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 June 30, 2003
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES ACT OF
1934
For the transition period from _________ to _________
Commission File Number 0-24249
PDI, INC.
(Exact name of Registrant as specified in its charter)
Delaware 22-2919486
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10 Mountainview Road
Upper Saddle River, New Jersey 07458
(Address of principal executive offices)
(201) 258-8450
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes |X| No |_|
As of August 1, 2003 the Registrant had a total of 14,342,258 shares of Common
Stock, $.01 par value, outstanding.
INDEX
PDI, INC.
PART I. FINANCIAL INFORMATION
Page
----
Item 1. Consolidated Financial Statements (unaudited)
Balance Sheets
June 30, 2003 and December 31, 2002...................................3
Statements of Operations -- Three and Six Months
Ended June 30, 2003 and 2002..........................................4
Statements of Cash Flows -- Six
Months Ended June 30, 2003 and 2002...................................5
Notes to Interim Financial Statements.................................6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................................20
Item 3 Quantitative and Qualitative Disclosures
About Market Risk........................................Not Applicable
Item 4. Controls and Procedures..............................................35
PART II. OTHER INFORMATION
Item 1. Legal Proceedings....................................................36
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..................37
Item 5. Other Information........................................Not Applicable
Item 6. Exhibits and Reports on Form 8-K.....................................38
SIGNATURES ...................................................................39
2
PDI, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)
June 30, December 31,
2003 2002
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents ............................................ $ 66,487 $ 66,827
Short-term investments ............................................... 1,767 5,834
Inventory ............................................................ 1,063 646
Accounts receivable, net of allowance for doubtful accounts of
$982 and $1,063 as of June 30, 2003 and December 31, 2002,
respectively ....................................................... 33,494 40,729
Unbilled costs and accrued profits on contracts in progress .......... 11,297 3,360
Deferred training .................................................... 2,470 1,106
Prepaid income tax ................................................... 14,843 18,856
Other current assets ................................................. 8,746 4,804
Deferred tax asset ................................................... 7,420 7,420
--------- ---------
Total current assets .................................................... 147,587 149,582
Net property and equipment .............................................. 16,369 18,295
Deferred tax asset ...................................................... 7,820 7,820
Goodwill ................................................................ 11,132 11,132
Other intangible assets ................................................. 1,954 2,261
Other long-term assets .................................................. 1,715 1,849
--------- ---------
Total assets ............................................................ $ 186,577 $ 190,939
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ..................................................... $ 5,484 $ 5,374
Accrued returns, rebates and sales discounts ......................... 16,093 16,500
Accrued incentives ................................................... 12,400 11,758
Accrued salaries and wages ........................................... 7,667 6,617
Unearned contract revenue ............................................ 5,197 9,473
Restructuring accruals ............................................... 800 4,699
Other accrued expenses ............................................... 10,882 13,307
--------- ---------
Total current liabilities ............................................... 58,523 67,728
--------- ---------
Total liabilities ....................................................... $ 58,523 $ 67,728
--------- ---------
Stockholders' equity:
Common stock, $.01 par value, 100,000,000 shares authorized:
shares issued and outstanding, June 30, 2003 - 14,248,048,
December 31, 2002 - 14,165,880; restricted shares
issued and outstanding at June 30, 2003 - 144,303,
December 31, 2002 - 44,325 ......................................... $ 144 $ 142
Preferred stock, $.01 par value, 5,000,000 shares authorized, no
shares issued and outstanding ...................................... -- --
Additional paid-in capital (includes restricted of $2,253 and $1,547
at June 30, 2003 and December 31, 2002 respectively) ............... 108,072 106,673
Retained earnings ....................................................... 20,837 17,247
Accumulated other comprehensive income (loss) ........................... 22 (100)
Unamortized compensation costs .......................................... (911) (641)
Treasury stock, at cost: 5,000 shares ................................... (110) (110)
--------- ---------
Total stockholders' equity .............................................. 128,054 123,211
--------- ---------
Total liabilities & stockholders' equity ................................ $ 186,577 $ 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 June 30, Six Months Ended June 30,
--------------------------- -------------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Revenue
Service, net ................................................. $ 71,177 $ 66,033 $ 138,688 $ 134,192
Product, net ................................................. 82 500 116 6,224
--------- --------- --------- ---------
Total revenue, net ........................................ 71,259 66,533 138,804 140,416
--------- --------- --------- ---------
Cost of goods and services
Program expenses (including related party amounts of
$328 and $8 for the quarters ended June 30, 2003 and
2002, respectively and $401 and $105 for the six months
ended June 30, 2003 and 2002, respectively) ................ 50,307 65,721 100,188 132,998
Cost of goods sold ........................................... 83 -- 145 --
--------- --------- --------- ---------
Total cost of goods and services .......................... 50,390 65,721 100,333 132,998
--------- --------- --------- ---------
Gross profit .................................................... 20,869 812 38,471 7,418
Compensation expense ............................................ 9,123 9,294 17,997 17,053
Other selling, general and administrative expenses .............. 7,206 6,450 13,039 9,775
Restructuring and other related expenses ....................... -- -- (270) --
Litigation settlement ........................................... -- -- 2,100 --
--------- --------- --------- ---------
Total operating expenses ..................................... 16,329 15,744 32,866 26,828
--------- --------- --------- ---------
Operating income (loss) ......................................... 4,540 (14,932) 5,605 (19,410)
Other income, net ............................................... 226 356 495 1,245
--------- --------- --------- ---------
Income (loss) before provision for taxes ........................ 4,766 (14,576) 6,100 (18,165)
Provision (benefit) for income taxes ............................ 1,954 (5,385) 2,510 (6,707)
--------- --------- --------- ---------
Net income (loss) ............................................... $ 2,812 $ (9,191) $ 3,590 $ (11,458)
========= ========= ========= =========
Basic net income (loss) per share ............................... $ 0.20 $ (0.66) $ 0.25 $ (0.82)
========= ========= ========= =========
Diluted net income (loss) per share ............................. $ 0.20 $ (0.66) $ 0.25 $ (0.82)
========= ========= ========= =========
Basic weighted average number of shares outstanding ............. 14,188 14,003 14,177 13,986
========= ========= ========= =========
Diluted weighted average number of shares outstanding ........... 14,266 14,003 14,252 13,986
========= ========= ========= =========
The accompanying notes are an integral part of these financial statements
4
PDI, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Six Months Ended June 30,
2003 2002
--------- ---------
Cash Flows From Operating Activities
Net income (loss) .................................................................. $ 3,590 $ (11,458)
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation and amortization .............................................. 2,660 3,046
Reserve for inventory obsolescence and bad debt ............................ 229 (2,262)
Loss on other investment ................................................... -- 379
Amortized compensation costs ............................................... 251 218
Other changes in assets and liabilities:
Decrease in accounts receivable ............................................ 7,005 28,233
(Increase) decrease in inventory ........................................... (418) 442
Increase in unbilled costs and accrued profits on contracts in progress .... (7,937) (3,670)
(Increase) decrease in deferred training ................................... (1,364) 470
Decrease (increase) in prepaid income tax .................................. 4,013 (2)
(Increase) decrease in other current assets ................................ (3,942) 3,370
Decrease (increase) in other long-term assets .............................. 134 (143)
Increase (decrease) in accounts payable .................................... 110 (4,374)
Decrease in accrued returns, rebates and sales discounts ................... (407) (47,947)
Decrease in accrued contract losses ........................................ -- (12,256)
Increase (decrease) in accrued liabilities ................................. 2,399 (8,978)
Decrease in restructuring liability ........................................ (3,898) --
Decrease in unearned contract revenue ...................................... (4,276) (5,219)
Decrease in other current liabilities ...................................... (2,945) (15,935)
--------- ---------
Net cash used in operating activities .............................................. (4,796) (76,086)
--------- ---------
Cash Flows From Investing Activities
Sale of short-term investments ................................................ 4,189 --
Purchase of short-term investments ............................................ -- (12,303)
Investment in iPhysicianNet ................................................... -- (379)
Purchase of property and equipment ............................................ (427) (3,847)
--------- ---------
Net cash provided by (used in) investing activities ................................ 3,762 (16,529)
--------- ---------
Cash Flows From Financing Activities
Net proceeds from employee stock purchase plan
and the exercise of stock options ............................................. 694 1,497
--------- ---------
Net cash provided by financing activities .......................................... 694 1,497
--------- ---------
Net decrease in cash and cash equivalents .......................................... (340) (91,118)
Cash and cash equivalents - beginning .............................................. 66,827 160,043
--------- ---------
Cash and cash equivalents - ending ................................................. $ 66,487 $ 68,925
========= =========
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 and six-month periods ended June 30, 2003 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2003. Certain prior period amounts have been reclassified to conform with the
current presentation with no effect on financial position, net income or cash
flows.
2. Revenue Recognition
The paragraphs that follow describe the guidelines that the Company
adheres to in accordance with GAAP when recognizing revenue and cost of goods
and services in its financial statements. GAAP requires that service revenue and
product revenue and their respective direct costs be shown separately on the
income statement.
Historically, the Company has derived a significant portion of its service
revenue from a limited number of clients. Concentration of business in the
pharmaceutical services industry is common and the industry continues to
consolidate. As a result, the Company is likely to continue to experience
significant client concentration in future periods. For the three and six month
periods ended June 30, 2003, two clients who each individually represented 10%
or more of the Company's service revenue, accounted for approximately 70.3% and
69.7%, respectively, of the Company's service revenue. For the three and six
month periods ended June 30, 2002, the Company's two largest clients who each
accounted for more than 10% of it service revenue totaled 61.8% and 73.7%,
respectively, of the Company's service revenue.
Service revenue and program expenses
Service revenue is earned primarily by performing product detailing
programs and other marketing and promotional services under contracts. Revenue
is recognized as the services are performed and the right to receive payment for
the services is assured. Revenue is recognized net of any potential penalties
until the performance criteria relating to the penalties have been achieved.
Bonus and other performance incentives, as well as termination payments, are
recognized as revenue in the period earned and when payment of the bonus,
incentive or other payment is assured. Under performance based contracts,
revenue is recognized when the performance based parameters are achieved.
Program expenses consist primarily of the costs associated with executing
product detailing programs, performance based contracts or other sales and
marketing services identified in the contract. Program expenses include
personnel costs and other costs associated with executing a product detailing or
other marketing or promotional program, as well as the initial direct costs
associated with staffing a product detailing program. Such costs include, but
are not limited to, facility rental fees, honoraria and travel expenses, sample
expenses and other promotional expenses. Personnel costs, which constitute the
largest portion of program expenses, include all labor related costs, such as
salaries, bonuses, fringe benefits and payroll taxes for the sales
representatives and sales managers and professional staff who are directly
responsible for executing a particular program. Initial direct program costs are
those costs associated with initiating a product detailing program, such as
recruiting, hiring and training the sales representatives who staff a particular
product detailing program. All personnel costs and initial direct
6
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
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 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 the Company distributes are recorded as a selling expense and are
included in other selling, general and administrative expenses in the
consolidated statements of operations.
As a result of the revenue recognition and program expense policies
described above, the Company may incur significant initial direct program costs
before recognizing revenue under a particular product detailing program. The
Company's inability to specifically negotiate for payments that are specifically
attributable to recruiting, hiring or training services in its product detailing
contracts could adversely impact the Company's operating results for periods in
which the costs associated with the product detailing services are incurred.
Product revenue and cost of goods sold
Product revenue is recognized when products are shipped and title is
transferred to the customer. Product revenue for the three and six month periods
ended June 30, 2003 resulted primarily from the sale of the Xylos Corporation
(Xylos) wound care product. Product revenue recognized in prior periods related
to the Ceftin contract which terminated in February 2002.
Cost of goods sold includes all expenses for both product distribution
costs, acquisition and manufacturing costs of the product sold. Inventory is
valued at the lower of cost or market value. Cost is determined using the
first-in, first-out costing method. Inventory to-date has consisted of only
finished goods.
3. Stock-Based Compensation
As of June 30, 2003 the Company has two stock-based employee compensation
plans described more fully in Note 21 to the consolidated financial statements
included in the Company's 2002 Annual Report on Form 10-K. Statement of
Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based
Compensation" allows companies a choice of measuring employee stock-based
compensation expense based on either the fair value method of accounting or the
intrinsic value approach under the Accounting Pronouncement Board (APB) Opinion
No. 25, "Accounting for Stock Issued to Employees, and related
Interpretations." The Company accounts for these plans under the recognition
and measurement principles of APB Opinion No. 25. No stock option-based employee
compensation cost is reflected in net income, as all options granted under those
plans had an exercise price equal to the market value of the underlying common
stock on the date of the grant. Certain employees have received restricted
common stock, the amortization of which is reflected in net income. As required
by SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure - an amendment of SFAS No. 123", the following table shows the
estimated effect on earnings and per share data as if the Company had applied
the fair value recognition provisions of SFAS No. 123 to stock-based employee
compensation.
7
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
-------- -------- -------- --------
(in thousands, except per share data)
Net income (loss), as reported $ 2,812 $ (9,191) $ 3,590 $(11,458)
Add: Stock-based employee
compensation expense included in
reported net income (loss), net of
related tax effects 82 69 196 138
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) (3,134) (4,026)
-------- -------- -------- --------
Pro forma net income (loss) $ 1,327 $(11,135) $ 652 $(15,346)
======== ======== ======== ========
Net income (loss) per share
Basic--as reported $ 0.20 $ (0.66) $ 0.25 $ (0.82)
======== ======== ======== ========
Basic--pro forma $ 0.09 $ (0.80) $ 0.05 $ (1.10)
======== ======== ======== ========
Diluted--as reported $ 0.20 $ (0.66) $ 0.25 $ (0.82)
======== ======== ======== ========
Diluted--pro forma $ 0.09 $ (0.80) $ 0.05 $ (1.10)
======== ======== ======== ========
Compensation cost for the determination of Pro forma net income (loss) -
as adjusted and related per share amounts were estimated using the Black Scholes
option pricing model, with the following assumptions: (i) risk free interest
rate of 2.46% and 4.09% at June 30, 2003 and 2002, respectively; (ii) expected
life of five years for the three and six month periods ended June 30, 2003 and
2002; (iii) expected dividends of $0 for the three and six month periods ended
June 30, 2003 and 2002; and (iv) volatility of 100% for the three and six month
periods ended June 30, 2003 and 2002. The weighted average fair value of options
granted during the three and six month periods ended June 30, 2003 was $6.66 and
for the three and six month periods ended June 30, 2002 was $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 $30.00 and above for either
cash or shares of restricted stock, depending upon the number of options held by
an eligible employee. The offer exchange period expired on May 12, 2003.
Approximately 310,403 shares of common stock underlying eligible options were
tendered by eligible employees and accepted by the Company. This number
represents approximately 87% of the total shares of common stock underlying
eligible options. A total of approximately 120 eligible participants elected to
exchange an aggregate of approximately 59,870 shares of common stock under
eligible options and received cash in the aggregate amount of approximately
$67,000 (which amount includes applicable withholding taxes). A total of
approximately 145 eligible participants elected to exchange an aggregate of
approximately 250,533 shares of common stock underlying eligible options in
exchange for an aggregate of approximately 49,850 shares of restricted stock.
All tendered options have been canceled and are eligible for re-issuance under
the Company's option plans. The restricted stock is subject to three-year cliff
vesting and is subject to forfeiture upon termination of employment other than
in the event of the recipient's death or disability.
8
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
4. Current Performance Based Contracts
In May 2001, the Company entered into a copromotion agreement with
Novartis Pharmaceuticals Corporation (Novartis) for the U.S. sales, marketing
and promotion rights for Lotensin(R), Lotensin HCT(R) and Lotrel(R), which
agreement runs through December 31, 2003. In July 2003, the FDA granted Novartis
pediatric exclusivity for Lotensin until February 2004. On May 20, 2002, this
agreement was replaced by two separate agreements, one for Lotensin and one for
Lotrel-Diovan through the addition of Diovan(R) and Diovan HCT(R). Pursuant to
the Lotensin agreement, the Company provides promotion, selling, marketing, and
brand management for Lotensin. In exchange, the Company is entitled to receive a
revenue split for Lotensin based on certain total prescription (TRx) objectives
above specified contractual baselines. Under the Lotrel-Diovan agreement, the
Company copromotes Lotrel, Diovan and Diovan HCT in the U.S. for which it is
entitled to be compensated on a fixed fee basis with potential incentive
payments based upon achieving certain 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 and six months ended June 30, 2003,
there is no assurance that actual revenues will exceed costs in the future; in
which event the activities covered by this program could yield an operating loss
and a contract loss reserve could be required.
In October 2002, the Company entered into an agreement with Xylos
Corporation (Xylos) for the exclusive U.S. commercialization rights to the Xylos
XCell(TM) Cellulose Wound Dressing (XCell) wound care products. Pursuant to this
agreement, the Company has certain minimum purchase requirements. The minimum
purchase requirement for the calendar year 2003 is $750,000. The minimum
purchase requirement for each subsequent calendar year is based on the aggregate
dollar volume of sales of products during the 12-month period ending with
September of the prior year, but in no event less than $750,000. The Company
began selling the Xylos product in January 2003.
On May 29, 2003, the Company entered into an agreement with Organogenesis,
Inc. (Organogenesis) whereby the Company will provide sales, marketing, and
clinical support for Apligraf(R), Organogenesis' living, bi-layered skin
substitute. The Company will leverage its wound care sales force and provide
marketing resources in support of Apligraf. PDI InServe will utilize its current
team of wound care nurses to provide aftersales clinical support for
practitioners. Under the terms of the agreement, the Company will receive a fee
with the potential to earn incentives based on performance. Organogenesis has
termination rights based on established performance criteria subject to 90 days'
notice.
On December 31, 2002, the Company entered into a licensing agreement with
Cellegy Pharmaceuticals, Inc. (Cellegy) for the exclusive North American rights
for Fortigel(TM), a testosterone gel product. The agreement is in effect for the
commercial life of the product. Cellegy submitted a New Drug Application (NDA)
for the hypogonadism indication to the U.S. Food and Drug Administration (FDA)
in June 2002. The initial 10-month Prescription Drug User Fee Act (PDUFA) date
for the product was April 5, 2003. In March 2003, Cellegy was notified by the
FDA that the PDUFA date had been revised to July 3, 2003. On July 3, 2003,
Cellegy was notified by the FDA that Fortigel was not approved. Cellegy is in
discussions with the FDA to determine the appropriate course of action needed to
meet deficiencies cited by the FDA in its determination. The Company cannot
predict with any certainty that the FDA will ultimately approve Fortigel for
sale in the U.S. Under the terms of the agreement, the Company paid Cellegy a
$15.0 million initial licensing fee on December 31, 2002. This nonrefundable
payment was made prior to FDA
9
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
approval and, since there is no alternative future use of the licensed rights,
the $15.0 million payment was expensed by the Company in December 2002, when
incurred. This amount was recorded in other selling, general, and administrative
expenses in the December 31, 2002 consolidated statements of operations.
Pursuant to the terms of the 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, if
incurred, will be recorded as an intangible asset and amortized over its
estimated useful life, as then determined, which is not expected to exceed the
life of the patent. Royalty payments to Cellegy over the term of the commercial
life of the product will range from 20% to 30% of net sales. As discussed in
Note 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 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 June 30, 2003 or December 31, 2002 as the Company had no further
obligations due to the termination of the contract. The Company recognized an
operating loss of $8.9 and $17.7 million under this contract for the three and
six month periods ended June 30, 2002, respectively. There was no activity for
the three month and six month periods ended June 30, 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
10
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
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 June 30, 2004, and certain
administrative functions regarding Medicaid rebates.
The Company has approximately $16.1 million in sales rebates and return
accruals related to Ceftin at June 30, 2003 for estimated settlement of these
obligations which were incurred through the contract termination date. A
significant portion of the accrual relates to a reserve for returns. As
discussed above, the products sold under the Ceftin agreement had expiration
dates estimated to run through June 30, 2004.
There was $6.2 million of product revenue recognized under the Ceftin
contract for the six months ended June 30, 2002, of which $716,000 was from the
sale of inventory. The balance of $5.5 million resulted from the net positive
adjustments recorded in sales returns and allowances, discounts and rebates
accounts for the first six months of 2002 that occurred as the Company continued
to satisfy its liabilities relating to the previous reserves recorded as a
result of Ceftin sales in prior periods. Because those reserves were initially
set up as estimates, using historical data and other information, there may
continue to be both positive and negative adjustments made as the liabilities
are settled in future periods, particularly through the expiration date of the
product sold, and such adjustments will be reflected in product revenue
consistent with the classification of such accruals when they were initially
recorded.
7. Other Investments
In October 2002, the Company acquired $1.0 million of preferred stock of
Xylos. As discussed in Note 4, the Company is the exclusive distributor of the
Xylos XCell product line. The Company recorded its investment in Xylos under the
cost method and its ownership interest in Xylos is less than five percent.
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 six months of 2003 and no losses were recorded in
the period due to the suspension of losses mentioned above because the
investment has been previously reduced to zero. The Company's ownership interest
in iPhysicianNet is less than five percent. The Company was informed by
iPhysicianNet that they were ceasing operations effective August 1, 2003.
8. Inventory
At June 30, 2003 and December 31, 2002, the Company had approximately $1.1
million 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.
11
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
9. New Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46). FIN
46 requires a variable interest entity to be consolidated by a company, if that
company is subject to a majority of the risk of loss from the variable interest
entity's activities or entitled to receive a majority of the entity's residual
returns or both. FIN 46 also requires disclosures about variable interest
entities that a company is not required to consolidate but in which it has a
significant variable interest. The consolidation requirements of FIN 46 apply
immediately to variable interest entities created after January 31, 2003 and to
existing entities in the first fiscal year or interim period beginning after
June 15, 2003. Certain of the disclosure requirements apply to all financial
statements issued after January 31, 2003, regardless of when the variable
interest entity was established. The initial adoption of this accounting
pronouncement did 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 the consensus is effective for
revenue arrangements entered into in the fiscal periods beginning after June 15,
2003. The Company does not believe that the adoption of EITF No. 00-21 will have
a material impact on its consolidated financial statements.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities." SFAS No. 149 amends SFAS No.
133 for decisions made as part of the FASB's Derivatives Implementation Group
process, other FASB projects dealing with financial instruments, and in
connection with implementation issues raised in relation to the application of
the definition of a derivative. This statement is generally effective for
contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. The Company does not believe the
adoption of this standard will have a material impact on its consolidated
financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." SFAS
No. 150 clarifies the definition of a liability as currently defined in FASB
Concepts Statement No. 6, "Elements of Financial Statements," as well as other
planned revisions. This statement requires a financial instrument that embodies
an obligation of an issuer to be classified as a liability. In addition, the
statement establishes standards for the initial and subsequent measurement of
these financial instruments and disclosure requirements. SFAS No. 150 is
effective for financial instruments entered into or modified after May 31, 2003
and for all other matters, at the beginning of the second quarter 2004. The
Company does not believe the adoption of this standard will have a material
impact 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 three-month and six-month periods ended
June 30, 2003 and 2002 is as follows:
12
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------ -----------------
2003 2002 2003 2002
------ ------ ------ ------
(in thousands)
Basic weighted average number
of common shares outstanding 14,188 14,003 14,177 13,986
Dilutive effect of stock options 78 -- 75 --
------ ------ ------ ------
Diluted weighted average number
of common shares outstanding 14,266 14,003 14,252 13.986
====== ====== ====== ======
Outstanding options at June 30, 2003 to purchase 1,068,330 shares of
common stock with exercise prices ranging from $14.16 to $93.75 were not
included in the computation of historical and pro forma diluted net income per
share because to do so would have been antidilutive. Outstanding options at June
30, 2002 to purchase 1,635,562 shares of common stock with exercise prices
ranging from $14.95 to $98.70 were not included in the computation of historical
and pro forma net loss per share because to do so would have been antidilutive
as a result of the Company's net loss.
11. Short-Term Investments
At June 30, 2003, short-term investments were $1.8 million, including
approximately $1.1 million of investments classified as available for sale
securities. At December 31, 2002, short-term investments were $5.8 million,
including approximately $1.1 million of investments classified as available for
sale securities. The unrealized after-tax gain/(loss) on the available for sale
securities is included as a separate component of stockholders' equity as
accumulated other comprehensive income/(loss). All other short-term investments
are stated at cost, which approximates fair value.
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.
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- --------------------
2003 2002 2003 2002
-------- -------- -------- --------
(Thousands)
Net income (loss) $ 2,812 $ (9,191) $ 3,590 $(11,458)
Other comprehensive income, net of tax:
Unrealized holding gain (loss) on
available-for-sale securities
arising during the period 58 (61) 89 (50)
Reclassification adjustment for losses
included in net income (loss) 33 21 33 41
-------- -------- -------- --------
Other comprehensive income (loss) $ 2,903 $ (9,231) $ 3,712 $(11,467)
======== ======== ======== ========
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
13
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
future because of the nature of the Company's business activities and recent
increases in litigation related to healthcare products including pharmaceuticals
increases this risk. The Company seeks to reduce its potential liability under
its service agreements through measures such as contractual indemnification
provisions with clients (the scope of which may vary from client to client, and
the performances of which are not secured) and insurance, though investors
should be aware the Company does not secure additional product liability
insurance for those products it details pursuant to its product detailing
service agreements. 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 monetary damages in
unspecified amounts and litigation expenses including attorneys' and experts'
fees. The essence of the allegations in the Second Consolidated and Amended
Complaint is that the Company intentionally or recklessly made false or
misleading public statements and omissions concerning its financial condition
and prospects with respect to its marketing of Ceftin in connection with the
October 2000 distribution agreement with GSK, its marketing of Lotensin in
connection with the May 2001 distribution agreement with Novartis, as well as
its marketing of Evista in connection with the October 2001 distribution
agreement with Eli Lilly & Co.
In February 2003, the Company filed a motion to dismiss the Second
Consolidated and Amended Complaint under the Private Securities Litigation
Reform Act of 1995 and Rules 9(b) and 12(b)(6) of the Federal Rules of Civil
Procedure. The Company believes that the allegations in this purported
securities class action are without merit and intends to defend the action
vigorously.
Bayer-Baycol Litigation
The Company has been named as a defendant in numerous lawsuits, including
two class action matters, alleging claims arising from the use of the
prescription compound Baycol that was manufactured by Bayer Pharmaceuticals
(Bayer) and detailed by the Company on Bayer's behalf under a contract sales
force agreement. The Company may be named in additional similar lawsuits. In
August 2001, Bayer announced that it was voluntarily withdrawing Baycol from the
U.S. market. To date, the Company has defended these actions vigorously and has
asserted a contractual right of indemnification against Bayer for all costs and
expenses the Company incurs relating to these proceedings. In February 2003, the
Company entered into a joint defense and indemnification agreement with Bayer,
pursuant to which Bayer has agreed to assume substantially all of the Company's
defense costs in pending and prospective proceedings, subject to certain limited
exceptions. Further, Bayer agreed to reimburse the Company for all reasonable
costs and expenses incurred to date in defending these proceedings. Bayer
previously agreed to reimburse
14
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
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 Auxilium (Settlement Agreement), by which the lawsuit and all
related counter claims were dropped without any admission of wrongdoing by
either party. The settlement terms included a cash payment which was paid upon
execution of the Settlement Agreement as well as certain other additional
expenses. The Company recorded a $2.1 million charge in the first quarter of
2003 related to this settlement. Pursuant to the Settlement Agreement, the
Company also agreed that it would (a) not sell, ship, distribute or transfer any
Fortigel product to any wholesalers, chain drug stores, pharmacies or hospitals
prior to November 1, 2003, and (b) pay Auxilium an additional amount per
prescription to be determined based upon a specified formula, in the event any
prescriptions are filled for Fortigel prior to January 26, 2004. As discussed in
Note 4, on July 3, 2003 Cellegy was notified by the FDA that Fortigel had not
been approved. The Company does not believe that the terms of the Settlement
Agreement will have any material impact on the success of its commercialization
of the product if and when the FDA approves it. There can be no assurances that
the FDA will approve the product at a later date.
Other Legal Proceedings
The Company is currently a party to other legal proceedings incidental to
its business.
While the Company currently believes that the ultimate outcome of these
proceedings individually and in the aggregate, will not have a material adverse
effect on its consolidated financial statements, litigation is subject to
inherent uncertainties. Were the Company to settle a proceeding for a material
amount or were an unfavorable ruling to occur in any pending proceeding, there
exists the possibility of a material adverse impact on the Company's results of
operations, cash flows or liquidity.
No amounts have been accrued for losses under any of the above mentioned
matters, other than for the Auxilium litigation settlement reserve, as no other
amounts are considered probable or reasonably estimable at this time.
Other than the foregoing, the Company is not currently a defendant in any
material pending litigation and it is not aware of any material threatened
litigation.
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
15
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
was larger than required. The Company estimated that the restructuring will
result in annualized selling, general and administrative (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 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 $5.4 million in restructuring expenses
were $3.7 million in severance expense consisting of cash and non-cash
termination payments to employees in connection with their involuntary
termination and $1.7 million in other restructuring exit costs relating to
leased facilities and other contractual obligations.
During the quarter ended March 31, 2003, the Company recognized a $270,000
reduction in the restructuring accrual due to negotiating higher sublease
proceeds than originally estimated for the leased facility in Cincinnati, Ohio.
During the quarter ended June 30, 2003 the Company incurred approximately
$133,000 of additional restructuring expense due to higher than expected
contractual termination costs. This additional expense was recorded in program
expenses consistent with the original recording of the restructuring charges.
Also during the quarter ended June 30, 2003 the Company recognized a
$473,000 reduction in the restructuring accrual due to lower than expected sales
force severance costs. Greater success in the reassignment of sales
representatives to other programs and the voluntary departure of other sales
representatives combined to reduce the requirement for severance costs. This
adjustment was recorded in program expenses consistent with the original
recording of the restructuring charges.
The accrual for restructuring and exit costs totaled approximately
$800,000 at June 30, 2003, and is recorded in current liabilities on the
accompanying balance sheet.
A roll forward of the activity for the 2002 Restructuring Plan (in
thousands) is as follows:
Balance at Balance at
December 31, 2002 Adjustments Payments June 30, 2003
Administrative severance $ 1,670 $ -- $(1,172) $ 498
Exit costs 1,288 (137) (849) 302
------- ------- ------- -------
2,958 (137) (2,021) 800
------- ------- ------- -------
Sales force severance 1,741 (473) (1,268) --
------- ------- ------- -------
Total $ 4,699 $ (610) $(3,289) $ 800
======= ======= ======= =======
15. Segment Information
The Company operates under three reporting segments: the sales and
marketing services group (SMSG), pharmaceutical products group (PPG) and medical
devices and diagnostics (MD&D), all of which have changed since the Company's
June 30, 2002 financial presentation. Since the termination of the Ceftin
contract and the elimination of Ceftin product sales effective February 28,
2002, the shift in management's focus on the business has been to view the
traditional fee for service type arrangements within the pharmaceutical industry
(offered by the SMSG segment) in the aggregate and to view the performance based
contracts for pharmaceutical products - those for which the Company is
compensated based predominantly on the performance of the products that it is
responsible for marketing and/or selling
16
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
(the PPG segment) - also in the aggregate. Further, all contracts within the
MD&D industry, regardless of the nature of the contract, are reported in the
MD&D segment. The SMSG segment includes the Company's contract sales (CSO)
units; and the Company's marketing services business unit, which includes
marketing research and medical education and communication services. The PPG
segment includes revenues earned through the Company's licensing and copromotion
of pharmaceutical products. The Company's MD&D segment includes PDI InServe,
contract sales, and product licensing. The segment information from prior
periods has been reclassified to conform to the current period's presentation.
Corporate charges are allocated to each of the operating segments on the
basis of total salary costs. Corporate charges include corporate headquarter
costs and certain depreciation expense. Capital expenditures have not been
allocated to the operating segments since it is impracticable to do so.
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
2003 2002 2003 2002
--------- --------- --------- ---------
(thousands)
Revenue
Sales and marketing services group $ 56,412 $ 48,704 $ 110,938 $ 102,954
Pharmaceutical products group 12,196 15,897 22,231 33,447
Medical devices and diagnostics 2,651 2,178 5,635 4,385
--------- --------- --------- ---------
Total $ 71,259 $ 66,779 $ 138,804 $ 140,786
========= ========= ========= =========
Revenue, intercompany
Sales and marketing services group $ -- $ 246 $ -- $ 370
Pharmaceutical products group -- -- -- --
Medical devices and diagnostics -- -- -- --
--------- --------- --------- ---------
Total $ -- $ 246 $ -- $ 370
========= ========= ========= =========
Revenue, less intercompany
Sales and marketing services group $ 56,412 $ 48,458 $ 110,938 $ 102,584
Pharmaceutical products group 12,196 15,897 22,231 33,447
Medical devices and diagnostics 2,651 2,178 5,635 4,385
--------- --------- --------- ---------
Total $ 71,259 $ 66,533 $ 138,804 $ 140,416
========= ========= ========= =========
Income (loss) from operations
Sales and marketing services group $ 10,966 $ 8,012 $ 21,377 $ 14,832
Pharmaceutical products group (489) (18,804) (3,890) (25,741)
Medical devices and diagnostics (1,932) (380) (3,836) (694)
Corporate charges (4,005) (3,760) (8,046) (7,807)
--------- --------- --------- ---------
Total $ 4,540 $ (14,932) $ 5,605 $ (19,410)
========= ========= ========= =========
Income (loss) from operations, intercompany
Sales and marketing services group $ -- $ 246 $ -- $ 302
Pharmaceutical products group -- (246) -- (302)
Medical devices and diagnostics -- -- -- --
Corporate charges -- -- -- --
--------- --------- --------- ---------
Total $ -- $ -- $ -- $ --
========= ========= ========= =========
17
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
Three Months Ended Six Months Ended
------------------- ------------------
June 30, June 30,
(continued) 2003 2002 2003 2002
-------- -------- -------- --------
(thousands)
Income (loss) from operations, less intercompany,
before corporate allocations
Sales and marketing services group $ 10,966 $ 7,766 $ 21,377 $ 14,530
Pharmaceutical products group (489) (18,558) (3,890) (25,439)
Medical devices and diagnostics (1,932) (380) (3,836) (694)
Corporate charges (4,005) (3,760) (8,046) (7,807)
-------- -------- -------- --------
Total $ 4,540 $(14,932) $ 5,605 $(19,410)
======== ======== ======== ========
Corporate allocations
Sales and marketing services group $ (3,124) $ (2,159) $ (6,165) $ (4,605)
Pharmaceutical products group (565) (1,434) (1,214) (2,872)
Medical devices and diagnostics (316) (167) (667) (330)
Corporate charges 4,005 3,760 8,046 7,807
-------- -------- -------- --------
Total $ -- $ -- $ -- $ --
======== ======== ======== ========
Income (loss) from operations, less corporate
allocations
Sales and marketing services group $ 7,842 $ 5,607 $ 15,212 $ 9,925
Pharmaceutical products group (1,054) (19,992) (5,104) (28,311)
Medical devices and diagnostics (2,248) (547) (4,503) (1,024)
Corporate charges -- -- -- --
-------- -------- -------- --------
Total $ 4,540 $(14,932) $ 5,605 $(19,410)
======== ======== ======== ========
Reconciliation of EBIT to income
before provision for income taxes
Total EBIT for operating groups $ 4,540 $(14,932) $ 5,605 $(19,410)
Other income, net 226 356 495 1,245
-------- -------- -------- --------
Income before provision
for income taxes $ 4,766 $(14,576) $ 6,100 $(18,165)
======== ======== ======== ========
Capital expenditures
Sales and marketing services group $ 209 $ 1,266 $ 417 $ 3,366
Pharmaceutical products group -- 217 -- 429
Medical devices and diagnostics 3 28 10 52
-------- -------- -------- --------
Total $ 212 $ 1,511 $ 427 $ 3,847
======== ======== ======== ========
Depreciation expense
Sales and marketing services group $ 893 $ 719 $ 1,774 $ 1,668
Pharmaceutical products group 122 663 377 923
Medical devices and diagnostics 94 99 202 148
-------- -------- -------- --------
Total $ 1,109 $ 1,491 $ 2,353 $ 2,739
======== ======== ======== ========
18
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
approximately $11.1 million as of June 30, 2003 and December 31, 2002.
There were no changes in the carrying amount of goodwill since December
31, 2002. The carrying amounts at June 30, 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 June 30, 2003 $ 3,344 $ -- $ 7,788 $11,132
======= ======= ======= =======
All identifiable intangible assets recorded as of June 30, 2003 are being
amortized on a straight-line basis over the life of the intangibles which is
primarily five years. The carrying amounts at June 30, 2003 and December 31,
2002 are as follows:
As of June 30, 2003 As of December 31, 2002
----------------------------- -----------------------------
Carrying Accumulated Carrying Accumulated
Amount Amortization Net Amount Amortization Net
----------------------------- -----------------------------
Covenant not to compete $1,686 $ 611 $1,075 $1,686 $ 442 $1,244
Customer relationships 1,208 438 770 1,208 318 890
Corporate tradename 172 63 109 172 45 127
------ ------ ------ ------ ------
Total $3,066 $1,112 $1,954 $3,066 $ 805 $2,261
====== ====== ====== ====== ====== ======
Amortization expense totaled approximately $153,000 and $307,000 for the
three-month and six-month periods ended June 30, 2003 and 2002, respectively.
Estimated amortization expense for the next five years is as follows:
2003 $ 613
=====
2004 613
=====
2005 613
=====
2006 422
=====
2007 --
=====
19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
Various statements made in this Quarterly Report on Form 10-Q are
"forward-looking statements" (within the meaning of the Private Securities
Litigation Reform Act of 1995) regarding the plans and objectives of management
for future operations. These statements involve known and unknown risks,
uncertainties and other factors that may cause our actual results, performance
or achievements to be materially different from any future results, performance
or achievements expressed or implied by these forward-looking statements. The
forward-looking statements included in this report are based on current
expectations that involve numerous risks and uncertainties. Our plans and
objectives are based, in part, on assumptions involving judgements about, among
other things, future economic, competitive and market conditions and future
business decisions, all of which are difficult or impossible to predict
accurately and many of which are beyond our control. Although we believe that
our assumptions underlying the forward-looking statements are reasonable, any of
these assumptions could prove inaccurate and, therefore, we cannot assure you
that the forward-looking statements included in this report will prove to be
accurate. In light of the significant uncertainties inherent in the
forward-looking statements included in this report, the inclusion of these
statements should not be interpreted by anyone that our objectives and plans
will be achieved. Factors that could cause actual results to differ materially
and adversely from those expressed or implied by forward-looking statements
include, but are not limited to, the factors, risks and uncertainties (i)
identified or discussed herein, (ii) set forth in "Risk Factors" under Part I,
item 1, of the Company's Annual Report on Form 10-K for the year ended December
31, 2002 as filed with the Securities and Exchange Commission, and (iii) set
forth in the Company's periodic reports on Forms 10-Q and 8-K as filed with the
Securities and Exchange Commission since January 1, 2003. We undertake no
obligation to revise or update publicly any forward-looking statements for any
reason.
Overview
We are a healthcare sales and marketing company serving the
biopharmaceutical and medical devices and diagnostics (MD&D) industries. We
create and execute sales and marketing campaigns intended to improve the
profitability of pharmaceutical or MD&D products. We do this by partnering with
companies who own the intellectual property rights to these products and who
recognize our ability to commercialize these products and maximize their sales
performance. We have a variety of agreement types that we enter into with our
partner companies, from fee for service arrangements to equity investments in a
product or in a company. We have previously made, and still intend to make,
acquisitions where appropriate in order to advance our strategy. Should an
acquisition(s) be made, we will report it in its relevant segment. Currently,
our three reporting segments include:
o PDI sales and marketing services group (SMSG), comprised of:
o dedicated contract sales services (CSO);
o shared contract sales services (CSO);
o marketing research and consulting services (MR&C); and
o medical education and communication services (EdComm).
o PDI pharmaceutical products group (PPG), comprised of:
o copromotion; and
o licensing.
o PDI medical devices and diagnostics group (MD&D), comprised of:
o contract sales services (CSO);
20
o InServe;
o copromotion; and
o licensing.
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. Any
failure to meet these benchmarks may result in the imposition of contractual
penalties and could adversely affect our future results of operations, cash
flows or liquidity. Also, our contracts might have a lower base fee enhanced by
potential incentives we can earn based on our performance. In these situations,
we have the opportunity to earn additional fees, as incentives, based on
attaining performance benchmarks.
Our product detailing contracts generally are for terms of one to three
years and may be renewed or extended. However, the majority of these contracts
are terminable by the client for any reason on 30 to 90 days' notice. These
contracts typically, but not always, provide for termination payments in the
event they are terminated by the client without cause. While the cancellation of
a contract by a client without cause may result in the imposition of penalties
on the client, these penalties may not act as an adequate deterrent to the
termination of any contract. In addition, we cannot assure you that these
penalties will offset the revenue we could have earned under the contract or the
costs we may incur as a result of its termination. Contracts may also be
terminated for cause if we fail to meet stated performance benchmarks. The loss
or termination of a large contract or the loss of multiple contracts could
adversely affect our future results of operations, cash flows or liquidity.
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 start-up expenses and a
greater risk of operating losses. These contracts normally require significant
participation from our PPG, MR&C and EdComm professionals whose skills include
marketing, brand management, trade relations and marketing research.
Beginning in the fourth quarter of 2000, we entered into a number of
significant performance based contracts. Our agreement with GlaxoSmithKline
(GSK), which we entered into in October 2000 regarding Ceftin(R), was a
marketing and distribution contract under which we had the exclusive right to
market and distribute designated Ceftin products in the U.S. The agreement had a
five-year term but was cancelable by either party without cause on 120 days'
notice. The agreement was terminated by mutual consent, effective February 28,
2002. Contracts such as the Ceftin agreement, which require us to purchase and
21
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), Lotensin HCT(R) and Lotrel(R), which agreement
runs through December 31, 2003. In July 2003, the FDA granted Novartis pediatric
exclusivity for Lotensin until February 2004. On May 20, 2002, this agreement
was replaced by two separate agreements, one for Lotensin and one for
Lotrel-Diovan through the addition of Diovan(R) and Diovan HCT(R). Pursuant to
this agreement, we provide promotion, selling, marketing, and brand management
for Lotensin. In exchange, we are entitled to receive a revenue split for
Lotensin based on certain total prescription (TRx) objectives above specified
contractual baselines. Also under this agreement, we copromote Lotrel, Diovan
and Diovan HCT in the U.S. for which we are entitled to be compensated on a
fixed fee basis with potential incentive payments based upon achieving certain
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 and
six months ended June 30, 2003, there is no assurance that actual revenues will
exceed costs in the future; in which event the activities covered by this
program could yield an operating loss and a contract loss reserve could be
required.
In 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 or June
30, 2003 as we had no further obligations due to the termination of the
contract. Operating losses of $8.9 million and $17.7 million were recognized in
the
22
quarter and six months ended June 30, 2002, respectively. There was no activity
in the quarter and six months ended June 30, 2003 since the termination was
effective December 31, 2002.
On December 31, 2002, we entered into a licensing agreement with Cellegy
Pharmaceuticals, Inc. (Cellegy) for the exclusive North American rights for
Fortigel(TM), a testosterone gel product. The agreement is in effect for the
commercial life of the product. Cellegy submitted a New Drug Application (NDA)
for the hypogonadism indication to the U.S. Food and Drug Administration (FDA)
in June 2002. The initial 10-month Prescription Drug User Fee Act (PDUFA) date
for the product was April 5, 2003. In March 2003, Cellegy was notified by the
FDA that the PDUFA date had been revised to July 3, 2003. On July 3, 2003,
Cellegy was notified by the FDA that Fortigel was not approved. Cellegy is in
discussions with the FDA to determine the appropriate course of action needed to
meet deficiencies cited by the FDA in its determination. We cannot predict with
any certainty that the FDA will ultimately approve Fortigel for sale in the U.S.
Under the terms of the agreement, we paid Cellegy a $15.0 million initial
licensing fee on December 31, 2002. This nonrefundable payment was made prior to
FDA approval and, since there is no alternative future use of the licensed
rights, the $15.0 million payment was expensed by us in December 2002, when
incurred. This amount was recorded in other selling, general, and administrative
expenses in the December 31, 2002 consolidated statement of operations. Pursuant
to the terms of the license agreement, we will be required to pay Cellegy a
$10.0 million incremental license fee milestone payment upon Fortigel's receipt
of all approvals required by the FDA to promote, sell and distribute the product
in the U.S. This incremental milestone license fee, if incurred, will be
recorded as an intangible asset and amortized over its estimated useful life, as
then determined, which is not expected to exceed the life of the patent. Royalty
payments to Cellegy over the term of the commercial life of the product will
range from 20% to 30% of net sales. As discussed in Note 13, 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
nationwide supplier of supplemental field-staffing programs for the MD&D
industry. InServe employs nurses, medical technologists and other clinicians who
visit hospital and non-hospital accounts and provide hands-on clinical education
and after-sales support to maximize product utilization and customer
satisfaction. InServe's clients include many of the leading MD&D manufacturers,
including Becton Dickinson, Boston Scientific and Johnson & Johnson.
In addition to helping establish our initial presence in the MD&D market,
the InServe acquisition facilitated our entry into, and helped us establish, a
contract sales business within the MD&D market. Our MD&D service contracts have
similar provisions to those sales and marketing services contracts described in
our SMSG segment.
In October 2002, we entered into an agreement with Xylos Corporation
(Xylos) for the exclusive U.S. commercialization rights to the Xylos XCell(TM)
Cellulose Wound Dressing (XCell) wound care products. Pursuant to this agreement
we have certain minimum purchase requirements. The minimum purchase requirement
for the calendar year 2003 is $750,000. The minimum purchase requirement for
each subsequent calendar year is based on the aggregate dollar volume of sales
of products during the 12-month period ending with September of the prior year,
but in no event less than $750,000. We began selling the Xylos product in
January 2003; however, initial sales have been significantly slower than
anticipated and we are currently reviewing our strategies regarding XCell.
Continued slow performance in selling the Xylos product could adversely affect
our results of operations, cash flows or liquidity and also could potentially
impair the MD&D unit's ability to recover the value of its intangible assets
including goodwill.
On May 29, 2003, we entered into an agreement with Organogenesis, Inc.
(Organogenesis) whereby we will provide sales, marketing, and clinical support
for Apligraf(R), Organogenesis' living, bi-layered skin substitute. We will
leverage our wound care sales force and provide marketing resources in support
23
of Apligraf. PDI InServe will utilize its current team of wound care nurses to
provide aftersale clinical support for practitioners. Under the terms of the
agreement, we will receive a fee with the potential to earn incentives based on
performance. Organogenesis has termination rights based on established
performance criteria subject to 90 days' notice.
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 26 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 pharmaceutical industry
continues to consolidate. As a result, we are likely to continue to experience
significant client concentration in future periods.
For the three and six month periods ended June 30, 2003, two clients, who
each individually represented 10% or more of our service revenue, accounted for
approximately 70.3% and 69.7%, respectively, of our service revenue. For the
three and six month periods ended June 30, 2002, our largest clients who each
accounted for more than 10% of our service revenue totaled 61.8% and 73.7%,
respectively, of our total service revenue.
Our product revenue for the three and six months ended June 30, 2003 was
comprised entirely of sales of the Xylos wound care products which began
commercialization during January 2003. Of the $6.2 million recorded as product
revenue for the six months ended June 30, 2002, approximately $716,000 was from
the sale of Ceftin inventory. The balance of $5.5 million resulted from the net
positive adjustments recorded in sales returns and allowances, discounts and
rebates that occurred during the six month period as we continued to satisfy our
liabilities relating to the previous reserves recorded as a result of Ceftin
sales in prior periods. Since those reserves were initially set up as estimates
using historical data and other information, there may continue to be both
positive and negative adjustments made as the liabilities are settled in future
periods, particularly through the expiration date of the product sold which runs
through June 2004. These adjustments will be reflected in product revenue
consistent with the classification of such accruals when they were 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.
24
Program expenses include personnel costs and other costs associated with
executing a product detailing or other marketing or promotional program, as well
as the initial direct costs associated with staffing a product detailing
program. Such costs include, but are not limited to, facility rental fees,
honoraria, travel expenses, sample expenses and other promotional expenses.
Personnel costs, which constitute the largest portion of program expenses,
include all labor related costs, such as salaries, bonuses, fringe benefits and
payroll taxes, for the sales representatives and sales managers and professional
staff who are directly responsible for executing a particular program. Initial
direct program costs are those costs associated with initiating a product
detailing program, such as recruiting, hiring and training the sales
representatives who staff a particular product detailing program. All personnel
costs and initial direct program costs, other than training costs, are expensed
as incurred for service offerings. Training costs include the costs of training
the sales representatives and managers on a particular product detailing program
so that they are qualified to properly perform the services specified in the
related contract. For all contracts, training costs are deferred and amortized
on a straight-line basis over the shorter of the life of the contract to which
they relate or 12 months. When we receive a specific contract payment from a
client upon commencement of a product detailing program expressly to compensate
us for recruiting, hiring and training services associated with staffing that
program, such payment is deferred and recognized as revenue in the same period
that the recruiting and hiring expenses are incurred and the amortization of the
deferred training is expensed. When we do not receive a specific contract
payment for recruiting, hiring and training, all revenue is deferred and
recognized over the life of the contract. Product detailing, marketing and
promotional expenses related to the detailing of products we distribute are
recorded as a selling expense and are included in other selling, general and
administrative expenses in the consolidated statements of operations.
We may incur significant initial direct program costs before recognizing
revenue under a particular product detailing program. Our inability to
specifically negotiate for payments that are specifically attributable to
recruiting, hiring or training services in our product detailing contracts could
adversely impact our operating results for periods in which the costs associated
with the product detailing services are incurred.
Product revenue and cost of goods sold
As mentioned previously, product revenue for the three and six month
periods ended June 30, 2003 resulted primarily from the sale of the Xylos wound
care products. Product revenue recognized in prior periods related to the Ceftin
contract which terminated by mutual consent in February 2002. Product revenue is
recognized when products are shipped and title is transferred to the customer.
Cost of goods sold includes all expenses for product distribution costs,
acquisition and manufacturing costs of the product sold. Inventory is valued at
the lower of cost or market value. Cost is determined using the first-in,
first-out costing method. Inventory to date has consisted of only finished
goods.
25
Consolidated Results of Operations
The following table sets forth, for the periods indicated, certain
consolidated statements of operations data as a percentage of revenue. The
trends illustrated in this table may not be indicative of future results.
Three Months Ended Six Months Ended
June 30, June 30,
------------------ -------------------
2003 2002 2003 2002
------ ------ ------ ------
Revenue
Service, net ....................................... 99.9% 99.2% 99.9% 95.6%
Product, net ....................................... 0.1 0.8 0.1 4.4
------ ------ ------ ------
Total revenue, net ............................... 100.0% 100.0% 100.0% 100.0%
Cost of goods and services
Program expenses ................................... 70.6 98.8 72.2 94.7
Cost of goods sold ................................. 0.1 0.0 0.1 0.0
------ ------ ------ ------
Total cost of goods and services ................. 70.7% 98.8% 72.3% 94.7%
Gross profit .......................................... 29.3 1.2 27.7 5.3
Compensation expense .................................. 12.8 14.0 13.0 12.2
Other selling, general and administrative expenses .... 10.1 9.7 9.4 7.1
Restructuring and other related expenses, net ......... -- -- (0.2) --
Litigation settlement ................................. -- -- 1.5 --
------ ------ ------ ------
Total operating expenses ........................... 22.9 23.7 23.7 19.3
------ ------ ------ ------
Operating income (loss) ............................... 6.4 (22.5) 4.0 (14.0)
Other income, net ..................................... 0.3 0.6 0.4 0.9
------ ------ ------ ------
Income (loss) before provision for income taxes ....... 6.7 (21.9) 4.4 (13.1)
Provision (benefit) for income taxes .................. 2.7 (8.1) 1.8 (4.8)
------ ------ ------ ------
Net income (loss) ..................................... 4.0% (13.8)% 2.6% (8.3)%
====== ====== ====== ======
Three Months Ended June 30, 2003 Compared to Three Months Ended June 30, 2002
Revenue. Net revenue for the quarter ended June 30, 2003 was $71.3
million, 7.1% more than net revenue of $66.5 million for the quarter ended June
30, 2002. As disclosed elsewhere in this MD&A, the Novartis sales force
responsible for Lotrel/Diovan is now classified in the SMSG segment instead of
the PPG segment where it was classified in 2002 due to a change in the nature of
the arrangement. Net revenue from the SMSG segment for the quarter ended June
30, 2003 was $56.4 million, approximately 16.4% more than net revenue of $48.4
million from that segment for the comparable prior year period. We were awarded
three significant fee for service contracts in July 2003. GSK awarded us a
contract beginning in July 2003 running through September 2004, which represents
between $80 million and $85 million in potential revenue over the fifteen month
agreement. The other contracts, which became effective August 1, 2003 will run
through December 31, 2004 and could represent an incremental revenue impact of
between $60 million and $70 million over their full term.
Net PPG service revenue for the quarter ended June 30, 2003 was $12.2
million compared to $15.9 million in the comparable prior year period.
Approximately $8.9 million was attributable to our Lotensin contract for the
three month period ended June 30, 2003. There was $500,000 in product revenue
recorded for the period ended June 30, 2002 all of which was attributable to the
changes in estimates related to sales allowances and returns, discounts and
rebates recorded on previous Ceftin sales.
26
Net revenue from the MD&D segment was $2.7 million compared to $2.2
million in the comparable prior year period. This increase was due to the
increased MD&D service revenue of approximately $391,000, or 18.0% and the Xylos
product sales of approximately $82,000.
Cost of goods and services. Cost of goods and services for the quarter
ended June 30, 2003 was $50.4 million, 23.3% less than cost of goods and
services of $65.7 million for the quarter ended June 30, 2002. As a percentage
of total net revenue, cost of goods and services decreased to 70.7% for the
quarter ended June 30, 2003 from 98.8% in the comparable prior year period.
Program expenses (i.e., cost of services) associated with the SMSG segment
for the quarter ended June 30, 2003 were $39.3 million, 15.3% more than program
expenses of $34.1 million for the prior year period due primarily to increased
revenue. As a percentage of sales and marketing services segment revenue,
program expenses for the quarters ended June 30, 2003 and 2002 were 69.7% and
70.4%, respectively.
Cost of goods and services associated with the PPG segment were $9.1
million and $30.1 million for the quarters ended June 30, 2003 and 2002,
respectively. As a percentage of PPG revenue, cost of goods and services for the
quarters ended June 30, 2003 and 2002 were 74.6% and 189.6%, 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 normally 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 profit in this segment was negative due
to the underperformance of our contracted products, most notably under the
Evista agreement which was terminated effective December 31, 2002. We incurred
an operating loss of approximately $8.9 million under the Evista contract in the
second quarter of 2002.
Performance based contracts can achieve a gross profit percentage above
our historical averages for contract sales programs if the performance of the
product(s) meets or exceeds expectations, but can be below normal gross profit
standards if the performance of the product falls short of expectations. While
we currently estimate that future revenues will exceed costs associated with
these agreements, there is no assurance that actual revenues will exceed costs;
in which event the activities covered by these agreements could yield an
operating loss.
Cost of goods and services associated with the MD&D segment for the
quarter ended June 30, 2003 were $2.0 million, of which $78,000 was related to
product sales, 33.2% more than program expenses of $1.5 million for the prior
year period.
Compensation expense. Compensation expense for the quarter ended June 30,
2003 was $9.1 million, 1.8% less than $9.3 million for the comparable prior year
period. As a percentage of total net revenue, compensation expense decreased to
12.8% for the quarter ended June 30, 2003 from 14.0% for the quarter ended June
30, 2002. Compensation expense for the quarter ended June 30, 2003 attributable
to the SMSG segment was $5.6 million, approximately the same as $5.6 million for
the quarter ended June 30, 2002. As a percentage of net revenue from the SMSG
segment, compensation expense decreased to 10.0% for the quarter ended June 30,
2003 from 11.6% for the quarter ended June 30, 2002 due to the increase in
revenue in the current year quarter. Compensation expense for the quarter ended
June 30, 2003 attributable to the PPG segment was $2.3 million, or 19.1% of PPG
revenue, compared to $2.9 million, or 18.4% in the prior year period. Due to the
FDA's determination that Fortigel is not approved at the current time, we are
not expecting to increase the SG&A investment in this segment in the near
future. Compensation expense for the MD&D segment for the quarter ended June 30,
2003 was $1.2 million compared to $0.8 million in the comparable prior year
period, reflecting the increased capabilities required for the launch and
continuing marketing of our wound care products.
27
Other selling, general and administrative expenses (other SG&A). Total
other SG&A expenses were $7.2 million for the quarter ended June 30, 2003, 11.7%
more than other SG&A expenses of $6.5 million for the quarter ended June 30,
2002. As a percentage of total net revenue, total other SG&A expenses increased
slightly to 10.1% for the quarter ended June 30, 2003 from 9.7% for the quarter
ended June 30, 2002.
Other SG&A expenses attributable to the SMSG segment for the quarter ended
June 30, 2003 were $3.6 million, 15.9% higher than $3.1 million attributable to
that segment for the comparable prior year period. As a percentage of net
revenue from sales and marketing services, other SG&A expenses remained the same
at 6.4% for the quarters ended June 30, 2003 and 2002, respectively.
Other SG&A expenses attributable to the PPG segment for the quarter ended
June 30, 2003 were $1.8 million compared to $2.9 million for the comparable
prior year period. We expect that there will be increases in infrastructure for
this segment during the next several quarters.
Other SG&A expenses attributable to the MD&D segment for the quarter ended
June 30, 2003 were $1.8 million, compared to $515,000 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. Excluding this $1.3 million increase in the MD&D
segment, the total other SG&A expenses would have been 9.2% less than the
comparable prior year period rather than 11.7% higher.
Operating income (loss). Operating income for the quarter ended June 30,
2003 was $4.5 million, compared to an operating loss of $14.9 million for the
quarter ended June 30, 2002.
Operating income for the quarter ended June 30, 2003 for the SMSG segment
was $7.8 million, or 39.9% higher than the SMSG operating income for the quarter
ended June 30, 2002 of $5.6 million. As a percentage of net revenue from the
SMSG segment, operating income for that segment increased to 13.9% for the
quarter ended June 30, 2003, from 11.6% for the comparable prior year period.
There was an operating loss for the PPG segment for the quarter ended June
30, 2003 of $1.0 million, compared to an operating loss of $20.0 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
and the performance on Lotensin, which exceeded the contractual TRx baseline by
a wider margin than had been expected.
The MD&D segment recorded an operating loss of $2.3 million, compared to
an operating loss of $546,000 in the comparable prior year period, primarily due
to the costs incurred for the launch of the Xylos wound care products.
Other income, net. Other income, net, for the quarters ended June 30, 2003
and 2002 was $226,000 and $356,000, 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 $2.0 million for the quarter ended June 30, 2003, compared to an
income tax benefit of $5.4 million for the quarter ended June 30, 2002, which
consisted of Federal and state corporate income taxes. The effective tax rate
for the quarter ended June 30, 2003 was 41.0%, compared to an effective tax
benefit rate of 36.9% for the quarter ended June 30, 2002. The rate for our 2002
tax benefit is lower than the 2003 effective tax rate because some states do not
permit loss carryforwards or may impose minimum taxes, or both.
Net income (loss). There was net income for the quarter ended June 30,
2003 of approximately $2.8 million, compared to a net loss of $9.2 million for
the quarter ended June 30, 2002 due to the factors discussed previously.
28
Six Months Ended June 30, 2003 Compared to Six Months Ended June 30, 2002
Revenue. Net revenue for the six months ended June 30, 2003 was $138.8
million, 1.1% less than net revenue of $140.4 million for the six months ended
June 30, 2002. 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. Net revenue from the SMSG segment for the six months ended June
30, 2003 was $111.0 million, $8.4 million more than net revenue of $102.6
million from that segment for the comparable prior year period. We were awarded
three significant fee for service contracts in July 2003. GSK awarded us a
contract beginning in July 2003 running through September 2004, which represents
between $80 million and $85 million in potential revenue over the fifteen month
agreement. The other contracts, which became effective August 1, 2003 will run
through December 31, 2004 and could represent an incremental revenue impact of
between $60 million and $70 million over their full term. Net PPG revenue for
the six months ended June 30, 2003 was $22.2 million, $11.2 million less than
net revenue of $33.4 million for the comparable prior year period, of which $6.2
million was product revenue. Approximately $16.4 million was attributable to our
Lotensin contract for the six months ended June 30, 2003. With regard to product
revenue in 2002, approximately $716,000 was attributable to sales of Ceftin and
$5.5 million was attributable to the changes in estimates related to sales
allowances and returns, and discounts and rebates recorded on previous Ceftin
sales. Net revenue for the MD&D segment for the six months ended June 30, 2003
was $5.6 million compare to $4.4 million for the comparable prior year period.
This increase can be attributed primarily to the increased revenue generated by
the MD&D service business.
Cost of goods and services. Cost of goods and services for the six months
ended June 30, 2003 was $100.3 million, 24.6% less than cost of goods and
services of $133.0 million for the six months ended June 30, 2002. The decrease
was primarily attributable to the termination of the Evista contract and the
related program expenses. As a percentage of total net revenue, cost of goods
and services decreased to 72.3% for the six months ended June 30, 2003 from
94.7% in the comparable prior year period. This decrease was primarily
attributable to the negative gross profit associated with the Eli Lilly and
Novartis contracts from the comparable prior year period. The gross profit
percentage of 27.7% attained on service revenue for the first six months of 2003
approximates our historical standards which had been established through the
year 2000.
Program expenses (i.e., cost of services) associated with the SMSG segment
for the six months ended June 30, 2003 were $77.4 million, $1.2 million more
than program expenses of $76.2 million for the prior year period. As a
percentage of sales and marketing services segment revenue, program expenses for
the six months ended June 30, 2003 and 2002 were 69.8% and 74.2%, respectively.
The gross profit increase to 30.2% from 25.8% 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.
Cost of goods and services associated with the PPG segment were $18.8
million and $53.9 million for the six months ended June 30, 2003 and 2002,
respectively. As a percentage of PPG revenue, cost of goods and services for the
six months ended June 30, 2003 and 2002 was 84.8% and 161.2%, respectively. The
decrease can be attributed to the termination of the Evista contract and the
improved performance of the Novartis Lotensin contract.
Performance based contracts can achieve a gross profit percentage above
our historical averages for contract sales programs if the performance of the
product(s) meets or exceeds expectations, but can be below normal gross profit
standards if the performance of the product falls short of baselines. While we
currently estimate that future revenues will equal or exceed costs associated
with our current PPG agreements, there is no assurance that this will occur; in
the event the activities covered by these agreements yield an operating loss, we
might be required to record a contract loss reserve.
Cost of goods and services associated with the MD&D segment were $4.1
million for the six months ended June 30, 2003, 38.9% more than cost of goods
and services of $2.9 million for the six months ended June 30, 2002. The Company
recognized a negative gross profit margin on the sale of the Xylos product for
the six month period ended June 30, 2003. The average per
29
unit sales price exceeded the average per unit acquisition cost of the inventory
by an amount considered normal for the industry. However, due primarily to the
low volume of initial sales of the product the fixed warehousing costs exceeded
the gross profit generated from sales of the product. Based on our current
projection, we expect to fully recover the cost of the Xylos inventory on hand
at June 30, 2003. However if revenue does not increase in an amount sufficient
to cover both the cost of inventory and the fixed warehousing costs, we could
continue to generate negative gross profit on the sales of the Xylos product.
Continued slow performance in selling the Xylos product could also potentially
impair the MD&D unit's ability to recover the value of its intangible assets
including goodwill.
Compensation expense. Compensation expense for the six months ended June
30, 2003 was $18.0 million, compared to $17.1 million for the comparable prior
year period. As a percentage of total net revenue, compensation expense
increased to 13.0% for the six months ended June 30, 2003 from 12.1% for the six
months ended June 30, 2002. The increased compensation expense for the six
months ended June 30, 2003 is due in large part to increased incentive
compensation expense accrual, due to improved results for the six-month period
ended June 30, 2003 as compared to the net loss experienced in the comparable
prior year period which greatly reduced incentive compensation potential;
excluding this increase in accrual, compensation expense for the six months
ended June 30, 2003 would be 11.7% lower than the comparable prior year period
due to the impact of the staff reduction and other efficiencies related to the
2002 Restructuring Plan. Compensation expense for the six months ended June 30,
2003 attributable to the SMSG segment was $10.9 million compared to $10.1
million for the six months ended June 30, 2002. As a percentage of net revenue
from the SMSG segment, compensation expense was 9.9% for both of the six-month
periods ended June 30, 2003 and June 30, 2002. Compensation expense for the six
months ended June 30, 2003 attributable to the PPG segment was $4.7 million, or
21.0% of PPG revenue, compared to $5.5 million, or 16.4% in the comparable prior
year period. Compensation expense for the six months ended June 30, 2003 for the
MD&D segment was $2.4 million compared to $1.5 million for the comparable prior
year period; increased management attention because of the start-up activities
in 2003 has resulted in higher compensation expense for this segment.
Other selling, general and administrative expenses. (other SG&A) Total
other SG&A expenses were $13.0 million for the six months ended June 30, 2003,
33.4% more than other SG&A expenses of $9.8 million for the six months ended
June 30, 2002. A significant portion of this unfavorable variance is
attributable to a large nonrecurring credit that lowered the 2002 expense base,
and the presence of additional investment in a start-up that began in 2003. A
credit of $2.3 million was recorded in the six months ended June 30, 2002 for
the reversal of a bad debt reserve associated with Ceftin sales and determined
to be no longer required as of March 31, 2002.
In 2003, MD&D had product sales force and marketing expenses of $1.8
million which were not present in 2002. Adjusting the six month periods ending
June 30, 2003 and 2002 for the two items listed above, other SG&A would have
been $11.2 million for the six months ended June 30, 2003, 7.4% less than $12.1
million for the comparable prior year period.
As a percentage of total net revenue, total other SG&A expenses, as
adjusted above, decreased to 8.1% for the six months ended June 30, 2003 from
8.6% for the six months ended June 30, 2002. Other SG&A expenses attributable to
the SMSG segment for the six months ended June 30, 2003 were $6.4 million, which
were comparable to the $6.4 million for the six months ended June 30, 2002.
As a percentage of net revenue from sales and marketing services, other
SG&A expenses were 5.8% and 6.2% for the six months ended June 30, 2003 and
2002, respectively. Other SG&A expenses attributable to the PPG segment for the
six months ended June 30, 2003 were $3.1 million compared to $2.4 million for
the comparable prior year period. Other SG&A expenses attributable to the MD&D
segment for the six months ended June 30, 2003 were $3.5 million compared to
$1.0 million for the six months ended June 30, 2002 due to the increased sales
and marketing costs as discussed above.
Restructuring and other related expenses. During the six months ended June
30, 2003, we recognized a $270,000 reduction in the restructuring accrual due to
negotiating higher sublease proceeds than originally estimated for the leased
facility in Cincinnati, Ohio. During the quarter ended June 30, 2003 we incurred
approximately $133,000 of additional restructuring expense due to higher than
expected contractual termination costs. This additional expense
30
was recorded in program expenses consistent with the original recording of the
restructuring charges. Also during the quarter ended June 30, 2003 we recognized
a $473,000 reduction in the restructuring accrual due to lower than expected
sales force severance costs. Greater success in the reassignment of sales
representatives to other programs and the voluntary departure of other sales
representatives combined to reduce the requirement for severance costs. This
expense reversal was recorded in program expenses consistent with the original
recording of the restructuring charges. See the "Restructuring and other related
expenses" disclosure in the "Liquidity and Capital Resources" section below for
further explanations of the Restructuring Plan and related activity.
Litigation settlement. On May 8, 2003, we entered into a settlement and
mutual release agreement with Auxilium (Settlement Agreement). We recorded a
$2.1 million charge in the first quarter of 2003 which included a cash payment
paid upon execution of the Settlement Agreement and other additional expenses
that were required as part of the settlement (refer to Note 13 in the unaudited
consolidated financial statements).
Operating income (loss). Operating income for the six months ended June
30, 2003 was $5.6 million, compared to an operating loss of $19.4 million for
the six months ended June 30, 2002. The operating loss was primarily the result
of losses generated by the performance based contracts in 2002, in particular
the Evista contract.
Operating income for the six months ended June 30, 2003 for the SMSG
segment was $15.2 million, or 53.3% more than SMSG operating income for the six
months ended June 30, 2002 of $9.9 million. As a percentage of net revenue from
the SMSG segment, operating income for that segment increased to 13.7% for the
six months ended June 30, 2003, from 9.7% for the comparable prior year period.
There was an operating loss for the PPG segment for the six months ended
June 30, 2003 of $5.1 million, compared to an operating loss of $28.3 million
for the prior year period. The large loss for the six months ended June 30, 2002
can be attributed to the performance of the Evista and Lotensin contracts.
There was an operating loss of $4.5 million for the six months ended June
30, 2003 for the MD&D segment compared to an operating loss of $1.0 million in
the comparable prior year period, primarily due to the start-up of the Xylos
product business.
Other income, net. Other income, net, for the six months ended June 30,
2003 and 2002 was $495,000 and $1.2 million, respectively. For the six months
ended June 30, 2003, other income, net, was comprised primarily of interest
income, which was significantly lower than the comparable prior year period due
to lower available cash balances and significantly lower interest rates. Other
income, net, for the comparable prior year period and was also comprised
primarily of interest income.
Provision (benefit) for income taxes. There was income tax expense $2.5
million for the six months ended June 30, 2003, compared to an income tax
benefit of $6.7 million for the six months ended June 30, 2002, which consisted
of Federal and state corporate income taxes. The effective tax rate for the six
months ended June 30, 2003 was 41.1%, compared to an effective tax benefit rate
of 36.9% for the six months ended June 30, 2002. The rate for our 2002 tax
benefit is lower than the 2003 effective tax rate because some states do not
permit loss carryforwards or may impose minimum taxes, or both.
Net income (loss). There was net income for the six months ended June 30,
2003 of $3.6 million, compared to a net loss of $11.5 million for the six months
ended June 30, 2002 due to the factors discussed previously.
31
Liquidity and Capital Resources
As of June 30, 2003, we had cash and cash equivalents of approximately
$66.5 million and working capital of approximately $89.1 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 six months ended June 30, 2003, net cash used in operating
activities was $4.8 million, compared to $76.1 million net cash used in
operating activities for the six months ended June 30, 2002. The main components
of cash used in operating activities during the six months ended June 30, 2003
were:
o cash used from other changes in assets and liabilities of $11.5
million, which includes an increase in other current assets for the
escrow funding relating to $2.9 million of letters of credit
associated with our insurance policies, and reductions in our
restructuring accruals of $3.9 million, partially offset by,
o net income of approximately $3.6 million, and
o depreciation and other non-cash expenses of approximately $3.1
million.
Inventory increased by $0.4 million. Inventory as of June 30, 2003 was
approximately $1.1 million and is associated with our XCell wound care product
distribution agreement with Xylos.
As of June 30, 2003, we had $5.2 million of unearned contract revenue and
$11.3 million of unbilled costs and accrued profits on contracts in progress.
When we bill clients for services before they have been completed, billed
amounts are recorded as unearned contract revenue, and are recorded as income
when earned. When services are performed in advance of billing, the value of
such services is recorded as unbilled costs and accrued profits on contracts in
progress. Substantially all unbilled costs and accrued profits are earned and
billed within 12 months from the end of the respective period. As of June 30,
2003 we had accumulated approximately $4.6 million in unbilled costs with regard
to the launching of two large dedicated CSO contracts. These amounts were billed
in July 2003.
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 six months ended June 30, 2003, net cash provided by investing
activities of $3.8 million consisted of $4.2 million received from the sale of
short-term investments, partially offset by $0.4 million in purchases of
property and equipment.
For the six months ended June 30, 2003, net cash provided by financing
activities of $0.7 million was due to the net proceeds received from the
employee stock purchase plan. For the six months ended June 30, 2002 net cash
provided by financing activities of $1.5 million was primarily due to the net
proceeds received from the employee stock purchase plan.
Capital expenditures during the six-month periods ended June 30, 2003 and
2002 were approximately $0.4 million and $3.8 million, respectively, and were
funded out of available cash. As a result of the significant investment in
capital expenditures during 2002 of $4.0 million and 2001 of $15.6 million, we
currently estimate that we will require capital expenditures of only
approximately $20.0 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.
Our revenue and profitability depend to a great extent on our
relationships with a limited number of large pharmaceutical companies. For the
six months ended June 30, 2003, we had two major clients that accounted for
approximately 36.5% and 33.2%, respectively, or a total of 69.7%, of our service
revenue. We are likely to continue to experience a high degree of client
concentration, particularly if there is further
32
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, cash flows or 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. The initial 10-month
Prescription Drug User Fee Act (PDUFA) date for the product was April 5, 2003.
In March 2003, Cellegy was notified by the FDA that the PDUFA date had been
revised to July 3, 2003. On July 3, 2003, Cellegy was notified by the FDA that
Fortigel was not approved. Cellegy is in discussions with the FDA to determine
the appropriate course of action needed to meet deficiencies cited by the FDA in
its determination. We cannot predict with any certainty that the FDA will
ultimately approve Fortigel for sale in the U.S. Therefore it is unlikely we
will be required to pay Cellegy the $10.0 million incremental license fee
milestone payment in 2003.
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 may be offset by incremental SG&A expenses
we could incur in 2003 and future periods if we are successful in expanding our
business platforms for our 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
were $3.7 million in severance expense consisting of cash and non-cash
termination payments to employees in connection with their involuntary
termination and $1.7 million in other restructuring exit costs relating to
leased facilities and other contractual obligations.
During the quarter ended March 31, 2003, we recognized a $270,000
reduction in to the restructuring accrual due to negotiating higher sublease
proceeds than originally estimated for the leased facility in Cincinnati, Ohio.
During the quarter ended June 30, 2003 we incurred approximately $133,000
of additional restructuring expense due to higher than expected contractual
termination costs. This additional expense was recorded in program expenses
consistent with the original recording of the restructuring charges.
33
Also during the quarter ended June 30, 2003 we recognized a $473,000
reduction in to the restructuring accrual due to lower than expected sales force
severance costs. Greater success in the reassignment of sales representatives to
other programs and the voluntary departure of other sales representatives
combined to reduce the requirement for severance costs. This adjustment was
recorded in program expenses consistent with the original recording of the
restructuring charges.
The accrual for restructuring and exit costs totaled approximately
$800,000 at June 30, 2003, and is recorded in current liabilities on the
accompanying balance sheet.
A roll forward of the activity for the 2002 Restructuring Plan (in
thousands) is as follows:
Balance at
December 31, 2002 Balance at
Adjustments Payments June 30, 2003
Administrative severance $ 1,670 $ -- $(1,172) $ 498
Exit costs 1,288 (137) (849) 302
------- ------- ------- -------
2,958 (137) (2,021) 800
------- ------- ------- -------
Sales force severance 1,741 (473) (1,268) --
------- ------- ------- -------
Total $ 4,699 $ (610) $(3,289) $ 800
======= ======= ======= =======
Use Of Non-GAAP Financial Information
This Form 10-Q contains non-GAAP financial information adjusted to exclude
certain costs, expenses, gains and losses and other non-comparable items. This
information is intended to enhance an investor's overall understanding of the
Company's past financial performance and prospects for the future. For example,
non-GAAP financial information is an indication of our baseline performance
before items that are considered by us to be not reflective of our operational
results. In addition, this information is among the primary indicators we use as
a basis for planning and forecasting of future periods. This information is not
intended to be considered in isolation or as a substitute for financial
information prepared in accordance with generally accepted accounting
principles.
34
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
As of June 30, 2003, PDI's management, including its Chief Executive Officer and
Chief Financial Officer, have conducted an evaluation of the effectiveness of
disclosure controls and procedures pursuant to Rule 13a-14 and 15d-14 under the
Securities Exchange Act of 1934, as amended. Based on that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that the disclosure
controls and procedures are effective in ensuring that all material information
required to be filed in this quarterly report has been made known to them in a
timely fashion.
(b) Changes in Internal Controls
There have been no significant changes in internal controls, or in factors that
could significantly affect internal controls, subsequent to the date the Chief
Executive Officer and Chief Financial Officer completed their evaluation.
35
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
detailed by us on Bayer's behalf under a contract sales force agreement. We may
be named in additional similar lawsuits. In August 2001, Bayer announced that it
was voluntarily withdrawing Baycol from the U.S. market. To date, we have
defended these actions vigorously and have asserted a contractual right of
indemnification against Bayer for all costs and expenses we incur relating to
these proceedings. In February 2003, we entered into a joint defense and
indemnification agreement with Bayer, pursuant to which Bayer has agreed to
assume substantially all of our defense costs in pending and prospective
proceedings, subject to certain limited exceptions. Further, Bayer agreed to
reimburse us for all reasonable costs and expenses incurred to date in defending
these proceedings. Bayer 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
36
claims related to our alleged breaches of a contract sales force agreement
entered into by the parties on November 20, 2002, and claims that we were
misappropriating trade secrets in connection with our exclusive license
agreement with Cellegy.
On May 8, 2003, we entered into a settlement and mutual release agreement
with Auxilium (Settlement Agreement), by which the lawsuit and all related
counter claims were dropped without any admission of wrongdoing by either party.
The settlement terms included a cash payment which was paid upon execution of
the Settlement Agreement as well as certain other additional expenses. We
recorded a $2.1 million charge in the first quarter of 2003 related to this
settlement. Pursuant to the Settlement Agreement, we also agreed that we would
(a) not sell, ship, distribute or transfer any Fortigel product to any
wholesalers, chain drug stores, pharmacies or hospitals prior to November 1,
2003, and (b) pay Auxilium an additional amount per prescription to be
determined based upon a specified formula, in the event any prescriptions are
filled for Fortigel prior to January 26, 2004. As discussed in Note 4, on July
3, 2003 Cellegy was notified by the FDA that Fortigel had not been approved. We
do not believe that the terms of the Settlement Agreement will have any material
impact on the success of our commercialization of the product if and when the
FDA approves it. There can be no assurances that the FDA will approve the
product at a later date.
Other Legal Proceedings
We are currently a party to other legal proceedings incidental to our
business.
While management currently believes that the ultimate outcome of these
proceedings, individually and in the aggregate, will not have a material adverse
effect on our consolidated financial statements, litigation is subject to
inherent uncertainties. Were we to settle a proceeding for a material amount or
were an unfavorable ruling to occur, there exists the possibility of a material
adverse impact on our results of operations, cash flows or liquidity.
No amounts have been accrued for losses under any of the above mentioned
matters, other than for the Auxilium litigation settlement reserve, as no other
amounts are considered probable or reasonably estimable at this time.
Item 2 - Not Applicable
Item 3 - Not Applicable
Item 4 - Submission of Matters to a Vote of Security Holders
On July 15, 2003, the Company held its 2003 Annual Meeting of
Stockholders. At the meeting Charles T. Saldarini, John M. Pietruski, and Frank
J. Ryan were reelected as Class II Directors of the Company for three year terms
with 12,663,586, 12,560,476, and 11,047,094 votes cast in favor of their
election, respectively, and 87,959, 191,078, and 1,704,451 votes withheld,
respectively. In addition, the appointment of PricewaterhouseCoopers LLP as
independent auditors of the Company for fiscal 2003 was ratified with 9,911,917
votes in favor, 2,834,626 votes against and 5,001 votes withheld.
Item 5 - Not Applicable
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
No.
---
32.1 Certification of Chief Executive Officer
32.2 Certification of Chief Financial Officer
37
(b) Reports on Form 8-K
During the three months ended June 30, 2003, the Company filed the following
reports on Form 8-K:
Date Item Description
------------ -------- ------------------------------
May 6, 2003 5 Earnings Press Release
May 14, 2003 5 Revised Earnings Press Release
38
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.
August 5, 2003 PDI, INC.
By: /s/ Charles T. Saldarini
---------------------------------
Charles T. Saldarini
Chief Executive Officer
By: /s/ Bernard C. Boyle
---------------------------------
Bernard C. Boyle
Chief Financial and Accounting
Officer
39
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 Form 10-Q for the quarter ended June 30, 2003 of
PDI, Inc.;
2. Based on my knowledge, this 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 report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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 report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15e and 15d-15e) for the registrant and have:
(a) Designed such disclosure controls and procedures,or caused such
disclosure controls and procedures to be designed under our supervision,
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 report is being
prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in the
case of annual report) that has materially affected, or is reasonably
likely to materially affect, the registrant's internal control over
financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
control over financial reporting.
/s/ Charles T. Saldarini
-----------------------------------------
Charles T. Saldarini
Vice Chairman and Chief Executive Officer
Date: August 5, 2003
40
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 Form 10-Q for the quarter ended June 30, 2003 of
PDI, Inc.;
2. Based on my knowledge, this 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 report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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 report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15e and 15d-15e) for the registrant and have:
(a) Designed such disclosure controls and procedures,or caused such
disclosure controls and procedures to be designed under our supervision,
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 report is being
prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in the
case of annual report) that has materially affected, or is reasonably
likely to materially affect, the registrant's internal control over
financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
control over financial reporting.
/s/ Bernard C. Boyle
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Bernard C. Boyle
Chief Financial Officer
Date: August 5, 2003
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