UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
Mark One
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period ended March 31, 2003
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES ACT OF
1934
For the transition period from ______ to _______
Commission File Number 0-24249
PDI, INC.
(Exact name of Registrant as specified in its charter)
Delaware 22-2919486
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10 Mountainview Road
Upper Saddle River, New Jersey 07458
(Address of principal executive offices)
(201) 258-8450
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [_]
As of May 9, 2003 the Registrant had a total of 14,232,029 shares of Common
Stock, $.01 par value, outstanding.
1
INDEX
PDI, INC.
Page
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PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited)
Balance Sheets
March 31, 2003 and December 31, 2002.............................3
Statements of Operations -- Three Months
Ended March 31, 2003 and 2002....................................4
Statements of Cash Flows -- Three
Months Ended March 31, 2003 and 2002.............................5
Notes to Financial Statements.......................................6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................19
Item 3 Quantitative and Qualitative Disclosures
About Market Risk...................................Not Applicable
Item 4. Controls and Procedures............................................30
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..................................................31
Item 2. Changes in Securities and Use of Proceeds..............Not Applicable
Item 3. Default Upon Senior Securities.........................Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders....Not Applicable
Item 5. Other Information......................................Not Applicable
Item 6. Exhibits and Reports on Form 8-K...................................32
SIGNATURES...................................................................34
2
PDI, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)
March 31, December 31,
2003 2002
--------- ------------
ASSETS
Current assets:
Cash and cash equivalents ....................................... $ 64,255 $ 66,827
Short-term investments .......................................... 4,094 5,834
Inventory, net .................................................. 964 646
Accounts receivable, net of allowance for doubtful accounts of
$798 and $1,063 as of March 31, 2003 and December 31, 2002,
respectively ................................................. 34,887 40,729
Unbilled costs and accrued profits on contracts in progress ..... 9,472 3,360
Deferred training ............................................... 2,168 1,106
Prepaid income tax .............................................. 16,204 18,856
Other current assets ............................................ 5,960 4,804
Deferred tax asset .............................................. 7,420 7,420
--------- ---------
Total current assets ............................................... 145,424 149,582
Net property and equipment ......................................... 17,266 18,295
Deferred tax asset ................................................. 7,820 7,820
Goodwill ........................................................... 11,132 11,132
Other intangible assets ............................................ 2,108 2,261
Other long-term assets ............................................. 1,749 1,849
--------- ---------
Total assets ....................................................... $ 185,499 $ 190,939
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ................................................ $ 5,011 $ 5,374
Accrued returns, rebates and sales discounts .................... 16,186 16,500
Accrued incentives .............................................. 9,936 11,758
Accrued salaries and wages ...................................... 7,191 6,617
Unearned contract revenue ....................................... 8,164 9,473
Restructuring accruals .......................................... 1,851 4,699
Other accrued expenses .......................................... 13,029 13,307
--------- ---------
Total current liabilities .......................................... 61,368 67,728
Total long-term liabilities ........................................ -- --
--------- ---------
Total liabilities .................................................. $ 61,368 $ 67,728
--------- ---------
Stockholders' equity:
Common stock, $.01 par value, 100,000,000 shares authorized:
shares issued and outstanding, March 31, 2003 and -
14,165,880, December 31, 2002 - 14,165,880; 44,325 restricted
shares issued and outstanding at March 31, 2003
and December 31, 2002 ........................................ $ 142 $ 142
Preferred stock, $.01 par value, 5,000,000 shares authorized,
no shares issued and outstanding ............................. -- --
Additional paid-in capital (includes restricted of $1,547 at
March 31, 2003 and December 31, 2002) ........................... 106,673 106,673
Retained earnings .................................................. 18,025 17,247
Accumulated other comprehensive loss ............................... (69) (100)
Unamortized compensation costs ..................................... (530) (641)
Treasury stock, at cost: 5,000 shares .............................. (110) (110)
--------- ---------
Total stockholders' equity ......................................... $ 124,131 $ 123,211
--------- ---------
Total liabilities & stockholders' equity ........................... $ 185,499 $ 190,939
========= =========
The accompanying notes are an integral part of these financial statements
3
PDI, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
Three Months Ended March 31,
----------------------------
2003 2002
------- -------
Revenue
Service, net .......................................... $67,511 $68,160
Product, net .......................................... 34 5,723
------- -------
Total revenue, net ................................. 67,545 73,883
------- -------
Cost of goods and services
Program expenses (including related party amounts of
$73 and $97 for the periods ended March 31,
2003 and 2002, respectively) ....................... 49,881 67,277
Cost of goods sold .................................... 62 --
------- -------
Total cost of goods and services ................... 49,943 67,277
------- -------
Gross profit ............................................. 17,602 6,606
Operating expenses
Compensation expense .................................. 8,874 7,759
Other selling, general and administrative expenses .... 5,833 3,325
Restructuring and other related expenses .............. (270) --
Litigation settlement ................................. 2,100 --
------- -------
Total operating expenses ........................... 16,537 11,084
------- -------
Operating income (loss) .................................. 1,065 (4,478)
Other income, net ........................................ 269 889
------- -------
Income (loss) before provision for taxes ................. 1,334 (3,589)
Provision (benefit) for income taxes ..................... 556 (1,322)
------- -------
Net income (loss) ........................................ $ 778 $(2,267)
======= =======
Basic net income (loss) per share ........................ $ 0.05 $ (0.16)
======= =======
Diluted net income (loss) per share ...................... $ 0.05 $ (0.16)
======= =======
Basic weighted average number of shares outstanding ...... 14,166 13,969
======= =======
Diluted weighted average number of shares outstanding .... 14,237 13,969
======= =======
The accompanying notes are an integral part of these financial statements
4
PDI, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Three Months Ended March 31,
----------------------------
2003 2002
------- --------
Cash Flows From Operating Activities
Net income (loss) ................................................ $ 778 $ (2,267)
Adjustments to reconcile net income (loss) to net cash
provided used in operating activities:
Depreciation and amortization .............................. 1,397 1,401
Reserve for inventory obsolescence and bad debt ............ 54 (2,132)
Amortized compensation costs ............................... 111 109
Other changes in assets and liabilities:
Decrease in accounts receivable ............................ 5,788 21,752
(Increase) decrease in inventory ........................... (318) 442
(Increase) in unbilled costs ............................... (6,112) (2,459)
(Increase) decrease in deferred training ................... (1,062) 1,104
Decrease in other current assets ........................... 1,496 1,766
Decrease in other long-term assets ......................... 100 556
(Decrease) in accounts payable ............................. (363) (3,631)
(Decrease) in accrued returns, rebates and sales discounts.. (314) (9,021)
(Decrease) in accrued contract losses ...................... -- (11,656)
(Decrease) in accrued liabilities .......................... (1,248) (1,773)
(Decrease) in restructuring liability ...................... (2,848) --
(Decrease) in unearned contract revenue .................... (1,309) (539)
(Decrease) in other current liabilities .................... (278) (7,877)
------- --------
Net cash used in operating activities ............................ (4,128) (14,225)
------- --------
Cash Flows From Investing Activities
Sale of short-term investments ................................ 1,771 4,021
Purchase of property and equipment ............................ (215) (2,336)
------- --------
Net cash provided by investing activities ........................ 1,556 1,685
------- --------
Cash Flows From Financing Activities
Net proceeds from exercise of stock options ................ -- 21
------- --------
Net cash provided by financing activities ........................ -- 21
------- --------
Net (decrease) in cash and cash equivalents ...................... (2,572) (12,519)
Cash and cash equivalents - beginning ............................ 66,827 160,043
------- --------
Cash and cash equivalents - ending ............................... $64,255 $147,524
======= ========
The accompanying notes are an integral part of these financial statements
5
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS
(unaudited)
1. Basis of Presentation
The accompanying unaudited interim consolidated financial statements and
related notes should be read in conjunction with the financial statements of
PDI, Inc. and its subsidiaries (the "Company" or "PDI") and related notes as
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2002 as filed with the Securities and Exchange Commission. The unaudited
interim financial statements of the Company have been prepared in accordance
with generally accepted accounting principles for interim financial reporting
and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. The unaudited
interim financial statements include all adjustments (consisting of normal
recurring adjustments) which, in the judgment of management, are necessary for a
fair presentation of such financial statements. Operating results for the
three-month period ended March 31, 2003 are not necessarily indicative of the
results that may be expected for the year ending December 31, 2003. Certain
prior period amounts have been reclassified to conform with the current
presentation with no effect on financial position, net income or cash flows.
2. Revenue Recognition
The paragraphs that follow describe the guidelines that the Company adheres
to in accordance with GAAP when recognizing revenue and cost of goods and
services in its financial statements. GAAP requires that service revenue and
product revenue and their respective direct costs be shown separately on the
income statement.
Historically, the Company has derived a significant portion of its service
revenue from a limited number of clients. Concentration of business in the
pharmaceutical services industry is common and the industry continues to
consolidate. As a result, the Company is likely to continue to experience
significant client concentration in future periods. The Company's significant
clients who each accounted for 10% or more of its service revenue, accounted for
approximately 69% and 78% of its service revenue for the quarters ended March
31, 2003 and 2002, respectively.
Service revenue and program expenses
Service revenue is earned primarily by performing product detailing
programs and other marketing and promotional services under contracts. Revenue
is recognized as the services are performed and the right to receive payment for
the services is assured. Revenue is recognized net of any potential penalties
until the performance criteria relating to the penalties have been achieved.
Bonus and other performance incentives, as well as termination payments, are
recognized as revenue in the period earned and when payment of the bonus,
incentive or other payment is assured. Under performance based contracts,
revenue is recognized when the performance based parameters are achieved.
Program expenses consist primarily of the costs associated with executing
product detailing programs, performance based contracts or other sales and
marketing services identified in the contract. Program expenses include
personnel costs and other costs associated with executing a product detailing or
other marketing or promotional program, as well as the initial direct costs
associated with staffing a product detailing program. Such costs include, but
are not limited to, facility rental fees, honoraria and travel expenses, sample
expenses and other promotional expenses. Personnel costs, which constitute the
largest portion of program expenses, include all labor related costs, such as
salaries, bonuses, fringe benefits and payroll taxes for the sales
representatives and sales managers and professional staff who are directly
responsible for executing a particular program. Initial direct program costs are
those costs associated with initiating a product detailing program, such as
recruiting, hiring and training the sales representatives who staff a particular
product detailing program. All personnel costs and initial direct program costs,
other than training costs, are expensed as incurred for service offerings.
Training costs include the costs of training the sales representatives and
managers on a particular product detailing
6
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
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 PDI receives a specific contract payment
from a client upon commencement of a product detailing program expressly to
compensate PDI 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 PDI does not receive a
specific contract payment for training, all revenue is deferred and recognized
over the life of the contract. Product detailing, marketing and promotional
expenses related to the detailing of products we distribute are recorded as a
selling expense and are included in other selling, general and administrative
expenses in the consolidated statements of operations.
As a result of the revenue recognition and program expense policies
described above, the Company may incur significant initial direct program costs
before recognizing revenue under a particular product detailing program. The
Company's inability to specifically negotiate for payments that are specifically
attributable to recruiting, hiring or training services in its product detailing
contracts could adversely impact the Company's operating results for periods in
which the costs associated with the product detailing services are incurred.
Product revenue and cost of goods sold
Product revenue is recognized when products are shipped and title is
transferred to the customer.
Cost of goods sold includes all expenses for both product distribution
costs, acquisition and manufacturing costs of the product sold. Inventory is
valued at the lower of cost or market value. Cost is determined using the first
in, first out costing method. Inventory to date has consisted of only finished
goods.
3. Stock-Based Compensation
As of March 31, 2003 the Company has two stock-based employee compensation
plans described more fully in Note 21 to the consolidated financial statements
included in the Company's 2002 Annual Report on Form 10-K. 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. The Company accounts for these plans under the
recognition and measurement principles of APB Opinion No. 25, "Accounting for
Stock Issued to Employees, 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 have
received restricted common stock, the amortization of which is reflected in net
income. As required by SFAS No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure - an amendment of SFAS No. 123", the following table
shows the estimated effect on earnings and per share data as if the Company had
applied the fair value recognition provisions of SFAS No. 123 to stock-based
employee compensation.
7
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
As of March 31,
-----------------
2003 2002
------- -------
(in thousands, except per share data)
Net income (loss), as reported $ 778 $(2,267)
Add: Stock-based employee compensation expense
included in reported net income (loss), net of
related tax effects 114 69
Deduct: Total stock-based employee compensation
expense determined under fair value based methods
for all awards, net of related tax effects (1,567) (2,013)
------- -------
Pro forma net loss $ (675) $(4,211)
======= =======
Income (loss) earnings per share
Basic--as reported $ 0.05 $ (0.16)
======= =======
Basic--pro forma $ (0.05) $ (0.30)
======= =======
Diluted--as reported $ 0.05 $ (0.16)
======= =======
Diluted--pro forma $ (0.05) $ (0.30)
======= =======
Compensation cost for the determination of Pro forma net loss - as
adjusted and related per share amounts were estimated using the Black Scholes
option pricing model, with the following assumptions: (i) risk free interest
rate of 2.93% and 4.85% at March 31, 2003 and 2002, respectively; (ii) expected
life of five years for the quarters ended March 31, 2003 and 2002; (iii)
expected dividends - $0 for the quarters ended March 31, 2003 and 2002; and (iv)
volatility of 100% for the quarters ended March 31, 2002 and 2003. The weighted
average fair value of options granted during the quarters ended March 31, 2003
and 2002 was $6.66 and $11.43, respectively.
In March 2003, the Company initiated an option exchange program
pursuant to which eligible employees, which excluded certain members of senior
management, were offered an opportunity to exchange an aggregate of 357,885
outstanding stock options with exercise prices of $30 and above for either cash
or shares of restricted stock, depending upon the number of options held by an
eligible employee. None of the eligible employees had been granted options
during the six month period prior to the offer. The offer exchange period
expired on May 12, 2003. Approximately 310,403 eligible options were tendered by
eligible employees and accepted by the Company. This number represents
approximately 87% of the total eligible options. A total of approximately 120
eligible participants elected to exchange an aggregate of approximately 59,870
eligible options and will receive 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 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.
4. Other 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) and Lotensin HCT(R), which agreement runs
through December 31, 2003. On May 20, 2002, this agreement was expanded through
the addition of Diovan(R) and Diovan HCT(R). Pursuant to this agreement, the
Company
8
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
provides promotion, selling, marketing, and brand management for Lotensin. In
exchange, the Company is entitled to receive a revenue split based on certain
total prescription (TRx) objectives above specified contractual baselines. Also
under this agreement, the Company copromotes Lotrel(R), Diovan and Diovan HCT in
the U.S. for which it is entitled to be compensated on a fixed fee basis with
potential incentive payments based upon achieving certain total prescription TRx
objectives. Revenue and costs from the Lotrel and Diovan programs are classified
in 2003 in the sales and marketing services segment as they are fee for service
programs in which the Company has greater certainty of recouping its expenses
with the additional potential for incentives at year end based on achieving
certain performance criteria. During 2002 revenue and expenses under these
programs were included in what is now referred to as the pharmaceutical products
group segment, since they were performance based programs where the Company was
not assured of recouping its expenses. Novartis has retained regulatory
responsibilities for Lotensin, Lotrel and Diovan and ownership of all
intellectual property. Additionally, Novartis will continue to manufacture and
distribute the products. In the event the Company's estimates of the demand for
Lotensin are not accurate or more sales and marketing resources than anticipated
are required, this program could have a material adverse impact on the Company's
results of operations, cash flows and liquidity. While the Company currently
estimates that future revenues will continue to exceed costs associated with
this program, as was the case in the quarter ended March 31, 2003, there is no
assurance that actual revenues will exceed costs in the future; in which event
the activities covered by this program could yield an operating loss and a
contract loss reserve could be required.
In October 2002, the Company entered into an agreement with Xylos
Corporation (Xylos) for the exclusive U.S. commercialization rights to the Xylos
XCell(TM) Cellulose Wound Dressing (XCell) wound care products. Pursuant to this
agreement the Company has certain minimum purchase requirements. The minimum
purchase requirement for the calendar year 2003 is $750,000. The minimum
purchase requirement for each subsequent calendar year is based on the aggregate
dollar volume of sales of products during the 12-month period ending with
September of the prior year, but in no event less than $750,000.
On December 31, 2002, the Company entered into a licensing agreement with
Cellegy Pharmaceuticals, Inc. (Cellegy) for the exclusive North American rights
for Fortigel(TM), a testosterone gel product. The agreement is in effect for the
commercial life of the product. Cellegy submitted a New Drug Application (NDA)
for the hypogonadism indication to the U.S. Food and Drug Administration (FDA)
in June 2002. The initial 10-month Prescription Drug User Fee Act (PDUFA) date
for the product was April 5, 2003. In March 2003, Cellegy was notified by the
FDA that the PDUFA date had been revised to July 3, 2003; however, there is no
certainty that FDA approval for the commercialization of the product will be
granted at that time, or at all. 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 statement of operations. Pursuant to the terms of the
license agreement, the Company will be required to pay Cellegy a $10.0 million
incremental license fee milestone payment upon Fortigel's receipt of all
approvals required by the FDA to promote, sell and distribute the product in the
U.S. This incremental milestone license fee 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 13, in May 2003, the Company settled a lawsuit which
sought to enjoin its performance under this agreement.
5. Evista Contract and Termination
In October 2001, the Company entered into an agreement with Eli Lilly and
Company (Eli Lilly) to copromote Evista(R) in the U.S. 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
9
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
to be compensated based on net sales achieved by the product above a
predetermined level. The agreement did not provide for the reimbursement of
expenses the Company incurred.
The Eli Lilly arrangement was a performance based contract. The Company was
required to commit a certain level of spending for promotional and selling
activities, including but not limited to sales representatives. The sales force
assigned to Evista was at times used to promote other products in addition to
Evista, including products covered by other PDI copromotion arrangements, which
partially offset the costs of the sales force. The Company's compensation for
Evista was determined based upon a percentage of net factory sales of Evista
above contractual baselines. To the extent that such baselines were not
exceeded, the Company received no revenue.
Based upon management's assessment of the future performance potential of
the Evista brand, on November 11, 2002, the Company and Eli Lilly mutually
agreed to terminate the contract as of December 31, 2002. The Company accrued a
contract loss of $7.8 million as of September 30, 2002 representing the
anticipated future loss expected to be incurred by the Company to fulfill its
contractual obligations under the Evista contract. There was no remaining
accrual at March 31, 2003 and December 31, 2002 as the Company had no further
obligations due to the termination of the contract. The Company recognized an
operating loss of $8.8 million under this contract in the first quarter of 2002.
There was no activity during the first quarter of 2003 as the contract was
terminated.
6. Ceftin Contract Termination
In October 2000, the Company entered into an agreement with GlaxoSmithKline
(GSK) for the exclusive U.S. sales, marketing and distribution rights for
Ceftin(R) Tablets and Ceftin(R) for Oral Suspension, two dosage forms of a
cephalosporin antibiotic, which agreement was terminated as of February 28, 2002
by mutual agreement of the parties. The agreement had a five-year term but was
cancelable by either party without cause on 120 days' notice. From October 2000
through February 2002, the Company marketed and sold Ceftin products, primarily
to wholesale drug distributors, retail chains and managed care providers.
On August 21 2001, the U.S. Court of Appeals overturned a preliminary
injunction granted by the New Jersey District Court, which allowed for the entry
of a generic competitor to Ceftin immediately upon approval by the FDA. The
affected Ceftin patent had previously been scheduled to run through July 2003.
As a result of this decision and its impact on future sales, in the third
quarter of 2001, PDI recorded a charge to cost of goods sold and a related
reserve of $24.0 million representing the anticipated future loss to be incurred
by the Company under the Ceftin agreement as of September 30, 2001. The recorded
loss was calculated as the excess of estimated costs that PDI was contractually
obligated to incur to complete its obligations under the arrangement, over the
remaining estimated gross profits to be earned under the contract from selling
the inventory. These costs primarily consisted of amounts paid to GSK to reduce
purchase commitments, estimated committed sales force expenses, selling and
marketing costs through the effective date of the termination, distribution
costs, and fees to terminate existing arrangements. The Ceftin agreement was
terminated by the Company and GSK under a mutual termination agreement entered
into in December 2001. Under the termination agreement, the Company agreed to
perform its marketing and distribution services through February 28, 2002. The
Company also maintained responsibility for sales returns for product sold until
the expiration date of the product sold, estimated to run through December 31,
2004, and certain administrative functions regarding Medicaid rebates.
The Company has approximately $16.2 million in sales rebates and return
accruals related to Ceftin at March 31, 2003 for estimated settlement of these
obligations which were incurred through the contract termination date. A
significant portion of the accrual relates to a reserve for returns. As
discussed above, certain of the products sold under the Ceftin agreement have
expiration dates through December 31, 2004.
10
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
There was $5.7 million of product revenue recognized under the Ceftin
contract for the three months ended March 31, 2002, of which $716,000 was from
the sale of inventory. The balance of $5.0 million resulted from the net
positive adjustments recorded in sales returns and allowances, discounts and
rebates accounts for the first quarter of 2002 that have occurred as we continue
to satisfy our liabilities relating to the previous reserves recorded as a
result of Ceftin sales in prior periods. Because those reserves were initially
set up as estimates, using historical data and other information, there may be
both positive and negative adjustments made as the liabilities are settled in
future periods and such adjustment will be reflected in product revenue with the
classification of such accruals when initially recorded.
7. Other Investments
In October 2002, the Company acquired $1.0 million of preferred stock of
Xylos Corporation (Xylos). As discussed in Note 4, the Company is the exclusive
distributor of the Xylos XCell(TM) product line. The Company recorded its
investment in Xylos under the cost method and its ownership interest in Xylos is
less than five percent.
The Company has an investment in the preferred stock of iPhysicianNet, Inc
(iPhysicianNet) that is accounted for under the equity method; however,
recognition of losses by the Company was suspended in 2000 after the Company's
investment was reduced to zero. During 2002, additional investments of $379,000
were made by the Company. Due to the continuing losses of iPhysicianNet, the
2002 investments were immediately expensed rather than recorded as an asset. The
Company does not have, nor has it ever had, any commitments to provide future
financing to iPhysicianNet. No investments were made by the Company in
iPhysicianNet during the first quarter of 2003 and no losses were recorded in
the quarter 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.
8. Inventory
At March 31, 2003 and December 31, 2002, the Company had approximately
$964,000 and $646,000, respectively, in finished goods inventory, relating to
the XCell wound care product being marketed and distributed in accordance with
the Xylos agreement discussed in Note 4.
9. 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
to be consolidated by a company, if that company is subject to a majority of the
risk of loss from the variable interest entity's activities or entitled to
receive a majority of the entity's residual returns or both. FIN 46 also
requires disclosures about variable interest entities that a company is not
required to consolidate but in which it has a significant variable interest. The
consolidation requirements of FIN 46 apply immediately to variable interest
entities created after January 31, 2003 and to existing entities in the first
fiscal year or interim period beginning after June 15, 2003. Certain of the
disclosure requirements apply to all financial statements issued after January
31, 2003, regardless of when the variable interest entity was established. The
initial adoption of this accounting pronouncement will not have a material
impact on the Company's consolidated financial statements.
In November 2002, the EITF reached a consensus on EITF Issue No. 00-21,
Accounting for Revenue Arrangements with Multiple Deliverables. EITF No. 00-21
provides guidance on how to determine when an arrangement that involves multiple
revenue-generating activities or deliverables should be divided into separate
units of accounting for revenue recognition purposes, and if this division is
required, how the arrangement consideration should be allocated among the
separate units of accounting. The guidance in
11
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
the consensus is effective for revenue arrangements entered into in the fiscal
periods beginning after June 15, 2003. The Company is currently waiting for the
EITF to complete its deliberations on certain implementation provisions to
finalize its evaluation of the effect that the adoption of EITF No. 00-21 will
have on its consolidated financial statements.
10. Historical and Pro Forma Basic and Diluted Net Income/Loss Per Share
Historical and pro forma basic and diluted net income/loss per share is
calculated based on the requirements of SFAS No. 128, "Earnings Per Share."
A reconciliation of the number of shares used in the calculation of basic
and diluted earnings per share for the quarters ended March 31, 2003 and 2002 is
as follows:
Three Months Ended
March 31,
------------------
2003 2002
------ ------
(in thousands)
Basic weighted average number of common
shares outstanding ............................ 14,166 13,969
Dilutive effect of stock options ................. 71 --
------ ------
Diluted weighted average number of common shares
outstanding ................................... 14,237 13,969
====== ======
Outstanding options at March 31, 2003 to purchase 1,383,108 shares of
common stock with exercise prices ranging from $14.16 to $98.70 were not
included in the computation of historical and pro forma diluted net income per
share because to do so would have been antidilutive. Outstanding options at
March 31, 2002 to purchase 1,630,257 shares of common stock with exercise prices
ranging from $15.74 to $98.70 were not included in the 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.
11. Short-Term Investments
At March 31, 2003, short-term investments were $4.1 million, including
approximately $1.1 million of investments classified as available for sale
securities. At March 31, 2002, short-term investments were $3.4 million,
including approximately $916,000 of investments classified as available for sale
securities. The unrealized after-tax gain/(loss) on the available for sale
securities is included as a separate component of stockholders' equity as
accumulated other comprehensive income/(loss). All other short-term investments
are stated at cost, which approximates fair value.
12. Other Comprehensive Income (Loss)
A reconciliation of net income (loss) as reported in the Consolidated
Statements of Operations to Other comprehensive income (loss), net of taxes is
presented in the table below.
12
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
Three Months Ended
March 31,
------------------
2003 2002
---- -------
(thousands)
Net income (loss)............................................ $778 $(2,267)
Other comprehensive income, net of tax:
Unrealized holding loss on
available-for-sale securities arising during period.. (69) (67)
Reclassification adjustment for losses
included in net income (loss)......................... -- 20
---- -------
Other comprehensive income (loss)............................ $709 $(2,314)
==== =======
13. Commitments and Contingencies
Due to the nature of the business that the Company is engaged in, such as
product detailing and distribution of products, these and other activities could
expose the Company to risk. Such risks include, among others, risk of liability
for personal injury or death to persons using products the Company promotes or
distributes. There can be no assurance that substantial claims or liabilities
will not arise in the future because of the nature of the Company's business
activities. The Company seeks to reduce its potential liability under its
service agreements through measures such as contractual indemnification
provisions with clients (the scope of which may vary from client to client, and
the performances of which are not secured) and insurance. The Company could,
however, also be held liable for errors and omissions of its employees in
connection with the services it performs that are outside the scope of any
indemnity or insurance policy. The Company could be materially adversely
affected if it were required to pay damages or incur defense costs in connection
with a claim that is outside the scope of an indemnification agreement; if the
indemnity, although applicable, is not performed in accordance with its terms;
or if the Company's liability exceeds the amount of applicable insurance or
indemnity.
Securities Litigation
In January and February 2002, the Company, its chief executive officer, and
its chief financial officer were served with three complaints that were filed in
the United States District Court for the District of New Jersey alleging
violations of the Securities Exchange Act of 1934 (the "1934 Act"). These
complaints were brought as purported shareholder class actions under Sections
10(b) and 20(a) of the 1934 Act and Rule 10b-5 established thereunder. On May
23, 2002, the Court consolidated all three lawsuits into a single action
entitled In re PDI Securities Litigation, Master File No. 02-CV-0211, and
appointed lead plaintiffs (Lead Plaintiffs) and Lead Plaintiffs' counsel. On or
about December 13, 2002, Lead Plaintiffs filed a second consolidated and amended
complaint (Second Consolidated and Amended Complaint), which superseded their
earlier complaints.
The complaint names the Company, its chief executive officer, and its chief
financial officer as defendants; purports to state claims against the Company on
behalf of all persons who purchased the Company's common stock between May 22,
2001 and August 12, 2002; and seeks money damages in unspecified amounts and
litigation expenses including attorneys' and experts' fees. The essence of the
allegations in the Second Consolidated and Amended Complaint is that the Company
intentionally or recklessly made false or misleading public statements and
omissions concerning its financial condition and prospects with respect to its
marketing of Ceftin in connection with the October 2000 distribution agreement
with GSK, its marketing of Lotensin in connection with the May 2001 distribution
agreement with Novartis Pharmaceuticals Corp., as well as its marketing of
Evista in connection with the October 2001 distribution agreement with Eli Lilly
& Co.
In February 2003, the Company filed a motion to dismiss the Second
Consolidated and Amended
13
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
Complaint under the Private Securities Litigation Reform Act of 1995 and Rules
9(b) and 12(b)(6) of the Federal Rules of Civil Procedure. The Company believes
that the allegations in this purported securities class action are without merit
and intends to defend the action vigorously.
Bayer-Baycol Litigation
The Company has been named as a defendant in numerous lawsuits, including
two class action matters, alleging claims arising from the use of the
prescription compound Baycol that was manufactured by Bayer Pharmaceuticals
(Bayer) and co-marketed by the Company on Bayer's behalf under a contract sales
force agreement. The Company may be named in additional similar lawsuits. In
August 2001, Bayer announced that it was voluntarily withdrawing Baycol from the
U.S. market. To date, the Company has defended these actions vigorously and has
asserted a contractual right of indemnification against Bayer for all costs and
expenses the Company incurs relating to these proceedings. In February 2003, the
Company entered into a joint defense and indemnification agreement with Bayer,
pursuant to which Bayer has agreed to assume substantially all of the Company's
defense costs in pending and prospective proceedings, subject to certain limited
exceptions. Further, Bayer agreed to reimburse the Company for all reasonable
costs and expenses incurred to date in defending these proceedings. Bayer
previously agreed to reimburse a minimum of $750,000 of legal fees which were
accrued at December 31, 2002 and received in the first quarter of 2003. The
Company is currently in discussions with Bayer regarding additional legal fee
reimbursements, however, no agreement has been reached and therefore no
additional amounts have been accrued to-date.
Auxilium Pharmaceuticals Litigation
On January 6, 2003, the Company was named as a defendant in a lawsuit filed
by Auxilium Pharmaceuticals, Inc. (Auxilium), in the Pennsylvania Court of
Common Pleas, Montgomery County. Auxilium was seeking monetary damages and
injunctive relief, including preliminary injunctive relief, based on several
claims related to the Company's alleged breaches of a contract sales force
agreement entered into by the parties on November 20, 2002, and claims that the
Company was misappropriating trade secrets in connection with its exclusive
license agreement with Cellegy.
On May 8, 2003, the Company entered into a settlement and mutual release
agreement with Auxillium (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 and other additional expenses that are
within the parameters of a $2.1 million litigation reserve established by PDI.
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 Auxillium an additional amount per prescription to be determined based upon
a specified formula (which amount may exceed the projected unit selling price),
for any Fortigel prescriptions filled prior to January 26, 2004. Based upon the
pending FDA approval for Fortigel, the Company does not believe that the terms
of the Settlement Agreement will have any material impact on the timing or
success of its commercialization of the product since the terms of the
settlement will not affect the Company's approach to its previously developed
pre-launch plans and programs, its marketing, trade stocking or clinical
strategies, nor does the settlement include any restrictions on the Company's
deployment of sales representatives to promote Fortigel.
Other Legal Proceedings
The Company is currently a party to other legal proceedings incidental to
its business.
While management currently believes that the ultimate outcome of all
pending proceedings, including those matters specifically mentioned above, both
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 in any
14
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
pending proceeding, there exists the possibility of a material adverse impact on
the results of operations and cash flows for the period in which the ruling or
settlement occurs.
No amounts have been accrued for losses under any of the above mentioned
matters, other than 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.
14. 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
sales and marketing services, and the recognition that the infrastructure that
supported these business units was larger than required. The Company estimated
that the restructuring will result in annualized SG&A savings of approximately
$14.0 million, based on the rate of SG&A spending at the time the Company
initiated the restructuring; however, these savings are expected to be offset by
potential incremental expenses the Company will incur in 2003 and future periods
in implementing its expanded business platforms for its PPG and MD&D segments.
The majority of the restructuring activities were completed by December 31,
2002, with full completion expected by September 30, 2003.
In connection with this plan, the Company originally estimated that it
would ultimately incur total restructuring expenses of approximately $5.4
million, other non-recurring expenses of approximately $0.1 million, and
accelerated depreciation of approximately $0.8 million. All but $0.3 million of
these expenses were recognized in 2002.
The primary items comprising the restructuring are $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. Approximately $0.2 million of these expenses will be
recognized in 2003.
During the quarter ended March 31, 2003, the Company recognized a $270,000
adjustment to the restructuring accrual due to negotiating higher sublease
proceeds than originally estimated for the leased facility in Cincinnati, Ohio.
The accrual for restructuring and exit costs totaled approximately $1.9
million at March 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 Balance at
December 31, 2002 Adjustments Payments March 31, 2003
----------------- ----------- -------- --------------
Administrative severance $1,670 $ -- $ (651) $1,019
Exit costs 1,288 (270) (659) 359
------ ----- ------- ------
2,958 (270) (1,310) 1,378
------ ----- ------- ------
Sales force severance 1,741 -- (1,268) 473
----- ----- ------- ------
Total $4,699 $(270) $(2,578) $1,851
====== ===== ======= ======
15. Segment Information
15
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
The Company operates under three reporting segments: sales and marketing
services group (SMSG), pharmaceutical products group (PPG) and medical devices
and diagnostics (MD&D), all of which have changed since the Company's March 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 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 the Company's licensing, copromotion and acquisition services,
including product sales. The Company's MD&D segment includes PDI InServe,
contract sales, and product licensing and acquisition. The segment information
from prior periods has been restated to conform to the current period's
presentation.
Corporate charges are allocated to each of the operating segments on the
basis of total salary costs. Corporate charges include corporate headquarter
costs and certain depreciation expense. Capital expenditures have not been
allocated to the operating segments since it is impracticable to do so.
Three Months Ended
March 31,
------------------
2003 2002
------- -------
(thousands)
Revenue
Sales and marketing services group....................... $54,526 $54,250
Pharmaceutical products group............................ 10,035 17,550
Medical devices and diagnostics.......................... 2,984 2,207
------- -------
Total................................................. $67,545 $74,007
======= =======
Revenue, intercompany
Sales and marketing services group....................... $ -- $ 124
Pharmaceutical products group............................ -- --
Medical devices and diagnostics.......................... -- --
------- -------
Total................................................. $ -- $ 124
======= =======
Revenue, less intercompany
Sales and marketing services group....................... $54,526 $54,126
Pharmaceutical products group............................ 10,035 17,550
Medical devices and diagnostics.......................... 2,984 2,207
------- -------
Total................................................. $67,545 $73,883
======= =======
Income (loss) from operations
Sales and marketing services group....................... $10,411 $ 6,817
Pharmaceutical products group............................ (3,401) (6,934)
Medical devices and diagnostics.......................... (1,904) (314)
Corporate charges........................................ (4,041) (4,047)
------- -------
Total................................................. $ 1,065 $(4,478)
======= =======
16
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
Three Months Ended
March 31,
------------------
2003 2002
------- -------
(thousands)
Income (loss) from operations, intercompany
Sales and marketing services group....................... $ -- $ 53
Pharmaceutical products group............................ -- (53)
Medical devices and diagnostics.......................... -- --
Corporate charges........................................ -- --
------- -------
Total................................................. $ -- $ --
======= =======
Income (loss) from operations, less intercompany, before
corporate allocations
Sales and marketing services group....................... $10,411 $ 6,764
Pharmaceutical products group............................ (3,401) (6,881)
Medical devices and diagnostics.......................... (1,904) (314)
Corporate charges........................................ (4,041) (4,047)
------- -------
Total................................................. $ 1,065 $(4,478)
======= =======
Corporate allocations
Sales and marketing services group....................... $(3,041) $(2,446)
Pharmaceutical products group............................ (649) (1,438)
Medical devices and diagnostics.......................... (351) (163)
Corporate charges........................................ 4,041 4,047
------- -------
Total................................................. $ -- $ --
======= =======
Income (loss) from operations, less corporate allocations
Sales and marketing services group....................... $ 7,370 $ 4,318
Pharmaceutical products group............................ (4,050) (8,319)
Medical devices and diagnostics.......................... (2,255) (477)
Corporate charges........................................ -- --
------- -------
Total................................................. $ 1,065 $(4,478)
======= =======
Reconciliation of income (loss) from operations to income
(loss) before provision for income taxes
Total EBIT for operating groups.......................... $ 1,065 $(4,478)
Other income, net........................................ 269 889
------- -------
Income before provision for income taxes.............. $ 1,334 $(3,589)
======= =======
Capital expenditures
Sales and marketing services group....................... $ 208 $ 2,100
Pharmaceutical products group............................ -- 212
Medical devices and diagnostics.......................... 7 24
------- -------
Total................................................. $ 215 $ 2,336
======= =======
Depreciation expense
Sales and marketing services group....................... $ 881 $ 949
Pharmaceutical products group............................ 255 250
Medical devices and diagnostics.......................... 108 49
------- -------
Total................................................. $ 1,244 $ 1,248
======= =======
17
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
16. Goodwill and Intangible Assets
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and
Other Intangible Assets." Under SFAS No. 142, goodwill is no longer amortized
but is evaluated for impairment on at least an annual basis. The Company has
established reporting units for purposes of testing goodwill for impairment.
Goodwill has been assigned to the reporting units to which the value of the
goodwill relates. The Company completed the first step of the transitional
goodwill impairment test and determined that no impairment existed at January 1,
2002. The Company performed the required annual impairment tests in the fourth
quarter of 2002 and determined that no impairment existed at December 31, 2002.
These tests involved determining the fair market value of each of the reporting
units with which the goodwill was associated and comparing the estimated fair
market value of each of the reporting units with its carrying amount. The
Company's total goodwill which is not subject to amortization totaled $11.1
million as of March 31, 2003 and December 31, 2002.
There were no changes in the carrying amount of goodwill since December 31,
2002. The carrying amounts at March 31, 2003 by operating segment are shown
below:
SMSG PPG MD&D Total
------ --- ------ -------
Balance as of December 31, 2002 $3,344 $-- $7,788 $11,132
Amortization -- -- -- --
Goodwill additions -- -- -- --
------ --- ------ -------
Balance as of March 31, 2003 $3,344 $-- $7,788 $11,132
====== === ====== =======
All identifiable intangible assets recorded as of March 31, 2003 are being
amortized on a straight-line basis over the life of the intangibles which is
primarily five years. The carrying amounts at March 31, 2003 and December 31,
2002 are as follows:
As of March 31, 2003 As of December 31, 2002
-------------------------------- --------------------------------
Carrying Accumulated Carrying Accumulated
Amount Amortization Net Amount Amortization Net
-------- ------------ ------ -------- ------------ ------
Covenant not to compete $1,686 $527 $1,159 $1,686 $442 $1,244
Customer relationships 1,208 377 831 1,208 318 890
Corporate tradename 172 54 118 172 45 127
------ ---- ------ ------ ---- ------
Total $3,066 $958 $2,108 $3,066 $805 $2,261
====== ==== ====== ====== ==== ======
Amortization expense totaled approximately $153,000 in the quarters ended
March 31, 2003 and 2002. Estimated amortization expense for the next five years
is as follows:
2003 $613
====
2004 613
====
2005 613
====
2006 422
====
2007 --
====
18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
Various statements made in this Quarterly Report on Form 10-Q are
"forward-looking statements" (within the meaning of the Private Securities
Litigation Reform Act of 1995) regarding the plans and objectives of management
for future operations. These statements involve known and unknown risks,
uncertainties and other factors that may cause our actual results, performance
or achievements to be materially different from any future results, performance
or achievements expressed or implied by these forward-looking statements. The
forward-looking statements included in this report are based on current
expectations that involve numerous risks and uncertainties. Our plans and
objectives are based, in part, on assumptions involving judgements about, among
other things, future economic, competitive and market conditions and future
business decisions, all of which are difficult or impossible to predict
accurately and many of which are beyond our control. Although we believe that
our assumptions underlying the forward-looking statements are reasonable, any of
these assumptions could prove inaccurate and, therefore, we cannot assure you
that the forward-looking statements included in this report will prove to be
accurate. In light of the significant uncertainties inherent in the
forward-looking statements included in this report, the inclusion of these
statements should not be interpreted by anyone that our objectives and plans
will be achieved. Factors that could cause actual results to differ materially
from those expressed or implied by forward-looking statements include, but are
not limited to, the factors set forth in "Risk Factors" under Part I, Item 1, of
the Company's Annual Report on Form 10-K for the year ended December 31, 2002 as
filed with the Securities and Exchange Commission.
Overview
We are a commercial sales and marketing company serving the
biopharmaceutical and medical devices and diagnostics (MD&D) industries. We
create and execute sales and marketing campaigns intended to improve the
profitability of pharmaceutical or MD&D products. We do this by partnering with
companies who own the intellectual property rights to these products and
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. Our three reporting segments include:
o PDI sales and marketing services group (SMSG), comprised of:
o dedicated contract sales services (CSO);
o shared contract sales services (CSO);
o marketing research and consulting services (MR&C) ; and
o medical education and communication services (EdComm).
o PDI pharmaceutical products group (PPG), comprised of:
o copromotion;
o licensing; and
o acquisitions.
o PDI medical devices and diagnostics group (MD&D), comprised of:
o contract sales services (CSO);
o InServe;
o copromotion;
o licensing; and
o acquisitions.
19
An analysis of these reporting segments and their results of operations is
contained in Note 15 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. Contracts may also be
terminated for cause if we fail to meet stated performance benchmarks, though
this has never happened. The loss or termination of a large contract or the loss
of multiple contracts could adversely affect our future revenue and
profitability.
Our MR&C and EdComm contracts generally are for projects lasting from three
to six months. The contracts are terminable by the client and provide for
termination payments in the event they are terminated without cause. Termination
payments include payment for all work completed to date, plus the cost of any
nonrefundable commitments made on behalf of the client. Due to the typical size
of the projects, it is unlikely that the loss or termination of any individual
MR&C or EdComm contract would have a material adverse impact on our results of
operations, cash flows or liquidity.
PDI Pharmaceutical Products Group
Our contracts within the PPG segment in general are more heavily
performance based and have a higher risk potential and correspondingly an
opportunity for higher profitability. We use a variety of structures for these
contracts. These contracts typically involve significant startup expenses and a
greater risk of operating losses. These contracts normally require significant
participation from our PPG and MR&C and EdComm professionals whose skills
include marketing, brand management, trade relations and marketing research.
Beginning in the fourth quarter of 2000, we entered into a number of
significant performance based contracts. Our agreement with GlaxoSmithKline
(GSK), which we entered into in October 2000 regarding Ceftin(R), was a
marketing and distribution contract under which we had the exclusive right to
market and distribute designated Ceftin products in the U.S. The agreement had a
five-year term but was cancelable by either party without cause on 120 days'
notice. The agreement was terminated by mutual consent, effective February 28,
2002. Contracts such as the Ceftin agreement, which require us to purchase and
distribute product, have a greater number of risk factors than a traditional fee
for service contract. Any future agreement that involves in-licensing or product
acquisition would have similar risk factors.
In May 2001, we entered into a copromotion agreement with Novartis
Pharmaceuticals Corporation (Novartis) for the U.S. sales, marketing and
promotion rights for Lotensin(R) and Lotensin HCT(R), which agreement runs
through December 31, 2003. On May 20, 2002, this agreement was expanded through
the addition of Diovan(R) and Diovan HCT(R). Pursuant to this agreement, we
provide promotion, selling,
20
marketing, and brand management for Lotensin. In exchange, we are entitled to
receive a revenue split based on certain total prescription (TRx) objectives
above specified contractual baselines. Also under this agreement, we copromote
Lotrel(R), Diovan and Diovan HCT in the U.S. for which we are entitled to be
compensated on a fixed fee basis with potential incentive payments based upon
achieving certain total prescription TRx objectives. Revenue and costs from the
Lotrel and Diovan programs are classified in 2003 in the sales and marketing
services segment as they are fee for service programs in which we have greater
certainty of recouping our expenses with the additional potential for incentives
at year end based on achieving certain performance criteria. During 2002 revenue
and expenses under these programs were included in what is now referred to as
the pharmaceutical products group segment, since they were performance based
programs where we were not assured of recouping our expenses. Novartis has
retained regulatory responsibilities for Lotensin, Lotrel and Diovan and
ownership of all intellectual property. Additionally, Novartis will continue to
manufacture and distribute the products. In the event our estimates of the
demand for Lotensin are not accurate or more sales and marketing resources than
anticipated are required, this program could have a material adverse impact on
our results of operations, cash flows and liquidity. While we currently estimate
that future revenues will continue to exceed costs associated with this program,
as was the case in the quarter ended March 31, 2003, there is no assurance that
actual revenues will exceed costs in the future; in which event the activities
covered by this program could yield an operating loss and a contract loss
reserve could be required.
In October 2001, we entered into an agreement with Eli Lilly and Company
(Eli Lilly) to copromote Evista(R) in the U.S. Under the terms of this
agreement, we provided sales representatives to copromote Evista to physicians
in the U.S. Our sales representatives augmented the Eli Lilly sales force
promoting Evista. Under this agreement, we were entitled to be compensated based
on net factory sales achieved above a predetermined level. The agreement did not
provide for the reimbursement of expenses we incurred.
The Eli Lilly arrangement was a performance based contract. We were
required to commit a certain level of spending for promotional and selling
activities, including but not limited to sales representatives. The sales force
assigned to Evista was at times used to promote other products in addition to
Evista, including products covered by other PDI copromotion arrangements, which
partially offset the costs of the sales force. Our compensation for Evista was
determined based upon a percentage of net factory sales of Evista above
contractual baselines. To the extent that these baselines were not exceeded, we
received no revenue.
Based upon management's assessment of the future performance potential of
the Evista brand, on November 11, 2002, we and Eli Lilly mutually agreed to
terminate the contract as of December 31, 2002. We accrued a contract loss of
$7.8 million as of September 30, 2002 representing the anticipated future loss
expected to be incurred by us to fulfill our contractual obligations under the
Evista contract. There was no remaining accrual as of December 31, 2002 as we
had no further obligations due to the termination of the contract. An operating
loss of $8.8 million was recognized in the first quarter of 2002. There was no
activity in 2003 since the termination was effective December 31, 2002.
On December 31, 2002, we entered into a licensing agreement with Cellegy
Pharmaceuticals, Inc. (Cellegy) for the exclusive North American rights for
Fortigel(TM), a testosterone gel product. The agreement is in effect for the
commercial life of the product. Cellegy submitted a New Drug Application (NDA)
for the hypogonadism indication to the U.S. Food and Drug Administration (FDA)
in June 2002. The initial 10-month Prescription Drug User Fee Act (PDUFA) date
for the product was April 5, 2003. In March 2003, Cellegy was notified by the
FDA that the PDUFA date had been revised to July 3, 2003; however, there is no
certainty that FDA approval for the commercialization of the product will be
granted at that time, or at all. Under the terms of the agreement, we paid
Cellegy a $15.0 million initial licensing fee on December 31, 2002. This
nonrefundable payment was made prior to FDA approval and, since there is no
alternative future use of the licensed rights, the $15.0 million payment was
expensed by us in December 2002, when incurred. This amount was recorded in
other selling, general, and administrative expenses in the December 31, 2002
consolidated statement of operations. Pursuant to the terms of the license
21
agreement, we will be required to pay Cellegy a $10.0 million incremental
license fee milestone payment upon Fortigel's receipt of all approvals required
by the FDA to promote, sell and distribute the product in the U.S. This
incremental milestone license fee 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 13, in May 2003, we settled a lawsuit which sought
to enjoin our performance under this agreement.
PDI Medical Devices and Diagnostics Group
On September 10, 2001, we acquired InServe Support Solutions (InServe) in a
transaction treated as an asset acquisition for tax purposes. InServe is a
leading nationwide supplier of supplemental field-staffing programs for the MD&D
industry. InServe employs nurses, medical technologists and other clinicians who
visit hospital and non-hospital accounts and provide hands-on clinical education
and after-sales support to maximize product utilization and customer
satisfaction. InServe's clients include many of the leading MD&D companies,
including Becton Dickinson, Boston Scientific and Johnson & Johnson.
In addition to helping establish our initial presence in the MD&D market,
the InServe acquisition facilitated our entry into, and helped us establish, a
contract sales business within the MD&D market. Our MD&D service contracts have
similar provisions to our sales and marketing services contracts.
A major focus of the MD&D group is product licensing and acquisition. We
believe that this segment of the MD&D market is well suited for strategic
alliances and partnerships with companies looking to maximize the commercial
value of their products. This product licensing and acquisition focus led us to
our first commercial partnership in the MD&D market. In October 2002, we entered
into an agreement with Xylos Corporation (Xylos) for the exclusive U.S.
commercialization rights to the Xylos XCell(TM) Cellulose Wound Dressing (XCell)
wound care products. Pursuant to this agreement we have certain minimum purchase
requirements. The minimum purchase requirement for the calendar year 2003 is
$750,000. The minimum purchase requirement for each subsequent calendar year is
based on the aggregate dollar volume of sales of products during the 12-month
period ending with September of the prior year, but in no event less than
$750,000.
Revenues and costs of revenue
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. GAAP requires that service revenue and product revenue
and their respective direct costs be shown separately on the income statement.
However, our reporting segments' revenue and direct costs may consist of both
product and service activities; the segment financial results are discussed
later in the Consolidated Results of Operations section beginning on page 24 and
in Note 15 to the consolidated financial statements located elsewhere in this
report.
Historically, we have derived a significant portion of our service revenue
from a limited number of clients. Concentration of business in the
pharmaceutical services industry is common and the industry continues to
consolidate. As a result, we are likely to continue to experience significant
client concentration in future periods. Our significant clients, who each
accounted for 10% or more of our service revenue, accounted for approximately
69% and 78% of our service revenue for the quarters ended March 31, 2003 and
2002, respectively. Our product revenue for the quarter ended March 31, 2003 was
comprised almost entirely of sales of the Xylos wound care product which just
began commercialization during the first quarter of 2003. Of the $5.7 million
recorded as product revenue for the quarter ended March 31, 2002, approximately
$716,000 was from the sale of Ceftin inventory. The balance of $5.0 million
resulted from the net positive adjustments recorded in sales returns and
allowances, discounts and
22
rebates that occurred in the first quarter of 2002 as we continued to satisfy
our liabilities relating to the previous reserves recorded as a result of Ceftin
sales in prior periods. Since those reserves were initially set up as estimates
using historical data and other information, there may be both positive and
negative adjustments made as the liabilities are settled in future periods, and
these adjustments will be reflected in product revenue in accordance with the
classification of such accruals as initially recorded.
Service revenue and program expenses
Service revenue is earned primarily by performing product detailing
programs and other marketing and promotional services under contracts. Revenue
is recognized as the services are performed and the right to receive payment for
the services is assured. Revenue is recognized net of any potential penalties
until the performance criteria relating to the penalties have been achieved.
Bonus and other performance incentives, as well as termination payments, are
recognized as revenue in the period earned and when payment of the bonus,
incentive or other payment is assured. Under performance based contracts,
revenue is recognized when the performance based parameters are achieved.
Program expenses consist primarily of the costs associated with executing
product detailing programs, performance based contracts or other sales and
marketing services identified in the contract. Program expenses include
personnel costs and other costs associated with executing a product detailing or
other marketing or promotional program, as well as the initial direct costs
associated with staffing a product detailing program. Such costs include, but
are not limited to, facility rental fees, honoraria and travel expenses, sample
expenses and other promotional expenses. Personnel costs, which constitute the
largest portion of program expenses, include all labor related costs, such as
salaries, bonuses, fringe benefits and payroll taxes for the sales
representatives and sales managers and professional staff who are directly
responsible for executing a particular program. Initial direct program costs are
those costs associated with initiating a product detailing program, such as
recruiting, hiring and training the sales representatives who staff a particular
product detailing program. All personnel costs and initial direct program costs,
other than training costs, are expensed as incurred for service offerings.
Training costs include the costs of training the sales representatives and
managers on a particular product detailing program so that they are qualified to
properly perform the services specified in the related contract. For all
contracts, training costs are deferred and amortized on a straight-line basis
over the shorter of the life of the contract to which they relate or 12 months.
When we receive a specific contract payment from a client upon commencement of a
product detailing program expressly to compensate us for recruiting, hiring and
training services associated with staffing that program, such payment is
deferred and recognized as revenue in the same period that the recruiting and
hiring expenses are incurred and the amortization of the deferred training is
expensed. When we do not receive a specific contract payment for recruiting,
hiring and training, all revenue is deferred and recognized over the life of the
contract. Product detailing, marketing and promotional expenses related to the
detailing of products we distribute are recorded as a selling expense and are
included in other selling, general and administrative expenses in the
consolidated statements of operations.
We may incur significant initial direct program costs before recognizing
revenue under a particular product detailing program. Our inability to
specifically negotiate for payments that are specifically attributable to
recruiting, hiring or training services in our product detailing contracts could
adversely impact our operating results for periods in which the costs associated
with the product detailing services are incurred.
Product revenue and cost of goods sold
As mentioned previously, product revenue for the quarter ended March 31,
2003 resulted primarily from the sale of the Xylos wound care product. Product
revenue recognized in prior periods related to the Ceftin contract which
terminated in February 2002. Product revenue is recognized when products are
shipped and title is transferred to the customer.
23
Cost of goods sold includes all expenses for both product distribution
costs, acquisition and manufacturing costs of the product sold. Inventory is
valued at the lower of cost or market value. Cost is determined using the first
in, first out costing method. Inventory to date has consisted of only finished
goods.
Consolidated Results of Operations
The following table sets forth, for the periods indicated, certain
statements of operations data as a percentage of revenue. The trends illustrated
in this table may not be indicative of future results.
Three Months Ended
March 31,
------------------
2003 2002
----- -----
Revenue
Service, net............................................ 99.9% 92.3%
Product, net............................................ 0.1 7.7
----- -----
Total revenue, net................................... 100.0% 100.0%
Cost of goods and services
Program expenses........................................ 73.9 91.1
Cost of goods sold...................................... 0.1 --
----- -----
Total cost of goods and services..................... 74.0 91.1
Gross profit............................................... 26.0 8.9
Compensation expense....................................... 13.1 10.5
Other selling, general and administrative expenses......... 8.6 4.5
Restructuring and other related expenses, net.............. (0.4) --
Litigation settlement...................................... 3.1 --
----- -----
Total operating expenses............................. 24.4 15.0
----- -----
Operating income (loss).................................... 1.6 (6.1)
Other income, net.......................................... 0.4 1.2
----- -----
Income (loss) before provision for income taxes............ 2.0 (4.9)
Provision (benefit) for income taxes....................... 0.8 (1.8)
----- -----
Net income (loss).......................................... 1.2% (3.1)%
===== =====
Revenue. Net revenue for the quarter ended March 31, 2003 was $67.5
million, 8.6% less than net revenue of $73.9 million for the quarter ended March
31, 2002. Net revenue from the SMSG segment for the quarter ended March 31, 2003
was $54.5 million, approximately $400,000 more than net revenue of $54.1 million
from that segment for the comparable prior year period. Net PPG service revenue
for the quarter ended March 31, 2003 was $10.0 million compared to $11.9 million
in the comparable prior year period. As disclosed elsewhere in the MD&A, the
Novartis sales force responsible for Lotrel/Diovan is now classified in the SMSG
segment instead of the PPG segment where it was classified in 2002 due to a
change in the nature of the arrangement. Additionally, there was also $5.7
million in product revenue recorded for the period ended March 31, 2002 compared
to product revenue of only $34,000 in 2003. Within product revenue in 2002,
approximately $716,000 was attributable to sales of Ceftin and $5.0 million was
attributable to the changes in estimates related to sales allowances and
returns, discounts and rebates recorded on previous Ceftin sales. Product
revenue in 2003 consisted entirely of the initial sales of the Xylos product.
Net revenue from the MD&D segment was $3.0 million compared to $2.2 million in
the comparable prior year period. This increase was due to the increased revenue
from the MD&D service segment and the Xylos product sales.
Cost of goods and services. Cost of goods and services for the quarter
ended March 31, 2003 was $49.9 million, 25.8% less than cost of goods and
services of $67.3 million for the quarter ended March 31, 2002. As a percentage
of total net revenue, cost of goods and services decreased to 73.9% for the
quarter
24
ended March 31, 2003 from 91.1% in the comparable prior year period. Program
expenses (i.e., cost of services) associated with the SMSG segment for the
quarter ended March 31, 2003 were $38.1 million, 9.5% less than program expenses
of $42.0 million for the prior year period. As a percentage of sales and
marketing services segment revenue, program expenses for the quarters ended
March 31, 2003 and 2002 were 69.8% and 77.7%, respectively. The gross profit
increase to 30.2% from 22.3% is primarily attributable to the amount of
performance incentives earned in the first quarter of 2003, which were
approximately $4.7 million, $2.6 million higher than in the comparable prior
year period. Without the increased performance incentives, the gross profit
percentage would have been 25.4%. Cost of goods and services associated with the
PPG segment were $9.8 million and $23.8 million for the quarters ended March 31,
2003 and 2002, respectively. As a percentage of PPG revenue, cost of goods and
services for the quarters ended March 31, 2003 and 2002 were 97.2% and 135.2%,
respectively. All of the contracts in the PPG segment have annual performance
parameters, the successful achievement of which will not be certain until the
fourth quarter of 2003. Until that time the gross profit percentage for the PPG
segment will be less than our traditional contracts in the SMSG segment. It is
not possible at this time to predict that these performance parameters will be
achieved or that the gross profit percentage will improve in future quarters.
During 2002, the gross profits in this segment were negative due to the
underperformance of our contracted products, most notably under the Evista
agreement which was terminated effective December 31, 2002. The Company incurred
an operating loss of approximately $8.8 million under the Evista contract in the
first quarter of 2002. Performance based contracts can achieve a gross profit
percentage above our historical averages for contract sales programs if the
performance of the product(s) meets or exceeds expectations, but can be below
normal gross profit standards if the performance of the product falls short of
expectations. While we currently estimate that future revenues will exceed costs
associated with these agreements, there is no assurance that actual revenues
will exceed costs; in which event the activities covered by these agreements
could yield an operating loss. Program expenses associated with the MD&D segment
for the quarter ended March 31, 2003 were $2.1 million, of which $62,000 was
related to product sales, 44.5% more than program expenses of $1.5 million for
the prior year period. The Company recognized a negative gross profit margin on
the sale of the Xylos product in the first quarter of 2003 due primarily to the
initial sales of the product not exceeding the fixed warehousing costs. The
average per unit sales price exceeded the average per unit acquisition cost of
the inventory by an amount considered normal for the industry.
Compensation expense. Compensation expense for the quarter ended March 31,
2003 was $8.9 million, 14.4% more than $7.8 million for the comparable prior
year period. As a percentage of total net revenue, compensation expense
increased to 13.1% for the quarter ended March 31, 2002 from 10.5% for the
quarter ended March 31, 2001. Compensation expense for the quarter ended March
31, 2003 attributable to the SMSG segment was $5.4 million compared to $4.5
million for the quarter ended March 31, 2002. As a percentage of net revenue
from the SMSG segment, compensation expense increased to 9.9% for the quarter
ended March 31, 2003 from 8.3% for the quarter ended March 31, 2002. The
increased compensation expense in the first quarter of 2003 is due in large part
to increased incentive compensation expenses due to improved results in the
first quarter of 2003 as compared to the net loss experienced in the first
quarter of 2002, which greatly reduced incentive compensation potential.
Compensation expense for the quarter ended March 31, 2002 attributable to the
PPG segment was $2.3 million, or 23.3% of PPG revenue, compared to $2.6 million,
or 14.6% in the prior year period. In future periods we expect the staffing for
this segment to increase as capabilities are added. Compensation expense for the
MD&D segment for the quarter ended March 31, 2003 was $1.2 million compared to
$717,000 in the comparable prior year period, reflecting the increased
capabilities required for the launch and continuing marketing of our wound care
products.
Other selling, general and administrative expenses. Total other selling,
general and administrative expenses were $5.8 million for the quarter ended
March 31, 2003, 75.4% more than other selling, general and administrative
expenses of $3.3 million for the quarter ended March 31, 2002. As a percentage
of total net revenue, total other selling, general and administrative expenses
increased to 8.7% for the quarter ended March 31, 2003 from 4.5% for the quarter
ended March 31, 2002. Other selling, general and administrative expenses
attributable to the SMSG segment for the quarter ended March 31, 2003 were $2.8
25
million, compared to other selling, general and administrative expenses of $3.3
million attributable to that segment for the comparable prior year period. As a
percentage of net revenue from sales and marketing services, other selling,
general and administrative expenses were 5.2% and 6.0% for the quarters ended
March 31, 2003 and 2002, respectively. The slight reduction in expense reflects
savings associated with the restructuring activities which primarily affected
the SMSG segment. Other selling, general and administrative expenses
attributable to the PPG segment for the quarter ended March 31, 2003 were $1.3
million compared to a credit of $459,000 for the comparable prior year period.
The first quarter of 2002 included a credit of $2.6 million due to the reversal
of certain prior reserves for bad debts, inventory obsolescence and Ceftin
contract losses which were subsequently resolved favorably. We expect that there
will be increases in infrastructure for this segment during the next several
quarters. Other selling, general and administrative expenses attributable to the
MD&D segment for the quarter ended March 31, 2003 were $1.7 million, compared to
$507,000 for the comparable prior year period. This increase was primarily
attributable to the sales force costs and other marketing costs associated with
the launch of our wound care products, which began in January 2003.
Restructuring and other related expenses. During the quarter ended March
31, 2003, we recognized a $270,000 adjustment to the restructuring accrual due
to negotiating higher sublease proceeds than originally estimated for the leased
facility in Cincinnati, Ohio. See the "Restructuring and other related expenses"
disclosure in the "Liquidity and Capital Resources" section below for further
explanations of the Restructuring Plan and related activity.
Litigation settlement. On May 8, 2003, we entered into a settlement and
mutual release agreement with Auxillium (Settlement Agreement). The settlement
terms included a cash payment paid upon execution of the Settlement Agreement
and other additional expenses that are within the parameters of the $2.1 million
litigation reserve established by PDI.
Operating income (loss). There was operating income for the quarter ended
March 31, 2003 of $1.1 million, compared to an operating loss of $4.5 million
for the quarter ended March 31, 2002. Operating income for the quarter ended
March 31, 2003 for the SMSG segment was $7.4 million, or 70.7% higher than the
SMSG operating income for the quarter ended March 31, 2002 of $4.3 million. As a
percentage of net revenue from the sales and marketing services segment,
operating income for that segment increased to 13.5% for the quarter ended March
31, 2003, from 8.1% for the comparable prior year period. The marketing research
unit and the medical education unit were major contributors to this increase in
profitability. There was an operating loss for the PPG segment for the quarter
ended March 31, 2003 of $4.0 million, compared to an operating loss of $8.3
million for the prior year period. The improvement in the PPG segment results
was primarily attributable to the termination of the Evista contract as of
December 31, 2002. The MD&D segment recorded an operating loss of $2.3 million,
compared to an operating loss of $477,000 in the comparable prior year period,
primarily due to the costs incurred for the launch of the Xylos wound care
product.
Other income, net. Other income, net, for the quarters ended March 31, 2003
and 2002 was $269,000 and $889,000, respectively, and was comprised primarily of
interest income which is lower in 2003 due to lower available cash balances and
significantly lower interest rates.
Provision (benefit) for income taxes. There was income tax expense of
approximately $556,000 for the quarter ended March 31, 2003, compared to an
income tax benefit of $1.3 million for the quarter ended March 31, 2002, which
consisted of Federal and state corporate income taxes. The effective tax rate
for the quarter ended March 31, 2003 was 41.7%, compared to an effective tax
benefit rate of 36.8% for the quarter ended March 31, 2002. The rate for our
2002 tax benefit is lower than the 2003 effective tax rate because some states
do not permit loss carryforwards or may impose minimum taxes, or both.
26
Net income (loss). There was net income for the quarter ended March 31,
2003 of approximately $778,000, compared to a net loss of $2.3 million for the
quarter ended March 31, 2002 due to the factors discussed previously.
Liquidity and Capital Resources
As of March 31, 2003, we had cash and cash equivalents of approximately
$64.3 million and working capital of approximately $84.1 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 quarter ended March 31, 2003, net cash used in operating activities
was $4.1 million, compared to $14.2 million net cash used in operating
activities for the quarter ended March 31, 2002. The main components of cash
used in operating activities were:
o cash used from other changes in assets and liabilities of $6.5
million, which includes an increase in other current assets for the
escrow funding relating to $1.8 million of letters of credit
associated with our insurance policies, and reductions in our
restructuring accruals of $2.8 million, partially offset by,
o net income of approximately $778,000, and
o depreciation and other non-cash expenses of approximately $1.5
million.
Inventory increased by $0.3 million for the first quarter of 2003.
Inventory as of March 31, 2003 of approximately $964,000 is associated with our
XCell wound care product distribution agreement with Xylos.
When we bill clients for services before they have been completed, billed
amounts are recorded as unearned contract revenue, and are recorded as income
when earned. When services are performed in advance of billing, the value of
such services is recorded as unbilled costs and accrued profits. As of March 31,
2003, we had $8.2 million of unearned contract revenue and $9.5 million of
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, including seasonality of product sales, number and size of programs,
contract terms and other timing issues; these variations may change in size and
direction with each reporting period.
For the three months ended March 31, 2003, net cash provided by investing
activities of $1.6 million consisted of $1.8 million received from the sale of
short-term investments, partially offset by $215,000 in purchases of property
and equipment.
For the three months ended March 31, 2003, there was no cash received from
financing activities. For the three months ended March 31, 2002 net cash
provided by financing activities was approximately $21,000. This was due to the
net proceeds received from the exercise of common stock options by employees.
Capital expenditures during the periods ended March 31, 2003 and 2002 were
approximately $215,000 and $2.3 million, respectively, and were funded out of
available cash. As a result of the significant investment in capital
expenditures during 2002 of $4.0 million and 2001 of $15.6 million, we currently
estimate that we will require capital expenditures of approximately $2.0 million
in 2003.
Due to the ability to carry back net operating losses incurred for the year
ended December 31, 2002, we expect to receive a Federal income tax refund of
approximately $20.0 million in 2003.
27
Our revenue and profitability depend to a great extent on our relationships
with a limited number of large pharmaceutical companies. For the three months
ended March 31, 2003, we had two major clients that accounted for approximately
35.5% and 33.5%, respectively, or a total of 69.0%, of our service revenue. We
are likely to continue to experience a high degree of client concentration,
particularly if there is further consolidation within the pharmaceutical
industry. The loss or a significant reduction of business from any of our major
clients, or a decrease in demand for our services, could have a material adverse
effect on our business, results of operations and liquidity.
Under our license agreement with Cellegy, we will be required to pay
Cellegy a $10.0 million incremental license fee milestone payment upon
Fortigel's receipt of all approvals required by the FDA to promote, sell and
distribute the product in the U.S. Upon payment, this incremental milestone
license fee will be recorded as an intangible asset and amortized over the
estimated commercial life of the product, as then determined. This payment will
be funded, when due, out of cash flows provided by operations and existing cash
balances. In addition, under the license 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.
We believe that our existing cash balances and expected cash flows
generated from operations will be sufficient to meet our operating and capital
requirements for the next 12 months. We continue to evaluate and review
financing opportunities and acquisition candidates in the ordinary course of
business.
Restructuring and other related expenses
During the third quarter of 2002, we adopted a restructuring plan, the
objectives of which were to consolidate operations in order to enhance operating
efficiencies (the 2002 Restructuring Plan). This plan was primarily in response
to the general decrease in demand within our markets for the sales and marketing
services segment, and the recognition that the infrastructure that supported
these business units was larger than required. We estimate that the
restructuring will 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 are expected to be offset by potential
incremental expenses we will incur in 2003 and future periods in implementing
our expanded business platforms for our PPG and MD&D segments. The majority of
the restructuring activities were completed by December 31, 2002, with full
completion expected by September 30, 2003.
In connection with this plan, we originally estimated that we would
ultimately require 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. All but $0.3 million of these
expenses were recognized in 2002.
The primary items comprising the $5.4 million in restructuring expenses are
$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. Approximately $0.2 million of these expenses will
be recognized in 2003.
During the quarter ended March 31, 2003, we recognized a $270,000
adjustment to the restructuring accrual due to negotiating higher sublease
proceeds than originally estimated for the leased facility in Cincinnati, Ohio.
The accrual for restructuring and exit costs totaled approximately $1.9
million at March 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:
28
Balance at Balance at
December 31, 2002 Adjustments Payments March 31, 2003
----------------- ----------- -------- --------------
Administrative severance $1,670 $ -- $ (651) $1,019
Exit costs 1,288 (270) (659) 359
------ ----- ------- ------
2,958 (270) (1,310) 1,378
------ ----- ------- ------
Sales force severance 1,741 -- (1,268) 473
------ ----- ------- ------
Total $4,699 $(270) $(2,578) $1,851
====== ===== ======= ======
29
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
Within the past 90 days, PDI's management, including its Chief Executive Officer
and Chief Financial Officer, have conducted an evaluation of the effectiveness
of disclosure controls and procedures pursuant to Rule 13a-14 and 15d-14 under
the Securities Exchange Act of 1934, as amended. Based on that evaluation, the
Chief Executive Officer and Chief Financial Officer concluded that the
disclosure controls and procedures are effective in ensuring that all material
information required to be filed in this quarterly report has been made known to
them in a timely fashion.
(b) Changes in Internal Controls
There have been no significant changes in internal controls, or in factors that
could significantly affect internal controls, subsequent to the date the Chief
Executive Officer and Chief Financial Officer completed their evaluation.
30
Part II - Other Information
Item 1 - Legal Proceedings
Securities Litigation
In January and February 2002, we, our chief executive officer, and our
chief financial officer were served with three complaints that were filed in the
United States District Court for the District of New Jersey alleging violations
of the Securities Exchange Act of 1934 (the "1934 Act"). These complaints were
brought as purported shareholder class actions under Sections 10(b) and 20(a) of
the 1934 Act and Rule 10b-5 established thereunder. On May 23, 2002, the Court
consolidated all three lawsuits into a single action entitled In re PDI
Securities Litigation, Master File No. 02-CV-0211, and appointed lead plaintiffs
("Lead Plaintiffs") and Lead Plaintiffs' counsel. On or about December 13, 2002,
Lead Plaintiffs filed a second consolidated and amended complaint ("Second
Consolidated and Amended Complaint"), which superseded their earlier complaints.
The complaint names us, our chief executive officer, and our chief
financial officer as defendants; purports to state claims against us on behalf
of all persons who purchased our common stock between May 22, 2001 and August
12, 2002; and seeks money damages in unspecified amounts and litigation expenses
including attorneys' and experts' fees. The essence of the allegations in the
Second Consolidated and Amended Complaint is that we intentionally or recklessly
made false or misleading public statements and omissions concerning our
financial condition and prospects with respect to our marketing of Ceftin in
connection with the October 2000 distribution agreement with GlaxoSmithKline,
our marketing of Lotensin in connection with the May 2001 distribution agreement
with Novartis Pharmaceuticals Corp., as well as our marketing of Evista in
connection with the October 2001 distribution agreement with Eli Lilly & Co.
In February 2003, we filed a motion to dismiss the Second Consolidated and
Amended Complaint under the Private Securities Litigation Reform Act of 1995 and
Rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure. We believe that
the allegations in this purported securities class action are without merit and
intend to defend the action vigorously.
Bayer-Baycol Litigation
We have been named as a defendant in numerous lawsuits, including two class
action matters, alleging claims arising from the use of the prescription
compound Baycol that was manufactured by Bayer Pharmaceuticals (Bayer) and
co-marketed by us on Bayer's behalf under a contract sales force agreement. We
may be named in additional similar lawsuits. In August 2001, Bayer announced
that it was voluntarily withdrawing Baycol from the U.S. market. To date, we
have defended these actions vigorously and have asserted a contractual right of
indemnification against Bayer for all costs and expenses we incur relating to
these proceedings. In February 2003, we entered into a joint defense and
indemnification agreement with Bayer, pursuant to which Bayer has agreed to
assume substantially all of our defense costs in pending and prospective
proceedings, subject to certain limited exceptions. Further, Bayer agreed to
reimburse us for all reasonable costs and expenses incurred to date in defending
these proceedings. Bayer previously agreed to reimburse a minimum of $750,000 of
legal fees which were accrued at December 31, 2002 and received in the first
quarter of 2003. We are currently in discussions with Bayer regarding additional
legal fee reimbursements, however, no agreement has been reached and therefore
no additional amounts have been accrued to-date.
Auxilium Pharmaceuticals Litigation
On January 6, 2003, we were named as a defendant in a lawsuit filed by
Auxilium Pharmaceuticals, Inc. (Auxilium), in the Pennsylvania Court of Common
Pleas, Montgomery County. Auxilium was seeking monetary damages and injunctive
relief, including preliminary injunctive relief, based on several
31
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 Auxillium (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 and other additional expenses that are within the
parameters of a $2.1 million litigation reserve established by us. 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 Auxillium
an additional amount per prescription to be determined based upon a specified
formula (which amount may exceed the projected unit selling price), for any
Fortigel prescriptions filled prior to January 26, 2004. Based upon the pending
FDA approval for Fortigel, we do not believe that the terms of the Settlement
Agreement will have any material impact on the timing or success of our
commercialization of the product since the terms of the settlement will not
affect our approach to our previously developed pre-launch plans and programs,
our marketing, trade stocking or clinical strategies, nor does the settlement
include any restrictions on our deployment of sales representatives to promote
Fortigel.
PDI v. C.E. Unterberg, Towbin Partners
On February 28, 2003, we commenced an action against C.E. Unterberg, Towbin
("Unterberg") in the Supreme Court of the State of New York in New York County.
The complaint alleges claims for defamation arising from an analyst report
issued on February 12, 2003. On April 21, 2003, Unterberg filed a motion to
dismiss this action.
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 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 results of operations for the period in which the
ruling or settlement occurs.
No amounts have been accrued for losses under any of the above mentioned
matters, other than the Auxilium litigation settlement reserve, as no other
amounts are considered probable or reasonably estimable at this time.
Item 2 - Not Applicable
Item 3 - Not Applicable
Item 4 - Not Applicable
Item 5 - Not Applicable
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
No.
---
32
99.1 Certification of Chief Executive Officer
99.2 Certification of Chief Financial Officer
(b) Reports on Form 8-K
During the three months ended March 31, 2003, the Company filed the
following reports on Form 8-K:
Date Item Description
- ----------------- ---- ---------------------------------
February 13, 2003 5 Auxilium Lawsuit
February 13, 2003 5 Earnings Press Release
March 25, 2003 5 Comments on Cellegy Press Release
33
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant has
caused this report to be signed on its behalf by the undersigned, thereto duly
authorized.
May 15, 2003 PDI, INC.
By: /s/ Charles T. Saldarini
------------------------------
Charles T. Saldarini
Chief Executive Officer
By: /s/ Bernard C. Boyle
------------------------------
Bernard C. Boyle
Chief Financial and Accounting
Officer
34
PDI, INC.
CERTIFICATIONS PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
CERTIFICATION
I, Charles T. Saldarini, certify that:
1. I have reviewed this quarterly report on Form 10-Q of PDI, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
/s/ Charles T. Saldarini
-----------------------------------------
Charles T. Saldarini
Vice Chairman and Chief Executive Officer
Date: May 15, 2003
35
PDI, INC.
CERTIFICATIONS PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
CERTIFICATION
I, Bernard C. Boyle, certify that:
1. I have reviewed this quarterly report on Form 10-Q of PDI, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
/s/ Bernard C. Boyle
---------------------------------
Bernard C. Boyle
Chief Financial Officer
Date: May 15, 2003
36