drug designed to specifically block the activity of the HER1/EGFR
protein. Currently, we are developing Tarceva(TM) in a global alliance with
Genentech, Inc. and Roche. Tarceva(TM) has demonstrated encouraging indications
of anti-cancer activity in single-agent, open label Phase I and Phase II trials
in non-small cell lung cancer, or NSCLC, bronchioloalveolar cell carcinoma, or
BAC (a form of lung cancer), glioblastoma multiforme, head and neck cancer,
hepatocellular carcinoma and ovarian cancer. Based upon these data, the alliance
embarked upon a comprehensive global development plan in 2001 designed to both
register Tarceva(TM) and maintain a competitive position against other EGFR
inhibitors. In October 2003, we announced that two Tarceva(TM) Phase III
clinical trials for front-line NSCLC (in combination with conventional
chemotherapy versus chemotherapy alone) did not meet their primary endpoints of
improving overall survival. We had considered these trials high risk as a result
of a competitor's previously announced failure of its EGFR inhibitor in this
setting which had demonstrated that combining an EGFR inhibitor concomitantly
with conventional chemotherapy drug regimens did not result in improved patient
benefit.
Tarceva(TM) is currently in a fully enrolled 731 patient Phase III
clinical trial for second/third-line NSCLC patients, which is our primary
registration study. This study compares the use of Tarceva(TM) as a monotherapy
versus placebo in lung cancer patients who have failed conventional chemotherapy
treatments. The study is designed to detect a survival advantage as its primary
endpoint with secondary endpoints that include time to symptomadic
deterioration, progression free survival and response rate. In January 2004, we
initiated the "rolling" submission of a New Drug Application, or NDA, with the
U.S. Food and Drug Administration
11
for the use of Tarceva(TM) in this setting. The "rolling" submission is an FDA
provision, available to drug candidates which have received Fast Track
designation, that allows for completed sections of an NDA to be submitted on an
ongoing basis. Fast Track status for Tarceva(TM) in the NSCLC indication was
granted by the FDA in September 2002. The Fast Track status is designed to
facilitate the review process by allowing the sponsor to submit sections of an
NDA as they become available, before knowing the results of the pivotal clinical
trials. Although the FDA has no obligation to begin reviewing sections of the
NDA until the final sections of the complete NDA are submitted, the FDA can
begin the review of the submitted sections, if resources permit. Such a review
can be advantageous to the overall product assessment timelines. The Fast Track
designation is limited to a new drug that is intended for the treatment of a
serious and life-threatening condition for which there is an unmet medical need.
Data from this clinical trial are now expected in the second quarter of this
year and additional components of the NDA filing will be provided to the FDA
once the data are available. Based on encouraging data from a Phase I study in
glioblastoma, our partner, Genentech, initiated a Phase II study for this
indication in August 2003. Tarceva(TM) is also in a Phase III trial for
pancreatic cancer where it is being tested in combination with gemcitabine
versus gemcitabine plus placebo. We expect top-line data for the ongoing Phase
III trials and Phase II glioblastoma trial during 2004. We estimate the approval
of Tarceva(TM) by the FDA in late fourth quarter of calendar 2004, or early
first quarter of calendar 2005, if the second/third-line NSCLC study
successfully meets its endpoint.
In December 2003, President Bush signed into law the Medicare Prescription
Drug, Improvement and Modernization Act of 2003. This Act materially changes the
Medicare reimbursement guidelines for intravenous and oral oncology products
which may impact the sales revenues of all intravenous chemotherapy agents. This
legislation will lower the reimbursement to oncologist for intravenous oncology
products like Novantrone(R) while providing increased reimbursement for drugs
like Tarceva(TM) (if approved by the FDA) which are not currently covered by
Medicare. The provisions affecting intravenous oncology products, such as
Novantrone(R) took effect in January 2004, while the provisions affecting
coverage for oral prescription drugs, such as Tarceva(TM) (if approved by the
FDA) will take effect in 2006. These changes in Medicare reimbursement may have
a negative impact on our sales commissions of Novantrone(R).
CRITICAL ACCOUNTING POLICIES
We prepare our consolidated financial statements in accordance with
accounting principles generally accepted in the United States. As such, we are
required to make certain estimates, judgments and assumptions that we believe
are reasonable based upon the information available. These estimates and
assumptions affect the reported amounts of assets and liabilities as of the date
of the consolidated financial statements and the reported amounts of revenues
and expenses during the periods presented. Actual results could differ
significantly from our estimates and the estimated amounts could differ
significantly under different assumptions and conditions. We believe that the
following discussion addresses our most critical accounting policies, which are
those that are most important to the portrayal of our financial condition and
results of operations and which require our most difficult and subjective
judgments, often as a result of the need to make estimates about the effect of
matters that are inherently uncertain. Note 1 to the consolidated financial
statements included in our Annual Report on Form 10-K
12
includes a summary of the significant accounting policies used in the
preparation of the consolidated financial statements.
Revenue Recognition
Sales commissions from Novantrone(R) on net oncology sales are recognized
in the period the sales occur based on the estimated split between oncology
sales and multiple sclerosis sales, as determined on a quarterly basis by an
external third party. The split between oncology and multiple sclerosis sales is
subject to further adjustment based on our review and the final review by the
external party, in the subsequent quarter. Based on past experience, we do not
believe these adjustments, if any, will be significant to the consolidated
financial statements.
Given the limited sales history of Gelclair(R), we at this time defer the
recognition of revenue on product shipments of Gelclair(R) to wholesale
customers until such time as the product is sold from the wholesale customer to
the retail and non-retail outlets. For each reporting period, we monitor
shipments from wholesale customers to pharmacies and hospitals and wholesale
customer reorder history based on data from an external third party.
We recognize all nonrefundable upfront license fees, including upfront
technology access fees, as revenue over the term of the related research
collaboration period in accordance with the guidance provided in the Securities
and Exchange Commission's Staff Accounting Bulletin No. 104, "Revenue
Recognition." The expected term is subject to change based upon the parties'
continuous monitoring of current research data and their projections for the
remaining development period.
Accruals for Clinical Research Organization and Clinical Site Costs
We make estimates of costs incurred to date but not yet invoiced in
relation to external clinical research organizations, or CROs, and clinical site
costs. We analyze the progress of clinical trials, including levels of patient
enrollment, invoices received and contracted costs when evaluating the adequacy
of the accrued liabilities. Significant judgments and estimates must be made and
used in determining the accrued balance in any accounting period.
Goodwill and Other Long-Lived Assets
SFAS No. 142, "Goodwill and Other Intangible Assets," requires that
goodwill and certain other intangibles with indefinite useful lives, are not
amortized into results of operations but instead are reviewed for impairment at
least annually and written down, and charged to results of operations in periods
in which the recorded value of goodwill and certain other intangibles is more
than their implied fair value. We completed our annual impairment review of
goodwill during the first quarter of fiscal 2004 and determined that no
impairment charge was required.
Our identifiable intangible assets are subject to amortization. SFAS No.
142 requires that intangible assets with estimable useful lives be amortized
over their respective estimated useful lives and reviewed for impairment in
accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets." SFAS No. 144, requires, among other things,
13
that long-lived assets be measured at the lower of carrying amount or fair
value, less cost to sell, whether reported in continuing operations or in
discontinued operations. We review our intangibles with determinable lives and
other long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying value of an asset may not be
recoverable. Our judgments regarding the existence of impairment indicators are
based on historical and projected future operating results, changes in the
manner of our use of the acquired assets or our overall business strategy, and
market and economic trends. Our two most significant intangible assets are our
rights to Novantrone(R) and Gelclair(R); and therefore, we continually monitor
sales activity and market and regulatory conditions for these products for the
existence of any impairment indicators. In the future, events could cause us to
conclude that impairment indicators exist and that certain intangibles with
determinable lives and other long-lived assets are impaired which may result in
an adverse impact on our financial condition and results of operations.
REVENUES
Total revenues for the three months ended December 31, 2003 were $11.4
million compared to revenues of $4.5 million for the three months ended December
31, 2002, an increase of $6.9 million or 155%. The increase in revenues was
primarily due to Novantrone(R) sales commissions. On March 11, 2003, we began
recording Novantrone(R) sales commissions, upon the execution of the
Co-Promotion Agreement with Serono. We launched our sales efforts for
Novantrone(R) during the third quarter of fiscal 2003. Sales commissions for the
three months ended December 31, 2003 and September 30, 2003 were $9.8 million
and $9.9 million, respectively. Oncology sales during calendar 2003 exceeded a
contractual threshold resulting in a higher sales commission rate for the
quarter ended December 31, 2003. We anticipate lower sales commissions as we
revert back to the base commission rate effective with the new calendar year. We
will continue at the lower commission rate until we achieve certain calendar
year oncology sales goals for Novantrone(R). We began recognizing Gelclair(R)
product sales during the third quarter of fiscal 2003, upon the closing of our
acquisition of Cell Pathways. We estimate that our fiscal 2004 products sales of
Gelclair(R) will be between $3.0 and $5.0 million. We launched our sales effort
for this product in October 2003. Total product sales for the three months ended
December 31, 2003 were $309,000. We currently estimate that our total fiscal
2004 sales commissions and product sales will be approximately $35 million.
License and other revenues decreased $240,000 or 16% for the three months
ended December 31, 2003 compared to the three months ended December 31, 2002.
This decrease was primarily due to the three months ended December 31, 2002
including the recognition of a portion of the $3.5 million technology access fee
received from Tanabe Seiyaku Co., Ltd. related to the collaboration which
expired on October 1, 2003. Total collaborative program revenues decreased $3.0
million or 100% for the three months ended December 31, 2003 compared to the
three months ended December 31, 2002. The decrease was due to the completion of
our collaborations with Anaderm Research Corporation in March 2003 and Tanabe in
October 2003. As a result of our strategic decision to divest all non-oncology
research programs we no longer expect collaborative revenues from research
alliances going forward.
14
EXPENSES
Total operating expenses for the three months ended December 31, 2003 were
$49.9 million compared to operating expenses of $35.8 million for the three
months ended December 31, 2002, an increase of $14.1 million or 39%. Operating
expenses primarily included (i) research and development expenses, which include
expenses related to the development of our lead clinical candidate, Tarceva(TM),
and expenses related to our proprietary and collaborative-based research; (ii)
selling, general and administrative expenses; and (iii) amortization of
intangibles.
Cost of products sold, which relate to sales of Gelclair(R), were $110,000
for the three months ended December 31, 2003, or 36% of product sales. There
were no costs of products sold in the comparable period of fiscal 2003 since we
acquired the rights to Gelclair(R) on June 12, 2003.
The largest component of our total expenses is our ongoing investments in
research and development, and particularly, the clinical development of our
product pipeline. We currently have multiple drug candidates in clinical
development including our most prominent candidate, Tarceva(TM), which is
currently in Phase III trials for NSCLC and pancreatic cancer, Phase II trials
for glioblastoma, and various other Phase I and II trials. We consider the
active management and development of our clinical pipeline crucial to the
long-term approval process. We manage our overall research, development and
in-licensing efforts in a manner designed to generate a constant flow of
clinical candidates into development to offset both the advancement of products
to the market and the anticipated attrition rate of drug candidates that fail in
clinical trials or are terminated for business reasons. The table below
summarizes the typical duration of each phase of clinical development and the
typical cumulative probabilities of success for approval of drug candidates
entering clinical development. The numbers are based upon industry survey data
for small molecule drugs:
ESTIMATED CUMULATIVE
DEVELOPMENT PHASE ESTIMATED COMPLETION TIME PROBABILITY OF SUCCESS
- ----------------- ------------------------- ----------------------
Phase I............ 1-2 Years 20%
Phase II........... 1-2 Years 30%
Phase III.......... 2-3 Years 65%
Registration....... 6-15 months 85%
The Tufts Center for the Study of Drug Development estimates that the
average cost to develop a new prescription drug is $802 million. The actual
probability of success for each drug candidate and clinical program will be
impacted by a variety of factors, including the quality of the molecule, the
validity of the target and disease indication, early clinical data, investment
in the program, competition and commercial viability. Because we manage our
pipeline in a dynamic manner, it is difficult to give accurate guidance on the
anticipated proportion of our research and development investments assigned to
any one program prior to the Phase III stage of development, or to the future
cash inflows from these programs. For the three months ended
15
December 31, 2003, we invested a total of approximately $10.8 million in
research and approximately $13.3 million in pre-clinical and clinical
development. We estimate our fiscal 2004 research and development cost will be
between $100 million and $110 million. We consider this level of investment
suitable to sustain one major Phase III program and two to four earlier clinical
stage programs at any time and we manage our overall research and development
investments toward this level of activity.
Research and development expenses decreased $4.1 million or 15% for the
three months ended December 31, 2003 compared to the three months ended December
31, 2002. Increases in costs associated with the clinical development of drug
candidates acquired in connection with our acquisition of Cell Pathways were
offset by a reduction in clinical development cost for Tarceva(TM). Although
there are multiple on-going clinical trials for Tarceva(TM), the large scale
Phase III trials have been completed or are near completion, while all four
Phase III trials were fully active in the prior year period.
Our most advanced development program is for Tarceva(TM). In January 2001,
we entered into the alliance with Genentech and Roche for the global development
and commercialization of Tarceva(TM). The significant perceived market potential
for Tarceva(TM) has resulted in the alliance partnership committing to an
unusually large and comprehensive global development plan for the candidate. The
global development plan consists of major Phase III clinical trials in lung and
pancreatic cancers and a large number of earlier stage trials in a variety of
disease settings, including glioblastoma. In addition, numerous collaborative
and investigator sponsored studies are ongoing in a number of other disease
settings including bronchioloalveolar cell carcinoma and gynecological
malignancies. The alliance partners have committed to invest a combined $300
million in the global development plan to be shared equally by the three
parties. Additional research and development investments can be made by the
parties outside of the global development plan with the consent of the other
parties. We estimate that we will invest an additional $10-$15 million in
Tarceva(TM) research and development outside of the global development plan
prior to the drug's targeted FDA approval in late fourth quarter of calendar
2004 or early first quarter of calendar 2005. As of December 31, 2003, we have
invested in excess of $82 million, representing our share of the costs incurred
to date in the tripartite global development plan and additional investments
outside the plan. Our research and development expenses for Tarceva(TM) incurred
for the three months ended December 31, 2003 were $6.9 million. We anticipate
investing a majority of the remaining $28-$33 million we have provisionally
budgeted for this program over the next two years. Should Tarceva(TM) be
successfully registered and launched, we would anticipate continued research and
development investment in the product to support its commercial growth. As of
December 31, 2003, we anticipate that the cost to complete the Phase III
clinical trials for Aptosyn(R) to be between $3.0 and $4.0 million.
Selling, general and administrative expenses increased $13.3 million or
178% for the three months ended December 31, 2003 compared to the three months
ended December 31, 2002. The increase was primarily due to (i) additional
management and personnel relating to the establishment of commercial operations
to support Gelclair(R) and Novantrone(R); (ii) subcontracting expenses relating
to our short-term transitional arrangement with a contract sales organization
consisting of a core of sales representatives as we build our commercial
operations; (iii) increased commercialization and marketing costs relating to
Tarceva(TM) which
16
are shared with Genentech in accordance with the terms of our collaboration with
Genentech; (iv) expenses for maintenance fees relating to Novantrone(R) sales in
oncology indications; and (v) transition support services provided by Celgene
Corporation as a result of our full recovery of rights to market and distribute
Gelclair(R) from Celgene. The sales and marketing infrastructure is currently
comprised of approximately 60 sales, marketing, medical affairs, commercial
planning and support personnel, including approximately 30 person sales force.
We expect selling, general and administrative costs to increase as we expand our
commercial operations and are currently estimating that our fiscal 2004 selling,
general and administrative costs will be between $85 million and $95 million.
Amortization of intangibles increased $4.8 million for the three months
ended December 31, 2003 compared to the three months ended December 31, 2002.
The increase primarily related to $3.7 million in amortization expense related
to our rights to Novantrone(R) and $843,000 in amortization expense related to
our rights to Gelclair(R). In the first quarter of fiscal 2004, we made the
decision not to renew our research agreement with British Biotech plc, which was
entered into upon the acquisition of certain assets from British Biotech. As a
result, we recorded an impairment loss relating to the license for compound
libraries of $217,000 which is included in amortization expense for the three
months ended December 31, 2003.
OTHER INCOME AND EXPENSE
Net investment income decreased $1.2 million or 44% for the three months
ended December 31, 2003 compared to the three months ended December 31, 2002.
The decrease was primarily attributable to a decrease in the average rate of
return on our investments and to less funds available for investment during the
respective periods. Interest expense increased $1.2 million or 75% for the three
months ended December 31, 2003 compared to the three months ended December 31,
2002. The increase was primarily due to the interest expense incurred on the
convertible senior subordinated notes. In September 2003, we issued $150.0
million aggregate principal amount of convertible senior subordinated notes,
which bear interest at 3.25% per annum, are payable semi-annually, and mature in
September 2023. For the three months ended December 31, 2003, other expense-net
was $318,000 compared to other income-net of $143,000 for the three months ended
December 31, 2002. Included in fiscal 2003 was the amortization of debt issuance
costs of $268,000. Included in fiscal 2002 was the realized gains from the sale
of investments of $345,000, offset by amortization of debt issuance costs of
$203,000.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2003, working capital, representing primarily cash, cash
equivalents, and restricted and unrestricted short-term investments, aggregated
$346.2 million compared to $379.6 million at September 30, 2003. This decrease
of $33.4 million is primarily due to net operating cash burn for the three month
period.
We expect to incur continued losses over the next few years as we continue
our investment in Tarceva(TM) and other product candidates in our pipeline as
well as our research programs and our commercial operations. We estimate that
our fiscal 2004 cash burn will be between $115 million and $120 million. We have
established a goal of achieving profitability
17
and positive cash flow within 24 months of a successful market launch of
Tarceva(TM). Although we believe that we have sufficient cash for operations for
the next few years, if the market launch of Tarceva(TM) is delayed or if
Tarceva(TM) does not receive FDA approval or if the approval process is delayed
or takes longer than expected, such events would have a negative impact on our
liquidity position, assuming our current cash burn. In addition, as we continue
to pursue strategic in-licensing and acquisition opportunities that would bring
additional products and clinical development candidates to our cancer pipeline,
we will be required to use our available cash and/or equity securities. To
achieve profitability, we, alone or with others, must successfully develop and
commercialize our technologies and products, conduct pre-clinical studies and
clinical trials, secure required regulatory approvals and obtain adequate
assistance to successfully manufacture, introduce and market such technologies
and products. The ability and time required to reach profitability is uncertain.
We believe that our existing cash resources provide a strong financial base from
which to fund our operations and capital requirements for at least the next
several years.
On September 8, 2003, we issued $135.0 million aggregate principal amount
of convertible senior subordinated notes in a private placement for net proceeds
of $130.3 million. On September 17, 2003, the bankers associated with this
convertible debt offering exercised an option to purchase an additional $15.0
million of notes, for an additional net proceeds of $14.5 million. The notes
bear interest at 3.25% per annum, payable semi-annually, and mature on September
8, 2023. The notes are convertible into shares of our common stock at a
conversion price of $50.02 per share, subject to normal and customary
adjustments such as stock dividends or other dilutive transactions. In
connection with the issuance of the notes, we used $19.0 million of the net
proceeds for the purchase of 503,800 shares of our common stock. With respect to
the notes, we pledged $14.2 million of U.S. government securities with
maturities at various dates through August 2006. Upon maturity, the proceeds of
these restricted investment securities will be sufficient to pay the first six
scheduled interest payments on the notes when due. The aggregate fair value and
amortized cost of the restricted investment securities at December 31, 2003 was
$14.3 million.
On February 1, 2002, we issued $200.0 million aggregate principal amount
of convertible senior subordinated notes in a private placement for net proceeds
to us of approximately $192.9 million. The notes bear interest at 4% per annum,
payable semi-annually, and mature on February 1, 2009. The notes are convertible
into shares of our common stock at a conversion price of $50 per share, subject
to normal and customary adjustment, such as stock dividends. In August and
September 2002, we purchased in the open market a total of $40.0 million in
principal amount of the notes for an aggregate purchase price of approximately
$26.2 million, including accrued interest of $133,000. The difference between
the purchase price and the principal amount of the notes retired and accrued
interest resulted in a net gain on the early retirement of the notes in the
fourth quarter of fiscal 2002 of approximately $12.6 million net of the write
off of related debt issuance cost. With respect to the notes, we pledged $22.9
million of U.S. government securities with maturities at various dates through
November 2004. Upon maturity, the proceeds of these restricted investment
securities will be sufficient to pay the first six scheduled interest payments
on the notes when due. The aggregate fair value and amortized cost of the
restricted investment securities at December 31, 2003 were $13.5 million and
$13.4 million, respectively.
18
If all or any portion of the notes issued in September 2003 and February
2002 have not been converted into common stock prior to their maturity dates, we
will be required to pay, in cash, the outstanding principal amounts of the notes
plus any accrued and unpaid interest. This could have a significant impact on
our liquidity depending on our cash position at time of maturity. If we do not
have sufficient cash to repay the debt, we may need to borrow additional funds
or sell additional equity in order to meet out debt obligations.
COMMITMENTS AND CONTINGENCIES
Our major outstanding contractual obligations relate to our senior
subordinated convertible notes and our facility leases. The following table
summarizes our significant contractual obligations at December 31, 2003 and the
effect such obligations are expected to have on our liquidity and cash flow in
future periods (in thousands):
2009 &
2004 2005 2006 2007 2008 THEREAFTER TOTAL
---- ---- ---- ---- ---- ---------- -----
Contractual Obligations:
Senior convertible debt (a) $ 11,275 $ 11,275 $ 11,275 $ 11,275 $ 11,275 $386,325 $442,700
Operating leases 6,680 8,285 6,896 5,595 6,526 54,151 88,133
Capital commitments 631 -- -- -- -- -- 631
Capital leases payable (b) 33 7 -- -- -- -- 40
-------- -------- -------- -------- -------- -------- --------
Total contractual obligations $ 18,619 $ 19,567 $ 18,171 $ 16,870 $ 17,801 $440,476 $531,504
======== ======== ======== ======== ======== ======== ========
- -----------------------
(a) Includes interest payments at a rate of 4% per annum and 3.25% per
annum relating to convertible senior subordinated notes issued in
February 2002 and September 2003, respectively.
(b) Includes interest payments.
Other significant commitments and contingencies include the following:
- We are committed to share equally with Genentech and Roche a
combined $300 million in certain global development costs for
Tarceva(TM). As of December 31, 2003, we have spent
approximately 80% of our commitment under the agreement. We
are also committed to share certain commercialization costs
relating to Tarceva(TM) with Genentech.
- In connection with our agreement to market and promote
Novantrone(R) in approved oncology indications, we are
required to pay quarterly maintenance fees until the later of
the expiration of the last valid patent claim or the first
generic date, as defined in the agreement, or unless the
agreement is earlier terminated.
- In connection with the exclusive distribution agreement to
market and distribute Gelclair(R) in North America, we are
committed to additional inventory purchases of $3.0 million
and $5.0 million in calendar 2003 and 2004, respectively. Our
commitment for calendar 2003 will be recorded during 2004 upon
shipment of the inventory. We are also committed to annual
marketing expenditures of $750,000, $500,000 and $250,000 for
2004 through 2006, 2007 through 2008 and 2009
19
through 2011, respectively. In addition, we are obligated to
spend $1.3 million annually for direct sales force efforts. We
could be responsible for milestone payments totaling $3.0
million related to achievement of certain sales, patent and
clinical trial milestones.
- Under agreements with external CROs we will continue to incur
expenses relating to the progress of Tarceva(TM) and other
candidate clinical trials. These disbursements can be based
upon the achievement of certain milestones, patient
enrollment, services rendered or as expenses are incurred by
the CROs.
- In connection with our termination agreement with Celgene, we
are required to make a payment to Celgene on the first
anniversary of the effective date provided that the transition
services, as defined in the agreement, have been provided to
us. The agreement also provides for a milestone payment to
Celgene upon the achievement of a specified amount of net
sales of Gelclair(R).
- We have outstanding letters of credit issued by a commercial
bank. One is an irrevocable letter of credit related to our
Oxford, England facility and expires annually with a final
expiration date of September 27, 2007. The amount under this
letter of credit is $2.5 million of which the full amount was
available on December 31, 2003. Another is an irrevocable
letter of credit related to our Horsham, Pennsylvania
facility, whose lease we assumed through the acquisition of
Cell Pathways. The letter expires annually with a final
expiration date of September 22, 2008. The amount under this
letter of credit is $400,000 of which the full amount was
available on December 31, 2003.
- In May 2003, we entered into a contract with a third-party
contract sales organization for the outsourcing of sales
representatives and other sales force infrastructure. The
remaining commitment is approximately $828,000 as of December
31, 2003.
- We have a retirement plan which provides postretirement
medical and life insurance benefits to eligible employees,
board members and qualified dependents. Eligibility is
determined based on age and years of service. We have accrued
postretirement benefit costs of $3.3 million at December 31,
2003.
- In connection with the acquisition of Cell Pathways, we
provided additional consideration in the form of five-year
contingent value rights through which each share of Cell
Pathways' common stock will be eligible for an additional 0.04
share of OSI common stock in the event of a filing of a new
drug application by June 12, 2008 for either of the two
clinical candidates acquired from Cell Pathways, OSI-461 or
Aptosyn(R).
- In connection with the acquisition of certain of Gilead's
oncology assets in December 2001, we are obligated to pay up
to an additional $30.0 million in either cash or a combination
of cash and common stock upon the achievement of
20
certain milestones related to the development of OSI-211, the
most advanced of Gilead's oncology product candidates acquired
by us.
- Under certain license and collaboration agreements with
pharmaceutical companies and educational institutions, we are
required to pay royalties and/or milestones upon the
successful development and commercialization of products.
- Under certain license agreements, we are required to pay
license fees for the use of technologies and products in our
research and development activities.
RECENT ACCOUNTING PRONOUNCEMENTS
On April 22, 2003, FASB determined that stock-based compensation should be
recognized as a cost in the financial statements and that such cost be measured
according to the fair value of the stock options. The FASB has not as yet
determined the methodology for calculating fair value and plans to issue an
exposure draft and final statement in 2004. We will continue to monitor
communications on this subject from the FASB in order to determine the impact on
our consolidated financial statements.
In December 2003, President Bush signed into law the Medicare Prescription
Drug, Improvement and Modernization Act of 2003. The Act introduced both a
Medicare prescription drug benefit and a federal subsidy to sponsors of retiree
health care plans that provide a benefit at least "actuarially equivalent" to
the Medicare benefit. These provisions of the new law will effect accounting
measurements. It is currently unclear whether the subsidy (1) should be
accounted for as a reduction of the accumulated postretirement benefit
obligation and net periodic postretirement benefit costs or (2) should be
accounted for as a payment to a plan sponsor as determined by reference to the
plan's benefit payments. It is also unclear under the current accounting
guidance whether the subsidy should be recorded immediately or deferred until
future periods. The FASB plans to issue authoritative guidance on the accounting
for subsidies later in 2004. We have elected to defer accounting for the effect
of the new Act as it relates to our postretirement plan, until FASB issues
further guidance.
FORWARD LOOKING STATEMENTS
A number of the matters and subject areas discussed in this Item 2
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and elsewhere in this report that are not historical or current
facts deal with potential future circumstances and developments. The discussion
of these matters and subject areas is qualified by the inherent risks and
uncertainties surrounding future expectations generally, and these discussions
may materially differ from our actual future experience involving any one or
more of these matters and subject areas. These forward looking statements are
also subject generally to the other risks and uncertainties that are described
in our annual report on Form 10-K for the fiscal year ended September 30, 2003.
21
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our cash flow and earnings are subject to fluctuations due to changes in
interest rates in our investment portfolio of debt securities, to the fair value
of equity instruments held and to foreign currency exchange rates. We maintain
an investment portfolio of various issuers, types and maturities. These
securities are generally classified as available-for-sale as defined by SFAS No.
115, "Accounting for Certain Investments in Debt and Equity Securities," and,
consequently, are recorded on the balance sheet at fair value with unrealized
gains or losses reported as a component of accumulated other comprehensive
income (loss) included in stockholders' equity. With respect to the convertible
senior subordinated notes issued in September 2003 and February 2002, we pledged
$14.2 million and $22.9 million, respectively, of U.S. government securities
(restricted investment securities) with maturities at various dates through
August 2006 and November 2004, respectively. Upon maturity, the proceeds of the
restricted investment securities will be sufficient to pay the first six
scheduled interest payments on the convertible senior subordinated notes when
due. We consider our restricted investment securities to be held-to-maturity as
defined by SFAS No. 115. These securities are reported at their amortized cost,
which includes the direct costs to acquire the securities, plus the amortization
of any discount or premium, and accrued interest earned on the securities. We
have not used or held derivative financial instruments in our investment
portfolio.
Our limited investments in certain biotechnology companies are carried on
the equity method or cost method of accounting using the guidance of applicable
accounting literature. Other-than-temporary losses are recorded against earnings
in the same period the loss was deemed to have occurred.
At December 31, 2003, we maintained a portion of our cash and cash
equivalents in financial instruments with original maturities of three months or
less. We also maintained an investment portfolio principally comprised of
government and government agency obligations and corporate obligations that are
subject to interest rate risk and will decline in value if interest rates
increase. A hypothetical 10% change in interest rates during the three months
ended December 31, 2003 would have resulted in approximately a $149,000 change
in our net loss.
Our long-term debt totaled $310.0 million at December 31, 2003 and was
primarily comprised of the convertible senior subordinated notes we issued in
September 2003 and February 2002 which bear interest at a fixed rate of 3.25%
and 4%, respectively.
Underlying market risk exists related to an increase in our stock price or
an increase in interest rates which may make the conversion of the convertible
senior subordinated notes to common stock beneficial to the convertible senior
subordinated notes holders. Conversion of the convertible senior subordinated
notes would have a dilutive effect on any future earnings and book value per
common share.
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ITEM 4. CONTROLS AND PROCEDURES
Evaluation of our Disclosure Controls and Procedures. The Securities and
Exchange Commission requires that as of the end of the period covered by this
Quarterly Report on Form 10-Q, the CEO and the CFO evaluate the effectiveness of
the design and operation of our disclosure controls and procedures (as defined
in Rule 13(a)-15(e)) under the Securities Exchange Act of 1934, or the Exchange
Act, and report on the effectiveness of the design and operation of our
disclosure controls and procedures. Accordingly, under the supervision and with
the participation of our management, including our CEO and CFO, we evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures as of the end of the period covered by this Quarterly Report on Form
10-Q.
CEO/CFO Conclusions about the Effectiveness of the Disclosure Controls and
Procedures. Based upon their evaluation of the disclosure controls and
procedures, our CEO and CFO have concluded that, subject to the limitations
noted below, our disclosure controls and procedures are effective to provide
reasonable assurance that material information relating to OSI and our
consolidated subsidiaries is made known to management, including the CEO and
CFO, on a timely basis and particularly during the period in which this
Quarterly Report on Form 10-Q was being prepared.
Limitations on the Effectiveness of Controls. Our management, including
the CEO and CFO, does not expect that our disclosure controls and procedures or
our internal control over financial reporting will prevent all error and all
fraud. A control system, no matter how well conceived and operated, can provide
only reasonable, not absolute, assurance that the objectives of the control
system are met. Further, the design of a control system must reflect the fact
that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within the company have been
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdowns can occur because of simple
error or mistake. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management
override of the control. The design of any system of controls also is based in
part upon certain assumptions about the likelihood of future events, and there
can be no assurance that any design will succeed in achieving its stated goals
under all potential future conditions; over time, control may become inadequate
because of changes in conditions, or the degree of compliance with the policies
or procedures may deteriorate. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur and
not be detected. While we believe that our disclosure controls and procedures
have been effective, in light of the foregoing we intend to continue to examine
and refine our disclosure controls and procedures and to monitor ongoing
developments in this area.
Changes in Internal Control Over Financial Reporting. There were no
changes in our internal control over financial reporting (as defined in Rule
13(a)-15(f)) under the Exchange Act identified in connection with the evaluation
of such internal control over financial reporting that occurred during the
period covered by this Quarterly Report on Form 10-Q, that have materially
23
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not applicable.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Not Applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
3.1 Certificate of Incorporation, as amended, filed by OSI
Pharmaceuticals, Inc. as an exhibit to the Form 10-K for the
fiscal year ended September 30, 2001 (file no. 000-15190), and
incorporated herein by reference.
3.2 Amended and Restated Bylaws, filed by OSI Pharmaceuticals,
Inc. as an exhibit to the Form 10-K for the fiscal year ended
September 30, 2001 (file no. 000-15190), and incorporated
herein by reference.
31.1* Certification of Chief Executive Officer pursuant to Rule
13a-14(a) or 15d-14(a).
31.2* Certification of Chief Financial Officer pursuant to Rule
13a-14(a) or 15d-14(a).
32.1* Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350.
25
32.2* Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350.
----------
* Filed herewith.
(B) REPORTS ON FORM 8-K
We filed a current report on October 2, 2003 with the Securities and
Exchange Commission via EDGAR, with respect to the results of certain Phase III
studies of Tarceva(TM). The earliest event covered by this report occurred on
October 1, 2003.
We filed a current report on November 20, 2003 with the Securities and
Exchange Commission via EDGAR, furnishing our financial results for the year
ended September 30, 2003. The earliest event covered by this report occurred on
November 17, 2003.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
OSI PHARMACEUTICALS, INC.
------------------------------------
(Registrant)
Date: February 3 , 2004 /s/ Colin Goddard, Ph.D.
------------ ------------------------------------------
Colin Goddard, Ph.D.
Chief Executive Officer
Date: February 3 , 2004 /s/ Robert L. Van Nostrand
------------ ------------------------------------------
Robert L. Van Nostrand
Vice President and Chief Financial Officer
(Principal Financial Officer)
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INDEX TO EXHIBITS
Exhibit
-------
3.1 Certificate of Incorporation, as amended, filed by OSI
Pharmaceuticals, Inc. as an exhibit to the Form 10-K for the fiscal
year ended September 30, 2002 (file no. 000-15190), and incorporated
herein by reference.
3.2 Amended and Restated Bylaws, filed by OSI Pharmaceuticals, Inc. as
an exhibit to the Form 10-K for the fiscal year ended September 30,
2002 (file no. 000-15190), and incorporated herein by reference.
31.1* Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
or 15d-14(a).
31.2* Certification of Chief Financial Officer pursuant to Rule 13a-14(a)
or 15d-14(a).
32.1* Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350.
32.2* Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350.
----------
* Filed herewith.
28