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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORT
PURSUANT TO SECTIONS 13 OR 15 (d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2003
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission file number: 0-24249
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, NJ 07458-1937
(Address of Principal Executive Offices)
Registrant's telephone number, including area code: (201) 258-8450
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to section 12(g) of the Act:
Common Stock, $.01 par value
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 in the Act.) Yes |X| No |_|
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of June 30, 2003 was approximately $88,875,889.
The number of shares outstanding of the registrant's common stock, $.01 par
value, as of March 1, 2004 was 14,456,735 shares.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III of this Report, to the extent not set
forth herein, is incorporated herein by reference from the registrant's
definitive proxy statement relating to the annual meeting of shareholders to be
held in 2004, which definitive proxy statement shall be filed with the
Securities and Exchange Commission within 120 days after the end of the fiscal
year to which this Report relates.
PDI, INC.
Form 10-K Annual Report
TABLE OF CONTENTS
Page
----
PART I.................................................................................................3
Item 1. Business...................................................................................3
Item 2. Properties................................................................................19
Item 3. Legal Proceedings.........................................................................20
Item 4. Submission of Matters to a Vote of Security Holders.......................................21
PART II...............................................................................................22
Item 5. Market for our Common Equity and Related Stockholder Matters..............................22
Item 6. Selected Financial Data...................................................................22
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.....24
Item 7A. Quantitative and Qualitative Disclosures about Market Risk................................41
Item 8. Financial Statements and Supplementary Data...............................................41
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures.....41
Item 9A. Controls and Procedures...................................................................42
PART III..............................................................................................43
Item 10. Directors and Executive Officers..........................................................43
Item 11. Executive Compensation....................................................................46
Item 12. Security Ownership of Certain Beneficial Owners and Management............................46
Item 13. Certain Relationship and Related Transactions.............................................46
Item 14. Principal Accounting Fees and Services....................................................47
PART IV...............................................................................................48
Item 15. Exhibits and Financial Statement Schedules................................................48
FORWARD LOOKING STATEMENT INFORMATION
Various statements made in this Annual Report on Form 10-K 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 judgments 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 under the headings "Business" and
"Risk Factors" in Part I, Item 1; "Legal Proceedings" in Part I, Item 3; and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in Part II, Item 7, of this Annual Report on Form 10-K, 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.
2
PART 1
ITEM 1. BUSINESS
Summary of Business
We are a 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 and MD&D products. We do this by partnering with
companies who own the intellectual property rights to these products and
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. In these agreements, we have leveraged our experience in:
o sales,
o brand management and product marketing,
o marketing research,
o medical education,
o medical affairs, and
o managed markets and to a limited extent, trade relations
to help our partners meet strategic and financial objectives and to provide
incremental value for product sales.
We have assembled our commercial capabilities through acquisition and
internal expansion and these capabilities can be applied on a stand-alone or
integrated basis. This flexibility enables us to provide a wide range of
marketing and promotional options that can benefit many different products
throughout the various stages of their life cycles. Our capabilities enable us
to take, where appropriate, total sales, marketing and distribution
responsibility for pharmaceutical and MD&D products.
It is important for us to form strong partnerships with companies within
the biopharmaceutical and MD&D industries. We assign an account executive to
each partner to ensure the partnership is working to the mutual benefit of both
parties. Our focus is to achieve operational excellence that delivers the
desired product sales results.
Reporting Segments and Operating Groups
We operate under three reporting segments: PDI Sales and Marketing Services
Group, PDI Pharmaceutical Products Group and PDI Medical Devices and Diagnostics
Group.
PDI Sales and Marketing Services Group (SMSG)
We are among the leaders in outsourced pharmaceutical sales and marketing
services in the U.S. We have designed and implemented programs for many of the
major pharmaceutical companies serving the U.S. market. Our clients include
AstraZeneca, GlaxoSmithKline, Novartis and Aventis as well as small
pharmaceutical companies and more than 20 other specialty pharmaceutical
companies. We have relationships built on consistent performance and program
results.
Our clients engage us on a contractual basis to design and implement
promotional programs for both prescription and over-the-counter products. The
programs in the PDI Sales and Marketing Services Group are designed to increase
product sales and are tailored to meet the specific needs of the product and the
client. These services are provided predominantly on a fee for service basis.
Occasionally, there is an opportunity for us to earn incentives if we meet or
exceed predetermined performance targets.
This segment, which includes contract sales, marketing research and medical
education and communications, represents 82.9% of consolidated revenue for 2003.
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o Contract Sales
Product detailing involves a representative meeting face-to-face with
targeted physicians and other healthcare decision makers to provide a technical
review of the product being promoted. Contract sales teams can be deployed on
either a dedicated or shared basis.
A dedicated contract sales team works exclusively on behalf of one client
and often carries the business cards of the client. The sales team is customized
to meet the specifications of our client with respect to representative profile,
physician targeting, product training, incentive compensation plans, integration
with clients' in-house sales forces, call reporting platform and data
integration. Without adding permanent personnel, the client gets a high quality,
industry-standard sales team comparable to its internal sales force.
Our shared sales teams sell multiple brands from different pharmaceutical
manufacturers. Through them, we make a face-to-face selling resource available
to those clients that want an alternative to a dedicated team. The PDI Shared
Sales teams are leading providers of these detailing programs in the U.S. Since
costs are shared among various companies, these programs may be less expensive
for the client than programs involving a dedicated sales force. With a shared
sales team, the client still gets targeted coverage of its physician audience
within the representatives' geographic territories.
o Marketing Research
Employing leading edge, in some instances proprietary, research
methodologies, we provide qualitative and quantitative marketing research to
pharmaceutical companies with respect to healthcare providers, patients and
managed care customers in the U.S. and globally. We offer a full range of
pharmaceutical marketing research services which includes studies to identify
the most impactful business strategy, profile, positioning, message, execution,
implementation, and post implementation for a product. Correctly implemented,
our marketing research model improves the knowledge clients obtain about how
physicians and other healthcare professionals will likely react to products.
We utilize a systematic approach to pharmaceutical marketing research.
Recognizing that every marketing need, and therefore every marketing research
solution, is unique, we have developed our marketing model to help identify the
work that needs to be done in order to identify critical paths to marketing
goals. At each step of the marketing model we can offer proven research
techniques, proprietary methodologies and customized study designs to address
specific product needs.
In addition to conducting marketing research, we have trained several
thousand industry professionals at our public seminars. Our professional
development seminars focus on key marketing processes and issues.
o Medical Education and Communications
Our medical education and communications group provides medical education
and promotional communications to the biopharmaceutical and MD&D industries.
Using an expert-driven, customized approach, we provide our clients with
integrated advocacy development, accredited continuing medical education (CME),
promotions, publication services and interactive sales initiatives to generate
incremental value for products.
We create custom designed programs focusing on optimizing the informed use
of our clients' products. Our services are executed through a customized,
integrated plan that can be leveraged across the product's entire life cycle. We
can meet a wide range of objectives, including advocacy during pre-launch,
communicating disease state awareness, supporting a product launch, helping an
under-performing brand, fending off new competition, and expanding market
leadership.
PDI Pharmaceutical Products Group (PPG)
The goal of our pharmaceutical products group is to source
biopharmaceutical products in the U.S. through licensing, copromotion,
acquisition or integrated commercialization services arrangements. This segment
represents
4
13.3% of consolidated revenue for 2003.
Licensing, copromotion and acquisition arrangements contain a greater level
of risk when compared to fee for service agreements, however, there is potential
for generating greater revenue at higher margins with longer-term visibility on
revenue. PPG's arrangements may be longer in duration and potentially less prone
to sudden termination than SMSG agreements.
o Licensing
Typically, under a licensing arrangement, we undertake the sales, marketing
and distribution responsibility for a product while another company maintains
ownership of the intellectual property and the patent on the product. The
company from which we license the product would typically retain responsibility
for manufacturing the product. In a licensing arrangement, we may make upfront
payments and/or royalty payments to our partner company.
We conduct the sales, marketing and distribution functions for the product
and we record the product sales in this reporting segment. Typically, we are
also responsible for medical affairs, certain clinical and regulatory affairs as
well as managed care and trade relations. Examples of the licensing agreements
that we have entered into are described in the Contracts section of this report.
o Copromotion
Copromotion arrangements, a frequently used strategy within the
biopharmaceutical industry, occur when two companies agree to mutually promote
the same product. Each party contributes expenses and resources toward the sales
and marketing effort, with the financial risks and rewards shared on a
predetermined basis.
Typically, our partner company will manufacture and distribute the product,
and be responsible for regulatory and medical affairs as well as managed care
and trade relations. We may exercise significant control over the sales and
marketing strategy for the product. Examples of the copromotion agreements that
we have entered into are described in the Contracts section of this report.
o Acquisition
To date we have not acquired any products; however, if we were to acquire a
product we would own the product outright and would most likely have total
commercial responsibility, inclusive of manufacturing, sales, marketing,
distribution, intellectual property defense and clinical and regulatory affairs.
o Integrated Commercialization Services
Given the broad array of our service offerings, we are able to provide
complete product commercialization capabilities (Integrated Commercialization
Services) to pharmaceutical companies on a fee for service basis. The execution
of these product sales, marketing and commercialization activities would be
substantially similar to those we perform in a copromotion, licensing or product
acquisition transaction; however, our fee structure and risk profile would be
markedly different.
We believe that Integrated Commercialization Services may be attractive to
pharmaceutical companies for products within their portfolio that they are no
longer actively promoting, but which our analysis indicates would respond to
promotion. Pharmaceutical companies may own products that are not being actively
promoted because resources are being focused on higher revenue generating
products, or because the product is nearing the end of its life cycle and the
company has decided to concentrate its promotional efforts on other products in
its portfolio. The decision not to promote a product often leads to reduced
demand and may also result in lower product revenue. Our Integrated
Commercialization Services enable our clients to continue to promote these
products and generate from them higher levels of revenue, while focusing their
limited internal resources on the higher growth products in their portfolios.
Our Integrated Commercialization Services can also be used by research
based biotechnology companies that own a product on the verge of coming to
market, or a product that has been on the market but is not performing up
5
to expectations. In this instance, we may be able to utilize our capabilities to
launch or relaunch the product with the objective of increasing the return that
the product delivers to our client. Research based biotechnology companies may
not have a well established sales and marketing infrastructure to deliver their
products to market and therefore may be attracted to our ability to provide such
infrastructure on a fee for service basis.
Medical Devices and Diagnostics (MD&D)
Our MD&D group provides an array of sales and marketing services to the
MD&D industry. Our core service is the provision of clinical sales teams. Our
clinical sales teams employ nurses, medical technologists, and other clinicians
who train and provide hands-on clinical education and after sales support to the
medical staff of hospitals and clinics that recently purchased our clients'
equipment. Our activities maximize product utilization and customer satisfaction
for the medical practitioners, while simultaneously enabling our clients' sales
forces to continue their selling activities instead of in-servicing the
equipment.
We also provide contract sales services within the MD&D market. We
leveraged our knowledge from years of providing sales forces to the
pharmaceutical industry and applied it to our MD&D business. As a result, we now
offer the provision of contract sales forces as one of the services that we
market to the MD&D industry to assist our clients in improving product sales.
In October 2002, we partnered with Xylos Corporation (Xylos) for the
exclusive U.S. commercialization rights to the Xylos XCell(TM) Cellulose Wound
Dressing (XCell) wound care products, by entering into an agreement pursuant to
which we became the exclusive commercialization partner for the sales, marketing
and distribution of the product line in the U.S. On January 2, 2004, we
exercised our contractual right to terminate the agreement on 135 days' notice
to Xylos since sales of XCell were not sufficient enough to sustain our
continued role as commercialization partner for the product. Our promotional
activities in support of the brand concluded in January 2004 and the agreement
will terminate effective May 16, 2004. We do not currently anticipate entering
into similar commercialization agreements in the MD&D market.
This segment represents 3.8% of consolidated revenue for 2003.
History
We commenced operations as a contract sales organization in 1987. From 1990
to 1995 contract sales became accepted in the pharmaceutical industry as a
tactical solution for a lower cost, high quality sales team. The representatives
were principally flextime. We were paid per call and there was little, if any,
risk sharing.
The expansion of pharmaceutical field forces in general and the acceptance
of contract sales by the industry were two main drivers that fueled our high
growth from 1996 to 2000. Our representatives were principally full-time
employees and we provided a compensation package that was competitive with those
of the major pharmaceutical companies in order to attract higher quality
personnel and become a better provider of contract sales services.
We completed our initial public offering in May 1998. In May 1999, we
acquired TVG, Inc. (TVG) which gave us one of the leading marketing research
groups in the U.S. and a scientifically focused medical education capability.
The addition of TVG provided us with incremental growth potential as a result of
the additional capabilities available to support our service offerings.
In August 1999, we added a shared sales capability through the acquisition
of ProtoCall, Inc. (ProtoCall), now PDI Shared Sales. This addition provided us
with a lower cost product offering and increased business opportunities with
existing and new clients. This offering also supplemented our dedicated sales
force capacity.
In September 2001, we acquired InServe Support Solutions (InServe) which
provides clinical sales support to the MD&D industry. InServe employs nurses,
medical technologists, and other clinicians who train healthcare practitioners
with respect to medical equipment. InServe informs and supports the end users of
medical equipment, with the objective of increasing satisfaction and utilization
of the equipment. The client benefits by reducing the time its sales
representatives spend on training and service, increasing the time available for
sales activity.
6
In June 2000, we established LifeCycle Ventures, Inc. (LCV) to support our
agreements that require marketing and other commercial capabilities. Our initial
strategy, in response to the market dynamics at the time, was to identify
under-promoted brands within pharmaceutical companies' product portfolios and
put a focused promotional effort behind them, increasing product performance.
This was the case in October 2000, when we entered into a sales, marketing and
distribution agreement with GlaxoSmithKline (GSK) in support of Ceftin(R). The
Ceftin agreement enabled us to add capabilities that we did not then have, such
as distribution, medical affairs, regulatory affairs and managed care and trade
relations.
The Ceftin agreement was terminated earlier than anticipated because of the
unexpected introduction of a generic equivalent into the market in February
2002. Notwithstanding this event, the Ceftin agreement successfully facilitated
our growth from a pure service provider to a commercial partner with expanded
capabilities and service offerings for the pharmaceutical industry.
From 2001 through 2003, we continued to identify other late stage
pharmaceutical products that could benefit from focused sales and marketing
efforts. Many companies had products within their portfolios that were
under-promoted and that could potentially benefit from focused sales and
marketing efforts. As the dynamics within the industry changed, affected by
mergers and acquisitions, a slowdown in the approval of new products, and
increased generic availability of once large brands, the willingness of
pharmaceutical companies to relinquish commercial control of products decreased.
During this period, we entered into a number of copromotion agreements,
including our agreements with Novartis Pharmaceuticals Corporation (Novartis).
Our copromotion agreement with Eli Lilly and Company (Eli Lilly) resulted in
significant operating losses. While copromotion agreements remain a viable
business arrangement with pharmaceutical companies, we now have a more stringent
set of parameters that must be met in order for us to consider an opportunity
favorably.
In the fourth quarter of 2002, we entered into two licensing arrangements,
one with Xylos and one with Cellegy Corporation (Cellegy). The Xylos arrangement
was for the sales, marketing and distribution rights for the XCell wound care
products. This product line achieved only modest sales during 2003, considerably
below expectations, and on January 2, 2004, we gave Xylos notice of termination
of the Xylos agreement effective May 16, 2004. The Cellegy agreement was for
exclusive North American rights for Fortigel(TM), a testosterone gel product. In
July 2003, Cellegy was notified by the U.S. Food and Drug Administration (FDA)
that Fortigel was not approved. On December 12, 2003, we instituted an action
against Cellegy in the U.S. District Court for the Southern District of New York
seeking to rescind the Cellegy license agreement on the grounds that it was
procured by fraud.
We believe that there are opportunities for us:
o to partner with companies that lack the necessary infrastructure
to commercialize their brands; and
o to take over the promotion of products that are no longer
receiving sales and marketing support .
Corporate Strategy
Our strategy is to source biopharmaceutical and MD&D products that we can
sell, market or commercialize. We do this by entering into agreements with
companies that own the rights to the product(s) and require our expertise in
generating product sales. We are compensated either through a fee for service or
by sharing in the product sales we generate. Also, we intend to focus on growing
our existing teams business and to seek acquisition opportunities within SMSG.
Contracts
Given the customized nature of our business, we utilize a variety of
contract structures.
Contracts within the sales and marketing services group are almost
exclusively fee for service. These contracts for dedicated teams, shared teams
and marketing research and medical education, contain specific activities that
we provide in return for a fee. They may contain operational benchmarks, such as
a minimum amount of activity or delivery within a specified amount of time.
These contracts can include incentive payments should our activities
7
generate results that meet or exceed predetermined performance targets.
The majority of our revenue in the sales and marketing services segment is
generated by contracts for dedicated sales teams. These contracts are generally
for terms of one to three years and may be renewed or extended. The majority of
these contracts, however, are terminable by the client for any reason upon 30 to
90 days' notice. These contracts typically, but not always, provide for
termination payments by the client upon termination without cause. While such
termination 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, these penalties may not offset the revenue we could have
earned under the contract or the costs we may incur as a result of its
termination. The loss or termination of a large contract or the loss of multiple
contracts could have a material adverse effect on our business, financial
condition and results of operations. Contracts may also be terminated for cause
or we may incur specific penalties if we fail to meet stated performance
benchmarks.
Our marketing research and consulting and medical education and
communications contracts generally are for projects lasting from three to six
months. The contracts are terminable by the client and typically provide for
termination payments in the event they are terminated by the client 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 these contracts, it is unlikely the loss or termination of
any individual contract would have a material adverse effect on our business,
financial condition or results of operations.
The contracts within the pharmaceutical products group can be either
performance based or fee for service and may require sales, marketing and
distribution of product. In performance based contracts, we provide and finance
a portion, if not all, of the commercial activities in support of a brand in
return for a percentage of product sales. An important performance parameter is
normally the level of sales or prescriptions attained by the product during the
period of our marketing or promotional responsibility, and in some cases, for
periods after our promotional activities have ended.
In the fourth quarter of 2000, we entered into a performance based contract
with GSK. Our agreement with GSK was in support of Ceftin and was an exclusive
sales, marketing and distribution contract. 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, due to
the unexpected entry of a competitive generic product.
In May 2001, we entered into a copromotion agreement with Novartis for the
U.S. sales, marketing and promotion rights for Lotensin(R), Lotensin HCT(R) and
Lotrel(R). That agreement ran through December 31, 2003. On May 20, 2002, that
agreement was replaced by two separate agreements: one for Lotensin and another
one for Lotrel, Diovan(R) and Diovan HCT(R). Both agreements ran through
December 31, 2003; however, the Lotrel-Diovan agreement was renewed on December
24, 2003 for an additional one year period. In February 2004, we were notified
by Novartis of its intent to terminate the Lotrel-Diovan contract without cause,
effective March 16, 2004. We will continue to be compensated under the terms of
the agreement through the effective termination date. The Lotensin agreement
called for us to provide promotion, selling, marketing and brand management for
Lotensin. In exchange, we were entitled to receive a percentage of product
revenue based on certain total prescription (TRx) objectives above specified
contractual baselines. Even though the Lotensin agreement ended December 31,
2003, we are still entitled to receive royalty payments on the sales of Lotensin
through December 31, 2004.
In October 2001, we entered into an agreement with Eli Lilly to copromote
Evista(R) in the U.S. Under this agreement, we were entitled to be compensated
based upon net sales achieved above a predetermined level. In the event these
predetermined net sales levels were not achieved, we would not receive any
revenue to offset expenses incurred. During 2002, it became apparent that the
net sales levels likely to be achieved would not be sufficient to recoup our
expenses. In November 2002, we agreed with Eli Lilly to terminate the Evista
copromotion agreement effective December 31, 2002.
In October 2002, we entered into an agreement with Xylos for the exclusive
U.S. commercialization rights to the XCell wound care products. On January 2,
2004, we exercised our contractual right to terminate the agreement on 135 days'
notice to Xylos, since sales of XCell were not sufficient to sustain our role as
commercialization partner for the product. Our promotional activities in support
of the brand concluded in January 2004, and the agreement will terminate
effective May 16, 2004.
8
On December 31, 2002, we entered into an exclusive licensing agreement with
Cellegy for the exclusive North American rights for the testosterone gel
product, Fortigel. 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 FDA in June 2002. In July 2003, Cellegy received a letter from
the FDA rejecting its NDA for Fortigel. Cellegy has told us that it 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 payment was made prior to FDA approval
and since there is no alternative future use of the licensed rights, we expensed
the $15.0 million payment 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, 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 (if such approvals are obtained) 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.
On December 12, 2003, we instituted an action against Cellegy in the U.S.
District Court for the Southern District of New York seeking to rescind the
license agreement on the grounds that it was procured by fraud. We are seeking
return of the $15.0 million license fee we paid plus additional damages caused
by Cellegy's conduct. See Item 3 - "Legal Proceedings" for additional
information.
Significant Customers
Our significant customers are discussed in Note 12 to the consolidated
financial statements included elsewhere in this report.
Marketing
Our marketing efforts target the biopharmaceutical and MD&D industries.
Companies with large product portfolios have been the most likely customers for
the services and solutions we provide, but we have also partnered with smaller,
emerging companies. Our marketing efforts are designed to reach the senior
sales, marketing and business development personnel within these companies, with
the goal of informing them of our full range of services and our reputation as a
high quality sales and marketing organization. Our tactical plan includes
advertising in trade publications, direct mail campaigns, presence at industry
seminars and a direct selling effort. We have a dedicated team of business
development specialists who work across the organization to identify needs
within the biopharmaceutical and MD&D industries which we can address. A
multi-disciplinary team of senior managers reviews possible business
opportunities as identified by the business development team and determines
strategies and negotiation positions to contract for the most attractive
business opportunities.
Competition
There are relatively few barriers to entry into the businesses in which we
operate and, as the industry continues to evolve, new competitors are likely to
emerge. We compete on the basis of such factors as reputation, service quality,
management experience, performance record, customer satisfaction, ability to
respond to specific client needs, integration skills and price. We believe we
compete effectively with respect to each of these factors. Increased competition
may lead to price and other forms of competition that could have a material
adverse effect on our business, financial condition and results of operations.
For our service offerings, the competition includes in-house sales and
marketing departments of biopharmaceutical and MD&D companies, emerging
companies within these segments and other contract sales organizations (CSOs).
Companies that compete with us from the perspective of having diversified
service offerings include Innovex (a subsidiary of Quintiles Transnational),
Ventiv Health, Nelson Professional Sales (a division of Publicis) and Cardinal
Health, Inc.
9
The competition for sourcing products into our PPG is primarily other
companies seeking to sell and market pharmaceutical products. Competing to
copromote, license and/or acquire brands involves risks in identifying,
assessing and contracting effectively for products in addition to the marketing
and distribution risks of the products we obtain.
Government and Industry Regulation
The healthcare sector is heavily regulated by both government and industry.
Various laws, regulations and guidelines established by government, industry and
professional bodies affect, among other matters, the approval, provision,
licensing, labeling, marketing, promotion, price, sale and reimbursement of
healthcare services and products, including pharmaceutical and MD&D products.
The federal government has extensive enforcement powers over the activities of
pharmaceutical manufacturers, including authority to withdraw product approvals,
commence actions to seize and prohibit the sale of unapproved or non-complying
products, to halt manufacturing operations that are not in compliance with good
manufacturing practices, and to impose or seek injunctions, voluntary recalls,
and civil monetary and criminal penalties. These restrictions or prohibitions on
sales or withdrawal of approval of products marketed by us could have a material
adverse effect on our business, financial condition and results of operations.
The Food, Drug and Cosmetic Act, as supplemented by various other statutes,
regulates, among other matters, the approval, labeling, advertising, promotion,
sale and distribution of drugs, including the practice of providing product
samples to physicians. Under this statute, the FDA regulates all promotional
activities involving prescription drugs. The distribution of pharmaceutical
products is also governed by the Prescription Drug Marketing Act (PDMA), which
regulates these activities at both the federal and state level. The PDMA imposes
extensive licensing, personnel record keeping, packaging, quantity, labeling,
product handling and facility storage and security requirements intended to
prevent the sale of pharmaceutical product samples or other diversions. Under
the PDMA and its implementing regulations, states are permitted to require
registration of manufacturers and distributors who provide pharmaceutical
products even if such manufacturers or distributors have no place of business
within the state. States are also permitted to adopt regulations limiting the
distribution of product samples to licensed practitioners and require extensive
record keeping and labeling of such samples for tracing purposes. The sale or
distribution of pharmaceutical products is also governed by the Federal Trade
Commission Act.
Some of the services that we currently perform or that we may provide in
the future may also be affected by various guidelines established by industry
and professional organizations. For example, ethical guidelines established by
the American Medical Association (AMA) govern, among other matters, the receipt
by physicians of gifts from health-related entities. These guidelines govern
honoraria and other items of economic value which AMA member physicians may
receive, directly or indirectly, from pharmaceutical companies. Similar
guidelines and policies have been adopted by other professional and industry
organizations, such as Pharmaceutical Research and Manufacturers of America, an
industry trade group.
There are also numerous federal and state laws pertaining to healthcare
fraud and abuse. In particular, certain federal and state laws prohibit
manufacturers, suppliers and providers from offering, giving or receiving
kickbacks or other remuneration in connection with ordering or recommending the
purchase or rental of healthcare items and services. The federal anti-kickback
statute imposes both civil and criminal penalties for, among other things,
offering or paying any remuneration to induce someone to refer patients to, or
to purchase, lease or order (or arrange for or recommend the purchase, lease or
order of) any item or service for which payment may be made by Medicare or other
federally-funded state healthcare programs (e.g., Medicaid). This statute also
prohibits soliciting or receiving any remuneration in exchange for engaging in
any of these activities. The prohibition applies whether the remuneration is
provided directly or indirectly, overtly or covertly, in cash or in kind.
Violations of the statute can result in numerous sanctions, including criminal
fines, imprisonment and exclusion from participation in the Medicare and
Medicaid programs.
Several states also have referral, fee splitting and other similar laws
that may restrict the payment or receipt of remuneration in connection with the
purchase or rental of medical equipment and supplies. State laws vary in scope
and have been infrequently interpreted by courts and regulatory agencies, but
may apply to all healthcare items or services, regardless of whether Medicare or
Medicaid funds are involved.
10
The FDA regulates the drug development process in the U.S. This impacts
products we may develop, license or acquire, including, for example, the Cellegy
licensed product. These regulations affect all aspects of the research programs
conducted on unapproved products in the U.S., including manufacturing of the
drug substance and drug product, preliminary pharmacology and toxicology
evaluation, and all exposure of human subjects or patients. This human testing
is performed under an Investigational New Drug Exemption (IND). When sufficient
evidence of efficacy and safety is available to enable unrestricted commercial
distribution, an NDA is submitted under the regulations. The NDA is a
comprehensive filing that includes, among other things, the results of all
Chemistry, Manufacturing and Controls (CMC) preclinical and clinical studies.
The FDA's review of this application results in a decision on the approval or
non-approval of the drug. Approved drugs may be marketed in the U.S.
post-approval, however, the NDA regulations require continuing monitoring and
reporting on the safety of the approved product in the general patient
population.
We cannot determine what effect changes in regulations or statutes or legal
interpretations, when and if established or enacted, may have on our business in
the future. Changes could require, among other things, changes to manufacturing
methods, expanded or different labeling, the recall, replacement or
discontinuance of certain products, additional record keeping or expanded
documentation of the properties of certain products and scientific
substantiation. Further, we may experience delays in the regulatory approval of
products we license or acquire. Such changes, or new legislation, or delays
could have a material adverse effect on our business, financial condition and
results of operations. Our failure, or the failure of our clients and/or the
partners, to comply with, or any change in, the applicable regulatory
requirements or professional organization or industry guidelines or regulatory
delays could, among other things, limit or prohibit us or our clients from
conducting business activities as presently conducted or proposed to be
conducted, result in adverse publicity, increase the costs of regulatory
compliance or result in monetary fines or other penalties. Any of these
occurrences could have a material adverse effect on our business, financial
condition and results of operations.
RISK FACTORS
In addition to the other information provided in our reports, you should
carefully consider the following factors in evaluating our business, operations
and financial condition. Additional risks and uncertainties not presently known
to us, that we currently deem immaterial or that are similar to those faced by
other companies in our industry or business in general, such as competitive
conditions, may also impair our business operations. The occurrence of any of
the following risks could have a material adverse effect on our business,
financial condition and results of operations.
We continue to look for opportunities to develop the pharmaceutical
products group segment of our business, which may include copromotion and
exclusive distribution arrangements, as well as licensing and brand ownership of
products, and most recently, Integrated Commercialization Services (ICS). We
cannot assure you that we can successfully develop this business.
Notwithstanding the fact that we had no product revenue from the
pharmaceutical products group segment of our business in 2003, we believe that
one area for our future growth is potentially to acquire copromotion and
distribution rights to pharmaceutical products and potentially to license or
acquire these products. These types of arrangements can significantly increase
our operating expenditures in the short-term. Typically, these agreements
require significant "upfront" payments, minimum purchase requirements, minimum
royalty payments, payments to third parties for production, inventory
maintenance and control, distribution services and accounts receivable
administration, as well as sales and marketing expenditures. In addition,
particularly where we license or acquire products before they are approved for
commercial use, we may be required to incur significant expense to gain the
required regulatory approvals. As a result, our working capital balance and cash
flow position could be materially and adversely affected until the products in
question become commercially viable, if ever. The risks that we face in
developing the pharmaceutical product segment of our business may increase in
proportion with:
o the number and types of products covered by these types of
agreements;
o the applicable stage of the drug regulatory process of the
products at the time we enter into these agreements; and
o our control over the manufacturing, distribution and marketing
processes.
11
In December 2002, we acquired from Cellegy the exclusive right to market
and sell Fortigel, a transdermal testosterone gel for the treatment of male
hypogonadism in the U.S., Puerto Rico, Mexico and Canada. While we have entered
into copromotion and exclusive distribution arrangements in the past, the
Cellegy agreement is our first licensing arrangement. We paid an initial $15.0
million license fee and another $10.0 million incremental license fee milestone
payment is due after the product has all FDA approvals (if such approvals are
obtained) required to promote, sell and distribute the product in the U.S. If
the drug is approved, in addition to paying Cellegy a royalty based on net
sales, all of the costs associated with manufacturing the drug, distributing it,
as well as sales and marketing expenditures would be our obligation. If
additional testing is required after the drug is approved for sale in the U.S.,
the costs associated with those tests are our obligation as well. Furthermore,
if we want to sell the drug in Mexico and Canada, we must fund the regulatory
process in those countries.
In July 2003, Cellegy received a letter from the FDA rejecting its NDA for
Fortigel. In December 2003, we filed a lawsuit against Cellegy for fraudulently
inducing us to enter the Cellegy License Agreement and for breaching certain
obligations under the License Agreement. (See Item 3 - Legal Proceedings, Note
19 - Commitments and Contingencies, and the Risk Factor describing the Cellegy
litigation in this section, below.) Since we filed the lawsuit, Cellegy is no
longer in regular contact with us regarding Fortigel. Thus, for example, we are
unaware of the FDA status regarding Fortigel (as of December 31, 2003, it had
not been approved) and are unaware of what steps Cellegy is taking to develop
Fortigel, to obtain FDA approval for Fortigel, and/or to arrange for a party to
manufacture Fortigel. We have requested this information from Cellegy but have
not received it. Accordingly, we may not possess the most current and reliable
information concerning the current status of, or future prospects relating to,
Fortigel. The issuance of the non-approvable letter by the FDA concerning
Fortigel, however, casts significant doubt upon Fortigel's prospects and whether
it will ever be approved. There can thus be no assurances that we will recover
the $15.0 million license fee or that we will ever receive any revenue in
connection with the Cellegy license agreement.
We are involved in lawsuits with Cellegy concerning the Cellegy License
Agreement.
On December 12, 2003, we filed a complaint against Cellegy in the United
States District Court for the Southern District of New York. The complaint
alleges that Cellegy fraudulently induced us to enter into the Cellegy license
agreement. The complaint also sets forth claims for misrepresentation and breach
of contract related to the license agreement. In the complaint, we seek, among
other remedies, rescission of the license agreement and return of the $15.0
million license fee we paid Cellegy. After we filed this lawsuit, also on
December 12, 2003, Cellegy filed a complaint against us in the United States
District Court for the Northern District of California. Cellegy's complaint
seeks a declaration that Cellegy did not fraudulently induce us to enter into
the license agreement and that Cellegy has not breached its obligations under
the agreement. Cellegy has sought to stay, dismiss or transfer our suit in favor
of its action in the California courts. We have sought to stay, transfer or
dismiss Cellegy's lawsuit in favor of its action in the New York courts. We are
unable to predict the ultimate outcome of these lawsuits.
We rely on third parties to manufacture all of our products and supply raw
materials. Our dependence on these third parties may result in unforeseen delays
or other problems beyond our control, which could have a material adverse effect
on our business, financial condition and results of operations and our
reputation.
We do not manufacture any products and expect to continue to depend on
third parties to provide us with sufficient quantities of products to meet
demand. As a result, we cannot assure you that we will always have a sufficient
supply of products on hand to satisfy demand or that the products we do have
will meet our specifications. This risk is more acute in those situations where
we have no control over the manufacturers. For example, our agreement with
Cellegy obligates us to purchase all quantities of the product from PanGeo
Pharma Inc. (PanGeo), a third-party manufacturer with which we have no
contractual relationship and to which Cellegy has granted exclusive
manufacturing rights. If there are any problems with this contract manufacturer,
the supply of product could be temporarily halted until either PanGeo is able to
get their facilities back on-line or we are able to source another supplier for
the product. Since we filed a lawsuit against Cellegy as described above,
Cellegy is no longer in regular contact with us regarding its manufacturing
capabilities to produce Fortigel. Accordingly, we may not possess the most
current and reliable information concerning PanGeo or other manufacturing
arrangements for Fortigel that may have been established by Cellegy. This
manufacturing shutdown could have a material impact on the future demand for the
product and thus could have a material adverse effect on our business, financial
condition and results of operations. Even if third-party manufacturers comply
with the terms of their supply arrangements, we cannot be
12
certain that supply interruptions will not occur or that our inventory will
always be adequate. Numerous factors could cause interruptions in the supply of
our finished products, including shortages in raw materials, strikes and
transportation difficulties. Any disruption in the supply of raw materials or an
increase in the cost of raw materials to our supplier could have a significant
effect on its ability to supply us with products.
In addition, manufacturers of products requiring FDA approval are required
to comply with FDA mandated standards, referred to as good manufacturing
practices, relating not only to the manufacturing process but to record-keeping
and quality control activities as well. Furthermore, they must pass a
pre-approval inspection of manufacturing facilities by the FDA and foreign
authorities before obtaining marketing approval, and are subject to periodic
inspection by the FDA and corresponding foreign regulatory authorities under
reciprocal agreements with the FDA. These inspections may result in compliance
issues that could prevent or delay marketing approval or require significant
expenditures on corrective measures.
If for any reason we are unable to obtain or retain our relationships with
third-party manufacturers on commercially acceptable terms, or if we encounter
delays or difficulties with contract manufacturers in producing or packaging our
products, the distribution, marketing and subsequent sales of these products
would be adversely affected, and we may have to seek alternative sources of
supply. We cannot assure you that we will be able to maintain our existing
manufacturing relationships or enter into new ones on commercially acceptable
terms, if at all.
Our license agreements may require us to make minimum payments to the licensor,
regardless of the revenue derived under the license, which could further strain
our working capital and cash flow position. In addition, these agreements may be
nonexclusive or may condition exclusivity on minimum sales levels.
Under our license agreement with Cellegy, we are required to make certain
minimum royalty payments to Cellegy once the product is approved, assuming such
an approval occurs. If the Cellegy product fails to gain market acceptance, we
would still be required to make these minimum royalty payments. This would
likely have a material adverse effect on our business, financial condition and
results of operations. In addition, the Cellegy License Agreement requires us to
satisfy certain minimum net sales requirements. If we fail to satisfy these
minimum net sales requirements, under certain circumstances Cellegy may, at its
option, convert our exclusive license to a nonexclusive license. This could mean
that we would face increased competition from third parties with respect to the
marketing and sale of the product.
The regulatory approval process is expensive, time consuming and uncertain and
may prevent us from obtaining required approvals for the commercialization of
drugs and products that we license or acquire.
In those potential situations where we license or acquire ownership of
drugs or other medical or diagnostic equipment, the product in question may not
yet be approved for sale to the public, in which case we may have the obligation
to obtain the required regulatory approvals. The research, testing,
manufacturing and marketing of drugs and other medical and diagnostic devices is
heavily regulated in the U.S. and other countries. The regulatory clearance
process typically takes many years and is extremely expensive. Despite the time
and expense expended, regulatory clearance is never guaranteed. The FDA can
delay, limit or deny approval of a drug for many reasons, including:
o safety or efficacy;
o inconsistent or inconclusive data or test results;
o failure to demonstrate compliance with the FDA's good
manufacturing practices; or
o changes in the approval process or new regulations.
The FDA continues to regulate the sale and marketing of drugs and medical and
diagnostic devices even after they have been approved for sale to the public.
Complying with these regulations may be costly and our failure to comply could
limit our ability to continue marketing and distributing these products.
Even after drugs have been approved for sale, the FDA continues to regulate
their sale. These post-approval regulatory requirements may require further
testing and/or clinical studies, and may limit our ability to market and
distribute the product or may limit the use of the product. Under our agreement
with Cellegy, we are responsible for
13
all post-approval regulatory compliance. If we fail to comply with the
regulatory requirements of the FDA, we may be subject to one or more of the
following administrative or judicially imposed sanctions:
o warning letters;
o civil penalties;
o criminal penalties;
o injunctions;
o product seizure or detention;
o product recalls;
o total or partial suspension of production; and
o FDA refusal to approve pending NDAs, or supplements to approved
NDAs.
FDA approval does not guarantee commercial success. If we fail to successfully
commercialize our products, our business, financial condition and results of
operations could be materially and adversely affected.
Even if a product is approved for sale to the general public, its
commercial success will depend on our marketing efforts and acceptance by the
general public. The commercial success of any drug or medical or diagnostic
device depends on a number of factors, including:
o demonstration of clinical efficacy and safety;
o cost;
o reimbursement policies of large third-party payors;
o competitive products;
o convenience and ease of administration;
o potential advantages over alternative treatment methods;
o marketing and distribution support; and
o successfully creating and sustaining demand.
We cannot assure you that any of our products will achieve commercial
success, regardless of how effective they may be.
Failure to obtain adequate reimbursement could limit our ability to market
products.
Our ability to commercialize products, including licensed or acquired
products, will depend in part on the reimbursements, if any, obtained from
third-party payors such as government health administration authorities, private
health insurers, managed care programs and other organizations. Third-party
payors are increasingly attempting to contain healthcare costs by limiting both
coverage and the level of reimbursement for pharmaceutical products and medical
devices. Cost control initiatives could decrease the price that we would receive
for products and affect our ability to commercialize any product. Third-party
payors also tend to discourage use of branded products when generic substitutes
are available. As a result, reimbursement may not be available to enable us to
maintain price levels sufficient to realize an appropriate return on our
investment in product acquisition and development. If adequate reimbursement
levels for either newly approved or branded products are not provided, our
business, financial condition and results of operations could be materially and
adversely affected.
We may require additional funds in order to implement our evolving business
model.
We may require additional funds in order to:
o license or acquire additional pharmaceutical or medical device
products or technologies;
o pursue regulatory approvals;
o develop incremental marketing and sales capabilities;
o pursue other business opportunities or meet future operating
requirements; and
o acquire other services businesses.
14
We may seek additional funding through public or private equity or debt
financing or other arrangements with collaborative partners. If we raise
additional funds by issuing equity securities, further dilution to existing
stockholders may result. In addition, as a condition to providing us with
additional funds, future investors may demand, and may be granted, rights
superior to those of existing stockholders. We cannot be sure, however, that
additional financing will be available from any of these sources or, if
available, will be available on acceptable or affordable terms. If adequate
additional funds are not available, we may be required to delay, reduce the
scope of, or eliminate one or more of our growth strategies.
Our contract sales business depends on expenditures by companies in the life
sciences industries.
Our service revenues depend on promotional, marketing and sales
expenditures by companies in the life sciences industries, including the
pharmaceutical, MD&D and biotechnology industries. Promotional, marketing and
sales expenditures by pharmaceutical manufacturers have in the past been, and
could in the future be, negatively impacted by, among other things, governmental
reform or private market initiatives intended to reduce the cost of
pharmaceutical products or by governmental, medical association or
pharmaceutical industry initiatives designed to regulate the manner in which
pharmaceutical manufacturers promote their products. Furthermore, the trend in
the life sciences industries toward consolidation may result in a reduction in
overall sales and marketing expenditures and, potentially, a reduction in the
use of contract sales and marketing services providers.
Changes in outsourcing trends in the pharmaceutical and biotechnology industries
could materially adversely affect our business, financial condition, results of
operations and growth rate.
Our business and growth depend in large part on demand from the
pharmaceutical and life sciences industries for outsourced marketing and sales
services. The practice of many companies in these industries has been to hire
outside organizations like us to conduct large sales and marketing projects.
However, companies may elect to perform these services internally for a variety
of reasons, including the rate of new product development and FDA approval of
those products, number of sales representatives employed internally in relation
to demand for or the need to promote new and existing products, and competition
from other suppliers. If these industries reduce their tendency to outsource
these projects, our business, financial condition, results of operations and
growth rate could be materially adversely affected.
Product liability claims could harm our business.
We could face substantial product liability claims in the event users of
any of the pharmaceutical and medical device products we market now or in the
future are alleged to cause negative reactions or adverse side effects or in the
event any of these products causes injury, is alleged to be unsuitable for its
intended purpose or is alleged to be otherwise defective. For example, we have
been named in numerous lawsuits as a result of our detailing of Baycol(R) on
behalf of Bayer Corporation (Bayer). Product liability claims, regardless of
their merits, could be costly and divert management's attention, or adversely
affect our reputation and the demand for our products. Although we currently
have product liability insurance in the aggregate amount of $10.0 million, we
cannot assure you that our insurance will be sufficient to cover fully all
potential claims. Also, adequate insurance coverage might not be available in
the future at acceptable costs, if at all.
We may be unable to secure or enforce adequate intellectual property rights to
protect the products or technologies we acquire, license or develop.
Our ability to successfully commercialize newly branded products or
technologies depends on our ability to secure and enforce intellectual property
rights, generally patents, and we may be unable to do so. To obtain patent
protection, we must be able to successfully persuade the U.S. Patent and
Trademark Office and its foreign counterparts to issue patents on a timely basis
and possibly in the face of third-party challenges. Even if we are granted a
patent, our rights may later be challenged or circumvented by third parties.
Likewise, a third-party may challenge our trademarks or, alternatively, use a
confusingly similar trademark. The issuance of a patent is not conclusive as to
its validity or enforceability and the patent life is limited. In addition, from
time to time, we might receive notices from third parties regarding patent
claims against us. These type claims, with or without merit, could be
time-consuming to defend, result in costly litigation, divert management's
attention and resources, and cause us to incur significant expenses. As a result
of litigation over intellectual property rights, we may be required to stop
15
selling a product, obtain a license from the owner to sell the product in
question or use the relevant intellectual property, which we may not be able to
obtain on favorable terms, if at all, or modify a product to avoid using the
relevant intellectual property. A successful claim of infringement against us
could have a material adverse effect on our business, financial condition and
results of operations.
If we do not meet performance goals set in our incentive-based and revenue
sharing arrangements, our profits could suffer.
We have the opportunity to analyze and sometimes enter into incentive-based
and revenue sharing arrangements with pharmaceutical companies. Under
incentive-based arrangements, we are typically paid a fixed fee and, in
addition, have an opportunity to increase our earnings based on the market
performance of the products being detailed in relation to targeted sales
volumes, sales force performance metrics or a combination thereof. Under revenue
sharing arrangements, our compensation is based on the market performance of the
products being detailed, usually expressed as a percentage of product sales.
These types of arrangements transfer some market risk from our clients to us. In
addition, these arrangements can result in variability in revenue and earnings
due to seasonality of product usage, changes in market share, new product
introductions, overall promotional efforts and other market related factors. As
an example, in October 2001, we entered into an agreement with Eli Lilly to
copromote Evista in the U.S. under which we were to receive payments once
product net sales exceeded a pre-determined baseline. Our net sales of Evista
were insufficient for us to achieve our revenue and profit goals and as a result
we incurred an operating loss for 2002 of $35.1 million on this contract, $28.9
million from operating activities and $6.2 million in unused sales force
capacity. This contract was terminated effective December 31, 2002.
Most of our service revenue is derived from a limited number of clients, the
loss of any one of which could adversely affect our business.
Our revenue and profitability depend to a great extent on our relationships
with a limited number of large pharmaceutical companies. In 2003, we had two
major clients that accounted for approximately 35.3% and 32.4%, respectively, or
a total of 67.7%, 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 could have a
material adverse effect on our business, financial condition and results of
operations. For example, in February 2004, we announced the early termination of
our fee for service contract arrangement with Novartis for the promotion of
Diovan and Lotrel. As a result, $28.9 million of anticipated revenue associated
with the Novartis contract in 2004 will not be realized. In February 2002, we
announced the termination of our fee for service contract arrangement with Bayer
and as a result, our 2002 revenues were reduced by approximately $20.0 million.
Our service contracts are generally short-term agreements and are cancelable at
any time, which may result in lost revenue and additional costs and expenses.
Our service contracts are generally for a term of one to three years and
many may be terminated by the client at any time for any reason. For example, as
discussed above, as a result of the early termination of our fee for service
contract arrangements with Bayer and Novartis, our 2002 revenues were reduced by
approximately $20.0 million due to the Bayer contract termination, and $28.9
million of anticipated revenue associated with the Novartis contract in 2004
will not be realized. The termination of a contract by one of our major clients
not only results in lost revenue, but also may cause us to incur additional
costs and expenses. All of our sales representatives are employees rather than
independent contractors. Accordingly, when a contract is terminated, unless we
can immediately transfer the related sales force to a new program, we either
must continue to compensate those employees, without realizing any related
revenue, or terminate their employment. If we terminate their employment, we may
incur significant expenses relating to their termination.
We and two of our officers are defendants in a class action shareholder lawsuit
which could divert our time and attention from more productive activities.
Beginning on January 24, 2002, several purported class action complaints
were filed in the U.S. District Court for the District of New Jersey, against us
and certain of our officers on behalf of persons who purchased our common stock
during the period between May 22, 2001 and August 12, 2002. We believe that
meritorious defenses
16
exist to the allegations asserted in these lawsuits and we intend to vigorously
defend these actions. Although we currently maintain director and officer
liability insurance coverage, there is no assurance that we will continue to
maintain such coverage or that any such coverage will be adequate to offset
potential damages.
Our failure, or that of our clients, to comply with applicable healthcare
regulations could limit, prohibit or otherwise adversely impact our business
activities.
Various laws, regulations and guidelines established by government,
industry and professional bodies affect, among other matters, the provision of,
licensing, labeling, marketing, promotion, sale and distribution of healthcare
services and products, including pharmaceutical and MD&D products. In
particular, the healthcare industry is governed by various federal and state
laws pertaining to healthcare fraud and abuse, including prohibitions on the
payment or acceptance of kickbacks or other remuneration in return for the
purchase or lease of products that are paid for by Medicare or Medicaid.
Sanctions for violating these laws include civil and criminal fines and
penalties and possible exclusion from Medicare, Medicaid and other federal or
state healthcare programs. Although we believe our current business arrangements
do not violate these federal and state fraud and abuse laws, we cannot be
certain that our business practices will not be challenged under these laws in
the future or that a challenge would not have a material adverse effect on our
business, financial condition and results of operations. Our failure, or the
failure of our clients, to comply with these laws, regulations and guidelines,
or any change in these laws, regulations and guidelines may, among other things,
limit or prohibit our business activities or those of our clients, subject us or
our clients to adverse publicity, increase the cost of regulatory compliance and
insurance coverage or subject us or our clients to monetary fines or other
penalties.
Our industry is highly competitive and our failure to address competitive
developments promptly will limit our ability to retain and increase our market
share.
Our primary competitors for sales services include in-house sales and
marketing departments of pharmaceutical companies, other CSOs and drug
wholesalers. We also compete for the licensing and acquisition of pharmaceutical
and MD&D products with other larger pharmaceutical and MD&D companies. There are
relatively few barriers to entry in the businesses in which we compete and, as
the industry continues to evolve, new competitors are likely to emerge. Many of
our current and potential competitors are larger than we are and have
substantially greater capital, personnel and other resources than we have.
Increased competition may lead to price and other forms of competition that
could have a material adverse effect on our market share, our ability to source
new business opportunities, our business, financial condition and results of
operations.
Consolidation of the wholesale distribution network for pharmaceutical products
could adversely impact the terms and conditions of our product sales.
The distribution network for pharmaceutical products has recently
experienced significant consolidation among wholesalers and chain stores. As a
result, a few large wholesale distributors control a significant share of the
market and we have less ability to negotiate price, return policies and other
terms and related provisions of the sale. As our distribution of products
expands, some of these wholesalers and distributors may account for a
significant portion of our product sales. Our inability to negotiate favorable
terms and conditions for product sales to those wholesalers could have a
material adverse effect on our business, financial condition and results of
operations.
If we are unable to attract key employees and consultants, we may be unable to
develop our emerging business model.
Successful execution of our business strategy depends, in large part, on
our ability to attract and retain qualified management, marketing and other
personnel with the skills and qualifications necessary to fully execute our
programs and strategy. Competition for personnel among companies in the
pharmaceutical industry is intense and we cannot assure you that we will be able
to continue to attract or retain the personnel necessary to support the growth
of our business.
17
Our business will suffer if we fail to attract and retain qualified sales
representatives.
The success and growth of our business depends on our ability to attract
and retain qualified pharmaceutical sales representatives. There is intense
competition for pharmaceutical sales representatives from CSOs and
pharmaceutical companies. On occasion, our clients have hired the sales
representatives that we trained to detail their products. We cannot be certain
that we can continue to attract and retain qualified personnel. If we cannot
attract and retain qualified sales personnel, we will not be able to expand our
teams business and our ability to perform under our existing contracts will be
impaired.
Our business will suffer if we lose certain key management personnel.
The success of our business also depends on our ability to attract and
retain qualified senior management, and financial and administrative personnel
who are in high demand and who often have multiple employment options.
Currently, we depend on a number of our senior executives, including Charles T.
Saldarini, our chief executive officer, Steven K. Budd, our president, global
sales and marketing services, and Bernard C. Boyle, our chief financial officer.
The loss of the services of any one or more of these executives could have a
material adverse effect on our business, financial condition and results of
operations. Except for a $5 million key-man life insurance policy on the life of
Mr. Saldarini and a $3 million policy on the life of Mr. Budd, we do not
maintain and do not contemplate obtaining insurance policies on any of our
employees.
Our controlling stockholder continues to have effective control of us, which
could delay or prevent a change in corporate control that may otherwise be
beneficial to our stockholders.
John P. Dugan, our chairman, beneficially owns approximately 34% of our
outstanding common stock. As a result, Mr. Dugan will be able to exercise
substantial control over the election of all of our directors, and to determine
the outcome of most corporate actions requiring stockholder approval, including
a merger with or into another company, the sale of all or substantially all of
our assets and amendments to our certificate of incorporation.
We have anti-takeover defenses that could delay or prevent an acquisition and
could adversely affect the price of our common stock.
Our certificate of incorporation and bylaws include provisions, such as
providing for three classes of directors, which are intended to enhance the
likelihood of continuity and stability in the composition of our board of
directors. These provisions may make it more difficult to remove our directors
and management and may adversely affect the price of our common stock. In
addition, our certificate of incorporation authorizes the issuance of "blank
check" preferred stock. This provision could have the effect of delaying,
deterring or preventing a future takeover or a change in control, unless the
takeover or change in control is approved by our board of directors, even though
the transaction might offer our stockholders an opportunity to sell their shares
at a price above the current market price.
Our quarterly revenues and operating results may vary, which may cause the price
of our common stock to fluctuate.
Our quarterly operating results may vary as a result of a number of
factors, including:
o the commencement, delay, cancellation or completion of programs;
o regulatory developments;
o uncertainty related to compensation based on achieving
performance benchmarks;
o the mix of services provided;
o the mix of programs -- i.e., contract sales, copromotion,
exclusive marketing, licenses;
o the timing and amount of expenses for implementing new programs
and services and acquiring license rights for products;
o the accuracy of estimates of resources required for ongoing
programs;
o the timing and integration of acquisitions;
o changes in regulations related to pharmaceutical companies; and
o general economic conditions.
18
In addition, in the case of revenue related to service contracts, we
recognize revenue as services are performed, while program costs, other than
training costs, are expensed as incurred. As a result, during the first two to
three months of a new contract, we may incur substantial expenses associated
with implementing that new program without recognizing any revenue under that
contract. This could have a material adverse impact on our operating results and
the price of our common stock for the quarters in which these expenses are
incurred. For these and other reasons, we believe that quarterly comparisons of
our financial results are not necessarily meaningful and should not be relied
upon as an indication of future performance. Fluctuations in quarterly results
could materially adversely affect the market price of our common stock in a
manner unrelated to our long-term operating performance.
Our stock price is volatile and could be further affected by events not within
our control. In 2003 our stock traded at a low of $6.86 and a high of $31.71.
The market for our common stock is volatile. The trading price of our
common stock has been and will continue to be subject to:
o volatility in the trading markets generally;
o significant fluctuations in our quarterly operating results;
o announcements regarding our business or the business of our
competitors;
o industry development;
o regulatory developments;
o changes in product mix;
o changes in revenue and revenue growth rates for us and for our
industry as a whole; and
o statements or changes in opinions, ratings or earnings estimates
made by brokerage firms or industry analysts relating to the
markets in which we operate or expect to operate.
Employees
As of December 31, 2003, we had 3,884 employees. Included in that amount
are 420 part-time field representatives employed by InServe, the number of which
vary from time to time based on project demand. We are not party to a collective
bargaining agreement with a labor union and we believe that our relations with
our employees are good.
Available Information
Our website address is www.pdi-inc.com. We are not including the
information contained on our website as part or, or incorporating it by
reference into, this annual report on Form 10-K. We make available free of
charge through our website our annual report on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K, and all amendments to those reports as
soon as reasonably practicable after such material is electronically filed with
or furnished to the Securities and Exchange Commission.
The public may read and copy any materials we file with the SEC at the
SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549.
The public may obtain information on the operation of the Public Reference Room
by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that
contains reports, proxy and information statements, and other information
regarding issuers such as us that file electronically with the SEC. The website
address is www.sec.gov.
ITEM 2. PROPERTIES
Facilities
Our corporate headquarters are located in Upper Saddle River, New Jersey,
in a 48,600 square foot facility. The lease for all but approximately 10,000
square feet of this space expires in the fourth quarter of 2004. The lease on
the remaining space expires in the second quarter of 2004. We have leased
approximately 84,000 square feet in Saddle River, New Jersey for a term of
approximately 12 years. We expect to relocate our corporate headquarters to this
location during the second quarter of 2004.
19
TVG operates out of a 48,000 square foot facility in Fort Washington,
Pennsylvania, under a lease that expires in the third quarter of 2005.
InServe operates out of a 9,100 square foot facility in Novato, California,
under a lease which expires in the second quarter of 2005.
We believe that our current and recently leased facilities are adequate for
our current and foreseeable operations and that suitable additional space will
be available if needed.
ITEM 3. 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 Corporation, 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
we 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 Baycol, a prescription
cholesterol-lowering medication. Baycol was distributed, promoted and sold by
Bayer in the U.S. through early August 2001, at which time Bayer voluntarily
withdrew Baycol from the U.S. market. Bayer retained certain companies, such as
us, to provide detailing services on its behalf pursuant to contract sales force
agreements. We may be named in additional similar lawsuits. To date, we have
defended these actions vigorously and have asserted a contractual right of
defense and 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 and to indemnify us in these lawsuits, subject to certain limited
exceptions. Further, Bayer agreed to reimburse us for all reasonable costs and
expenses incurred to date in defending these proceedings. As of February 20,
2004 Bayer has reimbursed us for approximately $1.6 million in legal expenses,
almost all of which was received in 2003 and is reflected as a credit within
selling, general and administrative expense.
20
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 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 were
filled for Fortigel prior to January 26, 2004. As discussed above, in July 2003,
Cellegy received a letter from the FDA rejecting its NDA for Fortigel. We will
not pay any additional amount to Auxilium as set forth in clause (b) above since
Fortigel was not approved by the FDA prior to January 26, 2004. 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.
Cellegy Pharmaceuticals Litigation
On December 12, 2003, we filed a complaint against Cellegy in the U.S.
District Court for the Southern District of New York. The complaint alleges that
Cellegy fraudulently induced us to enter into a license agreement with Cellegy
regarding Fortigel on December 31, 2002. The complaint also alleges claims for
misrepresentation and breach of contract related to the license agreement. In
the complaint, we seek, among other things, rescission of the license agreement
and return of the $15.0 million we paid Cellegy. After we filed this lawsuit,
also on December 12, 2003, Cellegy filed a complaint against us in the U.S.
District Court for the Northern District of California. Cellegy's complaint
seeks a declaration that Cellegy did not fraudulently induce us to enter the
license agreement and that Cellegy has not breached its obligations under the
license agreement. We are unable to predict the ultimate outcome of these
lawsuits.
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 business, financial condition and results of operations.
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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
21
PART II
ITEM 5. MARKET FOR OUR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is traded on the Nasdaq National Market under the symbol
"PDII." The following table sets forth, for each of the periods indicated, the
range of high and low closing sales prices for the common stock as reported by
the Nasdaq National Market.
High Low
------ ------
2003
First quarter............................................ 12.650 7.100
Second quarter........................................... 12.600 7.350
Third quarter............................................ 26.810 10.330
Fourth quarter........................................... 30.870 20.250
2002
First quarter............................................ 22.410 13.300
Second quarter........................................... 20.000 14.130
Third quarter............................................ 14.900 4.070
Fourth quarter........................................... 10.790 3.040
We believe that, as of March 1, 2004, we had approximately 3,000 beneficial
stockholders.
Equity Compensation Plan Information
Year Ended December 31, 2003
Number of securities
remaining available for
Number of securities Weighted-average future issuance under
to be issued upon exercise price of equity compensation
exercise of outstanding plans (excluding
outstanding options, options, warrants securities reflected in
Plan Category warrants and rights and rights column (a))
- --------------------------------- -------------------- ------------------ -----------------------
(a) (b)
Equity compensation plans
approved by security holders
(2000 Omnibus Incentive
Compensation Plan and 1998
Stock Option Plan)............ 1,037,599 $27.33 939,611
Equity compensation plans not
approved by security
holders(1).................... -- -- --
========= ====== =======
Total............................ 1,037,599 $27.33 939,611
========= ====== =======
(1) The Company does not have any equity compensation plans which have not been
approved by security holders.
Dividend policy
We have not paid any dividends and do not intend to pay any dividends in
the foreseeable future. Future earnings, if any, will be used to finance the
future growth of our business. Future dividends, if any, will be determined by
our board of directors.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data set forth below as of and for the
years ended December 31, 2003, 2002, 2001, 2000 and 1999 are derived from our
audited consolidated financial statements and the accompanying notes. Our
consolidated financial statements for 1999 reflect our acquisition of TVG in May
1999, which was accounted for as a pooling of interests, on a pro forma basis as
if TVG had been owned by the Company the entire period. Consolidated balance
sheets at December 31, 2003 and 2002 and consolidated statements of operations,
22
stockholders' equity and cash flows for the three years ended December 31, 2003,
2002 and 2001 and the related notes are included elsewhere in this Annual Report
on Form 10-K and have been audited by PricewaterhouseCoopers LLP, independent
auditors. The selected financial data set forth below should be read together
with, and are qualified by reference to, "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and our audited consolidated
financial statements and related notes appearing elsewhere in this report.
Statement of operations data:
Years Ended December 31,
----------------------------------------------------
2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
(in thousands, except per share data)
Revenue
Service, net.............................................. $329,061 $277,575 $281,269 $315,867 $174,902
Product, net.............................................. (11,613) 6,438 415,314 101,008 --
-------- -------- -------- -------- --------
Total revenue, net..................................... 317,448 284,013 696,583 416,875 174,902
-------- -------- -------- -------- --------
Cost of goods and services
Program expenses.......................................... 227,080 254,140 232,171 235,355 130,121
Cost of goods sold........................................ 1,287 -- 328,629 68,997 --
-------- -------- -------- -------- --------
Total cost of goods and services....................... 228,367 254,140 560,800 304,352 130,121
-------- -------- -------- -------- --------
Gross profit................................................. 89,081 29,873 135,783 112,523 44,781
Operating expenses
Compensation expense...................................... 36,901 32,670 39,263 32,820 19,611
Other selling, general and administrative expenses........ 30,347 44,163 83,815 38,827 9,448
Restructuring and other related expenses.................. 143 3,215 -- -- --
Litigation settlement..................................... 2,100 -- -- -- --
Acquisition and related expenses.......................... -- -- -- -- 1,246
-------- -------- -------- -------- --------
Total operating expenses............................... 69,491 80,048 123,078 71,647 30,305
-------- -------- -------- -------- --------
Operating income (loss)...................................... 19,590 (50,175) 12,705 40,876 14,476
Other income, net............................................ 1,073 1,967 2,275 4,864 3,471
-------- -------- -------- -------- --------
Income (loss) before provision (benefit) for income taxes ... 20,663 (48,208) 14,980 45,740 17,947
Provision (benefit) for income taxes......................... 8,405 (17,447) 8,626 18,712 7,539
-------- -------- -------- -------- --------
Net income (loss)............................................ $ 12,258 $(30,761) $ 6,354 $ 27,028 $ 10,408
======== ======== ======== ======== ========
Basic net income (loss) per share(1)......................... $ 0.86 $ (2.19) $ 0.46 $ 2.00 $ 0.87
======== ======== ======== ======== ========
Diluted net income (loss) per share(1)....................... $ 0.85 $ (2.19) $ 0.45 $ 1.96 $ 0.86
======== ======== ======== ======== ========
Basic weighted average number of shares outstanding(1)....... 14,231 14,033 13,886 13,503 11,958
======== ======== ======== ======== ========
Diluted weighted average number of shares outstanding(1)..... 14,431 14,033 14,113 13,773 12,167
======== ======== ======== ======== ========
Years Ended December 31,
------------------------------------------------------
1999
-------
(in thousands, except per share data)
Pro forma data (unaudited)
Income before provision for income taxes.................. $17,947
Pro forma provision for income taxes (2).................. 7,677
-------
Pro forma net income (2).................................. $10,270
=======
Pro forma basic net income per share (2).................. $ 0.86
=======
Pro forma diluted net income per share (2)................ $ 0.84
=======
Basic weighted average number of shares outstanding (1)... 11,958
=======
Pro forma diluted weighted average number of shares
outstanding (1)........................................ 12,167
=======
Balance sheet data:
As of December 31,
--------------------------------------------------
2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
(in thousands)
Cash and cash equivalents................................ $113,288 $ 66,827 $160,043 $109,000 $ 57,787
Working capital.......................................... 100,009 81,854 113,685 120,720 53,144
Total assets............................................. 219,623 190,939 302,671 270,225 102,960
Total long-term debt..................................... -- -- -- -- --
Stockholders' equity .................................... 138,448 123,211 150,935 138,110 60,820
- ----------
(1) See Note 9 to our audited consolidated financial statements included
elsewhere in this report for a description of the computation of basic and
diluted weighted average number of shares outstanding.
23
(2) Prior to our initial public offering, we were an S corporation and had not
been subject to Federal or New Jersey corporate income taxes, other than a
New Jersey state corporate income tax of approximately 2%. In addition,
TVG, a 1999 acquisition accounted for as a pooling of interest, was also
taxed as an S corporation from January 1997 to May 1999. Pro forma
provision for income taxes, pro forma net income and basic and diluted net
income per share for 1999 reflect a provision for income taxes as if we and
TVG had been taxed at the statutory tax rates in effect for C corporations
for all periods.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Cautionary Statement Identifying Important Factors That Could Cause Our Actual
Results to Differ From Those Projected in Forward Looking Statements.
Pursuant to the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, readers of this report are advised that this
document contains both statements of historical facts and forward looking
statements. Forward looking statements are subject to risks and uncertainties,
which could cause our actual results to differ materially from those indicated
by the forward looking statements. Examples of forward looking statements
include, but are not limited to (i) projections of revenues, income or loss,
earnings per share, capital expenditures, dividends, capital structure and other
financial items, (ii) statements regarding our plans and objectives including
product enhancements, or estimates or predictions of actions by customers,
suppliers, competitors or regulatory authorities, (iii) statements of future
economic performance, and (iv) statements of assumptions underlying other
statements.
This report also identifies important factors that could cause our actual
results to differ materially from those indicated by the forward looking
statements. These risks and uncertainties include, but are not limited to, the
factors, risks and uncertainties (i) identified or discussed herein, (ii) set
forth under the headings "Business" and "Risk Factors" in Part I, Item 1; "Legal
Proceedings" in Part I, Item 3; and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" in Part II, Item 7, of this
Annual Report on Form 10-K, 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.
The following Management's Discussion and Analysis of Financial Condition
and Results of Operations should be read in conjunction with our consolidated
financial statements and the related notes appearing elsewhere in this report.
Overview
We are a 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 and MD&D products. We do this by partnering with
companies who own the intellectual property rights to these products and
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 company.
Description of Reporting Segments and Nature of Contracts
Our business is organized into three reporting segments:
* 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).
* PDI pharmaceutical products group (PPG), comprised of:
24
o copromotion;
o licensing;
o acquisitions; and
o integrated commercialization services.
* PDI medical devices and diagnostics group (MD&D), comprised of:
o contract sales services (CSO);
o clinical sales teams;
o copromotion;
o licensing; and
o acquisitions.
An analysis of these reporting segments and their results of operations is
contained in Note 23 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. Also, our
contracts might have a lower base fee offset by built-in incentives we can earn
based on our performance. In these situations, we have the opportunity to earn
additional fees, 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. The loss or termination of a
large contract or the loss of multiple contracts could have a material adverse
effect on our business, financial condition and results of operations. As an
example, in February 2004, Novartis notified us that it was exercising its right
to terminate its contract with us without cause and as a result, $28.9 million
of anticipated revenue associated with the Novartis contract in 2004 will not be
realized. This contract was to run through December 31, 2004. 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 would
have a material adverse effect on our business, financial condition and results
of operations.
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 the loss or termination of any individual MR&C
or EdComm contract would have a material adverse effect on our business,
financial condition and results of operations.
PDI Pharmaceutical Products Group
The contracts within the pharmaceutical products group can be either
performance based or fee for service and may require sales, marketing and
distribution of product. In performance based contracts, we provide and finance
a portion, if not all, of the commercial activities in support of a brand in
return for a percentage of product sales. An important performance parameter is
normally the level of sales or prescriptions attained by the product during the
period of our marketing or promotional responsibility, and in some cases, for
periods after our promotional activities have ended.
In the fourth quarter of 2000, we entered into a performance based contract
with GSK. Our agreement with
25
GSK was in support of Ceftin and was an exclusive sales, marketing and
distribution contract. 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, due to the unexpected entry of a
competitive generic product.
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), Lotensin HCT(R) and Lotrel(R). That agreement
ran through December 31, 2003. On May 20, 2002, that agreement was replaced by
two separate agreements: one for Lotensin and another one for Lotrel, Diovan(R)
and Diovan HCT(R). Both agreements ran through December 31, 2003; however, the
Lotrel-Diovan agreement was renewed on December 24, 2003 for an additional one
year period. In February 2004, we were notified by Novartis of its intent to
terminate the Lotrel-Diovan contract without cause, effective March 16, 2004
and, as a result, $28.9 million of anticipated revenue associated with the
Lotrel-Diovan contract in 2004 will not be realized. We will continue to be
compensated under the terms of the agreement through the effective termination
date. Even though the Lotensin agreement ended December 31, 2003, we are still
entitled to receive royalty payments on the sales of Lotensin through December
31, 2004. The Lotensin agreement called for us to provide promotion, selling,
marketing and brand management for Lotensin. In exchange, we were entitled to
receive a percentage of product revenue based on certain total prescription
(TRx) objectives above specified contractual baselines. The revenue resulting
from the efforts of the Novartis sales force responsible for Lotrel-Diovan was
classified in the SMSG segment in 2003 instead of the PPG segment, where it was
classified in 2002, due to the fact that during 2002, we were reliant on the
attainment of performance incentives, whereas in 2003 this contract was
basically a fixed fee arrangement.
In October 2001, we entered into an agreement with Eli Lilly and Company
(Eli Lilly) to copromote Evista(R) in the U.S. Under this agreement, we were
entitled to be compensated based upon net sales achieved above a predetermined
level. In the event these predetermined net sales levels were not achieved, we
would not receive any revenue to offset expenses incurred. During 2002, it
became apparent that the net sales levels likely to be achieved would not be
sufficient to recoup our expenses. In November 2002, we agreed with Eli Lilly to
terminate the Evista copromotion agreement effective December 21, 2002.
On December 31, 2002, we entered into an exclusive 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. In July 2003, Cellegy received a letter from the FDA rejecting its
NDA for Fortigel. Cellegy has told us that it is in discussions with the FDA to
determine the appropriate course of action needed to meet deficiencies cited by
the FDA in its determination. Since we filed the lawsuit, Cellegy is no longer
in regular contact with us regarding Fortigel. Thus, for example, we are unaware
of the FDA status regarding Fortigel (as of December 31, 2003, it had not been
approved) and are unaware of what steps Cellegy is taking to develop Fortigel,
to obtain FDA approval for Fortigel, and/or to arrange for a party to
manufacture Fortigel. We have requested this information from Cellegy but have
not received it. Accordingly, we may not possess the most current and reliable
information concerning the current status of, or future prospects relating to,
Fortigel. The issuance of the non-approvable letter by the FDA concerning
Fortigel, however, casts significant doubt upon Fortigel's prospects and whether
it will ever be approved. We cannot predict with any certainty whether 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 payment was made prior to FDA approval and since there is no
alternative future use of the licensed rights, we expensed the $15.0 million
payment 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, 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 (if such approvals are obtained) 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.
On December 12, 2003, we instituted an action against Cellegy in the U.S.
District Court for the Southern District of New York seeking to rescind the
Cellegy license agreement on the grounds that it was procured by fraud. We are
seeking return of the license fee we paid on December 31, 2002 of $15.0 million
plus additional damages
26
caused by Cellegy's conduct.
PDI Medical Devices and Diagnostics Group
Our MD&D group provides an array of sales and marketing services to the
MD&D industry. Our core service is the provision of clinical sales teams. Our
clinical sales teams employ nurses, medical technologists, and other clinicians
who train and provide hands-on clinical education and after sales support to the
medical staff of hospitals and clinics that recently purchased our clients'
equipment. Our activities maximize product utilization and customer satisfaction
for the medical practitioners, while simultaneously enabling our clients' sales
forces to continue their selling activities instead of in-servicing the
equipment they had recently sold.
We also provide a contract sales business within the MD&D market. We took
our knowledge from years of providing sales forces to the pharmaceutical
industry and applied it to the MD&D business. As a result, we now have contract
sales as one of the services that we market to the MD&D industry, to assist our
clients in improving their product sales.
In October 2002, we partnered with Xylos Corporation (Xylos) for the
exclusive U.S. commercialization rights to the Xylos XCell(TM) Cellulose Wound
Dressing (XCell) wound care products, by entering into an agreement pursuant to
which we became the exclusive commercialization partner for the sales, marketing
and distribution of the product line in the U.S. On January 2, 2004, we
exercised our contractual right to terminate the agreement on 135 days' notice
to Xylos since sales of XCell were not sufficient to sustain our role as
commercialization partner for the product. Our promotional activities in support
of the brand concluded in January 2004 and the agreement will terminate
effective May 16, 2004. We provided a short-term loan in the amount of $250,000
to Xylos in February 2004. Under the terms of the loan agreement, we may provide
another $250,000, if requested by Xylos.
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 did not result in us earning any
significant incentive payments. On October 14, 2003, we and Organogenesis
simultaneously exercised our rights to terminate the agreement, and our wound
care sales force ceased marketing Apligraf as of January 12, 2004. We do not
believe that this termination will have a material adverse effect on our
business, financial condition or results of operations.
We currently do not anticipate entering into similar commercialization
agreements in the MD&D market.
Critical Accounting Policies
We prepare our financial statements in accordance with generally accepted
accounting principles (GAAP). The preparation of financial statements in
conformity with GAAP requires the use of estimates and assumptions that affect
the reported amounts of assets and liabilities, including disclosure of
contingent assets and liabilities, at the date of the financial statements and
the reported amounts of revenue and expenses during the reporting period. Our
critical accounting policies are those that are most important to our financial
condition and results and that require the most significant judgments on the
part of our management in their application. We believe that the following
represent our critical accounting policies. For a summary of all of our
significant accounting policies, including the critical accounting policies
discussed below, see Note 1 to the consolidated financial statements. Our
management and our independent accountants have discussed our critical
accounting policies with the audit committee of the board of directors. Because
of the uncertainty of factors surrounding the estimates or judgments in the
preparation of the consolidated financial statements, particularly as it relates
to a number of the judgmental items discussed in this section, actual results
may vary materially from these estimates.
27
Revenue Recognition and Associated Costs
The paragraphs that follow describe the guidelines that we adhere to in
accordance with GAAP when recognizing revenue and cost of goods and services in
our financial statements. In accordance with GAAP, service revenue and product
revenue and their respective direct costs have been shown separately on the
income statement.
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 industry continues to
consolidate. As a result, we are likely to continue to experience significant
client concentration in future periods. For the years ended December 31, 2003,
2002 and 2001, our largest clients, who each individually represented 10% or
more of our service revenue, accounted for approximately 67.7%, 64.1% and 60.0%,
respectively, of our 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.
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 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. 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.
Training Costs
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 amortization of the deferred training is
expensed. When we do not receive a specific contract payment for training, all
revenue is deferred and recognized over the life of the contract.
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
Product revenue is recognized when products are shipped and title is
transferred to the customer. Product revenue for the year ended December 31,
2003 was negative, primarily from the adjustment to the Ceftin returns
28
reserve, as discussed in Note 3 to the consolidated financial statements, net of
the sale of the Xylos wound care products. Product revenue recognized in prior
periods was related to the Ceftin contract which was terminated by mutual
consent in February 2002.
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.
Estimates for accrued rebates, discounts and sales allowances
For product sales, provision is made at the time of sale for all discounts
and estimated sales allowances. As is common in the pharmaceutical industry,
customers who purchased our Ceftin product are permitted to return unused
product, after approval from us, up to six months before and one year after the
expiration date for the product, but no later than December 31, 2004. The
products sold by us prior to the Ceftin agreement termination date of February
28, 2002 have expiration dates through June 2004. As discussed in Note 3 to the
consolidated financial statements, there was a $12.0 million adjustment to the
Ceftin returns reserve in 2003. This adjustment was recorded as a reduction to
revenue consistent with the initial recognition of the returns allowance and
resulted in us reporting net negative product revenue in 2003. Additionally,
certain customers were eligible for price rebates or discounts, offered as an
incentive to increase sales volume and achieve favorable formulary status, on
the basis of volume of purchases or increases in the product's market share over
a specified period, and certain customers are credited with chargebacks on the
basis of their resales to end-use customers, such as HMO's, which contracted
with us for quantity discounts. Furthermore, we are obligated to issue rebates
under the federally administered Medicaid program. In each instance we have the
historical data and access to other information, including the total demand for
the drug we distribute, our market share, the recent or pending introduction of
new drugs or generic competition, the inventory practices of our customers and
the resales by our customers to end-users having contracts with us, necessary to
reasonably estimate the amount of such returns or allowances, and record
reserves for such returns or allowances at the time of sale as a reduction of
revenue. The actual payment of these rebates varies depending on the program and
can take several calendar quarters before final settlement. As we settle these
liabilities in future periods, we will continue to monitor all appropriate
information and determine if any positive or negative adjustments are required
in that period. Any adjustments for changes in estimates are recorded through
revenue in that period.
Contract loss provisions
Provisions for losses to be incurred on contracts are recognized in full in
the period in which it is determined that a loss will result from performance of
the contractual arrangement. Performance based contracts have the potential for
higher returns but also an increased risk of contract loss as compared to the
traditional fee for service CSO contracts. As discussed in Notes 2 and 3 to the
consolidated financial statements, we recognized contract losses in 2002 and
2001 related to the Evista and Ceftin contracts, respectively.
Financial instruments
Our consolidated balance sheets reflect various financial instruments
including cash and cash equivalents and investments. We do not engage in trading
activities or off-balance sheet financial instruments. As a matter of policy,
excess cash and deposits are held by major banks or in high quality short-term
liquid instruments. We have investments, mainly in equity instruments, that are
carried at fair market value. We do not use derivative instruments such as swaps
or forward contracts. As discussed in Note 7 to the consolidated financial
statements, we have certain investments accounted for under the cost method and
certain investments accounted for under the equity method. We review our equity
investments for impairment on an ongoing basis based on our determination of
whether the decline in market value of the investment below its carrying value
is other than temporary.
Deferred taxes - valuation allowance
We evaluate the need for a deferred tax asset valuation allowance by
assessing whether it is more likely than not that we will realize our deferred
tax assets in the future. The assessment of whether or not a valuation allowance
is required often requires significant judgment including the forecast of future
taxable income and the calculation of
29
tax planning initiatives. Adjustments to the deferred tax allowance are made to
earnings in the period when such determination is made.
Goodwill impairment analysis
We adopted Statement of Financial Accounting Standards (SFAS) No. 142,
"Goodwill and Other Intangible Assets" in fiscal year 2002. The effect of this
adoption on us is that goodwill is no longer amortized but is evaluated for
impairment on at least an annual basis. We have established reporting units for
purposes of testing goodwill for impairment. The tests involve 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. Goodwill has been assigned to the
reporting units to which the value of the goodwill relates. We completed the
first step of the transitional goodwill impairment test and determined that no
impairment existed at January 1, 2002. We evaluate goodwill and other intangible
assets at least on an annual basis and whenever events and changes in
circumstances suggest that the carrying amount may not be recoverable based on
the estimated future cash flows. We performed the required annual impairment
tests in the fourth quarters of both 2003 and 2002 and determined that no
impairment existed at either December 31, 2003 or December 31, 2002.
Restructuring and other related expenses
In order to consolidate operations, downsize and improve operating
efficiencies, we have recorded restructuring charges. The recognition of
restructuring charges requires estimates and judgments regarding employee
termination benefits and other exit costs to be incurred when the restructuring
actions take place. Actual results can vary from these estimates which results
in adjustments in the period of the change in estimate.
Contingencies
In the normal course of business, we are subject to contingencies, such as
legal proceedings and tax matters. In accordance with SFAS No. 5, "Accounting
for Contingencies," we record accruals for such contingencies when it is
probable that a liability will be incurred and the amount of the loss can be
reasonably estimated. For a discussion of legal contingencies, please refer to
Note 19 to the consolidated financial statements.
Consolidated Results of Operations
The following table sets forth, for the periods indicated, selected
statement of operations data as a percentage of revenue. The trends illustrated
in this table may not be indicative of future operating results.
30
Years Ended December 31,
-------------------------------------
2003 2002 2001 2000 1999
----- ----- ----- ----- -----
Operating data
Revenue 103.7% 97.7% 40.4% 75.8% 100.0%
Service, net
Product, net (3.7) 2.3 59.6 24.2 --
----- ----- ----- ----- -----
Total revenue, net 100.0 100.0 100.0 100.0 100.0
----- ----- ----- ----- -----
Cost of goods and services
Program expenses 71.5 89.5 33.3 56.5 74.4
Cost of goods sold 0.4 -- 47.2 16.5 --
----- ----- ----- ----- -----
Total cost of goods and services 71.9 89.5 80.5 73.0 74.4
----- ----- ----- ----- -----
Gross profit 28.1 10.5 19.5 27.0 25.6
Operating expenses
Compensation expense 11.6 11.5 5.7 7.9 11.2
Other selling, general and administrative
expenses 9.6 15.5 12.1 9.3 5.4
Restructuring and other related expenses 0.1 1.1 -- -- --
Litigation settlement 0.6 -- -- -- --
Acquisition and related expenses -- -- -- -- 0.7
----- ----- ----- ----- -----
Total operating expenses 21.9 28.1 17.8 17.2 17.3
----- ----- ----- ----- -----
Operating income (loss) 6.2 (17.6) 1.7 9.8 8.3
Other income, net 0.3 0.7 0.3 1.2 2.0
----- ----- ----- ----- -----
Income (loss) before provision (benefit) for
income taxes 6.5 (16.9) 2.0 11.0 10.3
Provision (benefit) for income taxes 2.6 (6.1) 1.2 4.5 4.3
----- ----- ----- ----- -----
Net income (loss) 3.9% (10.8)% 0.8% 6.5% 6.0%
===== ===== ===== ===== =====
Pro forma data (unaudited)
Income (loss) before pro forma provision for
income taxes 10.3%
Pro forma provision for income taxes 4.4
-----
Pro forma net income (loss) 5.9%
=====
31
Comparison of 2003 and 2002
Revenue, net (in thousands)
----------------------------------------------------------------------------------------------------
Service Product
-------------------------------------------- ------------------------------------------
variance variance
2003 2002 fav/(unfav) % change 2003 2002 fav/(unfav) % change
-------- -------- ----------- -------- -------- ------ ----------- --------
SMSG $262,966 $179,067 $ 83,899 46.9% $ -- $ -- $ -- 0.0%
PPG 54,349 88,538 (34,189) (38.6)% (12,000) 6,438 (18,438) (286.4)%
MD&D 11,746 9,970 1,776 17.8% 387 -- 387 0.0%
-------------------------------------------- ------------------------------------------
Total $329,061 $277,575 $ 51,486 18.5% $(11,613) $6,438 $(18,051) (280.4)%
----------------------------------------------------------------------------------------------------
Revenue, net. Net revenue for 2003 was $317.4 million, 11.8% more than net
revenue of $284.0 million for the prior year period. Service revenue was $329.1
million in 2003, an increase of $51.5 million or 18.5% from the $277.6 million
recorded in 2002. This increase is mainly attributable to the addition of three
significant dedicated CSO contracts in July 2003, as well as the performance on
the Lotensin contract. Product revenue was negative $11.6 million as a result of
a $12.0 million increase in the Ceftin accrual which was recorded in the fourth
quarter of 2003; this increase was attributable to the changes in estimate
related to the allowance for sales returns recorded on previous Ceftin sales.
(Please see Note 3 to the consolidated financial statements.) This was partially
offset by Xylos product sales of approximately $387,000.
The SMSG segment had $263.0 million in revenue for 2003, an increase of
$83.9 million over 2002. This increase is attributable to the three new
dedicated CSO contracts mentioned previously, and the reclassification of the
Lotrel-Diovan revenues due to the renegotiation of our Novartis contract in May
2002. As discussed in the PDI Pharmaceutical Products Group section of the MD&A,
the Novartis sales force responsible for Lotrel-Diovan was classified in the
SMSG segment in 2003 instead of the PPG segment, where it was classified in
2002, due to the fact that during 2002, we were reliant on the attainment of
performance incentives, whereas in 2003 this contract was basically a fixed fee
arrangement. As discussed previously, in February 2004, we were notified by
Novartis of its intent to terminate the Lotrel-Diovan contract without case,
and, as a result, $28.9 million of anticipated revenue associated with the
Lotrel-Diovan contract in 2004 will not be realized.
The PPG segment had service revenue of $54.3 million, mainly attributable
to the results on behalf of Lotensin. We were able to maintain Lotensin
prescription levels relatively stable throughout the year, which resulted in us
earning additional revenue under the terms of the agreement. The decrease of
$34.2 million from the comparable prior year period can be primarily attributed
to the Lotrel-Diovan revenue reclassification discussed above.
Revenues for MD&D were $12.1 million for 2003 versus $10.0 million in 2002,
an increase of 21.7%. MD&D service revenue increased by $1.8 million and there
was product revenue of approximately $387,000 related to the sale of the Xylos
product. As discussed in Note 2 to the consolidated financial statements, we
gave Xylos notice of termination of the Xylos agreement on January 2, 2004,
effective May 16, 2004.
Cost of goods and services (in thousands)
----------------------------------------------------------------------------------------------------
Service Product
-------------------------------------------- ------------------------------------------
variance variance
2003 2002 fav/(unfav) % change 2003 2002 fav/(unfav) % change
-------- -------- ----------- -------- ------ -------- ----------- --------
SMSG $182,170 $133,113 $(49,057) (36.9)% $ -- $-- $ -- 0.0%
PPG 36,364 113,751 77,387 68.0% 23 -- (23) 0.0%
MD&D 8,546 7,276 (1,270) (17.5)% 1,264 -- (1,264) 0.0%
-------------------------------------------- ------------------------------------------
Total $227,080 $254,140 $ 27,060 10.6% $1,287 $-- $(1,287) 0.0%
----------------------------------------------------------------------------------------------------
32
Costs of goods and services. Cost of goods and services for 2003 was $228.4
million, which was $25.7 million or 10.1% less than cost of goods and services
of $254.1 million for 2002. During 2003 the gross profit percentage was 28.1%
compared to 10.5% in the comparable prior year period. The gross profit
attributable to service revenue was $102.0 million in 2003 versus $23.4 million
in 2002, an increase of 335.9%. During 2002 the Evista contract resulted in a
$34.7 million negative gross profit. Excluding the effect of the Evista
contract, the gross profit percentage for 2002 would have been 17.5%.
The SMSG segment had gross profit of $80.8 million with a gross profit
percentage of 30.7%, a substantial increase over the $45.9 million gross profit
and 25.7% gross profit percentage achieved in 2002, primarily due to the three
new significant contracts entered into during the current year. Generally, the
gross profit percentage achieved in 2003 was slightly higher than our historical
gross profit percentages and was attributable to the greater efficiencies
achieved in the performance of our contractual obligations for most service
units.
The PPG segment had $6.0 million in gross profit for 2003 compared to
negative gross profit of $18.8 million in 2002. Excluding the $12.0 million
effect of the increase in the Ceftin accrual for sales returns, the contracts
within PPG contributed $18.0 million in gross profit with a gross profit
percentage of 33.1%. Excluding the Evista contract, in 2002 total PPG would have
earned a positive gross profit of $16.0 million and a gross profit percentage of
17.6%; the Evista contract was terminated as of December 31, 2002. The increase
in gross profit percentage from an adjusted 17.6% to an adjusted 33.1% resulted
from our success on the Lotensin program. We were able to maintain Lotensin
prescription levels relatively stable throughout the year, which resulted in us
earning additional revenue under the terms of the agreement.
The MD&D segment earned a gross profit of $2.3 million and $2.7 million
for the years ended 2003 and 2002, respectively.
(Note: Compensation and other SG&A expense amounts for each segment contain
allocated corporate overhead.)
--------------------------------------------------------------------------------------
Compensation Expense (excluding restructuring
expense) (in thousands)
--------------------------------------------------------------------------------------
2003 % of revenue 2002 % of revenue $Inc/(Dec) % Inc/(Dec)
------- ------------ -------- ------------ ---------- -----------
SMSG $22,362 8.5% $19,645 11.0% $2,717 13.8%
PPG 10,187 24.1% 10,353 10.9% (166) (1.6)%
MD&D 4,352 35.9% 2,672 26.8% 1,680 62.9%
---------------------------------------------------------------------------
Total $36,901 11.6% $32,670 11.5% $4,231 13.0%
--------------------------------------------------------------------------------------
Compensation expense. Compensation expense for 2003 was $36.9 million, an
increase of $4.2 million or 13.0% more than the $32.7 million for the comparable
prior year period. This increase can be attributed to a $7.1 million increase in
the accrual for incentive compensation in 2003, which resulted from the improved
performance of most business units in 2003; this increase in incentive
compensation was partially offset by savings attributable to the reduced
headcount associated with our prior year restructuring initiative. As a
percentage of total net revenue, compensation expense increased slightly to
11.6% for 2003 from 11.5% for 2002. Compensation expense as a percent of revenue
for the SMSG segment decreased but increased for the MD&D and PPG segments. The
increase in expense, as a percent of revenue for the latter two segments,
reflects the investment of additional management effort during 2003 toward our
investigation of opportunities for licensing or acquiring products for those
segments.
------------------------------------------------------------------------------------------------
Other SG&A (excluding restructuring expense and litigation expense)
(in thousands)
------------------------------------------------------------------------------------------------
% of % of
2003 revenue 2002 revenue $Inc/(Dec) %Inc/(Dec)
------- ------- ------- ------- ---------- ----------
SMSG $16,836 6.4% $15,796 8.8% $ 1,040 6.6%
PPG 7,081 16.7% 25,700 27.1% (18,619) (72.4)%
MD&D 6,430 53.0% 2,658 26.7% 3,772 141.9%
---------------------------------------------------------------
Total $30,347 9.6% $44,154 15.5% $(13,807) (31.3)%
---------------------------------------------------------------
Less: Cellegy licensing fee -- -- 15,000 15.8% (15,000) 100.0)%
---------------------------------------------------------------
Adjusted Total $30,347 9.6% $29,154 10.3% $ 1,193 4.1%
------------------------------------------------------------------------------------------------
33
Other selling, general and administrative expenses. Total other SG&A
expenses were $30.3 million for 2003, which represented 9.6% of revenues. Other
selling, general and administrative expenses were $44.2 million in 2002, which
included the $15.0 million payment for the initial licensing fee associated with
the Cellegy agreement. Other SG&A expense as a percent of revenue for the SMSG
and PPG segments decreased but increased for the MD&D segment. There was a net
decrease in expense as a percent of revenue for the PPG segment in 2003 as
compared to 2002. During 2002, we incurred a $15.0 million (or 15.8% of revenue)
Cellegy license fee payment and the larger 2002 field teams required greater
administrative resources than in 2003. This increase as a percent of revenue for
the MD&D segment was primarily attributable to the sales force related costs and
other marketing costs associated with the marketing of our wound care products,
which began in January 2003.
Restructuring and other related expenses. During the year ended December
31, 2002, we accrued $6.3 million in restructuring and other related expenses in
connection with our decision to consolidate operations to create efficiencies.
During 2003, our initial accrual was adjusted to reflect the following:
o 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 $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 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;
o $413,000 of additional restructuring expense as a result of
higher than expected exit costs and corporate employee severance
costs. This adjustment was recorded in other SG&A expenses
consistent with the original recording of the restructuring
charges.
As of December 31, 2003, the restructuring accrual is $744,000, consisting
of remaining lease and corporate severance payments. All restructuring
activities associated with this accrual are substantially complete. The
restructuring accrual and related activities are discussed more fully in the
Restructuring and Other Related Expenses section of this MD&A.
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 (Please see Note 19 to the audited
consolidated financial statements).
Operating income (loss)
(in thousands)
--------------------------------------------
variance
2003 2002 fav/(unfav)
---- ---- -----------
SMSG $ 40,240 $ 7,908 $32,333
PPG (11,970) (55,210) 43,240
MD&D (8,680) (2,873) (5,808)
---------------------------------
Total $ 19,590 $(50,175) $69,765
--------------------------------------------
34
Operating income (loss). There was operating income for 2003 of $19.6
million, compared to an operating loss of $50.2 million in 2002, an increase of
$69.8 million. The 2002 period operating loss was primarily the result of losses
generated by the Evista contract and from the $15.0 million in licensing fee
expenses associated with the Cellegy agreement. Operating income for 2003 for
the SMSG segment was $40.2 million, or 408.9% more than the SMSG operating
income for 2002 of $7.9 million. As a percentage of net revenue from the SMSG
segment, operating income for that segment increased to 15.3% for 2003, from
4.4% for 2002. There was an operating loss for the PPG segment for 2003 of $12.0
million entirely attributable to the $12.0 million Ceftin accrual recorded in
the fourth quarter of 2003. As discussed in Note 3 to the consolidated financial
statements, the additional Ceftin accrual is attributable to the changes in
estimates related to the allowance for sales returns recorded on previous Ceftin
sales. This compares to an operating loss of $55.2 million in 2002, most of
which was attributable to the $35.1 million operating loss for the Evista
contract and the $15.0 million initial licensing fee associated with the Cellegy
agreement. There was an operating loss for 2003 for the MD&D segment of $8.7
million compared to an operating loss of $2.9 million in the prior period. The
2003 loss was due primarily to the 2003 Xylos product launch and the slower than
anticipated sales of that product.
Other income, net. Other income, net, for 2003 and 2002 was $1.1 million
and $2.0 million, respectively. For 2003, other income, net, was comprised
primarily of interest income. For 2002, other income, net, was primarily
comprised of $2.5 million in other income and net interest income, which was
partially offset by losses on minority investments and disposal of assets of
$0.5 million. The reduction in other income, net, in 2003 is primarily due to
lower interest rates in 2003.
Provision (benefit) for income taxes. There was an income tax provision of
$8.4 million for 2003, compared to an income tax benefit of $17.4 million for
2002, which consisted of Federal and state corporate income taxes. The effective
tax rate for 2003 was 40.7%, compared to an effective tax benefit rate of 36.2%
for 2002. During 2002, the benefit rate was lower than the target rate of 41% to
42% as a result of the effect of recording a valuation allowance against certain
state NOL carryforwards, for which it was determined that it was not more likely
than not that the benefit from the net operating losses would be realized and
the effect of non-deductible routinely incurred expenses. The effective tax rate
for 2003 was lower than the target rate of 41% to 42% due to reductions in
certain non-deductible costs and a decrease in the state effective tax rate
resulting from changes in state tax apportionment factors and an increase in the
number of filing jurisdictions required as a result of changes in our
operations. The tax benefit from the reversal of the state valuation allowance
was offset by a decrease in the value of our net state deferred tax asset
resulting from the decrease in our overall state effective tax rate.
Net income (loss). There was net income for 2003 of $12.3 million, compared
to a net loss of $30.8 million for 2002 due to the factors discussed above.
Comparison of 2002 and 2001
Revenue, net. Net revenue for 2002 was $284.0 million, 59.2% less than net
revenue of $696.6 million for the prior year period. This decrease of $412.6
million was almost entirely due to the mutual termination of the marketing sales
and distribution contract with GSK for Ceftin; this product lost its patent
protection in early 2002 and as a result we recorded only $6.4 million of
product revenue in 2002, of which $5.7 million was attributable to changes in
estimates related to sales returns, discounts and rebates recorded on previous
Ceftin sales. Service revenue was $277.6 million in 2002, a reduction of $3.7
million or 1.3% from the $281.3 million recorded in 2001. There was a $71.8
million revenue reduction for the SMSG segment, primarily attributable to the
loss of several significant dedicated CSO contracts and the general decrease in
demand within our markets for sales and marketing services. This unfavorable
variance was almost totally offset by the revenue increase for the PPG segment
which had revenues of $88.5 million in 2002 compared to $27.7 million in 2001;
the major reason for this increase was our Novartis contracts through which we
provided services for Lotensin and Lotrel for all of 2002 and through which we
added the Diovan products to our service base in May 2002. Revenues for MD&D
were $10.0 million for 2002 versus $2.8 million in 2001 due to the fact we
recorded revenue for InServe for the entire year of 2002 as opposed to only
three and one-half months in 2001, and we earned modest revenue of $1.7 million
from the initiation of our MD&D contract sales unit in 2002.
35
Costs of goods and services. Cost of goods and services for 2002 was $254.1
million, which was $306.7 million or 54.7% less than cost of goods and services
of $560.8 million for 2001. The mutual termination of the Ceftin contract
resulted in a $328.6 million reduction in cost of goods and services for the
product category. During 2002 the cost of goods and services for the service
category was $254.1 million, an increase of $21.9 million compared to 2001, and
the gross profit for the category was $23.4 million in 2002 versus $49.1 million
in 2001. Despite the 28.6% revenue reduction for the SMSG segment, the group
maintained its gross profit percentage, achieving a 25.7% gross profit
percentage in 2002 compared to 25.4% in 2001. PPG has suffered a negative gross
profit for both years. During 2001, the negative gross profit for PPG service of
$15.4 million was mostly due to startup expenses and lower than expected product
performance on the Novartis contracts. During 2002 the Novartis contracts
achieved a positive gross profit but the Evista contract resulted in a $34.7
million negative gross profit. Excluding the Evista contract, total PPG would
have earned a positive gross profit of $16.0 million and a 17.6% gross margin,
which is lower than the SMSG margin by 8.1 percentage points. 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(s) falls short of baselines. The Evista contract was
terminated as of December 31, 2002 and therefore did not adversely affect 2003.
The MD&D segment earned a modest gross profit in both years.
Compensation expense. Compensation expense for 2002 was $32.7 million,
16.8% less than $39.3 million for the comparable prior year period. As a
percentage of total net revenue, compensation expense increased to 11.5% for
2002 from 5.7% for 2001. Compensation expense for 2002 attributable to the sales
and marketing services segment was $19.6 million compared to $28.6 million for
2001. As a percentage of net revenue from the sales and marketing services
segment, compensation expense decreased slightly to 11.0% for 2002 from 11.4%
for 2001. Compensation expense for 2002 attributable to the PPG segment was
$10.4 million, or 10.9% of PPG net revenue, compared to $10.1 million, or 2.3%
in the prior year period. Compensation expense for 2002 attributable to the MD&D
segment was $2.7 million, or 26.8% of MD&D net revenue, compared to $0.6 million
for three and one-half months of 2001.
Other selling, general and administrative expenses. Total other SG&A
expenses were $44.2 million for 2002, 47.3% less than other selling, general and
administrative expenses of $83.8 million (of which $46.9 million was related to
Ceftin activities) for 2001. As a percentage of total net revenue, total other
SG&A expenses increased to 15.5% for 2002 from 12.1% for 2001. Other SG&A
expenses attributable to the sales and marketing services segment for 2002 were
$15.8 million, $2.8 million less than other SG&A expenses of $18.6 million
attributable to that segment for the comparable prior year period. As a
percentage of net revenue from the sales and marketing services segment, other
SG&A expenses were 8.8% and 7.4% for 2002 and 2001, respectively. Other selling,
general and administrative expenses attributable to the PPG segment for 2002
were $25.7 million, included in this amount was the $15.0 million initial
licensing fee expense associated with the Cellegy agreement. For 2001, other
selling, general and administrative expenses attributable to the PPG segment
were $64.6 million. Excluding $46.9 million in Ceftin field and other
promotional expenses, other selling, general and administrative expenses for
2001 were $17.7 million. Other SG&A expenses attributable to MD&D segment for
2002 were $2.7 million, $2.1 million more than other SG&A expenses of $0.6
million for three and one-half months of 2001. As a percentage of net revenue
from the MD&D segment, other SG&A expenses were 26.7% and 21.7% for 2002 and
2001, respectively.
Both compensation and other selling, general and administrative expenses
were higher as a percentage of revenue in the 2002 period than they were in
2001, even after excluding the SG&A expenses associated with the Ceftin
contract. This factor, considered with management's overall assessment of market
conditions and our cost structure, prompted us to undertake cost reduction
initiatives (see "Restructuring and Other Related Expenses").
Operating loss. There was an operating loss for 2002 of $50.2 million,
compared to operating income of $12.7 million for 2001. The 2002 period
operating loss was primarily the result of losses generated by the Evista
contract and from recording $15.0 million in licensing fee expenses associated
with the Cellegy agreement. Operating income for 2002 for the sales and
marketing services segment was $7.9 million, or 52.0% less than the sales and
marketing services operating income for 2001 of $16.5 million. As a percentage
of net revenue from the sales and marketing services segment, operating income
for that segment decreased to 4.4% for 2002, from 6.7% for 2001. There was an
operating loss for the PPG segment for 2002 of $55.2 million almost entirely
attributable to the $35.1 million operating loss for the Evista contract and the
$15.0 million initial licensing fee associated with the Cellegy agreement. There
was an operating loss for 2002 for the MD&D segment of $2.9 million compared to
an operating
36
loss of $0.2 million in the prior period. The 2002 loss was due primarily to
startup costs in preparation for the January 2003 Xylos product launch and the
initial efforts of the MD&D CSO unit.
Other income, net. Other income, net, for 2002 and 2001 was $2.0 million
and $2.3 million, respectively. For 2002, other income, net, was primarily
comprised of $2.5 million in other income and net interest income. The reduction
in 2002 was primarily due to significantly lower interest rates and reduced
investments in 2002, which was partially offset by losses on investments and
securities of approximately $0.5 million.
Benefit for income taxes. There was an income tax benefit of $17.4 million
for 2002, compared to an income tax provision of $8.6 million for 2001, which
consisted of Federal and state corporate income taxes. The effective tax benefit
rate for 2002 was 36.2%, compared to an effective tax rate of 57.6% for 2001.
During 2002, the benefit rate was lower than the target rate of 41% to 42%
primarily as a result of the effect of current state valuation allowances
recorded for certain states where the benefit from the net operating losses may
not be realized and the effect of non-deductible routinely incurred expenses.
During 2001, the increase in the effective tax rate was attributable to several
specific transactions or situations that when applied to our lower than normal
pretax earnings created a large deviation from our target effective tax rate.
For example, certain nondeductible expenses which are routinely incurred in
relatively consistent amounts had a significantly higher impact on the effective
tax rate in 2001, compared to prior years, due to the lower level of pretax
profits.
Net loss. There was a net loss for 2002 of $30.8 million, compared to net
income of $6.4 million for 2001 due to the factors discussed above.
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 originally 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 have been partially offset by incremental
SG&A expenses we incurred in the current period as we have been successful in
expanding our business platforms for our segments. Substantially all of the
restructuring activities have been completed as of December 31, 2003.
In connection with this plan, we originally estimated that we would 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 $0.1 million, all of these expenses were
recognized in 2002. The $0.1 million recognized in 2003 consisted of $0.4
million in additional expense incurred for severance and other exit costs
partially offset by the receipt of $0.3 million for subletting the Cincinnati,
Ohio facility.
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
37
severance costs. This adjustment was recorded in program expenses consistent
with the original recording of the restructuring charges.
During the quarter ended December 31, 2003, we recorded approximately
$413,000 in additional restructuring expense due to higher than expected
severance and other exit costs. This adjustment was recorded in SG&A consistent
with the original recording of the restructuring charges.
The accrual for restructuring and exit costs totaled approximately $744,000
at December 31, 2003, and is recorded in current liabilities on the balance
sheet included in the accompanying consolidated financial statements.
A roll forward of the activity for the 2002 Restructuring Plan (in
thousands) is as follows:
Balance at Write offs/ Balance at
December 31, 2002 Accruals Adjustments Payments December 31, 2003
----------------- -------- ----------- ----------- -----------------
Administrative severance $1,670 $ 58 $ -- $(1,443) $285
Exit costs 1,288 488 (270) (1,047) 459
------ ---- ----- ------- ----
$2,958 $546 $(270) $(2,490) $744
------ ---- ----- ------- ----
Sales force severance 1,741 -- (473) (1,268) --
------ ---- ----- ------- ----
Total $4,699 $546 $(743) $(3,758) $744
====== ==== ===== ======= ====
Liquidity and Capital Resources
As of December 31, 2003, we had cash and cash equivalents of approximately
$113.3 million and working capital of $100.0 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 year ended December 31, 2003, net cash provided by operating
activities was $41.6 million, compared to $89.0 million net cash used in
operating activities in 2002. The main components of cash provided by operating
activities were:
o cash provided from other changes in assets and liabilities of $23.7
million, primarily due to the receipt of a federal income tax refund
of $20.7 million in August 2003;
o net income of approximately $12.3 million; and
o add back of depreciation and amortization of other intangible assets
of approximately $6.2 million.
At December 31, 2003, the Company has a remaining reserve of $22.8 million
related to Ceftin sales returns. The Company estimates that it will pay this
amount beginning in 2004, using available cash on hand and cash provided by
operations.
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. The December 31, 2003 balance of the reserve is
approximately $818,000. On January 2, 2004 we gave Xylos notice of termination
of the Xylos agreement effective May 16, 2004. We continue to hold a $1.0
million investment of preferred stock of Xylos. In addition we provided a
short-term loan to Xylos in February 2004 of $250,000. Under the terms of the
agreement, we may provide another short-term loan of $250,000, if requested by
Xylos.
As of December 31, 2003, we had $3.6 million of unearned contract revenue
and $4.0 million of unbilled costs and accrued profits. 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. 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, the initiation and termination of contracts, contract terms and other
timing issues; these variations may change in size and direction with each
reporting period.
38
For the year ended December 31, 2003, net cash provided by investing
activities was $2.8 million which consisted of the sale of short-term
investments of $4.6 million, partially offset by $1.8 million in purchases of
property and equipment.
For the year ended December 31, 2003, net cash provided by financing
activities was $2.0 million. This amount is attributable to net proceeds
received from the employee stock purchase plan of $1.3 million and $0.7 million
in proceeds received from the exercise of stock options by employees.
Capital expenditures during the periods ended December 31, 2003 and 2002
were $1.8 million and $4.0 million, respectively, and were funded from available
cash. In the second quarter of 2004 we are anticipating 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 year ended
December 31, 2003, we had two major clients that accounted for approximately
35.3% and 32.4%, respectively, or a total of 67.7% 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, financial condition and results of operations.
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 (if such approvals are
obtained) 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. In July 2003, Cellegy received a letter from the FDA
rejecting its NDA for Fortigel. Cellegy has told us that it is in discussions
with the FDA to determine the appropriate course of action needed to meet
deficiencies cited by the FDA in its determination. Since we filed a lawsuit
against Cellegy (see below), Cellegy is no longer in regular contact with us
regarding Fortigel. Thus, for example, we are unaware of the FDA status
regarding Fortigel (as of December 31, 2003, it had not been approved) and are
unaware of what steps Cellegy is taking to develop Fortigel, to obtain FDA
approval for Fortigel, and/or to arrange for a party to manufacture Fortigel. We
have requested this information from Cellegy but have not received it.
Accordingly, we may not possess the most current and reliable information
concerning the current status of, or future prospects relating to, Fortigel. The
issuance of the non-approvable letter by the FDA concerning Fortigel, however,
casts significant doubt upon Fortigel's prospects and whether it will ever be
approved. We cannot predict with any certainty whether the FDA will ultimately
approve Fortigel for sale in the U.S. Since the drug remains unapproved, we were
not 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 December 12, 2003, we instituted an action against Cellegy in the U.S.
District Court for the Southern District of New York seeking to rescind the
Cellegy license agreement on the grounds that it was procured by fraud. We are
seeking return of the license fee we paid on December 31, 2002 of $15.0 million
plus additional damages caused by Cellegy's conduct.
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 foreseeable future. We continue to evaluate and review
financing opportunities and acquisition candidates in the ordinary course of
business. We are evaluating the need for a credit facility which would be
secured by our current assets for the purpose of increasing liquidity.
39
Contractual Obligations
As of December 31, 2003, the aggregate minimum future rental payments
required by non-cancelable operating leases with initial or remaining lease
terms exceeding one year are as follows (in thousands):
2004 2005 2006 2007 2008 Total
------ ------ ------ ------ ------ -------
Operating leases
Minimum lease payments $3,084 $2,576 $2,319 $2,167 $2,166 $12,312
Less minimum sublease rentals (135) (34) -- -- -- (169)
----------------------------------------------------
Net minimum lease payments $2,949 $2,542 $2,319 $2,167 $2,166 $12,143
====================================================
Quarterly Operating Results
Our results of operations have varied, and are expected to continue to
vary, from quarter to quarter. These fluctuations result from a number of
factors including, among other things, the timing of commencement, completion or
cancellation of major programs. In the future, our revenue may also fluctuate as
a result of a number of additional factors, including the types of products we
market and sell, delays or costs associated with acquisitions, government
regulatory initiatives and conditions in the healthcare industry generally.
Revenue, generally, is recognized as services are performed and products are
shipped. Program costs, other than training costs, are expensed as incurred. As
a result, we may incur substantial expenses associated with staffing a new
detailing program during the first two to three months of a contract without
recognizing any revenue under that contract. This could have an adverse impact
on our operating results for the quarters in which those expenses are incurred.
Revenue related to performance incentives is recognized in the period when the
performance based parameters are achieved. A significant portion of this revenue
could be recognized in the fourth quarter of a year. Costs of goods sold are
expensed when products are shipped. For milestone payments associated with
licensing agreements, amounts paid before the underlying product has obtained
regulatory approval and which have no alternate use are expensed as incurred,
whereas payments post-approval are capitalized and amortized over the economic
life of the product or agreement. We believe that because of these fluctuations,
quarterly comparisons of our financial results cannot be relied upon as an
indication of future performance.
The following table sets forth quarterly operating results for the eight
quarters ended December 31, 2003:
Quarter Ended
--------------------------------------------------------------------------------
Mar 31, Jun 30, Sep 30, Dec 31, Mar 31, Jun 30, Sep 30, Dec 31,
2003 2003 2003 2003 2002 2002 2002 2002
------- ------- ------- -------- ------- -------- -------- -------
(in thousands except per share data)
Revenue
Service, net ............................. $67,511 $71,177 $86,200 $104,173 $68,160 $ 66,033 $ 64,353 $79,029
Product, net ............................. 34 82 81 (11,810) 5,723 500 215 --
------- ------- ------- -------- ------- -------- -------- -------
Total revenue, net ................. 67,545 71,259 86,281 92,363 73,883 66,533 64,568 79,029
------- ------- ------- -------- ------- -------- -------- -------
Cost of goods and services
Program expenses ......................... 49,881 50,307 61,815 65,077 67,277 65,721 67,475 53,667
Cost of goods sold ....................... 62 83 952 190 -- -- -- --
------- ------- ------- -------- ------- -------- -------- -------
Total cost of goods and services ... 49,943 50,390 62,767 65,267 67,277 65,721 67,475 53,667
------- ------- ------- -------- ------- -------- -------- -------
Gross profit (loss) ......................... 17,602 20,869 23,514 27,096 6,606 812 (2,907) 25,362
Operating expenses
Compensation expense ..................... 8,874 9,123 9,297 9,607 7,759 9,294 9,157 6,459
Other selling, general and
administrative expenses ............... 5,833 7,206 7,676 9,632 3,325 6,450 9,433 24,956
Restructuring and other
related expenses ...................... (270) -- -- 413 -- -- 972 2,243
Litigation settlement .................... 2,100 -- -- -- -- -- -- --
------- ------- ------- -------- ------- -------- -------- -------
Total operating expenses ........... 16,537 16,329 16,973 19,652 11,084 15,744 19,562 33,658
------- ------- ------- -------- ------- -------- -------- -------
Operating income (loss) ..................... 1,065 4,540 6,541 7,444 (4,478) (14,932) (22,469) (8,296)
Other income net ............................ 269 226 246 332 889 356 459 263
------- ------- ------- -------- ------- -------- -------- -------
Income (loss) before provision
for taxes ................................ 1,334 4,766 6,787 7,776 (3,589) (14,576) (22,010) (8,033)
Provision (benefit) for income taxes ........ 556 1,954 2,605 3,290 (1,322) (5,385) (7,696) (3,044)
------- ------- ------- -------- ------- -------- -------- -------
Net income (loss) ........................... $ 778 $ 2,812 $ 4,182 $ 4,486 $(2,267) $ (9,191) $(14,314) $(4,989)
======= ======= ======= ======== ======= ======== ======== =======
Basic net income (loss) per share ........... $ 0.05 $ 0.20 $ 0.29 $ 0.31 $ (0.16) $ (0.66) $ (1.02) $ (0.35)
======= ======= ======= ======== ======= ======== ======== =======
Diluted net income (loss) per share ......... $ 0.05 $ 0.20 $ 0.29 $ 0.31 $ (0.16) $ (0.66) $ (1.02) $ (0.35)
======= ======= ======= ======== ======= ======== ======== =======
Weighted average number of shares:
Basic .................................... 14,166 14,188 14,252 14,320 13,969 14,003 14,063 14,097
======= ======= ======= ======== ======= ======== ======== =======
Diluted .................................. 14,237 14,266 14,543 14,677 13,969 14,003 14,063 14,097
======= ======= ======= ======== ======= ======== ======== =======
Note: For 2003, the sum of the quarterly basic net income per share amounts does
not equal the annual basic net income per share due to rounding.
40
Effect of new accounting pronouncements
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" (FIN 46). FIN 46 requires a variable interest entity
(VIE) to be consolidated by a company, if that company is subject to a majority
of the risk of loss from the VIE's activities or entitled to receive a majority
of the entity's residual returns or both. In December 2003, the FASB issued a
revision to the FIN 46 (FIN46R) which partially delayed the effective date of
the interpretation to March 31, 2004 and added additional scope exceptions.
Adoption of FIN46R is not expected to have a material impact on our business,
financial position or results of operations.
In December 2003, the Staff of the Securities and Exchange Commission
issued Staff Accounting Bulletin No. 104 (SAB 104), "Revenue Recognition," which
supercedes SAB 101, "Revenue Recognition in Financial Statements." SAB 104's
primary purpose is to rescind accounting guidance contained in SAB 101 related
to multiple element revenue arrangements, superceded as a result of the issuance
of EITF 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables."
Additionally, SAB 104 rescinds the SEC's "Revenue Recognition in Financial
Statements Frequently Asked Questions and Answers" (the FAQ) issued with SAB 101
that had been codified in SEC Topic 13, "Revenue Recognition." The revenue
recognition principles provided for in both SAB 101 and EITF 00-21 remain
largely unchanged. As a result, the adoption of SAB 104 is not expected to have
a material impact on our business, financial position and results of operations.
Use Of Non-GAAP Financial Information
This Form 10-K 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 our
past financial performance and our 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.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our financial statements and the required financial statement schedule are
included herein beginning on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None.
41
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our chief executive officer and
chief financial officer, has evaluated the effectiveness of our disclosure
controls and procedures (as such term is defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange
Act")) as of the end of the period covered by this report. Based on that
evaluation, our chief executive officer and chief financial officer have
concluded that, as of the end of such period, our disclosure controls and
procedures are effective.
Changes in Internal Controls
There have not been any changes in our internal control over financial
reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) during our fiscal fourth quarter that have materially affected, or
are reasonably likely to materially affect, our internal control over financial
reporting.
42
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
Directors and executive officers
The following table sets forth the names, ages and positions of our
directors, executive officers and key employees:
Name Age Position
- ---- --- --------
John P. Dugan 68 Chairman of the board of directors and director of strategic planning
Charles T. Saldarini 40 Chief executive officer and vice chairman of the board of directors
Steven K. Budd 47 President, global sales and marketing services group
Bernard C. Boyle 59 Chief financial officer, executive vice president and treasurer
Stephen Cotugno 44 Executive vice president -- corporate development and investor relations
Beth R. Jacobson 43 Executive vice president, general counsel and corporate secretary
Alan L. Rubino 49 Executive vice president and general manager -- sales teams business
Deborah Schnell 48 Executive vice president -- business development
Christopher Tama 45 Executive vice president and general manager -- pharmaceutical products
Joseph T. Curti(1)(3)(4) 65 Director
Larry Ellberger(1)(2) 56 Director
John C. Federspiel (1)(3) 49 Director
Gerald J. Mossinghoff(2)(3) 67 Director
John M. Pietruski(2)(3) 70 Director
Frank J. Ryan(1)(2) 64 Director
Jan Martens Vecsi 60 Director
- ----------
(1) Member of audit committee.
(2) Member of compensation and management development committee.
(3) Member of nominating and corporate governance committee.
(4) Member of science and technology committee.
John P. Dugan is our founder, chairman of the board of directors and
director of strategic planning. He served as our president from inception until
January 1995 and as our chief executive officer from inception until November
1997. In 1972, Mr. Dugan founded Dugan Communications, a medical advertising
agency that later became known as Dugan Farley Communications Associates Inc.
and served as its president until 1990. We were a wholly-owned subsidiary of
Dugan Farley in 1990 when Mr. Dugan became our sole stockholder. Mr. Dugan was a
founder and served as the president of the Medical Advertising Agency
Association from 1983 to 1984. Mr. Dugan also served on the board of directors
of the Pharmaceutical Advertising Council (now known as the Healthcare Marketing
Communications Council, Inc.) and was its president from 1985 to 1986. Mr. Dugan
received an M.B.A. from Boston University in 1964.
Charles T. Saldarini is our vice chairman and chief executive officer.
Joining PDI in 1987, Mr. Saldarini has held positions of increasing
responsibility, becoming president of PDI in January 1995, chief executive
officer in November 1997, and vice chairman in June 2000. In his 17 years at
PDI, his contributions have spanned the full range of our development. He is
responsible for making PDI the largest contract sales organization in the U.S.
Prior to PDI, Mr. Saldarini worked at Merrill Dow Pharmaceuticals. He received a
B.A. in political science from Syracuse University in 1985.
Steven K. Budd has served as our global president of the sales and
marketing services group since September 2003. Prior to that, he was our
president and chief operating officer, a position he filled since June 2000. Mr.
Budd joined us in April 1996 as vice president, account group sales. He became
executive vice president in July 1997, chief operating officer in January 1998,
and our president in June 2000. From January 1994 through April 1995, Mr. Budd
was employed by Innovex, Inc., as director of new business development. From
1989 through December 1993, he was employed by Professional Detailing Network
(now known as Nelson Professional Sales, a division of Publicis), as vice
president with responsibility for building sales teams and developing marketing
strategies. Mr. Budd received a B.A. in history and education from Susquehanna
University in 1978.
43
Bernard C. Boyle has served as our chief financial officer, executive vice
president and treasurer since March 1997. In 1990, Mr. Boyle founded BCB
Awareness, Inc., a firm that provided management advisory services, and served
as its president until March 1997. During that period he was also a partner in
Boyle & Palazzolo, Partners, an accounting firm. From 1982 through 1990 he
served as controller and then chief financial officer and treasurer of William
Douglas McAdams, Inc., an advertising agency. From 1966 through 1971, Mr. Boyle
was employed by the national accounting firm then known as Coopers & Lybrand
L.L.P. as supervisor/senior audit staff. Mr. Boyle received a B.B.A. in
accounting from Manhattan College in 1965 and an M.B.A. in corporate finance
from New York University in 1972.
Stephen P. Cotugno became our executive vice president - corporate
development and investor relations in January 2000. He joined us as a consultant
in 1997 and in January 1998 he was hired full time as vice president-corporate
development. Prior to joining us, Mr. Cotugno was an independent financial
consultant. He received a B.A. in finance and economics from Fordham University
in 1981.
Beth R. Jacobson joined us in November 2002 as executive vice president,
general counsel and corporate secretary. Previously, she was with Skadden, Arps,
Slate, Meagher & Flom, LLP for 15 years, where she practiced corporate law. She
received a B.A. from Wesleyan University in 1983 and a J.D. from New York
University Law School in 1987.
Alan L. Rubino joined us in January 2004 as executive vice president and
general manager of our sales teams business. He was most recently senior vice
president of the Pharmaceuticals Technology and Services Division within
Cardinal Health. He joined Cardinal Health as part of the acquisition of BLPG,
Inc., a healthcare marketing services company, where he was the executive vice
president and managing director. Prior to joining BLPG, he had a distinguished
career in key executive positions in marketing, sales and operations within
Hoffmann-LaRoche, most recently holding the position of vice president, business
operations. He received a B.A. in Economics from Rutgers University in 1976 with
a minor in biology and chemistry. Mr. Rubino has also attended management
courses at Harvard Business School.
Deborah Schnell is our executive vice president - business development. She
was one of the founders of ProtoCall which was acquired by PDI in 1999. Prior to
joining ProtoCall, Ms. Schnell spent approximately 20 years with IBM Corporation
where she worked across a broad range of areas, including manufacturing,
distribution and healthcare. She received a B.A. in speech pathology and
audiology from Miami of Ohio University in 1976.
Christopher Tama joined us as executive vice president and general manager
in January 2000. Mr. Tama is responsible for PDI Pharmaceutical Products Group
involving the commercialization of prescription pharmaceutical products secured
through licensing and acquisition. Prior to joining PDI, Mr. Tama was vice
president of marketing at Novartis Pharmaceuticals from 1996 through 2000. His
previous experience also includes the position of vice president of marketing at
G.D. Searle U.S. Operations and various marketing and sales positions of
increasing responsibility during his 13 years with Pharmacia. His marketing and
sales experience range many different therapeutic areas with both domestic and
global responsibility. He received a B.A. in economics from Villanova University
in 1981.
Dr. Joseph T. Curti became a director in August 2003. Dr. Curti was most
recently president and chief executive officer of Ferring Pharmaceuticals in
Tarrytown, NY. He previously held the position of president and chief executive
officer of Neurochem, Inc. in Kingston, Ontario and President of North American
Operations of Searle in Skokie, Ill. He spent 19 years at Pfizer in a number of
senior positions, both domestically and internationally, directing clinical drug
development, drug regulatory, licensing and marketing activities. He is
currently a member of the board of trustees and executive committee of Morehouse
School of Medicine in Atlanta, GA. Dr. Curti received a B.S. from St. Joseph's
University in Philadelphia in 1959 and an M.D. from Thomas Jefferson University
in Philadelphia in 1963.
Larry Ellberger became a director in February 2003. Mr. Ellberger is a
founder and partner in Healthcare Ventures Associates, Inc., a consulting firm
to pharmaceutical, biotech, vaccines and medical device companies. Until July
2003 Mr. Ellberger was Senior Vice President, Corporate Development at
PowderJect, PLC, a London Stock Exchange listed vaccines company. He had been a
member of PowderJect's Board of Directors since 1997. From November 1996 through
May 1999, Mr. Ellberger served as Chief Financial Officer of W. R. Grace and
from
44
May 1999 through November 1999 he served as Senior Vice President - Corporate
Development of W. R. Grace. Mr. Ellberger is a Director of Avant
Immunotherapeutics and The Jewish Children's Museum. Mr. Ellberger received a
B.A. in economics from Columbia College in 1968 and a B.S. in chemical
engineering from Columbia School of Engineering in 1969.
John C. Federspiel became a director in October 2001. Mr. Federspiel is
president of Hudson Valley Hospital Center, a 120-bed, short-term, acute care,
not-for-profit hospital in Westchester County, New York. Prior to joining Hudson
Valley Hospital in 1987, Mr. Federspiel spent an additional 10 years in health
administration, during which he held a variety of executive leadership
positions. Mr. Federspiel is an appointed Member of the State Hospital Review
and Planning Council, and has served as chairman of the Northern Metropolitan
Hospital Association, as well as other affiliations. Mr. Federspiel received a
B.S. degree from Ohio State University in 1975 and a M.B.A. from Temple
University in 1977.
Gerald J. Mossinghoff became a director in May 1998. Mr. Mossinghoff is a
former Assistant Secretary of Commerce and Commissioner of Patents and
Trademarks of the Department of Commerce (1981 to 1985) and served as President
of Pharmaceutical Research and Manufacturers of America from 1985 to 1996. Since
1997 he has been senior counsel to the law firm of Oblon, Spivak, McClelland,
Maier and Newstadt of Arlington, Virginia. Mr. Mossinghoff has been a visiting
professor of Intellectual Property Law at the George Washington University Law
School since 1997 and Adjunct Professor of Law at George Mason University School
of Law since 1997. Mr. Mossinghoff served as U.S. Ambassador to the Diplomatic
Conference on the Revision of the Paris Convention from 1982 to 1985 and as
Chairman of the General Assembly of the United Nations World Intellectual
Property Organization from 1983 to 1985. He is also a former Deputy General
Counsel of the National Aeronautics and Space Administration (1976 to 1981). Mr.
Mossinghoff received an electrical engineering degree from St. Louis University
in 1957 and a juris doctor degree with honors from the George Washington
University Law School in 1961. He is a member of the Order of the Coif and is a
Fellow in the National Academy of Public Administration. He is the recipient of
many honors, including NASA's Distinguished Service Medal and the Secretary of
Commerce Award for Distinguished Public Service.
John M. Pietruski became a director in May 1998. Since 1990 Mr. Pietruski
has been the chairman of the board of Encysive Corporation, a pharmaceutical
research and development company. He is a retired chairman of the board and
chief executive officer of Sterling Drug Inc. where he was employed from 1977
until his retirement in 1988. Mr. Pietruski is a member of the boards of
directors of First Energy Corp. and Xylos Corporation. Mr. Pietruski graduated
Phi Beta Kappa with a B.S. in business administration with honors from Rutgers
University in 1954.
Frank J. Ryan became a director in November 2002. Mr. Ryan's career
includes a 38-year tenure with Johnson & Johnson. Mr. Ryan recently retired as
Company Group Chairman with responsibility for worldwide Ethicon franchises and
Johnson & Johnson Canada. In addition, Mr. Ryan was a member of the Medical
Devices and Diagnostics Operating Group and Leader for the Group in Process
Excellence (Six Sigma) and IT. Throughout the years, Mr. Ryan held positions of
increasing responsibility, including Worldwide President of Chicopee, President
of Johnson and Johnson Hospital Services Co. and President of Ethicon, Inc. Mr.
Ryan received a B.S. degree in mechanical engineering from the Illinois
Institute of Technology in 1965 and a M.B.A. from the University of Chicago
Graduate School of Business in 1969.
Jan Martens Vecsi became a director in May 1998. Ms. Vecsi is the
sister-in-law of John P. Dugan, our chairman. Ms. Vecsi was employed by
Citibank, N.A. from 1967 through 1996 when she retired. Starting in 1984 she
served as the senior human resources officer and vice president of the Citibank
Private Bank. Ms. Vecsi received a B.A. in psychology and elementary education
from Immaculata College in 1965.
Board of directors and committees
Our board of directors is divided into three classes. Each year the
stockholders elect the members of one of the three classes to a three-year term
of office. Messrs. Dugan and Mossinghoff and Dr. Curti serve in the class whose
term expires in 2004; Ms. Vecsi and Messrs. Federspiel and Ellberger serve in
the class whose term expires in 2005; and Messrs. Saldarini, Pietruski and Ryan
serve in the class whose term expires in 2006.
45
Our board of directors has an audit committee, a compensation and
management development committee, a nominating and corporate governance
committee and a science and technology committee. The audit committee reviews
the scope and results of the audit and other services provided by our
independent accountants and our internal controls. The compensation and
management development committee is responsible for the approval of compensation
arrangements for our officers and the review of our compensation plans and
policies and development of our management. The nominating and corporate
governance committee is responsible for selecting individuals qualified to serve
as directors and on committees of the board, to advise the board with respect to
board composition, procedures and committees and with respect to corporate
governance principles applicable to us and to oversee the evaluation of the
board and our management. The science and technology committee is responsible
for advising the board on scientific matters and to periodically examine
management's direction regarding the acquisition or licensing of pharmaceutical
products and our technology initiatives. Each committee member is a non-employee
director of ours who meets the independence requirements of Nasdaq and
applicable law.
Audit Committee Financial Expert. The Board has determined that the
chairman of the audit committee, Mr. Ellberger, is an "audit committee financial
expert," as that term is defined in Item 401(h) of Regulation S-K, and
"independent" for purposes of current and recently-adopted Nasdaq listing
standards and Section 10A(m)(3) of the Securities Exchange Act of 1934.
Section 16(a) beneficial ownership reporting compliance
Section 16(a) of the Securities Exchange Act of 1934 requires our officers
and directors, and persons who own more than ten percent of a registered class
of our equity securities, to file reports of ownership and changes in ownership
with the Securities and Exchange Commission (SEC). Officers, directors and
greater than ten-percent stockholders are required by SEC regulation to furnish
us with copies of all Section 16(a) forms they file. Based solely on review of
the copies of such forms furnished to us, or written representations that no
Forms 5 were required, we believe that all Section 16(a) filing requirements
applicable to our officers and directors were complied with, except that a Form
4 filing on behalf of each of Messrs. Ellberger, Federspiel, Mossinghoff,
Pietruski and Ryan, and Ms. Vecsi, relating to the stock options automatically
granted to each of them as outside directors on the date of the 2003 annual
stockholders meeting, was not timely filed.
Code of Conduct
We have adopted a code of conduct that applies to our principal executive
officer, principal financial officer and other persons performing similar
functions, as well as all of our other employees and directors. This code of
conduct is posted on our website at www.pdi-inc.com and is filed as Exhibit 14.1
to this report.
ITEM 11. EXECUTIVE COMPENSATION
Information relating to executive compensation that is responsive to Item
11 of Form 10-K will be included in our Proxy Statement in connection with our
2004 annual meeting of stockholders and such information is incorporated by
reference herein.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information relating to security ownership of certain beneficial owners and
management that is responsive to Item 12 of Form 10-K will be included in our
Proxy Statement in connection with our 2004 annual meeting of stockholders and
such information is incorporated by reference herein.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information relating to certain relationships and related transactions that
is responsive to Item 13 of Form 10-K will be included in our Proxy Statement in
connection with our 2004 annual meeting of stockholders and such information is
incorporated by reference herein.
46
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Information relating to principal accounting fees and services that is
responsive to Item 14 of Form 10-K will be included in our Proxy Statement in
connection with our 2004 annual meeting of stockholders and such information is
incorporated by reference herein.
47
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
The following documents are filed as part of this report:
(a) (1) Financial Statements - See Index to Financial Statements on page
F-1 of this report.
(a) (2) Financial Statement Schedule
Schedule II: Valuation and Qualifying Accounts
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is included elsewhere in
the financial statements or notes thereto.
(a) (3) Exhibits
Exhibit
No. Description
------- -----------
3.1 Certificate of Incorporation of PDI, Inc.(1)
3.2 By-Laws of PDI, Inc.(1)
3.3 Certificate of Amendment of Certificate of Incorporation of PDI,
Inc.(4)
4.1 Specimen Certificate Representing the Common Stock(1)
10.1 Form of 1998 Stock Option Plan(1)
10.2 Form of 2000 Omnibus Incentive Compensation Plan(2)
10.3 Office Lease for Upper Saddle River, NJ corporate headquarters(1)
10.4 Form of Employment Agreement between the Company and Charles T.
Saldarini(4)
10.5 Agreement between the Company and John P. Dugan(1)
10.6 Form of Amended and Restated Employment Agreement between the
Company and Steven K. Budd(4)
10.7 Form of Amended and Restated Employment Agreement between the
Company and Bernard C. Boyle(4)
10.8 Form of Employment Agreement between the Company and Christopher
Tama(5)
10.9 Form of Amended and Restated Employment Agreement between the
Company and Stephen Cotugno(4)
10.10 Form of Employment Agreement between the Company and Beth
Jacobson(5)
10.11 Form of Employment Agreement between the Company and Alan Rubino*
10.12 Form of Loan Agreement between the Company and Steven K. Budd(3)
10.13 Exclusive License Agreement between the Company and Cellegy
Pharmaceuticals, Inc.(5)(6)
10.14 Saddle River Executive Centre Lease, as amended*
14.1 Code of Conduct*
21.1 Subsidiaries of the Registrant(4)
23.1 Consent of PricewaterhouseCoopers LLP*
48
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*
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*
----------
* Filed herewith
(1) Filed as an exhibit to our Registration Statement on Form S-1 (File No
333-46321), and incorporated herein by reference.
(2) Filed as an Exhibit to our definitive proxy statement dated May 10
2000, and incorporated herein by reference.
(3) Filed as an exhibit to our Annual Report on Form 10-K for the year
ended December 31, 1999, and incorporated herein by reference.
(4) Filed as an exhibit to our Annual Report on Form 10-K for the year
ended December 31, 2001, and incorporated herein by reference.
(5) Filed as an exhibit to our Annual Report on Form 10-K for the year
ended December 31, 2002, and incorporated herein by reference.
(6) The Securities and Exchange Commission granted the Registrant's
application for confidential treatment, pursuant to Rule 24b-2 under
the Exchange Act, of certain portions of this exhibit. These portions
of the exhibit have been redacted from the exhibit as filed.
(b) Reports on Form 8-K
During the three months ended December 31, 2003, the Company filed the following
reports on Form 8-K:
Date Item(s) Description
---- ------- -----------
November 6, 2003 7 and 12 Press Release: PDI Reports Third Quarter
Financial Results
December 11, 2003 5 and 7 Press Release: PDI Reports Preliminary
Earnings Guidance for 2004
December 15, 2003 5 and 7 Press Release: PDI Files Action Against
Cellegy Pharmaceuticals
December 24, 2003 5 and 7 Press Release: PDI Announces Contract with
Novartis
49
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this Form 10-K
to be signed on its behalf by the undersigned, thereunto duly authorized, on the
3rd day of March, 2004.
PDI, INC.
/s/ Charles T. Saldarini
---------------------------------
Charles T. Saldarini,
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this Form 10-K has been signed by the following persons on behalf of
the Registrant and in the capacities indicated and on the 3rd day of March,
2004.
Signature Title
--------- -----
/s/ John P. Dugan Chairman of the Board of Directors
- ---------------------------------
John P. Dugan
/s/ Charles T. Saldarini Vice Chairman of the Board of Directors and
- --------------------------------- Chief Executive Officer
Charles T. Saldarini
/s/ Bernard C. Boyle Chief Financial Officer and Treasurer
- --------------------------------- (principal accounting and financial officer)
Bernard C. Boyle
/s/ John M. Pietruski Director
- ---------------------------------
John M. Pietruski
/s/ Jan Martens Vecsi Director
- ---------------------------------
Jan Martens Vecsi
/s/ Frank Ryan Director
- ---------------------------------
Frank Ryan
/s/ Larry Ellberger Director
- ---------------------------------
Larry Ellberger
/s/ Dr. Joseph T. Curti Director
- ---------------------------------
Dr. Joseph T. Curti
50
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
Page
----
PDI, INC.
Report of Independent Auditors F-2
Consolidated Balance Sheets F-3
Consolidated Statements of Operations F-4
Consolidated Statements of Cash Flows F-5
Consolidated Statements of Stockholders' Equity F-6
Notes to Consolidated Financial Statements F-7
Schedule II. Valuation and Qualifying Accounts F-28
F-1
Report of Independent Auditors
To Board of Directors and
Stockholders of PDI, Inc.:
In our opinion, the consolidated financial statements listed in the accompanying
index appearing under Item 15(a)(1) present fairly, in all material respects,
the financial position of PDI, Inc. and its subsidiaries at December 31, 2003
and 2002, and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 2003 in conformity with
accounting principles generally accepted in the United States of America. In
addition, in our opinion, the financial statement schedule listed in the index
appearing under Item 15(a)(2), present fairly, in all material respects, the
information set forth therein when read in conjunction with the related
consolidated financial statements. These financial statements and financial
statement schedule are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements and
financial statement schedules based on our audits. We conducted our audits of
these statements in accordance with auditing standards generally accepted in the
United States of America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Florham Park, NJ
March 3, 2004
F-2
PDI, INC.
CONSOLIDATED BALANCE SHEETS
December 31,
-------------------
2003 2002
-------- --------
(in thousands)
ASSETS
Current assets:
Cash and cash equivalents ................................................... $113,288 $ 66,827
Short-term investments ...................................................... 1,344 5,834
Inventory, net of obsolescence reserve of $818 and $0 as of
December 31, 2003 and 2002, respectively ................................. 43 646
Accounts receivable, net of allowance for doubtful accounts of
$749 and $1,063 as of December 31, 2003 and 2002, respectively ........... 40,885 40,729
Unbilled costs and accrued profits on contracts in progress ................. 4,041 3,360
Deferred training ........................................................... 1,643 1,106
Prepaid income tax .......................................................... -- 18,856
Other current assets ........................................................ 8,847 4,804
Deferred tax asset .......................................................... 11,053 7,420
-------- --------
Total current assets ........................................................... 181,144 149,582
Net property and equipment .................................................. 14,494 18,295
Deferred tax asset .......................................................... 7,304 7,820
Goodwill .................................................................... 11,132 11,132
Other intangible assets ..................................................... 1,648 2,261
Other long-term assets ...................................................... 3,901 1,849
-------- --------
Total assets ................................................................... $219,623 $190,939
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................................................ $ 8,689 $ 5,374
Accrued rebates, sales discounts and returns ................................ 22,811 16,500
Accrued incentives .......................................................... 20,486 11,758
Accrued salaries and wages .................................................. 9,031 6,617
Unearned contract revenue ................................................... 3,604 9,473
Restructuring accruals ...................................................... 744 4,699
Other accrued expenses ...................................................... 15,770 13,307
-------- --------
Total current liabilities ...................................................... 81,135 67,728
-------- --------
Long-term liabilities .......................................................... -- --
-------- --------
Total liabilities .............................................................. $ 81,135 $ 67,728
======== ========
Commitments and Contingencies
Stockholders' equity:
Common stock, $.01 par value; 100,000,000 shares authorized; shares
issued and outstanding, 2003 - 14,387,126; 2002 - 14,165,880;
restricted $.01 par value; shares issued and outstanding, 2003- 136,178;
2002 - 44,325 ............................................................ $ 145 $ 142
Preferred stock, $.01 par value; 5,000,000 shares authorized, no
shares issued and outstanding ............................................ -- --
Additional paid-in capital (includes restricted of $2,361and $1,547
in 2003 and 2002, respectively) .......................................... 109,531 106,673
Retained earnings .............................................................. 29,505 17,247
Accumulated other comprehensive income (loss) .................................. 25 (100)
Unamortized compensation costs ................................................. (608) (641)
Treasury stock, at cost: 5,000 shares at December 31, 2003 and 2002 ............ (110) (110)
-------- --------
Total stockholders' equity ..................................................... $138,488 $123,211
-------- --------
Total liabilities & stockholders' equity ....................................... $219,623 $190,939
======== ========
The accompanying notes are an integral part of these
consolidated financial statements
F-3
PDI, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For The Years Ended December 31,
-----------------------------------------
2003 2002 2001
------------ ------------ -----------
(in thousands, except for per share data)
Revenue
Service, net ............................................ $329,061 $277,575 $281,269
Product, net ............................................ (11,613) 6,438 415,314
-------- -------- --------
Total revenue, net ................................... 317,448 284,013 696,583
-------- -------- --------
Cost of goods and services
Program expenses (including related party amounts of
$983, $516 and $1,057 for the periods ended
December 31, 2003, 2002 and 2001, respectively) ...... 227,080 254,140 232,171
Cost of goods sold ...................................... 1,287 -- 328,629
-------- -------- --------
Total cost of goods and services ..................... 228,367 254,140 560,800
-------- -------- --------
Gross profit ............................................... 89,081 29,873 135,783
Operating expenses
Compensation expense .................................... 36,901 32,670 39,263
Other selling, general and administrative expenses ...... 30,347 44,163 83,815
Restructuring and other related expenses ................ 143 3,215 --
Litigation settlement ................................... 2,100 -- --
-------- -------- --------
Total operating expenses ............................. 69,491 80,048 123,078
-------- -------- --------
Operating income (loss) .................................... 19,590 (50,175) 12,705
Other income, net .......................................... 1,073 1,967 2,275
-------- -------- --------
Income (loss) before provision (benefit) for taxes ......... 20,663 (48,208) 14,980
Provision (benefit) for income taxes ....................... 8,405 (17,447) 8,626
-------- -------- --------
Net income (loss) .......................................... $ 12,258 $(30,761) $ 6,354
======== ======== ========
Basic net income (loss) per share .......................... $ 0.86 $ (2.19) $ 0.46
======== ======== ========
Diluted net income (loss) per share ........................ $ 0.85 $ (2.19) $ 0.45
======== ======== ========
Basic weighted average number of shares outstanding ........ 14,231 14,033 13,886
======== ======== ========
Diluted weighted average number of shares outstanding ...... 14,431 14,033 14,113
======== ======== ========
The accompanying notes are an integral part of these
consolidated financial statements
F-4
PDI, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For The Years Ended December 31,
--------------------------------
2003 2002 2001
-------- -------- --------
(in thousands)
Cash Flows From Operating Activities
Net income (loss) from operations ..................................... $ 12,258 $(30,761) $ 6,354
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization ................................... 6,243 7,374 4,676
Loss on disposal of asset ....................................... -- -- 858
Amortized compensation costs .................................... 554 443 318
Deferred taxes, net ............................................. (3,117) 8,501 (19,411)
Reserve for inventory obsolescence and bad debt ................. 1,939 (2,080) 2,995
Loss on other investments ....................................... -- 379 1,863
Other changes in assets and liabilities, net of acquisitions:
(Increase) decrease in accounts receivable ...................... (1,277) 13,991 31,304
(Increase) decrease in inventory ............................... (216) (203) 35,066
(Increase) decrease in unbilled costs ........................... (681) 3,538 (3,703)
(Increase) decrease in deferred training ........................ (537) 4,463 (639)
Decrease (increase) in other current assets ..................... 14,813 (15,559) (477)
(Increase) decrease in other long-term assets ................... (2,052) 4,385 (2,071)
Increase (decrease) in accounts payable ......................... 3,316 (4,119) (21,969)
Increase (decrease) in accrued rebates and sales discounts ...... 6,311 (51,903) 44,026
(Decrease) increase in accrued contract losses .................. -- (12,256) 12,256
Increase (decrease) in accrued liabilities ...................... 11,957 (10,398) 6,411
(Decrease) in unearned contract revenue ......................... (5,869) (1,404) (12,939)
Increase (decrease) in other current liabilities ................ 1,943 (3,371) (4,623)
(Decrease) in other deferred compensation ....................... -- -- (169)
(Decrease) in restructuring liability ........................... (3,954) -- --
-------- -------- --------
Net cash provided by (used in) operating activities ................... 41,631 (88,980) 80,126
-------- -------- --------
Cash Flows From Investing Activities
Sale of short-term investments .................................. 4,614 1,532 6,225
Purchase of short-term investments .............................. -- -- (8,750)
Investments in Xylos, In2Focus, and iPhysicianNet ............... -- (1,379) (1,103)
Purchase of property and equipment .............................. (1,829) (4,012) (15,560)
Cash paid for acquisition, net of cash acquired ................. -- (2,735) (11,902)
-------- -------- --------
Net cash provided by (used in) investing activities ................... 2,785 (6,594) (31,090)
-------- -------- --------
Cash Flows From Financing Activities
Net proceeds from employee stock purchase plan
and the exercise of stock options ............................ 2,045 2,358 2,117
Purchase of treasury stock ...................................... -- -- (110)
-------- -------- --------
Net cash provided by financing activities ............................. 2,045 2,358 2,007
-------- -------- --------
Net increase (decrease) in cash and cash equivalents .................. 46,461 (93,216) 51,043
Cash and cash equivalents - beginning ................................. 66,827 160,043 109,000
-------- -------- --------
Cash and cash equivalents - ending .................................... $113,288 $ 66,827 $160,043
======== ======== ========
Cash paid for interest ................................................ $ 25 $ 33 $ 59
======== ======== ========
Cash paid for taxes ................................................... $ 9,619 $ 4,827 $ 18,023
======== ======== ========
The accompanying notes are an integral part of these
consolidated financial statements
F-5
PDI, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
Accumulated
Common Stock Treasury Stock Additional Other
--------------- --------------- Paid in Retained Comprehensive
Shares Amount Shares Amount Capital Earnings Income (Loss)
------ ------ ------ ------ ---------- -------- -------------
Balance - December 31, 2000 13,845 $138 -- $ -- $ 97,162 $41,654 $ (34)
Net income for the year ended December 31, 2001 6,354
Unrealized investment holding losses, net of tax (56)
Comprehensive income
Issuance of common stock 90 1 1,408
Issuance of employees' restricted common stock 7 737
Purchase of treasury stock 5 (110)
Exercise of common stock options 41 1 709
Tax benefit of nonqualified option exercise 3,695
Realized loss on sale of investment holdings 11
Amortization of deferred compensation costs
Deferred compensation costs
------ ---- --- ----- -------- ------- -----
Balance - December 31, 2001 13,983 $140 5 $(110) $103,711 $48,008 $ (79)
====== ==== === ===== ======== ======= =====
Net loss for the year ended December 31, 2002 (30,761)
Unrealized investment holding losses, net of tax (21)
Comprehensive income
Issuance of common stock 190 2 2,239
Issuance of employees' restricted common stock 29 593
Exercise of common stock options 8 130
Amortization of deferred compensation costs
Deferred compensation costs
------ ---- --- ----- -------- ------- -----
Balance - December 31, 2002 14,210 $142 5 $(110) $106,673 $17,247 $(100)
====== ==== === ===== ======== ======= =====
Net income for the year ended December 31, 2003 12,258
Unrealized investment holding gains, net of tax 125
Comprehensive income
Issuance of common stock 143 1 1,326
Issuance of employees' restricted common stock 129 1 814
Exercise of common stock options 41 1 526
Tax benefit of nonqualified option exercise 192
Amortization of deferred compensation costs
Deferred compensation costs
------ ---- --- ----- -------- ------- -----
Balance - December 31, 2003 14,523 $145 5 $(110) $109,531 $29,505 $ 25
====== ==== === ===== ======== ======= =====
Unamortized
Deferred Loan to Compensation
Compensation Officer Costs Total
------------ ----------- ------------ --------
Balance - December 31, 2000 $-- $-- $(810) $138,110
Net income for the year ended December 31, 2001 6,354
Unrealized investment holding losses, net of tax (56)
-------
Comprehensive income 6,298
Issuance of common stock 1,409
Issuance of employees' restricted common stock 737
Purchase of treasury stock (110)
Exercise of common stock options 710
Tax benefit of nonqualified option exercise 3,695
Realized loss on sale of investment holdings 11
Amortization of deferred compensation costs 318 318
Deferred compensation costs (243) (243)
--- --- ----- --------
Balance - December 31, 2001 $-- $-- $(735) $150,935
=== === ===== ========
Net loss for the year ended December 31, 2002 (30,761)
Unrealized investment holding losses, net of tax (21)
Comprehensive income (30,782)
Issuance of common stock 2,241
Issuance of employees' restricted common stock 593
Exercise of common stock options 130
Amortization of deferred compensation costs 443 443
Deferred compensation costs (349) (349)
--- --- ----- --------
Balance - December 31, 2002 $-- $-- $(641) $123,211
=== === ===== ========
Net income for the year ended December 31, 2003 12,258
Unrealized investment holding gains, net of tax 125
-------
Comprehensive income 12,383
Issuance of common stock 1,327
Issuance of employees' restricted common stock 815
Exercise of common stock options 527
Tax benefit of nonqualified option exercise 192
Amortization of deferred compensation costs 554 554
Deferred compensation costs (521) (521)
--- --- ----- --------
Balance - December 31, 2003 $-- $-- $(608) $138,488
=== === ===== ========
The accompanying notes are an integral part of
these consolidated financial statements
F-6
PDI, Inc.
Notes to the Consolidated Financial Statements
1. Nature of Business and Significant Accounting Policies
Nature of Business
PDI, Inc. ("PDI" and, together with its wholly owned subsidiaries, "the
Company") is a healthcare sales and marketing company serving the
biopharmaceutical and medical devices and diagnostics (MD&D) industries. See
Note 23 for segment information.
Principles of Consolidation
The consolidated financial statements include accounts of PDI and its
wholly owned subsidiaries TVG, Inc. (TVG), ProtoCall, Inc. (ProtoCall), InServe
Support Solutions, Inc. (InServe) and PDI Investment Company, Inc. (PDII). All
significant intercompany balances and transactions have been eliminated in
consolidation.
Use of Estimates
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles (GAAP) requires the Company to make
estimates and assumptions that affect the amounts reported in the financial
statements. Actual results could differ from those estimates. Significant
estimates include accrued contract losses, accrued incentives payable to
employees, valuation allowances related to deferred taxes, allowances for
doubtful accounts and inventory obsolescence, sales returns, and accruals for
sales rebates.
Revenue Recognition and Associated Costs
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 financial statements. In accordance with GAAP, service revenue and
product revenue and their respective direct costs have been 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 years ended December
31, 2003, 2002 and 2001, the Company's largest clients, who each individually
represented 10% or more of its service revenue, accounted for approximately
67.7%, 64.1% and 60.0%, respectively, of its 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.
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 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. 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.
F-7
PDI, Inc.
Notes to the Consolidated Financial Statements - continued
Training Costs
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 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 year ended December 31,
2003 was negative, primarily from the adjustment to the Ceftin returns reserve,
as discussed in Note 3 to the consolidated financial statements, net of the sale
of the Xylos wound care products. Product revenue recognized in prior periods
was related to the Ceftin contract which was terminated by mutual consent in
February 2002.
Cost of goods sold includes all expenses for product distribution costs,
acquisition and manufacturing costs of the product sold.
Estimates for accrued rebates, discounts and sales allowances
For product sales, provision is made at the time of sale for all discounts
and estimated sales allowances. As is common in the pharmaceutical industry,
customers who purchased the Company's Ceftin product are permitted to return
unused product, after approval from the Company, up to six months before, and
one year after the expiration date for the product, but no later than December
31, 2004. The products sold by the Company prior to the Ceftin agreement
termination date of February 28, 2002 have expiration dates through June 2004.
As discussed in Note 3 to the consolidated financial statements, there was a
$12.0 million adjustment to the Ceftin returns reserve in 2003. This adjustment
was recorded as a reduction to revenue consistent with the initial recognition
of the returns allowance and resulted in the Company reporting net negative
product revenue in 2003. Additionally, certain customers were eligible for price
rebates or discounts, offered as an incentive to increase sales volume and
achieve favorable formulary status, on the basis of volume of purchases or
increases in the product's market share over a specified period, and certain
customers are credited with chargebacks on the basis of their resales to end-use
customers, such as HMO's, which contracted with the Company for quantity
discounts. Furthermore, the Company is obligated to issue rebates under the
federally administered Medicaid program. In each instance the Company has the
historical data and access to other information, including the total demand for
the drug it distributes, its market share, the recent or pending introduction of
new drugs or generic competition, the inventory practices of the Company's
customers and the resales by its customers to end-users having contracts with
the Company, necessary to reasonably estimate the amount of such returns or
allowances, and record reserves for such returns or allowances at the time of
sale as a reduction of revenue. The actual payment of these rebates varies
depending on the program and can take several calendar quarters before final
settlement. As the Company settles these liabilities in future periods, it will
continue to monitor all appropriate information and determine if any positive or
negative adjustments are required in that period. Any adjustments for changes in
estimates are recorded through revenue in that period.
Contract Loss Provisions
Provisions for losses to be incurred on contracts are recognized in full in
the period in which it is determined that a loss will result from performance of
the contractual arrangement. Performance based contracts have the potential for
higher returns but also an increased risk of contract loss as compared to the
traditional fee for service CSO contracts. The Company did not recognize any
contract losses in 2003. As discussed in Notes 2 and 3 to the consolidated
financial statements, the Company recognized contract losses in 2002 and 2001
related to the Evista and Ceftin contracts, respectively.
F-8
PDI, Inc.
Notes to the Consolidated Financial Statements - continued
Unbilled Costs and Accrued Profits and Unearned Contract Revenue
In general, contractual provisions, including predetermined payment
schedules or submission of appropriate billing detail, establish the
prerequisites for billings. Unbilled costs and accrued profits arise when
services have been rendered and payment is assured but clients have not been
billed. These amounts are classified as a current asset. Normally, in the case
of detailing contracts, the clients agree to pay the Company a portion of the
fee due under a contract in advance of performance of services because of large
recruiting and employee development costs associated with the beginning of a
contract. The excess of amounts billed over revenue recognized represents
unearned contract revenue, which is classified as a current liability.
Cash and Cash Equivalents
Cash and cash equivalents consist of unrestricted cash accounts, highly
liquid investment instruments and certificates of deposit with an original
maturity of three months or less at the date of purchase.
Investments
The Company accounts for investments under Statement of Financial
Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt
and Equity Securities." Available-for-sale investments are valued at fair market
value based on quoted market values, with the resulting adjustments, net of
deferred taxes, reported as a separate component of stockholders' equity as
accumulated other comprehensive income (loss). For the purposes of determining
gross realized gains and losses, the cost of securities sold is based upon
specific identification. The Company also has certain other investments which
are accounted for under the cost method, which are included in other long-term
assets. Lastly, the Company has certain other investments which are accounted
for under the equity method of accounting, which requires the Company to
recognize its share of both profits and losses of the investee. These
investments are also included in other long-term assets. The Company reviews its
equity investments for impairment on an ongoing basis, based on its
determination of whether a decline in the fair value of the investments below
the Company's carrying value is other than temporary. See Note 7.
Inventory
Inventory is valued at the lower of cost or market value. Cost is
determined using the first in, first out costing method. Inventory consists
entirely of finished goods and is recorded net of a provision for obsolescence.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation.
Depreciation is computed using the straight-line method, based on estimated
useful lives of seven to ten years for furniture and fixtures, three to five
years for office equipment and computer equipment, and seven years for computer
software. Leasehold improvements are amortized over the shorter of the estimated
service lives or the terms of the related leases. Repairs and maintenance are
charged to expense as incurred. Upon disposition, the asset and related
accumulated depreciation are removed from the related accounts and any gains or
losses are reflected in operations. Purchased computer software is capitalized
and amortized over the software's useful life, unless the amounts are immaterial
in which case the Company expenses it immediately. Internally developed software
is also capitalized and amortized over its useful life in accordance with of the
American Institute of Certified Public Accountants' (AICPA) Statement of
Position (SOP) 98-1 "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use."
F-9
PDI, Inc.
Notes to the Consolidated Financial Statements - continued
Realizability of Carrying Value of Long-Lived Assets
The Company reviews the recoverability of long-lived assets and
finite-lived intangible assets when circumstances indicate that the carrying
amount of assets may not be recoverable. This evaluation is based on various
analyses including cash flow projections. In the event cash flow projections
indicate an impairment, the Company would record an impairment based on the fair
value of the assets at the date of the impairment. Effective January 1, 2002,
the Company began accounting for impairments under SFAS No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets". Prior to the adoption of this
standard, impairments were accounted for using SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of"
which was superceded by SFAS No. 144. No impairments of long-lived assets were
recorded in 2003, 2002, or 2001.
Goodwill and Other Intangible Assets
The Company adopted Statement of Financial Accounting Standards (SFAS) No.
142, "Goodwill and Other Intangible Assets" in fiscal year 2002. The effect of
this adoption on the Company is that 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. The
tests involve 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. 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
evaluates goodwill and other intangible assets at least on an annual basis and
whenever events and changes in circumstances suggest that the carrying amount
may not be recoverable based on the estimated future cash flows. The Company
performed the required annual impairment tests in the fourth quarters of both
2003 and 2002 and determined that no impairment existed at either December 31,
2003 or December 31, 2002.
Stock-Based Compensation
As of December 31, 2003 the Company has two stock-based employee
compensation plans described more fully in Note 20. 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." The
Company accounts for those plans under the recognition and measurement
principles of APB Opinion No. 25 and related Interpretations. 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
receive restricted common stock, the amortization of which is reflected in net
income. The following table illustrates the effect on net income and earnings
per share if the Company had applied the fair value recognition provisions of
SFAS No. 123 to stock-based employee compensation.
As of December 31,
----------------------------
2003 2002 2001
------- -------- -------
(in thousands, except per share data)
Net income (loss), as reported $12,258 $(30,761) $ 6,354
Add: Stock-based employee
compensation expense included in
reported net income (loss), net of
related tax effects 368 283 134
Deduct: Total stock-based employee
compensation expense determined under
fair value based methods for all
awards, net of related tax effects (6,133) (8,137) (5,769)
------- -------- -------
Pro forma net income (loss) $ 6,493 $(38,615) $ 719
======= ======== =======
Earnings (loss) per share
Basic--as reported $ 0.86 $ (2.19) $ 0.46
======= ======== =======
Basic--pro forma $ 0.46 $ (2.75) $ 0.05
======= ======== =======
Diluted--as reported $ 0.85 $ (2.19) $ 0.45
======= ======== =======
Diluted--pro forma $ 0.45 $ (2.75) $ 0.05
======= ======== =======
F-10
PDI, Inc.
Notes to the Consolidated Financial Statements - continued
Compensation cost for the determination of Pro forma net income (loss) and
related per share amounts were estimated using the Black Scholes option pricing
model, with the following assumptions: (i) risk free interest rate of 3.25%,
4.49% and 5.01% at December 31, 2003, 2002 and 2001, respectively; (ii) expected
life of five years for 2003, 2002 and 2001; (iii) expected dividends - $0 for
2003, 2002 and 2001; and (iv) volatility of 100% for 2003, 100% for 2002 and 90%
for 2001. The weighted average fair value of options granted during 2003, 2002
and 2001 was $11.23, $14.92 and $43.56, respectively.
Advertising
The Company recognizes advertising costs as incurred. The total amounts
charged to advertising expense were approximately $555,000, $259,000 and
$547,000 for the years ended December 31, 2003, 2002 and 2001, respectively.
Income Taxes
The Company applies an asset and liability approach to accounting for
income taxes. Deferred tax assets and liabilities are recognized for the
expected future tax consequences of temporary differences between the financial
statement and tax bases of assets and liabilities using enacted tax rates in
effect for the years in which the differences are expected to reverse. The
Company evaluates the need for a deferred tax asset valuation allowance by
assessing whether it is more likely than not that the Company will realize its
deferred tax assets in the future. The assessment of whether or not a valuation
allowance is required often requires significant judgment including the forecast
of future taxable income and the calculation of tax planning initiatives.
Adjustments to the deferred tax allowance are made to earnings in the period
when such determination is made.
License Fees
Costs related to the acquisition or licensing of products that have not yet
received regulatory approval to be marketed, and that have no alternative future
uses, are expensed as incurred, while costs incurred post-approval are
capitalized and amortized over the estimated economic life of the underlying
product. See Note 2.
Reclassifications
Certain reclassifications have been made to conform prior periods'
information to the current year presentation.
New Accounting Pronouncements
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" (FIN 46). FIN 46 requires a variable interest entity
(VIE) to be consolidated by a company, if that company is subject to a majority
of the risk of loss from the VIE's activities or entitled to receive a majority
of the entity's residual returns or both. In December 2003, the FASB issued a
revision to the FIN 46 (FIN46R) which partially delayed the effective date of
the interpretation to March 31, 2004 and added additional scope exceptions.
Adoption of FIN46 did not, and the adoption of FIN46R is not expected to, have a
material impact on the Company's business, financial position or results of
operations.
In December 2003, the Staff of the Securities and Exchange Commission
issued Staff Accounting Bulletin No. 104 (SAB 104), "Revenue Recognition," which
supercedes SAB 101, "Revenue Recognition in Financial Statements." SAB 104's
primary purpose is to rescind accounting guidance contained in SAB 101 related
to multiple element revenue arrangements, superceded as a result of the issuance
of EITF 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables."
Additionally, SAB 104 rescinds the SEC's "Revenue Recognition in Financial
Statements Frequently Asked Questions and Answers" (the FAQ) issued with SAB 101
that had been codified in SEC Topic 13, "Revenue Recognition." The revenue
recognition principles provided for in both SAB 101 and EITF 00-21 remain
largely unchanged. As a result, the adoption of SAB 104 is not expected to have
a material impact on the Company's business, financial position and results of
operations.
F-11
PDI, Inc.
Notes to the Consolidated Financial Statements - continued
2. 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
terminated 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). Both of these agreements ended December
31, 2003; however, the Lotrel-Diovan agreement was renewed on December 24, 2003
for an additional one year period. In February 2004, the Company was notified by
Novartis of its intent to terminate the Lotrel-Diovan contract, without cause,
effective March 16, 2004. The Company will continue to be compensated under the
terms of the agreement through the effective termination date. Even though the
Lotensin agreement ended December 31, 2003, the Company is still entitled to
receive royalty payments on the sales of Lotensin through December 31, 2004.
In October 2002, the Company entered into an agreement with 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
had certain minimum purchase requirements. The minimum purchase requirement for
the calendar year 2003 was $750,000, which was met. The minimum purchase
requirement for each subsequent calendar year was to be 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 did
have 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 actual 2003 sales did not meet the Company's forecasts. Based on these sales
results, the Company concluded that sales of XCell were not sufficient enough to
sustain the Company's continued role as commercialization partner for the
product and therefore, on January 2, 2004, the Company exercised its contractual
right to terminate the agreement on 135 days' notice to Xylos. The Company's
promotional activities in support of the brand concluded in January 2004. The
Company recorded a reserve for potential excess inventory during 2003. As
discussed in Note 7, the Company continues to have an investment in Xylos.
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. In July 2003, Cellegy received a letter from the FDA rejecting its
NDA for Fortigel. Cellegy has told the Company that it 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 whether 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
(if such approvals are obtained) 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 19, in May 2003, the Company settled a lawsuit with
Auxilium Pharmaceuticals, Inc. which sought to enjoin its performance under the
Cellegy agreement. Additionally, the Company filed a complaint against Cellegy
in December 2003, that alleges, among other things, that Cellegy fraudulently
induced the Company to enter into the licensing agreement, and seeks the return
of the $15.0 million initial licensing fee, plus additional damages caused by
Cellegy's conduct.
F-12
PDI, Inc.
Notes to the Consolidated Financial Statements - continued
3. Historic Performance Based Contracts
Evista
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 Company 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 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 as of December 31, 2002 as the Company had no further obligations due to
the termination of the contract. Operating losses of $35.1 million and $6.8
million were recognized under this contract for the years ended December 31,
2002 and December 31, 2001.
Ceftin
In October 2000, the Company entered into an agreement (the Ceftin
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
in February 2002 by mutual agreement of the parties. The Ceftin 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 Ceftin to
physicians and sold the 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 to GSK, which subsequently
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. The generic version of Ceftin was approved by the FDA in
February 2002 and it began to be manufactured in late March 2002. As a result of
this U.S. Court of Appeals decision and its impact on future sales, in the third
quarter of 2001 the Company 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 the Company
was contractually obligated to incur to complete its obligations under the
Ceftin Agreement, over the remaining estimated gross profits to be earned under
the Ceftin Agreement 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. GSK resumed exclusive
rights to Ceftin after the effective date of the termination of the Ceftin
Agreement, and the Company believes that GSK currently sells Ceftin under its
own label code.
Pursuant to the termination agreement, the Company agreed to perform
marketing and distribution services through February 28, 2002. As is common in
the pharmaceutical industry, customers who purchased the Company's Ceftin
product are permitted to return unused product, after approval from the Company,
up to six months before and one year after the expiration date for the product,
but no later than December 31, 2004. The products sold by the Company prior to
the Ceftin agreement termination date of February 28, 2002 have expiration dates
through June 2004. The Company also maintains responsibility for processing and
payment of certain sales rebates through December 31, 2004. The Company's Ceftin
sales aggregated approximately $628 million during the term of the Ceftin
agreement. Only minimal credits have been issued for returns of product sold by
the Company to date.
F-13
PDI, Inc.
Notes to the Consolidated Financial Statements - continued
As of December 31, 2002, the Company had accrued reserves of approximately
$16.5 million related to Ceftin sales. Of this accrual, $11.0 million related to
return reserves and $5.5 million related to sales rebates accruals. On an
ongoing basis, the Company assesses its reserve for product returns by:
analyzing historical sales and return patterns; monitoring prescription data for
branded Ceftin; monitoring inventory withdrawals by the wholesalers and
retailers for branded Ceftin; inquiring about inventory levels and potential
product returns with the wholesaler companies; and estimating demand for the
product. During the third quarter of 2003, the Company made a $5.5 million
payment to settle its estimated remaining sales rebate liabilities, and
concluded based on its returns reserve review process, which included a review
of prescription and withdrawal data for branded Ceftin as well as information
communicated to the Company by the wholesalers, that the remaining $11.0 million
reserve for returns was adequate as of September 30, 2003.
The Company has since determined, based primarily upon new information
obtained from its wholesalers as part of its ongoing reserve review process,
that significant amounts of inventory, incremental to that previously reported
by the wholesalers, are being held by them in inventory. The Company believes
that this resulted, in part, from the sale by the wholesalers of Ceftin product
not supplied by the Company and acquired by the wholesalers subsequent to the
mutual termination of the Ceftin agreement. The Company is in the process of
determining the reasons its lots were not sold. Based upon this information, the
Company increased its returns reserve as of December 31, 2003 by $12.0 million
to a total reserve of $22.8 million. Product held by one wholesaler currently
accounts for approximately two-thirds of this amount. This $22.8 million reserve
reflects the Company's estimated liability for all identified product that could
potentially be returned and an estimate of the Company's liability with respect
to remaining, but not yet identified, product sold by the Company that is still
being held in the trade.
The reserve has been calculated based on reimbursing the wholesalers at the
amount that they purchased the product from the Company. In certain instances,
the wholesalers have requested reimbursement at an amount higher than the
original purchase price. The difference is approximately $3.3 million. The
reserve as recorded by the Company is its best estimate based on its
interpretation of the contracts. The Company will continue to assess the
adequacy of its reserves until the Company's obligations for processing any
returned products ceases on December 31, 2004. The Company expects that it will
begin to pay these amounts in 2004.
4. Repurchase Program
On September 21, 2001, the Company announced that its Board of Directors
had unanimously authorized management to repurchase up to $7.5 million of its
Common Stock. Subject to availability, the transactions may be made from time to
time in the open market or directly from stockholders at prevailing market
prices that the Company deems appropriate. In October 2001, 5,000 shares were
repurchased in an open market transaction for a total of $110,000. No further
purchases have been made through December 31, 2003.
5. Acquisition
On September 10, 2001, the Company acquired 100% of the capital stock of
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. The acquisition has been accounted for as a purchase. The net
assets of InServe on the date of acquisition were approximately $1.3 million.
The Company made payments to InServe shareholders (the Seller) at closing of
$8.5 million, net of cash acquired. Additionally, the Company put $3.0 million
in escrow related to additional amounts payable during 2002 if certain defined
benchmarks were achieved. In April 2002, $1.2 million of the escrow was paid to
the Seller and $265,265 was returned to the Company due to non-achievement of a
performance benchmark. In September 2002, substantially all of the remaining
$1.5 million in escrow was paid to the Seller. In connection with these
transactions, the Company recorded $7.8 million in goodwill, which is included
in other long-term assets, and the remaining purchase price was allocated to
identifiable tangible and intangible assets and liabilities acquired.
The following unaudited pro forma results of operations for the year ended
December 31, 2001 assume that the Company and InServe had been combined as of
the beginning of the periods presented. The pro forma results include estimates
and assumptions which management believes are reasonable. However, pro forma
results are not necessarily indicative of the results which would have occurred
if the acquisition had been consummated as of the dates indicated, nor are they
necessarily indicative of future operating results.
F-14
PDI, Inc.
Notes to the Consolidated Financial Statements - continued
Year ended December 31,
2001
--------
(in thousands, except for per share data)
(unaudited)
Net sales - pro forma $702,958
========
Net income - pro forma $ 6,440
========
Pro forma diluted earnings per share $ 0.46
========
6. Short-Term Investments
At December 31, 2003, short-term investments were $1.3 million, including
approximately $1.1 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.
7. Other Investments
In October 2002, the Company acquired $1.0 million of preferred stock of
Xylos. The Company recorded its investment in Xylos under the cost method and
its ownership interest in Xylos is less than five percent. As discussed in Note
2, the Company served in 2003 as the exclusive distributor of the Xylos XCell
product line, but on January 2, 2004, the Company terminated that arrangement
effective May 16, 2004. Although Xylos recognized operating losses in 2003, the
Company believes that, based on current market conditions and activities at
Xylos, its investment in Xylos is not impaired as of December 31, 2003. In
addition, the Company provided a short-term loan in the amount of $250,000 to
Xylos in February 2004. Under the terms of the loan agreement, the Company may
provide another $250,000, if requested by Xylos.
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 2003 and no losses were recorded in the year 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 and they subsequently filed for bankruptcy
protection.
8. Inventory
At December 31, 2003 and December 31, 2002, the Company had approximately
$43,000 and $646,000, respectively, in finished goods inventory, net of
reserves, relating to the products being marketed and distributed in accordance
with the Xylos agreement discussed in Note 2. In the third quarter, as a result
of the continued lower than anticipated Xylos product sales, management recorded
a reserve of $835,000 to reduce the value of the XCell inventory to its
estimated net realizable value. The December 31, 2003 balance of the reserve is
approximately $818,000. As discussed in Note 2, on January 2, 2004 the Company
gave notice of termination of its agreement with Xylos, effective May 16, 2004,
and will therefore discontinue sales of the XCell product after the effective
date.
9. Historical Basic and Diluted Net Income/(Loss) Per Share
Historical 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 years ended December 31, 2003, 2002 and
2001 is as follows:
F-15
PDI, Inc.
Notes to the Consolidated Financial Statements - continued
Years Ended December 31,
------------------------
2003 2002 2001
------ ------ ------
(in thousands)
Basic weighted average number of common
shares outstanding ............................... 14,231 14,033 13,886
Dilutive effect of stock options .................... 200 -- 227
------ ------ ------
Diluted weighted average number of common shares
outstanding ...................................... 14,431 14,033 14,113
====== ====== ======
Outstanding options at December 31, 2003 to purchase 380,493 shares of
common stock with exercise prices of $27.00 to $93.75 were not included in the
2003 computation of historical and pro forma diluted net income per share
because to do so would have been antidilutive. Outstanding options at December
31, 2002 to purchase 1,514,297 shares of common stock with exercise prices of
$5.21 to $98.70 per share were not included in the 2002 computation of
historical and pro forma diluted net income per share because to do so would
have been antidilutive, as a result of the Company's net loss. Outstanding
options at December 31, 2001 to purchase 1,003,162 shares of common stock with
exercise prices of $27.00 to $98.70 were not included in the 2001 computation of
historical and pro forma diluted net income per share because to do so would
have been antidilutive.
10. Property and Equipment
Property and equipment consisted of the following as of December 31, 2003
and 2002:
December 31,
-------------------
2003 2002
-------- --------
(in thousands)
Furniture and fixtures.............................. $ 3,288 $ 3,644
Office equipment.................................... 3,204 3,177
Computer equipment.................................. 13,494 11,981
Computer software................................... 13,685 13,937
Leasehold improvements.............................. 1,905 1,703
-------- --------
Total property and equipment........................ 35,576 34,442
Less accumulated depreciation and amortization... (21,082) (16,147)
-------- --------
Property and equipment, net......................... $ 14,494 $ 18,295
======== ========
Depreciation expense was approximately $5.6 million, $6.8 million, and $4.0
million for December 31, 2003, 2002 and 2001, respectively.
11. Operating Leases
The Company leases facilities, automobiles and certain equipment under
agreements classified as operating leases which expire at various dates through
2016. Lease expense under these agreements for the years ended December 31,
2003, 2002 and 2001 was approximately $21.3 million, $26.1 million, and $28.4
million, respectively, of which $18.0 million in 2003, $21.2 million in 2002,
and $24.8 million in 2001 related to automobiles leased for employees for a term
of one-year from the date of delivery.
As of December 31, 2003, the aggregate minimum future rental payments
required by non-cancelable operating leases with initial or remaining lease
terms exceeding one year are as follows (in thousands):
2004 2005 2006 2007 2008 Total
------ ------ ------ ------ ------ -------
Operating leases
Minimum lease payments .......... $3,084 $2,576 $2,319 $2,167 $2,166 $12,312
Less minimum sublease rentals ... (135) (34) -- -- -- (169)
----------------------------------------------------
Net minimum lease payments ... $2,949 $2,542 $2,319 $2,167 $2,166 $12,143
====================================================
F-16
PDI, Inc.
Notes to the Consolidated Financial Statements - continued
12. Significant Customers
Service
During 2003, 2002 and 2001 the Company had several significant customers
for which it provided services under specific contractual arrangements. The
following sets forth the net service revenue generated by customers who
accounted for more than 10% of the Company's net service revenue during each of
the periods presented.
Years Ended December 31,
---------------------------
Customers 2003 2002 2001
--------- -------- ------- -------
(in thousands)
A........... $116,077 $88,354 $ --
B........... 106,584 89,739 89,522
C........... -- -- 60,120
At December 31, 2003 and 2002, two customers represented 69.2% and 62.0%,
respectively, of the aggregate of outstanding service accounts receivable and
unbilled services. The loss of any one of the foregoing customers could have a
material adverse effect on the Company's business, financial position, results
of operations and cash flows.
Product
Excluding the effects of the adjustment to the Ceftin reserve for sales
returns and rebates in 2003 and 2002 for changes in estimates, product revenue
from the sale of the Xylos wound care product was approximately $387,000 in 2003
and product revenue from the sale of Ceftin was approximately $716,000 in 2002.
Due to the immateriality of the product sales per customer in 2003 and 2002,
those sales are not shown in the chart below.
During 2001, the Company had several significant customers for which it
provided products related to its distribution arrangement with GSK. The
following sets forth the product revenue generated by customers who accounted
for more than 10% of the Company's product revenue during the year ended
December 31, 2001.
Years Ended December 31,
------------------------
Customers 2001
--------- ----
(in thousands)
A........... $157,541
B........... 122,063
C........... 53,392
13. Related Party Transactions
The Company purchases certain print advertising for initial recruitment of
representatives through a company that is wholly-owned by family members of the
Company's largest stockholder. The amounts charged to the Company for these
purchases totaled approximately $983,000, $516,000, and $1.1 million for the
years ended December 31, 2003, 2002 and 2001.
14. Income Taxes
The provision (benefit) for income taxes for the years ended December 31,
2003, 2002 and 2001 are summarized as follows:
F-17
PDI, Inc.
Notes to the Consolidated Financial Statements - continued
2003 2002 2001
------- -------- --------
(in thousands)
Current:
Federal.............................. $10,308 $(26,972) $ 23,346
State................................ 1,181 1,024 4,691
------ -------- --------
Total current........................ 11,489 (25,948) 28,037
Deferred................................ (3,084) 8,501 (19,411)
------- -------- --------
Provision (benefit) for income taxes.... $ 8,405 $(17,447) $ 8,626
======= ======== ========
A reconciliation of the difference between the Federal statutory tax rates
and the Company's effective tax rate is as follows:
2003 2002 2001
---- ----- ----
Federal statutory rate........................... 35.0% (35.0)% 35.0%
State income tax rate, net of Federal benefit.... 6.1 (1.1) 9.8
Meals and entertainment.......................... 0.3 0.8 6.7
Valuation allowance.............................. -- 0.3 4.8
Other............................................ (0.7) (1.2) 1.3
---- ----- ----
Effective tax rate............................... 40.7% (36.2)% 57.6%
==== ===== ====
The tax effects of significant items comprising the Company's deferred tax
assets and (liabilities) as of December 31, 2003 and 2002 are as follows:
2003 2002
------- -------
Deferred tax assets (liabilities)-- current
Allowances and reserves ....................... $ 9,938 $ 6,378
Inventory ..................................... 312 --
Compensation .................................. 762 1,042
Other ......................................... 41 --
------- -------
$11,053 $ 7,420
------- -------
Deferred tax assets (liabilities)-- non current
Property, plant and equipment ................. $(2,457) $(1,778)
State net operating loss carryforwards ........ 1,427 2,994
State taxes ................................... 1,296 1,178
Intangible assets ............................. (126) 58
Equity investment ............................. 1,882 1,941
Self insurance and other reserves ............. 1,466 548
Contract costs ................................ 5,698 5,820
Valuation allowance on deferred tax assets .... (1,882) (2,941)
------- -------
$ 7,304 $ 7,820
------- -------
Net deferred tax asset ........................ $18,357 $15,240
======= =======
At December 31, 2003, a valuation allowance of $1,881,851 has been recorded
related to the Company's equity investments. At December 31, 2002, the Company
had a valuation allowance of $2,941,161 related to certain state net operating
loss (NOL) carryforwards and the Company's equity investments. At December 31,
2003, the Company reduced the valuation allowance by $1,059,310 for state NOL
carryforwards that it believes will more likely than not be realized prior to
expiration. The future realization of the deferred tax assets related to the
state NOL carryforwards is contingent upon the Company's future results of
operations. The Company performs an analysis each year to determine whether the
Company's expected future income will more likely than not be sufficient to
realize the recorded deferred tax assets. At December, 31 2003, the Company had
approximately $47.2 million of state NOL carryforwards which will begin to
expire in 2010.
15. Preferred Stock
The Company's board of directors is authorized to issue, from time to time,
up to 5,000,000 shares of preferred stock in one or more series. The board is
authorized to fix the rights and designation of each series, including dividend
rights and rates, conversion rights, voting rights, redemption terms and prices,
liquidation preferences and the number of shares of each series. As of December
31, 2003 and 2002, there were no issued and outstanding shares of preferred
stock.
F-18
PDI, INC.
Notes to the Consolidated Financial Statements - continued
16. Loans to Stockholders/Officers
In November 1998, the Company agreed to lend $250,000 to an executive
officer of which $100,000 was funded in November 1998, and the remaining
$150,000 was funded in February 1999. This amount was recorded in other
long-term assets. Such loan is payable on December 31, 2008 and bears interest
at a rate of 5.5% per annum, payable quarterly in arrears. In February 2003,
$100,000 of this loan was repaid leaving a balance of $150,000.
17. Retirement Plans
During 2003, the Company restructured its qualified profit sharing plans
with 401(k) features. Effective January 1, 2003, the Company's InServe 401(k)
Plan (the "Inserve Plan") was frozen, and participants in the Inserve Plan began
to participate in the Company's PDI, Inc. 401(k) Plan (the "PDI Plan"). Under
the terms of the PDI Plan, the Company is committed to make mandatory cash
contributions in an amount equal to the employee contributions up to a maximum
of 2% of each participating employee's annual base wages. There is no option for
employees to invest any of their 401(k) funds in the Company's common stock. The
Company's total contribution expense related to the Company's 401(k) plans for
2003, 2002 and 2001 was approximately $905,000, $1.7 million, and $1.6 million,
respectively.
Effective January 1, 2004, the PDI Plan shall provide all "Safe Harbor
Eligible" plan participants with Company matching contributions (Safe Harbor
Matching Contributions) in accordance with the formula described below:
o Employee contributions of 1% to 3% of base salary will be matched
100%; and
o Employee contributions which exceed 3% but do not exceed 5% will
be matched 50%.
Employees must meet all Safe Harbor Matching Contributions eligibility
requirements as defined in the Plan in order to participate. Employees' account
balances derived from the Safe Harbor Matching Contributions will be immediately
vested. In addition the Company can make discretionary contributions to the
Plan. There will continue to be no option for employees to invest any of their
401(k) funds in the Company's common stock.
18. Deferred Compensation Arrangements
Beginning in 2000, the Company established a deferred compensation
arrangement whereby a portion of certain employees' salaries is withheld and
placed in a Rabbi Trust. The plan permits the employees to diversify these
assets through a variety of investment options. The Company adopted the
provisions of Emerging Issues Task Force (EITF) 97-14 "Accounting for Deferred
Compensation Arrangement Where Amounts are Earned and Held in a Rabbi Trust and
Invested" which requires the Company to consolidate into its financial
statements the net assets of the trust. The deferred compensation obligation has
been classified as a current liability and is adjusted, with the corresponding
charge or credit to compensation expense, to reflect changes in fair value of
the amounts owed to the employee. The assets in the trust are classified as
available-for-sale. In 2003 the market value of the investments increased by
$42,000, recorded as a debit to compensation expense. The credit to compensation
expense due to a decrease of the market value of the investments was
approximately $95,000 and $30,000 during 2002 and 2001, respectively. The total
value of the Rabbi Trust was approximately $1.1 million at each of December 31,
2003 and 2002.
In 2000, the Company established a Long-term Incentive Compensation Plan
whereby certain employees are required to take a portion of their bonus
compensation in the form of restricted Common Stock. The restricted shares vest
on the third anniversary of the grant date and are subject to accelerated
vesting and forfeiture under certain circumstances. The Company recorded
deferred compensation costs of approximately $349,000 and $243,000 during 2002
and 2001, respectively, which is being amortized over the three-year vesting
period. There were no deferred compensation costs during 2003. The unamortized
compensation costs have been classified as a separate component of stockholders'
equity.
19. Commitments and Contingencies
Due to the nature of the business that the Company is engaged in, such as
product detailing and distribution of products, it could be exposed to certain
risks. 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
F-19
PDI, INC.
Notes to the Consolidated Financial Statements - continued
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 was 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.
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 Baycol(R), a
prescription cholesterol-lowering medication. Baycol(R) was distributed,
promoted and sold by Bayer Corporation (Bayer) in the United States through
early August 2001, at which time Bayer voluntarily withdrew Baycol(R) from the
United States market. Bayer retained certain companies, such as the Company, to
provide detailing services on its behalf pursuant to contract sales force
agreements. The Company may be named in additional similar lawsuits. 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 and to indemnify the Company in these
lawsuits, 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. As of February 20, 2004, Bayer has reimbursed the
Company for approximately $1.6 million in legal expenses, almost all of which
was received in 2003 and is reflected as a credit within selling, general and
administrative expense.
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,
F-20
PDI, INC.
Notes to the Consolidated Financial Statements - continued
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, in July 2003, Cellegy received a letter from the FDA rejecting its NDA
for Fortigel. The Company will not pay any additional amount to Auxilium as set
forth in clause (b) above since Fortigel was not approved by the FDA prior to
January 26, 2004. 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.
Cellegy Pharmaceuticals Litigation
On December 12, 2003, the Company filed a complaint against Cellegy in the
U.S. District Court for the Southern District of New York. The complaint alleges
that Cellegy fraudulently induced the Company to enter into a December 2002
license agreement with Cellegy regarding Fortigel ("License Agreement"). The
complaint also alleges claims for misrepresentation and breach of contract
related to the License Agreement. In the complaint, the Company seeks, among
other things, rescission of the License Agreement and return of the $15.0
million initial licensing fee it paid Cellegy. After the Company filed this
lawsuit, also on December 12, 2003, Cellegy filed a complaint against the
Company in the U.S. District Court for the Northern District of California.
Cellegy's complaint seeks a declaration that Cellegy did not fraudulently induce
the Company to enter the License Agreement and that Cellegy has not breached its
obligations under the License Agreement. The Company is unable to predict the
ultimate outcome of these lawsuits.
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 business, financial
condition and results of operations.
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.
20. Stock-Based Compensation
In May 2000 the Board of Directors (the Board) approved the PDI, Inc. 2000
Omnibus Incentive Compensation Plan (the 2000 Plan). The purpose of the 2000
Plan is to provide a flexible framework that will permit the Board to develop
and implement a variety of stock-based incentive compensation programs based on
the changing needs of the Company, its competitive market and the regulatory
climate. The maximum number of shares as to which awards or options may at any
time be granted under the 2000 Plan is 2.2 million shares. Eligible participants
under the 2000 Plan include officers and other employees of the Company, members
of the Board and outside consultants, as specified under the 2000 Plan and
designated by the Compensation Committee of the Board. The right to grant Awards
under the 2000 Plan will terminate 10 years after the date the 2000 Plan was
adopted. No Participant may be granted, in the aggregate, more than 100,000
shares of Company common stock from all awards under the 2000 Plan.
In March 1998, the Board approved the 1998 Stock Option Plan (the 1998
Plan) which reserves for issuance up to 750,000 shares of the Company's common
stock, pursuant to which officers, directors and key employees of the
F-21
PDI, Inc.
Notes to the Consolidated Financial Statements - continued
Company and consultants to the Company are eligible to receive incentive and/or
non-qualified stock options. The 1998 Plan, which has a term of ten years from
the date of its adoption, is administered by a committee designated by the
Board. The selection of participants, allotment of shares, determination of
price and other conditions relating to the purchase of options is determined by
the committee, in its sole discretion. Incentive stock options granted under the
1998 Plan are exercisable for a period of up to 10 years from the date of grant
at an exercise price which is not less than the fair market value of the common
stock on the date of the grant, except that the term of an incentive stock
option granted under the 1998 Plan to a shareholder owning more than 10% of the
outstanding common stock may not exceed five years and its exercise price may
not be less than 110% of the fair market value of the common stock on the date
of the grant.
Options granted to members of the Board vest a third upon date of grant and
then a third over the next two years. All other options granted vest a third
each year over a three-year period.
At December 31, 2003, options for an aggregate of 1,037,599 shares were
outstanding under the Company's stock option plans and options to purchase
376,260 shares of common stock had been exercised since its inception.
The activity for the 2000 and 1998 Plans during the years ended December
31, 2003, 2002 and 2001 is set forth in the table below:
2003 2002 2001
-------------------- -------------------- --------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
Outstanding at beginning of year 1,514,297 $39.23 1,125,313 $53.60 653,921 $46.60
Granted 115,303 16.13 596,812 14.81 548,848 71.17
Exercised (42,373) 13.06 (6,520) 16.00 (40,733) 17.41
Terminated (549,628) 58.86 (201,308) 49.91 (36,723) 63.06
------------------- ------------------- -------------------
Outstanding at end of year 1,037,599 $27.33 1,514,297 $39.23 1,125,313 $53.60
=================== =================== ===================
Options exercisable at end of year 608,811 $31.87 611,871 $46.04 361,584 $37.11
=================== =================== ===================
The following table summarizes information about stock options outstanding
at December 31, 2003:
Options Outstanding Options Exercisable
---------------------------------------------------------- ----------------------
Remaining
Number of weighted Weighted Number of Weighted
Exercise price per options contractual exercise options exercise
share outstanding life (years) price exercisable price
---------------------------------------------------------- ----------------------
$ 5.21 - $ 9.56 63,334 8.9 $ 7.28 10,999 $ 8.35
$14.16 - $18.38 563,042 7.9 15.87 246,687 14.77
$21.10 - $29.88 203,312 6.2 26.64 195,401 26.82
$59.50 155,561 7.1 59.50 103,707 59.50
$80.00 - $93.75 52,350 7.1 81.85 52,017 81.77
----------------------------------- -------------------
1,037,599 7.5 $27.33 608,811 $31.87
=================================== ===================
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
F-22
PDI, Inc.
Notes to the Consolidated Financial Statements - continued
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.
Approximately 47,483 options, which were offered to, but did not
participate in, the option exchange program, are subject to variable accounting.
As such, the Company may record compensation expense if the market price of the
Company's common stock exceeds the exercise price of the non-tendered options
until these options are terminated, exercised or forfeited. The non-tendered
options have exercise prices ranging from $59.50 to $80.00 and a remaining life
of 6.8 to 7.1 years.
21. 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. This resulted in a
decrease in amortization expense that would have been recorded in the year ended
December 31, 2002 of approximately $1.1 million. The Company has established
reporting units for purposes of testing goodwill for impairment. Goodwill has
been assigned to the reporting units to which the value of the goodwill relates.
The Company completed the first step of the transitional goodwill impairment
test and has determined that no impairment existed at January 1, 2002. The
Company performed the required annual impairment tests in the fourth quarters of
both 2003 and 2002 and determined that no impairment existed at either December
31, 2003 or 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 is
$11.1 million as of December 31, 2003.
The statements of operations adjusted to exclude amortization expense for
2001 related to goodwill and related taxes are as follows:
For the Year Ended
December 31,
-------------------------
2001
-------------------------
(in thousands, except per
share data)
Reported net income $6,354
Add goodwill amortization 191
------
Adjusted net income $6,545
======
Basic earnings per share:
Reported net income per share $ 0.46
Add: Goodwill amortization 0.01
------
Adjusted basic net income per share $ 0.47
======
Diluted earnings per share:
Reported diluted net income per share $ 0.45
Add: Goodwill amortization 0.01
------
Adjusted diluted net income per share $ 0.46
======
F-23
PDI, Inc.
Notes to the Consolidated Financial Statements - continued
Changes in the carrying amount of goodwill for the years ended December 31,
2003 and 2002, by operating segment, were as follows:
SMSG PPG MD&D Total
Balance as of January 1, 2002 $3,344 $-- $5,067 $ 8,411
Amortization -- -- -- --
Goodwill additions -- -- 2,721 2,721
------ --- ------ -------
Balance as of December 31, 2002 $3,344 $-- $7,788 $11,132
====== === ====== =======
Balance as of January 1, 2003 $3,344 $-- $7,788 $11,132
Amortization -- -- -- --
Goodwill additions -- -- -- --
------ --- ------ -------
Balance as of December 31, 2003 $3,344 $-- $7,788 $11,132
====== === ====== =======
All intangible assets recorded as of December 31, 2003 and 2002 are being
amortized on a straight-line basis over the life of the intangibles which is
primarily five years.
As of December 31, 2003 As of December 31, 2002
Carrying Accumulated Carrying Accumulated
Amount Amortization Net Amount Amortization Net
-------------------------------- --------------------------------
Covenant not to compete $1,686 $ 780 $ 906 $1,686 $ 442 $1,244
Customer relationships 1,208 559 649 1,208 318 890
Corporate tradename 172 79 93 172 45 127
------------------------------- -------------------------------
Total $3,066 $1,418 $1,648 $3,066 $ 805 $2,261
=============================== ===============================
Amortization expense for the years ended December 31, 2003, 2002 and 2001
was approximately $613,000, $613,000 and $688,000, respectively. Amortization
expense included amounts related to goodwill during 2001 of approximately
$450,000. Estimated amortization expense for the next five years is as follows:
2004 $613
====
2005 613
====
2006 422
====
2007 --
====
2008 --
====
22. 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 originally 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 it initiated the restructuring. However, these savings have been
partially offset by incremental SG&A expenses the Company incurred in the
current period as the Company has been successful in expanding its business
platforms for its segments. Substantially all of the restructuring activities
have been completed as of December 31, 2003.
F-24
PDI, Inc.
Notes to the Consolidated Financial Statements - continued
In connection with this plan, the Company originally estimated that it
would 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 $0.1 million, all of these
expenses were recognized in 2002. The $0.1 million recognized in 2003 consisted
of $0.4 million in additional expense incurred for severance and other exit
costs partially offset by the receipt of $0.3 million for subletting the
Cincinnati, Ohio facility.
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 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, 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.
During the quarter ended December 31, 2003, the Company recorded
approximately $413,000 in additional restructuring expense due to higher than
expected corporate severance and other exit costs. This adjustment was recorded
in SG&A consistent with the original recording of the restructuring charges.
The accrual for restructuring and exit costs totaled approximately $744,000
at December 31, 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 Write offs/ Balance at
December 31, 2002 Accruals Adjustments Payments December 31, 2003
Administrative severance $1,670 $ 58 $ -- $(1,443) $285
Exit costs 1,288 488 (270) (1,047) 459
------ ---- ----- ------- ----
$2,958 $546 $(270) $(2,490) $744
------ ---- ----- ------- ----
Sales force severance 1,741 -- (473) (1,268) --
------ ---- ----- ------- ----
Total $4,699 $546 $(743) $(3,758) $744
====== ==== ===== ======= ====
23. 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), none of which have changed since the Company's
December 31, 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 PPG
contracts are characterized by either significant management effort required
from the Company's product marketing group, or reliance on the attainment of
performance incentives in order to fully cover the Company's costs, or both. The
Company's MD&D
F-25
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.
The accounting policies of the segments are described in Note 1. 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.
For the Year
Ended December 31,
------------------------------
2003 2002 2001
-------- -------- --------
Revenue
Sales and marketing services group ............... $262,966 $179,067 $348,860
Pharmaceutical products group .................... 42,349 94,976 449,539
Medical devices and diagnostics .................. 12,133 9,970 2,760
-------- -------- --------
Total ......................................... $317,448 $284,013 $801,159
======== ======== ========
Revenue, intercompany
Sales and marketing services group ............... $ -- $ -- $ 98,022
Pharmaceutical products group .................... -- -- 6,554
Medical devices and diagnostics .................. -- -- --
-------- -------- --------
Total ......................................... $ -- $ -- $104,576
======== ======== ========
Revenue, less intercompany
Sales and marketing services group ............... $262,966 $179,067 $250,838
Pharmaceutical products group .................... 42,349 94,976 442,985
Medical devices and diagnostics .................. 12,133 9,970 2,760
-------- -------- --------
Total ......................................... $317,448 $284,013 $696,583
======== ======== ========
Income (loss) from operations
Sales and marketing services group ............... $ 54,219 $ 17,247 $ 32,481
Pharmaceutical products group .................... (9,781) (48,821) (2,834)
Medical devices and diagnostics .................. (7,457) (2,068) (39)
Corporate charges ................................ (17,391) (16,533) (16,903)
-------- -------- --------
Total ......................................... $ 19,590 $(50,175) $ 12,705
======== ======== ========
Income from operations, intercompany
Sales and marketing services group ............... $ -- $ -- $ 4,284
Pharmaceutical products group .................... -- -- (4,284)
Medical devices and diagnostics .................. -- -- --
Corporate charges ................................ -- -- --
-------- -------- --------
Total ......................................... $ -- $ -- $ --
======== ======== ========
Income (loss) from operations, less intercompany,
before corporate allocations
Sales and marketing services group ............... $ 54,219 $ 17,247 $ 28,197
Pharmaceutical products group .................... (9,781) (48,821) 1,450
Medical devices and diagnostics .................. (7,457) (2,068) (39)
Corporate charges ................................ (17,391) (16,533) (16,903)
-------- -------- --------
Total ......................................... $ 19,590 $(50,175) $ 12,705
======== ======== ========
F-26
PDI, Inc.
Notes to the Consolidated Financial Statements - continued
For the Year
Ended December 31,
------------------------------
(continued) 2003 2002 2001
-------- -------- --------
Corporate allocations
Sales and marketing services group ................... $(13,979) $ (9,339) $(11,721)
Pharmaceutical products group ........................ (2,189) (6,389) (4,986)
Medical devices and diagnostics....................... (1,223) (805) (196)
Corporate charges..................................... 17,391 16,533 16,903
-------- -------- --------
Total.............................................. $ -- $ -- $ --
======== ======== ========
Income (loss) from operations, less corporate allocations
Sales and marketing services group.................... $ 40,240 $ 7,908 $ 16,476
Pharmaceutical products group......................... (11,970) (55,210) (3,536)
Medical devices and diagnostics....................... (8,680) (2,873) (235)
Corporate charges..................................... -- -- --
-------- -------- --------
Total.............................................. $ 19,590 $(50,175) $ 12,705
======== ======== ========
Reconciliation of income (loss) from operations to
income (loss) before provision for income taxes
Total income (loss) from operations for operating
groups............................................. $ 19,590 $(50,175) $ 12,705
Other income, net..................................... 1,073 1,967 2,275
-------- -------- --------
Income (loss) before provision for income taxes.... $ 20,663 $(48,208) $ 14,980
======== ======== ========
Capital expenditures
Sales and marketing services group ................... $ 1,746 $ 3,735 $ 14,277
Pharmaceutical products group......................... -- 217 1,213
Medical devices and diagnostics....................... 83 60 70
-------- -------- --------
Total.............................................. $ 1,829 $ 4,012 $ 15,560
======== ======== ========
Total Assets
Sales and marketing services group ................... $147,832 $114,742 $116,898
Pharmaceutical products group......................... 55,169 60,417 175,933
Medical devices and diagnostics....................... 16,622 15,780 9,840
-------- -------- --------
Total.............................................. $219,623 $190,939 $302,671
======== ======== ========
Depreciation expense
Sales and marketing services group ................... $ 4,181 $ 4,318 $ 2,760
Pharmaceutical products group......................... 1,029 2,277 1,199
Medical devices and diagnostics....................... 420 165 29
-------- -------- --------
Total.............................................. $ 5,630 $ 6,760 $ 3,988
======== ======== ========
F-27
Schedule II
PDI, INC.
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
BALANCE AT ADDITIONS (1) BALANCE AT
BEGINNING CHARGED TO DEDUCTIONS END
DESCRIPTION OF PERIOD OPERATIONS OTHER OF PERIOD
- ----------- ---------- ---------- ---------- ----------
Against trade receivables--
Year ended December 31, 2001
Allowance for doubtful accounts... $ 250,000 $8,590,676 $(5,148,629) $3,692,047
Year ended December 31, 2002
Allowance for doubtful accounts... 3,692,047 366,125 (2,994,695) 1,063,477
Year ended December 31, 2003
Allowance for doubtful accounts... $1,063,477 $1,526,626 $(1,840,762) $ 749,341
Against taxes--
Year ended December 31, 2001
Tax valuation allowance........... $ 989,000 $ 819,046 $ -- $1,808,046
Year ended December 31, 2002
Tax valuation allowance........... 1,808,046 1,133,115 -- 2,941,161
Year ended December 31, 2003
Tax valuation allowance........... $2,941,161 $ -- $(1,059,310) $1,881,851
Against inventory--
Year ended December 31, 2001
Inventory valuation allowance..... $ -- $ -- $ -- $ --
Year ended December 31, 2002
Inventory valuation allowance..... -- -- -- --
Year ended December 31, 2003
Inventory valuation allowance..... $ -- $ 835,448 $ (17,583) $ 817,865
- ----------
(1) Includes both actual write offs as well as changes in estimates in the
reserves.
F-28