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 December 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)
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(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
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes X No
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APPLICABLE ONLY TO CORPORATE ISSUERS:
At January 31, 2003 the registrant had outstanding 36,444,636 shares of common
stock, $.01 par value.
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONTENTS
PAGE NO.
--------
PART I. FINANCIAL INFORMATION.............................................................................1
Item 1. Financial Statements..............................................................................1
Consolidated Balance Sheets
- December 31, 2002 (unaudited) and September 30, 2002..........................................1
Consolidated Statements of Operations
- Three Months Ended December 31, 2002 and 2001 (unaudited).....................................2
Consolidated Statements of Cash Flows
- Three Months Ended December 31, 2002 and 2001 (unaudited).....................................3
Notes to Consolidated Financial Statements......................................................4
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............10
Item 3. Quantitative and Qualitative Disclosures About Market Risk.......................................21
Item 4. Controls and Procedures..........................................................................22
PART II. OTHER INFORMATION................................................................................24
Item 1. Legal Proceedings................................................................................24
Item 2. Changes in Securities and Use of Proceeds........................................................24
Item 3. Defaults Upon Senior Securities..................................................................24
Item 4. Submission of Matters to a Vote of Security Holders..............................................24
Item 5. Other Information................................................................................24
Item 6. Exhibits and Reports on Form 8-K.................................................................24
SIGNATURES................................................................................................26
CERTIFICATIONS............................................................................................27
EXHIBIT INDEX.............................................................................................31
i
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
DECEMBER 31, SEPTEMBER 30,
2002 2002
------------ ------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents................................................... $ 121,810 $ 152,578
Investment securities....................................................... 308,582 304,388
Restricted investment securities - short-term............................... 3,968 7,938
Receivables, including amounts due from related parties of $1,209 and $3,000
at December 31, 2002 and September 30, 2002, respectively............... 1,284 3,253
Interest receivable......................................................... 3,669 3,728
Prepaid expenses and other current assets................................... 4,282 3,873
----------- ----------
Total current assets............................................... 443,595 475,758
----------- ----------
Restricted investment securities - long-term..................................... 11,468 11,373
Property, equipment and leasehold improvements - net............................. 44,939 46,175
Debt issuance costs - net........................................................ 4,942 5,145
Goodwill......................................................................... 38,739 38,648
Other assets..................................................................... 1,954 1,945
----------- ----------
$ 545,637 $ 579,044
========== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses, including amounts due to related parties
of $2,392 and $2,190 at December 31, 2002 and September 30, 2002,
respectively............................................................. $ 21,516 $ 22,062
Unearned revenue - current; including amounts received in advance from
related parties of $5,677 and $7,687 as of December 31, 2002 and
September 30, 2002, respectively........................................ 6,444 8,613
Loans payable - current..................................................... 422 527
---------- ---------
Total current liabilities.......................................... 28,382 31,202
---------- ---------
Other liabilities:
Unearned revenue - long-term; representing amounts received in advance from
related parties......................................................... 5,000 6,250
Convertible senior subordinated notes and loans payable-long-term........... 160,000 160,014
Accrued postretirement benefit cost......................................... 2,644 2,470
---------- ---------
Total liabilities.................................................. 196,026 199,936
---------- ---------
Stockholders' equity:
Preferred stock, $.01 par value; 5,000 shares authorized; no shares issued
at December 31, 2002 and September 30, 2002............................. -- --
Common stock, $.01 par value; 200,000 shares authorized, 37,376 and 37,335
shares issued at December 31, 2002 and September 30, 2002,
respectively............................................................ 374 373
Additional paid-in capital.................................................. 708,761 708,435
Deferred compensation....................................................... (18) (49)
Accumulated deficit......................................................... (354,323) (324,223)
Accumulated other comprehensive income...................................... 1,250 1,005
---------- ---------
356,044 385,541
Less: treasury stock, at cost; 940 shares at December 31, 2002 and September 30,
2002.................................................................... (6,433) (6,433)
---------- ---------
Total stockholders' equity......................................... 349,611 379,108
---------- ---------
Commitments and contingencies
$ 545,637 $ 579,044
========== =========
See accompanying notes to consolidated financial statements.
1
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS EXCEPT PER SHARE DATA)
THREE MONTHS ENDED
DECEMBER 31
-------------------------------
2002 2001
------------ ----------
Revenues:
Collaborative program revenues, including $2,010 and $2,257 from related
parties in 2002 and 2001, respectively................................ $ 2,982 $ 3,116
License and other revenues, including $1,250 and $2,083
from related parties in 2002 and 2001, respectively................... 1,490 2,776
----------- ----------
4,472 5,892
----------- ----------
Expenses:
Research and development................................................. 28,223 17,254
Acquired in-process research and development (see note 3)................ -- 130,200
Selling, general and administrative...................................... 7,500 5,856
Amortization of intangibles.............................................. 54 309
----------- ----------
35,777 153,619
----------- ----------
Loss from operations............................................... (31,305) (147,727)
Other income (expense):
Investment income - net.................................................. 2,669 4,574
Interest expense......................................................... (1,607) (2)
Other income - net....................................................... 143 773
----------- ----------
Net loss.................................................................... $ (30,100) $ (142,382)
============ ===========
Weighted average shares of common stock outstanding......................... 36,414 35,140
=========== ==========
Basic and diluted net loss per common share................................. $ (0.83) $ (4.05)
=========== ==========
See accompanying notes to consolidated financial statements.
2
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
THREE MONTHS ENDED
DECEMBER 31
--------------------------------
2002 2001
------------ -----------
Cash flow from operating activities:
Net loss................................................................. $ (30,100) $ (142,382)
Adjustments to reconcile net loss to net cash
used in operating activities:
Gain on sale of diagnostic business................................ -- (1,000)
Loss (gain) on sale of investments................................. (345) 269
Depreciation and amortization...................................... 3,015 1,950
In-process research and development charge on acquisition of
Gilead's oncology assets....................................... -- 130,200
Non-cash compensation charges...................................... 101 1,887
Changes in assets and liabilities, net of the effects of business acquisition
in 2001:
Receivables........................................................ 2,029 (228)
Prepaid expenses and other current assets.......................... (352) (610)
Other assets....................................................... 25 (66)
Accounts payable and accrued expenses.............................. (675) (5,755)
Unearned revenue................................................... (3,419) (1,550)
Accrued postretirement benefit cost................................ 174 75
----------- ----------
Net cash used in operating activities....................................... (29,547) (17,210)
------------ -----------
Cash flows from investing activities:
Payments for acquisitions................................................ -- (134,942)
Net proceeds from sale of diagnostic business............................ -- 1,000
Purchases of investments (restricted and unrestricted)................... (127,078) (85,624)
Maturities and sales of investments (restricted and unrestricted)........ 126,658 79,540
Additions to property, equipment and leasehold improvements.............. (821) (943)
Additions to compound library assets..................................... (45) --
Investments in privately-owned companies................................. (50) (500)
------------ -----------
Net cash used in investing activities....................................... (1,336) (141,469)
------------ -----------
Cash flows from financing activities:
Proceeds from exercise of stock options, stock warrants and
employee purchase plan................................................ 256 1,582
Payments on loans and capital leases payable - net....................... (128) (32)
------------ -----------
Net cash provided by financing activities................................... 128 1,550
----------- ----------
Net decrease in cash and cash equivalents................................... (30,755) (157,129)
Effect of exchange rate changes on cash and cash equivalents................ (13) (88)
Cash and cash equivalents at beginning of year.............................. 152,578 225,150
----------- ----------
Cash and cash equivalents at end of period.................................. $ 121,810 $ 67,933
=========== ==========
Non-cash activities:
Issuance of common stock to employees.................................... $ 91 $ 375
=========== ==========
Issuance of common stock in connection with acquisition
of certain assets from Gilead......................................... $ -- $ 40,000
=========== ==========
See accompanying notes to consolidated financial statements.
3
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 (the "Company") as of December 31,
2002, their results of operations for the three months ended December 31, 2002
and 2001 and their cash flows for the three months ended December 31, 2002 and
2001. Certain reclassifications have been made to the prior period 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, as amended, for the fiscal year ended
September 30, 2002. Results for interim periods are not necessarily indicative
of results for the entire year.
(2) Revenue Recognition
The Company accounts for upfront nonrefundable technology access and
other upfront 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. The Company received a total of $25.0 million
in upfront fees from Genentech, Inc. and Roche in January 2001 which was being
recognized on a straight-line basis evenly over the expected three-year term of
the Company's required research and development efforts under the terms of the
agreement. In the fourth quarter of fiscal 2002, the expected term was changed
to four years to reflect the Company's revised estimate of the term of the
continued involvement in the research and development efforts under the
Tripartite Agreement with Genentech and Roche. In accordance with Accounting
Principle Board Opinion No. 20 "Accounting Changes," the remaining deferred
revenue is being recognized prospectively over the revised term. As a result,
the Company recorded revenues of $1.3 million in the first quarter of fiscal
2003 compared to $2.1 million had the upfront fees continued to be recognized
over a three-year period. This change in estimate increased the basic and
diluted loss by $.02 per share for the three months ended December 31, 2002.
(3) Acquisition
On December 21, 2001, the Company acquired certain assets from Gilead
Sciences, Inc. pursuant to the terms of an Asset Purchase Agreement dated as of
November 26, 2001. 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
4
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
the assumption of certain liabilities, and issued 924,984 shares of common
stock, valued at $40.0 million.
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 value assigned to the acquired in-process research and development,
in-process R&D, 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 and is
included in the accompanying consolidated statement of operations for the three
months ended December 31, 2001.
(4) Restricted Investments Securities
With respect to the convertible senior subordinated notes, issued in
February 2002, the Company originally pledged $22.9 million of U.S. Government
securities (Restricted Investment Securities) with maturities at various dates
through November 2004. The aggregate amortized cost of the Restricted Investment
Securities at December 31, 2002 was $15.4 million. Included in cash and cash
equivalents on the accompanying consolidated balance sheet as of December 31,
2002 is $4.0 million relating to the Restricted Investment Securities that have
reached maturity.
(5) Comprehensive Income (Loss)
Comprehensive loss for the three months ended December 31, 2002 and
2001 was as follows (in thousands):
FOR THE THREE MONTHS
ENDED DECEMBER 31,
-----------------------
2002 2001
---------- ----------
Net loss ............................................................................ $ (30,100) $(142,382)
Other comprehensive income (loss):
Foreign currency translation adjustments ................................... 659 (254)
Unrealized holding loss arising during period .............................. (66) (899)
Less: Reclassification adjustment for losses (gains) realized in income .... (348) 269
--------- ---------
245 (884)
--------- ---------
Total comprehensive loss ............................................................ $ (29,855) $(143,266)
========= =========
5
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
The components of accumulated other comprehensive income were as
follows (in thousands):
DECEMBER 31, SEPTEMBER 30,
2002 2002
------------ -------------
Cumulative foreign currency translation adjustment......... $ 339 $ (320)
Unrealized gains on available-for-sale securities.......... 911 1,325
------- -------
Accumulated other comprehensive income .................... $ 1,250 $ 1,005
======= =======
</Table>
(6) Net Loss per Common Share
A reconciliation between the numerators and the denominators of the
basic and diluted net loss per share computation is as follows (in thousands
except per share data):
FOR THE THREE MONTHS ENDED
DECEMBER 31,
--------------------------
2002 2001
--------- ----------
Net loss ...................................................... $(30,100) $ (142,382)
======== ==========
Weighted average common shares ................................ 36,414 35,140
Effect of common share equivalents ............................ -- --
-------- ----------
Weighted average common and potential common shares
outstanding .............................................. 36,414 35,140
======== ==========
Basic net loss per share ...................................... $ (0.83) $ (4.05)
======== ==========
Diluted net loss per share .................................... $ (0.83) $ (4.05)
========= ==========
Basic and diluted net loss per share is computed by dividing the net
loss per share by the weighted average number of common shares outstanding
during the period. The diluted net loss per share presented excludes the effect
of common share equivalents (stock options and convertible debt) since such
inclusion in the computation would be anti-dilutive. Such common share
equivalents (options and convertible debt, assuming all shares upon conversion
would be dilutive) amounted to 4.1 million for the three months ended December
31, 2002. Such common share equivalents (options) amounted to 1.8 million for
the three months ended December 31, 2001.
(7) Consolidation of Facility
In the fourth quarter of fiscal 2001, the Company announced its
strategic decision to close down its Birmingham, England facility. The
operations at the Birmingham, England
6
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
facility ceased on March 31, 2002; however, the Company is still in the process
of closing down the facility.
As of December 31, 2002, the remaining restructuring reserve relating
to the consolidation of the Birmingham, England facility was $984,000 relating
to non-cancelable lease exit costs. The consolidation activity for the three
months ended December 31, 2002 was as follows (in thousands):
LEASE
EXIT COSTS
----------
Balance at September 30, 2002.............................. $ 1,630
Cash paid.................................................. (693)
Foreign currency translation adjustments................... 47
-------
Balance at December 31, 2002............................... $ 984
=======
(8) Sale of Diagnostics Business
On November 30, 1999, the Company sold assets of its diagnostics
business to The Bayer Corporation including the assets of the Company's
wholly-owned diagnostics subsidiary, OSDI, Inc. 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 sale, the Company received a
contingent payment of $1.0 million in December 2001, which is included in other
income for the three months ended December 31, 2001.
(9) Accounting for Goodwill and Other Intangible Assets
Effective October 1, 2002, the Company fully adopted SFAS No. 142,
"Goodwill and Other Intangible Assets." SFAS No. 142 requires that goodwill and
intangible assets determined to have indefinite lives no longer be amortized but
instead be tested for impairment at least annually and whenever events or
circumstances occur that indicate impairment might have occurred.
As of September 30, 2002, the Company's intangible assets were $39.1
million, consisting of $36.5 million of goodwill, $2.1 million of acquired
workforce, and $458,000 for a license to compound libraries. In accordance with
SFAS No. 142, the goodwill has not been amortized as it was acquired in
connection with the acquisition of certain oncology assets from Gilead, which
occurred after July 1, 2001. Upon full adoption of SFAS No. 142, acquired
workforce no longer meets the definition of an identifiable intangible asset. As
a result, the net balance of $2.1 million as of September 30, 2002 was
reclassified to goodwill. The carrying amount of goodwill as of December 31,
2002, inclusive of the acquired workforce, was $38.7
7
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
million, which includes a $91,000 effect from foreign currency exchange rate
fluctuations during the three month period ended December 31, 2002.
The Company's identifiable intangible asset (license for compound
libraries), is subject to amortization. The Company reassessed the useful lives
of this intangible asset to make any necessary amortization period adjustments.
No adjustments resulted from this assessment. Amortization expense for this
intangible asset for the three months ended December 31, 2002 and 2001 was
$54,000 and $53,000, respectively. Amortization expense is estimated to be
$179,000 for the remainder of fiscal 2003, $239,000 in fiscal 2004 and $0 in
fiscal 2005.
Under the non-amortization approach, goodwill and certain other
intangibles are not amortized into results of operations but instead are
reviewed for impairment, written down, and charged to results of operations in
periods in which the recorded value of goodwill and certain other intangibles is
more than their implied fair value. The Company completed its impairment review
of goodwill during the first quarter of fiscal 2003 and determined that no
impairment charge was required upon adoption. A reconciliation of previously
reported net loss and net loss per share to the amounts adjusted for the
exclusion of acquired workforce amortization, is as follows (in thousands except
per share data):
For the three months ended
December 31,
--------------------------
2002 2001
---------- -----------
Reported net loss ............................. $ (30,100) $ (142,382)
Goodwill amortization ......................... -- --
Acquired workforce amortization ............... -- 258
---------- -----------
Adjusted net loss ............................. $ (30,100) $ (142,124)
========== ===========
Reported basic and diluted net loss per share.. $ (0.83) $ (4.05)
Goodwill amortization per share ............... -- --
Acquired workforce amortization per share ..... -- 0.01
---------- -----------
Adjusted basic and diluted net loss per share.. $ (0.83) $ (4.04)
========== ===========
(10) Amendment to Stock Option Plan
On December 11, 2002, the Board of Directors approved an amendment to
the 2001 Incentive and Non-Qualified Stock Option Plan (the "Stock Option
Plan"). The amendment to the Stock Option Plan only affected the automatic,
formula-based grants of non-qualified stock options to directors who are not
employees of the Company. Under the amended formula, each individual who becomes
a director on or after January 1, 2003 will receive an initial option to
purchase 50,000 shares of common stock upon his or her election to the Board.
Persons elected to the Board after June 13, 2001 but prior to January 1, 2003
were entitled to
8
OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
an initial grant of an option to purchase 30,000 shares of common stock upon
their initial election. All persons elected to the Board after June 13, 2001
receive grants of options to purchase 7,500 shares upon reelection 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).
(11) Amendment to the Stock Purchase Plan for the Non-Employee Directors
On December 11, 2002, the Board of Directors approved an amendment to
the Company's Stock Purchase Plan for Non-Employee Directors which was adopted
as of March 25, 1996 (the "Stock Purchase Plan"). Pursuant to the amended Stock
Purchase Plan, fifty-percent of the annual retainer fee earned by each
non-employee director will be paid to the director in the form of a restricted
stock award. The restricted stock award will be made as of each annual
stockholder meeting at which directors are elected beginning with the Annual
Meeting of Stockholders set for March 19, 2003. Annual restricted stock awards
will vest in monthly installments over the one-year term for which the award is
made. In the event a director's membership on the Board terminates prior to the
end of such one-year term, any unvested portion of the director's restricted
stock award will be forfeited. Shares of restricted stock awarded annually may
not be sold or transferred by the director until the first anniversary of the
date of grant of such award. Non-employee directors may elect to receive the
remaining fifty-percent of the director's annual retainer in the form of shares
of common stock under the Stock Purchase Plan as well.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THREE MONTHS ENDED DECEMBER 31, 2002 AND 2001
OVERVIEW
We are a leading biotechnology company focused on the discovery,
development and commercialization of high-quality oncology products that both
extend life and improve the quality-of-life for cancer patients worldwide. We
have established a balanced pipeline of oncology drug candidates that includes
both next-generation cytotoxic chemotherapy agents and novel mechanism-based,
gene-targeted therapies. We currently have four proprietary candidates in
clinical trials and two additional candidates in clinical trials with Pfizer
Inc.
Our most advanced drug candidate, Tarceva(TM) (erlotinib HCl), is a
small molecule inhibitor of the epidermal growth factor receptor, or HER1/EGFR.
The protein product of the HER1/EGFR gene is a receptor tyrosine kinase that is
over-expressed or mutated in many major solid tumors. We believe HER1/EGFR
inhibitors represent an exciting new class of relatively safe and well tolerated
anti-cancer agents that may have utility in treating a wide range of cancer
patients. Tarceva(TM) is an oral once-a-day small molecule drug designed to
specifically block the activity of the HER1/EGFR protein. Currently, we are
developing Tarceva(TM) in an alliance with Genentech, Inc. and Roche. If the
drug receives regulatory approval, Genentech will lead the marketing effort in
the United States and Roche will market it in the rest of the world. We will
receive milestone payments from both Genentech and Roche, an equal profit share
from U.S. sales, and royalties on sales outside of the United States.
Tarceva(TM) has demonstrated encouraging indications of anti-cancer activity in
single-agent, open label Phase II trials in non-small cell lung cancer, head and
neck cancer and ovarian cancer. Tarceva(TM) is currently in Phase III clinical
trials for non-small cell lung cancer and pancreatic cancer. In January 2003, we
announced the completion of patient enrollment in the Phase III
refractory/advanced non-small cell lung and pancreatic cancer trials. The
alliance has now completed target enrollment in all four Phase III Tarceva(TM)
trials, which involves a total of approximately 3,500 patients.
Behind Tarceva(TM) we have five additional drug candidates in earlier
stages of clinical development. Three of these (OSI-211, OSI-7904L and OSI-7836)
are next generation cytotoxic chemotherapy agents, which are being developed by
us, and the other two (CP-547,632 and CP-724,714) are gene-targeted therapies
currently being developed by Pfizer. We own commercial rights to the first three
and will receive royalty payments on the latter two if they are successfully
commercialized.
Our next generation cytotoxic chemotherapy candidates are designed to
improve upon currently marketed products in the same drug class. OSI-211 is a
liposomal formulation of lurtotecan, a topoisomerase-I inhibitor, that is being
developed to compete with topotecan
10
(Hycamptin(R)). OSI-7904L is a liposomal formulation of a thymidylate synthase
inhibitor, GW 1843, that is being developed as a potential competitor to
5-Fluorouracil (5-FU) and capecitabine (Xeloda(R)), and OSI-7836 is a nucleoside
analog being developed to compete with gemcitabine (Gemzar(R)). OSI-211 is in
Phase II clinical trials, and OSI-7904L and OSI-7836 are in Phase I clinical
trials. Like Tarceva(TM), the two gene-targeted therapies are receptor tyrosine
kinase inhibitors. CP-547,632 is a small molecule targeting the vascular
endothelial growth factor receptor, or VEGFR, and CP-724,714 is a small molecule
targeting HER2/erbB2. Both agents are currently in Phase I clinical trials.
In order to support our clinical pipeline, we have established (through
acquisition and internal investment) a high quality oncology clinical
development and regulatory affairs capability and a pilot scale chemical
manufacturing and process chemistry group. Behind our clinical pipeline we have
an extensive, fully integrated small molecule drug discovery organization
designed to generate a pipeline of high quality oncology drug candidates to move
into clinical development. This research operation has been built upon our
historical strengths in high throughput screening, chemical libraries, medicinal
and combinatorial chemistry, and automated drug profiling technology platforms.
With oncology as our focus, we have made the strategic decision to
divest all non-oncology research programs by the end of our second quarter in
fiscal 2003 or shortly thereafter, and realign our internal resources toward an
oncology strategy. In July 2002, we agreed to accelerate the conclusion of the
phase-down period of our funded research alliance with Anaderm Research
Corporation, a wholly-owned subsidiary of Pfizer focused on the development of
novel treatments for skin and hair conditions. As of December 31, 2002, we
received $4.5 million of a total $8.0 million phase-down fee for transferring to
Anaderm all of our research related to this collaboration. We will also receive
royalties on the sale of products for these treatments which may arise from
compounds that we have identified. We expect the transfer to be completed in the
second quarter. We also plan to divest our diabetes program and certain of our
adenosine receptor assets into a newly formed and externally funded entity in
which we will maintain a minority interest. Our diabetes program includes a
partnership with the Vanderbilt University Diabetes Center, a funded alliance
with Tanabe Seiyaku Co. Ltd., and six proprietary gene-targeted discovery
programs in the lead seeking and lead optimization phases, primarily focused in
the glucose regulation and obesity fields. We also intend to transfer to this
entity our existing diabetes teams comprised of approximately 24 employees. If
we are unable to obtain external funding for this newly formed entity, we will
consider other alternatives to discontinue the diabetes program, including the
out-licensing of diabetes assets and employee headcount reductions.
Historically, our research organization had been established to provide
early stage discovery research services to our pharmaceutical industry partners
who funded these activities. Since some of our employee skill sets were from
this multi-disease drug discovery service focus of our past collaborations and
not ideally suited to an oncology-only strategy, in October 2002, we made the
decision to reduce our employee headcount by approximately 9%
11
as we strive to better balance our staff and skill sets to focus on oncology
while maintaining strong fiscal control of the business.
CRITICAL ACCOUNTING POLICIES
We prepare our consolidated financial statements in accordance with
accounting principles generally accepted in the United States. 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 as of 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 our annual report on Form 10-K as amended for the year
ended September 30, 2002 includes a summary of the significant accounting
policies used in the preparation of the consolidated financial statements.
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 amended, or SAB No. 101. Our most
significant application of this policy, to date, is the $25.0 million in upfront
fees received from Genentech and Roche in January 2001 which was originally
being recognized evenly over the expected three-year term of our required
research and development efforts under the terms of the agreement. The expected
term is subject to change based upon the parties' continuous monitoring of
current research data and their projections for the remaining development
period. A change in this expected term impacts the period over which the
remaining deferred revenue would be recognized. In the fourth quarter of fiscal
2002, the expected term was changed to four years to reflect the revised
estimated timing of our research and development commitment for Tarceva(TM)
under the alliance. The revision was a result of the review of the current
research data available, current developments in the HER1/EGFR targeted therapy
market and the involved parties' revised projections for the clinical
development plan. As a result of this revision, we recorded revenues of $1.3
million for the three months ended December 31, 2002 compared to $2.1 million
had the upfront fees continued to be recognized over a three-year period.
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. Collaborative and other revenues are accrued for expenses
12
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.
Accruals for Clinical Research Organization and Clinical Site Costs
We make estimates of costs incurred to date but not yet invoiced in
relation to external clinical research organizations, or CROs, and clinical site
costs. We analyze the progress of clinical trials, including levels of patient
enrollment, invoices received and contracted costs when evaluating the adequacy
of the accrued liabilities. Significant judgments and estimates must be made and
used in determining the accrued balance in any accounting period. Actual results
could differ significantly from those estimates under different assumptions.
Accounting for Goodwill and Other Intangible Assets
Effective October 1, 2002, we fully adopted SFAS No. 142, "Goodwill and
Other Intangible Assets." SFAS No. 142 requires that goodwill and intangible
assets determined to have indefinite lives no longer be amortized but instead be
tested for impairment at least annually and whenever events or circumstances
occur that indicate impairment might have occurred. We reassessed the useful
life of our intangible asset (license for compound libraries) to make any
necessary amortization period adjustments. No adjustments resulted from this
assessment. Our identifiable intangible asset is subject to amortization.
Under the non-amortization approach, goodwill and certain other
intangibles are not amortized into results of operations but instead are
reviewed for impairment, written down, and charged to results of operations in
periods in which the recorded value of goodwill and certain other intangibles is
more than their implied fair value. We completed our impairment review of
goodwill during the first quarter of fiscal 2003 and determined that no
impairment charge was required upon adoption.
Accounting for the Impairment of Long-Lived Assets
On October 1, 2002, we adopted the provisions of SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144
requires, among other things, that long-lived assets to be measured at the lower
of carrying amount or fair value, less cost to sell, whether reported in
continuing operations or in discontinued operations. Intangibles with
determinable lives 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 with determinable lives and other long-lived assets are impaired
which may result in an adverse impact on our financial condition and results of
operations. The adoption of SFAS No. 144
13
did not have an impact on our consolidated financial statements as of and for
the quarter ended December 31, 2002.
REVENUES
Total revenues for the three months ended December 31, 2002 were $4.5
million, a decrease of $1.4 million or 24% compared to revenues of $5.9 million
for the three months ended December 31, 2001. Total collaborative program
revenues of $3.0 million for the three months ended December 31, 2002 decreased
$134,000 or 4% compared to the three months ended December 31, 2001. This
decrease was primarily due to the phase-down of our collaboration with Anaderm,
the conclusion of our funded collaboration with Sankyo Co., Ltd. in December
2001 and the conclusion of our service agreement with Helicon Therapeutics, Inc.
in August 2002. This decrease was offset by increased revenues relating to our
collaboration with Tanabe Seiyaku Co., Ltd. In July 2002, we entered into an
agreement with Pfizer to accelerate the phase-down period of the collaboration
with Anaderm so that it will terminate no later than April 23, 2003. In
consideration for the work to be performed by us during the accelerated
phase-down period, we received $4.5 million in September 2002 and will receive
$3.5 million upon the successful completion of the transition period. The $4.5
million is being recognized as revenue ratably over the expected term of the
transition period and the $3.5 million will be recognized upon the successful
completion of the transition. As of December 31, 2002, we have recognized $3.8
million of revenue related to the phase-down. As we continue to focus our
business away from collaborative-based to independent drug discovery and
development, we expect collaborative revenues to continue to decrease.
License and other revenues of $1.5 million for the three months ended
December 31, 2002 decreased $1.3 million or 46% compared to the three months
ended December 31, 2001. This decrease was due primarily to the decrease in the
amount of revenue recognized relating to the $25.0 million upfront fees received
from Genentech and Roche (see note 2 to the accompanying unaudited consolidated
financial statements). In accordance with the provisions of SAB No. 101, we were
recognizing the $25.0 million received from Genentech and Roche evenly over the
expected three-year development phase of our agreement. In the fourth quarter of
fiscal 2002, we changed the expected term of the agreement to four years to
reflect the revised estimated timing of our research and development commitment
for Tarceva(TM) under the alliance. The revision was a result of the review of
the current research data available, current developments in the HER1/EGFR
targeted therapy market and the involved parties' revised projections for the
clinical development plan. In accordance with Accounting Principles Board
Opinion No. 20, "Accounting Changes," the remaining deferred revenue will be
recognized prospectively over the revised term. As a result, we recorded
revenues of $1.3 million in the first quarter of fiscal 2003 compared to $2.1
million in the first quarter of fiscal 2002. This decrease was also due to a
decrease in revenues from certain administrative services provided to British
Biotech plc during the transition period following the acquisition of certain
assets from British Biotech.
14
EXPENSES
Operating expenses of $35.8 million decreased $117.8 million or 77% for
the three months ended December 31, 2002 compared to the three months ended
December 31, 2001. Excluding the in-process R&D charge of $130.2 million
recorded in the three months ended December 31, 2001, operating expenses
increased $12.4 million or 53% for the three months ended December 31, 2002
compared to the three months ended December 31, 2001. Operating expenses
primarily included (i) research and development expenses, which include expenses
related to the development of our lead clinical candidate, Tarceva(TM), and
proprietary and collaborative-based research; (ii) the $130.2 million charge
related to the acquired in-process R&D related to the oncology assets acquired
from Gilead in December 2001; (iii) selling, general and administrative
expenses; and (iv) amortization of intangibles. We intend to hold our core
operating costs, including expenses related to Tarceva(TM) development, to
approximately $140 - $145 million for fiscal 2003.
Research and development expenses increased $11.0 million or 64% for
the three months ended December 31, 2002 compared to the three months ended
December 31, 2001. The increase was related primarily to increased costs
associated with (i) the clinical development of Tarceva(TM) under our Tripartite
Agreement with Genentech and Roche and (ii) increased investments in our
proprietary cancer programs, including oncology candidates acquired from Gilead
in December 2001. These increases were slightly offset by a decrease in
collaborative-based research expenses in comparison to the prior period.
Included in research and development expenses for the three months ended
December 31, 2002 is a severance charge of $694,000. The charge related to a
reduction in headcount in October 2002 as we refocus our business on oncology
and away from services that we had historically provided to our former
collaborative partners.
In connection with the acquisition of certain assets from Gilead in
December 2001, we recorded an in-process R&D charge of $130.2 million during the
three months ended December 31, 2001, representing the estimated fair value 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, R&D costs, selling, general and administrative
costs, and the net cash flow reflects the assumptions that would be used by
market participants. We believe that the assumptions used in the valuation of
purchased in-process technology represented a reasonable estimate of the future
benefits attributable to the purchased in-process technology at the time of the
acquisition. No assurance can be given that actual results will not deviate from
those
15
assumptions in future periods. The acquired in-process R&D was allocated to the
following three oncology candidates: OSI-211, OSI-7904L and OSI-7836.
As of December 31, 2002, the technological feasibility of the three
candidates (acquired in-process technology) had not yet been reached. For each
project, we need to successfully complete a series of clinical trials and to
receive FDA or other regulatory approvals prior to commercialization. There can
be no assurances that any of these candidates 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 prior to
the development of comparable products by our competitors. If it is determined
that it is not cost beneficial to pursue the further development of any of these
candidates, we may discontinue such further development of certain or all of
these candidates.
Selling, general and administrative expenses increased $1.6 million or
28% for the three months ended December 31, 2002 compared to the three months
ended December 31, 2001. The increase was due to increased commercialization and
marketing costs relating to Tarceva(TM) which are shared with Genentech in
accordance with the terms of our collaboration with Genentech. This increase was
offset slightly by a decrease in relocation expenses relating to the
consolidation of the Birmingham, England facility with our Oxford, England
facility. Included in selling, general and administrative expenses for the three
months ended December 31, 2002 is a severance charge of $249,000 relating to a
reduction in headcount in October 2002. We anticipate that general and
administrative expenses will remain relatively steady during fiscal 2003 with an
increase in commercialization and marketing costs as we expand our commercial
operations in preparation for the launch of Tarceva(TM) and other development
programs.
Amortization of intangibles decreased $255,000 or 83% for the three
months ended December 31, 2002 compared to the three months ended December 31,
2001. The decrease was attributable to the full adoption of SFAS No. 142 on
October 1, 2002, whereby we ceased amortizing the assembled workforce acquired
from British Biotech and reclassified the balance of $2.1 million to goodwill.
OTHER INCOME AND EXPENSE
Net investment income decreased $1.9 million or 42% for the three
months ended December 31, 2002 compared to the three months ended December 31,
2001. The decrease was primarily attributable to a decrease in the average rate
of return on our investments and to less funds available for investment during
the respective periods. Interest expense increased $1.6 million for the three
months ended December 31, 2002 compared to the three months ended December 31,
2001, primarily due to the interest expense incurred on the convertible senior
subordinated notes issued in February 2002, a portion of which were retired in
August and September 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 December 31, 2002 and 2001, other income-net was
$143,000 and $773,000, respectively.
16
Included in the three months ended December 31, 2002 was realized gains from the
sale of investments of $345,000 offset by the amortization of debt issuance
costs of $203,000. Included in the three months ended December 31, 2001 was the
$1.0 million contingent payment received from The Bayer Corporation in December
2001, in connection with the sale of the diagnostic business in November 1999,
offset by realized losses from the sale of investments of $269,000.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2002, working capital, representing primarily cash,
cash equivalents, and restricted and unrestricted short-term investments,
aggregated $415.2 million compared to $444.6 million at September 30, 2002. This
decrease of $29.3 million resulted primarily from our net operating cash burn
for the period.
On February 1, 2002, we issued $200.0 million aggregate principal
amount of convertible senior subordinated notes in a private placement for net
proceeds to us of approximately $193.0 million. The notes bear interest at 4%
per annum, payable semi-annually, and mature on February 1, 2009. We pledged
$22.9 million of U.S. government securities which will be sufficient to provide
for the payment in full of the first six scheduled interest payments on the
notes when due. In August and September 2002, we retired a total of $40.0
million in principal amount of the notes for an aggregate purchase price of
$26.2 million, including accrued interest. Should conditions warrant, we may
from time-to-time continue to enter the market to repurchase additional notes.
We expect to incur continued losses over the next several years as we
continue our investment in Tarceva(TM) and 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 fiscal 2003 and, as
a result, we expect our operating expenses and cash burn to increase in fiscal
2003. Beyond fiscal 2003, as the Tarceva(TM) development expenses begin to wind
down, we expect a lower operating expense and cash burn base which we will
maintain until a successful Tarceva(TM) market launch. We have established a
goal of achieving profitability and positive cash flow within 18 to 24 months of
a successful market launch of Tarceva(TM). Although we believe that we have
sufficient cash for operations for the next few years, if the market launch of
Tarceva(TM) is delayed or if Tarceva(TM) does not receive FDA approval or if the
approval process is delayed or takes longer than expected, such events could
have a negative impact on our liquidity position, assuming our current cash
burn. In addition, as we pursue our goal of securing strategic in-licensing and
acquisition opportunities that would bring products and clinical development
candidates to our cancer pipeline, this will require the use of our available
cash and/or equity securities.
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
17
required to reach profitability is uncertain. We believe that our existing cash
resources provide a strong financial base from which to fund our operations and
capital requirements for at least the next several years.
COMMITMENTS AND CONTINGENCIES
Our major outstanding contractual obligations relate to our convertible
senior subordinated notes and our facility leases. The following table
summarizes our significant contractual obligations at December 31, 2002 and the
effect such obligations are expected to have on our liquidity and cash flow in
future periods (in thousands):
2008 &
2003 2004 2005 2006 2007 THEREAFTER TOTAL
---- ---- ---- ---- ---- ---------- -----
Contractual Obligations:
Senior convertible debt(a). $ 6,400 $6,400 $6,400 $6,400 $6,400 $169,600 $201,600
Operating leases........... 5,523 7,168 7,098 5,632 4,296 56,646 86,363
Construction commitments... 111 -- -- -- -- -- 111
Loans payable(b)........... 435 -- -- -- -- -- 435
------- ------- ------- ------- ------- -------- --------
Total contractual
obligations........... $12,469 $13,568 $13,498 $12,032 $10,696 $226,246 $288,509
======= ======= ======= ======= ======= ======== ========
- --------------
(a) Includes interest payments at a rate of 4% per annum
(b) Includes interest payments
Other significant commitments and contingencies include the following:
o We are committed to share equally with Genentech and Roche certain
global development costs of Tarceva(TM). We are also committed to share
certain commercialization cost relating to Tarceva(TM) with Genentech.
o In connection with the acquisition of certain of Gilead's oncology
assets in December 2001, we are obligated to pay up to an additional
$30.0 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, the most advanced of Gilead's oncology product candidates
acquired by us.
o Under agreements with external clinical research organizations, or
CROs, over the next 12 to 18 months we will continue to incur expenses
relating to the progress of Tarceva(TM) 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.
18
o In connection with our strategic decision to close down our Birmingham,
England facility, we expect to pay approximately $111,000 in
non-cancelable lease exit costs.
o 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
approximately $2.6 million at December 31, 2002.
o Under certain collaboration agreements with pharmaceutical companies
and educational institutions, we are required to pay royalties and/or
milestones upon the successful development and commercialization of
products.
o Under certain license agreements, we are required to pay license fees
for the use of technologies and products in our research and
development activities.
o We entered into a letter of credit with a commercial bank in relation
to one of our facilities. The irrevocable letter of credit expires
annually with a final expiration date of September 27, 2007. The amount
under this letter of credit is $2.2 million of which the full amount
was available on December 31, 2002.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities", effective for exit or disposal
activities that are initiated after December 31, 2002. Under SFAS No. 146, a
liability for a cost associated with an exit or disposal activity must only be
recognized when the liability is incurred. Under the previous guidance of EITF
94-3, "Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity including Certain Costs Incurred in a Restructuring",
we recognized a liability for an exit or disposal activity cost at the date of
our commitment. If we were to commit to further exit or disposal activities
subsequent to the effective date, we would be subject to the new rules regarding
expense recognition.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure." SFAS No. 148 provides
alternative methods of transition for an entity that voluntarily changes to the
fair value based method of accounting for stock-based employee compensation. It
also amends the disclosure provisions of SFAS No. 123 to require prominent
disclosure about the effects on reported net income of an entity's accounting
policy decisions with respect to stock-based employee compensation and is
effective for financial statements for fiscal years ending after December 15,
2002. We are currently assessing the impact of adoption of SFAS No. 148.
19
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." Interpretation No. 45 requires a
guarantor to include disclosure of certain obligations, and if applicable, at
the inception of the guarantee, recognize a liability for the fair value of
other certain obligations undertaken in issuing a guarantee. The recognition
requirement is effective for guarantees issued or modified after December 31,
2002 and is not expected to have a material impact on us.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities." FIN 46 clarifies the application of Accounting
Research Bulletin No. 51 to require consolidation of an entity if it is
controlled through interests other than voting interests. FIN 46 applies
immediately to any variable interest entities created after January 31, 2003 and
to variable interest entities in which an interest is obtained after that date.
It is applicable for us in the fourth quarter of fiscal year 2003, which ends
September 30, 2003, for interests acquired in variable interest entities prior
to February 1, 2003. We are currently assessing the impact of adoption of FIN
46.
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 that 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, as amended, for the fiscal year ended
September 30, 2002.
20
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 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, we 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 convertible senior subordinated notes when due. We consider our
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. 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 12(d) to the consolidated financial statements contained in
our annual report on Form 10-K, as amended, for the fiscal year ended September
30, 2002. We did not have any forward foreign exchange contracts as of or during
the three months ended December 31, 2002.
At December 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 3% 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
10% change in interest rates during the three months ended December 31, 2002
would have resulted in a $267,000 change in our net loss. We have not used or
held derivative financial instruments in our investment portfolio.
Our long-term debt totaled $160.0 million at December 31, 2002 and was
comprised of the convertible senior subordinated notes. The convertible senior
subordinated notes bear interest at a fixed rate of 4%.
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
21
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.
ITEM 4. CONTROLS AND PROCEDURES
CEO and CFO Certifications. Appearing immediately following the
Signatures section of this Quarterly Report there are two certifications, or the
Section 302 Certifications, one by each of our Chief Executive Officer, or CEO,
and Chief Financial Officer, or CFO. This section of the Quarterly Report which
you are currently reading contains information concerning the evaluation of our
disclosure controls and procedures and internal controls that is referred to in
the Section 302 Certifications and this information should be read in
conjunction with the Section 302 Certifications for a more complete
understanding of the topics presented.
Evaluation of our Disclosure Controls and Procedures. The Securities
and Exchange Commission requires that within 90 days prior to the filing of this
Quarterly Report on Form 10-Q, the CEO and the CFO evaluate the effectiveness of
the design and operation of our disclosure controls and procedures (as defined
in Rule 13(a)-14(c) and Rule 15(d)-19(c) under the Securities Exchange Act of
1934), and report on the effectiveness of the design and operation of our
disclosure controls and procedures. Within 90 days prior to the filing of this
Quarterly Report on Form 10-Q, under the supervision and with the participation
of our management, including our CEO and CFO, we evaluated the effectiveness of
the design and operation of our disclosure controls and procedures.
Limitations on the Effectiveness of Controls. Our management, including
the CEO and CFO, does not expect that our disclosure controls and procedures or
our internal controls will prevent all error and all fraud. A control system, no
matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Further,
the design of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to their
costs. Because of the inherent limitations in all control systems, no evaluation
of controls can provide absolute assurance that all control issues and instances
of fraud, if any, within the company have been detected. These inherent
limitations include the realities that judgments in decision-making can be
faulty, and that breakdowns can occur because of simple error or mistake.
Additionally, controls can be circumvented by the individual acts of some
persons, by collusion of two or more people, or by management override of the
control. The design of any system of controls also is based in part upon certain
assumptions about the likelihood of future events, and there can be no assurance
that any design will succeed in achieving its stated goals under all potential
future conditions; over time, control may become inadequate because of changes
in conditions, or the degree of compliance with the policies or procedures may
deteriorate. Because of the inherent limitations in a cost-effective control
system, misstatements due to error or fraud may occur and not be detected. While
we believe that our disclosure controls and procedures have been effective, in
light of the foregoing we intend to continue to examine and refine our
disclosure controls and procedures and to monitor ongoing developments in this
area.
22
CEO/CFO Conclusions about the Effectiveness of the Disclosure Controls
and Procedures. Based upon their evaluation of the disclosure controls and
procedures, our CEO and CFO have concluded that, subject to the limitations
noted above, our disclosure controls and procedures are effective to provide
reasonable assurance that material information relating to the Company and its
consolidated subsidiaries is made known to management, including the CEO and
CFO, on a timely basis and particularly during the period in which this
Quarterly Report on Form 10-Q was being prepared.
Changes in Internal Controls. There were no significant changes to our
internal controls or in other factors that could significantly affect our
internal controls, subsequent to the date of our last evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
23
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not applicable.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(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.
10.1* Amended and Restated Stock Purchase Plan for Non-Employee
Directors.
10.2* First Amendment to the 2001 Incentive and Non-Qualified
Stock Option Plan.
99.1* Certification of Chief Executive Officer pursuant to 18
U.S.C. ss. 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
24
99.2* Certification of Chief Financial Officer pursuant to 18
U.S.C.ss. 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
-----------------
* Filed herewith.
(b) REPORTS ON FORM 8-K
We filed a current report on October 1, 2002 with the Securities
and Exchange Commission via EDGAR, pertaining to three press releases. One press
release announced an update and commentary on the progress of our clinical trial
candidate, Tarceva(TM) (erlotinib HC1), following a release announcing
unfavorable results of a competitor's drug candidate which belongs to the same
class of targeted therapies as Tarceva(TM). Another press release announced the
Food and Drug Administration's designation of Tarceva(TM) as a Fast Track
Product for second-line or third line treatment of patients with certain types
of non-small cell lung cancer and also announced adjustments in two of the
registration studies in the OSI-Genetech-Roche alliance for Tarceva(TM). The
third press release announced that we had repurchased $40 million aggregate
principal amount of the convertible senior subordinated notes originally issued
in February 2002 in the open market for approximately $26 million. The earliest
event covered by the report occurred on August 19, 2002.
25
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: February 7, 2003 /s/ Colin Goddard, Ph.D.
-------------------------------------
Colin Goddard, Ph.D.
Chief Executive Officer
Date: February 7, 2003 /s/ Robert L. Van Nostrand
-------------------------------------
Robert L. Van Nostrand
Vice President and Chief Financial Officer
(Principal Financial Officer)
26
CERTIFICATION
I, Colin Goddard, certify that:
1. I have reviewed this quarterly report on Form 10-Q of OSI
Pharmaceuticals, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
27
6. The registrant's other certifying officer and I have indicated in
this quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: February 7, 2003
__________
/s/ COLIN GODDARD, Ph.D
--------------------------
Colin Goddard, Ph.D
Chief Executive Officer
28
CERTIFICATION
I, Robert L. Van Nostrand, certify that:
1. I have reviewed this quarterly report on Form 10-Q of OSI
Pharmaceuticals, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
29
6. The registrant's other certifying officer and I have indicated in
this quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: February 7, 2003
/s/ ROBERT L. VAN NOSTRAND
------------------------------------------
Robert L. Van Nostrand
Vice President and Chief Financial Officer
30
INDEX TO EXHIBITS
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.
10.1* Amended and Restated Stock Purchase Plan for Non-Employee
Directors.
10.2* First Amendment to the 2001 Incentive and Non-Qualified Stock
Option Plan.
99.1* Certification of Chief Executive Officer pursuant to 18
U.S.C. ss.1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
99.2* Certification of Chief Financial Officer pursuant to 18
U.S.C. ss.1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
-----------------
* Filed herewith.
31