24
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(X) Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the quarterly period ended
September 30, 1997
or
( ) Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the transition period from
__________ to __________
Commission File Number 1-6247
ALZA CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 77-0142070
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
950 Page Mill Road
P.O. Box 10950
Palo Alto, California 94303-0802
(Address of principal executive offices)
Registrant's telephone number, including area code (650) 494-5000
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 ( )
Number of shares outstanding of each of the registrant's classes
of common stock as of October 24, 1997:
Common Stock, $.01 par value - 85,393,375 shares
ALZA CORPORATION
FORM 10-Q for the Quarter Ended
September 30, 1997
INDEX
Part I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Statement of Income 3
Condensed Consolidated Balance Sheet 4
Condensed Consolidated Statement of Cash Flows 5
Notes to Financial Statements 6-9
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 10-17
Part II. Other Information
Item 1. Legal Proceedings 18
Item 6. Exhibits and Reports on Form 8-K 18
Signatures 19
Exhibits
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
ALZA CORPORATION
Condensed Consolidated Statement of Income (unaudited)
(In millions, except per share amounts)
Quarter Ended Nine Months Ended
September 30, September 30,
1997 1996 1997 1996
_________________________________________________________________
Revenues:
Royalties, fees and other $ 41.9 $ 39.5 $ 131.8 $ 126.1
Research and development 36.1 29.4 106.0 94.8
Net sales 36.5 29.5 100.4 83.8
_________________________________________________________________
Total revenues 114.5 98.4 338.2 304.7
Expenses:
Research and development 41.9 31.7 116.5 101.2
Costs of products shipped 22.0 21.4 64.9 67.0
Selling, general and
administrative 11.0 11.6 35.1 33.7
Acquisition of in-process
research and development 87.0 - 87.0 -
Contribution to Crescendo
Pharmaceuticals Corporation 247.0 - 247.0 -
Asset write-down 11.5 - 11.5 -
_________________________________________________________________
Total expenses 420.4 64.7 562.0 201.9
_________________________________________________________________
Operating income (loss) (305.9) 33.7 (223.8) 102.8
Interest expense 13.8 12.9 41.3 30.3
Distribution to debenture
holders 8.0 - 8.0 -
Interest and other income (17.8) (16.5) (48.3) (35.0)
_________________________________________________________________
Net interest and other
expense (income) 4.0 (3.6) 1.0 (4.7)
_________________________________________________________________
Income (loss) before
income taxes (309.9) 37.3 (224.8) 107.5
Provision for income taxes 16.6 14.2 49.0 40.9
_________________________________________________________________
Net income (loss) $(326.5) $ 23.1 $ (273.8) $ 66.6
=================================================================
Earnings (loss) per share $ (3.83) $ 0.27 $ (3.22) $ 0.78
=================================================================
Weighted average common and
common equivalent shares 85.2 97.3 85.0 93.1
=================================================================
See accompanying notes.
ALZA Corporation
Condensed Consolidated Balance Sheet (unaudited)
(In millions)
September 30, December 31,
1997 1996
_________________________________________________________________
ASSETS
Current assets:
Cash and cash equivalents $ 116.7 $ 187.7
Short-term investments 75.3 199.3
Receivables, net 108.1 116.6
Inventories, at cost:
Raw materials 18.3 17.7
Work in process 11.8 18.0
Finished goods 9.0 3.5
_________________________________________________________________
Total inventories 39.1 39.2
Prepaid expenses and other
current assets 22.4 19.2
_________________________________________________________________
Total current assets 361.6 562.0
Property, plant and equipment 373.6 408.1
Less accumulated depreciation
and amortization (71.6) (100.3)
_________________________________________________________________
Net property, plant and equipment 302.0 307.8
Investments in long-term securities 460.1 612.8
Other assets 233.5 131.1
_________________________________________________________________
Total assets $ 1,357.2 $ 1,613.7
=================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 37.8 $ 28.7
Accrued liabilities 46.7 37.2
Other current liabilities 1.9 1.3
_________________________________________________________________
Total current liabilities 86.4 67.2
5% convertible subordinated debentures 500.0 500.0
5 1/4% zero coupon convertible
subordinated debentures 397.4 382.3
Other long-term liabilities 84.5 67.5
Stockholders' equity:
Common stock and additional
paid-in capital 379.3 363.0
Net unrealized losses on available-
for-sale securities, net of tax effect (1.3) (0.1)
Retained earnings (deficit) (89.1) 233.8
_________________________________________________________________
Total stockholders' equity 288.9 596.7
_________________________________________________________________
Total liabilities and
stockholders' equity $ 1,357.2 $ 1,613.7
=================================================================
See accompanying notes.
ALZA CORPORATION
Condensed Consolidated Statement of Cash Flows (unaudited)
(In millions)
Nine Months Ended
September 30,
1997 1996
_________________________________________________________________
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(273.8) $ 66.6
Non-cash adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization 24.6 15.8
Interest on 5 1/4% zero coupon convertible
subordinated debentures 15.2 14.4
Increase (decrease) in current assets 6.4 (20.2)
Decrease (increase) in current liabilities 18.3 (2.2)
Asset write-down 11.5 -
Other 12.3 5.6
_________________________________________________________________
Net cash (used in) provided by
operating activities (185.5) 80.0
CASH FLOWS FROM INVESTING ACTIVITIES:
Sales and maturities of available-for-sale
securities 596.5 426.1
Purchases of available-for-sale securities (322.0) (736.5)
Product acquisition payments (60.0) -
Capital expenditures (23.6) (32.1)
Purchase of Therapeutic Discovery
Corporation's deferred tax asset (23.0) -
Other investing activities (26.2) (20.9)
_________________________________________________________________
Net cash provided by (used in)
investing activities 141.7 (363.4)
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuances of common stock 16.3 47.2
Issuance of long-term debt 6.5 -
Distribution of Crescendo
Pharmaceuticals Corporation shares
to stockholders (49.1) -
Principal payments on long-term debt (0.9) (0.9)
Net proceeds from 5% convertible
subordinated debentures - 488.8
_________________________________________________________________
Net cash (used in) provided by
financing activities (27.2) 535.1
_________________________________________________________________
Net (decrease)increase in cash and
cash equivalents (71.0) 251.7
Cash and cash equivalents at
beginning of period 187.7 88.0
_________________________________________________________________
Cash and cash equivalents at end of period $ 116.7 $ 339.7
=================================================================
See accompanying notes.
ALZA CORPORATION
Notes to Consolidated Financial Statements (unaudited)
1. Basis of Presentation
The information at September 30, 1997 and for the quarters
and nine months ended September 30, 1997 and 1996 is unaudited,
and includes all adjustments (consisting only of normal recurring
adjustments) that the management of ALZA Corporation ("ALZA")
believes necessary for fair presentation of the results for the
periods presented. Interim results are not necessarily
indicative of results for the full year. The condensed
consolidated financial statements should be read in conjunction
with the audited consolidated financial statements and
accompanying notes for the year ended December 31, 1996 included
in ALZA's 1996 Annual Report to Stockholders.
Beginning with the quarter ended March 31, 1997, ALZA changed
the presentation of its consolidated statement of income and
consolidated balance sheet. In the consolidated statement of
income, royalties, fees and other revenue now include items
related to operations that were previously reflected in interest
and other income. Interest expense and income are now shown
separately after operating income. On the consolidated balance
sheet, ALZA has reclassified securities which have maturities of
one year or more as investments in long-term securities; these
securities were previously treated as current assets. Prior year
amounts have been changed to conform with the current year
presentation.
2. Purchase of Therapeutic Discovery Corporation Shares
On September 29, 1997, ALZA purchased all of the Class A
Common Stock of Therapeutic Discovery Corporation ("TDC") for
$100 million in cash. This acquisition was recorded using the
purchase method of accounting and, accordingly, the purchase
price has been allocated to assets acquired based upon their fair
market value on the acquisition date. The purchase resulted in a
charge of $77 million to acquisition of in-process research and
development on ALZA's Statement of Income, and the remaining $23
million of the purchase price was allocated to a deferred tax
asset arising from TDC's net operating loss carryforward and
capitalized research and development.
3. Agreement with Alkermes, Inc.
Effective September 30, 1997, ALZA entered into a clinical
development and option agreement with Alkermes, Inc. ("Alkermes")
relating to RMP-7, a compound for facilitating chemotherapy drug
delivery to the brain. Under the terms of the agreement, ALZA
paid Alkermes $10 million, which was charged to acquisition of in-
process research and development on ALZA's Statement of Income.
Under the agreement, Alkermes will conduct additional clinical
activities related to the product, and ALZA has the option to
acquire exclusive worldwide commercialization rights to RMP-7.
ALZA CORPORATION
Notes to Consolidated Financial Statements (unaudited)
4. Crescendo Pharmaceuticals Corporation
Crescendo Pharmaceuticals Corporation ("Crescendo") was
formed by ALZA for the purpose of selecting and developing human
pharmaceutical products, and commercializing such products most
likely through licensing to ALZA. On September 29, 1997, ALZA
contributed $300 million in cash to Crescendo. On September 30,
1997, all of the outstanding shares of Crescendo Class A Common
Stock (the "Crescendo Shares") were distributed to the holders of
ALZA common stock and ALZA's outstanding convertible subordinated
debentures. Holders of record on September 18, 1997 received one
Crescendo Share for every 20 shares of ALZA common stock owned on
that date, a total of 4,268,760 Crescendo Shares; one Crescendo
Share for every 36 shares of ALZA common stock into which the
holder's 5% convertible subordinated debentures ("5% Debentures")
were convertible, a total of 363,700 Crescendo Shares; and one
Crescendo Share for every 37 shares of ALZA stock into which the
holder's 5 1/4% zero coupon convertible subordinated debentures
("5 1/4% Debentures") were convertible, a total of 333,010
Crescendo Shares. In each case, cash was distributed in lieu of
fractional shares. ALZA recorded a charge of $247 million,
including expenses of $4 million, interest expense of $8 million
related to the distribution to debenture holders and a dividend
of $49 million for the distribution of Crescendo Shares to ALZA
common stockholders.
In connection with the contribution to Crescendo and the
distribution of Crescendo Shares, ALZA and Crescendo entered into
a number of agreements, including the Development Agreement and
Technology License Agreement, discussed below. The agreements
between ALZA and Crescendo are more fully described in the
Crescendo Registration Statement on Form S-1 (Registration No.
333-31281) filed with the Securities and Exchange Commission on
September 5, 1997, and will be described in the ALZA Form 10-K
for the year ended December 31, 1997.
Crescendo and ALZA have entered into a Development Agreement
for the selection and development of human pharmaceutical
products. The development agreement provides, among other things,
that Crescendo will fund the development of seven products (the
"Initial Products") (OROS-Registered Trademark- oxybutynin, DUROS-
Trademark- leuprolide, OROS-Registered Trademark-
methylphenidate, IUTS progesterone, D-TRANS-Trademark-
testosterone matrix, E-TRANS-Trademark- LHRH and E-TRANS-
Trademark- insulin) from August 25, 1997, the date on which TDC
ceased funding such products, through October 31, 1997. ALZA
recorded revenues of $8.1 million in the third quarter of 1997 as
reimbursement from Crescendo for the development costs of the
Initial Products through September 30, 1997. Continuation of
development of the Initial Products after October 31, 1997 is
subject to ALZA proposing and Crescendo's Board of Directors
accepting work plans and cost estimates for the products.
ALZA CORPORATION
Notes to Consolidated Financial Statements (unaudited)
4. Crescendo Pharmaceuticals Corporation (continued)
ALZA and Crescendo have entered into a Technology License
Agreement pursuant to which ALZA has granted to Crescendo a
worldwide license to use ALZA technology solely to select and
develop Crescendo products, to conduct related activities, and to
commercialize such products. In exchange for the license to use
existing ALZA technology relating to the Initial Products,
Crescendo will pay a technology fee to ALZA, payable monthly over
a period of three years, in the amount of $1 million per month
for the 12 months following the distribution of Crescendo Shares,
$667,000 per month for the following 12 months and $333,000 per
month for the following 12 months. The technology fee will no
longer be payable at such time as fewer than two of the Initial
Products are being developed by Crescendo and/or have been
licensed by ALZA pursuant to the license option described below.
ALZA recorded a technology fee from Crescendo of $1 million for
the quarter ended September 30, 1997.
ALZA has an option to acquire an exclusive, royalty-bearing
license to each product developed by Crescendo under the
Development Agreement. The option is exercisable on a product by
product, country by country basis. Also, under Crescendo's
Restated Certificate of Incorporation ALZA has the right to
purchase all (but not less than all) of the Crescendo Shares.
5. Asset Write-down
During the third quarter of 1997, ALZA wrote down
approximately $11.5 million of fixed assets, $8.1 million of
which related to excess, under-utilized, or otherwise impaired
manufacturing equipment. Lower than expected production
requirements under a supply agreement with G.D. Searle & Co.
("Searle") for Covera-HS-Trademark- (verapamil) contributed to
under-utilization of the manufacturing equipment. Such equipment
was written-down to its fair market value, which was determined
based upon estimates of current market prices. ALZA has not yet
determined the ultimate disposition of these assets. The
remaining $3.4 million of the write-down is related primarily to
obsolete and idle assets that have no fair market value.
ALZA CORPORATION
Notes to Consolidated Financial Statements (unaudited)
6. Earnings (Loss) Per Share
For the quarter and nine months ended September 30, 1997, the
earnings (loss) per share calculation is based upon weighted
average shares of ALZA common stock outstanding during each
period. The effect of stock options and the 5 1/4% Debentures
were excluded from the calculation for both periods, as their
inclusion would have had an anti-dilutive effect. Earnings per
share for the quarter and nine months ended September 30, 1996 is
based on weighted average shares of ALZA common stock outstanding
during each period, plus dilutive warrants and options. The 5
1/4% Debentures are considered to be common stock equivalents,
and shares issuable upon an assumed conversion of the 5 1/4%
Debentures were dilutive for the quarter and nine months ended
September 30, 1996, respectively. The 5% Debentures are not
considered common stock equivalents and were not included in the
fully diluted earnings per share calculation for the periods
presented as their inclusion would have had an anti-dilutive
effect. Fully diluted earnings per share are not shown on the
Condensed Consolidated Statement of Income since dilution is less
than 3% for each period presented.
In February 1997, the Financial Accounting Standards Board
issued Statement No. 128, Earnings per Share ("SFAS 128"), which
is required to be adopted on December 31, 1997. At that time,
ALZA will be required to change the method currently used to
compute earnings per share and to restate all prior periods.
Under the new requirements for calculating basic earnings per
share, which replaces primary earnings per share, the dilutive
effect of stock options and other common stock equivalents will
be excluded. Diluted earnings per share, which replaces fully
diluted earnings per share, will include the dilutive effect of
stock options, other common stock equivalents and convertible
securities. Basic earnings (loss) per share is expected to be the
same as the reported primary earnings (loss) per share for the
quarter and nine months ended September 30, 1997, and for the
third quarter of 1996. Basic earnings per share is expected to
be $0.01 higher for the nine months ended September 30, 1996.
Diluted earnings (loss) per share is not expected to be
materially different from fully diluted earnings (loss) per share
for the quarter and nine months ended September 30, 1996 and
1997.
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Notice Concerning Forward-Looking Statements
Some of the statements made in this Form 10-Q are forward-
looking in nature, including but not limited to ALZA's product
development activities and plans, plans concerning the
commercialization of products, statements concerning potential
product sales, future costs of products shipped (and gross
margins), and associated marketing and selling expenses and other
statements that are not historical facts. The occurrence of the
events described, and the achievement of the intended results,
are subject to the future occurrence of many events, some or all
of which are not predictable or within ALZA's control; therefore,
actual results may differ materially from those anticipated in
any forward-looking statements. Many risks and uncertainties are
inherent in the pharmaceutical industry; others are more specific
to ALZA's business. Many of the significant risks related to
ALZA's business are described in ALZA's Annual Report on Form 10-
K, including risks associated with technology and product
development, clinical development, regulatory clearance to market
products and medical acceptance of products, changes in the
health care marketplace, patent and intellectual property
matters, regulatory and manufacturing issues, licensing or
acquiring products from third parties, commercializing
pharmaceutical products and competition.
Third Quarter 1997 Events
During the third quarter of 1997, ALZA exercised its option to
purchase all of the outstanding Class A Common Stock of TDC,
contributed $300 million to Crescendo and distributed the
Crescendo Shares. These transactions, and their impact on ALZA's
financial statements, are discussed below, and in Notes 2 and 4
of the Notes to Financial Statements.
In July 1997, ALZA acquired exclusive rights to Mycelex-
Registered Trademark- (clotrimazole) Troche in the United States
from Bayer Corporation ("Bayer"). Under the terms of the
agreement with Bayer, ALZA made a $50 million upfront payment to
Bayer and will make an additional payment if net sales of the
product during a certain period are above a specified level.
Bayer will manufacture Mycelex-Registered Trademark- Troche for
ALZA, and ALZA will make payments to Bayer based on net sales of
the product.
Effective September 30, 1997, ALZA entered into a clinical
development and option agreement with Alkermes relating to
RMP-7, a compound intended to facilitate the delivery of
chemotherapeutic agents to the brain. Under the terms of the
agreement, ALZA paid Alkermes $10 million, which was charged to
acquisition of in-process research and development on ALZA's
Statement of Income. Under the agreement, Alkermes will conduct
additional clinical activities related to the product, and ALZA
has the option to acquire exclusive worldwide commercialization
rights to RMP-7.
During the third quarter of 1997, ALZA wrote down
approximately $11.5 million of excess or under-utilized
manufacturing equipment and obsolete and idle assets. Lower than
expected production requirements under a supply agreement with
Searle for Covera-HS-Trademark- contributed to the under-
utilization of manufacturing assets.
RESULTS OF OPERATIONS
ALZA's net loss was $326.5 million, or $3.83 per share, for
the quarter ended September 30, 1997, reflecting non-recurring
charges of $353.5 million, or $4.14 per share. Excluding the non-
recurring items, net income was $27.0 million, or $0.31 per
share, for the third quarter of 1997, compared to net income of
$23.1 million, or $0.27 per share, for the third quarter of 1996.
The net loss for the nine months ended September 30, 1997 was
$273.8 million, or $3.22 per share (net income of $79.8 million,
or $0.91 per share, excluding non-recurring items), compared to
net income of $66.6 million, or $0.78 per share ($64.4 million,
or $0.76 per share, excluding non-recurring items), for the nine
months ended September 30, 1996.
ALZA's net income currently results primarily from royalties
and fees from client companies. Royalties and fees, which are
generally derived from sales by client companies of products
developed jointly with ALZA, vary from quarter to quarter as a
result of changing levels of product sales by client companies
and, occasionally, the receipt by ALZA of certain one-time fees.
Because ALZA's clients generally take responsibility for
obtaining necessary regulatory approvals and make all marketing
and commercialization decisions regarding such products, most of
the variables that affect ALZA's royalties and fees are not
directly within ALZA's control.
During the next several years, ALZA intends to become less
dependent on royalties and fees by continuing to expand ALZA's
sales and marketing activities and by directly marketing and
selling more products; however, there can be no assurance that
ALZA will be successful in undertaking this expansion, or that
any expanded sales and marketing activities will be successful,
due to factors such as the risks associated with developing,
clinically testing and obtaining regulatory clearance of products
for ALZA marketing, the difficulties and costs associated with
acquiring from third parties products for ALZA to market, the
length of the regulatory approval process, the uncertainties
surrounding the acceptance of new products by the intended
markets, the marketing of competitive products, risks relating to
patents and proprietary rights and the current health care cost
containment environment. ALZA expects that, in the near term,
net income will continue to result primarily from royalties on
sales by clients of currently marketed products.
Royalties, Fees and Other Revenue
Royalties, fees and other revenue were $41.9 million for the
quarter and $131.8 million for the nine months ended September
30, 1997, compared to $39.5 million and $126.1 million,
respectively, for the corresponding periods in 1996. Excluding
non-recurring items, royalties, fees and other revenue for the
nine months ended September 30, 1996 were $115.6 million. The
1996 non-recurring items consisted
primarily of a benefit from the reversal of a reserve for
royalties on sales of Procardia XL-Registered Trademark- and a
benefit in connection with the settlement of litigation related
to patent disputes concerning transdermal nicotine patches, which
were partially offset by a charge related to an advance payment
to the limited partners of the ALZA OROS-Registered Trademark-
Products Limited Partnership in connection with the purchase by
ALZA of their interests in the partnership.
Excluding the 1996 non-recurring items, royalties, fees, and
other income increased 6% for the third quarter and 14% for the
nine months ended September 30, 1997 compared to the
corresponding periods in 1996, primarily resulting from increased
royalties due to higher sales of Glucotrol XL-Registered
Trademark- by Pfizer Inc. ("Pfizer"), Duragesic-Registered
Trademark- by Janssen Pharmaceutica, Inc. ("Janssen") and Covera-
HS-Trademark- by Searle, which were partially offset by decreased
royalties on sales of Transderm-Nitro-Registered Trademark- by
Novartis Pharmaceuticals Corporation, Procardia XL-Registered
Trademark- by Pfizer and NicoDerm-Registered Trademark- CQ-
Trademark- by SmithKline Beecham ("SmithKline"). While sales of
NicoDerm-Registered Trademark- CQ-Trademark- increased during the
quarter, royalties declined as a result of a reduction in royalty
rates under ALZA's agreement covering the product, which provides
for a reduction in royalty rates above a specified sales level
each year. Royalties, fees and other revenue for the third
quarter of 1997 included a technology fee of $1 million from
Crescendo, discussed below. Royalties, fees and other revenue
for the nine months ended September 30, 1997 also included
upfront payments from Knoll Pharmaceutical Company in connection
with an agreement for continued development and worldwide
commercialization of the OROS-Registered Trademark- hydromorphone
product, from SmithKline in connection with the agreement for the
commercialization of the Nicoderm-Registered Trademark-
transdermal nicotine product in China and Japan, and from Pfizer
for the rights to commercialize the OROS-Registered Trademark-
pseudoephedrine product outside the U.S.
Sales of Procardia XL-Registered Trademark-, as reported by
Pfizer, decreased 11% and 16% for the quarter and nine months
ended September 30, 1997, respectively, compared to the same
periods in 1996. Royalties from Procardia XL-Registered
Trademark- accounted for approximately 35% and 30% of ALZA's
royalties, fees and other revenue for the quarter and nine months
ended September 30, 1997, respectively. In June 1997, Mylan
Laboratories Inc. ("Mylan") filed an Abbreviated New Drug
Application ("ANDA") with the FDA requesting clearance to market
a controlled-release nifedipine tablet as a generic alternative
to Procardia XL-Registered Trademark-. On July 8, 1997, Pfizer
filed a suit in federal court in Washington D.C. seeking to
prevent the review of the ANDA and to require Mylan to submit an
ANDA suitability petition. Additionally, Pfizer has filed a suit
against Mylan in federal court in Pennsylvania for infringement
of a patent licensed to Pfizer by a third party relating to
nifedipine. Under applicable law, Pfizer's suit may have the
effect of delaying FDA clearance of Mylan's ANDA. However, it is
not possible to predict the outcome of such litigation, nor is it
possible to predict the impact Mylan's product, if cleared for
marketing, may ultimately have on sales of Procardia XL-
Registered Trademark- and the resulting royalties to ALZA.
Research and Development
Research and development revenue was $36.1 million and
$106.0 million for the quarter and nine months ended
September 30, 1997, compared to $29.4 million and $94.8 million,
respectively, for the corresponding periods in 1996. Research
and development revenue from TDC was $18.5 million for the
quarter and $67.8 million for the nine months ended September 30,
1997, and $22.4 million and $73.9 million, respectively, for the
corresponding periods in 1996. Crescendo commenced operations in
the third quarter of 1997, and revenues from Crescendo for the
quarter and nine months ended September 30, 1997 were $8.1
million. Research and development revenue from other clients
increased in the quarter and nine months ended September 30, 1997
compared to the same periods in 1996, reflecting an increase in
product development activities under agreements with client
companies. Included in research and development revenue for the
nine months ended September 30, 1996 were $2.1 million of non-
recurring charges related to a credit to TDC and to certain
uncollectible receivables.
Research and development expenses were $41.9 million for the
quarter and $116.5 million for the nine months ended September
30, 1997, compared to $31.7 million and $101.2 million for the
corresponding periods in 1996, reflecting the increased activity
for client companies, including TDC and Crescendo.
Therapeutic Discovery Corporation
On September 29, 1997, ALZA purchased all of the outstanding
shares of TDC Class A Common Stock for $100 million in cash. The
purchase resulted in a charge of $77 million to acquisition of in-
process research and development on ALZA's Statement of Income,
and the remaining $23 million of the purchase price was allocated
to a deferred tax asset arising from TDC's net operating loss
carryforward and capitalized research and development.
Crescendo Pharmaceuticals Corporation
On September 29, 1997, ALZA contributed $300 million in cash
to Crescendo. On September 30, 1997, shares Crescendo Shares
were distributed to holders of ALZA common stock and ALZA's
outstanding convertible subordinated debentures. ALZA recorded a
charge of $247 million, including expenses of $4 million,
interest expense of $8 million related to the distribution to
debenture holders and a dividend of $49 million to ALZA common
stockholders for the distribution of Crescendo Shares.
Under the Development Agreement between ALZA and Crescendo,
Crescendo will fund the development of human pharmaceutical
products proposed by ALZA and accepted by Crescendo. The Initial
Products (OROS-Registered Trademark- oxybutynin, DUROS-Trademark-
leuprolide, OROS-Registered Trademark- methylphenidate, IUTS
progesterone, D-TRANS-Trademark- testosterone matrix, E-TRANS-
Trademark- LHRH and E-TRANS-Trademark- insulin) from August 25,
1997, the date on which TDC ceased funding such products, through
October 31, 1997. ALZA recorded revenues of $8.1 million in the
third quarter of 1997 as reimbursement for the development costs
of the Initial Products through September 30, 1997.
Continuation of development of the products after October 31,
1997, is subject to ALZA proposing and Crescendo's Board of
Directors accepting work plans and cost estimates for the
products (see Subsequent Events).
Under the Technology License Agreement between ALZA and
Crescendo, ALZA has granted to Crescendo a worldwide license to
use ALZA technology solely to select and develop Crescendo
products, and to conduct related activities, and to commercialize
such products. In exchange for the license to use existing ALZA
technology relating to the Initial Products, Crescendo will pay a
technology fee to ALZA, payable monthly over a period of three
years in the amount of
$1 million per month for the 12 months following the distribution
of Crescendo Shares, $667,000 per month for the following 12
months and $333,000 per month for the following 12 months. The
technology fee will no longer be payable at such time as fewer
than two of the Initial Products are being developed by Crescendo
and/or have been licensed by ALZA pursuant to the option, granted
to it by Crescendo, to license any or all Crescendo products.
ALZA recorded a technology fee from Crescendo of $1 million for
the quarter ended September 30, 1997.
ALZA has an option to acquire an exclusive, royalty-bearing
license to each product developed by Crescendo under the
Development Agreement. The option is exercisable on a product by
product, country by country basis. Also, under Crescendo's
Restated Certificate of Incorporation ALZA also has the right to
purchase all (but not less than all) of the Crescendo Shares.
Net Sales
Net sales were $36.5 million for the quarter and
$100.4 million for the nine months ended September 30, 1997, an
increase of 24% and 20%, respectively, compared to the
corresponding periods in 1996. The increases were due primarily
to sales of Mycelex-Registered Trademark- Troche, the U.S. rights
to which were acquired in July 1997, and higher sales of Ethyol-
Registered Trademark- compared with the same periods last year.
Net sales of Ethyol-Registered Trademark- for the quarter and the
nine months ended September 30, 1997 were $5.7 million and
$14.4 million, respectively, compared to $2.1 million and
$5.3 million for the same periods in 1996. Ethyol-Registered
Trademark- was launched in April 1996. Net sales of Mycelex-
Registered Trademark- Troche were $5.2 million for the third
quarter and the nine months ended September 30, 1997. Sales of
ALZA-marketed products increased to 39% and 29% of total net
sales for the quarter and nine months ended September 30, 1997,
respectively, from 19% in each of the corresponding periods in
1996. Net sales to client companies declined 5% for the third
quarter of 1997 compared with the third quarter of 1996, and
increased 4% for the nine months ended September 30, 1997
compared with the same period in 1996.
The timing and quantities of orders for products marketed by
client companies are not within ALZA's control. Net sales to
client companies, therefore, can be expected to fluctuate from
period to period, sometimes significantly, depending on the
volume, mix and timing of orders of products shipped to client
companies, and in some quarters, due to the shipment of launch
quantities of products to the clients. The timing and quantities
of orders for ALZA-marketed
products may vary from quarter to quarter due to factors such as
demand for the products, ordering patterns of wholesalers,
introduction and sales of competing products.
Costs of products shipped increased to $22.0 million for the
quarter and $64.9 million for the nine months ended September 30,
1997, compared to $21.4 million and $67.0 million, respectively,
for the corresponding 1996 periods, reflecting the increase in
net sales. Costs of products shipped for the nine months ended
September 30, 1996 includes a $2.4 million non-recurring charge
related primarily to costs associated with a limited recall of
two lots of the Duragesic-Registered Trademark- product.
ALZA's gross margin (net sales less costs of products
shipped) as a percent of net sales increased to 40% for the
quarter and 35% for the nine months ended September 30, 1997,
compared to 27% and 23% for the quarter and nine months ended
September 30, 1996, respectively, excluding the non-recurring
charge described above. The increase was largely due to
increased sales of ALZA-marketed products and higher margins on
products shipped to client companies. ALZA expects its gross
margin on net sales to increase from historical rates over the
longer term, although quarter-to-quarter fluctuations, even
significant ones, can be expected to continue to occur for the
reasons discussed above. A trend of higher than historical gross
margins may ultimately be achieved through a proportionate
increase in the sales of ALZA-marketed products in relation to
sales of client-marketed products, increased utilization of
capacity, and greater operating efficiencies.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were
$11.0 million and $35.1 million for the third quarter and nine
months ended September 30, 1997, compared with $11.6 million and
$33.7 million for the corresponding periods in 1996. The decline
in selling, general and administrative expenses in the third
quarter of 1997 compared with the third quarter of 1996 was due
primarily to the higher cash surrender value of life insurance
policies, which reduced expenses, partially offset by higher
sales and marketing expenses resulting from the expansion of
ALZA's sales force in support of Ethyol-Registered Trademark- and
Mycelex-Registered Trademark- Troche. Sales and marketing
expenses are expected to increase, primarily due to growth in the
sales force resulting from the acquisition of new products and
the amortization of acquisition fees for those products.
Interest Expense and Income
Interest expense increased to $13.8 million for the quarter
and $41.3 million for the nine months ended September 30, 1997,
compared to $12.9 million and $30.3 million, respectively, for
the corresponding periods in 1996. The increase in the third
quarter of 1997 compared to the third quarter of 1996 was due
primarily to lower amounts of capitalized interest and higher
interest on the 5 1/4% Debentures in the 1997 quarter. The
interest expense associated with
ALZA's 5% Debentures, which were issued in April 1996, also
contributed to the increase in interest expense for the nine
months ended September 30, 1997 compared with the same period in
1996.
Interest and other income increased to $17.8 million for the
quarter and $48.3 million for the nine months ended September 30,
1997, compared to $16.5 million and $35.0 million, respectively,
for the corresponding periods in 1996, primarily due to higher
average invested cash balances following ALZA's issuance of $500
million of 5% Debentures. Gains realized on sales of securities
were also included in interest and other income for the quarter
and nine month periods of 1997 and 1996. Interest and other
income is expected to be lower in future quarters as a result of
the reduction of cash and investment balances, as described under
Liquidity and Capital Resources below.
Effective Tax Rate
ALZA's 1997 effective combined federal and state income tax
rate is estimated to be 38% on income before the non-recurring
items. The non-recurring items recognized during the third
quarter of 1997 are generally not deductible for income tax
purposes. The effective tax rate for the year ended 1996 was
38%.
Subsequent Events
On October 20,1997, ALZA acquired the rights in the United
States to the Ditropan-Registered Trademark- (oxybutynin
chloride) product and trademark from Hoechst Marion Roussel, Inc.
("HMRI"). Under the terms of the agreement, ALZA made an upfront
payment to HMRI and will make additional payments if specified
sales levels of Ditropan-Registered Trademark- are achieved.
HMRI will manufacture and package the product for ALZA. ALZA
will have the right to market other products in the United States
under the Ditropan-Registered Trademark- tradename.
On October 21, 1997, the Board of Directors of Crescendo
approved, based upon ALZA's recommendation, work plans for the
continued development of six of the Initial Products. On ALZA's
recommendation, Crescendo determined not to fund additional
development of the
D-TRANS-Trademark- testosterone matrix product at this time.
On October 23, 1997, ALZA acquired the exclusive rights in
the United States and Canada to Elmiron-Registered Trademark-
(pentosan polysulfate sodium) and three additional urology
products, BiCitra-Registered Trademark-(sodium citrate and citric
acid), PolyCitra-Registered Trademark-(potassium citrate) and
Neutra-Phos-Registered Trademark-(potassium and sodium
phosphate), from Baker Norton Pharmaceuticals, Inc., and its
parent, IVAX Corporation (together, "IVAX"). Under the terms of
the agreement, ALZA paid a $75 million upfront fee to IVAX and
will pay additional fees if specified Elmiron-Registered
Trademark- sales levels are achieved during the next five years.
IVAX will manufacture and package the products for ALZA and will
receive payments from ALZA based on sales of the products. As
part of the product acquisition, ALZA hired the U.S. sales
representatives of IVAX, and effectively doubled the size of its
sales force.
ALZA has entered into an agreement with the developers Peery
and Arrillaga to form a limited liability company for the
development of a 13-acre parcel in Mountain View, California.
ALZA's initial investment in the partnership is $36 million,
which will be paid in November 1997. These funds will be applied
to the construction of buildings, which the limited liability
company will lease to ALZA. ALZA has also entered into a lease
of an adjacent seven acre parcel on which it plans to construct a
pilot plant, laboratories and other technical facilities. The
lease includes an option for ALZA to purchase the property and
for Peery and Arrillaga to sell the property to ALZA. On October
28, 1997, the Mountain View City Council approved construction
plans for the site.
LIQUIDITY AND CAPITAL RESOURCES
During the third quarter of 1997, ALZA paid $100 million in
cash for the purchase of all of the shares of TDC Class A Common
Stock, and contributed $300 million in cash to Crescendo, the
Class A Common Stock of which was distributed to ALZA security
holders. Also during the quarter, ALZA paid Bayer a $50 million
upfront fee for the United States rights to Mycelex-Registered
Trademark- Troche and made a $10 million payment to U.S.
Bioscience, Inc. related to Ethyol-Registered Trademark-, in
accordance with an agreement between the companies covering that
product. In October 1997, ALZA made an upfront payment of $75
million to IVAX for the United States and Canadian rights to
Elmiron-Registered Trademark- and three additional urology
products, and paid $10 million to Alkermes under the agreement
related to RMP-7. Cash was provided for these transactions from
the sales and maturities of short- and long-term investments, as
well as from cash and cash equivalents.
ALZA's capital spending for the nine months ended September
30, 1997 was $23.6 million for additions to property, plant and
equipment to support its expanding research, development and
manufacturing activities, compared to capital spending of $32.1
million in the same period of 1996. While ALZA believes its
current facilities and equipment are sufficient to meet its
current operating requirements, ALZA is expanding its facilities
and equipment to support its medium-term and long-term
requirements.
ALZA believes that its existing cash and investment balances
are adequate to fund its cash needs for 1997 and beyond. In
addition, should the need arise, ALZA believes it would be able
to borrow additional funds or otherwise raise additional capital.
ALZA may consider using its capital to make strategic investments
or to acquire or license technology or products. ALZA may also
enter into strategic alliances with third parties which could
provide additional funding for research and product development
and support for product marketing and sales.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Product liability suits have been filed against ALZA from
time to time relating to products manufactured or marketed by
ALZA, including several suits against ALZA and Janssen relating
to the Duragesic-Registered Trademark- product, which is
manufactured by ALZA and marketed by Janssen. Janssen is
managing the defense of these suits in consultation with ALZA
under an agreement between the parties. In the ordinary course
of business, ALZA is also a defendant in suits brought by
individuals relating to their employment with ALZA or the
termination of such employment.
Historically, the cost of resolution of liability (including
product liability) claims has not been significant, and ALZA does
not believe that the resolution of any asserted claims pending
against it, including the suits mentioned above, or of any
unasserted claims of which it is aware, would have a material
adverse impact on the operations or financial position of ALZA.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
10.1 Restated Certificate of Incorporation of Crescendo, as
corrected
10.2 Technology License Agreement between ALZA and Crescendo
10.3 Development Agreement between ALZA and Crescendo
10.4 License Option Agreement between ALZA and Crescendo
10.5 Amended and Restated Stock Plan
11 Statement Regarding Computation of Per Share Earnings
27 Financial Data Schedule
(b) Reports on Form 8-K filed during the quarter
On October 6, 1997, ALZA filed a Form 8-K to report the
special distribution of shares of Crescendo Pharmaceuticals
Corporation on September 30, 1997.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act
of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned thereunto duly authorized.
ALZA CORPORATION
Date: November 6, 1997 By: /s/ E. Mario
Dr. Ernest Mario
Chief Executive Officer
Date: November 6, 1997 By: /s/ Bruce C. Cozadd
Bruce C. Cozadd
Senior Vice President and
Chief Financial Officer