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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
Mark One
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period ended September 30, 2002
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES ACT OF
1934
For the transition period from ______ to _______
Commission File Number 0-24249
PDI, INC.
(Exact name of Registrant as specified in its charter)
Delaware 22-2919486
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10 Mountainview Road
Upper Saddle River, New Jersey 07458
(Address of principal executive offices)
(201) 258-8450
(Registrant's telephone number, including area code)
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 |_|
As of November 8, 2002 the Registrant had a total of 14,107,762 shares of Common
Stock, $.01 par value, outstanding.
1
INDEX
PDI, INC.
PART I. FINANCIAL INFORMATION
Page
----
Item 1. Consolidated Financial Statements (unaudited)
Balance Sheets
September 30, 2002 and December 31, 2001........................................................3
Statements of Operations -- Three and Nine Months
Ended September 30, 2002 and 2001...............................................................4
Statements of Cash Flows -- Nine Months
Ended September 30, 2002 and 2001...............................................................5
Notes to Financial Statements...................................................................6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................................................18
Item 3. Quantitative and Qualitative Disclosures About Market Risk.........................Not Applicable
Item 4. Controls and Procedures........................................................................31
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..............................................................................32
Item 2. Changes in Securities and Use of Proceeds..........................................Not Applicable
Item 3. Default Upon Senior Securities.....................................................Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders............................................33
Item 5. Other Information..................................................................Not Applicable
Item 6. Exhibits and Reports on Form 8-K...............................................................33
SIGNATURES................................................................................................34
2
PDI, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
September 30, December 31,
2002 2001
------------- ------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents .................................................. $ 83,941 $ 160,043
Short-term investments ..................................................... 1,869 7,387
Inventory, net ............................................................. -- 442
Accounts receivable, net of allowance for doubtful accounts of
$986 and $3,692 as of September 30, 2002 and December 31,
2001, respectively ..................................................... 24,245 52,640
Unbilled costs and accrued profits on contracts in progress ................ 9,333 6,898
Deferred training .......................................................... 3,193 5,569
Other current assets ....................................................... 17,504 8,101
Deferred tax asset ......................................................... 24,041 24,041
--------- ---------
Total current assets .......................................................... 164,126 265,121
Net property, plant & equipment ............................................... 19,951 21,044
Other long-term assets ........................................................ 14,396 16,506
--------- ---------
Total assets .................................................................. $ 198,473 $ 302,671
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ........................................................... $ 4,685 $ 9,493
Accrued returns, rebates and sales discounts ............................... 17,590 68,403
Accrued contract losses .................................................... 7,781 12,256
Accrued incentives ......................................................... 15,319 22,213
Accrued salaries and wages ................................................. 5,472 7,167
Unearned contract revenue .................................................. 8,026 10,878
Other accrued expenses ..................................................... 11,477 21,026
--------- ---------
Total current liabilities ..................................................... 70,350 151,436
--------- ---------
Long-term liabilities:
Deferred tax liability ................................................... 950 300
--------- ---------
Total long-term liabilities ................................................... 950 300
--------- ---------
Total liabilities ............................................................. $ 71,300 $ 151,736
--------- ---------
Stockholders' equity:
Common stock, $.01 par value, 100,000,000 shares authorized:
shares issued and outstanding, September 30, 2002 - 14,063,438,
December 31, 2001 - 13,968,097; restricted shares
issued and outstanding, September 30, 2002 - 44,325,
December 31, 2001 - 15,388 ............................................ $ 141 $ 140
Preferred stock, $.01 par value, 5,000,000 shares authorized, no
shares issued and outstanding ......................................... -- --
Additional paid-in capital .................................................... 104,252 102,757
Additional paid-in capital, restricted ........................................ 1,547 954
Retained earnings ............................................................. 22,236 48,008
Accumulated other comprehensive loss .......................................... (141) (79)
Unamortized compensation costs ................................................ (752) (735)
Treasury stock, at cost: 5,000 shares ......................................... (110) (110)
--------- ---------
Total stockholders' equity .................................................... $ 127,173 $ 150,935
--------- ---------
Total liabilities & stockholders' equity ...................................... $ 198,473 $ 302,671
========= =========
The accompanying notes are an integral part of these financial statements
3
PDI, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
2002 2001 2002 2001
-------- --------- --------- ---------
(unaudited)
Revenue
Service, net ........................................... $ 64,353 $ 71,129 $ 198,546 $ 214,005
Product, net ........................................... 215 44,544 6,438 218,676
-------- --------- --------- ---------
Total revenue, net .................................. 64,568 115,673 204,984 432,681
-------- --------- --------- ---------
Cost of goods and services
Program expenses (including related party amounts of
$4 and $100 for the quarters ended September 30, 2002
and 2001, and $109 and $685 for the nine months
ended September 30, 2002 and 2001, respectively) ..... 67,475 59,529 200,473 168,245
Cost of goods sold ..................................... -- 51,823 -- 167,561
-------- --------- --------- ---------
Total cost of goods and services .................... 67,475 111,352 200,473 335,806
-------- --------- --------- ---------
Gross (loss) profit ....................................... (2,907) 4,321 4,511 96,875
Operating expenses
Compensation expense ................................... 9,157 9,282 26,210 29,459
Other selling, general & administrative expenses ....... 9,433 24,560 19,207 73,833
Restructuring and other non-recurring charges .......... 972 -- 972 --
-------- --------- --------- ---------
Total operating expenses ............................. 19,562 33,842 46,389 103,292
-------- --------- --------- ---------
Operating loss ............................................ (22,469) (29,521) (41,878) (6,417)
Other income, net ......................................... 459 999 1,704 4,407
-------- --------- --------- ---------
Loss before tax benefit ................................... (22,010) (28,522) (40,174) (2,010)
Benefit for income taxes .................................. (7,696) (11,266) (14,403) (85)
-------- --------- --------- ---------
Net loss .................................................. $(14,314) $ (17,256) $ (25,771) $ (1,925)
======== ========= ========= =========
Basic net loss per share .................................. $ (1.02) $ (1.24) $ (1.84) $ (0.14)
======== ========= ========= =========
Diluted net loss per share ................................ $ (1.02) $ (1.24) $ (1.84) $ (0.14)
======== ========= ========= =========
Basic weighted average number of shares outstanding ....... 14,063 13,876 14,012 13,858
======== ========= ========= =========
Diluted weighted average number of shares outstanding ..... 14,063 13,876 14,012 13,858
======== ========= ========= =========
The accompanying notes are an integral part of these financial statements
4
PDI, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Nine Months Ended September 30,
-------------------------------
2002 2001
--------- ---------
(unaudited)
Cash Flows From Operating Activities
Net loss from operations ...................................................... $ (25,771) $ (1,925)
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization ......................................... 5,352 3,060
Reserve for inventory obsolescence and bad debt ....................... (2,128) 3,337
Loss on other investment .............................................. 379 --
Amortized compensation costs .......................................... 386 257
Deferred tax asset, net ............................................... 650 --
Other changes in assets and liabilities:
Decrease in accounts receivable ....................................... 30,523 14,266
Decrease (increase) in inventory ...................................... 442 (55,552)
(Increase) in unbilled costs .......................................... (2,435) (2,610)
Decrease (increase) in deferred training .............................. 2,376 (4)
(Increase) in other current assets .................................... (9,403) (1,890)
Decrease (increase) in other long-term assets ......................... 4,385 (250)
(Decrease) increase in accounts payable ............................... (4,807) 6,942
(Decrease) increase in accrued returns, rebates and sales discounts ... (50,812) 28,262
(Decrease) increase in accrued contract losses ........................ (4,475) 24,000
(Decrease) increase in accrued liabilities ............................ (7,997) 3,286
(Decrease) in unearned contract revenue ............................... (2,852) (12,326)
(Decrease) in other current liabilities ............................... (9,955) (22,067)
--------- ---------
Net cash used in operating activities ......................................... (76,142) (13,214)
--------- ---------
Cash Flows From Investing Activities
Sale of short-term investments ........................................... 5,456 --
Purchase of short-term investments ....................................... -- (13,291)
Cash paid for acquisition, net of cash acquired .......................... (2,735) (11,777)
Investments in iPhysicianNet and In2Focus ................................ (379) (1,102)
Purchase of property and equipment ....................................... (3,799) (10,376)
--------- ---------
Net cash used in investing activities ......................................... (1,457) (36,546)
--------- ---------
Cash Flows From Financing Activities
Net proceeds from employee stock purchase plan
and the exercise of stock options ........................................ 1,497 699
--------- ---------
Net cash provided by financing activities ..................................... 1,497 699
--------- ---------
Net decrease in cash and cash equivalents ..................................... (76,102) (49,061)
Cash and cash equivalents - beginning ......................................... 160,043 109,000
--------- ---------
Cash and cash equivalents - ending ............................................ $ 83,941 $ 59,939
========= =========
The accompanying notes are an integral part of these financial statements
5
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS
(unaudited)
1. Basis of Presentation
The accompanying unaudited interim financial statements and related notes
should be read in conjunction with the financial statements of PDI, Inc. and its
subsidiaries (the "Company" or "PDI") and related notes as included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2001 as
filed with the Securities and Exchange Commission. The unaudited interim
financial statements of the Company have been prepared in accordance with
generally accepted accounting principles for interim financial reporting and the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. The unaudited interim
financial statements include all adjustments (consisting only of normal
recurring adjustments) which, in the judgement of management, are necessary for
a fair presentation of such financial statements. Operating results for the
three-month and nine-month periods ended September 30, 2002 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2002. Certain prior period amounts have been reclassified to conform with the
current presentation with no effect on financial position, net income or cash
flows.
2. Ceftin Contract Termination
In October 2000, the Company entered into an agreement with
GlaxoSmithKline (GSK) for the exclusive U.S. marketing, sales and distribution
rights for Ceftin(R) Tablets and Ceftin(R) for Oral Suspension, two dosage forms
of a cephalosporin antibiotic, which agreement was terminated as of February 28,
2002 by mutual agreement of the parties. The agreement had a five-year term but
was cancelable by either party without cause on 120 days notice. From October
2000 through February 2002, the Company marketed and sold Ceftin products,
primarily to wholesale drug distributors, retail chains and managed care
providers.
On August 21 2001, the U.S. Court of Appeals overturned a preliminary
injunction granted by the New Jersey District Court, which allowed for the entry
of a generic competitor to Ceftin immediately upon approval by the FDA. The
affected Ceftin patent had previously been scheduled to run through July 2003.
As a result of this decision and its impact on future sales, in the third
quarter of 2001, PDI recorded a charge to cost of goods sold and a related
reserve of $24.0 million representing the anticipated future loss to be incurred
by the Company under the Ceftin agreement as of September 30, 2001. The recorded
loss was calculated as the excess of estimated costs that PDI was contractually
obligated to incur to complete its obligations under the arrangement, over the
remaining estimated gross profits to be earned under the contract from selling
the inventory. These costs primarily consisted of amounts paid to GSK to reduce
purchase commitments, estimated committed sales force expenses, selling and
marketing costs through the effective date of the termination, distribution
costs, and fees to terminate existing arrangements. The Ceftin agreement was
terminated by the Company and GSK under a mutual termination agreement entered
into in December 2001. Under the termination agreement, the Company agreed to
perform its marketing and distribution services through February 28, 2002. The
Company also maintained responsibility for sales returns for product sold until
the expiration date of the product sold, estimated to run through December 31,
2004, and certain administrative functions regarding Medicaid rebates.
As of September 30, 2002, the Company had no remaining Ceftin contract
loss reserve. At December 31, 2001, the reserve had consisted primarily of the
remaining estimated selling, general and administrative costs required to be
incurred to fulfill remaining obligations under the contract termination. While
the Company has certain responsibilities as discussed above, it had no remaining
Ceftin inventory purchase commitments as of September 30, 2002. The Company also
had approximately $17.6 million in
6
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
sales discounts, rebates and return reserves related to Ceftin at September 30,
2002 for estimated settlement of these obligations incurred through the contract
termination date.
3. Evista Contract and Termination
In October 2001, the Company entered into an agreement with Eli Lilly and
Company (Eli Lilly) to copromote Evista(R) in the U.S. Evista is approved in the
U.S. for the prevention and treatment of osteoporosis in postmenopausal women.
Under the terms of the agreement, the Company provides sales representatives to
copromote Evista to physicians in the U.S. The Company's sales representatives
augment the Eli Lilly sales force promoting Evista. Under this agreement, the
Company is entitled to be compensated based on net sales achieved above a
predetermined level. The agreement does not provide for the reimbursement of
expenses the Company incurs.
The Eli Lilly arrangement is a performance based contract for an original
term expiring December 31, 2003, subject to earlier termination upon the
occurrence of specific events. The Company is required to commit a certain level
of spending for promotional and selling activities, including but not limited to
sales representatives, which could range from $8.0 million to $12.0 million per
quarter. The sales force assigned to Evista may be used to promote other
products, including products covered by other PDI copromotion arrangements.
Since the inception of the agreement, the Evista sales force has been used to
promote products covered by other PDI copromotion arrangements, partially
offsetting the costs of the sales force. The Company's compensation for Evista
is determined based upon a percentage of net factory sales of Evista above
contractual baselines. To the extent that such baselines are not exceeded, which
was the case since the inception of the agreement through June 30, 2002, the
Company receives no revenue. Since the Company received no revenue under this
arrangement in the first half of 2002, it recognized negative gross profit of
approximately $8.7 million and $8.9 million for the quarters ended March 31,
2002 and June 30, 2002, respectively, relating to its Evista activities.
During the third quarter of 2002, the Company earned and subsequently
received $2.9 million from Eli Lilly under the Evista contract as a result of
sales exceeding cumulative contract baselines for the nine month period ended
September 30, 2002. Notwithstanding this revenue earned through the third
quarter, the Company believes, based upon available product performance data,
that it is probable that Evista sales will fall short of the 2002 annual
baseline, and no revenue will be earned by the Company for the full 2002 year.
In this event, the $2.9 million payment received for the third quarter will have
to be refunded to Eli Lilly. Accordingly, the $2.9 million was reserved for in
the third quarter.
Based upon management's assessment of the future performance potential of
Evista, on November 11, 2002, the Company and Eli Lilly mutually agreed to
terminate the contract as of December 31, 2002. As a result, due to the fact
that the Company believes that Evista sales will fall short of the 2002 annual
baseline and no revenue will be earned by the Company in the fourth quarter of
2002 or the full 2002 year, $7.8 million consisting of Evista sales force costs
required to be incurred by the Company between October 1, 2002 and the December
31, 2002 termination date to fulfill its remaining obligations under the
contract has been charged to cost of goods sold and an accrued contract loss has
been recorded in the balance sheet as of September 30, 2002.
7
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
4. Performance Based Contracts
In May 2001, the Company entered into an agreement with Novartis
Pharmaceuticals Corporation (Novartis) for the U.S. sales, marketing and
promotion rights for Lotensin(R) and Lotensin HCT(R), which agreement runs
through December 31, 2003. Under this agreement, the Company provides
promotional, selling, marketing, and brand management for Lotensin. In exchange,
the Company is entitled to receive a split of incremental net sales above
specified baselines. Also under this agreement with Novartis, the Company
copromotes Lotrel(R) in the U.S. for which it is entitled to be compensated on a
fixed fee basis with potential incentive payments based upon achieving certain
total prescription (TRx) objectives. On May 20, 2002, the Company expanded this
agreement with the addition of Diovan(R) and Diovan HCT(R). As with Lotrel, the
Company copromotes Diovan and Diovan HCT in the U.S. for which it is entitled to
be compensated on a fixed fee basis with potential incentive payments based upon
achieving certain TRx objectives. Novartis has retained regulatory
responsibilities for Lotensin, Lotrel and Diovan and ownership of all
intellectual property. Additionally, Novartis will continue to manufacture and
distribute the products. In the event the Company's estimates of the demand for
Lotensin are not accurate or more sales and marketing resources than anticipated
are required, the Novartis transaction could have a material adverse impact on
the Company's results of operations, cash flows and liquidity. Even though there
was an operating loss on this contract for the nine month period ended September
30, 2002, the Company's efforts on this contract did result in operating income
for the quarter ended September 30, 2002 because the sales of Lotensin exceeded
the specified baselines and the revenues earned exceeded operating costs. While
the Company currently estimates that future revenues will continue to exceed
costs associated with this agreement, there is no assurance that actual revenues
will exceed costs; in which event the activities covered by this agreement could
yield an operating loss and a contract loss reserve could be required.
5. Repurchase Program
On September 21, 2001, the Company announced that its Board of Directors
had unanimously authorized management to repurchase up to $7.5 million of its
common stock. Subject to availability, the transactions may be made from time to
time in the open market or directly from stockholders at prevailing market
prices that the Company deems appropriate. The repurchase program was
implemented to help ensure stability of the trading in PDI's common shares soon
after the September 11, 2001 terrorist activity. In October 2001, 5,000 shares
were repurchased in open market transactions for a total of $110,000. As of
September 30, 2002, no other shares had been repurchased under this program.
This program is ongoing and future purchases may be effected.
6. Acquisition
On September 10, 2001, the Company acquired 100% of the capital stock of
InServe Support Solutions ("InServe") in a transaction treated as an asset
acquisition for tax purposes. InServe is a nationwide supplier of supplemental
field-staffing programs for the medical device and diagnostics industries
("MD&D"). The acquisition has been accounted for as a purchase, subject to the
provisions of SFAS 141 and SFAS 142. The net assets of InServe on the date of
acquisition were approximately $1.3 million. The Company made payments to
InServe shareholders (the Seller) at closing of $8.5 million, net of cash
acquired. Additionally, the Company put $3.0 million in escrow related to
contingent payments payable during 2002 if certain defined benchmarks are
achieved. In April 2002, $1.2 million of the escrow was paid to the Seller and
$265,265 was returned to the Company due to non-achievement of a performance
benchmark. In September 2002, substantially all of the remaining $1.5 million in
escrow was paid to the Seller. In connection with these transactions, the
Company recorded $7.8 million in goodwill,
8
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
which is included in other long-term assets, and the remaining purchase price
was allocated to identifiable tangible and intangible assets and liabilities
acquired.
The following unaudited pro forma results of operations for the three and nine
months ended September 30, 2001 assume that the Company and InServe had been
combined as of the beginning of the period presented. The pro forma results
include estimates and assumptions which management believes are reasonable.
However, pro forma results are not necessarily indicative of the results which
would have occurred if the acquisition had been consummated as of the dates
indicated, nor are they necessarily indicative of future operating results.
Three Months Ended Nine Months Ended
September 30, 2001 September 30, 2001
------------------ ------------------
(in thousands, except for per share data)
(unaudited)
Total revenue, net - pro forma $ 118,407 $ 441,383
=========== =========
Net income - pro forma $ (17,322) $ (1,733)
=========== =========
Pro forma diluted earnings per share $ (1.25) $ (0.13)
=========== =========
7. Other Investments
In February 2002 and in July 2002, the Company made an additional
investment of approximately $379,000 in the preferred stock of iPhysicianNet,
Inc ("iPhysicianNet"), an equity investment which had previously been written
down as iPhysicianNet incurred losses. Since iPhysicianNet has only incurred
operating losses to date and the Company's cumulative share of losses would
exceed its investment, the Company was required to expense this additional
investment as incurred in the nine month period ended September 30, 2002.
During the nine months ended September 30, 2001, the Company made an
additional investment of approximately $1.1 million in convertible preferred
stock of In2Focus, Inc., ("In2Focus") a United Kingdom contract sales company,
bringing its total investment as of September 30, 2001 to $1.9 million, raising
PDI's ownership to approximately 14%. The Company recorded its investment under
the cost method. In light of the negative operating cash flows and the
uncertainty of achieving positive future results, the Company concluded as of
December 31, 2001 that its investment related to In2Focus was other than
temporarily impaired and it was written down to zero, the current estimated net
realizable value.
8. Inventory
At September 30, 2002, there was a zero inventory balance due to the sale
of all remaining inventory prior to the termination of PDI's distribution
agreement with GSK for Ceftin as discussed previously. For the nine months ended
September 30, 2001, inventory was valued at the lower of cost or fair value.
Cost was determined using the first in, first out costing method. Inventory
consisted of only finished goods and was recorded net of a provision for
obsolescence.
9
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
9. New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other
Intangible Assets" (SFAS 142). Under these new standards, all acquisitions
subsequent to June 30, 2001 must be accounted for under the purchase method of
accounting, and purchased goodwill is no longer amortized over its useful life.
Rather, goodwill will be subject to a periodic impairment test based upon its
fair value. Under these pronouncements, the Company's goodwill of approximately
$11.1 million will no longer be amortized; but will be subject to an annual
impairment test. The Company has assessed the impairment under SFAS 142 and the
results are discussed in footnote number 14.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations" ("SFAS 143"). SFAS 143 establishes accounting standards
for recognition and measurement of a liability for the costs of asset retirement
obligations. Under SFAS 143, the costs of retiring an asset will be recorded as
a liability when the retirement obligation arises, and will be amortized to
expense over the life of the asset.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS 144"). SFAS 144 addresses
financial accounting and reporting for the impairment or disposal of long-lived
assets and discontinued operations.
The adoption of these SFAS 141 through 144 did not have a material effect
on the consolidated financial position and results of operations of the Company.
PDI adopted these statements effective January 1, 2002.
In May 2002, the FASB issued SFAS No. 145, "Rescission of FAS Nos. 4, 44,
and 64. Amendment of FAS 13, and Technical Corrections as of April 2002" ("SFAS
145"). The statement rescinds SFAS 4 (as amended by SFAS 64) which required
extraordinary item treatment for gains and losses on extinguishments of debt, as
well as SFAS 44, which does not affect the Company. Additionally, the statement
amends certain provisions of SFAS 13 and other existing authoritative
pronouncements to make various technical corrections, clarify meanings, or
describe their applicability under changed conditions. The provisions of SFAS
145 related to extinguishments of debt are effective for the Company beginning
January 1, 2003, and all other provisions are effective for transactions
occurring on or financial statements issued after May 15, 2002. The Company is
currently evaluating the impact of this statement on its financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"). This Statement
addresses financial accounting and reporting for costs associated with exit or
disposal activities, and nullifies Emerging Issues Task Force (EITF) Issue No.
94-3, "Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." This Statement eliminates the definition and requirements for
recognition of exit costs in Issue 94-3, and requires that a liability for a
cost associated with an exit or disposal activity be recognized when the
liability is incurred rather than at the date of an entity's commitment to an
exit plan as was the case under EITF 94-3. This Statement also establishes that
fair value is the objective for initial measurement of the liability. SFAS 146
is effective for exit or disposal activities that are initiated after December
31, 2002. The restructuring activities approved as of September 30, 2002 have
been accounted for in accordance with EITF 94-3.
10
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
10. Historical and Pro Forma Basic and Diluted Net Income/Loss Per Share
Historical and pro forma basic and diluted net income/loss per share is
calculated based on the requirements of SFAS No. 128, "Earnings Per Share."
A reconciliation of the number of shares used in the calculation of basic
and diluted earnings per share for the three-month and nine-month periods ended
September 30, 2002 and 2001 is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- --------------------
2002 2001 2002 2001
------ ------ ------ ------
(in thousands)
Basic weighted average number
of common shares outstanding ....... 14,063 13,876 14,012 13,858
Dilutive effect of stock options ........ -- -- -- --
------ ------ ------ ------
Diluted weighted average number
of common shares outstanding ....... 14,063 13,876 14,012 13,858
====== ====== ====== ======
At September 30, 2002, 1,650,049 stock options were excluded from the
computation of diluted earnings per share due to their antidilutive effect. At
September 30, 2001, 1,141,288 stock options were excluded from the computation
of diluted earnings per share due to their antidilutive effect.
11. Short-Term Investments
At September 30, 2002, short-term investments were approximately $1.9
million, including approximately $1.2 million of investments classified as
available for sale securities. At December 31, 2001, short-term investments were
$7.4 million, including approximately $928,000 of investments classified as
available for sale securities. The unrealized after-tax gain/(loss) on the
available for sale securities is included as a separate component of
stockholders' equity as accumulated other comprehensive income (loss). All other
short-term investments are stated at cost, which approximates fair value.
11
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
12. Other Comprehensive Loss
A reconciliation of net loss as reported in the Consolidated Statements of
Operations to Other comprehensive loss, net of taxes is presented in the table
below.
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ---------------------
2002 2001 2002 2001
-------- -------- -------- -------
(thousands)
Net loss $(14,314) $(17,256) $(25,771) $(1,925)
Other comprehensive loss, net of tax:
Unrealized holding loss on
available-for-sale securities
arising during period (53) (56) (103) (129)
Reclassification adjustment for losses
included in net loss -- -- 41 10
-------- -------- -------- -------
Other comprehensive loss $(14,367) $(17,312) $(25,833) $(2,044)
======== ======== ======== =======
13. Commitments and Contingencies
The Company is engaged in the business of providing sales and marketing
services including the detailing of pharmaceutical products and providing after
sales support for medical devices and diagnostics, and through PDI Pharma is
also in the business of selling, marketing and distributing pharmaceutical
products. Such activities could expose the Company to risk of liability for
personal injury or death to persons using such products. The Company seeks to
reduce its potential liability under its service agreements through measures
such as contractual indemnification provisions with clients (the scope of which
may vary from client to client, and the performances of which are not secured)
and insurance. The Company could, however, also be held liable for errors and
omissions of its employees in connection with the services it performs that are
outside the scope of any indemnity or insurance coverage. The Company could be
materially adversely affected if it were required to pay damages or incur
defense costs in connection with a claim that is made outside the scope of an
indemnification agreement or insurance policy if the indemnity, although
applicable, is not performed in accordance with its terms; or if the Company's
liability exceeds the amount of applicable indemnity or insurance.
In January and February 2002, the Company, its chief executive officer,
and its chief financial officer were served with three complaints that were
filed in the United States District Court for the District of New Jersey
alleging violations of the Securities Exchange Act of 1934 (the "1934 Act").
These complaints were brought as purported shareholder class actions under
Sections 10(b) and 20(a) of the 1934 Act and Rule 10b-5 promulgated thereunder.
On May 23, 2002, the Court consolidated all three lawsuits into a single action
entitled In re PDI Securities Litigation, Master File No. 02-CV-0211, and
appointed lead plaintiffs ("Lead Plaintiffs") and Lead Plaintiffs' counsel. A
consolidated and amended complaint was filed on July 29, 2002 ("First
Consolidated and Amended Complaint").
The First Consolidated and Amended Complaint names the Company, its chief
executive officer, and its chief financial officer as defendants; purports to
state claims against them on behalf of all persons who purchased the Company's
common stock between May 22, 2001 and November 12, 2001; and seeks money damages
in unspecified amounts and litigation expenses including attorneys' and experts'
fees.
12
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
The essence of the allegations in the First Consolidated and Amended Complaint
is that the defendants intentionally or recklessly made false or misleading
public statements and omissions concerning the Company's financial condition and
prospects with respect to its marketing of Ceftin in connection with the October
2000 distribution agreement with GSK, as well as its marketing of Lotensin in
connection with the May 2001 distribution agreement with Novartis
Pharmaceuticals Corp. As of this filing, the Company has not yet answered the
First Consolidated and Amended Complaint.
On October 31, 2002, Lead Plaintiffs filed a motion for leave to file a second
consolidated and amended complaint, which would supersede the First Consolidated
and Amended Complaint. Lead Plaintiffs' proposed second consolidated amended
complaint names the Company, its chief executive officer, and its chief
financial officer as defendants; purports to state claims against them on behalf
of all persons who purchased the Company's common stock between May 22, 2001 and
August 12, 2002; and seeks money damages in unspecified amounts and litigation
expenses including attorneys' and experts' fees. The essence of the allegations
in Lead Plaintiffs' proposed second consolidated and amended complaint is that
the defendants intentionally or recklessly made false or misleading public
statements and omissions concerning the Company's financial condition and
prospects with respect to its marketing of Ceftin in connection with the October
2000 distribution agreement with GSK, its marketing of Lotensin in connection
with the May 2001 distribution agreement with Novartis Pharmaceuticals Corp., as
well as its marketing of Evista in connection with the October 2001 distribution
agreement with Eli Lilly. The Company believes that it is likely that the Court
will grant Lead Plaintiffs' motion for leave to file a second amended and
consolidated complaint and, if granted, intends to file a motion to dismiss
under the Private Securities Litigation Reform Act of 1995 and Rules 9(b) and
12(b)(6) of the Federal Rules of Civil Procedure. Discovery has not yet
commenced in the consolidated action. The Company believes that the allegations
in this purported securities class action are without merit and intends to
defend the action vigorously.
The Company has been named as a defendant in numerous lawsuits, including
two class action matters, alleging claims arising from the use of the
prescription compound Baycol that was manufactured by Bayer Pharmaceuticals
(Bayer) and marketed by the Company on Bayer's behalf. The Company may be named
in additional similar lawsuits. In August 2001, Bayer announced that it was
voluntarily withdrawing Baycol from the U.S. market. The Company intends to
defend these actions vigorously and has asserted a contractual right of
indemnification against Bayer for all costs and expenses it incurs relating to
these proceedings.
Other than the foregoing, the Company is not currently a party to any
material pending litigation and it is not aware of any material threatened
litigation.
14. Goodwill and Intangible Assets
The Company adopted SFAS 142, "Goodwill and Other Intangible Assets" in
fiscal year 2002. The effect of this adoption was to cease amortization of
goodwill and certain other indefinite-lived intangible assets, which resulted in
a decrease in amortization expense that would have been recorded in the third
quarter and nine months ended September 30, 2002 of approximately $280,000 and
$782,000, respectively. The Company has established reporting units for purposes
of testing goodwill for impairment. Goodwill has been assigned to the reporting
units to which the value of the goodwill relates. The Company completed the
first step of the transitional goodwill impairment test and has determined that
no impairment existed at January 1, 2002. The Company will evaluate goodwill and
other intangible assets at least on an annual basis and whenever events and
changes in circumstances suggest that the carrying amount may not be recoverable
based on the estimated future cash flows. The Company will
13
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
perform the required annual impairment tests in the fourth quarter of 2002. The
Company's total goodwill which is not subject to amortization is $11.1 million
as of September 30, 2002, all of which relates to the sales and marketing
services segment.
The statements of operations adjusted to exclude amortization expense for
2001 related to goodwill and related taxes are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ---------------------
2002 2001 2002 2001
-------- -------- -------- -------
(in thousands)
Net loss, as reported .................. $(14,314) $(17,256) $(25,771) $(1,925)
Pro forma goodwill amortization expense,
net of tax ........................ -- 68 -- 316
-------- -------- -------- -------
Net loss pro forma ..................... $(14,314) $(17,188) $(25,771) $(1,609)
======== ======== ======== =======
Net loss per share diluted pro forma ... $ (1.02) $ (1.24) $ (1.84) $ (0.12)
======== ======== ======== =======
15. Restructuring and Other Non-Recurring Charges
During the third quarter, the Company adopted a restructuring plan, the
objectives of which were to consolidate operations in order to enhance operating
efficiencies. This plan is primarily in response to a contraction in the
contract sales business. The majority of the restructuring activities will be
completed by December 31, 2002, with full completion expected by September 30,
2003.
In connection with this plan, the Company will record total restructuring
charges of approximately $5.3 million, other non-recurring charges of
approximately $0.3 million, and accelerated depreciation of approximately $0.8
million.
The restructuring charge is comprised of:
o $3.6 million in severance expense consisting of cash and
non-cash termination payments to be made to employees in
connection with their involuntary termination. Approximately
90% of affected employees will have left the Company's employ
by December 31, 2002, and the remaining employees are expected
to leave the Company in early 2003. All of the severance
expense will be recorded in the fourth quarter of 2002; and
o $1.7 million in restructuring costs consisting primarily of
reserves in connection with the closure or exit of leased
space located in Mahwah, NJ and Cincinnati, OH (which the
Company plans to close effective December 31, 2002),
Lawrenceville, NJ, Fort Washington, PA and Novato, CA.
The other non-recurring charges of $0.3 million relate to the writeoff of
fixed assets associated with certain of the Company's facilities being closed or
exited as part of the restructuring plan. The accelerated depreciation charges
of $0.8 million to be recognized in the third and fourth quarters relate to the
assets to be disposed that will still be in service through December 31, 2002.
14
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
In the third quarter of 2002, the Company recorded total restructuring and
non-recurring charges of $1.0 million, comprised of $0.7 million in
non-cancelable lease commitments and $0.3 million in asset writeoffs.
Additionally, approximately $0.2 million of accelerated depreciation expense
relating to assets to be disposed of but which will still be in service was
recorded in the third quarter. This accelerated depreciation expense is recorded
in selling, general and administrative expense in the statements of operations.
In the fourth quarter of 2002, the Company will record approximately $4.5
million in restructuring and non-recurring charges, comprised of $3.6 million in
severance and $0.9 million in lease commitment costs. Additionally,
approximately $0.6 million in accelerated depreciation will be recorded in
selling, general and administrative expense in the statements of operations in
the fourth quarter of 2002. The only remaining restructuring costs expected to
be expensed after December 31, 2002 are approximately $0.1 million in lease
termination costs relating to one of the facilities.
The reserve accrual for non-cancelable lease commitments at September 30,
2002 is $0.7 million and is recorded as part of current liabilities on the
accompanying balance sheet.
16. Segment Information
The Company operates under two reporting segments: sales and marketing
services, and PDI Pharma, both of which have changed since the December 31, 2001
financial presentation. Since the termination of the Ceftin contract and the
elimination of product sales, effective February 28, 2002, the shift in
management's focus on the business has been to view the traditional fee for
service type arrangements (offered by the "sales and marketing services"
segment) in the aggregate and to view the performance based contracts - those
for which the Company is compensated based on the performance of the products
that it is responsible for marketing and/or selling ("PDI Pharma" segment) -
also in the aggregate. The sales and marketing services segment includes the
Company's contract sales (CSO) business units; the Company's marketing services
business unit, which includes marketing research and medical education and
communication services; and the Company's medical device and diagnostics
business unit. The PDI Pharma segment includes the Company's LifeCycle Extension
services, product commercialization services and copromotion services, including
product sales. The segment information from prior periods has been restated to
conform to the current year's presentation.
In the Company's Quarterly Report on Form 10-Q for the three and nine
months ended September 30, 2001 and Annual Report on Form 10-K for the year
ended December 31, 2001, the Company had "contract sales and marketing services"
and "product sales and distribution" reporting segments. "Product sales and
distribution" was comprised only of the Ceftin contract which was a performance
based contract and is now included in the PDI Pharma segment. The PDI Pharma
segment now also includes the Company's other performance based contracts, such
as for Lotensin and Evista; previously these contracts were combined in the
Company's "contract sales and marketing services" segment. The "sales and
marketing services" segment is comprised of all non-performance based contracts.
Segment data includes a charge allocating all corporate headquarters costs
to each of the operating segments on the basis of total salary costs.
15
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- ------------------------
2002 2001 2002 2001
-------- --------- --------- ---------
(thousands)
Revenue
Sales and marketing services $ 43,092 $ 92,821 $ 150,431 $ 271,714
PDI Pharma 21,620 53,040 55,067 234,231
-------- --------- --------- ---------
Total $ 64,712 $ 145,861 $ 205,498 $ 505,945
======== ========= ========= =========
Revenue, intersegment
Sales and marketing services $ 144 $ 30,188 $ 514 $ 73,264
PDI Pharma -- -- -- --
-------- --------- --------- ---------
Total $ 144 $ 30,188 $ 514 $ 73,264
======== ========= ========= =========
Revenue, less intersegment
Sales and marketing services $ 42,948 $ 62,633 $ 149,917 $ 198,450
PDI Pharma 21,620 53,040 55,067 234,231
-------- --------- --------- ---------
Total $ 64,568 $ 115,673 $ 204,984 $ 432,681
======== ========= ========= =========
EBIT
Sales and marketing services $ 2,730 $ 12,063 $ 17,156 $ 39,955
PDI Pharma (15,123) (34,860) (35,277) (25,175)
Corporate charges (10,076) (6,724) (23,757) (21,197)
-------- --------- --------- ---------
Total $(22,469) $ (29,521) $ (41,878) $ (6,417)
======== ========= ========= =========
EBIT, intersegment
Sales and marketing services $ 68 $ 2,719 $ 370 $ 8,492
PDI Pharma (68) (2,719) (370) (8,492)
Corporate charges -- -- -- --
-------- --------- --------- ---------
Total $ -- $ -- $ -- $ --
======== ========= ========= =========
EBIT, less intersegment,
before corporate allocations
Sales and marketing services $ 2,662 $ 9,344 $ 16,786 $ 31,463
PDI Pharma (15,055) (32,141) (34,907) (16,683)
Corporate charges (10,076) (6,724) (23,757) (21,197)
-------- --------- --------- ---------
Total $(22,469) $ (29,521) $ (41,878) $ (6,417)
======== ========= ========= =========
Corporate allocations
Sales and marketing services $ (3,837) $ (3,455) $ (9,190) $ (12,651)
PDI Pharma (6,239) (3,269) (14,567) (8,546)
Corporate charges 10,076 6,724 23,757 21,197
-------- --------- --------- ---------
Total $ -- $ -- $ -- $ --
======== ========= ========= =========
16
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
(continued) 2002 2001 2002 2001
-------- -------- -------- --------
(thousands)
EBIT less corporate allocations
Sales and marketing services $ (1,175) $ 5,889 $ 7,596 $ 18,812
PDI Pharma (21,294) (35,410) (49,474) (25,229)
Corporate charges -- -- -- --
-------- -------- -------- --------
Total $(22,469) $(29,521) $(41,878) $ (6,417)
======== ======== ======== ========
Reconciliation of EBIT to income
before provision for income taxes
Total EBIT for operating groups $(22,469) $(29,521) $(41,878) $ (6,417)
Other income, net 459 999 1,704 4,407
-------- -------- -------- --------
Income before provision
for income taxes $(22,010) $(28,522) $(40,174) $ (2,010)
======== ======== ======== ========
Capital expenditures
Sales and marketing services $ (48) $ 4,260 $ 3,582 $ 9,223
PDI Pharma -- 176 217 1,153
-------- -------- -------- --------
Total $ (48) $ 4,436 $ 3,799 $ 10,376
======== ======== ======== ========
Depreciation expense
Sales and marketing services $ 1,973 $ 1,061 $ 4,653 $ 2,624
PDI Pharma 180 51 239 61
-------- -------- -------- --------
Total $ 2,153 $ 1,112 $ 4,892 $ 2,685
======== ======== ======== ========
17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
Various statements made in this Quarterly Report on Form 10-Q are
"forward-looking statements" (within the meaning of the Private Securities
Litigation Reform Act of 1995) regarding the plans and objectives of management
for future operations. These statements involve known and unknown risks,
uncertainties and other factors that may cause our actual results, performance
or achievements to be materially different from any future results, performance
or achievements expressed or implied by these forward-looking statements. The
forward-looking statements included in this report are based on current
expectations that involve numerous risks and uncertainties. Our plans and
objectives are based, in part, on assumptions involving judgements about, among
other things, future economic, competitive and market conditions and future
business decisions, all of which are difficult or impossible to predict
accurately and many of which are beyond our control. Although we believe that
our assumptions underlying the forward-looking statements are reasonable, any of
these assumptions could prove inaccurate and, therefore, we cannot assure you
that the forward-looking statements included in this report will prove to be
accurate. In light of the significant uncertainties inherent in the
forward-looking statements included in this report, the inclusion of these
statements should not be interpreted by anyone that our objectives and plans
will be achieved. Factors that could cause actual results to differ materially
from those expressed or implied by forward-looking statements include, but are
not limited to, the factors set forth in "Risk Factors Relating to Performance
Based Contracts" set forth below and "Certain Factors That May Affect Future
Growth," set forth under Part I, Item 1, of the Company's Annual Report on Form
10-K for the year ended December 31, 2001 as filed with the Securities and
Exchange Commission.
RISK FACTORS RELATING TO PERFORMANCE BASED CONTRACTS
In addition to the factors set forth in "Certain Factors that May Affect
Future Growth" under Part 1, Item 1 of our Annual Report on Form 10-K for the
year ended December 31, 2001 and other information provided in our reports, you
should consider the following carefully in evaluating our business and an
investment in our common stock. Additional risks and uncertainties not presently
known to us, that we currently deem immaterial or that are similar to those
faced by other companies in our industry or business in general, such as
competitive conditions, may also impair our business operations. If any of these
risks occur, our business, financial condition, or results of operations could
be materially adversely affected.
We have incurred operating losses under our performance based contracts
which, if they continue, could have a material adverse affect on our results of
operations and liquidity.
Some of our programs, including our Evista and Lotensin programs, require
us to increase sales of the product beyond minimum threshold requirements in
order to earn enough revenue to recoup our costs associated with the programs.
The third quarter of 2002 is the first period in which we have exceeded contract
baselines in our promotion of Evista, and as a result, we earned and
subsequently received $2.9 million from Eli Lilly. Notwithstanding this revenue
earned through the third quarter, we believe, based upon available product
performance data, that it is probable that Evista sales will fall short of the
2002 annual baseline and no revenue will be earned by us for the full 2002 year.
In this event, the $2.9 million payment received for the third quarter will have
to be refunded to Eli Lilly. Accordingly, the $2.9 million was reserved for in
the third quarter. Based upon our assessment of the future performance potential
of Evista, on November 11, 2002, we and Eli Lilly agreed to mutually terminate
the contract as of December 31, 2002. Accordingly, $7.8 million in Evista sales
force costs expected to be incurred between October 1, 2002 and the December 31,
2002 termination date, for which a contract loss reserve has been recorded in
the current period, have been charged to cost of goods sold.
18
Since inception of the Lotensin program, we have not sufficiently exceeded
contract baselines to cover the costs incurred in our promotion of Lotensin
which resulted in a loss for the six months ended June 30, 2002. There is no
assurance that actual revenues in future periods will exceed our costs under
these programs. Even though there is an operating loss on this contract for the
nine month period ending September 30, 2002, our efforts on this contract did
result in operating income for the quarter ended September 30, 2002 because the
sales of Lotensin exceeded the specified baselines and the revenues earned
exceeded the operating costs. While we currently estimate that future revenues
will continue to exceed costs associated with this agreement, there is no
assurance that actual revenues will exceed costs; in which event the activities
covered by this agreement could yield an operating loss and a contract loss
reserve could be required.
Overview
We are an innovative sales and marketing company serving the
pharmaceutical, biotech, and medical devices and diagnostics industries.
Partnering with clients, we provide product-specific programs designed to
maximize profitability throughout a product's lifecycle from pre-launch through
maturity. We are recognized as an industry leader based on our track record of
innovation and our ability to keep pace in a rapidly changing industry. We
leverage our expertise in sales, brand management and product marketing,
marketing research, medical education, medical affairs, and managed markets and
trade relations to help meet strategic objectives and provide incremental value
for product sales. We operate under two reporting segments: sales and marketing
services and PDI Pharma. Within our two reporting segments we provide the
following services:
o Sales and marketing services:
o dedicated contract sales services;
o shared contract sales services;
o medical devices and diagnostics sales and marketing services;
o marketing research and consulting services (TVG); and
o medical education and communication services (TVG).
o PDI Pharma:
o LifeCycle Extension services (LCXT);
o product commercialization services (PCS);and
o copromotion services.
Our contracts within the LCXT, PCS and copromotion subcategories are more
heavily performance based and have a higher risk potential and correspondingly
an opportunity for higher profitability. These contracts may involve significant
startup expenses and a greater risk of operating losses. These contracts
normally require significant participation from our PDI Pharma and TVG
professionals whose skills include marketing, brand management, trade relations
and marketing research.
Sales and Marketing Services
Given the customized nature of our business, we utilize a variety of
contract structures. Historically, most of our product detailing contracts were
fee for services, i.e., the client pays a fee for a specified package of
services. These contracts typically include operational benchmarks, such as a
minimum number of sales representatives or a minimum number of calls. Also, our
contracts might have a lower
19
base fee offset by built-in incentives we can earn based on our performance. In
these situations, we have the opportunity to earn additional fees based on
enhanced program results.
Our product detailing contracts generally are for terms of one to three
years and may be renewed or extended. However, the majority of these contracts
are terminable by the client for any reason on 30 to 90 days notice. These
contracts typically, but not always, provide for termination payments in the
event they are terminated by the client without cause. While the cancellation of
a contract by a client without cause may result in the imposition of penalties
on the client, these penalties may not act as an adequate deterrent to the
termination of any contract. In addition, we cannot assure you that these
penalties will offset the revenue we could have earned under the contract or the
costs we may incur as a result of its termination. The loss or termination of a
large contract or the loss of multiple contracts could adversely affect our
future revenue and profitability. As an example, in February 2002, Bayer
notified us that they were exercising their right to terminate their contract
with us without cause. Contracts may also be terminated for cause if we fail to
meet stated performance benchmarks. To date, no programs have been terminated
for cause.
On September 10, 2001, we acquired InServe Support Solutions (InServe) in
a transaction treated as an asset acquisition for tax purposes. The acquisition
was accounted for as a purchase in accordance with the provisions of Statement
of Financial Accounting Standards (SFAS) 141 and SFAS 142. The net assets of
InServe on the date of acquisition were approximately $1.3 million. At closing,
we paid the former shareholders of InServe $8.5 million, net of cash acquired.
Additionally, we deposited $3.0 million in escrow related to contingent payments
payable during 2002 if certain defined benchmarks are achieved. In April 2002,
$1.2 million of the escrow was paid to InServe shareholders (the Seller) and
$265,265 was returned to us due to nonachievement of a performance benchmark. In
September 2002, substantially all of the remaining $1.5 million in escrow was
paid to the Seller. In connection with these transactions, we recorded $7.8
million in goodwill, which is included in other long-term assets, and the
remaining purchase price was allocated to identifiable tangible and intangible
assets and liabilities acquired.
InServe is a leading nationwide supplier of supplemental field-staffing
programs for the medical devices and diagnostics industries. InServe provides
hands-on clinical education and after-sales support to maximize product
utilization and customer satisfaction. InServe's clients include many of the
leading medical devices and diagnostics companies, including Becton Dickinson,
Roche Diagnostics and Johnson & Johnson.
PDI Pharma
Beginning in the fourth quarter of 2000 we entered into a number of
significant performance based contracts and we use a variety of structures for
such contracts. Our agreement with GlaxoSmithKline (GSK) regarding Ceftin(R) was
a marketing and distribution contract, under which we had the exclusive right to
market and distribute the designated Ceftin products in the U.S. The agreement
had a five-year term but was cancelable by either party without cause on 120
days notice. The agreement was terminated by mutual consent, effective February
28, 2002. Contracts such as the Ceftin agreement, which require us to purchase
and distribute product, have a greater number of risk factors than a traditional
fee for service contract. Any future agreement that involves in-licensing or
product acquisition would have similar risk factors.
In May 2001, we entered into an agreement with Novartis Pharmaceuticals
Corporation (Novartis) for the U.S. sales, marketing and promotion rights for
Lotensin(R) and Lotensin HCT(R), which agreement runs through December 31, 2003.
Under this agreement, we provide promotional, selling, marketing, and brand
management for Lotensin. In exchange, we are entitled to receive a split of
incremental net sales above specified baselines. Also under this agreement with
Novartis, we copromote Lotrel(R) in the U.S. for which we are entitled to be
compensated on a fixed fee basis with potential incentive payments based upon
achieving certain total prescription (TRx) objectives. On May 20, 2002, we
expanded this agreement with the addition of Diovan(R) and Diovan HCT(R). As
with Lotrel, we copromote Diovan and Diovan HCT in
20
the U.S. for which we are entitled to be compensated on a fixed fee basis with
potential incentive payments based upon achieving certain TRx objectives.
Novartis has retained regulatory responsibilities for Lotensin, Lotrel and
Diovan and ownership of all intellectual property. Additionally, Novartis will
continue to manufacture and distribute the products. In the event our estimates
of the demand for Lotensin are not accurate or more sales and marketing
resources than anticipated are required, the Novartis transaction could have a
material adverse impact on our results of operations, cash flows and liquidity.
Even though there is an operating loss on this contract for the nine month
period ending September 30, 2002, our efforts on this contract did result in
operating income for the quarter ended September 30, 2002 because the sales of
Lotensin exceeded the specified baselines and the revenues earned exceeded the
operating costs. While we currently estimate that future revenues will continue
to exceed costs associated with this agreement, there is no assurance that
actual revenues will exceed costs; in which event the activities covered by this
agreement could yield an operating loss and a contract loss reserve could be
required.
In October 2001, we entered into an agreement with Eli Lilly to copromote
Evista in the U.S. Evista is approved in the U.S. for the prevention and
treatment of osteoporosis in postmenopausal women. Under the terms of the
agreement, we provide sales representatives to copromote Evista to physicians in
the U.S. Our sales representatives augment the Eli Lilly sales force promoting
Evista. Under this agreement, we are entitled to be compensated based on net
sales achieved above a predetermined level. The agreement does not provide for
the reimbursement of expenses we incur.
The Eli Lilly arrangement is a performance based contract for an original
term expiring December 31, 2003, subject to earlier termination upon the
occurrence of specific events. We are required to commit a certain level of
spending for promotional and selling activities, including but not limited to
sales representatives, which could range from $8.0 million to $12.0 million per
quarter. The sales force assigned to Evista may be used to promote other
products, including products covered by other PDI copromotion arrangements.
Since the inception of the agreement, the Evista sales force has been used to
promote products covered by other PDI copromotion arrangements, partially
offsetting the costs of the sales force. Our compensation for Evista is
determined based upon a percentage of net factory sales of Evista above
contractual baselines. To the extent that such baselines are not exceeded, which
was the case since the inception of the agreement through June 30, 2002, we
receive no revenue. Since we received no revenue under this arrangement in the
first half of 2002, we recognized negative gross profit of approximately $8.7
million and $8.9 million for the quarters ended March 31, 2002 and June 30,
2002, respectively.
During the third quarter of 2002 we earned and subsequently received $2.9
million from Eli Lilly under the Evista contract as a result of sales exceeding
cumulative contract baselines for the nine month period ended September 30,
2002. Notwithstanding this revenue earned through the third quarter, we believe,
based upon available product performance data, that it is probable that Evista
sales will fall short of the 2002 annual baseline and no revenue will be earned
by us for the full 2002 year. In this event, the $2.9 million payment received
for the third quarter will have to be refunded to Eli Lilly. Accordingly, the
$2.9 million was reserved for in the third quarter.
Based upon management's assessment of the future performance potential of
Evista, on November 11, 2002, we and Eli Lilly mutually agreed to terminate the
contract as of December 31, 2002. As a result, due to the fact that we believe
that Evista sales will fall short of the 2002 annual baseline and no revenue
will be earned by us in the fourth quarter of 2002 or the full 2002 year, $7.8
million consisting of Evista sales force costs required to be incurred by us
between October 1, 2002 and the December 31, 2002 termination date to fulfill
our remaining obligations under the contract has been charged to cost of goods
sold and an accrued contract loss has been recorded in the balance sheet as of
September 30, 2002.
21
Revenues and expenses
Our revenues and cost of goods and services are classified between service
and product sales for reporting purposes. Historically, we have derived a
significant portion of our service revenue from a limited number of clients.
However, concentration of business in the pharmaceutical outsourcing industry is
common and the industry continues to consolidate. Accordingly, we are likely to
continue to experience significant client concentration in future periods. Our
three largest clients accounted for approximately 71.0% and 69.2%, of our
service revenue for the quarters ended September 30, 2002 and 2001,
respectively, and 72.0% and 60.1% of our service revenue for the nine-month
periods ended September 30, 2002 and 2001, respectively. For the quarter ended
September 30, 2001, product revenue from sales of Ceftin primarily came from two
customers who accounted for approximately 52.8% of total net product revenue. Of
the $6.4 million recorded as product revenue for the nine months ended September
30, 2002, only approximately $716,000 was from the sale of Ceftin inventory. The
balance of $5.7 million resulted from the net positive adjustments recorded in
sales returns and allowances, discounts and rebates for the first nine months of
2002 that occurred as we continue to satisfy our liabilities relating to the
previous reserves recorded as a result of Ceftin sales in prior periods. Since
those reserves were initially set up as estimates, using historical data and
other information, there may be both positive and negative adjustments made as
the liabilities are settled in future periods and such adjustments will be
reflected in product revenue in accordance with the classification of such
accruals as initially recorded.
Service revenue and program expenses
Sales and marketing services revenue is earned primarily by performing
product detailing programs and other marketing and promotional services under
contracts. Revenue is recognized as the services are performed and the right to
receive payment for the services is assured. Revenue is recognized net of any
potential penalties until the performance criteria eliminating the penalties
have been achieved. Bonus and other performance incentives, as well as
termination payments, are recognized as revenue in the period earned and when
payment of the bonus, incentive or other payment is assured. Under performance
based contracts revenue is recognized when the performance based parameters are
attained.
Program expenses consist primarily of the costs associated with executing
product detailing programs, performance based contracts or other sales and
marketing services identified in the contract. Program expenses include
personnel costs and other costs associated with executing a product detailing or
other marketing or promotional program, as well as the initial direct costs
associated with staffing a product detailing program. Such costs include, but
are not limited to, facility rental fees, honoraria and travel expenses, sample
expenses and other promotional expenses. Personnel costs, which constitute the
largest portion of program expenses, include all labor related costs, such as
salaries, bonuses, fringe benefits and payroll taxes for the sales
representatives and sales managers and professional staff who are directly
responsible for executing a particular program. Initial direct program costs are
those costs associated with initiating a product detailing program, such as
recruiting, hiring and training the sales representatives who staff a particular
product detailing program. All personnel costs and initial direct program costs,
other than training costs, are expensed as incurred for service offerings.
Training costs include the costs of training the sales representatives and
managers on a particular product detailing program so that they are qualified to
properly perform the services specified in the related contract. Training costs
are deferred and amortized on a straight-line basis over the shorter of the life
of the contract to which they relate or 12 months. Expenses related to the
product detailing of products we distribute such as Ceftin (as discussed below
under Product revenue and cost of goods sold) are recorded as a selling expense
and are included in other selling, general and administrative expenses in the
consolidated statements of operations.
As a result of the revenue recognition and program expense policies
described above, we may incur significant initial direct program costs before
recognizing revenue under a particular product detailing program. We typically
receive an initial contract payment upon commencement of a product detailing
program as compensation for recruiting, hiring and training services associated
with staffing that program.
22
In these cases, the initial payment is recorded as revenue in the same period in
which the costs of the services are expensed. Our inability to specifically
negotiate in our product detailing contracts payments that are specifically
attributable to recruiting, hiring or training services could adversely impact
our operating results for periods in which the costs associated with the product
detailing services are incurred.
Product revenue and cost of goods sold
Our only product revenue to date related to the Ceftin contract which
terminated effective February 28, 2002. Product revenue is recognized when
products are shipped and title to products is transferred to the customer.
Provision is made at the time of sale for all discounts and estimated sales
allowances. We prepare our estimates for sales returns and allowances, discounts
and rebates based primarily on historical experience updated for changes in
facts and circumstances, as appropriate.
Cost of goods sold includes all expenses for both product distribution
costs and manufacturing costs of product sold. Inventory is valued at the lower
of cost or fair value. Cost is determined using the first in, first out costing
method. Inventory to date has consisted of only finished goods. Cost of goods
sold and gross margin on sales under the Ceftin agreement fluctuated based on
our quantity of product purchased, and our contractual unit costs including
applicable discounts, as well as fluctuations in the selling price for our
products including applicable discounts.
Corporate overhead
Selling, general and administrative expenses (SG&A) include compensation
and general corporate overhead. Compensation expense consists primarily of
salaries, bonuses, training and related benefits for senior management and other
administrative, marketing, finance, information technology and human resources
personnel who are not directly involved with executing a particular program.
Other selling, general and administrative expenses include corporate overhead
such as facilities costs, depreciation and amortization expenses and
professional services fees; and with respect to product that we distribute,
other SG&A also includes product detailing, marketing and promotional expenses.
Restructuring and Other Non-Recurring Charges
During the third quarter, we adopted a restructuring plan, the objectives
of which were to consolidate operations in order to enhance operating
efficiencies. This plan is primarily in response to the general decrease in
demand within our markets for sales and marketing services. The majority of the
restructuring activities will be completed by December 31, 2002, with full
completion expected by September 30, 2003.
In connection with this plan, we will record total restructuring charges
of approximately $5.3 million, other non-recurring charges of approximately $0.3
million, and accelerated depreciation of approximately $0.8 million.
The restructuring charge is comprised of:
o $3.6 million in severance expense consisting of cash and
non-cash termination payments to be made to employees in
connection with their involuntary termination. Approximately
90% of affected employees will have left our employ by
December 31, 2002, and the remaining employees are expected to
leave us in early 2003. All of the severance expense will be
recorded in the fourth quarter of 2002; and
o $1.7 million in restructuring costs consisting primarily of
reserves in connection with the closure or exit of leased
space located in Mahwah, NJ and Cincinnati, OH (which we plan
to close effective December 31, 2002), Lawrenceville, NJ, Fort
Washington, PA and Novato, CA.
23
The other non-recurring charges relate to the writeoff of fixed assets
associated with certain of our facilities being closed or exited as part of the
restructuring plan. The accelerated depreciation charges of $0.8 million relate
to the assets to be disposed of but still in service through December 31, 2002.
In the third quarter of 2002, we recorded total restructuring and
non-recurring charges of $1.0 million, comprised of $0.7 million in
non-cancelable lease commitments and $0.3 million of asset writeoffs.
Additionally, approximately $0.2 million of accelerated depreciation expense
related to assets to be disposed of but which will still be in service was
recorded in the third quarter. This accelerated depreciation expense is recorded
in selling, general and administrative expense in the statements of operations.
In the fourth quarter of 2002, we will record approximately $4.5 million in
restructuring and non-recurring charges, comprised of $3.6 million in severance
and $0.9 million in lease commitment costs. Additionally, approximately $0.6
million in accelerated depreciation will be recorded in selling, general and
administrative expense in the statements of operations in the fourth quarter of
2002. The only remaining restructuring costs expected to be expensed after
December 31, 2002 are approximately $0.1 million in lease termination costs
relating to one of the facilities.
The reserve accrual for non-cancelable lease commitments at September 30,
2002 is $0.7 million and is recorded as part of current liabilities on the
accompanying balance sheet.
Evista and Ceftin Contract Loss Reserves
Ceftin
On August 21, 2001 the U.S. Court of Appeals overturned a preliminary
injunction granted by the New Jersey District Court, which allowed for the entry
of a generic competitor to Ceftin immediately upon approval by the FDA. The
affected Ceftin patent had previously been scheduled to run through July 2003.
As a result of this decision and its impact on future sales, in the third
quarter of 2001, PDI recorded a charge to cost of goods sold for $24.0 million
representing the anticipated future loss to be incurred by the Company under the
Ceftin agreement as of September 30, 2001. The recorded loss was calculated as
the excess of estimated costs that PDI was contractually obligated to incur to
complete its obligations under the arrangement, over the remaining estimated
gross profits to be earned under the contract from selling the inventory. These
costs primarily consisted of amounts paid:
o to GSK to reduce purchase commitments,
o for estimated committed sales force expenses,
o for selling and marketing costs,
o for distribution costs, and
o for fees to terminate existing arrangements.
The Ceftin agreement was terminated by the Company and GSK under a mutual
termination agreement entered into in December 2001. Under the termination
agreement, the Company agreed to perform its marketing and distribution services
through February 28, 2002. The Company also maintained responsibility for sales
returns for product sold until the expiration date of the product sold,
estimated to run through December 31, 2004, and certain administrative functions
regarding Medicaid rebates. The combination of the decline in revenue and the
recorded contract loss caused a severe adverse effect on gross profit and
operating income for the three months and nine months ending September 30, 2001.
24
Evista
Based upon our assessment of the future performance potential of Evista as
compared to contractual baselines, on November 11, 2002, we and Eli Lilly
mutually agreed to terminate the contract as of December 31, 2002. As a result,
$7.8 million in Evista sales force costs expected to be incurred between October
1, 2002 and the December 31, 2002 termination date have been charged to cost of
goods sold and reserved for in a contract loss provision in the current period.
During the third quarter of 2002 we earned $2.9 million under the Evista
contract as a result of sales exceeding cumulative contract baselines; however,
this revenue has been reserved against since it will have to be refunded to Eli
Lilly if no revenue is earned based upon the annualized sales. During the entire
life of this contract, we have not recorded any performance based revenue
because we estimate that the sales of the product will not meet the established
baseline. All expenses incurred in the performance of this contract consisting
of sales force and other marketing expenses have consistently been charged to
cost of goods sold. These expenses have created negative gross profit for the
contract each quarter. The negative gross profits in 2002 have been as follows:
Third quarter Nine months
2002 2002
---------------------------
(in millions)
Loss from contracted operations $ 6.7 $ 24.4
Contract reserve loss 7.8 7.8
------- -------
Total Evista loss $ 14.5 $ 32.2
======= =======
Consolidated Results of Operations
The following table sets forth, for the periods indicated, certain
statements of operations data as a percentage of revenue. The trends illustrated
in this table may not be indicative of future results.
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2002 2001 2002 2001
----- ----- ----- -----
Revenue
Service, net 99.7% 61.5% 96.9% 49.5%
Product, net 0.3 38.5 3.1 50.5
----- ----- ----- -----
Total revenue, net 100.0% 100.0% 100.0% 100.0%
Cost of goods and services
Program expenses 104.5 51.5 97.8 38.9
Cost of goods sold -- 44.8 -- 38.7
----- ----- ----- -----
Total cost of goods and services 104.5% 96.3% 97.8% 77.6%
Gross (loss) profit (4.5) 3.7 2.2 22.4
Operating expenses
Compensation expense 14.2 8.1 12.7 6.8
Other selling, general and administrative expenses 14.6 21.2 9.4 17.1
Restructuring and non-recurring charges 1.5 -- 0.5 --
----- ----- ----- -----
Total operating expenses 30.3 29.3 22.6 23.9
----- ----- ----- -----
Operating loss (34.8) (25.6) (20.4) (1.5)
Other income, net 0.7 0.9 0.8 1.0
----- ----- ----- -----
Loss before benefit for income taxes (34.1) (24.7) (19.6) (0.5)
Benefit for income taxes (11.9) (9.8) (7.0) 0.0
----- ----- ----- -----
Net loss (22.2)% (14.9)% (12.6)% (0.5)%
===== ===== ===== =====
25
Quarter Ended September 30, 2002 Compared to Quarter Ended September 30, 2001
Revenue. Net revenue for the quarter ended September 30, 2002 was $64.6
million, 44.2% less than net revenue of $115.7 million for the quarter ended
September 30, 2001. Net revenue from the sales and marketing services segment
for the quarter ended September 30, 2002 was $43.0 million, $19.6 million less
than net revenue of $62.6 million from that segment for the comparable prior
year period. This decrease was primarily attributable to the loss of one large
dedicated CSO contract and the general decrease in demand within our markets for
sales and marketing services. Net PDI Pharma revenue for the quarter ended
September 30, 2002 was $21.6 million, of which $215,000 was product revenue
attributable to the changes in estimates related to sales allowances and
returns, and discounts and rebates recorded on previous Ceftin sales. During the
quarter, sales of Evista exceeded the cumulative contractual baseline for the
nine months ended September 30, 2002 and therefore we earned revenue of $2.9
million from that contract; however, since we believe that sales are likely to
fall short of the annual baseline for 2002, no revenue has been recognized. The
balance of $21.4 million in revenue was from other performance based contracts.
PDI Pharma revenue for the three months ended September 30, 2001 was $53.0
million; of that amount, net product revenue, consisting only of Ceftin, was
$44.5 million and $8.5 million was from other performance based contracts.
Cost of goods and services. Cost of goods and services for the quarter
ended September 30, 2002 was $67.5 million, 39.4% less than cost of goods and
services of $111.4 million for the quarter ended September 30, 2001. As a
percentage of total net revenue, cost of goods and services increased to 104.5%
for the quarter ended September 30, 2002 from 96.3% in the comparable prior year
period. Program expenses (i.e., cost of services) associated with the sales and
marketing services segment for the quarter ended September 30, 2002 were $31.6
million, 30.8% less than program expenses of $45.7 million for the prior year
period. As a percentage of sales and marketing services segment revenue, program
expenses for the quarters ended September 30, 2002 and 2001 were 73.6% and
73.0%, respectively. Cost of goods and services associated with the PDI Pharma
segment were $35.9 million and $65.7 million for the quarters ended September
30, 2002 and 2001, respectively. The decrease was primarily attributable to the
large cost of goods sold associated with the Ceftin contract in 2001. During the
third quarter 2001, there were charges to cost of goods sold for product sold as
well as for the $24.0 million charge for the Ceftin termination reserve. As a
percentage of PDI Pharma revenue, cost of goods and services for the quarters
ended September 30, 2002 and 2001 were 165.8% and 123.7%, respectively. This
increase was primarily attributable to the negative gross profit associated with
the Evista program. To date, the revenues earned from the Evista performance
based contract have fallen short of sales and marketing costs associated with
this contract. Performance based contracts can achieve a gross profit percentage
above our historical averages for contract sales programs if the performance of
the product(s) meets or exceeds expectations, but can be below normal gross
profit standards if the performance of the product falls short of baselines.
After considering the cumulative below baseline performance on the Evista
contract since inception on October 1, 2001, and the likelihood of continued
poor performance against the contractual baselines, and the mutual termination
of the contract by us and Eli Lilly, we determined that we would continue to
lose money over the remainder of the contract and recorded a contract loss
reserve of $7.8 million in the third quarter of 2002.
Compensation expense. Compensation expense for the quarter ended September
30, 2002 was $9.2 million, 1.3% less than $9.3 million for the comparable prior
year period. As a percentage of total net revenue, compensation expense
increased to 14.2% for the quarter ended September 30, 2002 from 8.0% for the
quarter ended September 30, 2001. Compensation expense for the quarters ended
September 30, 2002 and September 30, 2001 attributable to the PDI Pharma segment
was $2.8 million and $2.7 million, respectively; as a percentage of revenue,
compensation expense was 12.8% for the quarter ended September 30, 2002 compared
to 5.2% in the prior year period. Compensation expense for the quarter ended
September 30, 2002 attributable to the sales and marketing services segment was
$6.4 million
26
compared to $6.6 million for the quarter ended September 30, 2001. As a
percentage of net revenue from the sales and marketing services segment,
compensation expense increased to 14.9% for the quarter ended September 30, 2002
from 10.4% for the quarter ended September 30, 2001.
Other selling, general and administrative expenses. Total other selling,
general and administrative expenses were $9.4 million for the quarter ended
September 30, 2002, 61.6% less than other selling, general and administrative
expenses of $24.6 million (of which $17.6 million were related to Ceftin
activities) for the quarter ended September 30, 2001. As a percentage of total
net revenue, total other selling, general and administrative expenses decreased
to 14.6% for the quarter ended September 30, 2002 from 21.1% for the quarter
ended September 30, 2001. Other selling, general and administrative expenses
attributable to the sales and marketing services segment for the quarter ended
September 30, 2002 were $5.3 million, compared to other selling, general and
administrative expenses of $4.5 million attributable to that segment for the
comparable prior year period. As a percentage of net revenue from sales and
marketing services, other selling, general and administrative expenses were
12.4% and 7.1% for the quarters ended September 30, 2002 and 2001, respectively.
Other selling, general and administrative expenses attributable to the PDI
Pharma segment for the quarter ended September 30, 2002 were approximately $4.1
million, or 19.0% of revenue, compared to $20.1 million for the prior year
period. Excluding the $17.6 million associated with the Ceftin field and other
promotional expenses in the prior year period, other selling, general and
administrative expenses were $2.5 million, or 4.7% of revenue.
Both compensation and other selling, general and administrative expenses
were higher as a percentage of revenue in the 2002 period than they were in
2001, even after excluding the selling, general and administrative expenses
associated with the Ceftin contract. This factor, considered with management's
overall assessment of market conditions and our cost structure, prompted us to
undertake cost reduction initiatives (see section labeled "Restructuring and
Other Non-Recurring Charges").
Operating loss. There was an operating loss for the quarter ended
September 30, 2002 of $22.5 million, compared to an operating loss of $29.5
million for the quarter ended September 30, 2001. The current quarter
consolidated operating loss was primarily the result of losses generated by the
performance based contracts. The operating loss for the quarter ended September
30, 2002 for the sales and marketing services segment was $1.2 million, compared
to sales and marketing services operating income for the quarter ended September
30, 2001 of $5.9 million. There was an operating loss for the PDI Pharma segment
for the quarter ended September 30, 2002 of $21.3 million, compared to an
operating loss of $35.4 million for the prior year period, primarily
attributable to the contract loss reserve recorded for the Ceftin contract in
the third quarter of 2001.
Other income, net. Other income, net, for the quarters ended September 30,
2002 and 2001 was $459,000 and $999,000, respectively. For the quarter ended
September 30, 2002, other income, net, was comprised primarily of $412,000 in
interest income, which was significantly lower than the prior year period due to
significantly lower interest rates and decreased investments due to the
operating losses incurred. Additionally, there was net other income during the
quarter of $47,000. Other income, net, for the prior year period was comprised
primarily of interest income.
Benefit for income taxes. There was an income tax benefit of $7.7 million
for the quarter ended September 30, 2002, compared to an income tax benefit of
$11.3 million for the quarter ended September 30, 2001, which consisted of
Federal and state corporate income taxes. The effective tax benefit rate for the
quarter ended September 30, 2002 was 35.0%, compared to an effective tax rate of
39.5% for the quarter ended September 30, 2001. The provision this quarter
includes a valuation allowance for New Jersey net operating losses that may not
be utilized because of recent changes in the tax law.
Net loss. There was a net loss for the quarter ended September 30, 2002 of
$14.3 million, compared to a net loss of $17.3 million for the quarter ended
September 30, 2001 due to the factors discussed above.
27
Nine Months Ended September 30, 2002 Compared to Nine Months Ended September 30,
2001
Revenue. Net revenue for the nine months ended September 30, 2002 was
$205.0 million, 52.6% less than net revenue of $432.7 million for the nine
months ended September 30, 2001. Net revenue from the sales and marketing
services segment for the nine months ended September 30, 2002 was $149.9
million, $48.6 million less than net revenue of $198.5 million from that segment
for the comparable prior year period. This decrease was primarily attributable
to the loss of several significant dedicated CSO contracts and the general
decrease in demand within our markets for sales and marketing services. Net PDI
Pharma revenue for the nine months ended September 30, 2002 was $55.1 million,
of which $6.4 million was Ceftin product revenue. Within product revenue,
approximately $716,000 was attributable to sales of Ceftin and $5.7 million was
attributable to the changes in estimates related to sales allowances and
returns, and discounts and rebates recorded on previous Ceftin sales. The
balance of $48.7 million was from other performance based contracts, notably the
Novartis contract which now includes Diovan as well as Lotrel and Lotensin. PDI
Pharma revenue for the nine months ended September 30, 2001 was $234.2 million;
of that amount, net product revenue was $218.7 million and $15.5 in revenue was
from other performance based contracts.
Cost of goods and services. Cost of goods and services for the nine months
ended September 30, 2002 was $200.5 million, 40.3% less than cost of goods and
services of $335.8 million for the nine months ended September 30, 2001. As a
percentage of total net revenue, cost of goods and services increased to 97.8%
for the nine months ended September 30, 2002 from 77.6% in the comparable prior
year period. Program expenses (i.e., cost of services) associated with the sales
and marketing services segment for the nine months ended September 30, 2002 were
$110.7 million, 22.8% less than program expenses of $143.4 million for the prior
year period. As a percentage of sales and marketing services segment revenue,
program expenses for the nine months ended September 30, 2002 and 2001 were
73.9% and 72.3%, respectively. Cost of goods and services associated with the
PDI Pharma segment was $89.8 million and $192.4 million for the nine months
ended September 30, 2002 and 2001, respectively. The decrease was primarily
attributable to the large cost of goods sold associated with the Ceftin contract
in 2001. During the nine months ended September 30, 2001 there were charges to
cost of goods sold for product sold as well as for the $24.0 million charge for
the Ceftin termination reserve. As a percentage of PDI Pharma revenue, cost of
goods and services for the nine months ended September 30, 2002 and 2001 was
163.0% and 82.1%, respectively. This increase was primarily attributable to the
negative gross profit associated with the Evista program. To date the revenues
earned from the performance based contracts for Evista and Lotensin have fallen
short of sales and marketing costs associated with those contracts. Performance
based contracts can achieve a gross profit percentage above our historical
averages for contract sales programs if the performance of the product(s) meets
or exceeds expectations, but can be below normal gross profit standards if the
performance of the product falls short of baselines. After considering the
cumulative below baseline performance on the Evista contract since inception on
October 1, 2001, and the likelihood of continued poor performance, against
contract baselines and the mutual termination of the contract by us and Eli
Lilly, we determined that it was probable that Evista sales for the full year
2002 would be below the annual baseline and therefore we recorded a contract
loss reserve of $7.8 million in the third quarter of 2002 equal to the remaining
costs required to be incurred to fulfill our obligations through the contract
termination date.
Compensation expense. Compensation expense for the nine months ended
September 30, 2002 was $26.2 million, 11.0% less than $29.5 million for the
comparable prior year period. As a percentage of total net revenue, compensation
expense increased to 12.8% for the nine months ended September 30, 2002 from
6.8% for the nine months ended September 30, 2001. Compensation expense for the
nine months ended September 30, 2002 attributable to the sales and marketing
services segment was $17.9 million compared to $22.5 million for the nine months
ended September 30, 2001. As a percentage of net revenue from the sales and
marketing services segment, compensation expense increased slightly to 11.9% for
the nine months ended September 30, 2002 from 11.3% for the nine months ended
September 30, 2001. Compensation expense for the nine months ended September 30,
2002 attributable to the PDI Pharma
28
segment was $8.3 million, or 15.1% of PDI Pharma revenue, compared to $7.0
million, or 3.0% in the prior year period.
Other selling, general and administrative expenses. Total other selling,
general and administrative expenses were $19.2 million for the nine months ended
September 30, 2002, 74.0% less than other selling, general and administrative
expenses of $73.8 million (of which $51.1 million was related to Ceftin
activities) for the nine months ended September 30, 2001. As a percentage of
total net revenue, total other selling, general and administrative expenses
decreased to 9.4% for the nine months ended September 30, 2002 from 17.1% for
the nine months ended September 30, 2001. Other selling, general and
administrative expenses attributable to sales and marketing services segment for
the nine months ended September 30, 2002 were $12.9 million, $0.9 million less
than other selling, general and administrative expenses of $13.8 million
attributable to that segment for the comparable prior year period. As a
percentage of net revenue from sales and marketing services, other selling,
general and administrative expenses were 8.6% and 6.9% for the nine months ended
September 30, 2002 and 2001, respectively. Other selling, general and
administrative expenses attributable to the PDI Pharma segment for the nine
months ended September 30, 2002 were $6.3 million. For the nine months ended
September 30, 2001, other selling, general and administrative expenses were
$60.0 million. Excluding $51.1 million in Ceftin field and other promotional
expenses, other selling, general and administrative expenses for the nine months
ended September 30, 2001 were $8.9 million.
Both compensation and other selling, general and administrative expenses
were higher as a percentage of revenue in the 2002 period than they were in
2001, even after excluding the selling, general and administrative expenses
associated with the Ceftin contract. This factor, considered with management's
overall assessment of market conditions and our cost structure, prompted us to
undertake cost reduction initiatives (see section labeled "Restructuring and
Other Non-Recurring Charges").
Operating loss. There was an operating loss for the nine months ended
September 30, 2002 of $41.9 million, compared to an operating loss of $6.4
million for the nine months ended September 30, 2001. The 2002 period operating
loss was primarily the result of losses generated by the performance based
contracts. Operating income for the nine months ended September 30, 2002 for the
sales and marketing services segment was $7.6 million, or 59.6% less than the
sales and marketing services operating income for the nine months ended
September 30, 2001 of $18.8 million. As a percentage of net revenue from the
sales and marketing services segment, operating income for that segment
decreased to 5.1% for the nine months ended September 30, 2002, from 9.5% for
the comparable prior year period. There was an operating loss for the PDI Pharma
segment for the nine months ended September 30, 2002 of $49.5 million due
primarily to the performance of the Evista and Lotensin contracts, compared to
an operating loss of $25.2 million for the prior year period.
Other income, net. Other income, net, for the nine months ended September
30, 2002 and 2001 was $1.7 million and $4.4 million, respectively. For the nine
months ended September 30, 2002, other income, net, was primarily comprised of
$1.8 million in interest income, which was significantly lower than the prior
year due to significantly lower interest rates as well as reduced investments
due to the operating losses incurred in 2002. This was partially offset by line
of credit fees of approximately $100,000. Other income, net, for the prior year
period was comprised primarily of interest income.
Benefit for income taxes. There was an income tax benefit of $14.4 million
for the nine months ended September 30, 2002, compared to an income tax benefit
of $85,000 for the nine months ended September 30, 2001, which consisted of
Federal and state corporate income taxes. The effective tax benefit rate for the
nine months ended September 30, 2002 was 35.9%, compared to an effective tax
benefit rate of 4.2% for the nine months ended September 30, 2001. During 2001,
the increase in the effective tax rate was attributable to several specific
transactions or situations that when applied to our lower than normal pretax
earnings created a large deviation from our target effective tax rate of 41% to
42%. For example, certain nondeductible expenses which are routinely incurred
had a significantly higher impact on the effective tax rate in 2001, compared to
prior years, due to the lower level of pretax profits.
Net loss. There was a net loss for the nine months ended September 30,
2002 of $25.8 million, compared to a net loss of $1.9 million for the nine
months ended September 30, 2001 due to the factors discussed above.
29
Liquidity and capital resources
As of September 30, 2002, we had cash and cash equivalents and short-term
investments of approximately $85.8 million and working capital of $93.8 million
compared to cash and cash equivalents and short-term investments of
approximately $78.1 million and working capital of $102.9 million at September
30, 2001.
For the nine months ended September 30, 2002, net cash used in operating
activities was $76.1 million, compared to $13.2 million cash used in operating
activities for the same period in 2001. The main components of cash used in
operating activities were:
o a net loss from operations of $25.8 million,
o income tax receivable (part of other current assets) of $14.1 million,
o reduction in accrued returns, rebates and sales discounts associated with
the Ceftin agreement of $50.8 million, partially offset by
o cash generated from other changes in assets and liabilities of $14.6
million.
During the fourth quarter of 2001 we agreed with GSK to terminate the
Ceftin marketing and distribution agreement as of February 28, 2002, thus the
decline in inventory and the reduction in accounts receivable, accrued returns,
rebates and discounts, accrual for contract losses, and other liability accounts
were associated with the winding down of Ceftin activities. The balances in
"Other changes in assets and liabilities" may fluctuate depending on a number of
factors, including seasonality of product sales, the number and size of
programs, contract terms and other timing issues; these fluctuations may vary in
size and direction each reporting period.
When we bill clients for services before they have been completed, billed
amounts are recorded as unearned contract revenue, and are recorded as income
when earned. When services are performed in advance of billing, the value of
such services is recorded as unbilled costs and accrued profits. As of September
30, 2002, we had $8.0 million of unearned contract revenue and $9.3 million of
unbilled costs and accrued profits. Substantially all deferred and unbilled
costs and accrued profits are earned or billed, as the case may be, within 12
months of the end of the respective period.
For the nine months ended September 30, 2002, net cash used in investing
activities was $1.5 million, comprised of $2.7 million in payments made as part
of the InServe acquisition, $379,000 in other investments and $3.8 million in
additions to property, plant and equipment, partially offset by the sale of $5.4
million of short-term investments.
For the nine months ended September 30, 2002, net cash provided by
financing activities was $1.5 million. This increase in cash is due to the net
proceeds received from the employee stock purchase plan of $1.4 million and
approximately $131,000 in proceeds received from the exercise of common stock
options by employees.
Capital expenditures during the nine months ended September 30, 2002 and
2001 were $3.8 million and $10.4 million, respectively, and were funded from
available cash.
We believe that our cash and cash equivalents, short-term investments and
future cash flows generated from operations will be sufficient to meet our
foreseeable operating and capital requirements for the next twelve months. We
are currently exploring opportunities for a credit facility secured by our
current assets. We continue to evaluate and review acquisition candidates and
financing opportunities in the ordinary course of business.
30
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
Within the past 90 days, PDI's management, including its Chief Executive Officer
and Chief Financial Officer, have conducted an evaluation of the effectiveness
of disclosure controls and procedures pursuant to Rule 13a-14 and 15d-14 under
the Securities Exchange Act of 1934, as amended. Based on that evaluation, the
Chief Executive Officer and Chief Financial Officer concluded that the
disclosure controls and procedures are effective in ensuring that all material
information required to be filed in this quarterly report has been made known to
them in a timely fashion.
(b) Changes in Internal Controls
There have been no significant changes in internal controls, or in factors that
could significantly affect internal controls, subsequent to the date the Chief
Executive Officer and Chief Financial Officer completed their evaluation.
31
Part II - Other Information
Item 1 - Legal Proceedings
In January and February 2002, the Company, its chief executive officer,
and its chief financial officer were served with three complaints that were
filed in the United States District Court for the District of New Jersey
alleging violations of the Securities Exchange Act of 1934 (the "1934 Act").
These complaints were brought as purported shareholder class actions under
Sections 10(b) and 20(a) of the 1934 Act and Rule 10b-5 promulgated thereunder.
On May 23, 2002, the Court consolidated all three lawsuits into a single action
entitled In re PDI Securities Litigation, Master File No. 02-CV-0211, and
appointed lead plaintiffs ("Lead Plaintiffs") and Lead Plaintiffs' counsel. A
consolidated and amended complaint was filed on July 29, 2002 ("First
Consolidated and Amended Complaint").
The First Consolidated and Amended Complaint names the Company, its chief
executive officer, and its chief financial officer as defendants; purports to
state claims against them on behalf of all persons who purchased the Company's
common stock between May 22, 2001 and November 12, 2001; and seeks money damages
in unspecified amounts and litigation expenses including attorneys' and experts'
fees. The essence of the allegations in the First Consolidated and Amended
Complaint is that the defendants intentionally or recklessly made false or
misleading public statements and omissions concerning the Company's financial
condition and prospects with respect to its marketing of Ceftin in connection
with the October 2000 distribution agreement with GlaxoSmithKline, as well as
its marketing of Lotensin in connection with the May 2001 distribution agreement
with Novartis Pharmaceuticals Corp. As of this filing, the Company has not yet
answered the First Consolidated and Amended Complaint.
On October 31, 2002, Lead Plaintiffs filed a motion for leave to file a
second consolidated and amended complaint, which would supersede the First
Consolidated and Amended Complaint. Lead Plaintiffs' proposed second
consolidated amended complaint names the Company, its chief executive officer,
and its chief financial officer as defendants; purports to state claims against
them on behalf of all persons who purchased the Company's common stock between
May 22, 2001 and August 12, 2002; and seeks money damages in unspecified amounts
and litigation expenses including attorneys' and experts' fees. The essence of
the allegations in Lead Plaintiffs' proposed second consolidated and amended
complaint is that the defendants intentionally or recklessly made false or
misleading public statements and omissions concerning the Company's financial
condition and prospects with respect to its marketing of Ceftin in connection
with the October 2000 distribution agreement with GlaxoSmithKline, its marketing
of Lotensin in connection with the May 2001 distribution agreement with Novartis
Pharmaceuticals Corp., as well as its marketing of Evista in connection with the
October 2001 distribution agreement with Eli Lilly & Co. The Company believes
that it is likely that the Court will grant Lead Plaintiffs' motion for leave to
file a second amended and consolidated complaint and, if granted, intends to
file a motion to dismiss under the Private Securities Litigation Reform Act of
1995 and Rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure.
Discovery has not yet commenced in the consolidated action. The Company believes
that the allegations in this purported securities class action are without merit
and intends to defend the action vigorously.
The Company has been named as a defendant in numerous lawsuits, including
two class action matters, alleging claims arising from the use of the
prescription compound Baycol that was manufactured by Bayer Pharmaceuticals
(Bayer) and marketed by the Company on Bayer's behalf. The Company may be named
in additional similar lawsuits. In August 2001, Bayer announced that it was
voluntarily withdrawing Baycol from the U.S. market. The Company intends to
defend these actions vigorously and has asserted a contractual right of
indemnification against Bayer for all costs and expenses it incurs relating to
these proceedings.
Item 2 - Not Applicable
Item 3 - Not Applicable
32
Item 4 - Submission of Matters to a Vote of Security Holders
On July 18, 2002, the Company held its 2002 Annual Meeting of
Stockholders. At the meeting John C. Federspiel and Jan Martens Vecsi were
re-elected as Class III Directors of the Company for three year terms with
13,200,883 and 12,777,546 votes cast in favor of their election, respectively,
and 190,054 and 613,391 votes withheld, respectively. In addition, a proposed
amendment to the Company's 2000 Omnibus Incentive Compensation Plan to increase
the number of authorized shares from 1,500,000 to 2,200,000 was approved
(12,034,294 votes in favor, 954,859 votes against, and 401,784 votes withheld);
and the appointment of PricewaterhouseCoopers LLP as independent auditors of the
Company for fiscal 2002 was ratified (12,764,899 votes in favor, 624,929 votes
against, and 1,109 votes withheld).
Item 5 - Not Applicable
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
No.
---
99.1 Certification of Chief Executive Officer
99.2 Certification of Chief Financial Officer
(b) Reports on Form 8-K
During the three months ended September 30, 2002, the Company filed the
following report on Form 8-K:
Date Item Description
--------------- ------- ----------------------------
August 12, 2002 5 Earnings Press Release
33
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant
has caused this report to be signed on its behalf by the undersigned, thereto
duly authorized.
November 14, 2002 PDI, INC.
By: /s/ Charles T. Saldarini
--------------------------------
Charles T. Saldarini
Chief Executive Officer
By: /s/ Bernard C. Boyle
--------------------------------
Bernard C. Boyle
Chief Financial and Accounting
Officer
34
PDI, INC.
CERTIFICATIONS PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
CERTIFICATION
I, Charles T. Saldarini, certify that:
1. I have reviewed this quarterly report on Form 10-Q of PDI, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report is
being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal
controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
/s/ Charles T. Saldarini
-----------------------------------------
Charles T. Saldarini
Vice Chairman and Chief Executive Officer
Date: November 14, 2002
35
PDI, INC.
CERTIFICATIONS PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
CERTIFICATION
I, Bernard C. Boyle, certify that:
1. I have reviewed this quarterly report on Form 10-Q of PDI, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report is
being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal
controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
/s/ Bernard C. Boyle
-------------------------
Bernard C. Boyle
Chief Financial Officer
Date: November 14, 2002
36