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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 March 31, 2005
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
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(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 April 30, 2005, the registrant had outstanding 51,267,494 shares of common
stock, $.01 par value.
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONTENTS
Page No.
--------
PART I. FINANCIAL INFORMATION...................................................................... 1
Item 1. Financial Statements................................................................. 1
Consolidated Balance Sheets
- March 31, 2005 (Unaudited) and September 30, 2004...................................... 1
Consolidated Statements Of Operations
-Three Months Ended March 31, 2005 and 2004 (Unaudited).................................. 2
Consolidated Statements Of Cash Flows
-Three Months Ended March 31, 2005 and 2004 (Unaudited).................................. 3
Notes to Consolidated Financial Statements (Unaudited)..................................... 4
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.. 15
Item 3. Quantitative and Qualitative Disclosures About Market Risks............................ 28
Item 4. Controls and Procedures................................................................ 29
PART II. OTHER INFORMATION......................................................................... 31
Item 1. Legal Proceedings...................................................................... 31
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds............................ 31
Item 3. Defaults Upon Senior Securities........................................................ 31
Item 4. Submission of Matters to a Vote of Security Holders.................................... 31
Item 5. Other Information...................................................................... 32
Item 6. Exhibits............................................................................... 32
SIGNATURES......................................................................................... 34
INDEX TO EXHIBITS ................................................................................. 35
i
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT PER SHARE DATA)
MARCH 31, SEPTEMBER 30,
2005 2004
----------- -------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents .................................................................... $ 106,005 $ 84,598
Investment securities ........................................................................ 499,221 163,085
Restricted investment securities - short-term ................................................ 4,831 4,835
Receivables, including amounts due from related parties of $15,775 and $1,283 at
March 31, 2005 and September 30, 2004, respectively ........................................ 22,928 10,771
Inventory-net ................................................................................ 6,040 1,437
Interest receivable .......................................................................... 3,697 1,341
Prepaid expenses and other current assets .................................................... 7,114 9,378
----------- -------------
Total current assets ..................................................................... 649,836 275,445
----------- -------------
Restricted investment securities - long-term ................................................... 2,365 4,711
Property, equipment and leasehold improvements - net ........................................... 30,824 35,356
Debt issuance costs - net ...................................................................... 3,626 4,156
Goodwill ....................................................................................... 39,124 39,017
Other intangible assets - net .................................................................. 19,056 26,566
Other assets ................................................................................... 2,805 2,778
----------- -------------
$ 747,636 $ 388,029
=========== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses, including amounts due to related parties
of $14,360 and $13,903 at March 31, 2005 and September 30, 2004, respectively .............. $ 37,820 $ 46,140
Unearned revenue - current; including amounts from related parties
of $4,102 and $500 at March 31, 2005 and September 30, 2004, respectively .................. 4,677 1,074
Capital leases payable - current ............................................................. - 8
----------- -------------
Total current liabilities ................................................................ 42,497 47,222
----------- -------------
Other liabilities:
Deferred rent expense - long-term ............................................................ 2,125 1,873
Unearned revenue - long-term, representing amounts received in advance from related parties... 17,143 8,750
Convertible senior subordinated notes - long-term ............................................ 150,000 150,000
Contingent value rights ...................................................................... 22,047 22,047
Accrued postretirement benefit cost .......................................................... 4,491 3,904
----------- -------------
Total liabilities ........................................................................ 238,303 233,796
----------- -------------
Stockholders' equity:
Preferred stock, $.01 par value; 5,000 shares authorized; no shares issued at
March 31, 2005 and September 30, 2004 ...................................................... - -
Common stock, $.01 par value; 200,000 shares authorized, 52,600 and 45,030 shares
issued at March 31, 2005 and September 30, 2004, respectively .............................. 526 450
Additional paid-in capital ................................................................... 1,380,601 943,994
Deferred compensation ........................................................................ (471) (206)
Accumulated deficit .......................................................................... (846,850) (765,951)
Accumulated other comprehensive income ....................................................... 978 1,397
----------- -------------
534,784 179,684
Less: treasury stock, at cost; 1,443 shares at March 31, 2005 and September 30, 2004 ........... (25,451) (25,451)
----------- -------------
Total stockholders' equity ............................................................... 509,333 154,233
----------- -------------
Commitments and contingencies
$ 747,636 $ 388,029
=========== =============
See accompanying notes to consolidated financial statements.
1
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS EXCEPT PER SHARE DATA)
THREE MONTHS ENDED
MARCH 31,
------------------
2005 2004
-------- --------
Revenues:
Net revenue from unconsolidated joint business, from related party... $ 11,721 $ -
Royalties on product sales, from related party ...................... 83 -
Sales commissions and product sales ................................. 6,977 5,941
License and milestone revenues, including $236 and $1,250 from
related parties in 2005 and 2004, respectively .................... 286 1,275
-------- --------
19,067 7,216
-------- --------
Expenses:
Cost of goods sold .................................................. 423 2,044
Research and development ............................................ 26,949 26,721
Selling, general and administrative ................................. 23,031 21,804
Amortization of intangibles ......................................... 3,803 4,574
-------- --------
54,206 55,143
-------- --------
Loss from operations .............................................. (35,139) (47,927)
Other income (expense):
Investment income - net ............................................. 4,037 1,427
Interest expense .................................................... (1,219) (2,820)
Other expense - net ................................................. (183) (384)
-------- --------
Net loss .............................................................. $(32,504) $(49,704)
======== ========
Basic and diluted net loss per common share ........................... $ (0.64) $ (1.27)
======== ========
Weighted average shares of common stock outstanding ................... 51,096 38,985
======== ========
See accompanying notes to consolidated financial statements.
2
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31
---------------------
2005 2004
--------- ---------
Cash flows from operating activities:
Net loss .......................................................................... $ (32,504) $ (49,704)
Adjustments to reconcile net loss to net cash
used in operating activities:
Gain on sale of investment ...................................................... (68) (26)
Loss (gain) on sale and disposals of equipment .................................. (21) 87
Depreciation and amortization ................................................... 6,851 7,934
Provision for inventory obsolescence ............................................ -- 1,954
Non-cash compensation charges ................................................... 117 301
Other non-cash charges-net ...................................................... (98) --
Changes in assets and liabilities:
Receivables ................................................................... (10,909) 3,944
Inventory ..................................................................... (3,918) 89
Prepaid expenses and other current assets ..................................... (1,321) 277
Other assets .................................................................. 78 (7)
Accounts payable and accrued expenses ......................................... (4,273) (7,692)
Unearned revenue .............................................................. 1,792 (1,188)
Accrued postretirement benefit cost ........................................... 288 207
--------- ---------
Net cash used in operating activities ............................................... (43,986) (43,824)
--------- ---------
Cash flows from investing activities:
Purchases of investments (restricted and unrestricted) ............................ (274,779) (97,910)
Maturities and sales of investments (restricted and unrestricted) ................. 93,190 130,464
Net additions to property, equipment and leasehold improvements ................... (1,855) (574)
Additions to compound library assets .............................................. (241) --
Investments in privately-owned companies .......................................... (230) (150)
--------- ---------
Net cash provided by (used in) investing activities ................................. (183,915) 31,830
--------- ---------
Cash flows from financing activities:
Payment of expenses relating to public offering ................................... (116) --
Proceeds from the exercise of stock options, stock warrants, employee purchase plan
and other ..................................................................... 4,727 1,132
Debt issuance costs ............................................................... -- (102)
Payments on capital leases payable ................................................ (4) (15)
--------- ---------
Net cash provided by financing activities ........................................... 4,607 1,015
--------- ---------
Net decrease in cash and cash equivalents ........................................... (223,294) (10,979)
Effect of exchange rate changes on cash and cash equivalents ........................ (257) (67)
Cash and cash equivalents at beginning of period .................................... 329,556 114,238
--------- ---------
Cash and cash equivalents at end of period .......................................... $ 106,005 $ 103,192
========= =========
Non-cash activities:
Issuance of common stock to employees ............................................. $ -- $ 5
========= =========
Issuance of common stock to directors ............................................. $ 514 $ 425
========= =========
Acceleration of directors' options ................................................ $ -- $ 177
========= =========
Cash paid for interest ............................................................ $ 2,438 $ 5,638
========= =========
See accompanying notes to consolidated financial statements.
3
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. We own or have
rights to use various copyrights, trademarks and trade names used in our
business, including the following: Tarceva(TM) (erlotinib), Novantrone(R)
(mitoxantrone for injection concentrate) and Gelclair(R) Bioadherent Oral Gel.
(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, or 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 considered
necessary for a fair presentation have been included. Operating results for the
three months ended March 31, 2005 are not necessarily indicative of the results
that may be expected for the fiscal year ending December 31, 2005. For further
information, refer to the consolidated financial statements and footnotes
thereto included in our Annual Report on Form 10-K for the fiscal year ended
September 30, 2004. In December 2004, we changed our fiscal year end from
September 30 to December 31. The first fiscal year (which shall henceforth be
the calendar year) affected by this change will end on December 31, 2005.
(2) Tarceva Approval
On November 18, 2004, we announced that the United States Food and Drug
Administration, or FDA, approved our New Drug Application, or NDA, for
monotherapy use of Tarceva in the treatment of patients with locally advanced or
metastatic non-small cell lung cancer, or NSCLC, who have failed at least one
prior chemotherapy regimen. Tarceva met its primary endpoint of improving
overall survival and its key secondary endpoints of progression-free survival
and objective tumor response rate in a 731-patient randomized, double-blinded
placebo controlled Phase III trial. We, along with our U.S. partner, Genentech,
Inc., launched Tarceva on November 22, 2004.
On March 22, 2005, we announced that the Swiss health authority,
Swissmedic, approved Tarceva for the treatment of patients with locally advanced
or metastatic NSCLC after failure of at least one prior chemotherapy regimen.
Our partner, Roche, began selling Tarceva in Switzerland in late March 2005.
(3) Revenue Recognition
Revenue from Unconsolidated Joint Business
Revenue from unconsolidated joint business is related to our
co-promotion and manufacturing agreements with Genentech for Tarceva. It
consists of our share of the pretax co-promotion profit generated from our
co-promotion arrangement with Genentech for Tarceva, the partial reimbursement
from Genentech of our sales and marketing costs related to Tarceva, and the
reimbursement from Genentech of our manufacturing costs related to Tarceva.
Under the co-promotion arrangement, all U.S. sales of Tarceva and associated
costs and expenses, except for a
4
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
portion of our sales related costs, are recognized by Genentech. For the three
months ended March 31, 2005, Genentech recorded $47.6 million in net sales of
Tarceva in the United States and its territories. We record our share of the
co-promotion pretax profit on a quarterly basis, as set forth in our agreement
with Genentech. Pretax co-promotion profit under the co-promotion arrangement is
derived by calculating U.S. net sales of Tarceva to third-party customers and
deducting costs of sales, distribution, selling and marketing expenses, and
certain joint development expenses incurred by Genentech and us. The partial
reimbursement of our sales and marketing costs related to Tarceva is recognized
as revenue as the related costs are incurred. We defer the recognition of the
reimbursement of our manufacturing costs related to Tarceva until the time
Genentech ships the product to third-party customers at which time our risk of
inventory loss no longer exists. The unearned revenue related to shipments by
our third party manufacturers of Tarceva to Genentech that have not been shipped
to third-party customers was $2.8 million as of March 31, 2005 and is included
in unearned revenue-current in the accompanying consolidated balance sheet.
Net revenues from unconsolidated joint business consist of the following
(in thousands):
THREE MONTHS ENDED
MARCH 31, 2005
------------------
Co-promotion profit and reimbursement of sales
force and marketing related costs .................... $ 9,799
Reimbursement of manufacturing costs ................... 1,922
-------
Net revenue from unconsolidated joint business........ $11,721
=======
Royalties on Product Sales
We recognize royalties on product sales of Tarceva, which are based on
Roche's net sales of Tarceva outside of the United States and its territories,
as earned in accordance with contract terms when third-party sales can be
reliably measured and collection of funds is reasonably assured.
Sales Commissions and Product Sales
Sales commissions represent commissions earned on the sales of the drug,
Novantrone, in the United States for oncology indications pursuant to a
co-promotion agreement with Ares Trading S.A., an affiliate of Serono, S.A.
Sales commissions from Novantrone on net oncology sales are recognized in the
period the sales occur based on the estimated split between oncology sales and
multiple sclerosis sales of Novantrone, as determined by an external third
party. The split between oncology and multiple sclerosis sales is subject to
further adjustment based upon the parties' final review in the subsequent
quarter. Based on past experience, we do not believe these adjustments, if any,
will be significant to our consolidated financial statements. Sales commissions
totaled $6.6 million and $5.7 million for the three months ended March 31, 2005
and 2004, respectively.
Product sales represent sales of Gelclair in accordance with a
distribution agreement with Helsinn Healthcare S.A., which allowed us to market
and distribute Gelclair in North America. We terminated this distribution
agreement effective as of January 31, 2005. Pursuant to the terms
5
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
of the distribution agreement, we are continuing to sell off our remaining
inventory. In accordance with SFAS No. 48, "Revenue Recognition When Right of
Return Exists," given the limited sales history of Gelclair, we defer the
recognition of revenue on product shipments of Gelclair to wholesale customers
until such time as the product is sold from the wholesale customer to the retail
and non-retail outlets. 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 6). The unearned revenue related to
shipments of Gelclair to wholesale customers was $574,000 as of March 31, 2005
and September 30, 2004, and is included in unearned revenue-current in the
accompanying consolidated balance sheets.
Licenses and Milestone Revenues
Our revenue recognition policies for all nonrefundable upfront license
fees and milestone arrangements are in accordance with the guidance provided in
the Securities and Exchange Commission's Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements," as amended by SEC Staff
Accounting Bulletin No. 104, "Revenue Recognition." In addition, we follow the
provisions of Emerging Issues Task Force Issue 00-21, "Revenue Arrangements with
Multiple Deliverables" for multiple element revenue arrangements entered into or
materially amended after June 30, 2003. We received a total of $25.0 million in
upfront fees from Genentech and Roche in January 2001 which was being recognized
on a straight-line basis over the expected term of our required research and
development efforts under the terms of a tripartite agreement with Genentech and
Roche. As a result of an amendment to our collaboration agreement with Genentech
in June 2004, the remaining unearned upfront fee from Genentech of $1.8 million
is being recognized in accordance with EITF 00-21, as discussed further below.
The upfront fee from Roche was fully recognized as of December 31, 2004.
In September 2004 and December 2004, we also received $7.0 million and $10
million, respectively, in milestone payments from Genentech based upon the FDA's
notice of acceptance for filing and review of our NDA and approval of our NDA
for monotherapy use of Tarceva in the treatment of patients with locally
advanced or metastatic NSCLC who have failed at least one chemotherapy regimen.
As a result of the amendment to our collaboration agreement with Genentech in
June 2004, we were required to account for the Genentech milestones received and
the remaining unearned upfront fee of $1.8 million, discussed above, in
accordance with EITF 00-21. Milestones received from Genentech and the remaining
unearned upfront fee are being recognized over the term of our Manufacturing and
Supply Agreement with Genentech, under which the last items of performance to be
delivered to Genentech are set forth. This accounting resulted from the
inability to determine the fair value of the undelivered items in the
arrangement with Genentech as required by EITF 00-21. We are recognizing such
deferred revenue over the term of the Manufacturing and Supply Agreement based
on the lesser of the ratio of units of Tarceva sold by Genentech to total
expected unit sales, or the cumulative straight-line basis. The unrecognized
deferred revenue related to the milestones and upfront payment received from
Genentech was $18.4 million as of March 31, 2005 of which $1.3 million is
classified as short-term and the balance of $17.1 million was classified as
long-term in the accompanying consolidated balance sheet. The estimate of
expected unit sales will be adjusted periodically and when events or changes in
circumstances indicate that there could be a significant change in such
estimate.
6
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
In September 2004, we recognized $3.0 million in milestone revenues from
Roche based upon the European Agency for the Evaluation of Medicinal Products,
or EMEA's, notice of acceptance for filing and review of our application in the
European Union for the monotherapy use of Tarceva in the treatment of patients
with locally advanced or metastatic NSCLC who have failed at least one
chemotherapy regimen.
In March 2005, the alliance partners, OSI/Genentech/Roche, agreed to a
global development plan and budget for the continued development of Tarceva in
earlier stage lung cancer, other cancer indications and in a variety of
combinations including Tarceva/Avastin(TM) combinations. The cost of the
development plan will continue to be shared equally by the three partners. In
light of the revised development plan and budget for Tarceva, we are currently
reviewing the applicability of EITF 00-21 as it relates to future milestone
payments from Roche.
(4) 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, or 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.
Our 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 currently 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 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
MARCH 31,
------------------
2005 2004
------ ------
Risk-free interest rate .................................... 3.93% 2.03%
Dividend yield ............................................. 0% 0%
Volatility factors of expected market
price of our common stock ................................ 79.87% 74.73%
Weighted-average expected life of option (years) ........... 3 3
Weighted-average exercise price of stock option grants...... $50.14 $37.26
Weighted-average fair value of stock option grants ......... $26.85 $18.42
7
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
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 March 31, 2005 and 2004 is as follows (in
thousands, except per share information):
THREE MONTHS ENDED
MARCH 31,
------------------
2005 2004
-------- --------
Net loss ................................................ $(32,504) $(49,704)
Add: stock-based compensation included in net loss ..... 117 301
Compensation cost determined under fair value method.... (5,848) (5,975)
-------- --------
Pro forma net loss ..................................... $(38,235) $(55,378)
======== ========
Basic and diluted net loss per common share:
Net loss - as reported ................................. $ (0.64) $ (1.27)
======== ========
Net loss - pro forma ................................... $ (0.75) $ (1.42)
======== ========
In December 2004, the Financial Accounting Standards Board, or FASB,
issued SFAS No. 123R, "Share Based Payment," which replaces SFAS No. 123 and
supersedes APB No. 25. SFAS No. 123R requires that the cost resulting from all
share-based payment transactions be recognized in the consolidated financial
statements. SFAS No. 123R applies to all share-based payment transactions in
which an entity acquires goods or services by issuing its shares, options or
other equity instruments. SFAS No.123R establishes fair value as the measurement
objective in accounting for share-based payment arrangements and requires all
entities to apply a fair-value-based measurement method in accounting for
share-based payment transactions with employees, except for equity instruments
held by employee share ownership plans. SFAS No. 123R would have been effective
as of the beginning of the first interim or annual reporting period that begins
after June 15, 2005. On April 14, 2005 the Securities and Exchange Commission,
or SEC, issued a new rule that amended the compliance date for SFAS No. 123R.
The SEC's new rule allows companies to implement SFAS No.123R at the beginning
of their next fiscal year, which is our fiscal year beginning January 1, 2006.
The new rule does not change the accounting required by SFAS No. 123R. We expect
the adoption of SFAS No. 123R to have a material effect on our consolidated
financial statements.
(5) Restricted Assets
In September 2003, in connection with the issuance of $150.0 million in
3.25% convertible senior subordinated notes due 2023, or the 2023 Notes, we
pledged $14.2 million of U.S. government securities, or Restricted Investment
Securities, with maturities at various dates through August 2006. Upon maturity
of the Restricted Investment Securities, the proceeds are used to pay the first
six scheduled interest payments on the 2023 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. The balance
of Restricted Investment Securities decreases as scheduled interest payments are
made. The aggregate fair value and amortized cost of the Restricted Investment
Securities at March 31, 2005 were $7.1 million and $7.2 million, respectively,
of which $4.8 million was classified as short-term and the balance of $2.4
million was classified as long-term. The aggregate fair value and amortized cost
of the Restricted Investment Securities at September 30, 2004 were $9.5
8
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
million, of which $4.8 million was classified as short-term and the balance of
$4.7 million was classified as long-term.
With respect to our facility leases in Horsham, Pennsylvania and Oxford,
England, we have outstanding letters of credit issued by a commercial bank which
serve as security for our performance under the leases. The irrevocable letter
of credit for our Horsham, Pennsylvania facility expires annually 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 March 31, 2005. The irrevocable letter of
credit for our Oxford, England facility expires annually with a final expiration
date of September 27, 2007. This letter of credit is for $2.7 million, of which
the full amount was available on March 31, 2005. The collateral for these
letters of credit are maintained in a restricted investment account. Included in
cash and cash equivalents and investment securities as of March 31, 2005 is
$180,000 and $3.3 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, 2004 is $132,000 and
$3.4 million, respectively, relating to restricted cash and investments to
secure these letters of credit.
(6) Inventory
Inventory is comprised of Tarceva and Gelclair inventory and is stated at
the lower of cost or market, with cost being determined using the weighted
average method and first-in, first-out method, respectively. Included in
inventory are raw materials and work in process for Tarceva that may be used in
the production of pre-clinical and clinical product, which will be expensed to
research and development cost when consumed for these uses. Prior to receipt of
FDA approval of Tarceva for commercial sale on November 18, 2004, we had
expensed all costs associated with the production of Tarceva to research and
development expense in our consolidated statements of operations. Effective
November 18, 2004, we began to capitalize the costs of manufacturing Tarceva as
inventory, including the costs to label, package and ship previously
manufactured bulk inventory which costs had already been expensed as research
and development.
At March 31, 2005, the cost reflected in a portion of the finished goods
inventory for Tarceva consists solely of cost incurred to package and label
work-in-process inventory that had been previously expensed. As we continue to
process the inventory that was partially produced and expensed prior to November
18, 2004, we will continue to reflect in inventory only those incremental costs
incurred to complete such inventory into finished goods.
9
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
Inventory-net at March 31, 2005 and September 30, 2004, consisted of the
following (in thousands):
MARCH 31, SEPTEMBER 30,
2005 2004
--------- -------------
Raw materials ................. $ 557 $ --
Work in process ............... 2,394 --
Finished goods on hand, net ... 1,398 1,263
Inventory subject to return.... 1,691 174
--------- -------------
$ 6,040 $ 1,437
========= =============
Inventory subject to return represents the amount of Tarceva shipped to
Genentech and Gelclair shipped to wholesale customers which has not been
recognized, in accordance with our revenue recognition policy as discussed in
note 3.
(7) Comprehensive Income (Loss)
Comprehensive loss for the three months ended March 31, 2005 and 2004 was
as follows (in thousands):
THREE MONTHS ENDED
MARCH 31,
-------------------
2005 2004
-------- --------
Net loss .......................................................... $(32,504) $(49,704)
Other comprehensive income (loss):
Foreign currency translation adjustments ........................ (506) 462
Unrealized gains on derivative instruments arising
during period ................................................. - 102
Unrealized holding gains (losses) arising
during period ................................................. (1,706) 131
Less: Reclassification adjustment for losses (gains) realized
in net loss ................................................... (68) (13)
-------- --------
(2,280) 682
-------- --------
Total comprehensive loss .......................................... $(34,784) $(49,022)
======== ========
The components of accumulated other comprehensive income were as follows
(in thousands):
MARCH 31, SEPTEMBER 30,
2005 2004
--------- -------------
Cumulative foreign currency translation adjustment ........... $ 3,752 $ 2,034
Unrealized gains (losses) on available-for-sale securities.... (2,774) (666)
Unrealized gains on derivative instruments ................... - 29
-------- ------------
Accumulated other comprehensive income ....................... $ 978 $ 1,397
======== ============
(8) Net Loss per Common Share
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
respective period. Common share equivalents (convertible senior subordinated
notes, stock options and warrants) are not included
10
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
since their effect would be anti-dilutive. The contingent shares pursuant to the
contingent value rights are not included since the contingency condition has not
been satisfied.
Such common share equivalents (convertible senior subordinated notes,
stock options and warrants) and contingent shares for the three months ended
March 31, 2005 and 2004 amounted to (in thousands):
THREE MONTHS ENDED
MARCH 31,
------------------
2005 2004
----- -----
Common share equivalents................. 4,612 7,641
----- -----
Contingent shares........................ 1,585 1,585
----- -----
If the three months ended March 31, 2005 had resulted in net income and
had the common share equivalents for the 2023 Notes (2,998,800 shares) been
dilutive, interest expense related to the notes would have been added back to
net income to calculate diluted earnings per share. If the three months ended
March 31, 2004 had resulted in net income and had the common share equivalents
for the convertible senior subordinated notes due 2009, or the 2009 Notes,
(3,200,000 shares) and the 2023 Notes (2,998,800 shares) been dilutive, interest
expense related to the notes would have been added back to net income to
calculate diluted earnings per share. In July 2004, our 2009 Notes were fully
converted into shares of our common stock. The related interest expense of the
2023 Notes and the 2009 Notes for the three months ended March 31, 2005 and 2004
totaled $1.2 million and $2.8 million respectively.
(9) Goodwill and Other Intangible Assets
The carrying amount of goodwill as of March 31, 2005 of $39.1 million
includes a $107,000 effect from foreign currency exchange rate fluctuations
during the six-month period ended March 31, 2005. We completed our annual
impairment review of goodwill during the transition quarter ended December 31,
2004 and determined that no impairment charge was required.
The components of other intangible assets-net are as follows (in
thousands):
MARCH 31, 2005 SEPTEMBER 30, 2004
-------------- ------------------
NET NET
CARRYING ACCUMULATED BOOK CARRYING ACCUMULATED BOOK
AMOUNT AMORTIZATION VALUE AMOUNT AMORTIZATION VALUE
-------- ------------ ------- -------- ------------ -------
Novantrone rights ............. $ 46,009 $ (30,465) $15,544 $ 46,009 $ (23,004) $23,005
Acquired patent estate ........ 529 (28) 501 515 (7) 508
Acquired licenses issued to
other companies .............. 3,177 (166) 3,011 3,093 (40) 3,053
-------- ----------- ------- -------- ----------- -------
Total ......................... $ 49,715 $ (30,659) $19,056 $ 49,617 $ (23,051) $26,566
======== =========== ======= ======== =========== =======
The carrying amount of the acquired patent estate and licenses issued to
other companies includes a $98,000 effect from foreign currency exchange rate
fluctuations for the six-month period ended March 31, 2005. Amortization expense
for our intangible assets for the three months ended March 31, 2005 and 2004 was
$3.8 million and $4.6 million, respectively. Amortization expense for the three
months ended March 31, 2004, included $843,000 of
11
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
amortization expense related to our Gelclair rights, which were fully written
off during the three months ended September 30, 2004. Amortization expense is
estimated to be $11.4 million for the remaining nine months of 2005, $4.6
million in 2006 and $291,000 for 2007 through 2010.
(10) Consolidation of Facilities
During the quarter ended September 30, 2004, we announced the decision to
consolidate our U.K.-based oncology research and development activities into our
New York locations. During the quarter ended March 31, 2005, we recorded a
charge of $1.8 million for estimated facility lease return costs and remaining
rental obligations net of estimated sublease rental income in accordance with
SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities." This charge is included in selling, general and administrative
expenses in the accompanying consolidated statement of operations for the three
months ended March 31, 2005.
During the quarter ended September 30, 2004, we also made the decision not
to further utilize our Uniondale, New York facility. During the three months
ended March 31, 2004, we also committed to and approved an exit plan for our
Horsham, Pennsylvania facility which we acquired in connection with the
acquisition of Cell Pathways. We have recognized the rent obligations for the
remainder of the lease (through June 2008), offset by the sublease rental
income.
The consolidation activity for the three months ended March 31, 2005 and
March 31, 2004 was as follows (in thousands):
THREE MONTHS ENDED
MARCH 31,
------------------
2005 2004
------- ------
Opening liability, January 1 ....................... $ 4,302 $ -
Provision for rental obligations ................... 761 2,103
Provision for facility refurbishment ............... 1,019 -
Cash paid for rent less sublease income received.... (298) -
Cash paid for severance ............................ (1,173) -
Other .............................................. (106) -
------- ------
Ending liability ................................... $ 4,505 $2,103
======= ------
(11) Derivative Financial Instruments
From time to time, we enter into forward exchange contracts to reduce
foreign currency fluctuation risks relating to intercompany transactions for the
funding of our research and development activities in the United Kingdom. We
account for these derivative financial instruments in accordance with SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," which was
amended by SFAS No. 137 and SFAS No. 138. As of March 31, 2005, the notional and
fair value of the foreign exchange contract for (pound) 3.0 million was
$5.7 million and $5.6 million, respectively. The contract will mature in July
2005.
(12) Employee Post-Retirement Plan
We have a plan which provides post-retirement medical and life insurance
benefits to eligible employees, board members and qualified dependents.
Eligibility is determined based on
12
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
age and service requirements. These benefits are subject to deductibles,
co-payments and other limitations.
Under SFAS No. 106, "Employer's Accounting for Post-Retirement Benefits
Other Than Pensions", the cost of post-retirement medical and life insurance
benefits is accrued over the active service periods of employees to the date
they attain full eligibility for such benefits.
In May 2004, the FASB issued FASB Staff Position, or FSP, No.106-2,
"Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003." FSP No.106-2 provides guidance
on the accounting for the effects of the Medicare Prescription Drug, Improvement
and Modernization Act of 2003, or the MMA, for employers that sponsor
post-retirement health care plans that provide prescription drug benefits. It
requires those employers to provide certain disclosures regarding the effect of
the Federal subsidy provided by the MMA. The accumulated post-retirement
benefits obligation or net post-retirement benefits cost in the consolidated
financial statements or accompanying notes do not reflect the effects of the MMA
on our post-retirement benefit plan. We are in the process of determining the
impact of the MMA on the accumulated post-retirement benefits obligation and net
post-retirement benefits cost to be recorded.
Net post-retirement benefit costs for the three months ended March 31,
2005 and 2004 includes the following components (in thousands):
THREE MONTHS ENDED
MARCH 31,
------------------
2005 2004
------ ------
Service costs for benefits earned during the period ............ $ 210 $ 143
Interest costs on accumulated post-retirement benefits
obligation ..................................................... 88 66
Amortization of initial benefits attributed to past services.... 1 1
Amortization of loss ........................................... 16 10
------ ------
Net post-retirement benefit cost ............................... $ 315 $ 220
====== ======
(13) Litigation
In December 2004, several purported shareholder class action lawsuits were
filed in the United States District Court for the Eastern District of New York
against us, certain of our current and former executive officers and the members
of our Board of Directors. The lawsuits were brought on behalf of those who
purchased or otherwise acquired our common stock during certain periods in 2004,
which periods differ in the various complaints. The complaints allege that
defendants have made material misstatements concerning the survival benefit
associated with Tarceva and the size of Tarceva's potential market upon the
FDA's approval of the drug. The complaints allege violations of Sections 11,
12(a)(2) and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of
the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. The
complaints seek unspecified compensatory damages and other relief. We intend to
vigorously defend these actions. Based on the early stage of this litigation,
the ultimate outcome cannot be determined and accordingly no provision has been
recorded in the consolidated financial statements.
13
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
(14) Amended and Restated Stock Incentive Plan
On March 16, 2005 at the 2005 Annual Meeting of Stockholders, our
stockholders approved an amendment to our Amended and Restated Stock Incentive
Plan, or the Plan, which amendment was adopted by the Board of Directors on
January 21, 2005. The amendment increases the number of equity awards issuable
under the Plan by 2.8 million. The Plan permits the issuance of stock options,
and the grant of restricted stock, stock appreciation rights and stock bonus
awards upon such terms and conditions as the Compensation Committee appointed by
the Board of Directors determines.
(15) Subsequent Events
Purchase of Minority Interest in Prosidion
On April 14, 2005, we completed a stock-for-stock exchange resulting in
the acquisition of the minority interest shares of our majority owned UK-based
diabetes and obesity subsidiary, Prosidion Limited. We issued a total of 84,940
shares of OSI common stock in exchange for the 286,200 shares of Prosidion. In
addition to the stock-for-stock exchange, we paid $176,000 in cash to one of the
minority shareholders of Prosidion, who is a director of OSI, in exchange for
11,000 ordinary shares of Prosidion. The stock-for-stock exchange and payment of
cash to a shareholder resulted in Prosidion becoming our wholly-owned
subsidiary.
Purchase of Corporate Headquarters
On March 15, 2005, we entered into an Agreement of Sale and Purchase with
Swissair, Swiss Air Transport Co., Ltd., or Swissair, for the purchase of
certain property located in Melville, New York. The property includes a building
containing approximately 60,000 square feet of space and other improvements. The
purchase price for the property is $11.3 million, which was paid in cash at the
closing of the transaction on April 28, 2005.
The acquisition consisted of the acquisition of the leasehold interest in
the property from the Suffolk County Industrial Development Agency, or the
Agency. In order to obtain certain economic benefits offered by the Agency,
including, but not limited to, real estate tax abatements and sales tax
incentive, at the closing we entered into certain agreements whereby we acquired
the leasehold interest in the property from Swiss Air and preserved real estate
tax abatements and the availability of sales tax exemptions. At the end of the
term of the lease, as may be amended, modified and extended, we have the right
to acquire the property from the Agency for $1.00.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2005 AND 2004
OVERVIEW
We are a leading biotechnology company primarily focused on the discovery,
development and commercialization of high quality pharmaceutical products that
extend life or improve the quality-of-life for cancer and diabetes patients
worldwide. Our primary business remains oncology although we have a growing
business interest in the area of diabetes through our subsidiary, Prosidion
Limited. Our flagship product, Tarceva(TM) (erlotinib), is an oral, once-a-day,
small molecule inhibitor of the epidermal growth factor receptor, or HER1/EGFR.
Tarceva is the first EGFR inhibitor, and the first non-chemotherapy agent, to
demonstrate a survival benefit in advanced non-small cell lung cancer, or NSCLC,
and also in pancreatic cancer (in combination with gemcitabine), two forms of
cancer widely recognized as amongst the most difficult treatment challenges
facing oncologists. On November 18, 2004, after a review lasting only three and
a half months, the U.S. Food and Drug Administration, or FDA, approved our New
Drug Application, or NDA, for monotherapy use of Tarceva in the treatment of
patients with locally advanced or metastatic NSCLC who have failed prior
chemotherapy. We, along with our partner, Genentech, Inc., launched Tarceva on
November 22, 2004, two business days following approval. On May 2, 2005, we
announced that we filed a supplemental NDA, or sNDA, for the treatment of
front-line pancreatic cancer patients (in combination with gemcitabine). In
addition, our partner, Roche, has completed a regulatory filing under the
centralized process in the European Union, or EU, for Tarceva in NSCLC. We
anticipate that Roche will gain approval for the drug in the second half of
2005. On March 22, 2005, we announced that the Swiss health authority,
Swissmedic, approved Tarceva for the treatment of patients with locally advanced
or metastatic NSCLC after failure of at least one prior chemotherapy regimen.
Beyond Tarceva, we have a pipeline of oncology drug candidates that includes
signal transduction inhibitors, apoptosis (also known as programmed cell death)
inducers and a next-generation cytotoxic chemotherapy agent. We have established
a core commercial organization, which includes approximately 50 sales
representatives and managers covering the major territories in the United States
and its territories. We, along with Genentech, market and promote Tarceva for
its approved oncology indication in the United States. In addition, we market
and promote Novantrone(R) (mitoxantrone concentrate for injection) for approved
oncology indications in the United States, and we market and distribute
Gelclair(R), a bioadherent oral gel for the relief of pain associated with oral
mucositis, a frequent side-effect of chemotherapy in North America. In the area
of diabetes, our lead clinical candidate, PSN9301, an inhibitor of dipeptidyl
peptidase IV, or DP-IV, is in Phase II clinical trials for the treatment of type
2 diabetes. In addition to PSN9301, we have drug candidates targeting the
activation of glucokinase and the inhibition of glycogen phosphorylase, both key
enzymes in the regulation of glucose metabolism, which are expected to enter
clinical trials this year.
15
QUARTERLY UPDATE
Pipeline Update
Tarceva
On January 27, 2005, we along with our partners, announced detailed
results from our Phase III clinical study of Tarceva plus gemcitabine
chemotherapy in patients with locally advanced or metastatic pancreatic cancer.
We had previously announced that the trial had met its primary endpoint.
Specifically, we announced that the trial met its primary endpoint by
demonstrating a statistically significant 23.5 percent improvement in overall
survival when compared to patients receiving gemcitabine plus placebo (hazard
ratio = 0.81, p-value = 0.025). A hazard ratio of less than one indicates a
decreased risk of death and a p-value of less than 0.05 indicates statistical
significance. Twenty-four percent of patients receiving Tarceva plus gemcitabine
were alive after one year compared to 17 percent of patients receiving
gemcitabine plus placebo. Median survival in the Tarceva plus gemcitabine arm
was 6.4 months compared to 5.9 months in the gemcitabine plus placebo arm. On
May 2, 2005 we announced that we filed an sNDA with the FDA for the treatment of
front-line pancreatic cancer patients (in combination with gemcitabine).
On March 22, 2005, we announced that Swissmedic approved Tarceva for the
treatment of patients with locally advanced or metastatic NSCLC after failure of
at least one prior chemotherapy regimen. Our partner, Roche, began selling
Tarceva in Switzerland in late March 2005.
In March 2005, the alliance partners, OSI/Genentech/Roche, agreed to a
global development plan and budget for the continued development of Tarceva in
earlier stage lung cancer, other cancer indications and in a variety of
combinations including Tarceva /Avastin(TM) combinations. The cost of the
development plan will continue to be shared equally by the three partners.
In April 2005, at the Annual Meeting of the American Association for
Cancer Research, or AACR, there were several abstracts presented on our behalf
which included data from a comparative clinical study on the effects of smoking
on the pharmacokinetics of Tarceva in healthy (non-cancer patients) smokers and
non-smokers. Data from the study were consistent with the hypothesis that
smoking results in a reduction in the blood levels of Tarceva following dosing
of the drug. We intend to pursue studies in cancer patients in order to further
explore whether an increase in Tarceva dose in smokers will result in enhanced
clinical benefit.
Oncology (other than Tarceva)
In February 2005, we announced that we initiated a Phase I clinical study
of OSI-930, the first drug candidate to emerge from our research program focused
on the identification of dual c-kit/VEGFR inhibitors. In April 2005, we also
announced that we received a Notice of Allowance by the United States Patent and
Trademark Office for our patent application covering claims for OSI-930. The
resulting patent will cover the compound, compositions containing the compound,
and methods of treating cancers with the compound. The issuance of this patent
provides protection of OSI-930 until 2024. Both OSI-930 and OSI-817, a second
agent from our c-kit/VEGFR program, are designed to target both cancer cell
proliferation and blood vessel growth, or angiogenesis. We anticipate moving
both candidates through early stages of
16
development before selecting one of the two candidates for full clinical
development in cancer patients.
Diabetes and Obesity
In January 2005, we announced that Prosidion initiated a Phase II
proof-of-concept and dose range finding study with the DP-IV inhibitor, PSN9301.
In addition, Prosidion has two other small molecule drug candidates targeting
glucokinase activation, PSN105, and glycogen phosphorylase inhibition, PSN357,
which are both in late preclinical development and are scheduled to enter Phase
I clinical trials in the first half of 2005. A further glucokinase activator,
PSN010, with a different profile to PSN105, is scheduled to enter Phase I before
the end of 2005.
Corporate Update
Change in Our Fiscal Year End
On December 14, 2004, pursuant to a resolution approved by our Board of
Directors, we changed our fiscal year end from September 30 to December 31. The
decision to change our fiscal year end was made primarily for the purpose of
aligning our operating cycle with that of our principal alliance partners and
our industry sector. The first fiscal year, which will henceforth be the
calendar year, affected by this change will end December 31, 2005. This report
on Form 10-Q includes the results of operations of the first quarter of our
fiscal year ending December 31, 2005.
Purchase of Corporate Headquarters
On March 15, 2005, we entered into an Agreement of Sale and Purchase with
Swissair, Swiss Air Transport Co., Ltd., for the purchase of certain property
located in Melville, New York. The property includes a building containing
approximately 60,000 square feet of space and other improvements. The purchase
price for the property is $11.3 million, which was paid in cash as of the
closing of the transaction on April 28, 2005. Upon completion of renovations,
the building will serve as our corporate headquarters.
Purchase of Remaining Minority Interest in Prosidion
In April 2005, we completed a stock-for-stock exchange resulting in the
acquisition of minority interest shares of our subsidiary, Prosidion Limited. A
total of 84,940 shares of OSI were issued in exchange for the 286,200 minority
interest shares of Prosidion. In addition to the stock-for-stock exchange, we
paid $176,000 in cash to one of the minority shareholders of Prosidion, in
exchange for 11,000 ordinary shares of Prosidion. As a result of the acquisition
of the minority shares, Prosidion became our wholly owned subsidiary.
Board of Directors and Management Realignment
In April 2005, we announced that Mr. Michael G. Atieh will join our senior
management team as Executive Vice President, Chief Financial Officer and
Treasurer, effective May 31, 2005. Mr. Robert L. Van Nostrand will continue to
serve as our Chief Financial Officer until the end of May 2005 when he will
assume the role of Senior Vice President and Chief
17
Compliance Officer. In addition, our Board of Directors appointed Ms. Katharine
B. Stevenson to the Board as a non-executive director and chair of the Company's
audit committee effective May 1, 2005. We also announced that Dr. Nicole Onetto,
our former Chief Medical Officer, left the Company to pursue other interests,
effective May 2, 2005.
CRITICAL ACCOUNTING POLICIES
We prepare our consolidated financial statements in accordance with U.S.
generally accepted accounting principles. 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 for the fiscal year ended September 30, 2004 includes
a summary of the significant accounting policies used in the preparation of the
consolidated financial statements.
Revenue Recognition
Revenues from unconsolidated joint business are related to our
co-promotion and manufacturing agreements with Genentech for Tarceva. It
consists of our share of the pretax co-promotion profit generated from our
co-promotion arrangement with Genentech for Tarceva, the partial reimbursement
from Genentech of our sales and marketing costs related to Tarceva and the
reimbursement from Genentech of our manufacturing costs related to Tarceva.
Under the co-promotion arrangement, all U.S. sales of Tarceva and associated
costs and expenses, except for a portion of our sales related costs, are
recognized by Genentech. For the three months ended March 31, 2005, Genentech
recorded $47.6 million in net sales of Tarceva in the United States and its
territories. We record our 50% share of the co-promotion pretax profit on a
quarterly basis, as set forth in our agreement with Genentech. Pretax
co-promotion profit under the co-promotion arrangement is derived by calculating
U.S. net sales of Tarceva to third-party customers and deducting costs of sales,
distribution, selling and marketing expenses, and certain joint development
expenses incurred by Genentech and us. The partial reimbursement of sales and
marketing costs related to Tarceva is recognized as revenue as the related costs
are incurred. We defer the recognition of the reimbursement of our manufacturing
costs related to Tarceva until the time Genentech ships the product to
third-party customers at which time our risk of inventory loss no longer exists.
Sales commissions from Novantrone 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 the parties' final review in the
18
subsequent quarter. Based on past experience, we do not believe these
adjustments, if any, will be significant to our consolidated financial
statements.
Our revenue recognition policies for all nonrefundable upfront license
fees and milestone arrangements are in accordance with the guidance provided in
the Securities and Exchange Commission's Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements," as amended by SEC Staff
Accounting Bulletin No. 104, "Revenue Recognition." In addition, we follow the
provisions of Emerging Issues Task Force Issue 00-21, "Revenue Arrangements with
Multiple Deliverables" for multiple element revenue arrangements entered into or
materially amended after June 30, 2003. As a result of an amendment to our
agreement with Genentech in June 2004, we were required to account for the
Genentech milestones received and the remaining portion of the unearned upfront
fee in accordance with EITF 00-21. Milestones received from Genentech and the
remaining unearned upfront fee are being recognized over the term of our
Manufacturing and Supply Agreement with Genentech, under which the last items of
performance to be delivered to Genentech are set forth. This accounting resulted
from the inability to determine the fair value of the undelivered items in the
arrangement with Genentech as required by EITF 00-21. We are recognizing such
deferred revenue over the term of the Manufacturing and Supply Agreement based
on the lesser of the ratio of units of Tarceva sold by Genentech to total
expected unit sales, or the cumulative straight-line basis. The estimate of
expected unit sales will be adjusted periodically and when events or changes in
circumstances indicate that there could be a significant change in such
estimate. In March 2005, we agreed to a global development plan and budget with
our partners, Genentech and Roche, for the further development of Tarceva. In
light of the revised development plan and budget for Tarceva, we are currently
reviewing the applicability of EITF 00-21 as it relates to future milestone
payments from Roche. We believe that the revised development plan and budget
will not further affect the accounting for the milestones and upfront fees
received from Genentech.
Inventory
Our current inventory is comprised of Tarceva and Gelclair inventory and
is stated at the lower of cost or market value, and our inventory costs are
determined by the weighted average method and first-in, first-out method,
respectively. We analyze our inventory levels quarterly and write down inventory
that has become obsolete, inventory that has a cost basis in excess of its
expected net realizable value, and inventory in excess of expected requirements.
Expired inventory is disposed of and the related costs are written off.
Provisions for excess or expired inventory are primarily based on our estimates
of forecasted sales levels.
Prior to receipt of FDA approval of Tarceva for commercial sale on
November 18, 2004, we had expensed all costs associated with the production of
Tarceva to research and development expense. Effective November 18, 2004, we
began to capitalize the costs of manufacturing Tarceva as inventory, including
the costs to label, package and ship previously manufactured bulk inventory
whose costs had already been expensed as research and development. Although it
is our policy to state inventory reflecting full absorption costs, until we sell
all of our existing inventory for which all or a portion of the costs were
previously expensed, certain components of inventory will continue to reflect
costs incurred to process into finished goods previously expensed raw materials
and work in process.
19
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 three months ended December 31, 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 determinable 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, 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 when 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 most significant intangible asset is our rights to
Novantrone and therefore, we continually monitor sales activity and market and
regulatory conditions for this product for the existence of any impairment
indicators. In the future, events could cause us to conclude that impairment
indicators exist and that certain other 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
THREE MONTHS ENDED MARCH 31,
(IN THOUSANDS)
----------------------------
2005 2004 $ CHANGE
------- ------- ---------
Net revenue from unconsolidated
joint business ....................... $11,721 $ - $ 11,721
Royalties on product sales ........... 83 - 83
Sales commissions and product sales... 6,977 5,941 1,036
License and milestone revenues ....... 286 1,275 (989)
------- -------- ---------
Total revenues ....................... $19,067 $ 7,216 $ 11,851
======= ======== =========
20
Net Revenue from Unconsolidated Joint Business
Net revenue from unconsolidated joint business is related to our
co-promotion and manufacturing agreements with Genentech for Tarceva. It
consists of our share of the pretax co-promotion profit generated from our
co-promotion arrangement with Genentech for Tarceva, the partial reimbursement
from Genentech of our sales and marketing costs related to Tarceva, and the
reimbursement from Genentech of our manufacturing costs related to Tarceva.
Under the co-promotion arrangement, all U.S. sales of Tarceva and associated
costs and expenses, except for a portion of our sales-related costs, are
recognized by Genentech. For the three months ended March 31, 2005, Genentech
recorded $47.6 million in net sales of Tarceva in the United States and its
territories. Our share of these net sales is reduced by the significant costs
incurred on the sales and marketing of the product in order to maximize the
value with an effective launch and product growth strategy. We expect that there
will continue to be significant sales and marketing expenses incurred by both
Genentech and us relative to sales in this launch year.
Effective April 5, 2005, Genentech implemented a price increase to
wholesalers for the sale of Tarceva in the United States. The price for a 30-day
supply of 150 mg tablets increased from the launch price of $2,026 to $2,330.
The prices for a 30-day supply of the 100 mg and 25mg tablet strengths increased
from $1,783 to $2,060 and $648 to $750, respectively.
Royalties on Product Sales
We recorded revenues of $83,000 in the first quarter related to sales of
Tarceva by Roche outside of the United States.
Sales Commissions and Product Sales
Sales commissions represent commissions earned on the sales of Novantrone
in the United States for oncology indications. Sales commissions for the three
months ended March 31, 2005 were $6.6 million compared to sales commissions of
$5.7 million for the three months ended March 31, 2004, an increase of $954,000
or 17%. We believe the increase was primarily the direct result of our
commercial efforts related to Novantrone for approved oncology indications and a
3% price increase implemented by Serono in July 2004. We have the right to
market and promote Novantrone for approved oncology indications in the United
States through December 2017. However, the patent for Novantrone is scheduled to
expire in April 2006. The expiration of a product patent normally results in a
loss of market exclusivity for the covered pharmaceutical product and, therefore
we expect a significant decrease in our commissions related to Novantrone upon
patent expiration or shortly thereafter as a result of an expected decrease in
oncology sales.
Product sales represent sales of Gelclair in accordance with our
distribution agreement with Helsinn Healthcare S.A., which we terminated
effective as of January 31, 2005. Under the terms of the distribution agreement,
we are continuing to sell off our remaining inventory. Net sales of Gelclair for
the three months ended March 31, 2005 were $348,000 compared to $267,000 for the
comparable prior year period.
21
License and Milestone Revenues
License and milestone revenues consist principally of the recognition of
the ratable portion of the $25.0 million upfront fees from Genentech and Roche
and the ratable portion of the $17.0 million of milestone payments received from
Genentech. We recognized revenues of $236,000 and $1.3 million for the three
months ended March 31, 2005 and 2004 respectively, relating to these upfront
fees and milestone revenues.
As a result of an amendment to our agreement with Genentech in June 2004,
we are required to account for the Genentech milestones received totaling $17.0
million as of March 31, 2005 and the remaining unearned upfront fee, which
totaled $1.8 million as of June 2004, in accordance with EITF 00-21. Milestones
received from Genentech and the remaining unearned upfront fee are being
recognized over the term of our Manufacturing and Supply Agreement with
Genentech, under which the last items of performance to be delivered to
Genentech are set forth. We will recognize such deferred revenue over the term
of the Manufacturing and Supply Agreement based on the lesser of the ratio of
units of Tarceva sold by Genentech to total expected unit sales or the
cumulative straight-line basis. The unrecognized deferred revenue related to the
milestones and upfront payments received from Genentech was $18.4 million as of
March 31, 2005. The estimate of expected unit sales will be adjusted
periodically and when events or changes in circumstances indicate that there
could be a significant change in such estimate. Additional milestone payments
will be paid by Roche upon registration of Tarceva in the EU, and upon
successful filing and registration of Tarceva in Japan. Further milestones from
both Genentech and Roche are also due upon the successful filing and approval of
Tarceva in a second oncology indication and upon the approval of the first two
adjuvant oncology indications in the United States, European Union and Japan.
EXPENSES
THREE MONTHS ENDED MARCH 31,
(IN THOUSANDS)
----------------------------
2005 2004 $ CHANGE
------- -------- --------
Cost of goods sold .................... $ 423 $ 2,044 $(1,621)
Research and development .............. 26,949 26,721 228
Selling, general and administrative.... 23,031 21,804 1,227
Amortization of intangibles ........... 3,803 4,574 (771)
------- -------- -------
$54,206 $ 55,143 $ (937)
======= ======== =======
Cost of Goods Sold
Cost of goods sold include manufacturing-related expenses associated with
the sale of Tarceva to Genentech as well as the costs of product related to
sales of Gelclair. Prior to receipt of approval of Tarceva for commercial sale
on November 18, 2004, we had expensed all costs associated with the production
of Tarceva to research and development. Effective November 18, 2004, we began to
capitalize the costs of manufacturing Tarceva as inventory, including the costs
to label, package and ship previously manufactured bulk inventory whose costs
had already been expensed as research and development. Although it is our policy
to state inventory reflecting full absorption costs, until we sell all of our
existing inventory for which all or a portion of the costs were previously
expensed, certain components of inventory will continue to reflect costs
incurred to process into finished goods previously expensed raw materials and
work in process.
22
We anticipate that our cost of goods will increase in 2005 from quarter to
quarter as we work through our previously expensed inventory. Cost of goods sold
would have been $1.4 million higher for the quarter ended March 31, 2005, if the
Tarceva inventory sold had reflected the full absorption manufacturing costs.
The decrease in the cost of goods sold of $1.6 million primarily related
to the inclusion of a provision of $2.0 million, in the prior year period, in
relation to Gelclair inventory that we deemed in excess of forecasted demand,
based on the expiration date of the product. During the quarters ended September
30, 2004 and December 31, 2004, we recorded additional adjustments to the
provision due to additional inventory on hand and purchase commitments deemed in
excess of forecasted demand, as well as the termination of our distribution
agreement with Helsinn effective January 2005.
Research and Development
We consider the active management and development of our clinical pipeline
crucial to the long-term approval process for drug candidates. 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.
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 March 31, 2005, we invested a total of $10.7 million in research
and $16.2 million in pre-clinical and clinical development. For the three months
ended March 31, 2004, we invested a total of $13.5 million in research and $13.2
million in pre-clinical and clinical development. We consider this level of
investment suitable to sustain one major late stage clinical program and two to
four earlier stage clinical programs at any time and we manage our overall
research and development investments toward this level of activity.
Research and development expenses remained relatively constant during the
three months ended March 31, 2005, compared to March 31, 2004. During the
quarter ended March 31, 2005 research and development expenses related to our
diabetes programs increased $4.2 million, compared to the prior year period, due
to the continued development of our diabetes pre-clinical and clinical pipeline,
including PSN9301, PSN105 and PSN357. In January 2005, we announced that we
initiated a Phase II proof-of-concept and dose range finding study with the
DP-IV inhibitor, PSN9301. Offsetting this increase was a net decrease in our
oncology research programs (other than Tarceva) of $4.6 million, primarily due
to the consolidation of our U.K.-based oncology activities into our New York
locations and the decision to deprioritize or cease development of certain
clinical candidates including Aptosyn(R), OSI-7836 and OSI-211.
The significant perceived market potential for Tarceva has resulted in the
OSI/Genentech/Roche alliance committing to a large and comprehensive global
development plan for the candidate. The global development plan has included
major Phase III clinical trials in lung and pancreatic cancers and a large
number of earlier stage trials in a variety of disease
23
settings. The alliance partners initially committed to invest a combined $300
million in the global development plan to be shared equally by the three
parties. In March 2005, the alliance partners agreed to a global development
plan and budget for the continued development of Tarceva in earlier stage lung
cancer and other indications. The cost of the development plan will be shared
equally by the three parties. We have made and will continue to make additional
research and development investments outside of the global development plan with
the consent of the other parties. As of March 31, 2005, we invested in excess of
$119 million in the development of Tarceva since the return of the full rights
to the product from Pfizer Inc. in June 2000, representing our share of the
costs incurred to date in the tripartite global development plan and additional
investments outside the plan.
Selling, General and Administrative
Selling, general and administrative expenses increased $1.2 million for
the three months ended March 31, 2005 compared to the three months ended March
31, 2004 reflecting a net increase in sales and marketing efforts related to
Tarceva. The three months ended March 31, 2005 also included a charge of $1.8
million for estimated facility lease return costs and the remaining rental
obligations net of estimated sublease rental income for the unused portion of
our Oxford facility resulting from the consolidation of our U.K.-based oncology
operations. The three months ended March 31, 2004 included a charge of $1.8
million for the remaining rental obligations net of estimated sublease rental
income for our Horsham facility which we assumed in the Cell Pathways, Inc.
acquisition.
Our commercial expenses increased due to sales and marketing efforts
related to the launch of Tarceva, including the expansion of our sales force.
Offsetting these increases was a decrease related to our share of Genentech's
commercial expenses relating to Tarceva no longer being included in selling,
general and administrative expense and now being included as part of the
co-promotion profit and combined as part of net revenues from unconsolidated
joint business in the accompanying consolidated statement of operations for the
three months ended March 31, 2005.
Amortization of Intangibles
The amortization expense of $3.8 million primarily related to amortization
expense for our rights to Novantrone. The decrease from the prior year's quarter
was primarily related to amortization expense related to our rights to Gelclair.
During the three months ended September 30, 2004, we recorded an impairment
charge for the remaining carrying value of the Gelclair rights.
OTHER INCOME AND EXPENSE
THREE MONTHS ENDED MARCH 31,
(IN THOUSANDS)
----------------------------
2005 2004 $ CHANGE
------- ------- --------
Investment income-net .......... $ 4,037 $ 1,427 $ 2,610
Interest expense ............... (1,219) (2,820) 1,601
Other expense-net .............. (183) (384) 201
------- ------- --------
Total other income (expense).... $ 2,635 $(1,777) $ 4,412
------- ------- --------
24
The increase in investment income for the three months ended March 31,
2005 was primarily due to an increase in the funds available for investment and
an increase in the average rate of return on our investments. The increase in
funds available for investment was the result of the public offering completed
in November 2004 for net proceeds of approximately $419.6 million. The decrease
in interest expense resulted from the full conversion of the outstanding $160.0
million of our 4% convertible senior subordinated notes due 2009, or the 2009
Notes, in June 2004. As a result of the conversion, interest expense for the
three months ended March 31, 2005 represented interest expense only on our 3.25%
convertible senior subordinated notes due 2023, or the 2023 Notes. Other
expense-net for the periods are primarily comprised of the amortization of debt
issuance costs related to the convertible senior subordinated notes.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2005, working capital, representing primarily cash, cash
equivalents, and short-term investments, aggregated $607.3 million compared to
$228.2 million at September 30, 2004. The increase of $379.1 million was
primarily due to the net proceeds of $419.6 million from our public offering and
by proceeds from the exercise of options of $15.7 million offset by net cash
used in operating activities of $75.8 million.
We expect to incur continued losses during the two-year period following
the launch of Tarceva as we continue to invest in the commercialization and
development of Tarceva and other product candidates in our pipeline as well as
our research programs and our commercial operations. While we have established a
goal of achieving profitability and positive cash flow within two years of our
launch of Tarceva, the time required to reach profitability cannot be assessed
with certainty at this time. We also continue to pursue strategic in-licensing
and acquisition opportunities that would bring additional products, clinical
development candidates and research technologies to our cancer and diabetes
portfolio. We may choose to use some of our available cash and/or equity
securities to execute transactions arising from this effort.
In the past, we have funded our research, development, commercial and
administrative support efforts through public and private sales of our
securities, including debt and equity securities. On November 12, 2004, we
concluded a public offering of 6.0 million shares of common stock at a price of
$64.50 per share. Gross proceeds totaled $387.0 million with net proceeds of
$364.7 million after all related fees. In addition, on November 17, 2004,
underwriters associated with the offering exercised their over-allotment option
to purchase an additional 900,000 shares of our common stock at a price of
$64.50 per share. Gross proceeds from the exercise of the over-allotment option
totaled $58.1 million with net proceeds of $54.9 million. We believe that the
proceeds from this offering together with existing cash resources and projected
cash flows from Tarceva will be sufficient to execute our strategy going forward
as well as providing a solid financial base from which to fund our existing
operations. In September 2003, we issued a total of $150.0 million aggregate
principal amount of the 2023 Notes in a private placement for net proceeds of
$144.8 million. The 2023 Notes bear interest at 3.25% per annum, payable
semi-annually, and mature on September 8, 2023. The 2023 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. The related debt issuance costs of $5.3 million were
deferred and are being amortized on a straight-line basis over a five-year term,
which represents the earliest date the holders can redeem the
25
2023 Notes. With respect to the 2023 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 2023 Notes
when due. The aggregate fair value and amortized cost of the restricted
investment securities at March 31, 2005 were $7.1 million and $7.2 million,
respectively. If all or any portion of the 2023 Notes have not been converted
into common stock prior to their maturity date, 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 our debt obligations.
Commitments and Contingencies
Our major outstanding contractual obligations relate to our continuing
support for the global development plan for Tarceva, the 2023 Notes and our
facility leases. The following table summarizes our significant contractual
obligations at March 31, 2005 and the effect such obligations are expected to
have on our liquidity and cash flow in future periods (in thousands):
2010 &
2005 2006 2007 2008 2009 THEREAFTER TOTAL
------- ------- ------- ------- ------- ---------- --------
Contractual Obligations:
Senior convertible debt (a) ................ $ 2,438 $ 4,875 $ 4,875 $ 4,875 $ 4,875 $ 218,250 $240,188
Purchase obligations (b) ................... 30,574 34,874 24,174 8,174 5,274 13,700 116,770
Operating leases ........................... 6,273 5,706 5,878 6,201 5,686 48,711 78,455
Capital commitments (c) .................... 11,032 -- -- -- -- -- 11,032
Obligations related to exit activities(d)... 465 -- -- -- 1,011 -- 1,476
------- ------- ------- ------- ------- ---------- --------
Total contractual obligations ................. $50,782 $45,455 $34,927 $19,250 $16,846 $ 280,661 $447,921
======= ======= ======= ======= ======= ========== ========
- ---------------
(a) Includes interest payments at a rate of 3.25% per annum relating to the
2023 Notes.
(b) Purchase obligations include commercial and research and development
commitments and other significant purchase commitments.
(c) Includes remaining payment for purchase of our corporate headquarters,
which was paid on April 28, 2005.
(d) Includes payments for termination benefits and facility refurbishments.
Other significant commitments and contingencies include the following:
- Under agreements with external CROs we will continue to incur
expenses relating to clinical trials of Tarceva and other clinical
candidates. The timing and amount of these disbursements can be
based upon the achievement of certain milestones, patient
enrollment, services rendered or as expenses are incurred by the
CROs and therefore we cannot reasonably estimate the potential
timing of these payments.
- We have outstanding letters of credit issued by a commercial bank
totaling $3.1 million of which the full amounts were available on
March 31, 2005. One is an irrevocable letter of credit related to
our Oxford, England facility which expires and is renewed annually
with a final expiration date of September 27, 2007. Another is an
irrevocable letter of credit related to our Horsham,
26
Pennsylvania facility, whose lease we assumed through the
acquisition of Cell Pathways. The letter expires and is renewed
annually with a final expiration date of September 22, 2008.
- We have a retirement plan which provides post-retirement 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
$4.5 million at March 31, 2005.
- In connection with our 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).
- Under certain license and collaboration agreements with
pharmaceutical companies and educational institutions, we are
required to pay royalties and/or milestone payments upon the
successful development and commercialization of products. However,
successful research and development of pharmaceutical products is
high risk, and most products fail to reach the market. Therefore, at
this time the amount and timing of the payments, if any, are not
known.
- Under certain license and other agreements, we are required to pay
license fees for the use of technologies and products in our
research and development activities or milestone payments upon the
achievement of certain predetermined conditions. These license fees
are not deemed material to our consolidated financial statements and
the amount and timing of the milestone payments, if any, are not
known due to the uncertainty surrounding the successful research,
development and commercialization of the products.
ACCOUNTING PRONOUNCEMENTS
In March 2005, the FASB issued FASB Interpretation No. 47, "Accounting for
Conditional Asset Retirement Obligations", or FIN No. 47. FIN No. 47 clarifies
that an entity must record a liability for a "conditional" asset retirement
obligation if the fair value of the obligation can be reasonably estimated. The
provision is effective for no later than the end of fiscal years ending after
December 15, 2005, which is our year ending December 31, 2005. We are currently
evaluating the effect that this interpretation will have on our consolidated
financial statements.
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment."
This statement replaces SFAS No. 123, "Accounting for Stock-Based Compensation"
and supersedes APB No. 25, "Accounting for Stock Issued to Employees." SFAS 123R
requires all stock-based compensation to be recognized as an expense in the
financial statements and that such cost be measured according to the fair value
of stock options. SFAS 123R would have been effective for quarterly periods
beginning after June 15, 2005. On April 14, 2005 the SEC issued a new rule that
amended the compliance date for SFAS No. 123R. The SEC's new rule allows
companies to implement SFAS No.123R at the beginning of their next fiscal year,
which is our fiscal year beginning January 1, 2006. The new rule does not change
the accounting required by SFAS No. 123R. We currently provide the pro forma
disclosures required by SFAS No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure," on a quarterly and annual basis, and we are
currently evaluating the impact this statement will have on our consolidated
financial statements. We expect the adoption of SFAS No. 123R to have a material
effect on our consolidated financial statements.
27
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs" - an
amendment of ARB No. 43, Chapter 4. SFAS No. 151 requires all companies to
recognize a current-period charge for abnormal amounts of idle facility expense,
freight, handling costs and wasted materials. This statement also requires that
the allocation of fixed production overhead to the costs of conversion be based
on the normal capacity of the production facilities. SFAS No. 151 will be
effective for fiscal years beginning after June 15, 2005, which is our calendar
year 2006. We are currently evaluating the effect that this statement will have
on our consolidated financial statements.
In December 2003, President Bush signed into law the Medicare Prescription
Drug, Improvement and Modernization Act of 2003, or the MMA. The MMA 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 affect
accounting measurements. In May 2004, the FASB issued FASB Staff Position, or
FSP, No. 106-2, "Accounting and Disclosure Requirements Related to the
Improvement and Modernization Act of 2003." FSP No. FAS 106-2 provides guidance
on the accounting for the effects of the MMA, for employers that sponsor
post-retirement health care plans that provide prescription drug benefits. It
requires those employers to provide certain disclosures regarding the effect of
the Federal subsidy provided by the MMA. The accumulated post-retirement
benefits obligation or net post-retirement benefits cost in the consolidated
financial statements or accompanying notes do not reflect the effects of the MMA
on our post-retirement benefit plan. We are in the process of determining the
impact of the MMA on the accumulated post-retirement benefits obligation and net
post-retirement benefits cost.
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, 2004.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
Our cash flow and earnings are subject to fluctuations due to changes in
interest rates in our investment portfolio of debt securities, the fair value of
equity instruments held and 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 our 2023 Notes,
we pledged U.S. government securities, or Restricted Investment Securities, with
maturities at various dates through August 2006. Upon maturity, the
28
proceeds of the Restricted Investment Securities are sufficient to pay the first
six scheduled interest payments of the 2023 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.
At March 31, 2005, 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 periods would
have resulted in a $404,000 change in our net loss for the three months ended
March 31, 2005.
In March 2004, we began to enter into forward exchange contracts to reduce
foreign currency fluctuation risks relating to intercompany transactions for the
funding of our research activities in the United Kingdom. We account for these
derivative financial instruments in accordance with SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities," which was amended by SFAS
No. 137 and SFAS No. 138. As of March 31, 2005, the notional and fair value of
the foreign exchange contract for (pound) 3.0 million was $5.7 million and
$5.6 million, respectively. The contract will mature in July 2005.
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.
Our long-term debt totaled $150.0 million at March 31, 2005 and consists
of our 2023 Notes which bear interest at a fixed rate of 3.25%. 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 2023 Notes to common stock
beneficial to the note holders. Conversion of the 2023 Notes would have a
dilutive effect on any future earnings and book value per common share.
ITEM 4. CONTROLS AND PROCEDURES
CEO and CFO Certifications. Attached to this Quarterly Report as Exhibits
31.1 and 31.2, there are two certifications, or the Section 302 Certifications,
one by each of our Chief Executive Officer, or CEO, and our Chief Financial
Officer, or CFO. This Item 4 contains information concerning the evaluation of
our disclosure controls and procedures and internal control over financial
reporting that is referred to in the Section 302 Certifications and this
information should be read in conjunction with the Section 302 Certifications
for a more complete understanding of the topics presented.
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
29
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, despite 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 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, as opposed to 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, a system of controls 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. Except as noted
below, 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 affected, or are reasonably likely to materially affect, our
internal control over financial reporting. In connection with approval and
commercial launch of Tarceva, we recently implemented internal controls over the
recording of Tarceva inventory and related cost of goods sold and the
recognition of net revenue from unconsolidated joint business from a related
party.
30
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On or about December 16, 2004, several purported shareholder class action
lawsuits were filed in the United States District Court for the Eastern District
of New York against us, certain of our current and former executive officers
(Colin Goddard, Robert L. Van Nostrand, Gabriel Leung and Nicole Onetto) and the
members of our Board of Directors. The lawsuits were brought on behalf of those
who purchased or otherwise acquired our common stock during certain periods in
2004, which periods differ in the various complaints. The complaints allege that
defendants have made material misstatements concerning the survival benefit
associated with our product, Tarceva and the size of the potential market of
Tarceva upon FDA approval of the drug. The complaints allege violations of
Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and Sections 10(b)
and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated
thereunder. The complaints seek unspecified compensatory damages and other
relief. We intend to vigorously defend these actions.
ITEM 2. UNREGISTERED SALES OF EQUITY 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
Our annual meeting of stockholders was held on March 16, 2005. The
following ten directors were elected:
Votes For Votes Withheld
--------- --------------
1. Robert A. Ingram ` 35,109,700 9,893,328
2. Colin Goddard, Ph.D. 44,609,612 393,416
3. Michael G. Atieh 44,470,418 532,610
4. G. Morgan Browne 44,167,671 835,357
5. Daryl K. Granner, M.D. 44,457,718 545,310
6. Walter M. Lovenberg, Ph.D. 43,420,912 1,582,116
7. Viren Mehta 43,911,917 1,091,111
8. Herbert Pinedo, M.D., Ph.D. 44,769,724 233,304
9. Sir Mark Richmond 44,763,390 239,638
10. John P. White 31,811,117 13,191,911
In addition, the following matters were voted upon: (i) a proposal to
amend the Amended and Restated Stock Incentive Plan was approved (24,448,209
shares voted in favor, 12,001,358 shares voted against, 80,427 shares abstained,
and there were 8,473,034 broker non-votes); and (ii) the appointment of KPMG LLP
as independent registered public accounting firm for fiscal
31
year ending December 31, 2005 was ratified (44,558,866 shares voted in favor,
433,840 shares voted against, 10,322 shares abstained, and there were no broker
non-votes).
ITEM 5. OTHER INFORMATION
We compensate our non-employee directors for service on the Board of
Directors with an annual retainer fee as well as formula option grants. Details
of such compensation are set forth in Exhibit 10.7 of this report and
incorporated herein by reference.
Our Compensation Committee of our Board of Directors approves the
compensation, including the salaries and bonuses, of our executive officers.
Such compensation was approved by the committee for our fiscal year 2005.
Details of such compensation, including criteria for bonuses and stock option
grants, are set forth in Exhibit 10.8 of this report and incorporated herein by
reference.
ITEM 6. 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.
10.1+ Supply Agreement, dated February 2, 2005, by and between Schwarz
Pharma Manufacturing, Inc. and OSI Pharmaceuticals, Inc. (Filed
herewith)
10.2 Agreement of Sale and Purchase, dated March 15, 2005, by and between
Swissair, Swiss Air Transport Co., Ltd. and OSI Pharmaceuticals,
Inc. (Filed herewith)
10.3* Letter of Employment by and between OSI Pharmaceuticals, Inc. and
Mr. Robert L. Simon. (Filed herewith)
10.4* Change of Control Arrangement by and between OSI Pharmaceuticals,
Inc. and Barbara A. Wood, Esq. (Filed herewith)
10.5* Form of Non-Qualified Stock Option Agreement issued under the
Amended and Restated Stock Incentive Plan for directors and
employees of OSI Pharmaceuticals, Inc. (Filed herewith)
10.6* Form of Non-Qualified Stock Option Agreement issued under the
Amended and Restated Stock Incentive Plan for employees of Prosidion
Limited and OSI Pharmaceuticals (UK) Limited. (Filed herewith)
10.7* Compensatory Arrangements for Non-Employee Directors. (Filed
herewith)
32
10.8* Compensatory Arrangements of Executive Officers. (Filed herewith)
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
or 15d-14(a). (Filed herewith)
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a)
or 15d-14(a). (Filed herewith)
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350. (Filed herewith)
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350. (Filed herewith)
- ----------------------
* Indicates a management contract or compensatory plan, contract or
arrangement in which a director or executive officers participate.
+ Portions of this exhibit have been redacted and are subject to a
confidential treatment request filed with the Secretary of the Securities
and Exchange Commission pursuant to Rule 24b-2 under the Securities
Exchange Act of 1934, as amended.
33
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: May 10, 2005 /s/ Colin Goddard, Ph.D.
------------------------------------------
Colin Goddard, Ph.D.
Chief Executive Officer
Date: May 10, 2005 /s/ Robert L. Van Nostrand
------------------------------------------
Robert L. Van Nostrand
Vice President and Chief Financial Officer
(Principal Financial Officer)
34
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, 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.
10.1+ Supply Agreement, dated February 2, 2005, by and between Schwarz
Pharma Manufacturing, Inc. and OSI Pharmaceuticals, Inc. (Filed
herewith)
10.2 Agreement of Sale and Purchase, dated March 15, 2005, by and between
Swissair, Swiss Air Transport Co., Ltd. and OSI Pharmaceuticals,
Inc. (Filed herewith)
10.3* Letter of Employment by and between OSI Pharmaceuticals, Inc. and
Mr. Robert L. Simon. (Filed herewith)
10.4* Change of Control Arrangement by and between OSI Pharmaceuticals,
Inc. and Barbara A. Wood, Esq. (Filed herewith)
10.5* Form of Non-Qualified Stock Option Agreement issued under the
Amended and Restated Stock Incentive Plan for directors and
employees of OSI Pharmaceuticals, Inc. (Filed herewith)
10.6* Form of Non-Qualified Stock Option Agreement issued under the
Amended and Restated Stock Incentive Plan for employees of Prosidion
Limited and OSI Pharmaceuticals (UK) Limited. (Filed herewith)
10.7* Compensatory Arrangements for Non-Employee Directors. (Filed
herewith)
10.8* Compensatory Arrangements of Executive Officers. (Filed herewith)
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
or 15d-14(a). (Filed herewith)
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a)
or 15d-14(a). (Filed herewith)
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350. (Filed herewith)
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350. (Filed herewith)
- ----------------------
* Indicates a management contract or compensatory plan, contract or
arrangement in which a director or executive officers participate.
+ Portions of this exhibit have been redacted and are subject to a
confidential treatment request filed with the Secretary of the Securities
and Exchange Commission pursuant to Rule 24b-2 under the Securities
Exchange Act of 1934, as amended.