FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended MARCH 31, 2002
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OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 0-15190
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OSI PHARMACEUTICALS, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 13-3159796
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
58 SOUTH SERVICE ROAD, SUITE 110, MELVILLE, NEW YORK 11747
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(Address of principal executive offices) (Zip Code)
631-962-2000
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(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year,
if changed since last report.)
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/ /
APPLICABLE ONLY TO CORPORATE ISSUERS:
At April 30, 2002 the registrant had outstanding 36,281,308 shares of common
stock, $.01 par value.
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONTENTS
PAGE NO.
--------
PART I - FINANCIAL INFORMATION................................................1
Item 1. Financial Statements
Consolidated Balance Sheets
- March 31, 2002 (unaudited) and September 30, 2001................1
Consolidated Statements of Operations
- Three months ended March 31, 2002 and 2001 (unaudited)...........2
Consolidated Statements of Operations
- Six months ended March 31, 2002 and 2001 (unaudited).............3
Consolidated Statements of Cash Flows
- Six months ended March 31, 2002 and 2001 (unaudited).............4
Notes to Consolidated Financial Statements (unaudited).............5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................12
Item 3. Quantitative and Qualitative Disclosures about Market Risk.........21
PART II - OTHER INFORMATION...................................................23
Item 1. Legal Proceedings..................................................23
Item 2. Changes in Securities and Use of Proceeds..........................23
Item 3. Defaults Upon Senior Securities....................................23
Item 4. Submission of Matters to a Vote of Security Holders................23
Item 5. Other Information..................................................24
Item 6. Exhibits and Reports on Form 8-K...................................24
SIGNATURES................................. ..................................26
EXHIBIT INDEX.................................................................27
i
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, September 30,
2002 2001
-------------- ---------
ASSETS (unaudited)
Current assets:
Cash and cash equivalents................................................ $ 251,070,196 $ 225,149,872
Investment securities.................................................... 290,283,215 326,328,589
Restricted investment securities - short term............................ 7,936,512 -
Receivables, including amounts due from related parties of $2,883,354
and $2,359,625 at March 31, 2002 and September 30, 2001, respectively... 3,252,769 2,577,407
Interest receivable...................................................... 2,485,583 3,820,027
Grants receivable........................................................ 67,717 235,622
Prepaid expenses and other............................................... 5,579,651 3,120,605
-------------- -------------
Total current assets............................................... 560,675,643 561,232,122
-------------- -------------
Restricted investment securities - long term............................. 15,085,491 -
Property, equipment and leasehold improvements - net..................... 39,463,569 25,347,297
Compound library assets - net............................................ 541,328 923,668
Other assets............................................................. 1,830,986 502,019
Debt issuance costs - net................................................ 6,478,602 -
Intangible assets - net.................................................. 39,488,649 3,684,081
-------------- -------------
$ 663,564,268 $ 591,689,187
============== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses.................................... $ 16,786,090 $ 18,063,378
Unearned revenue - current; including amounts received in advance
from related parties of $8,666,878 and $8,676,571 as of March 31, 2002
and September 30, 2001, respectively................................... 9,651,826 9,621,799
Loans and capital leases payable - current............................... 453,368 111,136
-------------- -------------
Total current liabilities.......................................... 26,891,284 27,796,313
-------------- -------------
Other liabilities:
Unearned revenue - long-term; including amounts received in advance from
related parties of $6,476,191 and $10,678,572 as of March 31, 2002 and
September 30, 2001, respectively....................................... 6,913,692 11,553,571
Loans and capital leases payable - long-term............................. 96,190 51,703
Convertible senior subordinated notes ................................... 200,000,000 -
Deferred acquisition costs............................................... - 375,000
Accrued postretirement benefit cost...................................... 2,269,254 2,080,254
-------------- -------------
Total liabilities.................................................. 236,170,420 41,856,841
-------------- -------------
Stockholders' equity:
Preferred stock, $.01 par value; 5,000,000 shares authorized, no shares
issued at March 31, 2002 and September 30, 2001........................ - -
Common stock, $.01 par value; 200,000,000 shares authorized; 37,218,478
and 35,901,318 shares issued at March 31, 2002 and September 30, 2001,
respectively........................................................... 372,184 359,013
Additional paid-in capital............................................... 708,612,007 664,095,048
Deferred compensation ................................................... (647,986) (3,921,845)
Accumulated deficit...................................................... (272,640,607) (105,743,621)
Accumulated other comprehensive income (loss) ........................... (1,869,205) 1,476,296
-------------- -------------
433,826,393 556,264,891
Less: treasury stock, at cost; 939,618 shares at March 31, 2002 and
September 30, 2001....................................................... (6,432,545) (6,432,545)
-------------- -------------
Total stockholders' equity........................................... 427,393,848 549,832,346
-------------- -------------
Commitments and contingencies
$ 663,564,268 $ 591,689,187
============== =============
See accompanying notes to unaudited consolidated financial statements.
-1-
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended
March 31,
---------
2002 2001
---- ----
Revenues:
Collaborative program revenues,
principally from related parties................................ $ 4,041,483 $ 5,053,396
License and related revenues, including $2.1 million
from related parties in 2002 and 2001.................... 2,377,083 2,302,083
Other research revenues........................................... 351,613 175,946
-------------- --------------
6,770,179 7,531,425
-------------- --------------
Expenses:
Research and development.......................................... 26,525,374 10,778,075
Selling, general and administrative............................... 6,249,960 2,774,535
Amortization of intangibles....................................... 306,194 185,473
Production and service costs...................................... 21,612 74,752
-------------- --------------
33,103,140 13,812,835
-------------- --------------
Loss from operations................................. (26,332,961) (6,281,410)
Other income (expense):
Net investment income............................................. 3,465,271 7,722,426
Interest expense.................................................. (1,345,796) (6,127)
Other expense - net............................................... (301,434) (83,805)
-------------- --------------
Net income (loss).................................................... $ (24,514,920) $ 1,351,084
============= ==============
Weighted average number of shares of common stock outstanding:
Basic: ........................................................... 37,086,137 34,307,448
============== ==============
Diluted: ......................................................... 37,086,137 36,603,669
============== ==============
Net income (loss) per weighted average share of common stock
outstanding:
Basic: ........................................................... $ (0.66) $ .04
============== ==============
Diluted: ......................................................... $ (0.66) $ .04
============== ==============
See accompanying notes to unaudited consolidated financial statements.
-2-
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Six Months Ended
March 31,
---------
2002 2001
---- ----
Revenues:
Collaborative program revenues,
principally from related parties................................ $ 7,157,105 $ 10,321,812
License and related revenues, including $4.2 and $2.1 million
from related parties in 2002 and 2001, respectively.......... 4,720,832 2,595,833
Other research revenues........................................... 784,431 308,734
-------------- --------------
12,662,368 13,226,379
-------------- --------------
Expenses:
Research and development.......................................... 43,779,372 21,348,649
Acquired in-process research and development (see note 3) ........ 130,200,000 -
Selling, general and administrative............................... 12,055,786 5,724,668
Amortization of intangibles....................................... 615,575 370,946
Production and service costs...................................... 71,415 204,117
-------------- --------------
186,722,148 27,648,380
-------------- --------------
Loss from operations................................. (174,059,780) (14,422,001)
Other income (expense):
Net investment income............................................. 8,039,412 12,861,950
Interest expense.................................................. (1,347,802) (12,271)
Other income (expense) - net...................................... 471,184 (98,309)
-------------- --------------
Net loss before cumulative effect of accounting change............... (166,896,986) (1,670,631)
Cumulative effect of the change in accounting for the recognition
of upfront fees................................................. - (2,625,000)
-------------- --------------
Net loss............................................................. $(166,896,986) $ (4,295,631)
============= ==============
Weighted average number of shares of common stock outstanding:
Basic: ........................................................... 36,576,558 32,839,452
============== ==============
Diluted: ......................................................... 36,576,558 32,839,452
============== ==============
Net loss per weighted average share of common stock outstanding:
Basic:
Before cumulative effect of accounting change .................. $ (4.56) $ (.05)
Cumulative effect of accounting change ......................... - (.08)
-------------- --------------
After cumulative effect of accounting change ................... $ (4.56) $ (.13)
============== ==============
Diluted:
Before cumulative effect of accounting change .................. $ (4.56) $ (.05)
Cumulative effect of accounting change ......................... - (.08)
-------------- --------------
After cumulative effect of accounting change ................... $ (4.56) $ (.13)
============== ==============
See accompanying notes to unaudited consolidated financial statements.
-3-
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six Months Ended
March 31,
---------
2002 2001
---- ----
Cash flows from operating activities:
Net loss.......................................................... $ (166,896,986) $ (4,295,631)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
In-process research and development charge on acquisition of
Gilead's oncology assets.................................... 130,200,000 -
Loss (gain) on sale of investments............................ 180,721 (208,074)
Loss on sale of equipment..................................... - 64,865
Depreciation and amortization of property, equipment and
leaseholds................................................. 3,536,806 1,434,502
Amortization of other assets.................................. 1,156,383 1,304,041
Accretion of deferred acquisition costs....................... - 9,741
Non-cash compensation charges-net ............................ 2,255,857 1,650,953
Cumulative effect of the change in accounting for the
recognition of upfront fees................................. - 2,625,000
Changes in assets and liabilities, net of the effects of
business acquisition:
Receivables................................................... (675,822) (60,915)
Interest receivable........................................... 1,334,444 (1,913,273)
Grants receivable............................................. 167,905 251,045
Prepaid expenses and other current assets..................... (2,502,018) (490,419)
Other assets.................................................. (665,815) (1,120,555)
Accounts payable and accrued expenses......................... (2,642,112) (2,195,782)
Unearned revenue.............................................. (4,609,831) 22,251,968
Accrued postretirement benefit cost........................... 189,000 150,000
---------------- --------------
Net cash provided by (used in) operating activities.................. (38,971,468) 19,457,466
---------------- --------------
Cash flows from investing activities:
Payments for acquisition of Gilead's oncology assets.............. (135,742,156) -
Proceeds from sale of equipment and leasehold improvements........ - 35,000
Purchases of investments.......................................... (243,546,108) (280,887,622)
Maturities and sales of investments............................... 276,720,902 110,893,926
Purchases of restricted investments-net........................... (23,022,003) -
Additions to property, equipment and leasehold improvements....... (7,571,732) (1,817,083)
---------------- --------------
Net cash used in investing activities ............................... (133,161,097) (171,775,779)
---------------- --------------
Cash flows from financing activities:
Proceeds from issuance of convertible senior subordinated
notes............................................................. 200,000,000 -
Debt issuance costs............................................... 6,635,526 -
Net proceeds from issuance of common stock........................ - 474,254,619
Proceeds from exercise of stock options, stock warrants,
employee purchase plan and other.................................. 5,173,133 2,184,845
Payments on loans and capital leases payable...................... (240,255) (52,659)
---------------- --------------
Net cash provided by financing activities............................ 198,297,352 476,386,805
---------------- --------------
Net increase in cash and cash equivalents............................ 26,164,787 324,068,492
Effect of exchange rate changes on cash and cash equivalents ........ (244,463) (84,183)
Cash and cash equivalents at beginning of period..................... 225,149,872 48,392,635
---------------- --------------
Cash and cash equivalents at end of period .......................... $ 251,070,196 $ 372,376,944
================ ==============
Non-cash activities:
Issuance of common stock in satisfaction of deferred acquisition
costs........................................................... $ 375,000 $ -
================ ==============
Issuance of common stock in connection with acquisition of
Gilead's oncology assets........................................ $ 40,000,000 $ -
================ ==============
See accompanying notes to unaudited consolidated financial statements.
-4-
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) Basis of Presentation
---------------------
In the opinion of management, the accompanying unaudited consolidated financial
statements contain all adjustments (consisting of only normal recurring
accruals) necessary to present fairly the financial position of OSI
Pharmaceuticals, Inc. and its subsidiaries, collectively referred to as the
Company, as of March 31, 2002 and September 30, 2001, their results of
operations for the three and six months ended March 31, 2002 and 2001 and their
cash flows for the six months ended March 31, 2002 and 2001. Certain
reclassifications have been made to the prior period consolidated financial
statements to conform them to the current presentation.
It is recommended that these consolidated financial statements be read in
conjunction with the consolidated financial statements and notes thereto in the
Company's annual report on Form 10-K for the fiscal year ended September 30,
2001. Results for interim periods are not necessarily indicative of results for
the entire year.
(2) Revenue Recognition
-------------------
Prior to October 1, 2000, the Company recognized all nonrefundable upfront
license fees, including upfront technology access fees, as revenue when received
and when all contractual obligations of the Company relating to such fees had
been fulfilled. Effective October 1, 2000, the Company changed its method of
accounting for upfront nonrefundable technology access and other upfront fees to
recognize such fees over the term of the related research collaboration period
in accordance with the guidance provided in the Securities and Exchange
Commission's Staff Accounting Bulletin No. 101 - "Revenue Recognition in
Financial Statements," as amended ("SAB No. 101"). The Company received a total
of $25 million in upfront fees from Genentech, Inc. and Roche in January 2001
which is being recognized evenly over the expected three-year term of the
Company's required research and development efforts under the terms of the
agreements.
For the year ended September 30, 2000, the Company recognized the full $3.5
million technology access fee received from Tanabe Seiyaku Co., Ltd. ("Tanabe")
related to a four-year term collaboration. The Company's adoption of SAB No.
101, effective October 1, 2000, resulted in a $2.6 million cumulative effect of
a change in accounting principle related to the Tanabe fee and was reported as a
charge in the quarter ended December 31, 2000. The cumulative effect was
initially recorded as unearned revenue and is being recognized as revenue over
the remaining term of the collaboration agreement.
Collaborative program revenues represent funding arrangements for research and
development in the field of biotechnology and are recognized when earned in
accordance with the terms of the contracts and the related research and
development activities undertaken. Other research revenues are recognized
pursuant to the terms of grants which provide reimbursement of certain expenses
related to the Company's other research and development activities.
Collaborative and other research revenues are accrued for expenses incurred in
advance of the reimbursement and
-5-
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
deferred for cash payments received in advance of expenditures. Such deferred
revenues are recorded as revenue when earned. Included in license and related
revenues are patent license fees, maintenance fees and technology access and
other upfront fees.
During the six months ended March 31, 2001, the impact of the change in
accounting principle increased the net loss by $2.2 million, or $0.07 per share,
comprised of the $2.6 million cumulative effect of the change as described above
($0.08 per share), net of the $0.4 million of related deferred revenue that was
recognized as revenue during the six months ended March 31, 2001 ($0.01 per
share).
(3) Acquisition
------------
On December 21, 2001, the Company acquired certain assets from Gilead Sciences,
Inc. ("Gilead") pursuant to the terms of an Asset Purchase Agreement dated as
of November 26, 2001. Gilead is a biopharmaceutical company that discovers,
develops, manufactures and commercializes proprietary therapeutics for
infectious diseases. The assets purchased by the Company included: (a) a
pipeline of three clinical oncology candidates, (b) certain related intellectual
property, and (c) rights to Gilead's leased facilities located in Boulder,
Colorado, as well as leasehold improvements and certain fixed assets. In
connection with the acquisition, the Company retained 117 Gilead employees
representing expertise in clinical operations, regulatory affairs, toxicology
and IN VIVO pharmacology. The results of operations of Gilead's oncology assets
have been included in the consolidated statement of operations commencing as of
the date of the closing. In consideration for the assets, the Company paid
approximately $135.7 million, which includes professional fees and the
assumption of certain liabilities, and issued 924,984 shares of common stock,
valued at $40 million. The value of the 924,984 common shares issued was
determined based on the closing price of the Company's stock on the date of
closing. The Company would also be obligated to pay contingent consideration of
up to an additional $30 million in either cash or a combination of cash and
common stock, at its option, upon the achievement of certain milestones related
to the development of OSI-211 (formerly NX211), the most advanced of Gilead's
oncology product candidates acquired by the Company. Additionally, the Company
assumed certain royalty and milestone obligations to third parties in connection
with the oncology candidates acquired as part of the acquisition.
The acquisition was accounted for under the purchase method of accounting. The
purchase price was allocated to the acquired assets and liabilities assumed
based on the fair values as of the date of the acquisition. The Company obtained
a third-party valuation to assist management in determining the fair value of
certain assets. The excess of the purchase price paid over the fair value of the
net assets acquired representing goodwill was approximately $35.7 million.
During the three months ended March 31, 2002, the Company recorded an increase
of $800,000 to the goodwill for additional payments to Gilead for
acquisition-related costs. In accordance with Financial Accounting Standards
Board SFAS No. 142, "Goodwill and Other Intangible Assets," which is applicable
to acquisitions occurring after July 1, 2001, such goodwill will not be
amortized. The value assigned to the acquired in-process research and
development ("R&D")
-6-
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
was determined by identifying those acquired in-process research projects for
which: (a) technological feasibility had not been established at the acquisition
date, (b) there was no alternative future use, and (c) the fair value was
estimable based on reasonable assumptions. The acquired in-process R&D was
valued at $130.2 million and expensed at the acquisition date in the
consolidated statement of operations for the three months ended December 31,
2001. The portion of the purchase price assigned to the acquired in-process R&D
was allocated to the following three clinical oncology candidates: OSI-211
(formerly NX211), a liposomal lurtotecan ($19.9 million), OSI-7904L (formerly
GS7904L), a liposomal thymidylate ($13.4 million) and OSI-7836 (formerly
GS7836), a Gemzar(R) analog ($96.9 million).
The purchase price was allocated as follows (in thousands):
In-process R&D acquired................................... $130,200.0
Fixed assets.............................................. 10,528.7
Goodwill.................................................. 36,527.9
Prepaid expenses and other assets......................... 663.5
-------------
Total assets and in-process R&D acquired.................. 177,920.1
Less liabilities assumed.................................. (2,177.6)
-------------
Cash and common stock paid................................ $175,742.5
============
The value of the acquired in-process R&D was determined by estimating the
projected net cash flows related to products under development, based upon the
future revenues to be earned upon commercialization of such products. In
determining the value of the in-process R&D, the assumed commercialization dates
for these products ranged from 2004 to 2008. Given the risks associated with the
development of new drugs, the revenue and expense forecasts were
probability-adjusted to reflect the risk of advancement through the approval
process. The risk adjustments applied were based on each compound's stage of
development at the time of assessment and the historical probability of
successful advancement for compounds at that stage. These modeled cash flows
were discounted back to their net present value. The projected net cash flows
from such projects were based on management's estimates of revenues and
operating profits related to such projects. The in-process R&D was valued based
on the income approach that focuses on the income-producing capability of the
assets. The underlying premise of this approach is that the value of an asset
can be measured by the present worth of the net economic benefit (cash receipts
less cash outlays) to be received over the life of the asset. Significant
assumptions and estimates used in the valuation of in-process R&D included: the
stage of development for each of the three projects; future revenues; growth
rates for each product; product sales cycles; the estimated life of a product's
underlying technology; future operating expenses; probability adjustments to
reflect the risk of developing the acquired technology into commercially viable
products; and a discount rate of 18% to reflect present value.
In connection with the acquisition, the Company adopted a Non-Qualified Stock
Option Plan for Former Employees of Gilead Sciences, Inc. The Company granted
ten-year options to purchase an aggregate of 693,582 shares of common stock of
the Company at a purchase price of $45.01
-7-
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
per share, which represents the fair value of the Company's stock at the date
granted. The options vest one-third in a year from the date of grant and monthly
thereafter for twenty-four months.
The following pro forma financial information presents a summary of the
consolidated results of operations of the Company for the three and six months
ended March 31, 2002 and 2001 assuming the acquisition had taken place as of
October 1, 2001 and 2000, respectively (in thousands, except per share
information):
Three months ended Six months ended
March 31, March 31,
---------- ---------
2002 2001 2002 2001
---- ---- ---- ----
Revenues....................................................... $ 6,770 $ 7,531 $ 12,662 $ 13,226
Loss before non-recurring charge related to the acquisition
and cumulative effect of accounting change................. (24,515) (7,013) (47,340) (19,912)
Net loss before non-recurring charge related to the ...........
acquisition................................................ (24,515) (7,013) (47,340) (22,537)
Basic and diluted net loss per share:
Before cumulative effect of accounting change.............. $ (0.66) $ (0.20) $ (1.28) $ (0.59)
Cumulative effect of accounting change..................... $ - $ - $ - $ (0.08)
------------ ---------- ---------- ----------
Before non-recurring charge related to the acquisition..... $ (0.66) $ (0.20) $ (1.28) $ (0.67)
=========== ========== ========== ==========
The unaudited pro forma financial information has been prepared for comparative
purposes only. The pro forma information includes the historical unaudited
results of Gilead's oncology assets for the respective periods. The pro forma
financial information includes adjustments to the Company's historical results
to reflect incremental depreciation expense related to the mark-up of fixed
assets to fair value, reduced interest income generated from cash that was used
for the acquisition, additional interest expense and the issuance of 924,984
shares of common stock and excludes the nonrecurring charge of $130.2 million
related to the acquired in-process R&D. The pro forma information does not
purport to be indicative of operating results that would have been achieved had
the acquisition taken place on the dates indicated or the results that may be
obtained in the future.
(4) Note Offering
-------------
On February 1, 2002, the Company issued $200 million aggregate principal amount
of convertible senior subordinated notes ("Notes") in a private placement for
net proceeds to the Company of approximately $193.4 million. The Notes bear
interest at 4% per annum, payable semi-annually, and mature on February 1, 2009.
The Notes are convertible into shares of the Company's common stock at a
conversion price of $50 per share, subject to normal and customary adjustments
such as stock dividends or other dilutive transactions. The Company may redeem
the Notes, in whole or in part, at any time before February 1, 2005 if the
closing price of the Company's common stock has exceeded 150% of the conversion
price then in effect for a specified period of time ("Provisional Redemption").
Upon any such Provisional Redemption,
-8-
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
the Company is required to pay interest that would have been due through
February 1, 2005. The Company may also redeem some or all of the Notes at any
time on or after February 1, 2005 if the closing price of the Company's common
stock has exceeded 140% of the conversion price then in effect for a specified
period of time. Upon a change in control, as defined in the indenture governing
the Notes, the holders of the Notes will have the right to require the Company
to repurchase all of the Notes, or a portion thereof, not previously called for
redemption at a purchase price equal to 100% of the principal amount of the
Notes purchased, plus accrued and unpaid interest. The Company may elect to pay
the purchase price in common stock instead of cash. The number of shares of
common stock a holder will receive will equal the repurchase price divided by
95% of the average of the closing prices of the Company's common stock for the
five-trading day period ending on the third business day prior to the repurchase
date. The related debt issuance costs of approximately $6.6 million were
deferred and are being amortized on a straight-line basis over the term of the
Notes.
With respect to the Notes, the Company pledged $22.9 million of U.S. government
securities ("Restricted Investment Securities") with maturities at various dates
through November 2004. Upon maturity, the proceeds of the Restricted Investment
Securities will be sufficient to pay the first six scheduled interest payments
on the Notes when due. The Company considers its Restricted Investment
Securities to be "held-to-maturity," as defined by SFAS No. 115, "Accounting for
Certain Investments in Debt and Equity Securities." These securities are
reported at their amortized cost, which includes the direct costs to acquire the
securities, plus the amortization of any discount or premium, and accrued
interest earned on the securities. The aggregate fair value and amortized cost
of the Restricted Investment Securities, at March 31, 2002 was $22.9 million and
23.0 million, respectively.
(5) Comprehensive Income (Loss)
---------------------------
Comprehensive income (loss) for the three and six months ended March 31, 2002
and 2001 was as follows (in thousands):
Three months ended Six months ended
March 31, March 31,
---------- ---------
2002 2001 2002 2001
---- ---- ---- ----
Net income (loss)...................................... $ (24,515) $ 1,351 $ (166,897) $ (4,296)
Other comprehensive income (loss):
Foreign currency translation adjustments.......... (401) (209) (655) (175)
Unrealized holding gains (losses) arising
during period................................. (1,972) 1,086 (2,871) 1,141
Less: Reclassification adjustment for
(gains) losses realized in net income (loss).. (88) (208) 181 (208)
---------- --------- -------------- ----------
(2,461) 669 (3,345) 758
---------- --------- -------------- ----------
Total comprehensive income (loss)...................... $ (26,976) $ 2,020 $ (170,242) $ (3,538)
========== ========= ============== ==========
-9-
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
The components of accumulated other comprehensive income (loss) were as follows
(in thousands):
March 31, September 30,
2002 2001
---- ----
Cumulative foreign currency translation
adjustment......................................... $ (1,670) $ (1,015)
Unrealized gains (losses) on available-for-sale
securities......................................... (199) 2,491
------------- ------------
Accumulated other comprehensive income (loss)............ $ (1,869) $ 1,476
============= ============
(6) Net Income (Loss) Per Common Share
----------------------------------
A reconciliation between the numerators and the denominators of the basic and
diluted income (loss) per share computation is as follows (in thousands, except
per share information):
Three months ended Six months ended
March 31, March 31,
--------- ---------
2002 2001 2002 2001
---- ---- ---- ----
Net income (loss) available for common
stockholders...................................... $ (24,515) $ 1,351 $ (166,897) $ (4,296)
=========== ============= ============= ===========
Weighted average common shares......................... 37,086 34,307 36,577 32,839
Effect of dilutive stock options....................... - 2,297 - -
----------- ------------- ----------- -----------
Weighted average common and potential common
shares outstanding................................ 37,086 36,604 36,577 32,839
=========== ============= ============= ===========
Basic income (loss) per share.......................... $ (0.66) $ .04 $ (4.56) $ (.13)
=========== ============= ============= ===========
Diluted income (loss) per share........................ $ (0.66) $ .04 $ (4.56) $ (.13)
=========== ============= ============= ===========
For the three months ended March 31, 2002, all outstanding stock options and
convertible debt were excluded in the net loss per share calculation because
they would have been anti-dilutive. For the three months ended March 31, 2001,
127,000 stock options were excluded in the net income per share calculation
because their effect would have been anti-dilutive.
For the six months ended March 31, 2002, all outstanding stock options and
convertible debt were excluded in the net loss per share calculations because
their effect would have been anti-dilutive. For the six months ended March 31,
2001, all outstanding stock options were excluded in the net loss per share
calculations because their effect would have been anti-dilutive.
(7) Consolidation of Facilities
---------------------------
In the fourth quarter of fiscal 2001, the Company announced its strategic
decision to close down its Tarrytown, New York facility and its Birmingham,
England facility. The operations at the
-10-
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Birmingham, England facility ceased on March 31, 2002, however, the Company is
still in the process of closing down the facility. The Tarrytown, New York
facility is expected to close down in July 2002. The estimated cost to close
down these two facilities was approximately $5.1 million and was recorded in R&D
expense ($4.5 million) and in selling, general and administrative expenses
($613,000) in the fourth quarter of fiscal 2001. This charge consisted of a
write down of equipment and leaseholds ($2.5 million), severance costs
($581,000) and non-cancelable lease exit costs ($2.0 million).
At March 31, 2002, the remaining restructuring reserve relating to the
consolidation implemented in the fourth quarter was approximately $4.7 million.
The consolidation activity for the six months ended March 31, 2002 was as
follows (in thousands):
Writedown of
Severance Lease Equipment and
Costs Exit Costs Leaseholds Total
----- ---------- ---------- -----
Balance at September 30, 2001....... $ 581 $ 2,000 $ 2,500 $ 5,081
Cash paid........................... (220) - - (220)
Foreign currency translation
adjustments.................... (6) (60) (64) (130)
------- ---------- -------- --------
Balance at March 31, 2002........... $ 355 $ 1,940 $ 2,436 $ 4,731
======= ========== ======== ========
(8) Sale of Diagnostics Business
----------------------------
On November 30, 1999, the Company sold assets of its diagnostics business to
Bayer Corporation including the assets of the Company's wholly-owned diagnostics
subsidiary, OSDI, based in Cambridge, Massachusetts. The assets sold included
certain contracts, equipment and machinery, files and records, intangible
assets, intellectual property, inventory, prepaid expenses and other assets
primarily related to the operations of the diagnostics business. Under the terms
of the agreement, the Company received a contingent payment of $1.0 million in
December 2001, which is included in other income (expense) for the six months
ended March 31, 2002.
(9) Stock Option Plan
-----------------
The Board of Directors adopted the 2001 Incentive and Non-Qualified Stock Option
Plan, effective June 13, 2001 which was approved by the stockholders at the
annual meeting of stockholders on March 13, 2002. Under the plan, the Company
may grant incentive stock options and non-qualified stock options to purchase up
to 4,000,000 shares. Participation in the plan is limited to directors,
officers, employees and consultants of the Company or a parent or subsidiary of
the Company.
The plan also continues the automatic, formula-based grants of non-qualified
stock options to directors who are not employees of the Company. Persons elected
to the board after June 13,
-11-
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
2001 are entitled to an initial grant of a non-qualified option to purchase
30,000 shares of common stock upon their initial election with annual grants of
options to purchase 7,500 shares thereafter upon re-election to the board.
Persons elected to the board prior to June 13, 2001, will continue to be
eligible for annual grants of options to purchase shares of common stock in an
amount which depends upon the number of years of service as a director (20,000
shares reducing to 7,500 shares).
-12-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
THREE AND SIX MONTHS ENDED MARCH 31, 2002 AND 2001
OVERVIEW
We are a biopharmaceutical company primarily focused on the discovery,
development and commercialization of novel products for the treatment of cancer.
We have built a pipeline of discovery programs and drug candidates addressing
unmet needs in cancer, complemented by selected opportunities arising from our
extensive drug discovery research programs that represent significant commercial
opportunities outside of cancer, particularly diabetes. We have seven candidates
in clinical trials and seven candidates in late stage pre-clinical development.
Our lead product candidate, Tarceva(TM) (erlotinib HCl, OSI-774) is a
potent, selective and orally active, small molecule inhibitor of the epidermal
growth factor receptor, or EGFR. A high proportion of the approximately 1.2
million new U.S. solid tumor patients each year may benefit from EGFR targeted
drugs. We, therefore, believe that this new class of EGFR inhibitors has
significant market potential. Tarceva(TM) has demonstrated encouraging
indications of activity in cancer and has exhibited a well-tolerated side-effect
profile as a monotherapy in three open-label Phase II clinical trials for the
treatment of non-small cell lung, ovarian and head and neck cancers. In January
2001, we entered into concurrent agreements with Genentech, Inc. and Roche for
the global co-development and commercialization of Tarceva(TM) and have since
initiated Phase III clinical trials in lung cancer and pancreatic cancer. To
date, we have received upfront fees and equity investments totaling $95 million
under these agreements. In addition, we may receive scheduled milestone payments
of up to $92 million based on the successful filing and registration of the drug
in major markets. In the United States, we will employ an essentially equal cost
and profit sharing arrangement for the commercialization of Tarceva(TM) with
Genentech. Outside of the United States, we will receive royalties from Roche on
net sales of products.
In our oncology program, we are building the infrastructure and
capabilities required for the full commercialization of products arising from
our cancer research and development efforts. In our diabetes and other
proprietary programs, we intend to develop our own drug candidates through the
early stages of clinical development prior to entering into co-development and
commercialization agreements with leading pharmaceutical companies in return for
significant milestone and royalty payments on product sales.
To date, none of our proprietary or collaborative programs have
resulted in commercial products; therefore, we have not received any revenues or
royalties from the sale of products by us or by our collaborators. We have
funded our operations primarily through public and private placements of equity
securities, the private placement of convertible debt securities and payments
under collaborative research agreements with major pharmaceutical companies.
In November 2001, we received the return of full commercial rights to
OSI-754 (formerly CP-609,754), a farnesyl transferase inhibitor, that was
undergoing Phase I trials with Pfizer Inc.
-13-
OSI-754 was jointly discovered in our collaboration with Pfizer as part of our
longstanding alliance in cancer drug discovery and was being developed by Pfizer
as a targeted therapy for use in major solid tumor indications (i.e., colon and
lung). We have plans to develop OSI-754 for tumors such as bladder cancer where
mutant and over-expressed forms of the H-ras oncogene are present. If the drug
is successfully developed, we will pay Pfizer a royalty on sales.
On December 21, 2001, we acquired certain oncology assets from Gilead
Sciences, Inc., which included a pipeline of three clinical oncology candidates
and certain related intellectual property, as well as Gilead's Boulder, Colorado
operations, including clinical research and drug development personnel,
infrastructure and facilities. The Gilead employees retained by us provide us
with extensive expertise in clinical development, regulatory affairs, toxicology
and IN VIVO pharmacology. The acquisition forms a key part of management's
strategy to build a completely integrated and high quality drug discovery,
development and commercial organization in oncology. The acquisition has
complemented and enhanced our ability to successfully execute key components of
our business strategy, including carrying out our obligations for the
development and registration of Tarceva(TM) in our alliance with Genentech and
Roche. In consideration for these assets, we paid Gilead $130 million in cash
and issued to Gilead 924,984 shares of common stock valued at $40 million as of
the closing date. We would also be obligated to pay up to an additional $30
million in either cash or a combination of cash and common stock upon the
achievement of certain milestones related to the development of OSI-211
(formerly NX211). We are also assuming certain royalty and milestone obligations
to third parties in connection with these oncology products.
CRITICAL ACCOUNTING POLICIES
We prepare our consolidated financial statements in accordance with
accounting principles generally accepted in the United States of America. As
such, we are required to make certain estimates, judgments and assumptions that
we believe are reasonable based upon the information available. These estimates
and assumptions affect the reported amounts of assets and liabilities at the
date of the consolidated financial statements and the reported amounts of
revenue and expenses during the periods presented. Actual results could differ
significantly from those estimates under different assumptions and conditions.
We believe that the following discussion addresses our most critical accounting
policies which are those that are most important to the portrayal of our
financial condition and results of operations and which require our most
difficult and subjective judgments, often as a result of the need to make
estimates about the effect of matters that are inherently uncertain. Note 1 to
the consolidated financial statements included in the Form 10-K for the year
ended September 30, 2001 includes a summary of the significant accounting
policies used in the preparation of the consolidated financial statements. The
following is a brief discussion of the accounting policies that we believe are
most critical to aid in fully understanding and evaluating our reported
financial results.
REVENUE RECOGNITION: We recognize all nonrefundable upfront license
fees, including upfront technology access fees, as revenue over the term of the
related research collaboration period in accordance with the guidance provided
in the Securities and Exchange Commission's Staff Accounting Bulletin No. 101 -
"Revenue Recognition in Financial Statements," as
-14-
amended ("SAB No. 101"). Our most significant application of this policy, to
date, is the $25 million in upfront fees received from Genentech and Roche in
January 2001 which is being recognized evenly over the expected three-year term
of our required research and development efforts under the terms of the
agreement. Collaborative program revenues represent funding arrangements for
research and development in the field of biotechnology and are recognized when
earned in accordance with the terms of the contracts and the related development
activities undertaken. Other research revenues are recognized pursuant to the
terms of grants which provide reimbursement of certain expenses related to the
Company's other research and development activities. Collaborative and other
research revenues are accrued for expenses incurred in advance of the
reimbursement and deferred for cash payments received in advance of
expenditures. Such deferred revenues are recorded as revenue when earned.
Included in license and related revenues are patent license fees, maintenance
fees and technology access and other upfront fees.
ACCRUALS FOR CLINICAL RESEARCH ORGANIZATION AND SITE COSTS: We make
estimates of costs incurred to date but not yet invoiced in relation to external
clinical research organizations, or CROs, and site costs. We analyze the
progress of clinical trials, invoices received and contracted costs when
evaluating the adequacy of the accrued liabilities. Significant judgments and
estimates must be made and used in connection with the accrued balance in any
accounting period. Actual results could differ significantly from those
estimates under different assumptions.
INTANGIBLE AND LONG-LIVED ASSETS: Intangible and other long-lived
assets are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying value of an asset may not be recoverable. Our
judgments regarding the existence of impairment indicators are based on
historical and projected future operating results, changes in the manner of our
use of the acquired assets or our overall business strategy, and market and
economic trends. In the future, events could cause us to conclude that
impairment indicators exist and that certain intangibles assets are impaired
which may result in an adverse impact on our financial condition and results of
operations.
RESULTS OF OPERATIONS
For the three months ended March 31, 2002, we had a net loss of $24.5
million compared to net income of $1.4 million for the three months ended March
31, 2001. Contributing to the net income for the three months ended March 31,
2001 was the recognition of $2.1 million of upfront fees from Genentech and
Roche and $7.7 million of interest income resulting from the increased funds
available for investment. For the six months ended March 31, 2002, we had a net
loss of $166.9 million compared to a net loss of $4.3 million for the six months
ended March 31, 2001. The increase in the net loss for the six months ended
March 31, 2002 compared to the six months ended March 31, 2001 was primarily
related to the in-process research and development charge of $130.2 million in
connection with the acquisition of Gilead's oncology assets, as well as an
increase in research and development expenses. Excluding the non-recurring
charge of $130.2 million related to the in-process R&D acquired, the net loss
for the six months ended March 31, 2002 would have been $36.7 million, or $1.00
per share. Included in
-15-
the net loss for the six months ended March 31, 2001 was a non-cash charge of
$2.6 million related to the cumulative effect of a change in accounting
principle for the recognition of upfront fees upon the adoption of SAB No. 101
(see note 2 to the accompanying consolidated financial statements). Excluding
the effect of this change in accounting principle, the net loss for the six
months ended March 31, 2001 would have been $2.1 million or $.06 per share.
REVENUES
Revenues decreased approximately $761,000 or 10% and $564,000 or 4%,
respectively, for the three and six months ended March 31, 2002 compared to the
three and six months ended March 31, 2001. The decrease for the three and six
months is primarily due to a decrease in collaborative program revenue offset
partly by an increase in other research revenue.
Collaborative program revenues decreased approximately $1.0 million or
20% and $3.2 million or 31% for the three and six months ended March 31, 2002,
respectively, compared to the three and six months ended March 31, 2001. This
decrease for the three months ended March 31, 2002 was primarily due to the
conclusion of our funded collaborations with Pfizer in April 2001 and Sankyo
Co., Ltd. in December 2001 offset by an increase in revenues from the Anaderm
collaboration. The decrease in collaborative program revenues for the six months
ended March 31, 2002 was primarily due to the conclusion of our funded
collaborations with Solvay in December 2000 and with Pfizer and Sankyo, as
discussed above. As we focus our business away from collaborative-based to
independent drug discovery and development, we expect collaborative revenues to
continue to decrease.
License and related revenues increased approximately $75,000 or 3% and
$2.1 million or 82%, respectively, for the three and six months ended March 31,
2002 compared to the three and six months ended March 31, 2001. The increase for
the six months ended March 31, 2002 relates to the recognition of $4.2 million
of the upfront fees received from Genentech and Roche compared to $2.1 million
recognized during the six months ended March 31, 2001. In accordance with the
provisions of SAB No. 101, the $25 million upfront fee received from Genentech
and Roche is being recognized evenly over the expected three-year development
phase of our contractual agreement.
Other research revenues increased approximately $175,000 or 100% and
$476,000 or 154%, respectively, for the three and six months ended March 31,
2002 compared to the three and six months ended March 31, 2001. The increase for
the three months was primarily related to transition assistance services
provided to Gilead, and the increase for the six months was primarily related to
certain administrative services provided to British Biotech plc during the
transitional period.
EXPENSES
Operating expenses increased approximately $19.3 million or 140% and
$159.1 million or 575%, respectively, for the three and six months ended March
31, 2002 compared to the three and six months ended March 31, 2001. Operating
expenses primarily include: (i) research and development expenses, which include
expenses related to the development of our
-16-
lead clinical candidate, Tarceva(TM), and proprietary and collaborative-based
research expenses; (ii) the $130.2 million charge related to the acquired
in-process research and development (for the six months ended March 31, 2002);
and (iii) selling, general and administrative expenses.
Research and development expenses increased approximately $15.7 million
and $22.4 million, respectively, for the three and six months ended March 31,
2002 compared to the three and six months ended March 31, 2001. This increase
was primarily related to the clinical development of Tarceva(TM) under our
Tripartite Agreement with Genentech and Roche and our increased investment in
proprietary cancer programs, including the oncology candidates recently acquired
from Gilead. Included in research and development expenses for the six months
ended March 31, 2002 is a charge of approximately $700,000 related to a license
agreement with Cydex, Inc. for the CAPTISOL(R) IV technology. The licensing of
the CAPTISOL(R) IV technology allows us to evaluate intravenous (IV) and other
liquid formulations of oral products that offer additional treatment choices to
physicians and patients. Under the terms of the license agreement, we agreed to
pay royalties on net sales of liquid formulations in addition to certain
milestone payments. For the three and six months ended March 31, 2002, the
increase in research and development expense associated with our proprietary
programs was offset by a decrease in collaborative research and development
expenses. Our ability to shift our resources from collaborative research efforts
to proprietary efforts has been enhanced as a result of the conclusion of our
Solvay, Pfizer and Sankyo collaborations in December 2000, April 2001 and
December 2001, respectively.
Certain non-cash, stock option based compensation charges also impacted
research and development expenses. In accordance with EITF Issue 96-18
"Accounting For Equity Instruments that Are Issued to Other Than Employees for
Acquiring, or In Conjunction with Selling, Goods or Services," the amount of
compensation expense to be recorded in future periods related to the
non-employee grants is subject to change each reporting period based upon the
then fair value of these options using a Black-Scholes option pricing model
until expiration of the grant vesting period. The remeasurement of the value of
these options at March 31, 2002 resulted in the recapture of approximately
$232,000 of previously recognized compensation expense for the three months
ended March 31, 2002, and a charge of $1.1 million in compensation expense for
the six months ended March 31, 2002, related to stock options issued to
consultants involved in research and development activities. Deferred
compensation for stock options issued to these non-employee consultants was
approximately $451,000 as of March 31, 2002, which will be recognized as
compensation expense over the vesting period of the options.
For the three months ended March 31, 2002, we recorded approximately
$121,000 in compensation expense related to stock options granted in September
2000 to our then President and Head of Research and Development. As a result of
his resignation as an employee effective February 1, 2002, no additional
compensation expense will be recorded subsequent to February 1, 2002 and the
remaining deferred compensation of approximately $2.4 million was reversed
during the three months ended March 31, 2002.
In connection with the acquisition of certain assets from Gilead, we
recorded an in-process research and development charge of $130.2 million
representing the estimated fair value
-17-
of the acquired in-process technology that had not yet reached technological
feasibility and had no alternative future use (see note 3 to the accompanying
consolidated financial statements). We obtained a third party valuation to
assist us in determining the fair value of certain assets. The value was
determined by estimating the costs to develop the purchased in-process
technology into commercially viable products, estimating the resulting net cash
flow from such projects and discounting the net cash flows back to their present
value. These cash flows were probability-adjusted to take into account the
uncertainty surrounding the successful development and commercialization of the
acquired in-process technology. The resulting net cash flows were based on
estimated revenue, cost of sales, research and development costs, selling,
general and administrative costs and the net cash flow reflects the assumptions
that would be used by market participants. In determining the value of the
in-process research and development, the assumed commercialization dates for
these products ranged from 2004 to 2008. We believe that the assumptions used in
the valuation of purchased in-process technology represent a reasonable estimate
of the future benefits attributable to the purchased in-process technology. No
assurance can be given that actual results will not deviate from those
assumptions in future periods.
Below is a brief description of the in-process research and development
projects we acquired from Gilead, the development status for each project and
the estimated value at the date of acquisition.
VALUE AT
ACQUISITION DATE
PROJECT PROJECT DESCRIPTION DEVELOPMENT STATUS (IN MILLIONS)
- -------------------------------- -------------------------------------- ------------------------ ---------------------
OSI-211 (formerly NX211) a liposomal formulation of lurtotecan Phase II clinical $ 19.9
trials
OSI-7904L (formerly GS7904L) a liposomal formulation of a Phase I clinical 13.4
thymidylate synthase inhibitor trials
OSI-7836 (formerly GS7836) a nucleoside analog of Gemzar(R) Phase I clinical trials 96.9
-----------
$ 130.2
-----------
As of March 31, 2002, the technological feasibility of the projects had
not yet been reached. Each project would need to successfully complete a series
of clinical trials and to receive FDA or other regulatory approvals prior to
commercialization. Our current estimates of the required investments for the
full development and registration for these next generation cytotoxic drugs can
range from $80 to $120 million per drug. There can be no assurances that any of
these projects will ever reach feasibility or develop into products that can be
marketed profitably, nor can there be assurance we will be able to develop and
commercialize these products before our competitors. If it is determined that it
is not cost beneficial to pursue the further development of any of these
projects, we may discontinue the further development of certain or all of these
projects. Our revenue and profitability in future periods, as well as the value
of the goodwill acquired, may become impaired if these projects are not
successfully developed.
Selling, general and administrative expenses increased approximately
$3.5 million or 125% and $6.3 million or 111%, respectively, for the three and
six months ended March 31, 2002 compared to the three and six months ended March
31, 2001. The increases were primarily
-18-
attributable to the increased expenses for additional management and
administrative personnel and consultants to support our clinical trial programs
and research and development efforts, as well as an increase in facilities
expenses, including relocation cost related to the consolidation of facilities,
and other professional fees associated with expansion and corporate development
activities. Compensation expenses include the remeasurement of the value of
stock options at March 31, 2002 granted to non-research and development
consultants in accordance with EITF Issue 96-18, which resulted in $201,000 in
compensation expense for the six months ended March 31, 2002. Deferred
compensation for stock options issued to these non-employee consultants was
approximately $197,000 as of March 31, 2002. We expect that general and
administrative expenses will increase as we continue to support and expand our
clinical trial programs and research and development efforts.
Amortization of intangibles increased approximately $121,000 or 65% and
$244,630 or 66%, respectively, for the three and six months ended March 31, 2002
compared to the three and six months ended March 31, 2001. The increase related
to the amortization of the capitalized workforce and library license acquired
from British Biotech in September 2001.
OTHER INCOME AND EXPENSE
Net investment income decreased by approximately $4.3 million or 55%
and $4.8 million or 37%, respectively, for the three and six months ended March
31, 2002 compared to the three and six months ended March 31, 2001. The decrease
in net investment income is primarily due to a decrease in the average rate of
return on our investments and to less funds available for investment during the
three and six months ended March 31, 2002 compared to the three and six months
ended March 31, 2001. Interest expense increased approximately $1.3 million for
the three and six months ended March 31, 2002 compared to the three and six
months ended March 31, 2001. The increase for the three and six month periods
relates to the interest incurred on the convertible senior subordinated notes
issued in February 2002. The convertible senior subordinated notes bear interest
at 4% per annum, payable semi-annually, and mature on February 1, 2009. For the
three months ended March 31, 2002 other expenses increased $217,000 compared to
the three months ended March 31, 2001. For the six months ended March 31, 2002
we had other income of $471,000 compared to other expenses of $98,000 for the
six months ended March 31, 2001. Included in the three and six months ended
March 31, 2002 is $157,000 of non-cash expense related to the amortization of
debt issuance costs. Also included in the six months ended March 31, 2002 is the
recognition of the $1.0 million contingent payment received from Bayer
Corporation in December 2001, in connection with the sale of the diagnostic
business in November 1999.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2002, working capital, representing primarily cash, cash
equivalents and short-term investments, aggregated approximately $533.8 million
compared to $533.4 million at September 30, 2001. This increase of approximately
$400,000 resulted primarily from the net proceeds from the issuance of the
convertible senior subordinated notes and cash proceeds from the exercise of
stock options offset by net cash paid for the acquisition of Gilead's oncology
-19-
assets and related expenses and our operating cash burn for the six months ended
March 31, 2002.
On December 21, 2001, we acquired certain assets from Gilead pursuant
to the terms of an Asset Purchase Agreement dated as of November 26, 2001. The
assets purchased include: (a) a pipeline of three clinical oncology candidates,
(b) related intellectual property, and (c) rights to Gilead's leased facilities
located in Boulder, Colorado, as well as leasehold improvements and certain
fixed assets. In connection with the acquisition, we retained 117 Gilead
employees. The results of operations of the acquired Gilead oncology assets have
been included in the consolidated statement of operations since the date of
closing. In consideration for the assets, we paid $134.9 million in cash, which
includes professional fees and the assumption of certain liabilities, and issued
924,984 shares of common stock, valued at $40 million. The value of the 924,984
shares of common stock issued was determined based on the closing price of our
stock on the date of closing. We would also be obligated to pay contingent
consideration of up to an additional $30 million in either cash or a combination
of cash and common stock, at our option, upon the achievement of certain
milestones related to the development of OSI-211 (formerly NX211). Additionally,
we are assuming certain royalty and milestone obligations to third parties in
connection with the oncology candidates acquired as part of the acquisition.
On February 1, 2002, we issued $200 million aggregate principal amount
of convertible senior subordinated notes in a private placement for proceeds to
us of approximately $193.4 million. The notes bear interest at 4% per annum,
payable semi-annually, and mature on February 1, 2009. The notes are convertible
into shares of our common stock at a conversion price of $50 per share, subject
to adjustment in certain circumstances. We may redeem the notes, in whole or in
part, at any time before February 1, 2005 if the closing price of our common
stock has exceeded 150% of the conversion price then in effect for a specified
period of time. Upon any such early redemption, we are required to pay interest
that would have been due through February 1, 2005. We may also redeem some or
all of the notes at any time on or after February 1, 2005 if the closing price
of our common stock has exceeded 140% of the conversion price then in effect for
a specified period of time. Upon a change in control, as defined in the
indenture governing the notes, the holders of the notes will have the right to
require us to repurchase all of the notes, or a portion thereof, not previously
called for redemption at a purchase price equal to 100% of the principal amount
of the notes purchased, plus accrued and unpaid interest. We may elect to pay
the purchase price in common stock instead of cash. The number of shares of
common stock a holder will receive will equal the repurchase price divided by
95% of the average of the closing prices of our common stock for the
five-trading day period ending on the third business day prior to the repurchase
date. We pledged $22.9 million of U.S. government securities which will be
sufficient upon receipt of scheduled principal and interest payments to provide
for the payment in full of the first six scheduled interest payments on the
notes when due. We intend to use the proceeds from this issuance for the
development of our product pipeline, licensing and acquisition opportunities
that add oncology products and late stage drug candidates and general corporate
purposes.
We expect to incur additional losses over the next several years as we
continue our investment in Tarceva(TM) and other product candidates in our
pipeline. Additionally, as we
-20-
continue to shift our focus toward internal drug development, we expect
collaborative revenues to continue to decrease. To achieve profitability, we,
alone or with others, must successfully develop and commercialize our
technologies and products, conduct pre-clinical studies and clinical trials,
secure required regulatory approvals and obtain adequate assistance to
successfully manufacture, introduce and market such technologies and products.
The ability and time required to reach profitability is uncertain. We believe
that amounts received from the private placement of convertible senior
subordinated notes, existing cash resources, and projected funding from
collaborative research and development programs provide a strong financial base
from which to fund our operations and capital requirements for at least the next
several years.
We expect our cash burn to increase over the next several years as we
invest in the clinical development of Tarceva(TM) as well as other product
candidates in our pipeline. The major expenses associated with the broad-based
Phase III development program for Tarceva(TM) are expected to occur in 2002 and
2003. We anticipate our operating cash burn will approximate $115 to $130
million for each of these years as we fulfill our obligations on the Tarceva(TM)
development program and continue our ongoing research and development
operations.
COMMITMENTS AND CONTINGENCIES
Our major outstanding contractual obligations relate to our senior
subordinated convertible debt and our facilities leases. The following table
summarizes our significant contractual obligations at March 31, 2002 and the
effect such obligations are expected to have on our liquidity and cash flow in
future periods (in thousands):
<Caption>
2007 &
2002 2003 2004 2005 2006 Thereafter Total
- ---------------------------------- ---------- ---------- ---------- ---------- --------- ------------- -----------
Contractual Obligations:
- ---------------------------------- ---------- ---------- ---------- ---------- --------- ------------- -----------
Senior convertible debt (a) $ 4,000.0 $ 8,000.0 $ 8,000.0 $ 8,000.0 $ 8,000.0 $ 220,000.0 $256,000.0
- ---------------------------------- ---------- ---------- ---------- ---------- ---------- ------------ -----------
Operating leases 3,074.7 5,985.1 5,911.1 5,947.1 4,854.1 54,066.1 79,838.2
- ---------------------------------- ---------- ---------- ---------- ---------- ---------- ------------- ----------
Construction Committments 579.6 ---- ---- ---- ---- ---- 579.6
- ---------------------------------- ---------- ---------- ---------- ---------- ---------- ------------- ----------
Loans & capital leases payable(b) 297.2 287.2 ---- ---- ---- ---- 584.4
- ---------------------------------- ---------- ---------- ---------- ---------- ---------- ------------- ----------
Additonal purchase payment
to Gilead (c) 750.0 ---- ---- ---- ---- ---- 750.0
- ---------------------------------- ---------- ---------- ---------- ---------- ---------- ------------- ----------
Total contractual
obligations $ 8,701.5 $ 14,272.3 $ 13,911.1 $ 13,947.1 $ 12,854.1 $ 274,066.1 $337,752.2
- ---------------------------------- ---------- ---------- ---------- ---------- ---------- ------------- ----------
(a) Includes interest payments at a rate of 4% per annum.
(b) Includes interest payments
(c) Represents estimated payments to Gilead for reimbursement of
severance paid to former Gilead employees not retained by
OSI.
Other significant commitments and contingencies include the following:
* A commitment to share equally certain global development costs of
Tarceva(TM) with Genentech and Roche.
* In connection with the acquisition of certain of Gilead's oncology
assets in December 2001, we would be obligated to pay up to an
additional $30 million in either cash or a combination of cash and
common stock upon the achievement of certain milestones
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related to the development of OSI-211, the most advanced of Gilead's
oncology product candidates acquired by us.
* Under agreements with external clinical research organizations, or
CROs, we incur expenses relating to the progress of clinical trials.
These disbursements can be based upon the achievement of certain
milestones, patient enrollment, services rendered or as expenses
are incurred by the CROs.
* In connection with our strategic decision to close down our Tarrytown,
New York facility and our Birmingham, England facility, we expect to
pay approximately $2.3 million in severance costs and non-cancelable
lease exit costs during fiscal 2002 (see Note 7 to the accompanying
consolidated financial statements).
* We have a retirement plan which provides postretirement medical and
life insurance benefits to eligible employees, board members and
qualified dependents. Eligibility is determined based on age and years
of service. We have accrued postretirement benefit costs of $2.3
million at March 31, 2002.
* Under certain collaboration agreements with pharmaceutical companies
and educational institutions, we would be required to pay royalties
and/or milestones upon the successful development and commercialization
of products.
* Under certain license agreements we are required to pay license fees
for the use of technologies and products in our research and
development activities.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board issued SFAS No.
141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 141 requires that the purchase method of accounting be used
for all future business combinations. It specifies the criteria which intangible
assets acquired in a business combination must meet in order to be recognized
and reported apart from goodwill. SFAS No. 142 requires that goodwill and
intangible assets with indefinite useful lives no longer be amortized, but
instead tested for impairment at least annually in accordance with the
provisions of SFAS No. 142. SFAS No. 142 also requires that intangible assets
with estimable useful lives be amortized over their respective estimated useful
lives, and reviewed for impairment in accordance with SFAS No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of." SFAS No. 141 and No. 142 are effective for fiscal years beginning on or
after December 15, 2001; however, both of these statements are effective for
acquisitions and other intangibles acquired on or after July 1, 2001. We adopted
the applicable provisions of these statements for the accounting of the Gilead
and the British Biotech acquisitions, which occurred after July 1, 2001.
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Upon full adoption, we will evaluate our existing intangible assets
that were acquired in prior purchase business combinations and make any
necessary reclassifications in order to conform with the new criteria in SFAS
No. 141 for recognition apart from goodwill. We will be required to reassess the
useful lives and residual values of all intangible assets acquired and make any
necessary amortization period adjustments. In addition, we will be required to
test goodwill and, to the extent an intangible asset is identified as having an
indefinite useful life, the intangible asset for impairment in accordance with
SFAS No. 142. Any impairment loss will be measured as of the date of adoption
and recognized as the cumulative effect of a change in accounting principle. As
a result of the acquisition of certain assets from Gilead on December 21, 2001,
we have $36.5 million in goodwill as of March 31, 2002, which in accordance with
SFAS No. 142, will not be amortized. As of September 30, 2001, we had goodwill
which was fully amortized and unamortized identifiable intangible assets in the
amount of $3.7 million. We are currently assessing the impact of the full
adoption of these accounting standards.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" which supercedes SFAS No. 121. SFAS
No. 144 requires, among other things, that long-lived assets be measured at the
lower of carrying amount or fair value, less cost to sell, whether reported in
continuing operations or in discontinued operations. SFAS No. 144 is effective
for fiscal years beginning after December 15, 2001 and interim periods within
those fiscal years. We are currently assessing the impact of adopting SFAS No.
144.
FORWARD LOOKING STATEMENTS
A number of the matters and subject areas discussed in this Item 2
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and elsewhere in this report are not historical or current facts
deal with potential future circumstances and developments. The discussion of
these matters and subject areas is qualified by the inherent risks and
uncertainties surrounding future expectations generally, and these discussions
may materially differ from our actual future experience involving any one or
more of these matters and subject areas. These forward looking statements are
also subject generally to the other risks and uncertainties that are described
in our annual report on Form 10-K for the fiscal year ended September 30, 2001.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our cash flow and earnings are subject to fluctuations due to changes
in interest rates in our investment portfolio of debt securities, to the fair
value of equity instruments held, and, to an immaterial extent, to foreign
currency exchange rates. We maintain an investment portfolio of various issuers,
types and maturities. These securities are generally classified as
available-for-sale and, consequently, are recorded on the balance sheet at fair
value with unrealized gains or losses reported as a component of accumulated
other comprehensive income (loss) included in stockholders' equity. With respect
to the convertible senior subordinated notes, the Company pledged $22.9 million
of U.S. government securities with maturities at various dates through November
2004. Upon maturity, the proceeds of the Restricted Investment Securities will
be
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sufficient to pay the first six scheduled interest payments on the convertible
senior subordinated notes when due. The Company considers its Restricted
Investment Securities to be "held-to-maturity," as defined by SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity Securities." These
securities are reported at their amortized cost, which includes the direct costs
to acquire the securities, plus the amortization of any discount or premium, and
accrued interest earned on the securities. Our limited investments in certain
biotechnology companies are carried on the equity method or cost method of
accounting using the guidance of applicable accounting literature.
Other-than-temporary losses are recorded against earnings in the same period the
loss was deemed to have occurred. It is uncertain whether other-than-temporary
losses will be material to our results of operations in the future. Other than
foreign currency exchange rates, we do not currently hedge these exposures. We
at times minimize risk by hedging the foreign currency exchange rates exposure
through forward contracts as more fully described in note 11(d) to the
consolidated financial statements contained in our annual report on Form 10-K
for the fiscal year ended September 30, 2001.
At March 31, 2002, we maintained a portion of our cash and cash
equivalents in financial instruments with original maturities of three months or
less. We also maintained an investment portfolio containing financial
instruments of which approximately 23% have original maturities of less than 12
months. These financial instruments, principally comprised of government and
government agency obligations and corporate obligations, are subject to interest
rate risk and will decline in value if interest rates increase. A hypothetical
ten percent change in interest rates during the three and six months ended March
31, 2002 would have resulted in approximately a $347,000 and $804,000 change in
our net loss, respectively. We have not used derivative financial instruments in
our investment portfolio.
Our long-term debt totaled approximately $200 million at March 31, 2002
and was comprised principally of the convertible senior subordinated notes. The
convertible senior subordinated notes bear interest a fixed rate of 4%, and
therefore an immediate ten percent change in interest rates would not have a
material effect on our financial condition or results of operations.
Underlying market risk exists related to an increase in our stock price
or an increase in interest rates which may make the conversion of the
convertible senior subordinated notes to common stock beneficial to the
convertible senior subordinated notes holders. Conversion of the convertible
senior subordinated notes would have a dilutive effect on any future earnings
and book value per common share.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not applicable.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On February 1, 2002, we issued $200,000,000 aggregate principal amount
of 4% Convertible Senior Subordinated Notes due 2009 to Merrill Lynch & Co.,
Merrill Lynch, Pierce, Fenner & Smith Incorporated, Robertson Stephens, Inc.,
Adams, Harkness & Hill, Inc. and Lazard Freres & Co. LLC, the initial purchasers
of the notes, for resale in transactions exempt from the registration
requirements of the Securities Act of 1933, as amended, to persons reasonably
believed by the initial purchasers to be "qualified institutional buyers" as
defined in Rule 144A under the Securities Act. The initial purchasers' discount
was $6,500,000. We intend to use the proceeds of the sale to continue the
development of our product pipeline, licensing and acquisition opportunities
that add oncology products and late stage drug candidates, and for general
corporate purposes. Interest on the notes accrue at a rate of 4% per year and
will mature in 2009. The notes are convertible into shares of our common stock
at any time on or prior to maturity, at a conversion price of $50 per share,
subject to normal and customary adjustments in certain circumstances. We filed a
registration statement to enable the selling securityholders to sell their notes
and the shares issuable upon conversion of the notes.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our annual meeting of stockholders was held on March 13, 2002. The
following nine directors were elected:
Votes for Votes Withheld
--------- --------------
1. Colin Goddard, Ph.D. 25,712,699 3,022,491
2. Edwin A. Gee, Ph.D. 28,082,168 653,022
3. G. Morgan Browne 28,149,665 585,525
4. John H. French II 28,148,755 586,435
5. Daryl K. Granner, M.D. 28,106,319 628,871
6. Walter M. Lovenberg, Ph.D. 28,002,239 732,951
7. Viren Mehta 28,002,719 732,471
8. Sir Mark Richmond 28,175,236 559,954
9. John P. White 27,996,897 738,293
The Institutional Shareholder Services recommended shareholders
withhold votes for Dr. Goddard citing concerns with the failure to establish a
fully independent nominating committee for its Board of Directors. Dr. Goddard,
as Chairman of the Board, currently chairs this board
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committee. The Board of Directors is currently reviewing this and other aspects
of its governance procedures.
In addition, the following matters were voted upon: (i) a proposal to
adopt our 2001 Incentive and Non-Qualified Stock Option Plan was approved
(18,742,257 shares voted in favor, 1,923,173 shares voted against, 36,410 shares
abstained and there were 8,033,350 broker non-votes); and (ii) the appointment
of KPMG LLP as auditors for fiscal year ending September 30, 2002 was ratified
(28,198,415 shares voted in favor, 506,710 shares voted against, 30,005 shares
abstained and there were no broker non-votes).
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
3.1 Certificate of Incorporation, as amended,
filed by OSI Pharmaceuticals, Inc. as an
exhibit to the Form 10-K for the fiscal year
ended September 30, 2001 (file no.
000-15190), and incorporated herein by
reference.
3.2 Amended and Restated Bylaws, filed by OSI
Pharmaceuticals, Inc. as an exhibit to the
Form 10-K for the fiscal year ended
September 30, 2001 (file no. 000-15190), and
incorporated herein by reference.
4.1 Indenture, dated February 1, 2002, by and
between OSI Pharmaceuticals, Inc. and The
Bank of New York, filed as an exhibit to OSI
Pharmaceuticals, Inc.'s registration
statement on Form S-3 filed April 19, 2002
(file no. 333-86624), and incorporated
herein by reference.
4.2 Form of 4% Convertible Senior Subordinated
Note Due 2009 (included in Exhibit 4.1).
4.3 Registration Rights Agreements, dated
February 1, 2002, by and among OSI
Pharmaceuticals, Inc., Merrill Lynch & Co.,
Merrill Lynch, Pierce, Fenner & Smith,
Incorporated, Robertson Stephens, Inc.,
Adams, Harkness & Hill, Inc. and Lazard
Freres & Co. LLC, filed as an exhibit to OSI
Pharmaceuticals, Inc.'s registration
statement on Form S-3 filed April 19, 2002
(file no. 333-86624), and incorporated
herein by reference.
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(b) REPORTS ON FORM 8-K
We filed the following current reports on Form 8-K with the Securities
and Exchange Commission via EDGAR:
1. Form 8-K on January 7, 2002 with respect to the acquisition
of certain oncology assets of Gilead Sciences, Inc. in December 2001. The
earliest event covered by this report occurred on December 21, 2001.
2. Form 8-K on January 25, 2002 with respect to the offering
of 4% Convertible Senior Subordinated Notes. The earliest event covered by this
report occurred on January 24, 2002.
3. Form 8-K on January 25, 2002 which provided unaudited pro
forma financial information with respect to the acquisition of certain oncology
assets of Gilead in December 2001, as well as the reorganization of our senior
research and development management team. The earliest event covered by this
report occurred on January 22, 2002.
4. Form 8-K on January 29, 2002 with respect to a purchase
agreement providing for the sale of the 4% Convertible Senior Subordinated
Notes. The earliest event covered by this report occurred on January 29, 2002.
5. Form 8-K/A on March 6, 2002 which provided financial
information with respect to the acquisition of certain oncology assets of Gilead
in December 2001. This report amended the Form 8-K filed on January 7, 2002. The
earliest event covered by this report occurred on December 21, 2001.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
OSI PHARMACEUTICALS, INC.
------------------------------------------
(Registrant)
Date: May 10, 2002 /S/ Colin Goddard, Ph.D.
------------------------------------------
Colin Goddard, Ph.D.
Chairman of the Board and
Chief Executive Officer
Date: May 10, 2002 /S/ Robert L. Van Nostrand
------------------------------------------
Robert L. Van Nostrand
Vice President and Chief Financial Officer
(Principal Financial Officer)
EXHIBIT INDEX
Exhibit
- -------
3.1 Certificate of Incorporation, as amended, filed by OSI Pharmaceuticals,
Inc. as an exhibit to the Form 10-K for the fiscal year ended September
30, 2001 (file no. 000-15190), and incorporated herein by reference.
3.2 Amended and Restated Bylaws, filed by OSI Pharmaceuticals, Inc. as an
exhibit to the Form 10-K for the fiscal year ended September 30, 2001
(file no. 000-15190), and incorporated herein by reference.
4.1 Indenture, dated February 1, 2002, by and between OSI Pharmaceuticals,
Inc. and The Bank of New York, filed as an exhibit to OSI
Pharmaceuticals, Inc.'s registration statement on Form S-3 filed April
19, 2002 (file no. 333-86624), and incorporated herein by reference.
4.2 Form of 4% Convertible Senior Subordinated Note Due 2009 (included in
Exhibit 4.1).
4.3 Registration Rights Agreements, dated February 1, 2002, by and among
OSI Pharmaceuticals, Inc., Merrill Lynch & Co., Merrill Lynch, Pierce,
Fenner & Smith, Incorporated, Robertson Stephens, Inc., Adams, Harkness
& Hill, Inc. and Lazard Freres & Co. LLC, filed as an exhibit to OSI
Pharmaceuticals, Inc.'s registration statement on Form S-3 filed April
19, 2002 (file no. 333-86624), and incorporated herein by reference.