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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, 2003
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 October 31, 2003 the Registrant had a total of 14,356,317 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, 2003 and December 31, 2002............................3
Statements of Operations -- Three and Nine Months
Ended September 30, 2003 and 2002...................................4
Statements of Cash Flows -- Nine
Months Ended September 30, 2003 and 2002............................5
Notes to Interim Financial Statements...............................6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................21
Item 3. Quantitative and Qualitative Disclosures
About Market Risk......................................Not Applicable
Item 4. Controls and Procedures............................................37
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..................................................38
Item 2. Changes in Securities and Use of Proceeds..........................39
Item 3. Default Upon Senior Securities.....................................39
Item 4. Submission of Matters to a Vote of Security Holders................39
Item 5. Other Information..................................................39
Item 6. Exhibits and Reports on Form 8-K...................................39
SIGNATURES....................................................................41
2
PDI, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)
September 30, December 31,
2003 2002
------------- ------------
ASSETS
Current assets:
Cash and cash equivalents ................................................. $ 99,125 $ 66,827
Short-term investments .................................................... 1,697 5,834
Inventory, net of obsolescence reserve of $835 and $0 as of
September 30, 2003 and December 31, 2002, respectively .................. 174 646
Accounts receivable, net of allowance for doubtful accounts of
$1,328 and $1,063 as of September 30, 2003 and December
31, 2002, respectively ................................................ 37,700 40,729
Unbilled costs and accrued profits on contracts in progress ............... 4,466 3,360
Deferred training ......................................................... 1,703 1,106
Prepaid income tax ........................................................ -- 18,856
Other current assets ...................................................... 7,853 4,804
Deferred tax asset ........................................................ 7,420 7,420
--------- ---------
Total current assets ......................................................... 160,138 149,582
Net property and equipment ................................................... 15,809 18,295
Deferred tax asset ........................................................... 7,820 7,820
Goodwill ..................................................................... 11,132 11,132
Other intangible assets ...................................................... 1,801 2,261
Other long-term assets ....................................................... 1,709 1,849
--------- ---------
Total assets ................................................................. $ 198,409 $ 190,939
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable .......................................................... $ 5,164 $ 5,374
Accrued returns, rebates and sales discounts .............................. 10,767 16,500
Accrued incentives ........................................................ 17,004 11,758
Accrued salaries and wages ................................................ 8,425 6,617
Unearned contract revenue ................................................. 8,673 9,473
Restructuring accruals .................................................... 474 4,699
Other accrued expenses .................................................... 15,301 13,307
--------- ---------
Total current liabilities .................................................... 65,808 67,728
--------- ---------
Total liabilities ............................................................ $ 65,808 $ 67,728
--------- ---------
Stockholders' equity:
Common stock, $.01 par value, 100,000,000 shares authorized:
shares issued and outstanding, September 30, 2003 - 14,259,203,
December 31, 2002 - 14,165,880; restricted shares issued and
outstanding at September 30, 2003 - 141,770, December 31, 2002
- 44,325 ................................................................ $ 144 $ 142
Preferred stock, $.01 par value, 5,000,000 shares authorized, no
shares issued and outstanding ........................................... -- --
Additional paid-in capital (includes restricted shares of $2,253 and
$1,547 at September 30, 2003 and December 31, 2002, respectively) ......... 108,264 106,673
Retained earnings ............................................................ 25,019 17,247
Accumulated other comprehensive income (loss) ................................ 43 (100)
Unamortized compensation costs ............................................... (759) (641)
Treasury stock, at cost: 5,000 shares ........................................ (110) (110)
--------- ---------
Total stockholders' equity ................................................... 132,601 123,211
--------- ---------
Total liabilities & stockholders' equity ..................................... $ 198,409 $ 190,939
========= =========
The accompanying notes are an integral part of these financial statements
3
PDI, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- -------------------------
2003 2002 2003 2002
------- -------- --------- ---------
Revenue
Service, net .................................................... $86,200 $ 64,353 $ 224,888 $ 198,546
Product, net .................................................... 81 215 197 6,438
------- -------- --------- ---------
Total revenue, net ........................................... 86,281 64,568 225,085 204,984
------- -------- --------- ---------
Cost of goods and services
Program expenses (including related party amounts of $653
and $4 for the quarters ended September 30, 2003 and 2002,
respectively and $1,287 and $109 for the nine months ended
September 30, 2003 and 2002, respectively) .................... 61,815 67,475 162,004 200,473
Cost of goods sold .............................................. 952 -- 1,097 --
------- -------- --------- ---------
Total cost of goods and services ............................. 62,767 67,475 163,101 200,473
------- -------- --------- ---------
Gross profit (loss) ................................................ 23,514 (2,907) 61,984 4,511
Compensation expense ............................................... 9,297 9,157 27,294 26,210
Other selling, general and administrative expenses ................. 7,676 9,433 20,714 19,207
Restructuring and other related expenses .......................... -- 972 (270) 972
Litigation settlement .............................................. -- -- 2,100 --
------- -------- --------- ---------
Total operating expenses ........................................ 16,973 19,562 49,838 46,389
------- -------- --------- ---------
Operating income (loss) ............................................ 6,541 (22,469) 12,146 (41,878)
Other income, net .................................................. 246 459 741 1,704
------- -------- --------- ---------
Income (loss) before provision for taxes ........................... 6,787 (22,010) 12,887 (40,174)
Provision (benefit) for income taxes ............................... 2,605 (7,696) 5,115 (14,403)
------- -------- --------- ---------
Net income (loss) .................................................. $ 4,182 $(14,314) $ 7,772 $ (25,771)
======= ======== ========= =========
Basic net income (loss) per share .................................. $ 0.29 $ (1.02) $ 0.55 $ (1.84)
======= ======== ========= =========
Diluted net income (loss) per share ................................ $ 0.29 $ (1.02) $ 0.54 $ (1.84)
======= ======== ========= =========
Basic weighted average number of shares outstanding ................ 14,252 14,063 14,202 14,012
======= ======== ========= =========
Diluted weighted average number of shares outstanding .............. 14,543 14,063 14,349 14,012
======= ======== ========= =========
The accompanying notes are an integral part of these financial statements
4
PDI, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Nine Months Ended September 30,
-------------------------------
2003 2002
--------- -----------
Cash Flows From Operating Activities
Net income (loss) ........................................................................... $ 7,772 $ (25,771)
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Depreciation and amortization ....................................................... 4,428 5,352
Reserve for inventory obsolescence and bad debt ..................................... 2,041 (2,128)
Loss on other investment ............................................................ -- 379
Amortized compensation costs ........................................................ 403 387
Deferred tax asset, net ............................................................. -- 650
Other changes in assets and liabilities:
Decrease in accounts receivable ..................................................... 1,823 30,523
(Increase) decrease in inventory .................................................... (363) 442
(Increase) in unbilled costs and accrued profits on contracts in progress ........... (1,106) (2,435)
(Increase) decrease in deferred training ............................................ (596) 2,377
Decrease (increase) in other current assets ......................................... 15,807 (9,403)
Decrease in other long-term assets .................................................. 140 4,385
(Decrease) in accounts payable ...................................................... (209) (4,807)
(Decrease) in accrued returns, rebates and sales discounts .......................... (5,733) (50,813)
(Decrease) in accrued contract losses ............................................... -- (4,475)
Increase (decrease) in accrued liabilities .......................................... 7,760 (7,997)
(Decrease) in restructuring liability ............................................... (4,225) --
(Decrease) in unearned contract revenue ............................................. (800) (2,852)
Increase (decrease) in other current liabilities .................................... 1,473 (9,955)
-------- ---------
Net cash provided by (used in) operating activities ......................................... 28,615 (76,141)
-------- ---------
Cash Flows From Investing Activities
Sale of short-term investments ......................................................... 4,279 5,456
Cash paid for acquisition, net of cash acquired ........................................ -- (2,735)
Investment in iPhysicianNet ............................................................ -- (379)
Purchase of property and equipment ..................................................... (1,482) (3,799)
-------- ---------
Net cash provided by (used in) investing activities ......................................... 2,797 (1,457)
-------- ---------
Cash Flows From Financing Activities
Net proceeds from employee stock purchase plan
and the exercise of stock options .................................................. 886 1,496
-------- ---------
Net cash provided by financing activities ................................................... 886 1,496
-------- ---------
Net increase (decrease) in cash and cash equivalents ........................................ 32,298 (76,102)
Cash and cash equivalents - beginning ....................................................... 66,827 160,043
-------- ---------
Cash and cash equivalents - ending .......................................................... $ 99,125 $ 83,941
======== =========
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 consolidated financial statements and
related notes should be read in conjunction with the consolidated 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, 2002 as filed with the Securities and Exchange
Commission. The unaudited interim consolidated financial statements of the
Company have been prepared in accordance with generally accepted accounting
principles (GAAP) 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 GAAP for complete financial
statements. The unaudited interim consolidated financial statements include all
adjustments (consisting of normal recurring adjustments) which, in the judgment
of management, are necessary for a fair presentation of such financial
statements. Operating results for the three and nine month periods ended
September 30, 2003 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2003. 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. Revenue Recognition
The paragraphs that follow describe the guidelines that the Company
adheres to in accordance with GAAP when recognizing revenue and cost of goods
and services in its financial statements. GAAP requires that service revenue and
product revenue and their respective direct costs be shown separately on the
income statement.
Historically, the Company has derived a significant portion of its service
revenue from a limited number of clients. Concentration of business in the
pharmaceutical services industry is common and the industry continues to
consolidate. As a result, the Company is likely to continue to experience
significant client concentration in future periods. For the three and nine month
periods ended September 30, 2003, the Company's largest clients who each
individually represented 10% or more of the Company's service revenue, accounted
for approximately 76.3% and 68.0%, respectively, of the Company's service
revenue. For the three and nine month periods ended September 30, 2002, the
Company's largest clients who each accounted for more than 10% of the Company's
service revenue totaled 71.0% and 72.0%, respectively, of the Company's service
revenue.
Service revenue and program expenses
Service 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 relating to 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 achieved.
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
6
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
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. For all contracts, 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. When the Company receives a specific contract payment
from a client upon commencement of a product detailing program expressly to
compensate the Company for recruiting, hiring and training services associated
with staffing that program, such payment is deferred and recognized as revenue
in the same period that the recruiting and hiring expenses are incurred and
amortization of the deferred training is expensed. When the Company does not
receive a specific contract payment for training, all revenue is deferred and
recognized over the life of the contract. Product detailing, marketing and
promotional expenses related to the detailing of products the Company
distributes 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, the Company may incur significant initial direct program costs
before recognizing revenue under a particular product detailing program. The
Company's inability to specifically negotiate for payments that are specifically
attributable to recruiting, hiring or training services in its product detailing
contracts could adversely impact the Company's operating results for periods in
which the costs associated with the product detailing services are incurred.
Product revenue and cost of goods sold
Product revenue is recognized when products are shipped and title is
transferred to the customer. Product revenue for the three and nine month
periods ended September 30, 2003 resulted primarily from the sale of the Xylos
Corporation (Xylos) wound care products. Product revenue recognized in prior
periods related to the Ceftin contract which terminated by mutual consent in
February 2002.
Cost of goods sold includes all expenses for both product distribution
costs, acquisition and manufacturing costs of the product sold. Inventory is
valued at the lower of cost or market value. Cost is determined using the
first-in, first-out costing method. Inventory to date has consisted of only
finished goods.
3. Stock-Based Compensation
As of September 30, 2003 the Company has two stock-based employee
compensation plans described more fully in Note 21 to the consolidated financial
statements included in the Company's 2002 Annual Report on Form 10-K. Statement
of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based
Compensation" allows companies a choice of measuring employee stock-based
compensation expense based on either the fair value method of accounting or the
intrinsic value approach under the Accounting Pronouncement Board (APB) Opinion
No. 25, "Accounting for Stock Issued to Employees, and Related Interpretations."
The Company accounts for these plans under the recognition and measurement
principles of APB Opinion No. 25. No stock option-based employee compensation
cost is reflected in net income, as all options granted under those plans had an
exercise price equal to the market value of the underlying common stock on the
date of the grant. Certain employees have received restricted common stock, the
amortization of which is reflected in net income. As required by SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure - an
Amendment of SFAS No. 123", the following table shows the estimated effect on
earnings and per share data as if the Company had applied the fair value
recognition provisions of SFAS No. 123 to stock-based employee compensation.
7
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
------- -------- ------- --------
(in thousands, except per share data)
Net income (loss), as reported $ 4,182 $(14,314) $ 7,772 $(25,771)
Add: Stock-based employee
compensation expense included in
reported net income (loss), net of
related tax effects 82 69 294 207
Deduct: Total stock-based employee
compensation expense determined under
fair value based methods for all
awards, net of related tax effects (1,666) (2,013) (4,800) (6,039)
------- -------- ------- --------
Pro forma net income (loss) $ 2,598 $(16,258) $ 3,266 $(31,603)
======= ======== ======= ========
Net income (loss) per share
Basic--as reported $ 0.29 $ (1.02) $ 0.55 $ (1.84)
======= ======== ======= ========
Basic--pro forma $ 0.18 $ (1.16) $ 0.23 $ (2.26)
======= ======== ======= ========
Diluted--as reported $ 0.29 $ (1.02) $ 0.54 $ (1.84)
======= ======== ======= ========
Diluted--pro forma $ 0.18 $ (1.16) $ 0.23 $ (2.26)
======= ======== ======= ========
Compensation cost for the determination of Pro forma net income (loss) -
as adjusted and related per share amounts were estimated using the Black Scholes
option pricing model, with the following assumptions: (i) risk free interest
rate of 2.85% and 2.63% at September 30, 2003 and 2002, respectively; (ii)
expected life of five years for the three and nine month periods ended September
30, 2003 and 2002; (iii) expected dividends of $0 for the three and nine month
periods ended September 30, 2003 and 2002; and (iv) volatility of 100% for the
three and nine month periods ended September 30, 2003 and 2002. The weighted
average fair value of options granted during the three and nine month periods
ended September 30, 2003 was $12.94 and $11.23, respectively, and for the three
and nine month periods ended September 30, 2002 was $8.71 and $11.80,
respectively.
In March 2003, the Company initiated an option exchange program pursuant
to which eligible employees, which excluded certain members of senior
management, were offered an opportunity to exchange an aggregate of 357,885
outstanding stock options with exercise prices of $30.00 and above for either
cash or shares of restricted stock, depending upon the number of options held by
an eligible employee. The offer exchange period expired on May 12, 2003.
Approximately 310,403 shares of common stock underlying eligible options were
tendered by eligible employees and accepted by the Company. This number
represents approximately 87% of the total shares of common stock underlying
eligible options. A total of approximately 120 eligible participants elected to
exchange an aggregate of approximately 59,870 shares of common stock under
eligible options and received cash in the aggregate amount of approximately
$67,000 (which amount includes applicable withholding taxes). A total of
approximately 145 eligible participants elected to exchange an aggregate of
approximately 250,533 shares of common stock underlying eligible options in
exchange for an aggregate of approximately 49,850 shares of restricted stock.
All tendered options have been canceled and are eligible for re-issuance under
the Company's option plans. The restricted stock is subject to three-year cliff
vesting and is subject to forfeiture upon termination of employment other than
in the event of the recipient's death or disability.
8
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
4. Current Performance Based Contracts
In May 2001, the Company entered into a copromotion agreement with
Novartis Pharmaceuticals Corporation (Novartis) for the U.S. sales, marketing
and promotion rights for Lotensin(R), Lotensin HCT(R) and Lotrel(R), which
agreement runs through December 31, 2003. On May 20, 2002, this agreement was
replaced by two separate agreements, one for Lotensin and one for Lotrel-Diovan
through the addition of Diovan(R) and Diovan HCT(R). Pursuant to the Lotensin
agreement, the Company provides promotion, selling, marketing and brand
management for Lotensin. In exchange, the Company is entitled to receive a
revenue split for Lotensin based on certain total prescription (TRx) objectives
above specified contractual baselines. Under the Lotrel-Diovan agreement, the
Company copromotes Lotrel, 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. Revenue and costs from the
Lotrel and Diovan programs are classified in 2003 in the sales and marketing
services segment as they are fee for service programs in which the Company has
greater certainty of recouping its expenses with the additional potential for
incentives at year end based on achieving certain performance criteria. During
2002 revenue and expenses under these programs were included in what is now
referred to as the pharmaceutical products group segment, since they were
performance based programs where the Company was not assured of recouping its
expenses. 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, this program could have a
material adverse impact on the Company's future results of operations, financial
condition or cash flows. While the Company currently estimates that future
revenues will continue to exceed costs associated with this program, as was the
case in the three and nine months ended September 30, 2003, there is no
assurance that actual revenues will exceed costs in the future; in which event
the activities covered by this program could yield an operating loss and a
contract loss reserve could be required. In July 2003, the FDA granted Novartis
pediatric exclusivity for Lotensin until February 2004, although the agreement
terminates on December 31, 2003. The sales force assigned to Lotensin was at
times used to promote other products in addition to Lotensin, including products
covered by the Company's other copromotion arrangements, which partially offset
the cost of the sales force.
In October 2002, the Company entered into an agreement with Xylos
Corporation (Xylos) for the exclusive U.S. commercialization rights to the Xylos
XCell(TM) Cellulose Wound Dressing (XCell) wound care products. Pursuant to this
agreement, the Company has certain minimum purchase requirements. The minimum
purchase requirement for the calendar year 2003 is $750,000. The minimum
purchase requirement for each subsequent calendar year is based on the aggregate
dollar volume of sales of products during the 12-month period ending with
September of the prior year, but in no event less than $750,000. The Company has
the right to terminate the agreement with 135 days' notice to Xylos, beginning
January 1, 2004. The Company began selling the Xylos products in January 2003;
however, initial sales were significantly slower than anticipated and sales
continue to perform materially slower than our sales forecasts. The Company is
currently reviewing its strategies regarding its agreement with Xylos. Continued
slow performance in selling the Xylos products could adversely affect the
Company's future results of operations, financial condition or cash flows and
also could potentially impair the MD&D segment's ability to recover the value of
its intangible assets including goodwill.
On May 29, 2003, the Company entered into an agreement with Organogenesis,
Inc. (Organogenesis) whereby the Company agreed to provide sales, marketing and
clinical support for Apligraf(R), Organogenesis' living, bi-layered skin
substitute. The Company leveraged its wound care sales force to provide
marketing resources in support of Apligraf. PDI InServe also utilized its
current team of wound care nurses to provide after-sales clinical support for
practitioners. Under the terms of the agreement, the Company received a fee with
the potential to earn incentives based on performance. However, Apligraf sales
thus far have not been strong enough for the Company to earn significant
incentive payments. On October 14, 2003, the Company and Organogenesis each
simultaneously exercised their termination rights to terminate the agreement,
and the wound care sales force will cease marketing Apligraf as of January 12,
9
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
2004. The Company does not believe that this termination will have a material
adverse impact on the future results of operations, financial condition or cash
flows of the Company. The Company is actively negotiating with Organogenesis to
provide them with a dedicated sales team to provide marketing resources in
support of Apligraf. However, there can be no assurance that the Company will be
able to reach an agreement with Organogenesis.
On December 31, 2002, the Company entered into a licensing agreement with
Cellegy Pharmaceuticals, Inc. (Cellegy) for the exclusive North American rights
for Fortigel(TM), a testosterone gel product. The agreement is in effect for the
commercial life of the product. Cellegy submitted a New Drug Application (NDA)
for the hypogonadism indication to the U.S. Food and Drug Administration (FDA)
in June 2002. The initial 10-month Prescription Drug User Fee Act (PDUFA) date
for the product was April 5, 2003. In March 2003, Cellegy was notified by the
FDA that the PDUFA date had been revised to July 3, 2003. On July 3, 2003,
Cellegy was notified by the FDA that Fortigel was not approved. Cellegy is in
discussions with the FDA to determine the appropriate course of action needed to
meet deficiencies cited by the FDA in its determination. The Company cannot
predict with any certainty that the FDA will ultimately approve Fortigel for
sale in the U.S. Under the terms of the agreement, the Company paid Cellegy a
$15.0 million initial licensing fee on December 31, 2002. This nonrefundable
payment was made prior to FDA approval and, since there is no alternative future
use of the licensed rights, the $15.0 million payment was expensed by the
Company in December 2002, when incurred. This amount was recorded in other
selling, general, and administrative expenses in the December 31, 2002
consolidated statements of operations. Pursuant to the terms of the licensing
agreement, the Company will be required to pay Cellegy a $10.0 million
incremental license fee milestone payment upon Fortigel's receipt of all
approvals required by the FDA to promote, sell and distribute the product in the
U.S. This incremental milestone license fee, if incurred, will be recorded as an
intangible asset and amortized over its estimated useful life, as then
determined, which is not expected to exceed the life of the patent. Royalty
payments to Cellegy over the term of the commercial life of the product will
range from 20% to 30% of net sales. As discussed in Note 12, in May 2003, the
Company settled a lawsuit which sought to enjoin its performance under this
agreement.
On October 8, 2003, the Company gave notice of non-binding mediation to
Cellegy regarding the licensing agreement. The Company maintains that it was
fraudulently induced into the licensing agreement and that Cellegy has
materially breached certain material provisions of the licensing agreement. The
Company is seeking return of the $15.0 million initial licensing fee plus
additional damages caused by Cellegy's conduct. The Company intends to pursue
all legal remedies, if necessary, post mediation.
5. Historic Performance Based Contracts
In October 2001, the Company entered into an agreement with Eli Lilly and
Company (Eli Lilly) to copromote Evista(R) in the U.S. Under the terms of the
agreement, the Company provided sales representatives to copromote Evista to
physicians in the U.S. The Company's sales representatives supplemented the Eli
Lilly sales force promoting Evista. Under this agreement, the Company was
entitled to be compensated based on net sales achieved by the product above a
predetermined level. The agreement did not provide for the reimbursement of
expenses the Company incurred.
The Eli Lilly arrangement was a performance based contract. The Company
was required to commit a certain level of spending for promotional and selling
activities, including but not limited to sales representatives. The sales force
assigned to Evista was at times used to promote other products in addition to
Evista, including products covered by other PDI copromotion arrangements, which
partially offset the costs of the sales force. The Company's compensation for
Evista was determined based upon a percentage of net factory sales of Evista
above contractual baselines. To the extent that such baselines were not
exceeded, the Company received no revenue.
Based upon management's assessment of the future performance potential of
the Evista brand, on November 11, 2002, the Company and Eli Lilly mutually
agreed to terminate the contract as of December
10
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
31, 2002. The Company accrued a contract loss of $7.8 million as of September
30, 2002 representing the anticipated future loss expected to be incurred by the
Company to fulfill its contractual obligations under the Evista contract. There
was no remaining accrual at September 30, 2003 or December 31, 2002 as the
Company had no further obligations due to the termination of the contract.
Operating losses of $14.5 and $32.2 million were recognized under this contract
for the three and nine month periods ended September 30, 2002, respectively.
There was no activity for the three and nine month periods ended September 30,
2003 since the termination was effective December 31, 2002.
In October 2000, the Company entered into an agreement with
GlaxoSmithKline (GSK) for the exclusive U.S. sales, marketing 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
six months after the expiration date of the product sold and certain
administrative functions regarding Medicaid rebates. The Company's obligations
for processing any returned products expires on December 31, 2004.
The Company has approximately $10.8 million in sales rebates and return
accruals related to Ceftin at September 30, 2003 for estimated settlement of
these obligations which were incurred through the contract termination date. A
significant portion of the accrual relates to a reserve for returns. The
products sold under the Ceftin agreement had expiration dates estimated to run
through June 30, 2004.
There was $6.4 million of product revenue recognized under the Ceftin
contract for the nine months ended September 30, 2002, of which $716,000 was
from the sale of inventory. The balance of $5.7 million resulted from the net
positive adjustments recorded in sales returns and allowances, discounts and
rebates accounts for the first nine months of 2002 that occurred as the Company
continued to satisfy its 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 continue to be both positive and negative adjustments made as the
liabilities are settled in the future periods in which the Company is
responsible for the liabilities, and such adjustments will be reflected in
product revenue consistent with the classification of such accruals when they
were initially recorded. As discussed above, the Company is responsible for the
processing and payment through December 31, 2004 of sales rebates and returns
for products it sold under the Ceftin agreement.
11
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
6. Other Investments
In October 2002, the Company acquired $1.0 million of preferred stock of
Xylos. As discussed in Note 4, the Company is the exclusive distributor of the
Xylos XCell product line. The Company recorded its investment in Xylos under the
cost method and its ownership interest in Xylos is less than five percent. Based
on current market conditions, the Company believes that as of September 30, 2003
its investment in Xylos is not impaired.
The Company has an investment in the preferred stock of iPhysicianNet,
Inc. (iPhysicianNet) that is accounted for under the equity method; however,
recognition of losses by the Company was suspended in 2000 after the Company's
investment was reduced to zero. During 2002, additional investments of $379,000
were made by the Company. Due to the continuing losses of iPhysicianNet, the
2002 investments were immediately expensed rather than recorded as an asset. The
Company does not have, nor has it ever had, any commitments to provide future
financing to iPhysicianNet. No investments were made by the Company in
iPhysicianNet during the first nine months of 2003 and no losses were recorded
in the period due to the suspension of losses mentioned above because the
investment has been previously reduced to zero. The Company's ownership interest
in iPhysicianNet is less than five percent. The Company was informed by
iPhysicianNet that they ceased operations effective August 1, 2003.
7. Inventory
At September 30, 2003 and December 31, 2002, the Company had approximately
$174,000 and $646,000, respectively, in finished goods inventory, relating to
the products being marketed and distributed in accordance with the Xylos
agreement discussed in Note 4. As a result of the continued lower than
anticipated Xylos product sales, management performed an analysis of its XCell
inventory as of September 30, 2003, to determine whether the inventory balance
was appropriately stated at its net realizable value. Based on the results of
this analysis, management recorded a reserve of $835,000 to reduce the value of
the XCell inventory to an estimated net realizable value of $174,000.
8. New Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46). FIN
46 requires a variable interest entity to be consolidated by a company, if that
company is subject to a majority of the risk of loss from the variable interest
entity's activities or entitled to receive a majority of the entity's residual
returns or both. FIN 46 also requires disclosures about variable interest
entities that a company is not required to consolidate but in which it has a
significant variable interest. The consolidation requirements of FIN 46 apply
immediately to variable interest entities created after January 31, 2003 and to
existing entities in the first fiscal year or interim period beginning after
June 15, 2003. Certain of the disclosure requirements apply to all financial
statements issued after January 31, 2003, regardless of when the variable
interest entity was established. FASB deferred the latest date by which all
public entities must apply FIN 46, to the first reporting period ending after
December 15, 2003. The Company does not believe the adoption of this standard
will have a material impact on its consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." SFAS
No. 150 clarifies the definition of a liability as currently defined in FASB
Concepts Statement No. 6, "Elements of Financial Statements," as well as other
planned revisions. This statement requires a financial instrument that embodies
an obligation of an issuer to be classified as a liability. In addition, the
statement establishes standards for the initial and subsequent measurement of
these financial instruments and disclosure requirements. SFAS No. 150 is
effective for financial instruments entered into or modified after May 31, 2003
and for all other matters, at the beginning of the second quarter 2004. FASB
decided to defer the provisions of paragraphs 9 and 10 of FAS 150. While the
specific timing of the final issuance of SFAS No. 150 was not stated, it is
expected
12
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
that the SFAS No. 150 will be issued in the very near term. The Company does not
believe the adoption of this standard will have a material impact on its
consolidated financial statements.
9. 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 and nine month periods ended
September 30, 2003 and 2002 is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
2003 2002 2003 2002
------ ------ ------ ------
(in thousands)
Basic weighted average number
of common shares outstanding ................ 14,252 14,063 14,202 14,012
Dilutive effect of stock options ................ 291 -- 147 --
------ ------ ------ ------
Diluted weighted average number
of common shares outstanding ................ 14,543 14,063 14,349 14,012
====== ====== ====== ======
Outstanding options at September 30, 2003 to purchase 447,174 shares of
common stock with exercise prices ranging from $21.10 to $93.75 were not
included in the computation of historical and pro forma diluted net income per
share because to do so would have been antidilutive. Outstanding options at
September 30, 2002 to purchase 1,650,2049 shares of common stock with exercise
prices ranging from $5.21 to $98.70 were not included in the computation of
historical and pro forma net loss per share because to do so would have been
antidilutive as a result of the Company's net loss.
10. Short-Term Investments
At September 30, 2003, short-term investments were $1.7 million, including
approximately $1.2 million of investments classified as available for sale
securities. At December 31, 2002, short-term investments were $5.8 million,
including approximately $1.1 million 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. Other Comprehensive Income (Loss)
A reconciliation of net income (loss) as reported in the Consolidated
Statements of Operations to Other comprehensive income (loss), net of taxes is
presented in the table below.
13
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2003 2002 2003 2002
------ -------- ------ --------
(in thousands)
Net income (loss) $4,182 $(14,314) $7,772 $(25,771)
Other comprehensive income, net of tax:
Unrealized holding gain (loss) on
available-for-sale securities
arising during the period 16 (53) 106 (103)
Reclassification adjustment for losses
included in net income (loss) 3 -- 37 41
------ -------- ------ --------
Other comprehensive income (loss) $4,201 $(14,367) $7,915 $(25,833)
====== ======== ====== ========
12. Commitments and Contingencies
Due to the nature of the business that the Company is engaged in, such as
product detailing and distribution of products, these and other activities could
expose the Company to risk. Such risks include, among others, risk of liability
for personal injury or death to persons using products the Company promotes or
distributes. There can be no assurance that substantial claims or liabilities
will not arise in the future because of the nature of the Company's business
activities and recent increases in litigation related to healthcare products
including pharmaceuticals increases this risk. 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 policy. 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 outside the scope of an
indemnification agreement; if the indemnity, although applicable, is not
performed in accordance with its terms; or if the Company's liability exceeds
the amount of applicable insurance or indemnity.
Securities Litigation
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 established 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. On or
about December 13, 2002, Lead Plaintiffs filed a second consolidated and amended
complaint (Second Consolidated and Amended Complaint), which superseded their
earlier complaints.
The complaint names the Company, its chief executive officer, and its
chief financial officer as defendants; purports to state claims against the
Company 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 the Second Consolidated and Amended Complaint is
that the Company intentionally or recklessly made false or misleading public
statements and omissions concerning its 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, as well as its marketing of
Evista in connection with the October 2001 distribution agreement with Eli
Lilly.
14
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
In February 2003, the Company filed a motion to dismiss the Second
Consolidated and Amended Complaint under the Private Securities Litigation
Reform Act of 1995 and Rules 9(b) and 12(b)(6) of the Federal Rules of Civil
Procedure. The Company believes that the allegations in this purported
securities class action are without merit and intends to defend the action
vigorously.
Bayer-Baycol Litigation
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 detailed by the Company on Bayer's behalf under a contract sales
force agreement. 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. To date, the Company has defended these actions vigorously and has
asserted a contractual right of indemnification against Bayer for all costs and
expenses the Company incurs relating to these proceedings. In February 2003, the
Company entered into a joint defense and indemnification agreement with Bayer,
pursuant to which Bayer has agreed to assume substantially all of the Company's
defense costs in pending and prospective proceedings, subject to certain limited
exceptions. Further, Bayer agreed to reimburse the Company for all reasonable
costs and expenses incurred to date in defending these proceedings. Bayer has
reimbursed the Company for legal expenses which the Company had expensed as
incurred during 2002 and 2003; (i) $750,000 of the reimbursement was received in
the first quarter of 2003 and (ii) $540,000 of the reimbursement was received in
October 2003. The Company is currently in discussions with Bayer regarding
additional legal fee reimbursements; however, no agreement has been reached and
therefore no additional amounts have been accrued to date.
Auxilium Pharmaceuticals Litigation
On January 6, 2003, the Company was named as a defendant in a lawsuit
filed by Auxilium Pharmaceuticals, Inc. (Auxilium), in the Pennsylvania Court of
Common Pleas, Montgomery County. Auxilium was seeking monetary damages and
injunctive relief, including preliminary injunctive relief, based on several
claims related to the Company's alleged breaches of a contract sales force
agreement entered into by the parties on November 20, 2002, and claims that the
Company was misappropriating trade secrets in connection with its exclusive
license agreement with Cellegy.
On May 8, 2003, the Company entered into a settlement and mutual release
agreement with Auxilium (Settlement Agreement), by which the lawsuit and all
related counter claims were dropped without any admission of wrongdoing by
either party. The settlement terms included a cash payment which was paid upon
execution of the Settlement Agreement as well as certain other additional
expenses. The Company recorded a $2.1 million charge in the first quarter of
2003 related to this settlement. Pursuant to the Settlement Agreement, the
Company also agreed that it would (a) not sell, ship, distribute or transfer any
Fortigel product to any wholesalers, chain drug stores, pharmacies or hospitals
prior to November 1, 2003, and (b) pay Auxilium an additional amount per
prescription to be determined based upon a specified formula, in the event any
prescriptions are filled for Fortigel prior to January 26, 2004. As discussed in
Note 4, on July 3, 2003, Cellegy was notified by the FDA that Fortigel had not
been approved. The Company believes that it will not pay any additional amount
to Auxilium as set forth in clause (b) above since Fortigel was not approved by
the FDA on July 3, 2003, and it is management's belief that FDA approval of
Fortigel will not be given prior to January 26, 2004, if at all. The Company
does not believe that the terms of the Settlement Agreement will have any
material impact on the success of its commercialization of the product if or
when the FDA approves it. There can be no assurances that the FDA will approve
the product at a later date.
15
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
Other Legal Proceedings
The Company is currently a party to other legal proceedings incidental to
its business. While the Company currently believes that the ultimate outcome of
these proceedings individually and in the aggregate, will not have a material
adverse effect on its consolidated financial statements, litigation is subject
to inherent uncertainties. Were the Company to settle a proceeding for a
material amount or were an unfavorable ruling to occur, there exists the
possibility of a material adverse impact on the Company's future results of
operations, financial condition or cash flows.
No amounts have been accrued for losses under any of the above mentioned
matters, other than for the Auxilium litigation settlement reserve, as no other
amounts are considered probable or reasonably estimable at this time.
Other than the foregoing, the Company is not currently a defendant in any
material pending litigation and it is not aware of any material threatened
litigation.
13. Restructuring and Other Related Expenses
During the third quarter of 2002, the Company adopted a restructuring
plan, the objectives of which were to consolidate operations in order to enhance
operating efficiencies (the 2002 Restructuring Plan). This plan was primarily in
response to the general decrease in demand within the Company's markets for the
sales and marketing services segment, and the recognition that the
infrastructure that supported these business units was larger than required. The
Company estimated that the restructuring would result in annualized SG&A savings
of approximately $14.0 million, based on the level of SG&A spending at the time
the Company initiated the restructuring; however, these savings may be offset by
incremental SG&A expenses we could incur in future periods if the Company is
successful in expanding its business platforms for its segments. Essentially all
of the restructuring activities have been completed as of September 30, 2003.
In connection with this plan, the Company originally estimated that it
would ultimately incur total restructuring expenses of approximately $5.4
million, other non-recurring expenses of approximately $0.1 million, and
accelerated depreciation of approximately $0.8 million. Excluding $0.3 million,
all of these expenses were recognized in 2002; due to various factors, the $0.3
million will not be incurred.
The primary items comprising the $5.4 million in restructuring expenses
were $3.7 million in severance expense consisting of cash and non-cash
termination payments to employees in connection with their involuntary
termination and $1.7 million in other restructuring exit costs relating to
leased facilities and other contractual obligations.
During the quarter ended March 31, 2003, the Company recognized a $270,000
reduction in the restructuring accrual due to negotiating higher sublease
proceeds than originally estimated for the leased facility in Cincinnati, Ohio.
During the quarter ended June 30, 2003 the Company incurred approximately
$133,000 of additional restructuring expense due to higher than expected
contractual termination costs. This additional expense was recorded in program
expenses consistent with the original recording of the restructuring charges.
Also during the quarter ended June 30, 2003 the Company recognized a
$473,000 reduction in the restructuring accrual due to lower than expected sales
force severance costs. Greater success in the reassignment of sales
representatives to other programs and the voluntary departure of other sales
representatives combined to reduce the requirement for severance costs. This
adjustment was recorded in program expenses consistent with the original
recording of the restructuring charges.
16
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
The accrual for restructuring and exit costs totaled approximately
$474,000 at September 30, 2003, and is recorded in current liabilities on the
accompanying balance sheet.
A roll forward of the activity for the 2002 Restructuring Plan (in
thousands) is as follows:
Balance at Balance at
December 31, 2002 Adjustments Payments September 30, 2003
Administrative severance $ 1,670 $ -- $(1,434) $236
Exit costs 1,288 (137) (913) 238
------- ------- ------- ----
2,958 (137) (2,347) 474
------- ------- ------- ----
Sales force severance 1,741 (473) (1,268) --
------- ------- ------- ----
Total $ 4,699 $ (610) $(3,615) $474
======= ======= ======= ====
14. Segment Information
The Company operates under three reporting segments: the sales and
marketing services group (SMSG), pharmaceutical products group (PPG) and medical
devices and diagnostics (MD&D), all of which have changed since the Company's
September 30, 2002 financial presentation. Since the termination of the Ceftin
contract and the elimination of Ceftin 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 within the pharmaceutical industry
(offered by the SMSG segment) in the aggregate and to view the performance based
contracts for pharmaceutical products - those for which the Company is
compensated based predominantly on the performance of the products that it is
responsible for marketing and/or selling (the PPG segment) - also in the
aggregate. Further, all contracts within the MD&D industry, regardless of the
nature of the contract, are reported in the MD&D segment. The SMSG segment
includes the Company's contract sales (CSO) units; and the Company's marketing
services business unit, which includes marketing research and medical education
and communication services. The PPG segment includes revenues earned through the
Company's licensing and copromotion of pharmaceutical products. The Company's
MD&D segment includes PDI InServe, contract sales, and product licensing. The
segment information from prior periods has been reclassified to conform to the
current period's presentation.
Corporate charges are allocated to each of the operating segments on the
basis of total salary costs. Corporate charges include corporate headquarter
costs and certain depreciation expense. Certain corporate capital expenditures
have not been allocated from the SMSG segment to the other operating segments
since it is impracticable to do so.
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- ----------------------
2003 2002 2003 2002
------- ------- -------- --------
(in thousands)
Revenue
Sales and marketing services group $70,569 $40,536 $181,507 $143,490
Pharmaceutical products group 12,663 21,619 34,894 55,067
Medical devices and diagnostics 3,049 2,557 8,684 6,941
------- ------- -------- --------
Total $86,281 $64,712 $225,085 $205,498
======= ======= ======== ========
Revenue, intercompany
Sales and marketing services group $ -- $ 144 $ -- $ 514
Pharmaceutical products group -- -- -- --
Medical devices and diagnostics -- -- -- --
------- ------- -------- --------
Total $ -- $ 144 $ -- $ 514
======= ======= ======== ========
17
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -------------------------
(continued) 2003 2002 2003 2002
-------- -------- --------- ---------
(in thousands)
Revenue, less intercompany
Sales and marketing services group $ 70,569 $ 40,392 $ 181,507 $ 142,976
Pharmaceutical products group 12,663 21,619 34,894 55,067
Medical devices and diagnostics 3,049 2,557 8,684 6,941
-------- -------- --------- ---------
Total $ 86,281 $ 64,568 $ 225,085 $ 204,984
======== ======== ========= =========
Income (loss) from operations
Sales and marketing services group $ 12,349 $ 1,375 $ 33,725 $ 16,208
Pharmaceutical products group 361 (19,208) (3,529) (44,949)
Medical devices and diagnostics (2,232) (572) (6,067) (1,265)
Corporate charges (3,937) (4,064) (11,983) (11,872)
-------- -------- --------- ---------
Total $ 6,541 $(22,469) $ 12,146 $ (41,878)
======== ======== ========= =========
Income (loss) from operations, intercompany
Sales and marketing services group $ -- $ 68 $ -- $ 370
Pharmaceutical products group -- (68) -- (370)
Medical devices and diagnostics -- -- -- --
Corporate charges -- -- -- --
-------- -------- --------- ---------
Total $ -- $ -- $ -- $ --
======== ======== ========= =========
Income (loss) from operations, less intercompany,
before corporate allocations
Sales and marketing services group $ 12,349 $ 1,307 $ 33,725 $ 15,838
Pharmaceutical products group 361 (19,140) (3,529) (44,579)
Medical devices and diagnostics (2,232) (572) (6,067) (1,265)
Corporate charges (3,937) (4,064) (11,983) (11,872)
-------- -------- --------- ---------
Total $ 6,541 $(22,469) $ 12,146 $ (41,878)
======== ======== ========= =========
Corporate allocations
Sales and marketing services group $(3,256) $ (2,220) $ (9,421) $ (6,826)
Pharmaceutical products group (452) (1,634) (1,666) (4,506)
Medical devices and diagnostics (229) (210) (896) (540)
Corporate charges 3,937 4,064 11,983 11,872
-------- -------- --------- ---------
Total $ -- $ -- $ -- $ --
======== ======== ========= =========
Income (loss) from operations, less corporate
allocations
Sales and marketing services group $ 9,093 $ (913) $ 24,304 $ 9,012
Pharmaceutical products group (91) (20,774) (5,195) (49,085)
Medical devices and diagnostics (2,461) (782) (6,963) (1,805)
Corporate charges -- -- -- --
-------- -------- --------- ---------
Total $ 6,541 $(22,469) $ 12,146 $ (41,878)
======== ======== ========= =========
Reconciliation of EBIT to income (loss)
before provision for income taxes
Total EBIT for operating groups $ 6,541 $(22,469) $ 12,146 $ (41,878)
Other income, net 246 459 741 1,704
-------- -------- --------- ---------
Income (loss) before provision
for income taxes $ 6,787 $(22,010) $ 12,887 $ (40,174)
======== ======== ========= =========
18
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- ------------------
(continued) 2003 2002 2003 2002
------ ------- ------ ------
(in thousands)
Capital expenditures
Sales and marketing services group $1,036 $ (48) $1,453 $3,526
Pharmaceutical products group -- -- -- 217
Medical devices and diagnostics 19 -- 29 56
------ ------- ------ ------
Total $1,055 $ (48) $1,482 $3,799
====== ======= ====== ======
Depreciation expense
Sales and marketing services group $1,249 $ 1,361 $3,023 $3,029
Pharmaceutical products group 276 706 653 1,629
Medical devices and diagnostics 89 86 291 234
------ ------- ------ ------
Total $1,614 $ 2,153 $3,967 $4,892
====== ======= ====== ======
15. Goodwill and Intangible Assets
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and
Other Intangible Assets." Under SFAS No. 142, goodwill is no longer amortized
but is evaluated for impairment on at least an annual basis. 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 determined that no impairment existed at January 1,
2002. The Company performed the required annual impairment tests in the fourth
quarter of 2002 and determined that no impairment existed at December 31, 2002.
These tests involved determining the fair market value of each of the reporting
units with which the goodwill was associated and comparing the estimated fair
market value of each of the reporting units with its carrying amount. The
Company's total goodwill which is not subject to amortization totaled
approximately $11.1 million as of September 30, 2003 and December 31, 2002.
There were no changes in the carrying amount of goodwill since December
31, 2002. The carrying amounts at September 30, 2003 by operating segment are
shown below:
(in thousands) SMSG PPG MD&D Total
---- --- ---- -----
Balance as of December 31, 2002 $3,344 $ -- $7,788 $11,132
Amortization -- -- -- --
Goodwill additions -- -- -- --
------ ------ ------ -------
Balance as of September 30, 2003 $3,344 $ -- $7,788 $11,132
====== ====== ====== =======
All identifiable intangible assets recorded as of September 30, 2003 are
being amortized on a straight-line basis over the life of the intangibles which
is primarily five years. The carrying amounts at September 30, 2003 and December
31, 2002 are as follows:
As of September 30, 2003 As of December 31, 2002
---------------------------------- --------------------------------
Carrying Accumulated Carrying Accumulated
Amount Amortization Net Amount Amortization Net
-------- ------------ ------ -------- ------------ ------
(in thousands)
Covenant not to compete $1,686 $ 695 $ 991 $1,686 $442 $1,244
Customer relationships 1,208 499 709 1,208 318 890
Corporate tradename 172 71 101 172 45 127
------ ------ ------ ------ ---- ------
Total $3,066 $1,265 $1,801 $3,066 $805 $2,261
====== ====== ====== ====== ==== ======
19
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
Amortization expense totaled approximately $153,000 and $460,000 for the
three-month and nine-month periods ended September 30, 2003 and 2002,
respectively. Estimated amortization expense for the next five years is as
follows:
(in thousands)
2003 $ 613
=====
2004 613
=====
2005 613
=====
2006 422
=====
2007 --
=====
20
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
and adversely from those expressed or implied by forward-looking statements
include, but are not limited to, the factors, risks and uncertainties (i)
identified or discussed herein, (ii) set forth in "Risk Factors" under Part I,
item 1, of the Company's Annual Report on Form 10-K for the year ended December
31, 2002 as filed with the Securities and Exchange Commission, and (iii) set
forth in the Company's periodic reports on Forms 10-Q and 8-K as filed with the
Securities and Exchange Commission since January 1, 2003. We undertake no
obligation to revise or update publicly any forward-looking statements for any
reason.
Overview
We are a premier healthcare sales and marketing company serving the
biopharmaceutical and medical devices and diagnostics (MD&D) industries. We
create and execute sales and marketing campaigns intended to improve the
profitability of pharmaceutical or MD&D products. We do this by partnering with
companies who own the intellectual property rights to these products and who
recognize our ability to commercialize these products and maximize their sales
performance. We have a variety of agreement types that we enter into with our
partner companies, from fee for service arrangements to equity investments in a
product or in a company. We have previously made, and still intend to make,
acquisitions where appropriate in order to advance our strategy. Should an
acquisition(s) be made, we will report it in its relevant segment. Currently,
our three reporting segments include:
o PDI sales and marketing services group (SMSG), comprised of:
o dedicated contract sales services (CSO);
o shared contract sales services (CSO);
o marketing research and consulting services (MR&C); and
o medical education and communication services (EdComm).
o PDI pharmaceutical products group (PPG), comprised of:
o copromotion; and
o licensing.
o PDI medical devices and diagnostics group (MD&D), comprised of:
o contract sales services (CSO);
o InServe;
21
o copromotion; and
o licensing.
An analysis of these reporting segments and their results of operations is
contained in Note 14 to the consolidated financial statements found elsewhere in
this report and in the Consolidated Results of Operations discussion below.
PDI Sales and Marketing Services Group
Given the customized nature of our business, we utilize a variety of
contract structures. Historically, most of our product detailing contracts have
been fee for service, 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. Any
failure to meet these benchmarks may result in the imposition of contractual
penalties and could adversely affect our future results of operations, financial
condition or cash flows. Also, our contracts might have a lower base fee
enhanced by potential incentives we can earn based on our performance. In these
situations, we have the opportunity to earn additional fees, as incentives,
based on attaining performance benchmarks.
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. Contracts may also be
terminated for cause if we fail to meet stated performance benchmarks. The loss
or termination of a large contract or the loss of multiple contracts could
adversely affect our future results of operations, financial condition or cash
flows.
Our MR&C and EdComm contracts generally are for projects lasting from
three to six months. The contracts are terminable by the client and provide for
termination payments in the event they are terminated without cause. Termination
payments include payment for all work completed to date, plus the cost of any
nonrefundable commitments made on behalf of the client. Due to the typical size
of the projects, it is unlikely that the loss or termination of any individual
MR&C or EdComm contract would have a material adverse impact on our future
results of operations, financial condition, or cash flows.
PDI Pharmaceutical Products Group
Our contracts within the PPG segment in general are more heavily
performance based and have a higher risk potential and correspondingly an
opportunity for higher profitability. We use a variety of structures for these
contracts. These contracts typically involve significant start-up expenses and a
greater risk of operating losses. These contracts normally require significant
participation from our PPG, MR&C and EdComm professionals whose skills include
marketing, brand management, trade relations and marketing research.
Beginning in the fourth quarter of 2000, we entered into a number of
significant performance based contracts. Our agreement with GlaxoSmithKline
(GSK), which we entered into in October 2000 regarding Ceftin(R), was a
marketing and distribution contract under which we had the exclusive right to
market and distribute 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 may have similar risk factors.
22
In May 2001, we entered into a copromotion agreement with Novartis
Pharmaceuticals Corporation (Novartis) for the U.S. sales, marketing and
promotion rights for Lotensin(R), and Lotensin HCT(R) and Lotrel(R), which
agreement runs through December 31, 2003. On May 20, 2002, this agreement was
replaced by two separate agreements, one for Lotensin and one for Lotrel-Diovan
through the addition of Diovan(R) and Diovan HCT(R). Pursuant to this agreement,
we provide promotion, selling, marketing and brand management for Lotensin. In
exchange, we are entitled to receive a revenue split for Lotensin based on
certain total prescription (TRx) objectives above specified contractual
baselines. Under the Lotrel-Diovan agreement, we copromote Lotrel, Diovan and
Diovan HCT 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 TRx
objectives.
Revenue and costs from the Lotrel and Diovan programs are classified in
2003 in the sales and marketing services segment as they are fee for service
programs in which we have greater certainty of recouping our expenses with the
additional potential for incentives at year end based on achieving certain
performance criteria. During 2002 revenue and expenses under these programs were
included in what is now referred to as the pharmaceutical products group
segment, since they were performance based programs where we were not assured of
recouping our expenses. 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, this program
could have a material adverse impact on our future results of operations,
financial condition or cash flows. While we currently estimate that future
revenues will continue to exceed costs associated with this program, as was the
case in the three and nine months ended September 30, 2003, there is no
assurance that actual revenues will exceed costs in the future; in which event
the activities covered by this program could yield an operating loss and a
contract loss reserve could be required. In July 2003, the FDA granted Novartis
pediatric exclusivity for Lotensin until February 2004, although our agreement
terminates on December 31, 2003. The sales force assigned to Lotensin was at
times used to promote other products in addition to Lotensin, including products
covered by our other copromotion arrangements, which partially offset the costs
of the sales force.
In October 2001, we entered into an agreement with Eli Lilly and Company
(Eli Lilly) to copromote Evista(R) in the U.S. Under the terms of this
agreement, we provided sales representatives to copromote Evista to physicians
in the U.S. Our sales representatives augmented the Eli Lilly sales force
promoting Evista. Under this agreement, we were entitled to be compensated based
on net factory sales achieved above a predetermined level. The agreement did not
provide for the reimbursement of expenses we incurred.
The Eli Lilly arrangement was a performance based contract. We were
required to commit a certain level of spending for promotional and selling
activities, including but not limited to sales representatives. The sales force
assigned to Evista was at times used to promote other products in addition to
Evista, including products covered by other PDI copromotion arrangements, which
partially offset the costs of the sales force. Our compensation for Evista was
determined based upon a percentage of net factory sales of Evista above
contractual baselines. To the extent that these baselines were not exceeded, we
received no revenue.
Based upon management's assessment of the future performance potential of
the Evista brand, on November 11, 2002, we and Eli Lilly mutually agreed to
terminate the contract as of December 31, 2002. We accrued a contract loss of
$7.8 million as of September 30, 2002 representing the anticipated future loss
expected to be incurred by us to fulfill our contractual obligations under the
Evista contract. There was no remaining accrual at September 30, 2003 or
December 31, 2002 as we had no further obligations due to the termination of the
contract. Operating losses of $14.5 million and $32.2 million were recognized
under this contract for the three and nine months ended September 30, 2002,
respectively. There was no activity
23
in the three and nine months ended September 30, 2003 since the termination was
effective December 31, 2002.
On December 31, 2002, we entered into a licensing agreement with Cellegy
Pharmaceuticals, Inc. (Cellegy) for the exclusive North American rights for
Fortigel(TM), a testosterone gel product. The agreement is in effect for the
commercial life of the product. Cellegy submitted a New Drug Application (NDA)
for the hypogonadism indication to the U.S. Food and Drug Administration (FDA)
in June 2002. The initial 10-month Prescription Drug User Fee Act (PDUFA) date
for the product was April 5, 2003. In March 2003, Cellegy was notified by the
FDA that the PDUFA date had been revised to July 3, 2003. On July 3, 2003,
Cellegy was notified by the FDA that Fortigel was not approved. Cellegy is in
discussions with the FDA to determine the appropriate course of action needed to
meet deficiencies cited by the FDA in its determination. We cannot predict with
any certainty that the FDA will ultimately approve Fortigel for sale in the U.S.
Under the terms of the agreement, we paid Cellegy a $15.0 million initial
licensing fee on December 31, 2002. This nonrefundable payment was made prior to
FDA approval and, since there is no alternative future use of the licensed
rights, the $15.0 million payment was expensed by us in December 2002, when
incurred. This amount was recorded in other selling, general, and administrative
expenses in the December 31, 2002 consolidated statement of operations. Pursuant
to the terms of the licensing agreement, we will be required to pay Cellegy a
$10.0 million incremental license fee milestone payment upon Fortigel's receipt
of all approvals required by the FDA to promote, sell and distribute the product
in the U.S. This incremental milestone license fee, if incurred, will be
recorded as an intangible asset and amortized over its estimated useful life, as
then determined, which is not expected to exceed the life of the patent. Royalty
payments to Cellegy over the term of the commercial life of the product will
range from 20% to 30% of net sales. As discussed in Note 12, in May 2003 we
settled a lawsuit which sought to enjoin our performance under this agreement.
On October 8, 2003, we gave notice of non-binding mediation to Cellegy
regarding the licensing agreement. We maintain that we were fraudulently induced
into the licensing agreement and that Cellegy has materially breached certain
material provisions of the licensing agreement. We are seeking return of the
$15.0 million initial licensing fee plus additional damages caused by Cellegy's
conduct. We intend to pursue all legal remedies, if necessary, post mediation.
PDI Medical Devices and Diagnostics Group
On September 10, 2001, we acquired 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 MD&D
industry. InServe employs nurses, medical technologists and other clinicians who
visit hospital and non-hospital accounts and provide hands-on clinical education
and after-sales support to maximize product utilization and customer
satisfaction. InServe's clients include many of the leading MD&D manufacturers,
including Becton Dickinson, Boston Scientific and Johnson & Johnson.
In addition to helping establish our initial presence in the MD&D market,
the InServe acquisition facilitated our entry into, and helped us establish, a
contract sales business within the MD&D market. Our MD&D service contracts have
similar provisions to those sales and marketing services contracts described in
our SMSG segment.
In October 2002, we entered into an agreement with Xylos Corporation
(Xylos) for the exclusive U.S. commercialization rights to the Xylos XCell(TM)
Cellulose Wound Dressing (XCell) wound care products. Pursuant to this agreement
we have certain minimum purchase requirements. The minimum purchase requirement
for the calendar year 2003 is $750,000. The minimum purchase requirement for
each subsequent calendar year is based on the aggregate dollar volume of sales
of products during the 12-month period ending with September of the prior year,
but in no event less than $750,000. We have the right to terminate the agreement
with 135 days' notice to Xylos, beginning January 1, 2004. We began selling the
24
Xylos products in January 2003; however, initial sales were significantly slower
than anticipated and sales continue to perform materially slower than our sales
forecasts. We are currently reviewing our strategies regarding our agreement
with Xylos. Continued slow performance in selling the Xylos products could
adversely affect our results of future operations, financial condition or cash
flows and also could potentially impair the MD&D segment's ability to recover
the value of its intangible assets including goodwill.
On May 29, 2003, we entered into an agreement with Organogenesis, Inc.
(Organogenesis) whereby we agreed to provide sales, marketing, and clinical
support for Apligraf(R), Organogenesis' living, bi-layered skin substitute. We
leveraged our wound care sales force to provide marketing resources in support
of Apligraf. PDI InServe also utilized its current team of wound care nurses to
provide after-sales clinical support for practitioners. Under the terms of the
agreement, we received a fee with the potential to earn incentives based on
performance. However, Apligraf sales thus far have not been strong enough for us
to earn significant incentive payments. On October 14, 2003, we and
Organogenesis each simultaneously exercised our termination rights to terminate
the agreement, and the wound care sales force will cease marketing Apligraf as
of January 12, 2004. We do not believe that this termination will have a
material adverse impact on our future results of operations, financial condition
or cash flows. We are actively negotiating with Organogenesis to provide them
with a dedicated sales team to provide marketing resources in support of
Apligraf. However, there can be no assurance we will be able to reach an
agreement with Organogenesis.
Revenues and costs of revenue
The paragraphs that follow describe the guidelines that we adhere to in
accordance with generally accepted accounting principles (GAAP) when recognizing
revenue and cost of goods and services in our financial statements. GAAP
requires that service revenue and product revenue and their respective direct
costs be shown separately on the income statement. However, our reporting
segments' revenue and direct costs may consist of both product and service
activities; the segment financial results are discussed later in the
Consolidated Results of Operations section beginning on page 27 and in Note 14
to the consolidated financial statements located elsewhere in this report.
Historically, we have derived a significant portion of our service revenue
from a limited number of clients. Concentration of business in the
pharmaceutical services industry is common and the pharmaceutical industry
continues to consolidate. As a result, we are likely to continue to experience
significant client concentration in future periods.
For the three and nine month periods ended September 30, 2003, our largest
clients, who each individually represented 10% or more of our service revenue,
accounted for approximately 76.3% and 68.0%, respectively, of our total service
revenue. For the three and nine month periods ended September 30, 2002, our
largest clients who each accounted for more than 10% of our service revenue
totaled 71.0% and 72.0%, respectively, of our total service revenue.
Our product revenue for the three and nine months ended September 30, 2003
was comprised primarily of sales of the Xylos wound care products which began
commercialization during January 2003. Of the $6.4 million recorded as product
revenue for the nine months ended September 30, 2002, 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 that occurred during the nine month period as we continued 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 continue to be both
positive and negative adjustments made as the liabilities are settled the in
future periods in which we are responsible for the liabilities. These
adjustments will be reflected in product revenue consistent with the
classification of such accruals when they were initially recorded. As discussed
in Note 5 to the consolidated financial statements
25
located elsewhere in this report, we are responsible for the processing and
payment through December 31, 2004 of sales rebates and returns for products it
sold under the Ceftin agreement.
Service revenue and program expenses
Service 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 relating to 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 achieved.
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, 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. For all
contracts, 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.
When we receive a specific contract payment from a client upon commencement of a
product detailing program expressly to compensate us for recruiting, hiring and
training services associated with staffing that program, such payment is
deferred and recognized as revenue in the same period that the recruiting and
hiring expenses are incurred and the amortization of the deferred training is
expensed. When we do not receive a specific contract payment for recruiting,
hiring and training, all revenue is deferred and recognized over the life of the
contract. Product detailing, marketing and promotional expenses related to the
detailing of products we distribute 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. Our inability
to specifically negotiate for payments that are specifically attributable to
recruiting, hiring or training services in our product detailing contracts 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
As mentioned previously, product revenue for the three and nine month
periods ended September 30, 2003 resulted primarily from the sale of the Xylos
wound care products. Product revenue recognized in prior periods related to the
Ceftin contract which terminated by mutual consent in February 2002. Product
revenue is recognized when products are shipped and title is transferred to the
customer.
Cost of goods sold includes all expenses for product distribution costs,
acquisition and manufacturing costs of the product sold. Inventory is valued at
the lower of cost or market value. Cost is determined using the first-in,
first-out costing method. Inventory to date has consisted of only finished
goods.
26
Consolidated Results of Operations
The following table sets forth, for the periods indicated, certain
consolidated 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,
------------------- --------------------
2003 2002 2003 2002
------ ------ ------ ------
Revenue
Service, net .................................. 99.9% 99.7% 99.9% 96.9%
Product, net .................................. 0.1 0.3 0.1 3.1
------ ------ ------ ------
Total revenue, net .......................... 100.0% 100.0% 100.0% 100.0%
Cost of goods and services
Program expenses .............................. 71.6 104.5 72.0 97.8
Cost of goods sold ............................ 1.1 -- 0.5 --
------ ------ ------ ------
Total cost of goods and services ............ 72.7% 104.5% 72.5% 97.8%
Gross profit (loss) .............................. 27.3 (4.5) 27.5 2.2
Compensation expense ............................. 10.8 14.2 12.1 12.7
Other selling, general and administrative expenses 8.9 14.6 9.2 9.4
Restructuring and other related expenses, net .... -- 1.5 (0.1) 0.5
Litigation settlement ............................ -- -- 0.9 --
------ ------ ------ ------
Total operating expenses ...................... 19.7 30.3 22.1 22.6
------ ------ ------ ------
Operating income (loss) .......................... 7.6 (34.8) 5.4 (20.4)
Other income, net ................................ 0.3 0.7 0.3 0.8
------ ------ ------ ------
Income (loss) before provision for income taxes .. 7.9 (34.1) 5.7 (19.6)
Provision (benefit) for income taxes ............. 3.1 (11.9) 2.2 (7.0)
------ ------ ------ ------
Net income (loss) ................................ 4.8% (22.2)% 3.5% (12.6)%
====== ====== ====== ======
Three Months Ended September 30, 2003 Compared to Three Months Ended September
30, 2002
Revenue. Net revenue for the quarter ended September 30, 2003 was $86.3
million, 33.6% more than net revenue of $64.6 million for the quarter ended
September 30, 2002. As disclosed elsewhere in this MD&A, the Novartis sales
force responsible for Lotrel/Diovan is now classified in the SMSG segment
instead of the PPG segment where it was classified in 2002 due to a change in
the nature of the arrangement.
Net revenue from the SMSG segment for the quarter ended September 30, 2003
was $70.6 million, approximately 74.7% more than net revenue of $40.4 million
from that segment for the comparable prior year period. For the quarter ended
September 30, 2003, $19.6 million in revenue was earned on three significant fee
for service contracts awarded in July 2003. GSK awarded us a contract beginning
in July 2003 running through September 2004, which represents between $80.0
million and $85.0 million in potential revenue over the fifteen-month agreement.
The other contracts, which became effective August 1, 2003 will run through
December 31, 2004 and could represent an incremental revenue impact of between
$60.0 million and $70.0 million over their full term. The remaining change from
the prior year primarily reflects the reclassification of revenues earned from
the Lotrel/Diovan contract as previously described.
Net PPG service revenue for the quarter ended September 30, 2003 was $12.7
million compared to $21.4 million in the comparable prior year period.
Approximately $10.9 million was attributable to our Lotensin contract for the
three-month period ended September 30, 2003. The decrease in revenues from the
prior year primarily reflects the reclassification of revnues earned from the
Lotrel/Diovan contract as previously described. There was approximately $215,000
in product revenue recorded for the period ended September 30, 2002, related to
the net positive adjustments recorded in sales returns and allowances, discounts
and rebates accounts for the quarter.
27
Net revenue from the MD&D segment was $3.0 million compared to $2.6
million in the comparable prior year period. This increase was due to the
increased MD&D service revenue of approximately $411,000 and the Xylos product
sales of approximately $81,000.
Cost of goods and services. Cost of goods and services for the quarter
ended September 30, 2003 was $62.8 million, 7.0% less than cost of goods and
services of $67.5 million for the quarter ended September 30, 2002. As a
percentage of total net revenue, cost of goods and services decreased to 72.7%
for the quarter ended September 30, 2003 from 104.5% in the comparable prior
year period.
Program expenses (i.e., cost of services) associated with the SMSG segment
for the quarter ended September 30, 2003 were $51.1 million, 70.5% more than
program expenses of $29.9 million for the prior year period due primarily to
increased revenue. As a percentage of sales and marketing services segment
revenue, program expenses for the quarters ended September 30, 2003 and 2002
were 72.4% and 74.1%, respectively.
Cost of goods and services associated with the PPG segment were $8.5
million and $35.9 million for the quarters ended September 30, 2003 and 2002,
respectively. As a percentage of PPG revenue, cost of goods and services for the
quarters ended September 30, 2003 and 2002 were 67.5% and 165.8%, respectively.
The Lotensin contract allows us to detail other products along with Lotensin;
gross profit resulting from the Lotensin team's efforts has been positively
impacted because the team details two other products along with Lotensin,
therefore positively leveraging the cost of the team. In 2002, cost of sales was
greater than 100% of revenue due primarily to the impact of the loss on the
Evista contract.
All of the contracts in the PPG segment have annual performance
parameters, the successful achievement of which will not be certain until the
fourth quarter of 2003. Normally, until that time the gross profit percentage
for the PPG segment would be less than our traditional contracts in the SMSG
segment; however, in the third quarter of 2003, because of the excellent
performance of Lotensin and our ability to leverage the cost of the team, gross
profit for the PPG segment was more than our traditional contracts delivered. It
is not possible at this time to predict whether these performance parameters
will be achieved in future quarters. During 2002, the gross profit in this
segment was negative due to the underperformance of our contracted products,
most notably under the Evista agreement which was terminated effective December
31, 2002. We incurred an operating loss of approximately $14.5 million under the
Evista contract in the third quarter of 2002.
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 expectations. While
we currently estimate that future revenues will exceed costs associated with
these agreements, there is no assurance that actual revenues will exceed costs;
in which event the activities covered by these agreements could yield an
operating loss.
Cost of goods and services associated with the MD&D segment for the
quarter ended September 30, 2003 were $3.2 million, of which $952,000 was
related to product sales, 87.3% more than cost of goods and services of $1.7
million for the prior year period. Of the product cost of sales, a reserve of
$835,000 was recorded to bring our XCell wound care product inventory to its
estimated net realizable value of approximately $174,000 as a result of our
determination that the sales potential for these products has diminished
materially.
Compensation expense. Compensation expense for the quarter ended September
30, 2003 was $9.3 million, 1.5% more than the $9.2 million for the comparable
prior year period. As a percentage of total net revenue, compensation expense
decreased to 10.8% for the quarter ended September 30, 2003 from 14.2% for the
quarter ended September 30, 2002. This was partially attributable to the lower
cost base created by the restructuring.
28
Compensation expense for the quarter ended September 30, 2003 attributable
to the SMSG segment was $5.5 million, $0.4 million less than $5.9 million for
the quarter ended September 30, 2002. As a percentage of net revenue for the
SMSG segment, compensation expense decreased to 7.8% for the quarter ended
September 30, 2003 from 14.5% for the quarter ended September 30, 2002 due to
the SMSG segment maintaining its cost levels despite the increase in revenue in
the current year quarter.
Compensation expense for the quarter ended September 30, 2003 attributable
to the PPG segment was $2.7 million, or 21.4% of PPG revenue, compared to $2.5
million, or 11.6% in the prior year period due to decrease in revenue year over
year. Due to the FDA's determination that Fortigel is not approved at the
current time, we are not expecting to increase the SG&A investment in this
segment in the near future.
Compensation expense for the MD&D segment for the quarter ended September
30, 2003 was $1.1 million compared to $0.8 million in the comparable prior year
period, reflecting the increased capabilities required for the continuing
marketing of our wound care products.
Other selling, general and administrative expenses (other SG&A). Total
other SG&A expenses were $7.7 million, which includes a credit of approximately
$317,000 for reimbursement of legal fees associated with the current Baycol
litigation, for the quarter ended September 30, 2003, 18.6% less than other SG&A
expenses of $9.4 million for the quarter ended September 30, 2002. As a
percentage of total net revenue, total other SG&A expenses decreased to 8.9% for
the quarter ended September 30, 2003 from 14.6% for the quarter ended September
30, 2002.
Other SG&A expenses attributable to the SMSG segment for the quarter ended
September 30, 2003 were $4.9 million, 3.8% higher than $4.7 million attributable
to that segment for the comparable prior year period. As a percentage of net
revenue from sales and marketing services, other SG&A expenses decreased to 6.9%
for the quarter ended September 30, 2003 compared to 11.7% in the comparable
prior year period.
Other SG&A expenses attributable to the PPG segment for the quarter ended
September 30, 2003 were $1.5 million compared to $3.8 million for the comparable
prior year period. In the third quarter of 2003, there were fewer field
personnel in this segment, which required less resources to provide services for
the group; therefore, the allocation of corporate expenses to this segment is
lower than in the comparable prior year period.
Other SG&A expenses attributable to the MD&D segment for the quarter ended
September 30, 2003 were $1.3 million, compared to $0.9 million for the
comparable prior year period. This increase was primarily attributable to the
sales force costs and other marketing costs associated with the continued
marketing of our wound care products, which began in January 2003.
Restructuring and other related expenses. See the "Restructuring and other
related expenses" disclosure in the "Liquidity and Capital Resources" section
below for further explanations of the Restructuring Plan and related activity in
2003 and 2002.
Operating income (loss). Operating income for the quarter ended September
30, 2003 was $6.5 million, compared to an operating loss of $22.5 million for
the quarter ended September 30, 2002.
Operating income for the quarter ended September 30, 2003 for the SMSG
segment was $9.1 million, compared to an operating loss for the quarter ended
September 30, 2002 of $0.9 million. As a percentage of net revenue from the SMSG
segment, operating income for that segment was 12.9% for the quarter ended
September 30, 2003.
There was an operating loss for the PPG segment for the quarter ended
September 30, 2003 of $91,000, compared to an operating loss of $20.8 million
for the comparable prior year period which was
29
adversely affected by the poor performance on the Evista contract. During the
quarter ended September 30, 2003, $1.5 million in Lotensin revenue was deferred
because of contractual obligations.
The MD&D segment recorded an operating loss of $2.5 million for the
quarter ended September 30, 2003, compared to an operating loss of $0.8 million
in the comparable prior year period, primarily due to the costs incurred for the
launch of the Xylos wound care products, and the recognition of a reserve
against inventory.
Other income, net. Other income, net, for the quarters ended September 30,
2003 and 2002 was $246,000 and $459,000, respectively, and was comprised
primarily of interest income which is lower in 2003 due to lower interest rates.
Provision (benefit) for income taxes. There was income tax expense of
approximately $2.6 million for the quarter ended September 30, 2003, compared to
an income tax benefit of $7.7 million for the quarter ended September 30, 2002,
which consisted of Federal and state corporate income taxes. The effective tax
rate for the quarter ended September 30, 2003 was 38.4%, compared to an
effective tax benefit rate of 35.0% for the quarter ended September 30, 2002.
The rate for our 2002 tax benefit is lower than the 2003 effective tax rate
because some states do not permit loss carryforwards or may impose minimum
taxes, or both.
Net income (loss). There was net income for the quarter ended September
30, 2003 of approximately $4.2 million, compared to a net loss of $14.3 million
for the quarter ended September 30, 2002 due to the factors discussed above.
Nine Months Ended September 30, 2003 Compared to Nine Months Ended September 30,
2002
Revenue. Net revenue for the nine months ended September 30, 2003 was
$225.1 million, $20.1 million or 9.8% more than net revenue of $205.0 million
for the nine months ended September 30, 2002. As disclosed above, the Novartis
sales force responsible for Lotrel/Diovan is now classified in the SMSG segment
instead of the PPG segment where it was classified in 2002 due to a change in
the nature of the arrangement.
Net revenue from the SMSG segment for the nine months ended September 30,
2003 was $181.5 million, $38.5 million more than net revenue of $143.0 million
from that segment for the comparable prior year period. For the nine months
ended September 30, 2003, $19.6 million in revenue was earned on three
significant fee for service contracts awarded in July 2003. GSK awarded us a
contract beginning in July 2003 running through September 2004, which represents
between $80.0 million and $85.0 million in potential revenue over the
fifteen-month agreement. The other contracts, which became effective August 1,
2003 will run through December 31, 2004 and could represent an incremental
revenue impact of between $60.0 million and $70.0 million over their full term.
Net PPG revenue for the nine months ended September 30, 2003 was $34.9
million, $20.2 million less than net revenue of $55.1 million for the comparable
prior year period, of which $6.4 million was product revenue. Approximately
$27.3 million was attributable to our Lotensin contract for the nine months
ended September 30, 2003. The decrease in revenue from the prior year primarily
reflects the reclassification of revenues earned from the Lotrel/Diovan contract
as previously described. With regard to product revenue in 2002, 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.
Net revenue for the MD&D segment for the nine months ended September 30,
2003 was $8.7 million compared to $6.9 million for the comparable prior year
period. This increase can be attributed primarily to the increase in revenue
generated by the MD&D service business.
Cost of goods and services. Cost of goods and services for the nine months
ended September 30, 2003 was $163.1 million, $37.4 million or 18.6% less than
cost of goods and services of $200.5 million for
30
the nine months ended September 30, 2002. The decrease was primarily
attributable to the termination of the Evista contract and the related program
expenses. As a percentage of total net revenue, cost of goods and services
decreased to 72.5% for the nine months ended September 30, 2003 from 97.8% in
the comparable prior year period. This decrease was primarily attributable to
the negative gross profit associated with the Evista contract from the
comparable prior year period. The gross profit percentage of 27.5% attained on
service revenue for the first nine months of 2003 approximates our historical
standards which had been established through the year 2000.
Program expenses (i.e., cost of services) associated with the SMSG segment
for the nine months ended September 30, 2003 were $128.5 million, $22.4 million
more than program expenses of $106.1 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, 2003 and 2002 were 70.8% and 74.2%,
respectively. The gross profit increase to 29.2% from 25.8% is primarily
attributable to higher performance incentives earned in the first quarter of
2003.
Cost of goods and services associated with the PPG segment were $27.4
million and $89.8 million for the nine months ended September 30, 2003 and 2002,
respectively. As a percentage of PPG revenue, cost of goods and services for the
nine months ended September 30, 2003 and 2002 was 78.5% and 163.0%,
respectively. The decrease can be attributed to the termination of the Evista
contract and the improved performance of the Lotensin 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. While we
currently estimate that future revenues will equal or exceed costs associated
with our current PPG agreements, there is no assurance that this will occur; in
the event the activities covered by these agreements yield an operating loss, we
might be required to record a contract loss reserve.
Cost of goods and services associated with the MD&D segment were $7.2
million for the nine months ended September 30, 2003, 56.5% more than cost of
goods and services of $4.6 million for the nine months ended September 30, 2002.
We recognized a negative gross profit margin on the sale of the XCell products
for the nine-month period ended September 30, 2003. This negative gross margin
was due primarily to the recognition of a $835,000 reserve to bring the XCell
wound care product inventory to its net realizable value as a result of our
determination that the sales potential for these products has diminished
materially. If revenue does not increase in an amount sufficient to cover both
the adjusted cost of inventory and the associated fixed warehousing costs, we
could continue to generate negative gross profit on the sales of the XCell
products. We are currently reviewing our strategies regarding our agreement with
Xylos. Continued slow performance in selling the Xylos products could adversely
affect our future results of operations, financial condition or cash flows.
Compensation expense. Compensation expense for the nine months ended
September 30, 2003 was $27.3 million, compared to $26.2 million for the
comparable prior year period. As a percentage of total net revenue, compensation
expense decreased to 12.1% for the nine months ended September 30, 2003 from
12.8% for the nine months ended September 30, 2002. The increased compensation
expense for the nine months ended September 30, 2003 is due in large part to
increased incentive compensation expense due to improved results for the
nine-month period ended September 30, 2003 as compared to the net loss
experienced in the comparable prior year period which greatly reduced incentive
compensation potential; excluding this increase in incentive compensation,
compensation expense for the nine months ended September 30, 2003 would be 8.5%
lower than the comparable prior year period due to the impact of the staff
reduction and other efficiencies related to the 2002 Restructuring Plan.
31
Compensation expense for the nine months ended September 30, 2003
attributable to the SMSG segment was $16.4 million compared to $16.0 million for
the nine months ended September 30, 2002. As a percentage of net revenue from
the SMSG segment, compensation expense decreased to 9.1% for the nine-month
period ended September 30, 2003 as compared to 11.2% in the comparable prior
year period due to increased revenue in the SMSG segment for the nine-month
period ended September 30, 2003.
Compensation expense for the nine months ended September 30, 2003
attributable to the PPG segment was $7.4 million compared to $8.0 million in the
comparable prior year period. As a percentage of revenue, compensation expense
increased to 21.2% compared to 14.5% in the comparable prior year period; this
increase is due to lower revenue for the nine-month period ended September 30,
2003.
Compensation expense for the nine months ended September 30, 2003 for the
MD&D segment was $3.5 million compared to $2.2 million for the comparable prior
year period; increased corporate management charges because of the participation
of that group in the start-up activities in 2003 has resulted in higher
compensation expense for this segment.
Other selling, general and administrative expenses (other SG&A). Total
other SG&A expenses were $20.7 million, which includes a credit of approximately
$1.2 million for reimbursement of legal fees associated with the current Baycol
litigation, for the nine months ended September 30, 2003, 7.8% more than other
SG&A expenses of $19.2 million for the nine months ended September 30, 2002.
This unfavorable variance is attributable to a large nonrecurring credit that
lowered the 2002 expense base; a credit of $2.3 million was recorded in the nine
months ended September 30, 2002 for the reversal of a bad debt reserve
associated with Ceftin sales and determined to be no longer required as of March
31, 2002. This was partially offset by a net savings in other SG&A in the nine
months ended September 30, 2003 of $0.8 million. As a percentage of total net
revenue, total other SG&A expenses decreased to 9.2% for the nine months ended
September 30, 2003 from 9.4% for the nine months ended September 30, 2002.
Other SG&A expenses attributable to the SMSG segment for the nine months
ended September 30, 2003 were $11.3 million, which were comparable to the $11.1
million for the nine months ended September 30, 2002. As a percentage of net
revenue from sales and marketing services, other SG&A expenses were 6.2% and
7.8% for the nine months ended September 30, 2003 and 2002, respectively.
Other SG&A expenses attributable to the PPG segment for the nine months
ended September 30, 2003 were $4.6 million compared to $6.2 million for the
comparable prior year period.
Other SG&A expenses attributable to the MD&D segment for the nine months
ended September 30, 2003 were $4.8 million compared to $1.9 million for the nine
months ended September 30, 2002 due to the increased sales and marketing costs
that can be attributed to the Xylos agreement.
Restructuring and other related expenses. During the nine months ended
September 30, 2003:
o we recognized a $270,000 reduction in the restructuring
accrual due to negotiating higher sublease proceeds than
originally estimated for the leased facility in Cincinnati,
Ohio;
o we incurred approximately $133,000 of additional restructuring
expense due to higher than expected contractual termination
costs. This additional expense was recorded in program
expenses consistent with the original recording of the
restructuring charges;
o we recognized a $473,000 reduction in the restructuring
accrual due to lower than expected sales force severance
costs. Greater success in the reassignment of sales
representatives to other programs and the voluntary departure
of other sales representatives combined to reduce the
requirement for severance costs. This expense reversal was
recorded in program expenses consistent with the original
recording of the restructuring charges.
32
See the "Restructuring and other related expenses" disclosure in the
"Liquidity and Capital Resources" section below for further explanations of the
Restructuring Plan and related activity.
Litigation settlement. On May 8, 2003, we entered into a settlement and
mutual release agreement with Auxilium (Settlement Agreement). We recorded a
$2.1 million charge in the first quarter of 2003 which included a cash payment
paid upon execution of the Settlement Agreement and other additional expenses
that were required as part of the settlement (refer to Note 12 in the unaudited
consolidated financial statements).
Operating income (loss). Operating income for the nine months ended
September 30, 2003 was $12.1 million, compared to an operating loss of $41.9
million for the nine months ended September 30, 2002. The operating loss was
primarily the result of losses generated by the performance based contracts in
2002, in particular the Evista contract.
Operating income for the nine months ended September 30, 2003 for the SMSG
segment was $24.3 million, or 169.7% more than SMSG operating income of $9.0
million for the nine months ended September 30, 2002. As a percentage of net
revenue from the SMSG segment, operating income for that segment increased to
13.4% for the nine months ended September 30, 2003, from 6.3% for the comparable
prior year period.
There was an operating loss for the PPG segment for the nine months ended
September 30, 2003 of $5.2 million, compared to an operating loss of $49.1
million for the prior year period. The large loss for the nine months ended
September 30, 2002 can be attributed to the performance of the Evista contract.
During 2003, the PPG segment has met its goals of successfully marketing
Lotensin, which has significantly exceeded its contractual TRx baseline, and of
leveraging the team's sales force with additional products. Current TRx trends
indicate that Lotensin will significantly exceed its contractual TRx baseline
for the fourth quarter 2003 thereby generating the highest quarterly revenue for
the year; additionally, revenue deferred because of contractual obligations
through the first three quarters, totaling $4.7 million, will be recognized in
the fourth quarter of 2003. The combination of the above two factors should
result in this segment being profitable for the full year of 2003.
A large investment of corporate management and staff time has been made in
the setting of strategic direction and evaluation of product licensing and
product acquisition opportunities. This has resulted in allocation of corporate
overhead costs to the PPG segment.
There was an operating loss of $7.0 million for the nine months ended
September 30, 2003 for the MD&D segment compared to an operating loss of $1.8
million in the comparable prior year period, primarily due to the start-up of
the Xylos products business.
Other income, net. Other income, net, for the nine months ended September
30, 2003 and 2002 was $741,000 and $1.7 million, respectively. For the nine
months ended September 30, 2003, other income, net, was comprised primarily of
interest income, which was significantly lower than the comparable prior year
period due to lower available cash balances and significantly lower interest
rates. Other income, net, for the comparable prior year period was also
comprised primarily of interest income.
Provision (benefit) for income taxes. There was income tax expense of $5.1
million for the nine months ended September 30, 2003, compared to an income tax
benefit of $14.4 million for the nine months ended September 30, 2002, which
consisted of Federal and state corporate income taxes. The effective tax rate
for the nine months ended September 30, 2003 was 39.7%, compared to an effective
tax benefit rate of 35.9% for the nine months ended September 30, 2002. The rate
for our 2002 tax benefit was lower than the 2003 effective tax rate because some
states do not permit loss carryforwards or may impose minimum taxes, or both.
33
Net income (loss). There was net income for the nine months ended
September 30, 2003 of $7.8 million, compared to a net loss of $25.8 million for
the nine months ended September 30, 2002 due to the factors discussed
previously.
Liquidity and Capital Resources
As of September 30, 2003, we had cash and cash equivalents of
approximately $99.1 million and working capital of approximately $94.3 million,
compared to cash and cash equivalents of approximately $66.8 million and working
capital of approximately $81.9 million at December 31, 2002.
For the nine months ended September 30, 2003, net cash provided by
operating activities was $28.6 million, compared to $76.1 million net cash used
in operating activities for the nine months ended September 30, 2002. The main
components of cash provided by operating activities during the nine months ended
September 30, 2003 were:
o cash provided from other changes in assets and liabilities of $14.0
million, primarily due to the receipt of a federal income tax refund
of $20.7 million in August 2003, partially offset by reductions of
$5.7 million in our accrued returns, rebates and sales discounts
liability;
o net income of approximately $7.8 million, and
o depreciation and other non-cash expenses of approximately $6.9
million which included an inventory valuation adjustment of $835,000
which was charged to cost of goods sold; amortization of
compensation expense associated with restricted stock of $403,000,
and amortization of intangible assets of $460,000, all of which was
charged to SG&A.
In the third quarter of 2003, a valuation reserve of $835,000 was recorded
to reduce the value of the inventory associated with our XCell wound care
products to its net realizable value of approximately $174,000 as a result of
management's determination that the sales potential for this product has
diminished materially. Our present plan is to explore our strategies with Xylos
regarding the Xylos agreement.
As of September 30, 2003, we had $8.7 million of unearned contract revenue
and $4.5 million of unbilled costs and accrued profits on contracts in progress.
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 on contracts in
progress. Substantially all costs and accrued profits are earned and billed
within 12 months from the end of the respective period.
The net changes in the "Other changes in assets and liabilities" section
of the consolidated statement of cash flows may fluctuate depending on a number
of factors, including seasonality of product sales, number and size of programs,
contract terms and other timing issues; these variations may change in size and
direction with each reporting period.
For the nine months ended September 30, 2003, net cash provided by
investing activities of $2.8 million consisted of $4.3 million received from the
sale of short-term investments, partially offset by $1.5 million in purchases of
property and equipment.
For the nine months ended September 30, 2003, net cash provided by
financing activities of approximately $886,000 was due to the net proceeds
received from the employee stock purchase plan. For the nine months ended
September 30, 2002 net cash provided by financing activities of $1.5 million was
also primarily due to the net proceeds received from the employee stock purchase
plan.
Capital expenditures during the nine-month periods ended September 30,
2003 and 2002 were approximately $1.5 million and $3.8 million, respectively,
and were funded out of available cash. As a result of the significant investment
in capital expenditures during 2002 of $4.0 million and 2001 of $15.6
34
million, we currently estimate that we will require capital expenditures of only
approximately $2.0 million in 2003. In 2004 we will be moving our corporate
headquarters to a new facility; in connection with that move, we are expecting
to incur capital expenditures of approximately $3.0 million to $4.0 million.
Due to the ability to carry back net operating losses incurred for the
year ended December 31, 2002, we received a Federal income tax refund of
approximately $20.7 million in August 2003.
Our revenue and profitability depend to a great extent on our
relationships with a limited number of large pharmaceutical companies. For the
nine months ended September 30, 2003, we had two major clients that accounted
for approximately 34.4% and 33.6%, respectively, or a total of 68.0% of our
service revenue. We are likely to continue to experience a high degree of client
concentration, particularly if there is further consolidation within the
pharmaceutical industry. The loss or a significant reduction of business from
any of our major clients, or a decrease in demand for our services, could have a
material adverse effect on our business, future results of operations, financial
condition or cash flows.
Under our licensing agreement with Cellegy, we will be required to pay
Cellegy a $10.0 million incremental license fee milestone payment upon
Fortigel's receipt of all approvals required by the FDA to promote, sell and
distribute the product in the U.S. Upon payment, this incremental milestone
license fee will be recorded as an intangible asset and amortized over the
estimated commercial life of the product, as then determined. This payment will
be funded, when due, out of cash flows provided by operations and existing cash
balances. In addition, under the licensing agreement, we will be required to pay
Cellegy royalty payments ranging from 20% to 30% of net sales, including minimum
royalty payments, if and when complete FDA approval is received. We believe that
these royalty payments will be offset by product revenue. The initial 10-month
Prescription Drug User Fee Act (PDUFA) date for the product was April 5, 2003.
In March 2003, Cellegy was notified by the FDA that the PDUFA date had been
revised to July 3, 2003. On July 3, 2003, Cellegy was notified by the FDA that
Fortigel was not approved. Cellegy is in discussions with the FDA to determine
the appropriate course of action needed to meet deficiencies cited by the FDA in
its determination. We cannot predict with any certainty that the FDA will
ultimately approve Fortigel for sale in the U.S. Management believes that it
will not be required to pay Cellegy the $10.0 million incremental license fee
milestone payment in 2003, and it is unclear at this point when or if Cellegy
will get Fortigel approved by the FDA which would trigger our obligation to pay
$10.0 million to Cellegy.
On October 8, 2003, we gave notice of non-binding mediation to Cellegy
regarding the licensing agreement. We maintain that we were fraudulently induced
into the licensing agreement and that Cellegy has materially breached certain
material provisions of the licensing agreement. We are seeking return of the
$15.0 million initial licensing fee plus additional damages caused by Cellegy's
conduct. We intend to pursue all legal remedies, if necessary, post mediation.
We believe that our existing cash balances and expected cash flows
generated from operations will be sufficient to meet our operating and capital
requirements for the next 12 months. We continue to evaluate and review
financing opportunities and acquisition candidates in the ordinary course of
business.
Restructuring and other related expenses
During the third quarter of 2002, we adopted a restructuring plan, the
objectives of which were to consolidate operations in order to enhance operating
efficiencies (the 2002 Restructuring Plan). This plan was primarily in response
to the general decrease in demand within our markets for the sales and marketing
services segment, and the recognition that the infrastructure that supported
these business units was larger than required. We estimated that the
restructuring would result in annualized SG&A savings of approximately $14.0
million, based on the level of SG&A spending at the time we initiated the
restructuring; however, these savings may be offset by incremental SG&A expenses
we could incur in future periods if we are successful in expanding our business
platforms for our segments. Essentially all of the restructuring activities have
been completed as of September 30, 2003.
35
In connection with this plan, we originally estimated that we would
ultimately incur total restructuring expenses of approximately $5.4 million,
other non-recurring expenses of approximately $0.1 million, and accelerated
depreciation of approximately $0.8 million. Excluding $0.3 million, all of these
expenses were recognized in 2002; due to various factors, the $0.3 million will
not be incurred.
The primary items comprising the $5.4 million in restructuring expenses
were $3.7 million in severance expense consisting of cash and non-cash
termination payments to employees in connection with their involuntary
termination and $1.7 million in other restructuring exit costs relating to
leased facilities and other contractual obligations.
During the quarter ended March 31, 2003, we recognized a $270,000
reduction in to the restructuring accrual due to negotiating higher sublease
proceeds than originally estimated for the leased facility in Cincinnati, Ohio.
During the quarter ended June 30, 2003, we incurred approximately $133,000
of additional restructuring expense due to higher than expected contractual
termination costs. This additional expense was recorded in program expenses
consistent with the original recording of the restructuring charges.
Also during the quarter ended June 30, 2003, we recognized a $473,000
reduction in the restructuring accrual due to lower than expected sales force
severance costs. Greater success in the reassignment of sales representatives to
other programs and the voluntary departure of other sales representatives
combined to reduce the requirement for severance costs. This adjustment was
recorded in program expenses consistent with the original recording of the
restructuring charges.
The accrual for restructuring and exit costs totaled approximately
$474,000 at September 30, 2003, and is recorded in current liabilities on the
accompanying balance sheet.
A roll forward of the activity for the 2002 Restructuring Plan (in
thousands) is as follows:
Balance at Balance at
December 31, 2002 Adjustments Payments September 30, 2003
Administrative severance $ 1,670 $ -- $(1,434) $236
Exit costs 1,288 (137) (913) 238
------- ------- ------- ----
2,958 (137) (2,347) 474
------- ------- ------- ----
Sales force severance 1,741 (473) (1,268) --
------- ------- ------- ----
Total $ 4,699 $ (610) $(3,615) $474
======= ======= ======= ====
Use Of Non-GAAP Financial Information
This Form 10-Q contains non-GAAP financial information adjusted to exclude
certain costs, expenses, gains and losses and other non-comparable items. This
information is intended to enhance an investor's overall understanding of the
Company's past financial performance and prospects for the future. For example,
non-GAAP financial information is an indication of our baseline performance
before items that are considered by us to be not reflective of our operational
results. In addition, this information is among the primary indicators we use as
a basis for planning and forecasting of future periods. This information is not
intended to be considered in isolation or as a substitute for financial
information prepared in accordance with GAAP.
36
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
As of September 30, 2003, 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.
37
Part II - Other Information
Item 1 - Legal Proceedings
Securities Litigation
In January and February 2002, we, our chief executive officer, and our
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 established 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. On or about December 13, 2002,
Lead Plaintiffs filed a second consolidated and amended complaint ("Second
Consolidated and Amended Complaint"), which superseded their earlier complaints.
The complaint names us, our chief executive officer, and our chief
financial officer as defendants; purports to state claims against us on behalf
of all persons who purchased our 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 the
Second Consolidated and Amended Complaint is that we intentionally or recklessly
made false or misleading public statements and omissions concerning our
financial condition and prospects with respect to our marketing of Ceftin in
connection with the October 2000 distribution agreement with GlaxoSmithKline,
our marketing of Lotensin in connection with the May 2001 distribution agreement
with Novartis Pharmaceuticals Corp., as well as our marketing of Evista in
connection with the October 2001 distribution agreement with Eli Lilly.
In February 2003, we filed a motion to dismiss the Second Consolidated and
Amended Complaint under the Private Securities Litigation Reform Act of 1995 and
Rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure. We believe that
the allegations in this purported securities class action are without merit and
intend to defend the action vigorously.
Bayer-Baycol Litigation
We have 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
detailed by us on Bayer's behalf under a contract sales force agreement. We may
be named in additional similar lawsuits. In August 2001, Bayer announced that it
was voluntarily withdrawing Baycol from the U.S. market. To date, we have
defended these actions vigorously and have asserted a contractual right of
indemnification against Bayer for all costs and expenses we incur relating to
these proceedings. In February 2003, we entered into a joint defense and
indemnification agreement with Bayer, pursuant to which Bayer has agreed to
assume substantially all of our defense costs in pending and prospective
proceedings, subject to certain limited exceptions. Further, Bayer agreed to
reimburse us for all reasonable costs and expenses incurred to date in defending
these proceedings. Bayer has reimbursed us for legal expenses which we had
expensed as incurred; (i)$750,000 of the reimbursement was received in the first
quarter of 2003 and (ii) $540,000 of the reimbursement was received in October
2003. We are currently in discussions with Bayer regarding additional legal fee
reimbursements; however, no agreement has been reached and therefore no
additional amounts have been accrued to date.
Auxilium Pharmaceuticals Litigation
On January 6, 2003, we were named as a defendant in a lawsuit filed by
Auxilium Pharmaceuticals, Inc. (Auxilium), in the Pennsylvania Court of Common
Pleas, Montgomery County. Auxilium was seeking monetary damages and injunctive
relief, including preliminary injunctive relief, based on several claims related
to our alleged breaches of a contract sales force agreement entered into by the
parties on
38
November 20, 2002, and claims that we were misappropriating trade secrets in
connection with our exclusive license agreement with Cellegy.
On May 8, 2003, we entered into a settlement and mutual release agreement
with Auxilium (Settlement Agreement), by which the lawsuit and all related
counter claims were dropped without any admission of wrongdoing by either party.
The settlement terms included a cash payment which was paid upon execution of
the Settlement Agreement as well as certain other additional expenses. We
recorded a $2.1 million charge in the first quarter of 2003 related to this
settlement. Pursuant to the Settlement Agreement, we also agreed that we would
(a) not sell, ship, distribute or transfer any Fortigel product to any
wholesalers, chain drug stores, pharmacies or hospitals prior to November 1,
2003, and (b) pay Auxilium an additional amount per prescription to be
determined based upon a specified formula, in the event any prescriptions are
filled for Fortigel prior to January 26, 2004. As discussed in Note 4, on July
3, 2003, Cellegy was notified by the FDA that Fortigel had not been approved. We
believe that we will not pay any additional amount to Auxilium as set forth in
clause (b) above since Fortigel was not approved by the FDA on July 3, 2003, and
it is management's belief that FDA approval of Fortigel will not be given prior
to January 26, 2004, if at all. We do not believe that the terms of the
Settlement Agreement will have any material impact on the success of our
commercialization of the product if or when the FDA approves it. There can be no
assurances that the FDA will approve the product at a later date.
Other Legal Proceedings
We are currently a party to other legal proceedings incidental to our
business. While management currently believes that the ultimate outcome of these
proceedings, individually and in the aggregate, will not have a material adverse
effect on our consolidated financial statements, litigation is subject to
inherent uncertainties. Were we to settle a proceeding for a material amount or
were an unfavorable ruling to occur, there exists the possibility of a material
adverse impact on our future results of operations, financial condition or cash
flows.
No amounts have been accrued for losses under any of the above mentioned
matters, other than for the Auxilium litigation settlement reserve, as no other
amounts are considered probable or reasonably estimable at this time.
Item 2 - Not Applicable
Item 3 - Not Applicable
Item 4 - Submission of Matters to a Vote of Security Holders
On July 15, 2003, the Company held its 2003 Annual Meeting of
Stockholders. At the meeting Charles T. Saldarini, John M. Pietruski, and Frank
J. Ryan were reelected as Class II Directors of the Company for three year terms
with 12,663,586, 12,560,476, and 11,047,094 votes cast in favor of their
election, respectively, and 87,959, 191,078, and 1,704,451 votes withheld,
respectively. In addition, the appointment of PricewaterhouseCoopers LLP as
independent auditors of the Company for fiscal 2003 was ratified with 9,911,917
votes in favor, 2,834,626 votes against and 5,001 votes withheld.
Item 5 - Not Applicable
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
No.
---
31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
39
32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section
1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section
1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
During the three months ended September 30, 2003, the Company filed the
following reports on Form 8-K:
Date Item Description
--------------- --------- ------------------------------------------
July 7, 2003 5 FDA "Not Approved" Letter For Fortigel
July 11, 2003 5 Revised 2003 EPS Guidance
July 29, 2003 5 Announcement for Contract Sales Agreements
40
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 5, 2003 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
41