UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
---------
FORM 10-Q
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MARK ONE
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004
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 |_|
INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS
DEFINED IN RULE 12B-2 OF THE EXCHANGE ACT.)
YES |X| NO |_|
AS OF APRIL 30, 2004 THE REGISTRANT HAD A TOTAL OF 14,564,838 SHARES OF COMMON
STOCK, $.01 PAR VALUE, OUTSTANDING.
1
INDEX
PDI, INC.
PART I. FINANCIAL INFORMATION
PAGE
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
BALANCE SHEETS
MARCH 31, 2004 AND DECEMBER 31, 2003................................3
STATEMENTS OF OPERATIONS -- THREE MONTHS
ENDED MARCH 31, 2004 AND 2003.......................................4
STATEMENTS OF CASH FLOWS -- THREE MONTHS
ENDED MARCH 31, 2004 AND 2003.......................................5
NOTES TO CONSOLIDATED 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............................................31
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS..................................................32
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS..............NOT APPLICABLE
ITEM 3. DEFAULT UPON SENIOR SECURITIES.........................NOT APPLICABLE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS....NOT APPLICABLE
ITEM 5. OTHER INFORMATION......................................NOT APPLICABLE
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K...................................33
SIGNATURES ...................................................................35
2
PDI, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)
March 31, December 31,
2004 2003
----------- ----------
ASSETS
Current assets:
Cash and cash equivalents................................ $ 74,706 $113,288
Short-term investments................................... 44,166 1,344
Inventory, net........................................... - 43
Accounts receivable, net of allowance for doubtful
accounts of $1,253 and $749 as of March 31, 2004 and
December 31, 2003, respectively...................... 28,004 40,885
Unbilled costs and accrued profits on contracts in
progress ............................................ 18,603 4,041
Deferred training........................................ 2,100 1,643
Other current assets..................................... 9,080 8,847
Deferred tax asset....................................... 11,046 11,053
-------- --------
Total current assets........................................ 187,705 181,144
Net property and equipment.................................. 15,724 14,494
Deferred tax asset.......................................... 7,304 7,304
Goodwill.................................................... 11,132 11,132
Other intangible assets..................................... 1,495 1,648
Other long-term assets...................................... 3,901 3,901
-------- --------
Total assets................................................ $227,261 $219,623
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable......................................... $ 8,717 $ 8,689
Accrued returns.......................................... 22,523 22,811
Accrued incentives....................................... 11,093 20,486
Accrued salaries and wages............................... 11,077 9,031
Unearned contract revenue................................ 10,299 3,604
Restructuring accruals................................... 580 744
Income taxes and other accrued expenses.................. 17,305 15,770
-------- --------
Total current liabilities................................... 81,594 81,135
Total long-term liabilities................................. - -
-------- --------
Total liabilities........................................... $ 81,594 $ 81,135
-------- --------
Commitments and Contingencies (note 12)
Stockholders' equity:
Common stock, $.01 par value, 100,000,000 shares
authorized: shares issued and outstanding, March 31, 2004
- 14,484,341 and December 31, 2003 - 14,387,126;
161,115 and 136,178 restricted shares issued and
outstanding at March 31, 2004 and December 31, 2003,
respectively........................................... $ 147 $ 145
Preferred stock, $.01 par value, 5,000,000 shares
authorized, no shares issued and outstanding........... - -
Additional paid-in capital (includes restricted of $4,955
and $2,361 as of March 31, 2004 and December 31, 2003,
respectively) ......................................... 112,881 109,531
Retained earnings........................................... 35,480 29,505
Accumulated other comprehensive income...................... 54 25
Unamortized compensation costs.............................. (2,785) (608)
Treasury stock, at cost: 5,000 shares....................... (110) (110)
-------- --------
Total stockholders' equity.................................. $145,667 $138,488
-------- --------
Total liabilities & stockholders' equity.................... $227,261 $219,623
======== ========
The accompanying notes are an integral part of these financial statements
3
PDI, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
THREE MONTHS ENDED MARCH 31,
2004 2003
----------- -----------
Revenue
Service, net.......................................................... $88,266 $67,511
Product, net.......................................................... 101 34
------- -------
Total revenue, net.................................................. 88,367 67,545
------- -------
Cost of goods and services
Program expenses (including related party amounts of
$180 and $73 for the periods ended
March 31, 2004 and 2003, respectively)............................... 61,707 49,881
Cost of goods sold.................................................... 145 62
------- -------
Total cost of goods and services.................................... 61,852 49,943
------- -------
Gross profit............................................................. 26,515 17,602
Operating expenses
Compensation expense.................................................. 10,216 8,874
Other selling, general and administrative expenses.................... 6,490 5,833
Restructuring and other related expenses (credits).................... - (270)
Litigation settlement................................................. - 2,100
------- -------
Total operating expenses............................................ 16,706 16,537
------- -------
Operating income......................................................... 9,809 1,065
Other income, net........................................................ 318 269
------- -------
Income before provision for taxes........................................ 10,127 1,334
Provision for income taxes............................................... 4,152 556
------- -------
Net income............................................................... $ 5,975 $ 778
======= =======
Basic net income per share............................................... $ 0.41 $0.05
======= =======
Diluted net income per share............................................. $ 0.40 $0.05
======= =======
Basic weighted average number of shares outstanding...................... 14,461 14,166
======= =======
Diluted weighted average number of shares outstanding.................... 14,767 14,237
======= =======
The accompanying notes are an integral part of these financial statements
4
PDI, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
THREE MONTHS ENDED MARCH 31,
2004 2003
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income................................................................. $ 5,975 $ 778
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization...................................... 1,512 1,397
Reserve for inventory obsolescence and bad debt.................... 505 54
Deferred taxes, net................................................ 7 -
Stock compensation costs........................................... 651 111
Other changes in assets and liabilities:
Decrease in accounts receivable.................................... 12,376 5,788
Decrease (increase) in inventory................................... 43 (318)
(Increase) in unbilled costs....................................... (14,562) (6,112)
(Increase) in deferred training.................................... (457) (1,062)
(Increase) decrease in other current assets........................ (233) 1,496
Decrease in other long-term assets................................. - 100
Increase (decrease) in accounts payable............................ 28 (363)
(Decrease) in accrued returns...................................... (288) (314)
(Decrease) in accrued liabilities.................................. (4,755) (1,248)
(Decrease) in restructuring liability.............................. (164) (2,848)
Increase (decrease) in unearned contract revenue................... 6,695 (1,309)
(Decrease) in income taxes and other accrued expenses.............. (1,058) (278)
-------- -------
Net cash provided by (used in) operating activities........................ 6,275 (4,128)
-------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Sale of short-term investments........................................ - 1,771
Purchase of short-term investments.................................... (42,793) -
Purchase of property and equipment.................................... (2,588) (215)
-------- -------
Net cash (used in) provided by investing activities........................ (45,381) 1,556
-------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from exercise of stock options........................... 524 -
-------- -------
Net cash provided by financing activities.................................. 524 -
-------- -------
Net (decrease) in cash and cash equivalents................................ (38,582) (2,572)
Cash and cash equivalents - beginning...................................... 113,288 66,827
-------- -------
Cash and cash equivalents - ending......................................... $ 74,706 $64,255
======== =======
The accompanying notes are an integral part of these financial statements
5
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited interim consolidated financial statements and
related notes should be read in conjunction with the consolidated financial
statements of PDI, Inc. and its subsidiaries (the "Company" or "PDI") and
related notes as included in the Company's Annual Report on Form 10-K for the
year ended December 31, 2003 as filed with the Securities and Exchange
Commission. The unaudited interim consolidated financial statements of the
Company have been prepared in accordance with generally accepted accounting
principles (GAAP) for interim financial reporting and the instructions to Form
10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of
the information and footnotes required by GAAP for complete financial
statements. The unaudited interim consolidated financial statements include all
adjustments (consisting of normal recurring adjustments) which, in the judgment
of management, are necessary for a fair presentation of such financial
statements. Operating results for the three month period ended March 31, 2004
are not necessarily indicative of the results that may be expected for the year
ending December 31, 2004. 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 financial statements. In accordance with GAAP, service revenue
and product revenue and their respective direct costs have been shown separately
on the consolidated statements of operations.
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 months ended
March 31, 2004 and 2003, the Company's three and two largest clients,
respectively, who each individually represented 10% or more of our service
revenue, accounted for approximately 80.7%, and 69.0%, respectively, of the
Company's service revenue.
SERVICE REVENUE AND PROGRAM EXPENSES
Service revenue is earned primarily by performing product detailing
programs and other marketing and promotional services under contracts. Revenue
is recognized as the services are performed and the right to receive payment for
the services is assured. Revenue is recognized net of any potential penalties
until the performance criteria relating to the penalties have been achieved.
Performance incentives, as well as termination payments, are recognized as
revenue in the period earned and when payment of the bonus, incentive or other
payment is assured. Under performance based contracts, revenue is recognized
when the performance based parameters are achieved.
Program expenses consist primarily of the costs associated with executing
product detailing programs, performance based contracts or other sales and
marketing services identified in the contract. Program expenses include
personnel costs and other costs associated with executing a product detailing or
other marketing or promotional program, as well as the initial direct costs
associated with staffing a product detailing program. Such costs include, but
are not limited to, facility rental fees, honoraria and travel expenses, sample
expenses and other promotional expenses. Personnel costs, which constitute the
largest portion of program expenses, include all labor related costs, such as
salaries, bonuses, fringe benefits and payroll taxes for the sales
representatives and sales managers and professional staff who are directly
responsible for executing a particular program. Initial direct program costs are
those costs associated with initiating a product detailing program, such as
recruiting, hiring, and training the sales representatives who staff a
particular product detailing program. All personnel costs and initial direct
program costs, other than training costs, are expensed as incurred for service
offerings. Product detailing,
6
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
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.
TRAINING COSTS
Training costs include the costs of training the sales representatives and
managers on a particular product detailing program so that they are qualified to
properly perform the services specified in the related contract. For all
contracts, training costs are deferred and amortized on a straight-line basis
over the shorter of the life of the contract to which they relate or 12 months.
When the Company receives a specific contract payment from a client upon
commencement of a product detailing program expressly to compensate the Company
for recruiting, hiring and training services associated with staffing that
program, such payment is deferred and recognized as revenue in the same period
that the recruiting and hiring expenses are incurred and amortization of the
deferred training is expensed. When the Company does not receive a specific
contract payment for training, all revenue is deferred and recognized over the
life of the contract.
PRODUCT REVENUE AND COST OF GOODS SOLD
Product revenue is recognized when products are shipped and title is
transferred to the customer. Product revenue for the three months ended March
31, 2004 and 2003 was primarily from the sale of the Xylos wound care products.
Cost of goods sold includes all expenses for product distribution costs,
acquisition and manufacturing costs of the product sold.
3. STOCK-BASED COMPENSATION
As of March 31, 2004 the Company has two stock-based employee compensation
plans described more fully in Note 20 to the consolidated financial statements
included in the Company's 2003 Annual Report on Form 10-K. SFAS No. 123,
"ACCOUNTING FOR STOCK-BASED COMPENSATION" allows companies a choice of measuring
employee stock-based compensation expense based on either the fair value method
of accounting or the intrinsic value approach under the Accounting Pronouncement
Board (APB) Opinion No. 25. The Company accounts for these plans under the
recognition and measurement principles of APB Opinion No. 25, "ACCOUNTING FOR
STOCK ISSUED TO EMPLOYEES, AND RELATED INTERPRETATIONS." No stock option-based
employee compensation cost is reflected in net income, as all options granted
under those plans had an exercise price equal to the market value of the
underlying common stock on the date of the grant except for approximately
$234,000 related to the acceleration of unvested stock options for several
employees terminated during the year. Certain employees have received restricted
common stock, the amortization of which is reflected in net income. As required
by SFAS No. 148, "ACCOUNTING FOR STOCK-BASED COMPENSATION - TRANSITION AND
DISCLOSURE - AN AMENDMENT OF SFAS NO. 123", the following table shows the
estimated effect on earnings and per share data as if the Company had applied
the fair value recognition provisions of SFAS No. 123 to stock-based employee
compensation.
7
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
As of March 31,
2004 2003
----------------------------------------
(in thousands, except per share data)
Net income, as reported $ 5,975 $ 778
Add: Stock-based employee compensation expense
included in reported net income, net of
related tax effects 384 114
Deduct: Total stock-based employee compensation
expense determined under fair value based
methods for all awards, net of related tax
effects (748) (1,567)
--------------- ---------------
Pro forma net income (loss) $ 5,611 $ (675)
=============== ===============
Net income (loss) per share
Basic--as reported $ 0.41 $ 0.05
=============== ===============
Basic--pro forma $ 0.39 $ (0.05)
=============== ===============
Diluted--as reported $ 0.40 $ 0.05
=============== ===============
Diluted--pro forma $ 0.38 $ (0.05)
=============== ===============
Compensation cost for the determination of pro forma net loss - as
adjusted and related per share amounts were estimated using the Black Scholes
option pricing model, with the following assumptions: (i) risk free interest
rate of 2.80% and 2.93% at March 31, 2004 and 2003, respectively; (ii) expected
life of five years for the quarters ended March 31, 2004 and 2003; (iii)
expected dividends - $0 for the quarters ended March 31, 2004 and 2003; and (iv)
volatility of 100% for the quarters ended March 31, 2004 and 2003. The weighted
average fair value of options granted during the quarters ended March 31, 2004
and 2003 was $18.62 and $6.66, 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 were canceled and became eligible for re-issuance under the
Company's option plans. The restricted stock is subject to three-year cliff
vesting and is subject to forfeiture upon termination of employment other than
in the event of the recipient's death or disability.
Approximately 47,483 options, which were offered to, but did not
participate in, the option exchange program, are subject to variable accounting.
As such, the Company may record compensation expense if the market price of the
Company's common stock exceeds the exercise price of the non-tendered options
8
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
until these options are terminated, exercised or forfeited. The non-tendered
options have exercise prices ranging from $59.50 to $80.00 and a remaining life
of 6.5 to 6.8 years.
4. CEFTIN CONTRACT TERMINATION
In October 2000, the Company entered into an agreement (the Ceftin
Agreement) with GlaxoSmithKline (GSK) for the exclusive U.S. sales, marketing
and distribution rights for Ceftin(R) Tablets and Ceftin(R) for Oral Suspension,
two dosage forms of a cephalosporin antibiotic, which agreement was terminated
in February 2002 by mutual agreement of the parties. The Ceftin Agreement had a
five-year term but was cancelable by either party without cause on 120 days'
notice. From October 2000 through February 2002, the Company marketed Ceftin to
physicians and sold the products primarily to wholesale drug distributors,
retail chains and managed care providers.
On August 21, 2001, the U.S. Court of Appeals overturned a preliminary
injunction granted by the New Jersey District Court to GSK, which subsequently
allowed for the entry of a generic competitor to Ceftin immediately upon
approval by the FDA. The affected Ceftin patent had previously been scheduled to
run through July 2003. The generic version of Ceftin was approved by the FDA in
February 2002 and it began to be manufactured in late March 2002. As a result of
this U.S. Court of Appeals decision and its impact on future sales, in the third
quarter of 2001 the Company recorded a charge to cost of goods sold and a
related reserve of $24.0 million representing the anticipated future loss to be
incurred by the Company under the Ceftin Agreement as of September 30, 2001. The
recorded loss was calculated as the excess of estimated costs that the Company
was contractually obligated to incur to complete its obligations under the
Ceftin Agreement, over the remaining estimated gross profits to be earned under
the Ceftin Agreement from selling the inventory. These costs primarily consisted
of amounts paid to GSK to reduce purchase commitments, estimated committed sales
force expenses, selling and marketing costs through the effective date of the
termination, distribution costs, and fees to terminate existing arrangements.
The Ceftin Agreement was terminated by the Company and GSK under a mutual
termination agreement entered into in December 2001. GSK resumed exclusive
rights to Ceftin after the effective date of the termination of the Ceftin
Agreement, and the Company believes that GSK currently sells Ceftin under its
own label code.
Pursuant to the termination agreement, the Company agreed to perform
marketing and distribution services through February 28, 2002. As is common in
the pharmaceutical industry, customers who purchased the Company's Ceftin
product are permitted to return unused product, after approval from the Company,
up to six months before and one year after the expiration date for the product,
but no later than December 31, 2004. The products sold by the Company prior to
the Ceftin Agreement termination date of February 28, 2002 have expiration dates
through June 2004. The Company also maintains responsibility for processing and
payment of certain sales rebates through December 31, 2004. The Company's Ceftin
sales aggregated approximately $628 million during the term of the Ceftin
Agreement.
As of December 31, 2002, the Company had accrued reserves of approximately
$16.5 million related to Ceftin sales. Of this accrual, $11.0 million related to
return reserves and $5.5 million related to sales rebates accruals. On an
ongoing basis, the Company assesses its reserve for product returns by:
analyzing historical sales and return patterns; monitoring prescription data for
branded Ceftin; monitoring inventory withdrawals by the wholesalers and
retailers for branded Ceftin; inquiring about inventory levels and potential
product returns with the wholesaler companies; and estimating demand for the
product. During the third quarter of 2003, the Company made a $5.5 million
payment to settle its estimated remaining sales rebate liabilities, and
concluded based on its returns reserve review process, which included a review
of prescription and withdrawal data for branded Ceftin as well as information
communicated to the Company by the wholesalers, that the remaining $11.0 million
reserve for returns was adequate as of September 30, 2003.
9
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
The Company has since determined, based primarily upon new information
obtained from its wholesalers as part of its ongoing reserve review process,
that significant amounts of inventory, incremental to that previously reported
by the wholesalers, are being held by them in inventory. The Company believes
that this resulted, in part, from the sale by the wholesalers of Ceftin product
not supplied by the Company and acquired by the wholesalers subsequent to the
mutual termination of the Ceftin agreement. Based upon this information, the
Company increased its returns reserve $12.0 million to a total reserve of $22.8
million in the fourth quarter 2003.
On March 31, 2004, the Company signed an agreement and waiver with a large
wholesaler by which the Company agreed to pay that wholesaler $10.0 million, and
purchase $2.5 million worth of services from that wholesaler by March 31, 2006,
in exchange for that wholesaler waiving, to the fullest extent permitted by law,
all rights with respect to any additional returns of Ceftin to the Company. The
Company made the payment on April 5, 2004.
The Company's reserve of $22.5 million at March 31, 2004 reflects the
Company's estimated liability for all identified product that could potentially
be returned by all the remaining wholesalers (including the $12.5 million
settlement discussed above), and an estimate of the Company's liability with
respect to remaining, but not yet identified, product sold by the Company that
is still being held in the trade.
The reserve has been calculated based on reimbursing the wholesalers at the
amount that they purchased the product from the Company. In certain instances,
the wholesalers have requested reimbursement at an amount higher than the
original purchase price. The difference is approximately $2.0 million. The
reserve as recorded by the Company is its best estimate based on its
interpretation of the contracts. The Company will continue to assess the
adequacy of its reserves until the Company's obligations for processing any
returned products ceases on December 31, 2004.
5. OTHER PERFORMANCE BASED CONTRACTS
In May 2001, the Company entered into a copromotion agreement with
Novartis Pharmaceuticals Corporation (Novartis) for the U.S. sales, marketing
and promotion rights for Lotensin(R), Lotensin HCT(R) and Lotrel(R). That
agreement was scheduled to run through December 31, 2003. On May 20, 2002, this
agreement was replaced by two separate agreements, one for Lotensin and one for
Lotrel-Diovan through the addition of Diovan(R) and Diovan HCT(R). Both of these
agreements ended December 31, 2003; however, the Lotrel-Diovan agreement was
renewed on December 24, 2003 for an additional one year period. In February
2004, the Company was notified by Novartis of its intent to terminate the
Lotrel-Diovan contract, without cause, effective March 16, 2004 and, as a
result, $28.9 million of anticipated revenue associated with the Lotrel-Diovan
Contract in 2004 will not be realized. The Company was compensated under the
terms of the agreement through the effective termination date. Even though the
Lotensin agreement ended December 31, 2003, the Company is still entitled to
receive royalty payments on the sales of Lotensin through December 31, 2004. The
royalties earned under this arrangement totaled $2.3 million during the first
quarter of 2004; the royalties earned during the remaining quarters of 2004 are
expected to diminish substantially because the product lost its patent
protection in February 2004.
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. The Company
began selling the Xylos products in January 2003; however, sales were
significantly slower than anticipated and actual 2003 sales did not meet the
Company's forecasts. The Company did have the right to terminate the agreement
with 135 days' notice to Xylos, beginning January 1, 2004. Based on these sales
results, the Company concluded that sales of XCell were not sufficient enough to
sustain the Company's continued role as commercialization partner for the
product and therefore, on January 2, 2004, the Company exercised its contractual
right to terminate the agreement on 135 days' notice to Xylos. The Company is
still accepting orders for XCell products until May 16, 2004 when the agreement
will terminate; however, the Company's promotional activities in support of the
brand
10
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
concluded in January 2004. The Company recorded a reserve for potential excess
inventory during 2003 of approximately $835,000. As discussed in Note 6, the
Company continues to have an investment in Xylos. In addition, in February 2004,
the Company entered into a term loan agreement with Xylos, pursuant to which it
has made loans to Xylos in an aggregate amount of $500,000; $375,000 was
disbursed in the quarter ended March 31, 2004 and the remaining $125,000 was
disbursed in April 2004. Pursuant to the terms of the agreement, the loans are
due to be repaid on June 30, 2005.
On December 31, 2002, the Company entered into a licensing agreement with
Cellegy Pharmaceuticals, Inc. (Cellegy) for the exclusive North American rights
for Fortigel(TM), a testosterone gel product. The agreement is in effect for the
commercial life of the product. Cellegy submitted a New Drug Application (NDA)
for the hypogonadism indication to the U.S. Food and Drug Administration (FDA)
in June 2002. In July 2003, Cellegy received a letter from the FDA rejecting its
NDA for Fortigel. Cellegy has told the Company that it is in discussions with
the FDA to determine the appropriate course of action needed to meet
deficiencies cited by the FDA in its determination. Since the Company filed the
lawsuit, Cellegy is no longer in regular contact with the Company regarding
Fortigel. Thus, for example, the Company is unaware of the precise FDA status
regarding Fortigel (as of March 31, 2004, it had not been approved) and the FDA
continued to express concern about the high supraphysiologic Cmax serum
testosterone levels achieved in subjects of Fortigel testing. The Company is
also unaware of what steps Cellegy is taking to develop Fortigel, to obtain FDA
approval for Fortigel, and/or to arrange for a party to manufacture Fortigel.
The Company has requested this information from Cellegy but has not received
full and complete responses from Cellegy. Accordingly, the Company may not
possess the most current and reliable information concerning the current status
of, or future prospects relating to Fortigel. The Company cannot predict with
any certainty whether the FDA will ultimately approve Fortigel for sale in the
U.S. Under the terms of the agreement, the Company paid Cellegy a $15.0 million
initial licensing fee on December 31, 2002. This nonrefundable payment was made
prior to FDA approval and, since there is no alternative future use of the
licensed rights, the $15.0 million payment was expensed by the Company in
December 2002, when incurred. This amount was recorded in other selling,
general, and administrative expenses in the December 31, 2002 consolidated
statements of operations. Pursuant to the terms of the licensing agreement, the
Company will be required to pay Cellegy a $10.0 million incremental license fee
milestone payment upon Fortigel's receipt of all approvals required by the FDA
(if such approvals are obtained) to promote, sell and distribute the product in
the U.S. This incremental milestone license fee, if incurred, will be recorded
as an intangible asset and amortized over its estimated useful life, as then
determined, which is not expected to exceed the life of the patent. The Company
believes that it will not be required to pay Cellegy the $10.0 million
incremental license fee milestone payment in 2004, and it is unclear at this
point when or if Cellegy will get Fortigel approved by the FDA which would
trigger the Company's obligation to pay $10.0 million to Cellegy. Royalty
payments to Cellegy over the term of the commercial life of the product would
range from 20% to 30% of net sales.
As discussed in Note 12, in May 2003, the Company settled a lawsuit with
Auxilium Pharmaceuticals, Inc. which sought to enjoin its performance under the
Cellegy agreement. Additionally, the Company filed a complaint against Cellegy
in December 2003, that alleges, among other things, that Cellegy fraudulently
induced the Company to enter into the licensing agreement, and seeks the return
of the $15.0 million initial licensing fee, plus additional damages caused by
Cellegy's conduct.
6. OTHER INVESTMENTS
In October 2002, the Company acquired $1.0 million of preferred stock of
Xylos. The Company recorded its investment in Xylos under the cost method and
its ownership interest in Xylos is less than five percent. As discussed in Note
5, the Company served in 2003 as the exclusive distributor of the Xylos XCell
product line, but on January 2, 2004, the Company terminated that arrangement
effective May 16, 2004. In addition, in February 2004, the Company entered into
a term loan agreement with Xylos, pursuant to which it has made loans to Xylos
in an aggregate amount of $500,000; $375,000 was disbursed
11
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
in the quarter ended March 31, 2004 and the remaining $125,000 was disbursed in
April 2004. Pursuant to the terms of the agreement, the loans are due to be
repaid on June 30, 2005. Although Xylos recognized operating losses in 2003 and
the first quarter of 2004, the Company continues to believe that, based on
current prospects and activities at Xylos, its investment in Xylos is not
impaired and the amounts loaned are recoverable as of March 31, 2004. However,
if Xylos continues to experience losses and is not able to generate sufficient
cash flows through financing, the Company may not recover its loans and its
investment may become impaired.
7. INVENTORY
At March 31, 2004 the Company's finished goods inventory relating to the
XCell wound care products for which the Company is still accepting orders in
connection with the Xylos agreement discussed in Note 5 is fully reserved. At
December 31, 2003, the Company had approximately $43,000 in finished goods
inventory, net of reserves.
In the third quarter of 2003, as a result of the continued lower than
anticipated Xylos product sales, management recorded a reserve of $835,000 to
reduce the value of the XCell inventory to its estimated net realizable value.
At March 31, 2004 the balance of the reserve was approximately $761,000. As
discussed in Note 5, on January 2, 2004 the Company gave notice of termination
of its agreement with Xylos, effective May 16, 2004, and will therefore
discontinue processing orders for the XCell products after the effective date.
The Company anticipates that any future sales of the XCell products will be
negligible and accordingly has fully reserved for the remaining inventory as of
March 31, 2004.
8. NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued Interpretation No. 46, "CONSOLIDATION OF
VARIABLE INTEREST ENTITIES" (FIN 46). FIN 46 requires a variable interest entity
(VIE) to be consolidated by a company, if that company is subject to a majority
of the risk of loss from the VIE's activities or entitled to receive a majority
of the entity's residual returns or both. In December 2003, the FASB issued a
revision to the FIN 46 (FIN46R) which partially delayed the effective date of
the interpretation to March 31, 2004 and added additional scope exceptions. The
adoption of FIN46 and FIN46R did not have a material impact on the Company's
business, financial position or results of operations.
In December 2003, the Staff of the Securities and Exchange Commission
issued Staff Accounting Bulletin No. 104 (SAB 104), "REVENUE RECOGNITION," which
supercedes SAB 101, "REVENUE RECOGNITION IN FINANCIAL STATEMENTS." SAB 104's
primary purpose is to rescind accounting guidance contained in SAB 101 related
to multiple element revenue arrangements, superceded as a result of the issuance
of EITF 00-21, "ACCOUNTING FOR REVENUE ARRANGEMENTS WITH MULTIPLE DELIVERABLES."
Additionally, SAB 104 rescinds the SEC's "REVENUE RECOGNITION IN FINANCIAL
STATEMENTS FREQUENTLY ASKED QUESTIONS AND ANSWERS" (the FAQ) issued with SAB 101
that had been codified in SEC Topic 13, "REVENUE RECOGNITION." The revenue
recognition principles provided for in both SAB 101 and EITF 00-21 remain
largely unchanged. As a result, the adoption of SAB 104 is not expected to have
a material impact on the Company's business, financial position and results of
operations.
9. HISTORICAL AND PRO FORMA BASIC AND DILUTED NET INCOME PER SHARE
Historical and pro forma basic and diluted net income per share is
calculated based on the requirements of SFAS No. 128, "EARNINGS PER SHARE."
12
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
A reconciliation of the number of shares used in the calculation of basic
and diluted earnings per share for the quarters ended March 31, 2004 and 2003 is
as follows:
THREE MONTHS ENDED
MARCH 31,
2004 2003
------- ------
(in thousands)
Basic weighted average number of common
shares outstanding......................................... 14,461 14,166
Dilutive effect of stock options............................. 306 71
------- ------
Diluted weighted average number of common shares
outstanding................................................ 14,767 14,237
====== ======
Outstanding options at March 31, 2004 to purchase 380,673 shares of common
stock with exercise prices ranging from $27.00 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 March 31, 2003 to
purchase 1,383,108 shares of common stock with exercise prices ranging from
$14.16 to $98.70 were not included in the computation of historical and pro
forma diluted net income per share because to do so would have been
antidilutive.
10. SHORT-TERM INVESTMENTS
At March 31, 2004, short-term investments were $44.2 million, including
approximately $1.5 million of investments classified as available for sale
securities. At March 31, 2003, short-term investments were $4.1 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. All other short-term investments are
stated at cost, which approximates fair value.
11. OTHER COMPREHENSIVE INCOME
A reconciliation of net income as reported in the consolidated statements
of operations to other comprehensive income, net of taxes is presented in the
table below.
THREE MONTHS ENDED
MARCH 31,
2004 2003
------- --------
(in thousands)
Net income............................................................. $ 5,975 $ 778
Other comprehensive income, net of tax:
Unrealized holding gain/(loss) on
available-for-sale securities arising during period............. 10 (69)
Realized losses on sales of securities included in net income .... 19 -
------- --------
Other comprehensive income............................................. $ 6,004 $ 709
======= ========
12. COMMITMENTS AND CONTINGENCIES
Due to the nature of the business in which the Company is engaged, such as
product detailing and distribution of products, it could be exposed to certain
risks. Such risks include, among others, risk of
13
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
liability for personal injury or death to persons using products the Company
promotes or distributes. There can be no assurance that substantial claims or
liabilities will not arise in the future because of the nature of the Company's
business activities and recent increases in litigation related to healthcare
products including pharmaceuticals increases this risk. The Company seeks to
reduce its potential liability under its service agreements through measures
such as contractual indemnification provisions with clients (the scope of which
may vary from client to client, and the performances of which are not secured)
and insurance. The Company could, however, also be held liable for errors and
omissions of its employees in connection with the services it performs that are
outside the scope of any indemnity or insurance policy. The Company could be
materially adversely affected if it was required to pay damages or incur defense
costs in connection with a claim that is outside the scope of an indemnification
agreement; if the indemnity, although applicable, is not performed in accordance
with its terms; or if the Company's liability exceeds the amount of applicable
insurance or indemnity.
SECURITIES LITIGATION
In January and February 2002, the Company, its chief executive officer and
its chief financial officer were served with three complaints that were filed in
the United States District Court for the District of New Jersey alleging
violations of the Securities Exchange Act of 1934 (the "Exchange Act"). These
complaints were brought as purported shareholder class actions under Sections
10(b) and 20(a) of the Exchange Act and Rule 10b-5 established thereunder. On
May 23, 2002, the Court consolidated all three lawsuits into a single action
entitled In re PDI Securities Litigation, Master File No. 02-CV-0211, and
appointed lead plaintiffs (Lead Plaintiffs) and Lead Plaintiffs' counsel. On or
about December 13, 2002, Lead Plaintiffs filed a second consolidated and amended
complaint (Second Consolidated and Amended Complaint), which superseded their
earlier complaints.
The complaint names the Company, its chief executive officer and its chief
financial officer as defendants; purports to state claims against the Company on
behalf of all persons who purchased the Company's Common Stock between May 22,
2001 and August 12, 2002; and seeks money damages in unspecified amounts and
litigation expenses including attorneys' and experts' fees. The essence of the
allegations in the Second Consolidated and Amended Complaint is that the Company
intentionally or recklessly made false or misleading public statements and
omissions concerning its financial condition and prospects with respect to its
marketing of Ceftin in connection with the October 2000 distribution agreement
with GSK, its marketing of Lotensin in connection with the May 2001 distribution
agreement with Novartis, as well as its marketing of Evista(R) in connection
with the October 2001 distribution agreement with Eli Lilly and Company.
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. That motion is fully submitted to the court for its decision. The
Company believes that the allegations in this purported securities class action
are without merit and intends to defend the action vigorously.
BAYER-BAYCOL LITIGATION
The Company has been named as a defendant in numerous lawsuits, including
two class action matters, alleging claims arising from the use of Baycol(R), a
prescription cholesterol-lowering medication. Baycol was distributed, promoted
and sold by Bayer Corporation (Bayer) in the United States through early August
2001, at which time Bayer voluntarily withdrew Baycol from the United States
market. Bayer retained certain companies, such as the Company, to provide
detailing services on its behalf pursuant to contract sales force agreements.
The Company may be named in additional similar lawsuits. To date, the Company
has defended these actions vigorously and has asserted a contractual right of
indemnification against Bayer for all costs and expenses the Company incurs
relating to these proceedings. In February 2003, the Company entered into a
joint defense and indemnification agreement with Bayer,
14
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
pursuant to which Bayer has agreed to assume substantially all of the Company's
defense costs in pending and prospective proceedings and to indemnify the
Company in these lawsuits, subject to certain limited exceptions. Further, Bayer
agreed to reimburse the Company for all reasonable costs and expenses incurred
to date in defending these proceedings. As of February 20, 2004 Bayer has
reimbursed the Company for approximately $1.6 million in legal expenses, of
which approximately $700,000 was received in the quarter ended March 31, 2003
and was reflected as a credit within selling, general and administrative
expense. No amounts have been recorded in 2004.
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 were filled for Fortigel prior to January 26, 2004. As discussed
in Note 5, in July 2003, Cellegy received a letter from the FDA rejecting its
NDA for Fortigel. The Company did not pay any additional amount to Auxilium as
set forth in clause (b) above since Fortigel was not approved by the FDA prior
to January 26, 2004. The Company does not believe that the terms of the
Settlement Agreement will have any impact on the success of its
commercialization of the product if, or when, the FDA approves it.
CELLEGY PHARMACEUTICALS LITIGATION
On December 12, 2003, the Company filed a complaint against Cellegy in
the U.S. District Court for the Southern District of New York. The complaint
alleges that Cellegy fraudulently induced the Company to enter into a December
2002 license agreement with Cellegy regarding Fortigel ("License Agreement").
The complaint also alleges claims for misrepresentation and breach of contract
related to the License Agreement. In the complaint, the Company seeks, among
other things, rescission of the License Agreement and return of the $15.0
million initial licensing fee it paid Cellegy. After the Company filed this
lawsuit, also on December 12, 2003, Cellegy filed a complaint against the
Company in the U.S. District Court for the Northern District of California.
Cellegy's complaint seeks a declaration that Cellegy did not fraudulently induce
the Company to enter the License Agreement and that Cellegy has not breached its
obligations under the License Agreement. By order dated April 23, 2004, the
Company's lawsuit was transferred to the Northern District of California where
it will be consolidated with Cellegy's action. The Company is unable to predict
the ultimate outcome of these lawsuits.
OTHER LEGAL PROCEEDINGS
The Company is currently a party to other legal proceedings incidental to
its business. While the Company currently believes that the ultimate outcome of
these proceedings individually and in the aggregate, will not have a material
adverse effect on its consolidated financial statements, litigation is
15
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
subject to inherent uncertainties. Were the Company to settle a proceeding for a
material amount or were an unfavorable ruling to occur, there exists the
possibility of a material adverse impact on the Company's business, financial
condition and results of operations.
No amounts have been accrued for losses under any of the above mentioned
matters, as no amounts are considered probable or reasonably estimable at this
time.
Other than the foregoing, the Company is not currently a defendant in any
material pending litigation and it is not aware of any material threatened
litigation.
13. RESTRUCTURING AND OTHER RELATED EXPENSES
During the third quarter of 2002, the Company adopted a restructuring
plan, the objectives of which were to consolidate operations in order to enhance
operating efficiencies (the 2002 Restructuring Plan). This plan was primarily in
response to the general decrease in demand within the Company's markets for the
sales and marketing services segment, and the recognition that the
infrastructure that supported these business units was larger than required. The
Company originally estimated that the restructuring would result in annualized
SG&A savings of approximately $14.0 million, based on the level of SG&A spending
at the time it initiated the restructuring. However, these savings have been
partially offset by incremental SG&A expenses the Company incurred in the
current period as the Company has been successful in expanding its business
platforms. Substantially all of the restructuring activities were completed as
of December 31, 2003.
During the quarter ended March 31, 2003, the Company recognized a $270,000
reduction in to the restructuring accrual due to negotiating higher sublease
proceeds than originally estimated for the leased facility in Cincinnati, Ohio.
The accrual for restructuring and exit costs totaled approximately
$580,000 at March 31, 2004, and is recorded in current liabilities on the
accompanying balance sheet.
16
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
A roll forward of the activity for the 2002 Restructuring Plan is as follows:
(in thousands) BALANCE AT ADJUSTMENTS PAYMENTS BALANCE AT
DECEMBER 31, 2003 MARCH 31, 2004
Administrative severance $ 285 $ - $ (93) $ 192
Exit costs 459 - (71) 388
------ ------ ------- ---------
744 - (164) 580
------ ------ ------- ---------
Sales force severance - - - -
------ ------ ------- ---------
TOTAL $ 744 $ - $ (164) $ 580
====== ====== ======= =========
14. SEGMENT INFORMATION
Effective in the first quarter of 2004, the Company reorganized its
internal operating units from three reporting segments into two reporting
segments: sales and marketing services group (SMSG) and PDI products group
(PPG). These reorganized segments reflect the termination of the Xylos agreement
and the decision to manage the other medical device and diagnostic (MD&D) units
under the Company's existing contract sales structure. Additionally, the
reorganized segments reflect the greater emphasis the Company intends to place
on its services business and away from licensing and acquiring pharmaceutical
and medical device products. As a result of this reorganization, the MD&D
segment was disaggregated and assimilated into the two remaining segments. The
MD&D segment was comprised of the clinical sales unit, MD&D contract sales unit,
and product licensing. The SMSG segment now includes the Company's clinical
sales and MD&D contract sales units; the Company's dedicated and shared contract
sales units; and the Company's marketing research and medical education and
communication services. The businesses within SMSG recognize revenue
predominantly through fee-for-service contracts. The PPG contracts are
characterized by either significant management effort required from the
Company's product marketing group, or reliance on the attainment of performance
incentives in order to fully cover the Company's costs, or both. The PPG segment
now includes MD&D product offerings in addition to the rest of the Company's
copromotion services. PPG derives revenue through a variety of agreement types
including directly from product sales or based on a formula with product sales
as its basis. The segment information from prior periods has been restated to
conform to the current period's presentation.
Corporate charges are allocated to each of the operating segments on the
basis of total salary costs. Corporate charges include corporate headquarter
costs and certain depreciation expense. Capital expenditures have not been
allocated to the operating segments since it is impracticable to do so.
THREE MONTHS ENDED
MARCH 31,
---------------------------------
2004 2003
---------------- ---------------
(in thousands)
Revenue
Sales and marketing services group.................................. $ 85,895 $ 57,476
PDI products group.................................................. 2,472 10,069
--------- -----------
Total........................................................... $ 88,367 $ 67,545
========= ===========
Income (loss) from operations, before corporate allocations
Sales and marketing services group.................................. $ 17,473 $ 10,120
PDI products group.................................................. 509 (5,014)
Corporate charges................................................... (8,173) (4,041)
--------- -----------
Total........................................................... $ 9,809 $ 1,065
========= ===========
17
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
---------------------------------
2004 2003
---------------- ---------------
(continued) (in thousands)
Corporate allocations
Sales and marketing services group.................................. $ (8,047) $ (3,314)
PDI products group.................................................. (126) (727)
Corporate charges................................................... 8,173 4,041
--------- -----------
Total........................................................... $ - $ -
========= ===========
Income (loss) from operations, less corporate
allocations
Sales and marketing services group.................................. $ 9,426 $ 6,806
PDI products group.................................................. 383 (5,741)
Corporate charges................................................... - -
--------- -----------
Total........................................................... $ 9,809 $ 1,065
========= ===========
Reconciliation of income from operations to income
before provision for income taxes
Total EBIT for operating groups..................................... $ 9,809 $ 1,065
Other income, net................................................... 318 269
--------- -----------
Income before provision for income taxes........................ $ 10,127 $ 1,334
========= ===========
Capital expenditures
Sales and marketing services group.................................. $ 2,588 $ 215
PDI products group.................................................. - -
--------- -----------
Total........................................................... $ 2,588 $ 215
========= ===========
Depreciation expense
Sales and marketing services group.................................. $ 1,340 $ 971
PDI products group.................................................. 19 273
--------- -----------
Total........................................................... $ 1,359 $ 1,244
========= ===========
15. GOODWILL AND INTANGIBLE ASSETS
Effective January 1, 2002, the Company adopted SFAS No. 142, "GOODWILL AND
OTHER INTANGIBLE ASSETS." Under SFAS No. 142, goodwill is no longer amortized
but is evaluated for impairment on at least an annual basis. The Company has
established reporting units for purposes of testing goodwill for impairment.
Goodwill has been assigned to the reporting units to which the value of the
goodwill relates. The Company performed the required annual impairment tests in
the fourth quarter of 2003 and determined that no impairment existed at December
31, 2003. These tests involved determining the fair market value of each of the
reporting units with which the goodwill was associated and comparing the
estimated fair market value of each of the reporting units with its carrying
amount. The Company's total goodwill which is not subject to amortization
totaled $11.1 million as of March 31, 2004 and December 31, 2003.
There were no changes in the carrying amount of goodwill since December
31, 2003. The carrying amounts at March 31, 2004 by operating segment are shown
below:
(in thousands) SMSG PPG TOTAL
---- --- -----
Balance as of December 31, 2003 $ 11,132 $ - $11,132
Amortization - - -
Goodwill additions - - -
-------- ------- -------
Balance as of March 31, 2004 $ 11,132 $ - $11,132
======== ======= =======
18
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
All identifiable intangible assets recorded as of March 31, 2004 are being
amortized on a straight-line basis over the life of the intangibles which is
primarily five years. The carrying amounts at March 31, 2004 and December 31,
2003 are as follows:
(in thousands) As of March 31, 2004 As of December 31, 2003
-------------------------------------- ------------------------------------
Carrying Accumulated Carrying Accumulated
Amount Amortization Net Amount Amortization Net
-------------------------------------- ------------------------------------
Covenant not to compete $ 1,686 $ 864 $ 822 $ 1,686 $ 780 $ 906
Customer relationships 1,208 619 589 1,208 559 649
Corporate tradename 172 88 84 172 79 93
--------- -------- --------- -------- --------- ------
Total $ 3,066 $ 1,571 $ 1,495 $ 3,066 $ 1,418 $1,648
========= ======== ========= ======== ========= ======
Amortization expense totaled approximately $153,000 in the quarters ended
March 31, 2004 and 2003. Estimated amortization expense for the next five years
is as follows:
(in thousands)
2004 $ 613
=====
2005 613
=====
2006 613
=====
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, 2003 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, 2004. 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
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 performance based
contracts.
REPORTING SEGMENTS
Our business is organized into two reporting segments:
o PDI sales and marketing services group (SMSG), comprised of:
o Sales Teams Business
o Dedicated contract sales teams
o Shared contract sales teams
o Medical device and diagnostic contract sales teams
o Clinical sales teams
o Hybrid teams
o Marketing research and consulting (MR & C)
o Medical education and communications (EdComm)
o PDI products group (PPG) is comprised of those agreements in which PDI is
directly or indirectly compensated on the basis of product sales. This
segment currently has the remaining revenue from
20
PDI's agreement with Novartis in support of Lotensin and the agreement with
Xylos in support of XCell wound care products. Both agreements have been
terminated and the PPG segment is reporting the residual financial activity
from those agreements.
We reorganized our segments in the first quarter of 2004 due to the
termination of the Xylos agreement and the decision to manage the other MD&D
units under our existing contract sales structure. Additionally, the reorganized
segments reflect the greater emphasis we intend to place on our services
business and away from licensing and acquiring pharmaceutical and medical device
products. The businesses within the sales and marketing services group recognize
revenue predominantly through fee-for-service contracts. The products group
derives revenue through a variety of agreement types including directly from
product sales or based on a formula with product sales as its basis. The PPG
contracts are characterized by either significant management effort required
from our product marketing group, or reliance on the attainment of performance
incentives in order to fully cover our costs, or both.
DESCRIPTION OF BUSINESSES
SALES AND MARKETING SERVICES GROUP (SMSG)
DEDICATED CONTRACT SALES TEAMS
Product detailing involves a representative meeting face-to-face with
targeted physicians and other healthcare decision makers to provide a technical
review of the product being promoted. Dedicated contract sales teams work
exclusively on behalf of one client and often carry the business cards of the
client. Each sales team is customized to meet the specifications of our client
with respect to representative profile, physician targeting, product training,
incentive compensation plans, integration with clients' in-house sales forces,
call reporting platform and data integration. Without adding permanent
personnel, the client gets a high quality, industry-standard sales team
comparable to its internal sales force.
SHARED CONTRACT SALES TEAMS
Our shared sales teams sell multiple brands from different pharmaceutical
manufacturers. Through them, we make a face-to-face selling resource available
to those clients that want an alternative to a dedicated team. The PDI Shared
Sales teams are leading providers of these detailing programs in the U.S. Since
costs are shared among various companies, these programs may be less expensive
for the client than programs involving a dedicated sales force. With a shared
sales team, the client still gets targeted coverage of its physician audience
within the representatives' geographic territories.
MEDICAL DEVICE AND DIAGNOSTICS CONTRACT SALES TEAMS
MD&D contract sales is an outsourced solution for selling medical devices
to hospitals, clinics and other healthcare institutions. The MD&D contract sales
teams work exclusively on behalf of one client. Each sales team is customized to
meet the specifications of our client with respect to representative profile,
identified territories, product training, incentive compensation plans,
integration with clients' in-house sales forces, activity reporting platform,
program duration, and data integration. Without adding permanent personnel, the
client gets a high quality, industry-standard sales team.
MEDICAL DEVICE AND DIAGNOSTICS CLINICAL SALES TEAMS
Our clinical sales teams employ nurses, medical technologists, and other
clinicians who train and provide hands-on clinical education and after sales
support to the medical staffs of hospitals and clinics that recently purchased
our clients' equipment. Our activities maximize product utilization and customer
satisfaction for the medical practitioners, while simultaneously enabling our
clients' sales forces to continue their selling activities instead of
in-servicing the equipment.
21
HYBRID TEAMS
Hybrid teams take elements of the different sales teams outlined above and
coordinate their activities to achieve a unique solution for a client. In order
to gain greater physician coverage across the country, a client may want to
deploy a dedicated team to the large metropolitan markets and supplement that
team with a shared team in order to reach additional markets and physicians not
reached by the dedicated team. Another example of a hybrid team may be the
combination of a sales team with a clinical team when the product requires a
sales effort along with clinical support. Hybrid teams enable us to craft the
correct solution for clients with unique challenges.
MARKETING RESEARCH (MR & C)
Employing leading edge, and in some instances proprietary, research
methodologies, we provide qualitative and quantitative marketing research to
pharmaceutical companies with respect to healthcare providers, patients and
managed care customers in the U.S. and globally. We offer a full range of
pharmaceutical marketing research services which includes studies to identify
the most impactful business strategy, profile, positioning, message, execution,
implementation, and post implementation for a product. Correctly implemented,
our marketing research model improves the knowledge clients obtain about how
physicians and other healthcare professionals will likely react to products.
We utilize a systematic approach to pharmaceutical marketing research.
Recognizing that every marketing need, and therefore every marketing research
solution, is unique, we have developed our marketing model to help identify the
work that needs to be done in order to identify critical paths to marketing
goals. At each step of the marketing model we can offer proven research
techniques, proprietary methodologies and customized study designs to address
specific product needs.
In addition to conducting marketing research, we have trained several
thousand industry professionals at our public seminars. Our professional
development seminars focus on key marketing processes and issues.
MEDICAL EDUCATION AND COMMUNICATIONS (EdComm)
Our medical education and communications group provides medical education
and promotional communications to the biopharmaceutical and MD&D industries.
Using an expert-driven, customized approach, we provide our clients with
integrated advocacy development, accredited continuing medical education (CME),
promotions, publication services and interactive sales initiatives to generate
incremental value for products.
We create custom designed programs focusing on optimizing the informed use
of our clients' products. Our services are executed through a customized,
integrated plan that can be leveraged across the product's entire life cycle. We
can meet a wide range of objectives, including advocacy during pre-launch,
communicating disease state awareness, supporting a product launch, helping an
under-performing brand, fending off new competition, and expanding market
leadership.
PDI PRODUCTS GROUP (PPG)
There are occasions when a biopharmaceutical or medical device or
diagnostic company would want to outlicense, sell or copromote a product that
they own or to which they own the rights. They may not have the capabilities to
market a product themselves or they may have other products in their portfolio
on which they are concentrating their sales and marketing resources. In this
instance, our products group works to create a mutually beneficial partnership
arrangement, pursuant to which we utilize our sales, marketing and
commercialization capabilities to commercialize the product for our partner.
These
22
agreements may require upfront payments, royalty payments, milestone payments
and many other compensation strategies. These agreements generally are riskier
for us, but generally have the potential to deliver greater revenues, margins
and consistency than our services businesses.
Given the broad array of our service offerings, we are able to provide
complete product commercialization capabilities (Integrated Commercialization
Services) to pharmaceutical companies on a fee for service basis. The execution
of these product sales, marketing and commercialization activities would be
substantially similar to those we perform in a copromotion, licensing or product
acquisition transaction; however, our fee structure and risk profile would be
markedly different.
NATURE OF CONTRACTS BY SEGMENT
Given the customized nature of our business, we utilize a variety of
contract structures. Historically, most of our product detailing contracts have
been fee for service, i.e., the client pays a fee for a specified package of
services. These contracts typically include operational benchmarks, such as a
minimum number of sales representatives or a minimum number of calls. Also, our
contracts might have a lower base fee offset by built-in incentives we can earn
based on our performance. In these situations, we have the opportunity to earn
additional fees, as incentives, based on attaining performance benchmarks.
Our product detailing contracts generally are for terms of one to three
years and may be renewed or extended. However, the majority of these contracts
are terminable by the client for any reason on 30 to 90 days' notice. These
contracts sometimes provide for termination payments in the event they are
terminated by the client without cause. While the cancellation of a contract by
a client without cause may result in the imposition of penalties on the client,
these penalties may not act as an adequate deterrent to the termination of any
contract. In addition, we cannot assure you that these penalties will offset the
revenue we could have earned under the contract or the costs we may incur as a
result of its termination. The loss or termination of a large contract or the
loss of multiple contracts could adversely affect our future revenue and
profitability. Contracts may also be terminated for cause if we fail to meet
stated performance benchmarks.
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 of all work completed to date, plus the cost of any
nonrefundable commitments made on behalf of the client. Due to the typical size
of the projects, it is unlikely the loss or termination of any individual MR&C
or EdComm contract would have a material adverse impact on our results of
operations, cash flows and liquidity.
The contracts within the products group can be either performance based or
fee for service and may require sales, marketing and distribution of product. In
performance-based contracts, we provide and finance a portion, if not all, of
the commercial activities in support of a brand in return for a percentage of
product sales. An important performance parameter is normally the level of sales
or prescriptions attained by the product during the period of our marketing or
promotional responsibility, and in some cases, for periods after our promotional
activities have ended.
In May 2001, we entered into a copromotion agreement with Novartis
Pharmaceuticals Corporation (Novartis) for the U.S. sales, marketing and
promotion rights for Lotensin(R), Lotensin HCT(R) and Lotrel(R). That agreement
was scheduled to run through December 31, 2003. On May 20, 2002, that agreement
was replaced by two separate agreements: one for Lotensin and another one for
Lotrel, Diovan(R) and Diovan HCT(R). The Lotensin agreement called for us to
provide promotion, selling, marketing and brand management for Lotensin. In
exchange, we were entitled to receive a percentage of product revenue based on
certain total prescription (TRx) objectives above specified contractual
baselines. Both agreements ran through December 31, 2003; however, the
Lotrel-Diovan agreement was renewed on December 24, 2003 for an additional
one-year period. In February 2004, we were notified by Novartis of its intent to
terminate
23
the Lotrel-Diovan contract without cause, effective March 16, 2004 and, as a
result, $28.9 million of anticipated revenue associated with the Lotrel-Diovan
contract in 2004 will not be realized. We were compensated under the terms of
the agreement through the effective termination date. Even though the Lotensin
agreement ended December 31, 2003, we are still entitled to receive royalty
payments on the sales of Lotensin through December 31, 2004. The royalties
earned under this arrangement totaled $2.3 million during the first quarter of
2004; the royalties earned during the remaining quarters of 2004 are expected to
diminish substantially because the product lost its patent protection in
February 2004.
On December 31, 2002, we entered into an exclusive licensing agreement
with Cellegy Pharmaceuticals, Inc. (Cellegy) for the exclusive North American
rights for Fortigel(TM), a testosterone gel product. The agreement is in effect
for the commercial life of the product. Cellegy submitted a New Drug Application
(NDA) for the hypogonadism indication to the U.S. Food and Drug Administration
(FDA) in June 2002. In July 2003, Cellegy received a letter from the FDA
rejecting its NDA for Fortigel. Cellegy has told us that it is in discussions
with the FDA to determine the appropriate course of action needed to meet
deficiencies cited by the FDA in its determination. Since we filed the lawsuit,
Cellegy is no longer in regular contact with us regarding Fortigel. Thus, for
example, we are unaware of the precise FDA status regarding Fortigel (as of
March 31, 2004, it had not been approved) and the FDA continued to express
concern about the high supraphysiologic Cmax serum testosterone levels achieved
in subjects of Fortigel testing. We are also unaware of what steps Cellegy is
taking to develop Fortigel, to obtain FDA approval for Fortigel, and/or to
arrange for a party to manufacture Fortigel. We have requested this information
from Cellegy but have not received full and complete responses from Cellegy.
Accordingly, we may not possess the most current and reliable information
concerning the current status of, or future prospects relating to Fortigel. The
issuance of the non-approvable letter by the FDA concerning Fortigel, however,
casts significant doubt upon Fortigel's prospects and whether it will ever be
approved. We cannot predict with any certainty whether the FDA will ultimately
approve Fortigel for sale in the U.S. Under the terms of the agreement, we paid
Cellegy a $15.0 million initial licensing fee on December 31, 2002. This payment
was made prior to FDA approval and since there is no alternative future use of
the licensed rights, we expensed the $15.0 million payment in December 2002,
when incurred. This amount was recorded in other selling, general and
administrative expenses in the December 31, 2002 consolidated statements of
operations. Pursuant to the terms of the licensing agreement, we will be
required to pay Cellegy a $10.0 million incremental license fee milestone
payment upon Fortigel's receipt of all approvals required by the FDA (if such
approvals are obtained) to promote, sell and distribute the product in the U.S.
This incremental milestone license fee, if incurred, will be recorded as an
intangible asset and amortized over its estimated useful life, as then
determined, which is not expected to exceed the life of the patent. We believe
that we will not be required to pay Cellegy the $10.0 million incremental
license fee milestone payment in 2004, and it is unclear at this point when or
if Cellegy will get Fortigel approved by the FDA which would trigger our
obligation to pay $10.0 million to Cellegy. Royalty payments to Cellegy over the
term of the commercial life of the product would range from 20% to 30% of net
sales. See Note 12 for more information on Cellegy Pharmaceuticals Litigation.
In October 2002, we partnered with Xylos Corporation (Xylos) for the
exclusive U.S. commercialization rights to the Xylos XCell(TM) Cellulose Wound
Dressing (XCell) wound care products, by entering into an agreement pursuant to
which we became the exclusive commercialization partner for the sales, marketing
and distribution of the product line in the U.S. On January 2, 2004, we
exercised our contractual right to terminate the agreement on 135 days' notice
to Xylos since sales of XCell were not sufficient to sustain our role as
commercialization partner for the product. We are still accepting orders for
XCell products until May 16, 2004 when the agreement will terminate; however,
our promotional activities in support of the brand concluded in January 2004.
See Notes 5 and 6 to the financial statements for more information. We currently
do not anticipate entering into similar commercialization agreements in the MD&D
market.
24
REVENUE RECOGNITION AND ASSOCIATED COSTS
The paragraphs that follow describe the guidelines that we adhere to in
accordance with generally accepted accounting principles (GAAP) when recognizing
revenue and cost of goods and services in our financial statements. In
accordance with GAAP, service revenue and product revenue and their respective
direct costs have been shown separately on the income statement.
Historically, we have derived a significant portion of our service revenue
from a limited number of clients. Concentration of business in the
pharmaceutical services industry is common and the industry continues to
consolidate. As a result, we are likely to continue to experience significant
client concentration in future periods. For the three months ended March 31,
2004 and 2003, our three and two largest clients, respectively, who each
individually represented 10% or more of our service revenue, accounted for
approximately 80.7%, and 69.0%, respectively, of our service revenue.
SERVICE REVENUE AND PROGRAM EXPENSES
Service revenue is earned primarily by performing product detailing
programs and other marketing and promotional services under contracts. Revenue
is recognized as the services are performed and the right to receive payment for
the services is assured. Revenue is recognized net of any potential penalties
until the performance criteria relating to the penalties have been achieved.
Performance incentives, as well as termination payments, are recognized as
revenue in the period earned and when payment of the bonus, incentive or other
payment is assured. Under performance based contracts, revenue is recognized
when the performance based parameters are achieved.
Program expenses consist primarily of the costs associated with executing
product detailing programs, performance based contracts or other sales and
marketing services identified in the contract. Program expenses include
personnel costs and other costs associated with executing a product detailing or
other marketing or promotional program, as well as the initial direct costs
associated with staffing a product detailing program. Such costs include, but
are not limited to, facility rental fees, honoraria and travel expenses, sample
expenses and other promotional expenses. Personnel costs, which constitute the
largest portion of program expenses, include all labor related costs, such as
salaries, bonuses, fringe benefits and payroll taxes for the sales
representatives and sales managers and professional staff who are directly
responsible for executing a particular program. Initial direct program costs are
those costs associated with initiating a product detailing program, such as
recruiting, hiring, and training the sales representatives who staff a
particular product detailing program. All personnel costs and initial direct
program costs, other than training costs, are expensed as incurred for service
offerings. Product detailing, marketing and promotional expenses related to the
detailing of products we distribute are recorded as a selling expense and are
included in other selling, general and administrative expenses in the
consolidated statements of operations.
TRAINING COSTS
Training costs include the costs of training the sales representatives and
managers on a particular product detailing program so that they are qualified to
properly perform the services specified in the related contract. For all
contracts, training costs are deferred and amortized on a straight-line basis
over the shorter of the life of the contract to which they relate or 12 months.
When we receive a specific contract payment from a client upon commencement of a
product detailing program expressly to compensate us for recruiting, hiring and
training services associated with staffing that program, such payment is
deferred and recognized as revenue in the same period that the recruiting and
hiring expenses are incurred and amortization of the deferred training is
expensed. When we do not receive a specific contract payment for training, all
revenue is deferred and recognized over the life of the contract.
25
As a result of the revenue recognition and program expense policies
described above, we may incur significant initial direct program costs before
recognizing revenue under a particular product detailing program. Our inability
to specifically negotiate for payments that are specifically attributable to
recruiting, hiring or training services in our product detailing contracts could
adversely impact our operating results for periods in which the costs associated
with the product detailing services are incurred.
PRODUCT REVENUE AND COST OF GOODS SOLD
Product revenue is recognized when products are shipped and title is
transferred to the customer. Product revenue of approximately $101,000 and
$34,000 for the three months ended March 31, 2004 and 2003, respectively, was
primarily from the sale of the Xylos wound care products.
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.
CONSOLIDATED RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
statements of operations data as a percentage of revenue. The trends illustrated
in this table may not be indicative of future results.
THREE MONTHS ENDED
MARCH 31,
-----------------------
2004 2003
-------- --------
Revenue
Service, net..................................................................... 99.9% 99.9%
Product, net..................................................................... 0.1 0.1
----- -----
Total revenue, net.............................................................. 100.0% 100.0%
Cost of goods and services
Program expenses................................................................. 69.8 73.9
Cost of goods sold............................................................... 0.2 0.1
----- -----
Total cost of goods and services................................................ 70.0 74.0
Gross profit........................................................................ 30.0 26.0
Compensation expense................................................................ 11.6 13.1
Other selling, general and administrative expenses.................................. 7.3 8.6
Restructuring and other related expenses (credits), net............................. - (0.4)
Litigation settlement............................................................... - 3.1
----- -----
Total operating expenses........................................................ 18.9 24.4
----- -----
Operating income.................................................................... 11.1 1.6
Other income, net................................................................... 0.4 0.4
----- -----
Income before provision for income taxes............................................ 11.5 2.0
Provision for income taxes.......................................................... 4.7 0.8
----- -----
Net income.......................................................................... 6.8% 1.2%
===== =====
REVENUE. Net revenue for the quarter ended March 31, 2004 was $88.4
million, 30.8% more than net revenue of $67.5 million for the quarter ended
March 31, 2003. Net revenue from the SMSG segment for the quarter ended March
31, 2004 was $85.9 million, 49.4% more than net revenue of $57.4 million from
that segment for the comparable prior year period. This increase is mainly
attributable to the addition of three significant dedicated contract sales teams
contracts in July 2003. Subsequent quarters in 2004 will be adversely affected
by the termination of the Lotrel-Diovan contract (see Note 5 to the financial
statements). On May 3, 2004, we announced the awarding of two new dedicated
contract sales teams contracts which total approximately $34.0 million in
revenue for the remainder of 2004. Net PPG revenue for the quarter ended March
31, 2004 was $2.5 million; of this, $2.3 million is due to Lotensin royalties
and the remaining amount consists primarily of approximately $101,000 in product
revenue related to the sale of the Xylos product. The Lotensin royalties earned
during the remaining quarters of 2004 are expected to diminish
26
substantially because the product lost its patent protection in February 2004.
Net PPG revenue was $10.1 million in the comparable prior year period. The large
decrease can be attributed to the completion of the Lotensin contract which
ended December 31, 2003.
COST OF GOODS AND SERVICES. Cost of goods and services for the quarter
ended March 31, 2004 was $61.9 million, 23.8% more than cost of goods and
services of $49.9 million for the quarter ended March 31, 2003. As a percentage
of total net revenue, cost of goods and services decreased to 70.0% for the
quarter ended March 31, 2004 from 74.0% in the comparable prior year period.
Program expenses (i.e., cost of services) associated with the SMSG segment for
the quarter ended March 31, 2004 were $61.6 million, 53.5% more than program
expenses of $40.1 million for the prior year period. This increase is mainly
attributable to the addition of three significant dedicated contract sales teams
contracts in July 2003. As a percentage of sales and marketing services segment
revenue, program expenses for the quarters ended March 31, 2004 and 2003 were
71.7% and 69.8%, respectively. Cost of goods and services associated with the
PPG segment were approximately $244,000 and $9.8 million for the quarters ended
March 31, 2004 and 2003, respectively. This decrease can be attributed to the
completion of the Lotensin contract which ended December 31, 2003.
COMPENSATION EXPENSE. Compensation expense for the quarter ended March 31,
2004 was $10.2 million, 15.1% more than $8.9 million for the comparable prior
year period. The increase in compensation expense was primarily due to
approximately $1.0 million recorded for severance related expense resulting from
the elimination of several positions. As a percentage of total net revenue,
compensation expense decreased to 11.6% for the quarter ended March 31, 2004
from 13.1% for the quarter ended March 31, 2003 due to continuing cost
management efforts. Compensation expense for the quarter ended March 31, 2004
attributable to the SMSG segment was $9.1 million compared to $6.1 million for
the quarter ended March 31, 2003; the percentage of net revenue was 10.6% for
each of the periods. Compensation expense for the quarter ended March 31, 2004
attributable to the PPG segment was $1.1 million, or 44.1% of PPG revenue,
compared to $2.8 million, or 27.7% in the prior year period; this decrease can
be attributed to the lower level of resources required after the completion of
the Lotensin contract which ended December 31, 2003.
OTHER SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Total other selling,
general and administrative expenses were $6.5 million for the quarter ended
March 31, 2004, 11.3% more than other selling, general and administrative
expenses of $5.8 million for the quarter ended March 31, 2003. Excluding
approximately $700,000 in legal fee reimbursements from Bayer in the first
quarter 2003, total other selling, general and administrative expenses is
essentially the same for both periods. As a percentage of total net revenue,
total other selling, general and administrative expenses decreased to 7.3% for
the quarter ended March 31, 2004 from 8.6% for the quarter ended March 31, 2003
due to continuing cost management efforts. Other selling, general and
administrative expenses attributable to the SMSG segment for the quarter ended
March 31, 2004 were $5.7 million, compared to other selling, general and
administrative expenses of $3.4 million attributable to that segment for the
comparable prior year period. This increase is primarily due to a larger portion
of corporate overhead costs being allocated to the SMSG segment in the current
period. As a percentage of net revenue from sales and marketing services, other
selling, general and administrative expenses were 6.7% and 5.9% for the quarters
ended March 31, 2004 and 2003, respectively. Other selling, general and
administrative expenses attributable to the PPG segment for the quarter ended
March 31, 2004 were approximately $754,000 compared to $2.4 million for the
comparable prior year period; this decrease can be attributed to the lower level
of resources required after the completion of the Lotensin contract which ended
December 31, 2003.
RESTRUCTURING AND OTHER RELATED EXPENSES (CREDITS). For the quarter ended
March 31, 2004 we did not recognize any adjustments to the restructuring
accrual. During the quarter ended March 31, 2003, we recognized a $270,000
credit adjustment to the restructuring accrual due to negotiating higher
sublease proceeds than originally estimated for the leased facility in
Cincinnati, Ohio. See the "RESTRUCTURING AND
27
OTHER RELATED EXPENSES" disclosure below for further explanations of the
Restructuring Plan and related activity.
LITIGATION SETTLEMENT. On May 8, 2003, we entered into a settlement and
mutual release agreement with Auxillium (Settlement Agreement). The settlement
terms included a cash payment paid upon execution of the Settlement Agreement
and other additional expenses that totaled $2.1 million. This expense was
recorded in the quarter ended March 31, 2003.
OPERATING INCOME. Operating income for the quarter ended March 31, 2004
was $9.8 million, compared to operating income of $1.1 million for the quarter
ended March 31, 2003. Operating income for the quarter ended March 31, 2004 for
the SMSG segment was $9.4 million, or 38.5% higher than the SMSG operating
income for the quarter ended March 31, 2003 of $6.8 million. As a percentage of
net revenue from the sales and marketing services segment, operating income for
that segment decreased to 11.0% for the quarter ended March 31, 2004, from 11.8%
for the comparable prior year period. There was operating income for the PPG
segment for the quarter ended March 31, 2004 of approximately $383,000,
substantially due to the $2.3 million in royalties received for Lotensin,
compared to an operating loss of $5.7 million for the prior year period.
OTHER INCOME, NET. Other income, net, for the quarters ended March 31,
2004 and 2003 was $318,000 and $269,000, respectively, and was comprised
primarily of interest income.
PROVISION FOR INCOME TAXES. Income tax expense was $4.1 million for the
quarter ended March 31, 2004, compared to income tax expense of approximately
$556,000 for the quarter ended March 31, 2003, which consisted of Federal and
state corporate income taxes. The effective tax rate for the quarter ended March
31, 2004 was 41.0%, compared to an effective tax rate of 41.7 % for the quarter
ended March 31, 2003. The effective tax rate for the quarter ended March 31,
2004 is lower than the effective tax rate for the quarter ended March 31, 2003
because the permanent book versus tax differences were a larger proportion of
projected pretax income in 2003 as compared to 2004.
NET INCOME. Net income for the quarter ended March 31, 2004 was
approximately $6.0 million, compared to net income of approximately $778,000 for
the quarter ended March 31, 2003. This increase is due to the factors discussed
above.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2004, we had cash and cash equivalents and short-term
investments of approximately $118.9 million and working capital of approximately
$106.1 million, compared to cash and cash equivalents and short-term investments
of approximately $114.6 million and working capital of approximately $100.0
million at December 31, 2003.
For the three months ended March 31, 2004, net cash provided by operating
activities was $6.3 million, compared to $4.1 million net cash used in operating
activities for the three months ended March 31, 2003. The main components of
cash provided by operating activities during the three months ended March 31,
2004 were:
o net income of approximately $6.0 million; and
o depreciation and other non-cash expenses of approximately $2.7 million
which included bad debt expense of approximately $500,000, stock
compensation expense of approximately $684,000 and amortization of
intangible assets of approximately $153,000, each of which was charged
to SG&A; partially offset by
o cash used in "other changes in assets and liabilities" of $2.4
million.
28
As of March 31, 2004, we had $18.6 million of unbilled costs and accrued
profits on contracts in progress. 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. Normally, all unbilled costs and accrued
profits are earned and billed within 12 months from the end of the respective
period. Substantially all of the $18.6 million of unbilled costs were billed in
April 2004. Also, as of March 31, 2004, we had $10.3 million of unearned
contract revenue. 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.
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 the number and size of programs, contract terms and other
timing issues; these variations may change in size and direction with each
reporting period.
For the three months ended March 31, 2004, net cash used in investing
activities was $45.4 million. This consisted of $42.8 million used in the
purchase of a laddered portfolio of short-term investments in very high grade
debt instruments with a focus on preserving capital, maintaining liquidity, and
maximizing returns in accordance with our investment criteria. In an effort to
gain a higher yield from cash on hand, we made short-term investments having
maturity dates occurring after June 30, 2004 and through October 31, 2005.
Capital expenditures during the three-month period ended March 31, 2004 were
$2.6 million, almost entirely composed of purchases related to our expected move
to our new corporate headquarters in the third quarter of 2004. There was
approximately $215,000 in capital expenditures for the quarter ended March 31,
2003. For both periods, all capital expenditures were funded out of available
cash. We are expecting to incur total capital expenditures of approximately $4.0
million in connection with our corporate headquarters move.
For the three months ended March 31, 2004, net cash provided by financing
activities of approximately $524,000 was due to the net proceeds received from
the exercise of stock options.
Our revenue and profitability depend to a great extent on our
relationships with a limited number of large pharmaceutical companies. For the
three months ended March 31, 2004, we had three major clients that accounted for
approximately 43.3%, 23.2% and 14.2%, respectively, or a total of 80.7% of our
service revenue. We are likely to continue to experience a high degree of client
concentration, particularly if there is further consolidation within the
pharmaceutical industry. The loss or a significant reduction of business from
any of our major clients, or a decrease in demand for our services, could have a
material adverse effect on our business, future results of operations, financial
condition or cash flows.
Under our licensing agreement with Cellegy, we will be required to pay
Cellegy a $10.0 million incremental license fee milestone payment upon
Fortigel's receipt of all approvals required by the FDA to promote, sell and
distribute the product in the U.S. Upon payment, this incremental milestone
license fee will be recorded as an intangible asset and amortized over the
estimated commercial life of the product, as then determined. This payment will
be funded, when due, out of cash flows provided by operations and existing cash
balances. In addition, under the licensing agreement, we would 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. The
initial 10-month Prescription Drug User Fee Act (PDUFA) date for the product was
April 5, 2003. In March 2003, Cellegy was notified by the FDA that the PDUFA
date had been revised to July 3, 2003. On July 3, 2003, Cellegy was notified by
the FDA that Fortigel was not approved. Cellegy is in discussions with the FDA
to determine the appropriate course of action needed to meet deficiencies cited
by the FDA in its determination. We cannot predict with any certainty that the
FDA will ultimately approve Fortigel for sale in the U.S. Management believes
that it will not be required to pay Cellegy the $10.0 million incremental
license fee milestone payment in 2004, and it is unclear at this point when or
if Cellegy will get Fortigel approved by the FDA which would trigger our
obligation to pay $10.0 million to Cellegy.
On December 12, 2003, we filed a complaint against Cellegy in the U.S.
District Court for the
29
Southern District of New York. The complaint alleges that Cellegy fraudulently
induced us to enter into a license agreement with Cellegy regarding Fortigel on
December 31, 2002. The complaint also alleges claims for misrepresentation and
breach of contract related to the license agreement. In the complaint, we seek,
among other things, rescission of the license agreement and return of the $15.0
million we paid Cellegy. After we filed this lawsuit, also on December 12, 2003,
Cellegy filed a complaint against us in the U.S. District Court for the Northern
District of California. Cellegy's complaint seeks a declaration that Cellegy did
not fraudulently induce us to enter the license agreement and that Cellegy has
not breached its obligations under the license agreement. By order dated April
23, 2004 our lawsuit was transferred to the Northern District of California
where it will be consolidated with Cellegy's action. We are unable to predict
the ultimate outcome of these lawsuits.
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 originally estimated that the
restructuring would result in annualized SG&A savings of approximately $14.0
million, based on the level of SG&A spending at the time we initiated the
restructuring. However, these savings have been partially offset by incremental
SG&A expenses we incurred in the current period as we have been successful in
expanding our business platforms. Substantially all of the restructuring
activities were completed as of December 31, 2003.
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.
The accrual for restructuring and exit costs totaled approximately
$580,000 at March 31, 2004, and is recorded in current liabilities on the
accompanying balance sheet.
A roll forward of the activity for the 2002 Restructuring Plan is as
follows:
BALANCE AT BALANCE AT
(in thousands) DECEMBER 31, 2003 ADJUSTMENTS PAYMENTS MARCH 31, 2004
Administrative severance $ 285 $ - $ (93) $ 192
------ ------ ------- ---------
Exit costs 459 - (71) 388
------ ------ ------- ---------
744 - (164) 580
------ ------ ------- ---------
Sales force severance - - - -
------ ------ ------- ---------
TOTAL $ 744 $ - $ (164) $ 580
====== ====== ======= =========
30
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Our management, with the participation of our chief executive officer and
chief financial officer, has evaluated the effectiveness of our disclosure
controls and procedures (as such term is defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange
Act")) as of the end of the period covered by this report. Based on that
evaluation, our chief executive officer and chief financial officer have
concluded that, as of the end of such period, our disclosure controls and
procedures are effective.
CHANGES IN INTERNAL CONTROLS
There have not been any changes in our internal control over financial
reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) during the quarter ended March 31, 2004 that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.
31
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 "Exchange Act"). These complaints
were brought as purported shareholder class actions under Sections 10(b) and
20(a) of the Exchange Act and Rule 10b-5 established thereunder. On May 23,
2002, the Court consolidated all three lawsuits into a single action entitled In
re PDI Securities Litigation, Master File No. 02-CV-0211, and appointed lead
plaintiffs ("Lead Plaintiffs") and Lead Plaintiffs' counsel. On or about
December 13, 2002, Lead Plaintiffs filed a second consolidated and amended
complaint ("Second Consolidated and Amended Complaint"), which superseded their
earlier complaints.
The complaint names us, our chief executive officer and our chief
financial officer as defendants; purports to state claims against us on behalf
of all persons who purchased our common stock between May 22, 2001 and August
12, 2002; and seeks money damages in unspecified amounts and litigation expenses
including attorneys' and experts' fees. The essence of the allegations in the
Second Consolidated and Amended Complaint is that we intentionally or recklessly
made false or misleading public statements and omissions concerning our
financial condition and prospects with respect to our marketing of Ceftin in
connection with the October 2000 distribution agreement with GlaxoSmithKline,
our marketing of Lotensin in connection with the May 2001 distribution agreement
with Novartis Pharmaceuticals Corporation, as well as our marketing of Evista(R)
in connection with the October 2001 distribution agreement with Eli Lilly and
Company.
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. That motion is
fully submitted to the court for its decision. We believe that the allegations
in this purported securities class action are without merit and we intend to
defend the action vigorously.
BAYER-BAYCOL LITIGATION
We have been named as a defendant in numerous lawsuits, including two
class action matters, alleging claims arising from the use of Baycol, a
prescription cholesterol-lowering medication. Baycol was distributed, promoted
and sold by Bayer in the U.S. through early August 2001, at which time Bayer
voluntarily withdrew Baycol from the U.S. market. Bayer retained certain
companies, such as us, to provide detailing services on its behalf pursuant to
contract sales force agreements. We may be named in additional similar lawsuits.
To date, we have defended these actions vigorously and have asserted a
contractual right of defense and indemnification against Bayer for all costs and
expenses we incur relating to these proceedings. In February 2003, we entered
into a joint defense and indemnification agreement with Bayer, pursuant to which
Bayer has agreed to assume substantially all of our defense costs in pending and
prospective proceedings and to indemnify us in these lawsuits, subject to
certain limited exceptions. Further, Bayer agreed to reimburse us for all
reasonable costs and expenses incurred to date in defending these proceedings.
As of February 20, 2004 Bayer has reimbursed us for approximately $1.6 million
in legal expenses, of which approximately $700,000 was received in the quarter
ended March 31, 2003 and was reflected as a credit within selling, general and
administrative expense. No amounts have been recorded in 2004.
32
CELLEGY PHARMACEUTICALS LITIGATION
On December 12, 2003, we filed a complaint against Cellegy in the U.S.
District Court for the Southern District of New York. The complaint alleges that
Cellegy fraudulently induced us to enter into a license agreement with Cellegy
regarding Fortigel on December 31, 2002. The complaint also alleges claims for
misrepresentation and breach of contract related to the license agreement. In
the complaint, we seek, among other things, rescission of the license agreement
and return of the $15.0 million we paid Cellegy. After we filed this lawsuit,
also on December 12, 2003, Cellegy filed a complaint against us in the U.S.
District Court for the Northern District of California. Cellegy's complaint
seeks a declaration that Cellegy did not fraudulently induce us to enter the
license agreement and that Cellegy has not breached its obligations under the
license agreement. By order dated April 23, 2004 our lawsuit was transferred to
the Northern District of California where it will be consolidated with Cellegy's
action. We are unable to predict the ultimate outcome of these lawsuits.
OTHER LEGAL PROCEEDINGS
We are currently a party to other legal proceedings incidental to our
business. While management currently believes that the ultimate outcome of these
proceedings, individually and in the aggregate, will not have a material adverse
effect on our consolidated financial statements, litigation is subject to
inherent uncertainties. Were we to settle a proceeding for a material amount or
were an unfavorable ruling to occur, there exists the possibility of a material
adverse impact on our business, financial condition and results of operations.
No amounts have been accrued for losses under any of the above mentioned
matters, as no amounts are considered probable or reasonably estimable at this
time.
ITEM 2 - NOT APPLICABLE
ITEM 3 - NOT APPLICABLE
ITEM 4 - NOT APPLICABLE
ITEM 5 - NOT APPLICABLE
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Exhibit
No.
- -------
31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section
1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
32.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section
1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
33
(b) REPORTS ON FORM 8-K
During the three months ended March 31, 2004, the Company filed the
following reports on Form 8-K:
DATE ITEM(S) DESCRIPTION
---------------------- ------------ ------------------------------------------------------------------------
January 21, 2004 5 and 7 Press Release: PDI Terminates Xylos Agreement
February 18, 2004 5 and 7 Press Release: PDI Announces Notice of Termination of Novartis Contract
March 4, 2004 12 and 7 Press Release: PDI Reports Fourth Quarter and Year End 2003 Financial
Results
34
SIGNATURES
In accordance with the requirements of the Securities and Exchange Act of
1934, the registrant has caused this report to be signed on its behalf by the
undersigned, thereto duly authorized.
May 03, 2004 PDI, INC.
(Registrant)
By: /s/ Charles T. Saldarini
-----------------------------------
Charles T. Saldarini
Chief Executive Officer
By: /s/ Bernard C. Boyle
-----------------------------------
Bernard C. Boyle
Chief Financial and Accounting
Officer
35