UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q/A
Mark One
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period ended June 30, 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.)
Saddle River Executive Centre
1 Route 17 South
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 August 5, 2004 the Registrant had a total of 14,690,689 shares of Common
Stock, $.01 par value, outstanding.
1
Explanatory Note
This Amendment No. 1 on Form 10-Q/A (this Amendment) amends the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2004 (the Original
Filing), and is being filed to include direct reimbursements received by the
Company from its clients for certain costs incurred as part of revenue with an
identical increase to cost of goods and services, rather than being netted
against cost of goods and services. Revenue and cost of goods and services is
being increased by $8.2 million and $6.4 million for the quarters ended June 30,
2004 and 2003, respectively, and $12.5 million and $12.0 million for the six
months ended June 30, 2004 and 2003, respectively. Subsequent to the issuance of
its consolidated financial statements for the year ended December 31, 2003 and
the quarters ended March 31, 2004 and June 30, 2004, the Company determined that
its accounting for reimbursable costs should be restated to reclassify these
costs as revenue rather than a reduction of cost of goods and services in
accordance with Emerging Issues Task Force (EITF) No. 01-14, "INCOME STATEMENT
CHARACTERIZATION OF REIMBURSEMENTS RECEIVED FOR 'OUT-OF-POCKET' EXPENSES
INCURRED."
A description of these adjustments and a summary showing their effect on
the restated consolidated statements of operations is provided in Note 1B to the
unaudited interim consolidated financial statements. This Amendment has no
effect on the Company's gross profit, operating income, net income, earnings per
share, cash flows, liquidity or financial condition as presented in the Original
Filing. Additionally, this Amendment has no effect on the consolidated balance
sheets, consolidated statements of cash flows or consolidated statements of
stockholders' equity as presented in the Original Filing.
The Company is filing this report in order to amend certain information in
Items 1, 2 and 4 of Part I; to reflect the restatement of the June 30, 2004 and
2003 unaudited interim consolidated statements of operations and the notes to
the unaudited interim consolidated financial statements attached hereto solely
to the extent necessary to reflect the adjustments described herein; and the
principal executive officer and principal financial officer certifications
pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act of 2002. Except for
the foregoing items, no other information in the Original Filing is revised by
this Amendment. Items not being amended are presented for the convenience of the
reader only. This report continues to be presented as of the date of the
Original Filing, and the Company has not updated the disclosure in this report
to a later date. Therefore, this Amendment should be read together with other
documents that the Company has filed with the Securities and Exchange Commission
subsequent to the filing of the Original Filing. Information in such reports and
documents updates and supersedes certain information contained in this
Amendment. The filing of this Amendment shall not be deemed an admission that
the Original Filing, when made, included any known, untrue statement of material
fact, or knowingly omitted to state a material fact necessary to make a
statement not misleading.
The Company is not amending any reports affected by the restatement prior
to the Original Filing; therefore, the consolidated financial statements and
related financial information included in such reports should no longer be
relied upon and are hereby superseded.
2
INDEX
PDI, INC.
PART I. FINANCIAL INFORMATION
Page
Item 1. Consolidated Financial Statements (unaudited)
Balance Sheets
June 30, 2004 and December 31, 2003.................................3
Statements of Operations -- Three and Six Months
Ended June 30, 2004 and 2003 (Restated).............................4
Statements of Cash Flows -- Six Months
Ended June 30, 2004 and 2003........................................5
Notes to Consolidated Interim Financial Statements (Restated).......6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................23
Item 3. Quantitative and Qualitative Disclosures
About Market Risk......................................Not Applicable
Item 4. Controls and Procedures............................................38
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..................................................39
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................40
Item 5. Other Information......................................Not Applicable
Item 6. Exhibits and Reports on Form 8-K...................................40
SIGNATURES ...................................................................42
3
PDI, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)
June 30, December 31,
2004 2003
--------- ------------
ASSETS
Current assets:
Cash and cash equivalents.......................... $ 91,545 $113,288
Short-term investments............................. 33,795 1,344
Inventory, net..................................... -- 43
Accounts receivable, net of allowance for doubtful
accounts of $559 and $749 as of June 30, 2004
and December 31, 2003, respectively............ 30,848 40,885
Unbilled costs and accrued profits on contracts
in progress .................................. 4,991 4,041
Deferred training and other program costs.......... 3,037 1,643
Other current assets............................... 11,831 8,847
Deferred tax asset................................. 6,834 11,053
-------- --------
Total current assets.................................. 182,881 181,144
Net property and equipment............................ 16,892 14,494
Deferred tax asset.................................... 7,304 7,304
Goodwill.............................................. 11,132 11,132
Other intangible assets............................... 1,341 1,648
Other long-term assets................................ 3,830 3,901
-------- --------
Total assets.......................................... $223,380 $219,623
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................... $ 5,162 $ 8,689
Accrued returns.................................... 11,382 22,811
Accrued incentives................................. 14,050 20,486
Accrued salaries and wages......................... 9,203 9,031
Unearned contract revenue.......................... 15,397 3,604
Restructuring accruals............................. 444 744
Income taxes and other accrued expenses............ 14,294 15,770
-------- --------
Total current liabilities............................. 69,932 81,135
Total long-term liabilities........................... -- --
-------- --------
Total liabilities..................................... $ 69,932 $ 81,135
-------- --------
Commitments and Contingencies (note 12)
Stockholders' equity:
Common stock, $.01 par value, 100,000,000 shares
authorized: shares issued and outstanding, June 30,
2004 - 14,619,271, and December 31, 2003 -
14,387,126; 161,115 and 136,178 restricted shares
issued and outstanding at June 30, 2004
and December 31, 2003, respectively............... $ 148 $ 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 June 30, 2004 and
December 31, 2003, respectively) 115,421 109,531
Retained earnings..................................... 40,523 29,505
Accumulated other comprehensive income................ 58 25
Unamortized compensation costs........................ (2,592) (608)
Treasury stock, at cost: 5,000 shares................. (110) (110)
--------- ---------
Total stockholders' equity............................ $ 153,448 $138,488
--------- ---------
Total liabilities & stockholders' equity.............. $ 223,380 $219,623
========= =========
The accompanying notes are an integral part of these financial statements
4
PDI, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
Three Months Ended June 30 Six Months Ended June 30,
----------------------------- -----------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
(Restated) (Restated) (Restated) (Restated)
Revenue
Service........................................... $92,519 $77,542 $185,066 $150,641
Product, net...................................... (1,131) 82 (1,030) 116
------- ------- -------- --------
Total revenue, net............................. 91,388 77,624 184,036 150,757
------- ------- -------- --------
Cost of goods and services
Program expenses (including related party amounts
of $0 and $328 for the quarters ended June 30,
2004 and 2003, respectively and $180 and $401 for
the six months ended June 30, 2004 and 2003,
respectively) 69,483 56,672 135,471 112,141
Cost of goods sold................................ 89 83 233 145
------- ------- -------- --------
Total cost of goods and services............... 69,572 56,755 135,704 112,286
------- ------- -------- --------
Gross profit......................................... 21,816 20,869 48,332 38,471
Compensation expense................................. 7,924 9,123 18,140 17,997
Other selling, general and administrative expenses... 5,657 7,206 12,148 13,039
Restructuring and other related expenses............ - - - (270)
Litigation settlement................................ - - - 2,100
------- ------- -------- --------
Total operating expenses....................... 13,581 16,329 30,288 32,866
------- ------- -------- --------
Operating income..................................... 8,235 4,540 18,044 5,605
Other income, net.................................... 313 226 631 495
------- ------- -------- --------
Income before provision for taxes.................... 8,548 4,766 18,675 6,100
Provision for income taxes........................... 3,505 1,954 7,657 2,510
------- ------- -------- --------
Net income........................................... $ 5,043 $ 2,812 $ 11,018 $ 3,590
======= ======= ======== ========
Basic net income per share........................... $ 0.35 $ 0.20 $ 0.76 $ 0.25
======= ======= ======== ========
Diluted net income per share......................... $ 0.34 $ 0.20 $ 0.74 $ 0.25
======= ======= ======== ========
Basic weighted average number of shares outstanding.. 14,533 14,188 14,497 14,177
======= ======= ======== ========
Diluted weighted average number of shares outstanding 14,918 14,266 14,843 14,252
======= ======= ======== ========
The accompanying notes are an integral part of these financial statements
5
PDI, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Six Months Ended June 30,
2004 2003
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income........................................... $ 11,018 $ 3,590
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization................ 2,911 2,660
Reserve for inventory obsolescence and
bad debt 39 229
Deferred taxes, net.......................... 4,220 --
Stock compensation costs..................... 844 251
Other changes in assets and liabilities:
Decrease in accounts receivable.............. 9,998 7,006
Decrease (increase) in inventory............. 43 (418)
(Increase) in unbilled costs................. (949) (7,937)
(Increase) in deferred training.............. (1,394) (1,364)
Decrease in prepaid income tax............... -- 4,013
(Increase) in other current assets........... (2,985) (3,942)
Decrease in other long-term assets........... 71 134
(Decrease) increase in accounts payable...... (3,527) 110
(Decrease) in accrued returns................ (11,429) (407)
(Decrease) increase in accrued liabilities... (6,264) 2,399
(Decrease) in restructuring liability........ (300) (3,898)
Increase (decrease) in unearned contract
revenue ................................... 11,793 (4,276)
(Increase) in income taxes and other
accrued expenses (1,476) (2,945)
-------- --------
Net cash provided by (used in) operating activities.. 12,613 (4,796)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Sale of short-term investments.................. -- 4,189
Purchase of short-term investments.............. (32,418) --
Purchase of property and equipment.............. (5,002) (427)
-------- --------
Net cash (used in) provided by investing activities.. (37,420) 3,762
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from exercise of stock options..... 3,064 694
-------- --------
Net cash provided by financing activities............ 3,064 694
-------- --------
Net (decrease) in cash and cash equivalents.......... (21,743) (340)
Cash and cash equivalents - beginning................ 113,288 66,827
-------- --------
Cash and cash equivalents - ending................... $ 91,545 $ 66,487
======== ========
The accompanying notes are an integral part of these financial statements
6
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/A 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/A 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 and six month periods ended
June 30, 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.
1B. RESTATEMENT OF CONSOLIDATED FINANCIAL STATEMENTS
The Company has restated its previously issued consolidated financial
statements for the quarters ended June 30, 2004 and 2003 (the previously issued
financial statements) to apply the provisions of EITF 01-14, "Income Statement
Characterization of Reimbursement Received for `Out-of-Pocket' Expenses
Incurred." (EITF 01-14) In September 2004, the Company became aware that it
should have been applying EITF 01-14 to the previously issued financial
statements. In accordance with EITF 01-14, direct reimbursements received by the
Company from its clients for certain costs incurred should have been included as
part of revenue with an identical increase to cost of goods and services, rather
than being netted against cost of goods and services. Revenue and cost of goods
and services in the previously issued financial statements were increased by
$8.2 million and $6.4 million for the quarters ended June 30, 2004 and 2003,
respectively, and $12.5 million and $12.0 million for the six months ended June
30, 2004 and 2003, respectively. EITF 01-14, which was issued in late 2001, was
applicable for years beginning in 2002, and also required reclassification of
all previous periods for comparative purposes.
This restatement does not affect previously reported gross profit,
operating income, net income, earnings per share, cash flows, liquidity or
financial condition. Additionally, there is no effect on the consolidated
balance sheets, consolidated statements of cash flows or consolidated statements
of stockholders' equity for the previously issued financial statements. A
summary of the effects of the restatement to reclassify these amounts is as
follows:
7
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
QUARTER ENDED QUARTER ENDED SIX MONTHS SIX MONTHS
JUNE 30, 2004 JUNE 30, 2003 JUNE 30, 2004 JUNE 30, 2003
-------------------------------------------------------------------------------------------------
AS AS AS AS
PREVIOUSLY AS PREVIOUSLY AS PREVIOUSLY AS PREVIOUSLY AS
REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED
-------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS
OF OPERATIONS:
Service revenue $ 84,334 $ 92,519 $ 71,177 $ 77,542 $ 172,600 $ 185,066 $ 138,688 $ 150,641
Product revenue (1,131) (1,131) 82 82 (1,030) (1,030) 116 116
--------- --------- --------- --------- --------- --------- --------- ---------
TOTAL REVENUE 83,203 91,388 71,259 77,624 171,570 184,036 138,804 150,757
--------- --------- --------- --------- --------- --------- --------- ---------
Program expenses 61,298 69,483 50,307 56,672 123,005 135,471 100,188 112,141
Cost of goods sold 89 89 83 83 233 233 145 145
--------- --------- --------- --------- --------- --------- --------- ---------
TOTAL COST OF 61,387 69,572 50,390 56,755 123,238 135,704 100,333 112,286
GOODS AND SERVICES
--------- --------- --------- --------- --------- --------- --------- ---------
GROSS PROFIT $ 21,816 $ 21,816 $ 20,869 $ 20,869 $ 48,332 $ 48,332 $ 38,471 $ 38,471
--------- --------- --------- --------- --------- --------- --------- ---------
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 and six months
ended June 30, 2004, the Company's two largest clients who each individually
represented 10% or more of its service revenue, accounted for approximately
65.7%, and 65.3%, respectively, of the Company's service revenue. For the three
and six months ended June 30, 2003, the Company's two largest clients who each
accounted for 10% or more of its service revenue totaled 66.5%, and 67.7%,
respectively, of the Company's service revenue.
SERVICE REVENUE AND PROGRAM EXPENSES
Service revenue is earned primarily by performing product detailing
programs and other marketing and promotional services under contracts. Revenue
is recognized as the services are performed and the right to receive payment for
the services is assured. Revenue is recognized net of any potential penalties
until the performance criteria relating to the penalties have been achieved.
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
8
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
benefits and payroll taxes for the sales representatives and sales managers and
professional staff who are directly responsible for executing a particular
program. Initial direct program costs are those costs associated with initiating
a product detailing program, such as recruiting, hiring, and training the sales
representatives who staff a particular product detailing program. All personnel
costs and initial direct program costs, other than training costs, are expensed
as incurred for service offerings. Product detailing, marketing and promotional
expenses related to the detailing of products the Company distributes are
recorded as a selling expense and are included in other selling, general and
administrative expenses in the consolidated statements of operations.
REIMBURSABLE OUT-OF-POCKET EXPENSES
Reimbursable out-of-pocket expenses include those relating to travel and
out-of pocket expenses and other similar costs, for which the Company is
reimbursed at cost from its clients. In accordance with the requirements of EITF
01-14, it is required that reimbursements received for out-of-pocket expenses
incurred be characterized as revenue and an identical amount be included as cost
of goods and services 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 and six month periods
ended June 30, 2004 was negative, primarily from the adjustment to the Ceftin
returns reserve, as discussed in Note 4 to the consolidated financial
statements, net of the sale of the Xylos wound care products. Product revenue of
$82,000 and $116,000 for the three and six month periods ended June 30, 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
In June 2004, the Company adopted the PDI, Inc. 2004 Stock Award and
Incentive Plan (the 2004 Plan), which was approved by the Company's board of
directors in March 2004 and approved by the Company's Stockholders in June 2004.
The 2004 Plan replaces the Company's 2000 Omnibus Incentive Compensation Plan
and 1998 Stock Option Plan (the Preexisting Plans), reserving 2,896,868 shares
for options, restricted stock and a variety of other types of awards. The 2004
Plan authorizes a broad range of awards, including stock options, stock
appreciation rights, restricted stock, deferred stock, other awards based on
common stock, dividend equivalents, stock-based performance awards, cash-based
performance awards, shares issuable in lieu of rights to cash compensation and
discounted options pursuant to an
9
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
employee stock purchase program. No new awards will be authorized for grant
under the Preexisting Plans, but previously authorized awards under those plans
will remain in effect. The 2004 Plan is described more fully in the Company's
2004 Definitive Proxy Statement and the Preexisting Plans are 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. Certain employees have
received restricted common stock, the amortization of which is reflected in net
income and was $193,000 and $569,000 for the three and six month periods ended
June 30, 2004. Additionally, during the first quarter of 2004, the Company
accelerated the vesting of stock option grants and restricted stock grants for
certain employees which resulted in total compensation of approximately $275,000
in the quarter ended March 31, 2004. 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.
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
--------------- --------------------- ------------------- -----------------
(in thousands, except per share data)
Net income, as reported $ 5,043 $ 2,812 $ 11,018 $ 3,590
Add: Stock-based employee compensation expense
included in reported net income, net of related tax
effects 114 82 498 196
Deduct: Total stock-based employee compensation
expense determined under fair value based methods
for all awards, net of related tax effects (936) (1,567) (2,068) (3,134)
-------- --------- ---------- ----------
Pro forma net income $ 4,221 $ 1,327 $ 9,448 $ 652
======== ========= ========== ==========
Net income per share
Basic--as reported $ 0.35 $ 0.20 $ 0.76 $ 0.25
======== ========= ========== ==========
Basic--pro forma $ 0.29 $ 0.09 $ 0.65 $ 0.05
======== ========= ========== ==========
Diluted--as reported $ 0.34 $ 0.20 $ 0.74 $ 0.25
======== ========= ========== ==========
Diluted--pro forma $ 0.28 $ 0.09 $ 0.64 $ 0.05
======== ========= ========== ==========
10
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
Compensation cost for the determination of pro forma net income - 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 3.81% and 2.46% at June 30, 2004 and 2003, respectively; (ii) expected
life of five years for the three and six month periods ended June 30, 2004 and
2003; (iii) expected dividends - $0 for the three and six month periods ended
June 30, 2004 and 2003; and (iv) volatility of 100% for the three and six months
periods ended June 30, 2004 and 2003. The weighted average fair value of options
granted during the three and six month periods ended June 30, 2004 was $21.45
and $19.23, respectively and $6.66 for the three and six month periods ended
June 30, 2003.
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
until these options are terminated, exercised or forfeited. To date, this has
not occurred. The non-tendered options have exercise prices ranging from $59.50
to $80.00 and a remaining life of 6.2 to 6.5 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
11
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
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.
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. In the second quarter of 2004 the
Company increased its return reserve by approximately $1.2 million based
primarily upon new information obtained from the wholesalers as part of the
Company's ongoing reserve review process.
The Company's reserve of $11.4 million at June 30, 2004 reflects the
Company's estimated liability for all identified product that could potentially
be returned by all the remaining wholesalers, 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, with respect to
12
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
certain wholesalers, reimbursing the wholesalers at the amount that they
purchased the product from the Company. The reserve as recorded by the Company
is its best estimate based on its understanding of its obligations. The reserve
also includes a liability of $2.5 million for services to be purchased by the
Company from a large wholesaler which the Company was able to negotiate in lieu
of cash payments as described above. However, 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 were scheduled to end 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 agreement, without cause, effective March 16, 2004 and, as a
result, $28.9 million of anticipated revenue associated with the Lotrel-Diovan
agreement 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 for the three and six month periods
ended June 30, 2004 were approximately $643,000 and $2.9 million, respectively;
the royalties earned during the remainder 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
accepted orders for XCell products through May 16, 2004 when the agreement
terminated; however, the Company's promotional activities in support of the
brand concluded in January 2004. The Company recorded a reserve for potential
excess inventory during 2003 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 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. Under the terms of the
agreement, the Company paid Cellegy a $15.0 million initial licensing fee on
December 31, 2002. Under the terms of the licensing agreement, if it should be
enforced (see discussion of the lawsuit below), this nonrefundable
13
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
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, if it should be enforced (see discussion of lawsuit below), 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, 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. Since the Company filed the
lawsuit, Cellegy is no longer in regular contact with the Company regarding
Fortigel. Thus, for example, the Company has been informed that Cellegy is in
continuing contact with the FDA but the Company is unaware of the precise FDA
status regarding Fortigel (as of June 30, 2004, it had not been approved).
Accordingly, the Company 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. The Company cannot predict with any certainty whether
the FDA will ultimately approve Fortigel for sale in the U.S.
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.
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 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 through the first six
months 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 June 30, 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.
In May 2004, the Company entered into a loan agreement with TMX
Interactive, Inc. (TMX), a provider of sales force effectiveness technology.
Pursuant to the loan agreement, the Company provided TMX with a term loan
facility of $500,000 and a convertible loan facility of $500,000, each of which
are due to be repaid on November 26, 2005. In connection with the convertible
loan facility, the Company has the right to convert all, or, in multiples of
$100,000, any part of the convertible note into common stock of TMX.
14
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
7. INVENTORY
At June 30, 2004 the Company no longer has any finished goods inventory
relating to the XCell wound care products. 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.
As discussed in Note 5, on January 2, 2004 the Company gave notice of
termination of its agreement with Xylos, effective May 16, 2004. At June 30,
2004 all remaining inventory had been destroyed.
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 condition and 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 did not have a material
impact on the Company's business, financial condition 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." A
reconciliation of the number of shares used in the calculation of basic and
diluted earnings per share for the periods ended June 30, 2004 and 2003 is as
follows:
15
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- --------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
(in thousands)
Basic weighted average number
of common shares outstanding .......................... 14,533 14,188 14,497 14,177
Dilutive effect of stock options and
restricted stock .................................... 385 78 346 75
------ ------ ------ ------
Diluted weighted average number
of common shares outstanding .......................... 14,918 14,266 14,843 14,252
====== ====== ====== ======
Outstanding options at June 30, 2004 to purchase 264,229 shares of common
stock with exercise prices ranging from $29.53 to $93.75 were not included in
the computation of historical and pro forma diluted net income per share because
to do so would have been antidilutive. Outstanding options at June 30, 2003 to
purchase 1,068,330 shares of common stock with exercise prices ranging from
$14.16 to $93.75 were not included in the computation of historical and pro
forma diluted net income per share because to do so would have been
antidilutive.
10. SHORT-TERM INVESTMENTS
At June 30, 2004, short-term investments were $33.8 million, including
approximately $1.5 million of investments classified as available for sale
securities. At June 30, 2003, short-term investments were $1.8 million,
including approximately $1.1 million of investments classified as available for
sale securities. The unrealized after-tax gain/(loss) on the available for sale
securities is included as a separate component of stockholders' equity as
accumulated other comprehensive income. 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 Six Months Ended
June 30, June 30,
------------------------------- -------------------------------
2004 2003 2004 2003
-------------- ------------- ------------- -------------
(thousands)
Net income ..................................................... $ 5,043 $ 2,812 $11,018 $ 3,590
Other comprehensive income, net of tax:
Unrealized holding gain on
available-for-sale securities
arising during the period ............................... 1 58 11 89
Reclassification adjustment for losses
included in net income .................................. 3 33 22 33
------- ------- ------- -------
Other comprehensive income ..................................... $ 5,047 $ 2,903 $11,051 $ 3,712
======= ======= ======= =======
16
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
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 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
17
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
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, 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. To date, 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. The Company filed an answer to
Cellegy's complaint on June 18, 2004, in which it makes the same allegations and
claims for relief as it does in its
18
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
New York action, and it also alleges Cellegy violated California unfair
competition law. By order dated April 23, 2004, the Company's lawsuit was
transferred to the Northern District of California where it may 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 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 effect on the Company's business, financial
condition and results of operations.
No material 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 objective of which was 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 subsequent
periods 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 the restructuring accrual due to negotiating higher sublease
proceeds than originally estimated for the leased facility in Cincinnati, Ohio.
During the quarter ended June 30, 2003 the Company incurred approximately
$133,000 of additional restructuring expense due to higher than expected
contractual termination costs. This additional expense was recorded in program
expenses consistent with the original recording of the restructuring charges.
Also during the quarter ended June 30, 2003 the Company recognized a
$473,000 reduction in the restructuring accrual due to lower than expected sales
force severance costs. Greater success in the reassignment of sales
representatives to other programs and the voluntary departure of other sales
representatives combined to reduce the requirement for severance costs. This
adjustment was recorded in program expenses consistent with the original
recording of the restructuring charges.
The accrual for restructuring and exit costs totaled approximately
$444,000 at June 30, 2004, and is recorded in current liabilities on the
accompanying balance sheet.
19
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
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 JUNE 30, 2004
Administrative severance $ 285 $ -- $(155) $ 130
Exit costs 459 -- (145) 314
----- ----- ----- -----
744 -- (300) 444
----- ----- ----- -----
Sales force severance -- -- -- --
----- ----- ----- -----
TOTAL $ 744 $ -- $(300) $ 444
===== ===== ===== =====
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 Six Months Ended
June 30, June 30,
--------------------------------- ---------------------------------
2004 2003 2004 2003
--------------- --------------- --------------- ---------------
(in thousands)
Revenue (RESTATED)
Sales and marketing services group $ 91,873 $ 65,244 $ 182,049 $ 128,308
PDI products group (485) 12,380 1,987 22,449
--------- --------- --------- ---------
Total $ 91,388 $ 77,624 $ 184,036 $ 150,757
========= ========= ========= =========
Income (loss) from operations, before
corporate allocations
Sales and marketing services group $ 16,185 $ 10,792 $ 33,658 $ 20,912
PDI products group (1,031) (2,247) (522) (7,261)
Corporate charges (6,919) (4,005) (15,092) (8,046)
--------- --------- --------- ---------
Total $ 8,235 $ 4,540 $ 18,044 $ 5,605
========= ========= ========= =========
20
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------------- ---------------------------------
(continued) 2004 2003 2004 2003
--------------- --------------- --------------- ---------------
(in thousands)
Corporate allocations
Sales and marketing services group $ (6,884) $ (3,361) $(14,931) $ (6,675)
PDI products group (35) (644) (161) (1,371)
Corporate charges 6,919 4,005 15,092 8,046
-------- -------- -------- --------
Total $ -- $ -- $ -- $ --
======== ======== ======== ========
Income (loss) from operations, less corporate
allocations
Sales and marketing services group $ 9,301 $ 7,431 $ 18,727 $ 14,237
Pharmaceutical products group (1,066) (2,891) (683) (8,632)
Corporate charges -- -- -- --
-------- -------- -------- --------
Total $ 8,235 $ 4,540 $ 18,044 $ 5,605
======== ======== ======== ========
Reconciliation of income from operations to
income before provision for income taxes
Total EBIT for operating groups $ 8,235 $ 4,540 $ 18,044 $ 5,605
Other income, net 313 226 631 495
-------- -------- -------- --------
Income before provision for income taxes $ 8,548 $ 4,766 $ 18,675 $ 6,100
======== ======== ======== ========
Capital expenditures
Sales and marketing services group $ 2,414 $ 212 $ 5,002 $ 427
PDI products group -- -- -- --
-------- -------- -------- --------
Total $ 2,414 $ 212 $ 5,002 $ 427
======== ======== ======== ========
Depreciation expense
Sales and marketing services group $ 1,239 $ 928 $ 2,579 $ 1,899
PDI products group 6 181 25 454
-------- -------- -------- --------
Total 1,245 $ 1,109 $ 2,604 $ 2,353
======== ======== ======== ========
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 June 30, 2004 and December 31, 2003.
There were no changes in the carrying amount of goodwill since December
31, 2003. The carrying amounts at June 30, 2004 by operating segment are shown
below:
21
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
(in thousands) SMSG PPG TOTAL
---- --- -----
Balance as of December 31, 2003 $11,132 $ -- $11,132
Amortization -- -- --
Goodwill additions -- -- --
------- ------- -------
Balance as of June 30, 2004 $11,132 $ -- $11,132
======= ======= =======
All identifiable intangible assets recorded as of June 30, 2004 are being
amortized on a straight-line basis over the life of the intangibles which is
primarily five years. The carrying amounts at June 30, 2004 and December 31,
2003 are as follows:
(in thousands) As of June 30, 2004 As of December 31, 2003
----------------------------------------- ------------------------------------------
Carrying Accumulated Carrying Accumulated
Amount Amortization Net Amount Amortization Net
----------------------------------------- ------------------------------------------
Covenant not to compete $1,686 $ 948 $ 738 $1,686 $ 780 $ 906
Customer relationships 1,208 680 528 1,208 559 649
Corporate tradename 172 97 75 172 79 93
------ ------ ------ ------ ------ ------
Total $3,066 $1,725 $1,341 $3,066 $1,418 $1,648
====== ====== ====== ====== ====== ======
Amortization expense totaled approximately $153,000 and $307,000 for the
three and six months ended June 30, 2004 and 2003. Estimated amortization
expense for the next five years is as follows:
(in thousands)
2004 $ 613
===
2005 613
===
2006 422
===
2007 -
===
2008 -
===
22
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/A 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/A 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, 10-Q/A 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.
RESTATEMENT OF CONSOLIDATED FINANCIAL STATEMENTS
We have restated our previously issued consolidated financial statements
for the quarters ended June 30, 2004 and 2003 (the previously issued financial
statements) to apply the provisions of EITF 01-14, "Income Statement
Characterization of Reimbursement Received for `Out-of-Pocket' Expenses
Incurred." (EITF 01-14) In September 2004, we became aware that we should have
been applying EITF 01-14 to the previously issued financial statements. In
accordance with EITF 01-14, direct reimbursements received by us from our
clients for certain costs incurred should have been included as part of revenue
with an identical increase to cost of goods and services, rather than being
netted against cost of goods and services. Revenue and cost of goods and
services in the previously issued financial statements were increased by $8.2
million and $6.4 million for the quarters ended June 30, 2004 and 2003,
respectively, and $12.5 million and $12.0 million for the six months ended June
30, 2004 and 2003, respectively. EITF 01-14, which was issued in late 2001, was
applicable for years beginning in 2002, and also required reclassification of
all previous periods for comparative purposes.
This restatement does not affect previously reported gross profit,
operating income, net income, earnings per share, cash flows, liquidity or
financial condition. Additionally, there is no effect on the consolidated
balance sheets, consolidated statements of cash flows or consolidated statements
of stockholders' equity for the previously issued financial statements. A
summary of the effects of the restatement to reclassify these amounts is as
follows:
23
QUARTER ENDED QUARTER ENDED SIX MONTHS SIX MONTHS
JUNE 30, 2004 JUNE 30, 2003 JUNE 30, 2004 JUNE 30, 2003
----------------------------------------------------------------------------------------------------------
AS PREVIOUSLY AS PREVIOUSLY AS PREVIOUSLY AS PREVIOUSLY
REPORTED AS RESTATED REPORTED AS RESTATED REPORTED AS RESTATED REPORTED AS RESTATED
----------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS
OF OPERATIONS:
Service revenue $ 84,334 $ 92,519 $ 71,177 $ 77,542 $ 172,600 $ 185,066 $ 138,688 $ 150,641
Product revenue (1,131) (1,131) 82 82 (1,030) (1,030) 116 116
--------- ---------- ---------- --------- ---------- ---------- --------- ---------
TOTAL REVENUE 83,203 91,388 71,259 77,624 171,570 184,036 138,804 150,757
--------- ---------- ---------- --------- ---------- ---------- --------- ---------
Program expenses 61,298 69,483 50,307 56,672 123,005 135,471 100,188 112,141
Cost of goods sold 89 89 83 83 233 233 145 145
--------- ---------- ---------- --------- ---------- ---------- --------- ---------
TOTAL COST OF GOODS 61,387 69,572 50,390 56,755 123,238 135,704 100,333 112,286
AND SERVICES
--------- ---------- ---------- --------- ---------- ---------- --------- ---------
GROSS PROFIT $ 21,816 $ 21,816 $ 20,869 $ 20,869 $ 48,332 $ 48,332 $ 38,471 $ 38,471
--------- ---------- ---------- --------- ---------- ---------- --------- ---------
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, ranging 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 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
24
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, program duration 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.
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 custom
solutions for clients with unique challenges.
25
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, including 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 agreements may require upfront payments, royalty payments, milestone
payments and/or 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.
26
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 have a material adverse effect on our business,
financial condition and results of operations. 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 effect on our business,
financial condition and results of operations.
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 were scheduled to run through December 31, 2003;
however, the Lotrel-Diovan agreement was renewed on December 24, 2003 for an
additional one-year period. In February 2004, we were notified by Novartis of
its intent to terminate the Lotrel-Diovan contract without cause, effective
March 16, 2004 and, as a result, $28.9 million of anticipated revenue associated
with the Lotrel-Diovan contract in 2004 will not be realized. We 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 for the three and six
month periods ended June 30, 2004 were approximately $643,000 and $2.9 million,
respectively; the royalties earned during the remainder of 2004 are expected to
diminish substantially because the product lost its patent protection in
February 2004.
27
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. Under the terms of the
agreement, we paid Cellegy a $15.0 million initial licensing fee on December 31,
2002. Under the terms of the licensing agreement, if it should be enforced (see
discussion of the lawsuit below), this nonrefundable 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, if it should be enforced (see discussion of
lawsuit below), 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. As discussed in Note 12, we filed a complaint against
Cellegy in December 2003, that alleges, among other things, that Cellegy
fraudulently induced us 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. Since we filed the lawsuit, Cellegy is no longer in
regular contact with us regarding Fortigel. Thus, for example, we have been
informed that Cellegy is in continuing contact with the FDA but we are unaware
of the precise FDA status regarding Fortigel (as of June 30, 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.
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 accepted orders for XCell products
through May 16, 2004 when the agreement terminated; 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.
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
28
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 and six months ended June
30, 2004, our two largest clients who each individually represented 10% or more
of our service revenue, accounted for approximately 65.7%, and 65.3%,
respectively, of our service revenue. For the three and six months ended June
30, 2003, our two largest clients who each accounted for 10% or more of our
service revenue totaled 66.5%, and 67.7%, 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.
REIMBURSABLE OUT-OF-POCKET EXPENSES
Reimbursable out-of-pocket expenses include those relating to travel and
out-of pocket expenses and other similar costs, for which we are reimbursed at
cost from our clients. In accordance with the requirements of EITF 01-14, it is
required that reimbursements received for out-of-pocket expenses incurred be
characterized as revenue and an identical amount be included as cost of goods
and services 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
29
compensate us for recruiting, hiring and training services associated with
staffing that program, such payment is deferred and recognized as revenue in the
same period that the recruiting and hiring expenses are incurred and
amortization of the deferred training is expensed. When we do not receive a
specific contract payment for training, all revenue is deferred and recognized
over the life of the contract.
As a result of the revenue recognition and program expense policies
described above, we may incur significant initial direct program costs before
recognizing revenue under a particular product detailing program. Our inability
to specifically negotiate for payments that are specifically attributable to
recruiting, hiring or training services in our product detailing contracts could
adversely impact our operating results for periods in which the costs associated
with the product detailing services are incurred.
PRODUCT REVENUE AND COST OF GOODS SOLD
Product revenue is recognized when products are shipped and title is
transferred to the customer. Product revenue of negative $1.1 million and
negative $1.0 million for the three and six months ended June 30, 2004 was
primarily due to the $1.2 million increase in the Ceftin returns reserve as
discussed more fully in Note 3. Additionally we had product revenue of $82,000
and $116,000 for the three and six months ended June 30, 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
consolidated statements of operations data as a percentage of revenue. The
trends illustrated in this table may not be indicative of future results.
As Restated
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- ---------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
Revenue
Service, net ..................................................... 101.2% 99.9% 100.6% 99.9%
Product, net ..................................................... (1.2) 0.1 (0.6) 0.1
------- ------- ------- -------
Total revenue, net ............................................. 100.0% 100.0% 100.0% 100.0%
Cost of goods and services
Program expenses ................................................. 76.0 73.0 73.6 74.4
Cost of goods sold ............................................... 0.1 0.1 0.1 0.1
------- ------- ------- -------
Total cost of goods and services ............................... 76.1% 73.1% 73.7% 74.5%
Gross profit ........................................................ 23.9 26.9 26.3 25.5
Compensation expense ................................................ 8.7 11.8 9.9 11.9
Other selling, general and administrative expenses .................. 6.2 9.3 6.6 8.6
Restructuring and other related expenses, net ....................... -- -- -- --
(0.2)
Litigation settlement ............................................... -- -- -- 1.4
------- ------- ------- -------
Total operating expenses ....................................... 14.9 21.1 16.5 21.7
------- ------- ------- -------
Operating income .................................................... 9.0 5.8 9.8 3.8
Other income, net ................................................... 0.3 0.3 0.3 0.3
------- ------- ------- -------
Income before provision for income taxes ............................ 9.3 6.1 10.1 4.1
Provision for income taxes .......................................... 3.8 2.5 4.1 1.7
------- ------- ------- -------
Net income .......................................................... 5.5% 3.6% 6.0% 2.4%
======= ======= ======= =======
30
THREE MONTHS ENDED JUNE 30, 2004 COMPARED TO THREE MONTHS ENDED JUNE 30, 2003
REVENUE. Net revenue for the quarter ended June 30, 2004 was $91.4
million, 17.7% more than net revenue of $77.6 million for the quarter ended June
30, 2003. Net revenue from the SMSG segment for the quarter ended June 30, 2004
was $91.2 million, 40.8% more than net revenue of $65.2 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. On May 3, 2004 we announced the addition of two new
dedicated contract sales teams contracts which we expect to total approximately
$34.0 million in revenue, excluding revenues associated with reimbursable
out-of-pocket expenses, for 2004. Net PPG revenue for the quarter ended June 30,
2004 was approximately negative $485,000; this consisted of $646,000 in revenue
due to Lotensin royalties and $58,000 in product revenue related to the sale of
the Xylos product entirely offset by the $1.2 million increase in the Ceftin
reserve (as discussed more fully in Note 4 to the financial statements),
resulting in the net negative product revenue. The Lotensin royalties earned
during the remaining quarters of 2004 are expected to continue to diminish
substantially because the product lost its patent protection in February 2004.
Net PPG revenue was $12.4 million in the comparable prior year period. The
Lotensin contract, which was a major contributor in 2003 was completed December
31, 2003.
COST OF GOODS AND SERVICES. Cost of goods and services for the quarter
ended June 30, 2004 was $69.6 million, 22.6% more than cost of goods and
services of $56.8 million for the quarter ended June 30, 2003. As a percentage
of total net revenue, cost of goods and services increased to 76.1% for the
quarter ended June 30, 2004 from 73.1% in the comparable prior year period.
Program expenses (i.e., cost of services) associated with the SMSG segment for
the quarter ended June 30, 2004 were $69.6 million, 46.6% more than program
expenses of $47.5 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 June 30, 2004 and 2003 were
75.7% and 72.8%, respectively. There were two significant reasons why program
expenses were lower as a percent of revenue for the quarter ended June 30, 2003
as compared to the quarter ended June 30, 2004: greater efficiencies in a large
recruiting and hiring effort for the quarter ended June 30, 2003 generated cost
savings; and we benefited during 2003 from higher medical education revenues,
which have a high gross profit percentage. Cost of goods and services associated
with the PPG segment were zero and $9.3 million for the quarters ended June 30,
2004 and 2003, respectively. This decrease can be primarily attributed to the
completion of the Lotensin contract which ended December 31, 2003. Also during
the quarter ended June 30, 2003 we recognized a $340,000 net reduction in the
restructuring accrual associated with the 2002 Restructuring Plan (see Note 4
and "RESTRUCTURING AND OTHER RELATED EXPENSES" disclosure below for further
explanations).
COMPENSATION EXPENSE. Compensation expense for the quarter ended June 30,
2004 was $7.9 million, 13.1% less than $9.1 million for the comparable prior
year period. The decrease in compensation expense was primarily due to the
decrease in incentive compensation expense compared to the comparable prior year
period. As a percentage of total net revenue, compensation expense decreased to
8.7% for the quarter ended June 30, 2004 from 11.8% for the quarter ended June
30, 2003 due to the increase in revenue and continuing cost management efforts.
Compensation expense for the quarter ended June 30, 2004 attributable to the
SMSG segment was $7.3 million compared to $6.3 million for the quarter ended
June 30, 2003. This increase can be attributed to a greater amount of internal
resources and management's time and effort being allocated to the SMSG segment
in 2004; nevertheless, compensation expense as a percentage of net revenue
decreased to 8.0% from 9.7% in the comparable prior year period. Compensation
expense for the quarter ended June 30, 2004 attributable to the PPG segment was
approximately $575,000 compared to $2.8 million 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.
31
OTHER SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Total other selling,
general and administrative expenses were $5.7 million for the quarter ended June
30, 2004, 21.5% less than other selling, general and administrative expenses of
$7.2 million for the quarter ended June 30, 2003. This decrease is primarily a
result of a reduction of sales force and marketing costs related to Xylos.
During 2003, we incurred approximately $1.0 million in sales force and marketing
costs as compared to $28,000 for the quarter ended June 30, 2004 as we stopped
selling the products on May 16, 2004. As a percentage of total net revenue,
total other selling, general and administrative expenses decreased to 6.2% for
the quarter ended June 30, 2004 from 9.3% for the quarter ended June 30, 2003
due to continuing cost management efforts. Other selling, general and
administrative expenses attributable to the SMSG segment for the quarter ended
June 30, 2004 were $5.7 million, compared to other selling, general and
administrative expenses of $4.0 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 utilized by 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 6.2% and 6.1% for the quarters
ended June 30, 2004 and 2003, respectively. Other selling, general and
administrative expenses attributable to the PPG segment for the quarter ended
June 30, 2004 were approximately $5,000 compared to $3.2 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 and the termination of the Xylos agreement.
OPERATING INCOME. Operating income for the quarter ended June 30, 2004 was
$8.2 million, compared to operating income of $4.5 million for the quarter ended
June 30, 2003. Operating income as a percentage of revenue increased to 9.0% for
the three months ended June 30, 2004 from 5.8% in the comparable prior year
period. Operating income for the quarter ended June 30, 2004 for the SMSG
segment was $9.3 million, or 25.2% higher than the SMSG operating income for the
quarter ended June 30, 2003 of $7.4 million. As a percentage of net revenue from
the sales and marketing services segment, operating income for that segment
decreased to 10.1% for the quarter ended June 30, 2004, from 11.4% for the
comparable prior year period. There was an operating loss for the PPG segment
for the quarter ended June 30, 2004 of approximately $1.1 million, primarily due
to the $1.2 million increase in the Ceftin returns reserve compared to an
operating loss of $2.9 million for the prior year period.
OTHER INCOME, NET. Other income, net, for the quarters ended June 30, 2004
and 2003 was $313,000 and $226,000, respectively, and was comprised primarily of
interest income.
PROVISION FOR INCOME TAXES. Income tax expense was $3.5 million for the
quarter ended June 30, 2004, compared to income tax expense of approximately
$1.9 million for the quarter ended June 30, 2003, which consisted of Federal and
state corporate income taxes. The effective tax rate for the quarters ended June
30, 2004 and June 30, 2003 was 41.0% for both periods.
NET INCOME. Net income for the quarter ended June 30, 2004 was
approximately $5.0 million, compared to net income of approximately $2.8 million
for the quarter ended June 30, 2003. This increase is due to the factors
discussed above.
SIX MONTHS ENDED JUNE 30, 2004 COMPARED TO SIX MONTHS ENDED JUNE 30, 2003
REVENUE. Net revenue for the six months ended June 30, 2004 was $184.0
million, 22.1% more than the comparable prior year period. Net revenue from the
SMSG segment for the six months ended June 30, 2004 was $182.0 million, 41.9%
more than net revenue of $128.3 million for the six months ended June 30, 2003.
This increase is mainly attributable to the addition of three significant
dedicated contract sales teams contracts in July 2003 which are still ongoing in
2004. Net PPG revenue for the six months ended June 30, 2004 was $2.0 million;
that consisted primarily of Lotensin royalties, partially offset by the $1.2
million of negative revenue that was recognized due to the increase in the
Ceftin returns reserve (as discussed more fully in Note 4 to the financial
statements). The Lotensin royalties earned during the remaining two quarters of
2004 are expected to diminish substantially because the product lost its patent
32
protection in February 2004. Net PPG revenue was $22.4 million in the comparable
prior year period. The Lotensin contract, which was a major contributor in 2003,
was completed December 31, 2003.
COST OF GOODS AND SERVICES. Cost of goods and services for the six months
ended June 30, 2004 was $135.7 million, 20.9% more than cost of goods and
services of $112.3 million for the six months ended June 30, 2003. As a
percentage of total net revenue, cost of goods and services decreased to 73.7%
for the six months ended June 30, 2004 from 74.5% in the comparable prior year
period. Program expenses (i.e., cost of services) associated with the SMSG
segment for the quarter ended June 30, 2004 were $135.5 million, 45.4% more than
program expenses of $93.2 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 six months ended June 30,
2004 and 2003 were 74.4% and 72.6%, respectively. The reduction in gross profit
percentage of 1.8% is primarily attributable to greater incentive payments
earned in 2003, and severance and reassignment costs incurred in 2004 associated
with programs that terminated early. Cost of goods and services associated with
the PPG segment were $244,000 and $19.1 million for the six months ended June
30, 2004 and 2003, respectively. This decrease can be primarily attributed to
the completion of the Lotensin contract that ended December 31, 2003. Also
during the quarter ended June 30, 2003 we recognized a $340,000 net reduction in
the restructuring accrual associated with the 2002 Restructuring Plan (see Note
4 and "RESTRUCTURING AND OTHER RELATED EXPENSES" disclosure below for further
explanations.)
COMPENSATION EXPENSE. Compensation expense for the six months ended June
30, 2004 was $18.1 million, essentially the same as $18.0 million for the
comparable prior year period. As a percentage of total net revenue, compensation
expense decreased to 9.9% for the six months ended June 30, 2004 from 11.9% for
the six months ended June 30, 2003 due to continuing cost management efforts.
Compensation expense for the six months ended June 30, 2004 attributable to the
SMSG segment was $16.5 million compared to $12.4 million for the six month
period ended June 30, 2003; this increase can be attributed to a greater amount
of management's time and effort being allocated to the SMSG segment in 2004. As
a percentage of net revenue from sales and marketing services, compensation
expense decreased to 9.0% from 9.7% in the comparable prior year period.
Compensation expense for the six months ended June 30, 2004 attributable to the
PPG segment was $1.7 million or 83.9% of PPG revenue, compared to $5.6 million
or 24.9% in the prior year period. A large portion of compensation expense
through the six months ended June 30, 2004 attributable to the PPG segment was
for severance related activities which occurred in the first quarter of 2004.
The decrease from the comparable prior year period 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 $12.1 million for the six months ended
June 30, 2004, 6.8% less than other selling, general and administrative expenses
of $13.0 million for the six months ended June 30, 2003. Excluding approximately
$700,000 in legal fee reimbursements from Bayer in the first quarter of 2003,
total other selling, general and administrative expenses are approximately $1.6
million less for the comparable period in 2004. As a percentage of total net
revenue, total other selling, general and administrative expenses decreased to
6.6% for the six months ended June 30, 2004 from 8.6% for the six months ended
June 30, 2003. Other selling, general and administrative expenses attributable
to the SMSG segment for the six months ended June 30, 2004 were $11.4 million,
compared to other selling, general and administrative expenses of $7.4 million
attributable to that segment for the comparable prior year period. This increase
is primarily due to a larger portion of resources and corporate overhead costs
being utilized by 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 6.3% and 5.8% for the six months ended June 30,
2004 and 2003, respectively. Other selling, general and administrative expenses
attributable to the PPG segment for the six months ended June 30, 2004 were
approximately $759,000 compared to $5.6 million for the comparable prior year
period; this decrease can be attributed to the lower level of
33
resources required after the completion of the Lotensin contract which ended
December 31, 2003 and the termination of the Xylos agreement.
RESTRUCTURING AND OTHER RELATED EXPENSES (CREDITS). For the six months
ended June 30, 2004 we did not recognize any adjustments to the restructuring
accrual. During the six months ended June 30, 2003, we recognized a $270,000
reduction in the restructuring accrual due to negotiating higher sublease
proceeds than originally estimated for the leased facility in Cincinnati, Ohio.
During the quarter ended June 30, 2003 we also incurred approximately $133,000
of additional restructuring expense due to higher than expected contractual
termination costs. This additional expense was recorded in program expenses
consistent with the original recording of the restructuring charges. Also during
the quarter ended June 30, 2003 we recognized a $473,000 reduction in the
restructuring accrual due to greater success in the reassignment of sales
representatives to other programs and the voluntary departure of other sales
representatives which combined to reduce the requirement for severance costs.
This adjustment was recorded in program expenses consistent with the original
recording of the restructuring charges. See the "RESTRUCTURING AND 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 six months ended June 30, 2004
was $18.0 million, an increase of 221.9%, compared to operating income of $5.6
million for the six months ended June 30, 2003. Operating income as a percentage
of revenue increased to 9.8% for the six months ended June 30, 2004 from 3.7% in
the comparable prior year period. This relates to higher revenue and gross
margin from the impact of three dedicated sales contracts entered into in July
2003 as well as the impact of management's cost containment efforts. Operating
income for the six months ended June 30, 2004 for the SMSG segment was $18.7
million, or 31.5% higher than the SMSG operating income for the six months ended
June 30, 2003 of $14.2 million. As a percentage of net revenue from the sales
and marketing services segment, operating income for that segment decreased to
10.3% for the six months ended June 30, 2004, from 11.1% for the comparable
prior year period. There was an operating loss for the PPG segment for the six
months ended June 30, 2004 of approximately $683,000, substantially due to the
$1.2 million increase in the Ceftin returns reserve, compared to an operating
loss of $8.6 million for the prior year period.
OTHER INCOME, NET. Other income, net, for the six months ended June 30,
2004 and 2003 was $631,000 and $495,000, respectively, and was comprised
primarily of interest income.
PROVISION FOR INCOME TAXES. Income tax expense was $7.7 million for the six
months ended June 30, 2004, compared to income tax expense of approximately $2.5
million for the six months ended June 30, 2003, which consisted of Federal and
state corporate income taxes. The effective tax rate for the six month period
ended June 30, 2004 was 41.0%, comparable to an effective tax rate of 41.1 % for
the six months ended June 30, 2003.
NET INCOME. Net income for the six months ended June 30, 2004 was
approximately $11.0 million, compared to net income of approximately $3.6
million for the six months ended June 30, 2003. This increase is due to the
factors discussed above.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2004, we had cash and cash equivalents and short-term
investments of approximately $125.3 million and working capital of approximately
$112.9 million, compared to cash and cash
34
equivalents and short-term investments of approximately $114.6 million and
working capital of approximately $100.0 million at December 31, 2003.
For the six months ended June 30, 2004, net cash provided by operating
activities was $12.6 million, compared to $4.8 million net cash used in
operating activities for the six months ended June 30, 2003. The main components
of cash provided by operating activities during the six months ended June 30,
2004 were:
o net income of approximately $11.0 million; and
o depreciation and other non-cash expenses of approximately $3.8 million
which included bad debt expense of approximately $39,000, stock
compensation expense of approximately $844,000 and amortization of
intangible assets of approximately $307,000, each of which was charged
to SG&A; partially offset by
o a net cash decrease in "other changes in assets and liabilities" of
$6.4 million.
As of June 30, 2004, we had $5.0 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. Also, as of June 30, 2004, we had $15.4 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 six months ended June 30, 2004, net cash used in investing
activities was $37.4 million. This consisted of $32.4 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 September 30, 2004 and through February 28, 2006
with an average maturity date of approximately 11 months. Capital expenditures
during the six-month period ended June 30, 2004 were $5.0 million, almost
entirely composed of purchases related to the move to our new corporate
headquarters which occurred in July of 2004. The lease at our new location,
which replaces our expiring leases, is for approximately 83,000 square feet and
has a duration of approximately 12 years at market rates. There was
approximately $427,000 in capital expenditures for the six months ended June 30,
2003. For both periods, all capital expenditures were funded out of available
cash. We are expecting to incur an additional $2.5 million during the second
half of 2004 in total capital expenditures in connection with our corporate
headquarters move.
For the six months ended June 30, 2004, net cash provided by financing
activities of approximately $3.1 million was due to the net proceeds received
from the exercise of stock options and the employee stock purchase plan.
Our revenue and profitability depend to a great extent on our
relationships with a limited number of large pharmaceutical companies. For the
six months ended June 30, 2004, we had two major clients that accounted for
approximately 44.5% and 20.8%, respectively, or a total of 65.3% 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
35
from any of our major clients, or a decrease in demand for our services, could
have a material adverse effect on our business, financial condition and results
of operations.
Under our licensing agreement with Cellegy, we will be required to pay
Cellegy a $10.0 million incremental license fee milestone payment upon
Fortigel's receipt of all approvals required by the FDA 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 Southern District of New York. The complaint alleges that
Cellegy fraudulently induced us to enter into a license agreement with Cellegy
regarding Fortigel on December 31, 2002. The complaint also alleges claims for
misrepresentation and breach of contract related to the license agreement. In
the complaint, we seek, among other things, rescission of the license agreement
and return of the $15.0 million we paid Cellegy. After we filed this lawsuit,
also on December 12, 2003, Cellegy filed a complaint against us in the U.S.
District Court for the Northern District of California. Cellegy's complaint
seeks a declaration that Cellegy did not fraudulently induce us to enter the
license agreement and that Cellegy has not breached its obligations under the
license agreement. We filed an answer to Cellegy's complaint on June 18, 2004,
in which we make the same allegations and claims for relief as we do in our New
York action, and we also allege Cellegy violated California unfair competition
law. By order dated April 23, 2004 our lawsuit was transferred to the Northern
District of California where it may be consolidated with Cellegy's action. We
are unable to predict the ultimate outcome of these lawsuits.
The restatement of the unaudited interim consolidated financial statements
for the three and six month periods ended June 30, 2004 and 2003 as discussed in
Note 1B to the unaudited interim consolidated financial statements has no effect
on our cash balances, liquidity or financial condition.
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
objective of which was 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 subsequent periods as we have been successful in
expanding our business platforms. Substantially all of the restructuring
activities were completed as of December 31, 2003.
36
During the quarter ended March 31, 2003, we recognized a $270,000
reduction in the restructuring accrual due to negotiating higher sublease
proceeds than originally estimated for the leased facility in Cincinnati, Ohio.
During the quarter ended June 30, 2003 we incurred approximately $133,000
of additional restructuring expense due to higher than expected contractual
termination costs. This additional expense was recorded in program expenses
consistent with the original recording of the restructuring charges.
Also during the quarter ended June 30, 2003 we recognized a $473,000
reduction in the restructuring accrual due to lower than expected sales force
severance costs. Greater success in the reassignment of sales representatives to
other programs and the voluntary departure of other sales representatives
combined to reduce the requirement for severance costs. This adjustment was
recorded in program expenses consistent with the original recording of the
restructuring charges.
The accrual for restructuring and exit costs totaled approximately
$444,000 at June 30, 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 JUNE 30, 2004
Administrative severance $ 285 $-- $(155) $ 130
Exit costs 459 -- (145) 314
----- --- ----- -----
744 -- (300) 444
----- --- ----- -----
Sales force severance --
----- -----
----- --- ----- -----
----- --- ----- -----
TOTAL $ 744 $-- $(300) $ 444
===== === ===== =====
37
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
The Company became aware of the applicability of the accounting
pronouncement, EITF 01-14, to the Company's financial statements in September
2004. EITF 01-14 should have been applied to such financial statements beginning
with first quarter of 2002. Due to the non-application of EITF 01-14 since 2002,
the Company discovered certain errors in the classification of reimbursable
costs in its consolidated statements of operations since 2002, which are
described in Note 1B to the consolidated financial statements in the Form 10-K/A
for 2003 filed on November 3, 2004. As a result, the Company determined that a
material weakness existed in its financial reporting and disclosure controls
regarding the selection and application of generally accepted accounting
principles (GAAP), and preparation of the consolidated financial statements.
Accordingly, the Company has determined that its internal controls over
financial reporting and disclosure controls and procedures were not effective as
of June 30, 2004.
The Company considered the impact of the material weakness as of June 30,
2004, and determined that the magnitude of any actual or potential misstatement
was limited to an increase by identical amounts in revenue and cost of goods and
services in the relevant financial statements with no changes to gross profit,
operating income, net income, or earnings per share, nor is there any effect on
the consolidated balance sheets, consolidated statements of cash flows, or
consolidated statements of changes in stockholders' equity.
Beginning in September 2004, the Company has taken a series of steps
designed to improve the control processes regarding the selection and
application of GAAP and preparation and review of the consolidated financial
statements. Specifically, key personnel involved in the Company's financial
reporting processes have enhanced the process through which authoritative
guidance will be monitored on a regular basis. Review of both authoritative
guidance and industry practices will be conducted in order to ensure that all
new guidance is being complied with in the preparation of the financial
statements, related disclosures and periodic filings with the SEC. Additionally,
when the Company became aware of the non-application of EITF 01-14, all prior
consolidated financial statements which were filed with the SEC since 2002 were
reviewed internally and by an outside consultant for compliance with all
authoritative guidance and the application of GAAP and such filings were
determined to be in compliance.
CHANGES IN INTERNAL CONTROLS
Except as described above in "Evaluation of Disclosure Controls and Procedures,"
there has been no change in the Company's internal control over financial
reporting and disclosure controls (as such terms are defined in Rules 13a-15(e),
13a-15(f), 15d-15(e) and 15d-15(f) under the Exchange Act) that was identified
in connection with management's evaluation, as described above, that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
38
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.
39
CELLEGY PHARMACEUTICALS LITIGATION
On December 12, 2003, we filed a complaint against Cellegy in the U.S.
District Court for the Southern District of New York. The complaint alleges that
Cellegy fraudulently induced us to enter into a license agreement with Cellegy
regarding Fortigel on December 31, 2002. The complaint also alleges claims for
misrepresentation and breach of contract related to the license agreement. In
the complaint, we seek, among other things, rescission of the license agreement
and return of the $15.0 million we paid Cellegy. After we filed this lawsuit,
also on December 12, 2003, Cellegy filed a complaint against us in the U.S.
District Court for the Northern District of California. Cellegy's complaint
seeks a declaration that Cellegy did not fraudulently induce us to enter the
license agreement and that Cellegy has not breached its obligations under the
license agreement. We filed an answer to Cellegy's complaint on June 18, 2004,
in which we make the same allegations and claims for relief as we do in our New
York action, and we also allege Cellegy violated California unfair competition
law. By order dated April 23, 2004 our lawsuit was transferred to the Northern
District of California where it may 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 effect on our business, financial condition and results of operations.
No material 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 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On June 16, 2004, the Company held its 2004 Annual Meeting of
Stockholders. At the meeting John P. Dugan and Dr. Joseph T. Curti were
reelected as Class I Directors of the Company for three year terms with
13,098,343 and 13,451,339 votes cast in favor of their election, respectively.
In addition, the appointment of PricewaterhouseCoopers LLP as independent
auditors of the Company for fiscal 2004 was ratified with 13,610,996 votes in
favor, 387,197 votes against and 1,729 votes withheld. In addition, the PDI,
Inc. 2004 Stock Award and Incentive Compensation Plan was approved with
8,094,575 votes in favor, 4,520,659 votes against, and 4,540 votes withheld.
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
40
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
(B) REPORTS ON FORM 8-K
During the three months ended June 30, 2004, the Company filed the following
reports on Form 8-K:
Date Item(s) Description
-------------- ----------- ----------------------------------------------
May 5, 2004 7 and 12 Press Release: PDI Reports First Quarter 2004
Financial Results
June 24, 2004 5 PDI announces retirement of Gerald J.
Mossinghoff, Board Member
41
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.
November 3, 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
42