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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
AMENDMENT NO. 1
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______ TO _______
COMMISSION FILE NUMBER 0-15313
SAVIENT PHARMACEUTICALS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 13-3033811
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
ONE TOWER CENTER, EAST BRUNSWICK, NEW JERSEY 08816
(Address of principal executive offices)
(732) 418-9300
(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 |_|
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |X| No |_|
Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock, as of the latest practicable date.
The number of shares outstanding of the registrant's Common Stock, par value
$.01 per share, as of November 5, 2004 was 60,443,777.
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EXPLANATORY NOTE
Savient Pharmaceuticals, Inc. is filing this Amendment No. 1 to Quarterly
Report on Form 10-Q/A for the quarter ended September 30, 2004 to reflect the
restatement of its unaudited financial statements for the quarterly and year-
to-date periods ended September 30, 2004. As previously announced in its
Current Report on Form 8-K filed on January 6, 2005 with the Securities and
Exchange Commission (the "SEC"), the restatement results from a change in the
manner in which Savient recognizes revenue for certain of its product sales,
as more fully described in Part I, Item 1, Note 9 of this Form 10-Q/A. The
change described above will have no effect on Savient's previously reported
results for the full year ended December 31, 2003.
This Form 10-Q/A has not been updated except as required to reflect the
effects of the restatement. This Form 10-Q/A includes changes to Part I, Items
1, 2 and 4, and Part II, Item 6. Except as identified in the prior sentence,
no other items included in the original Form 10-Q have been amended, and such
items remain in effect as of the filing date of the original Form 10-Q.
Additionally, this Form 10-Q/A does not purport to provide an update or a
discussion of any other developments at the Company subsequent to the original
filing.
SAVIENT PHARMACEUTICALS, INC.
FORM 10-Q/A
FOR THE QUARTER ENDED SEPTEMBER 30, 2004
TABLE OF CONTENTS
PAGE
----
PART I - FINANCIAL INFORMATION
ITEM 1. Consolidated Financial Statements 3
Consolidated Balance Sheets at September 30, 2004 and December 31, 2003 3
Consolidated Statements of Operations for the three and nine months ended
September 30, 2004 and 2003 4
Consolidated Statement of Changes in Stockholders' Equity for the nine months
ended September 30, 2004 5
Consolidated Statements of Cash Flows for the nine months ended
September 30, 2004 and 2003 6
Notes to Consolidated Financial Statements 7
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations 12
Risk Factors That May Affect Results 24
ITEM 4. Controls and Procedures 40
PART II - OTHER INFORMATION
ITEM 6. Exhibits 44
Signatures 45
Exhibit Index 46
2
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
SAVIENT PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
SEPTEMBER 30,
2004
(RESTATED) DECEMBER 31, 2003
------------- -----------------
(UNAUDITED)
ASSETS
Current Assets:
Cash and cash equivalents ............... $ 21,984 $ 17,219
Short-term investments .................. 2,736 5,582
Accounts receivable, net ................ 11,962 33,375
Inventories, net ........................ 21,648 20,216
Deferred income taxes ................... 99 2,888
Prepaid expenses and other current
assets.................................. 3,912 4,163
-------- --------
Total current assets .................. 62,341 83,443
Property and equipment, net .............. 67,665 70,426
Intangible assets, net ................... 72,700 75,743
Goodwill ................................. 40,121 40,121
Deferred income taxes .................... -- 13,767
Severance pay funded ..................... 2,923 2,660
Other assets (including restricted cash
of $1,280) ............................. 3,627 4,380
-------- --------
Total assets .......................... $249,377 $290,540
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable (including income tax
payable of $1,362 at
September 30, 2004 and $4,774 at
December 31, 2003) .................... $ 17,854 $ 16,816
Current portion of long-term debt ....... 7,040 7,020
Deferred revenues ....................... 856 848
Other current liabilities ............... 18,816 19,846
-------- --------
Total current liabilities ............. 44,566 44,530
-------- --------
Long-term debt ........................... 621 5,903
Deferred revenues ........................ 7,671 7,836
Severance pay ............................ 6,089 5,851
Negative goodwill ........................ 16,028 16,028
Deferred income taxes .................... 21,850 22,962
Commitments and contingent liabilities
(note 7)
Stockholders' equity:
Preferred stock - $.01 par value; 4,000
shares authorized; no shares issued..... -- --
Common stock - $.01 par value; 150,000
shares authorized; issued: 60,264 at
September 30, 2004 and 59,618 at
December 31, 2003....................... 603 595
Additional paid-in capital ............... 218,087 216,706
Accumulated deficit ...................... (67,850) (31,931)
Accumulated other comprehensive income ... 1,712 2,060
-------- --------
Total stockholders' equity ............... 152,552 187,430
-------- --------
Total liabilities and stockholders'
equity................................ $249,377 $290,540
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
3
SAVIENT PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
NINE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ---------------------
2004 2004
(RESTATED) 2003 (RESTATED) 2003
---------- ------- ---------- -------
Revenues:
Product sales, net ...................... $ 70,135 $87,110 $23,593 $32,112
Contract fees ........................... 672 1,070 222 327
Royalties ............................... 4,848 2,425 1,044 855
Other revenues .......................... 991 2,088 697 487
-------- ------- ------- -------
Total revenues ........................ 76,646 92,693 25,556 33,781
-------- ------- ------- -------
Expenses:
Research and development ................ 21,811 25,384 6,265 11,528
Marketing and sales ..................... 17,709 17,390 5,175 5,412
General and administrative .............. 18,766 17,839 5,999 6,343
Retirement .............................. 2,110 -- -- --
Cost of product sales ................... 25,782 14,556 9,556 4,876
Amortization of intangibles associated
with acquisition........................ 3,038 3,038 1,013 1,013
Commissions and royalties ............... 4,530 3,935 1,620 1,704
-------- ------- ------- -------
Total expenses ........................ 93,746 82,142 29,628 30,876
-------- ------- ------- -------
Operating (loss) income .................. (17,100) 10,551 (4,072) 2,905
Other (expense) income, net .............. (683) 3,938 13 3,517
-------- ------- ------- -------
(Loss) income before income taxes ........ (17,783) 14,489 (4,059) 6,422
Income taxes ............................. 18,136 4,636 1,150 2,064
-------- ------- ------- -------
Net (loss) income ........................ (35,919) 9,853 (5,209) 4,358
======== ======= ======= =======
(Loss) earnings per common share:
Basic ................................... $ (0.60) $ 0.17 $ (0.09) $ 0.07
======== ======= ======= =======
Diluted ................................. $ (0.60) $ 0.17 $ (0.09) $ 0.07
======== ======= ======= =======
Weighted average number of common and
common equivalent shares:
Basic ................................... 59,961 59,076 60,182 59,339
======== ======= ======= =======
Diluted ................................. 59,961 59,555 60,182 60,164
======== ======= ======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
4
SAVIENT PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(UNAUDITED)
(IN THOUSANDS)
COMMON STOCK ACCUMULATED TOTAL
--------------- ADDITIONAL ACCUMULATED OTHER STOCKHOLDERS'
PAR PAID-IN DEFICIT COMPREHENSIVE EQUITY
SHARES VALUE CAPITAL (RESTATED) (LOSS) INCOME (RESTATED)
------ ----- ---------- ----------- ------------- -------------
Balance, December 31, 2003 ............... 59,618 $595 $216,706 $(31,931) $2,060 $187,430
Comprehensive loss:
Net loss for nine months
ended September 30, 2004 .............. (35,919) (35,919)
Unrealized loss on marketable
securities, net........................ (185) (185)
Currency translation adjustment ......... (163) (163)
--------
Total comprehensive loss ................. (36,267)
--------
Issuance of common stock ................. 646 8 1,381 1,389
------ ---- -------- -------- ------ --------
Balance, September 30, 2004 .............. 60,264 $603 $218,087 $(67,850) $1,712 $152,552
====== ==== ======== ======== ====== ========
The accompanying notes are an integral part of these consolidated financial
statements.
5
SAVIENT PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------
2004
(RESTATED) 2003
---------- -------
Cash flows from operating activities:
Net (loss) income ....................... $(35,919) $ 9,853
Adjustments to reconcile net (loss)
income to net cash provided by
operating activities:
Depreciation and amortization ........... 4,848 3,110
Amortization of intangible assets
associated with acquisition............. 3,038 3,038
Deferred revenues ....................... (157) (4,234)
Deferred income taxes ................... 15,444 130
Provision for severance pay ............. 238 759
Unrealized (gain) loss on investments ... -- (286)
Gain (loss) on sales of short-term
investments............................. (19) (265)
(Gain) loss on sales of fixed assets .... 290 (36)
Provision for inventory reserve ......... 2,200 --
Common stock issued as payment for
services................................ 70 163
Write down of investment ................ 1,000 --
Changes in: Accounts receivables ........ 21,413 10,225
Inventories ........................... (3,632) (1,997)
Prepaid expenses and other current
assets................................ 251 (2,954)
Accounts payable ...................... 1,038 (3,258)
Other current liabilities ............. (1,030) (939)
-------- -------
Net cash provided by operating activities 9,073 13,309
-------- -------
Cash flows from investing activities:
Short-term investments .................. (1,046) 40
Capital expenditures .................... (2,377) (6,975)
Changes in other long-term assets ....... (245) (538)
Other investments ....................... -- --
Severance pay funded .................... (263) (257)
Net cash paid in acquisition ............ -- (41)
Proceeds from sales of fixed assets ..... -- 38
Proceeds from sales of short-term
investments............................. 3,729 1,204
-------- -------
Net cash used in investing activities .... (202) (6,529)
-------- -------
Cash flows from financing activities:
Repayment of long-term debt ............. (5,262) (4,238)
Proceeds from issuance of common stock .. 1,319 1,833
-------- -------
Net cash used in financing activities .... (3,943) (2,405)
-------- -------
Effect of exchange rate changes .......... (163) 341
Net increase in cash and cash equivalents 4,765 4,716
Cash and cash equivalents at beginning of
period.................................. 17,219 12,211
-------- -------
Cash and cash equivalents at end of
period.................................. $ 21,984 $16,927
======== =======
Supplementary Information
Other information:
Income tax paid ......................... $ 3,693 $ 4,242
Interest paid ........................... $ 233 $ 346
The accompanying notes are an integral part of these consolidated financial
statements.
6
SAVIENT PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Throughout these Notes to Consolidated Financial Statements, all amounts and
comparisons reflect balances and amounts on a restated basis. For information
on the restatements, see Note 9, Restatement.
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and notes required by generally accepted accounting principles for
complete financial statements. In the opinion of management, the unaudited
interim financial statements furnished herein include all adjustments
necessary for a fair presentation of the Company's financial position at
September 30, 2004 and the results of its operations and cash flows for the
three and nine months ended September 30, 2004 and 2003. Except for the
valuation allowance recorded in connection with the Company's deferred tax
assets described in note 6 below, all such adjustments are of a normal and
recurring nature. Interim financial statements are prepared on a basis
consistent with the Company's annual financial statements. Results of
operations for the three- and nine-month periods ended September 30, 2004 are
not necessarily indicative of the operating results that may be expected for
the year ending December 31, 2004.
The consolidated balance sheet as of December 31, 2003 has been derived from
the audited financial statements at that date but does not include all of the
information and notes required by accounting principles generally accepted in
the United States of America for complete financial statements.
For further information, refer to the consolidated financial statements and
notes thereto included in the Company's Annual Report on Form 10-K for the
year ended December 31, 2003.
2. INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined
using the weighted-average method. If inventory costs exceed expected market
value due to obsolescence or quantities in excess of expected demand, reserves
are recorded for the difference between the cost and the market value. These
reserves are determined based on estimates. The reserves at September 30, 2004
were $2,200,000. In addition, loss contract reserves of $874,000, included in
other current liabilities, were established in the third quarter for
outstanding purchase orders and the resolution of other commitments that will
be in excess of expected demand.
The Company's inventories include Oxandrin inventories that the Company
believes would potentially be in excess of expected product demand if the FDA
approves a generic form of the product in the near term. The amount of such
potential excess will vary depending upon the timing of the approval of a
generic product, the number of generic products that are approved and the rate
by which generic sales reduce demand for branded Oxandrin. If generic approval
occurs during the fourth quarter of 2004, the Company estimates that such
potential excess may be up to $7.0 million.
Inventories at September 30, 2004 and December 31, 2003 are summarized
below:
SEPTEMBER 30, 2004
(RESTATED) DECEMBER 31, 2003
------------------ -----------------
(UNAUDITED)
(IN THOUSANDS)
Raw material................. $ 3,568 $ 6,677
Work in process.............. 3,120 1,720
Finished goods............... 17,160 12,477
Inventory reserves........... (2,200) (658)
------- -------
Total ...................... $21,648 $20,216
======= =======
7
SAVIENT PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. NET PRODUCT SALES
Product sales are recognized when title to the product has transferred to
our customers in accordance with the terms of sale, and when collectability is
probable, net of discounts, sales incentives, sales allowances and sales
returns. The terms of sale offered to customers include transfer of title upon
delivery, transfer of title upon delivery to the customer's shipper or
carrier, and transfer of title upon shipping.
Through December 31, 2003, sales returns had been minimal and insignificant
to the Company's results of operations. However, beginning in the first
quarter of 2004 and continuing through the second quarter, the Company became
aware that retail customers of the Company's wholesalers were preparing to
return expired product, primarily 2.5-mg Oxandrin and 10-mg Oxandrin.
Historically, the Company had experienced virtually no returns of the 2.5-mg
Oxandrin tablet because of the product's five-year shelf life. The 10-mg
Oxandrin tablet, which was introduced in the second half of 2002, currently
has a two-year shelf life. Through the first six months of 2004, the Company
issued credits to its wholesalers in the amount of $1,732,000 and recorded a
provision for estimated future product returns totalling $2,957,000.
In the third quarter of 2004, the Company issued credits to its wholesalers
in the amount of $1,563,000. The Company also determined that the rate of
product returns was greater than that estimated in the previous quarter. On
the basis of this information, the Company increased its estimates for future
product returns and recorded an additional provision totalling $5,036,000 in
the third quarter of 2004. For the nine months ended September 30, 2004, the
aggregate provision for returns was $11,288,000. As of September 30, 2004, the
Company's provision for future returns was $7,993,000.
The Company will continue to monitor its product returns. The Company
regularly reviews the factors that influence its estimates including (i)
actual returns experience; (ii) the demand for the Company's products; (iii)
estimated inventory levels of its wholesaler customers; and (iv) other
relevant factors. If necessary, the Company makes adjustments when it believes
that actual product returns may differ from established reserves. Changes in
facts and circumstances and the demand for the Company's products could result
in material changes in the amount of returned product, and actual results may
differ materially from the Company's estimates.
4. EARNINGS PER SHARE OF COMMON STOCK
The Company has applied Statement of Financial Accounting Standards ("SFAS")
No. 128, "Earnings Per Share" in its calculation and presentation of earnings
per share - "basic" and "diluted". Basic earnings per share are computed by
dividing income available to common stockholders (the numerator) by the
weighted average number of common shares (the denominator) for the period. The
computation of diluted earnings per share is similar to basic earnings per
share, except that the denominator is increased to include the number of
additional common shares that would have been outstanding if the potentially
dilutive common shares had been issued.
8
SAVIENT PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. EARNINGS PER SHARE OF COMMON STOCK -- (CONTINUED)
The numerator in calculating both basic and diluted earnings per common
share for each period presented is the reported net income. The denominator is
based on the following weighted average number of common shares:
NINE MONTHS THREE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------- ----------------
2004 2003 2004 2003
------ ------ ------ ------
(UNAUDITED)
(IN THOUSANDS)
Basic .................................... 59,961 59,076 60,182 59,339
Incremental shares for assumed conversion
of options.............................. -- 479 -- 825
------ ------ ------ ------
Diluted .................................. 59,961 59,555 60,182 60,164
====== ====== ====== ======
The difference between basic and diluted weighted average common shares
resulted from the assumption that the dilutive stock options outstanding were
exercised. For the nine months ended September 30, 2004 and 2003, options to
purchase 8,000,848 shares and 5,697,120 shares, respectively, were not
included in the diluted earnings per share calculation as their effect would
have been anti-dilutive.
5. STOCK-BASED COMPENSATION
As permitted by SFAS No. 123, "Accounting for Stock Based Compensation," the
Company accounts for stock-based compensation arrangements with employees in
accordance with the provisions of Accounting Principles Board ("APB") Opinion
No. 25, "Accounting for Stock Issued to Employees." Compensation expense for
stock options issued to employees is based on the difference on the date of
grant between the fair value of the Company's stock and the exercise price of
the option. No stock-based employee compensation cost is reflected in net
income, as all granted options had an exercise price equal to the market value
of the underlying common stock at the date of grant. The Company accounts for
equity instruments issued to non-employees in accordance with the provisions
of SFAS No. 123 and Emerging Issues Task Force ("EITF") Issue No. 96-18,
"Accounting for Equity Instruments That Are Issued to Other Than Employees for
Acquiring, or in Conjunction With Selling, Goods or Services." All
transactions in which goods or services are the consideration received for the
issuance of equity instruments are accounted for based on the fair value of
the consideration received or the fair value of the equity instrument issued,
whichever is more reliably measurable.
9
SAVIENT PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. STOCK-BASED COMPENSATION -- (CONTINUED)
The following table illustrates the effect on net income and earnings per
share if the Company had applied the fair value recognition provisions of SFAS
No. 123 to stock-based compensation:
NINE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
2004 2004
(RESTATED) 2003 (RESTATED) 2003
---------- ------ ---------- ------
(UNAUDITED)
(IN THOUSANDS EXCEPT PER SHARE DATA)
Net (loss) income as reported ............ $(35,919) $9,853 $(5,209) $4,358
Deduct:
Total stock based employee compensation
expense determined under fair value
based method for all awards, net of
related tax effects..................... 4,935 9,518 2,362 2,924
-------- ------ ------- ------
Pro forma net (loss) income .............. $(40,854) $ 335 $(7,571) $1,434
======== ====== ======= ======
Basic (loss) earnings per common share:
As reported ............................. $ (0.60) $ 0.17 $ (0.09) $ 0.07
======== ====== ======= ======
Pro forma ............................... $ (0.68) $ 0.01 $ (0.13) $ 0.02
======== ====== ======= ======
Diluted (loss) earnings per common share:
As reported ............................. $ (0.60) $ 0.17 $ (0.09) $ 0.07
======== ====== ======= ======
Pro forma ............................... $ (0.68) $ 0.01 $ (0.13) $ 0.02
======== ====== ======= ======
6. INCOME TAXES
Deferred income taxes are recognized for the tax consequences of temporary
differences by applying the enacted statutory tax rates to differences between
the financial statement carrying amounts and the tax bases of existing assets
and liabilities and for capital and net operating losses and tax credits carry
forward. A valuation allowance against deferred income tax assets is required
if the Company determines that it is more likely than not that a part of or
the entire amount of deferred income tax assets will not be realized.
Based upon the Company's current business outlook and the change in its
strategic direction, the likelihood of the Company being able to fully realize
its deferred income tax benefits against future income is uncertain.
Accordingly, in the second quarter of 2004, the Company recorded a $16,272,000
valuation allowance against its deferred income tax assets and a corresponding
provision for income taxes. The remaining deferred income tax asset and
deferred income tax liability relate primarily to foreign operations.
7. COMMITMENTS AND CONTINGENCIES
The Company has received notification of claims filed that certain of its
products may infringe certain third-party patents in the normal course of
operations. Management believes that these claims have no merit, and the
Company intends to defend them vigorously. The Company does not expect the
outcome of these claims to have a significant adverse effect on its financial
position, results of operations or cash flows. However, were an unfavorable
ruling to occur in any subsequent period, there exists the possibility of a
material adverse effect on the Company's operating results. No accrual can be
determined at this time.
On December 20, 2002, a purported stockholder class action was filed against
the Company and three of its officers. The action is pending under the caption
A.F.I.K. Holding SPRL v. Fass, No. 02-6048 (HAA) in the U.S. District Court
for the District of New Jersey and alleges violations of Sections 10(b) and
20(a) of the Securities Exchange Act of 1934. Plaintiff purports to represent
a class of stockholders who purchased shares
10
SAVIENT PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. COMMITMENTS AND CONTINGENCIES -- (CONTINUED)
of the Company between April 19, 1999 and August 2, 2002. The complaint
asserts that the Company's financial statements were materially false and
misleading because the Company restated its earnings and financial statements
for the years ended 1999, 2000 and 2001, as reflected in the Company's Form 8-
K and accompanying press release issued August 2, 2002. Five virtually
identical actions were filed in January and February 2003. In September 2003,
the actions were consolidated and co-lead plaintiffs and co-lead counsel were
appointed in accordance with the Private Securities Litigation Reform Act. The
lead plaintiffs filed an amended consolidated complaint in March 2004. In July
2004, the Company filed a brief in support of a motion to dismiss this case
and in October 2004, the lead plaintiffs filed their brief in opposition to
the motion to dismiss. The Company cannot predict when the court will make a
decision on this motion.
On October 27, 2003, the Company received a letter addressed to the Board of
Directors from attorneys for a purported stockholder of the Company demanding
that the Company commence legal proceedings to recover its damages against
directors who served on the Company's board immediately prior to the June 2003
Annual Meeting of Stockholders, Fulbright & Jaworski L.L.P., Arthur Andersen
LLP, the partners of Arthur Andersen responsible for the audit of the
Company's financial statements for 1999, 2000 and 2001, as well as all other
officers and directors responsible for the alleged wrongdoing. The letter
claims that some or all of these persons were responsible for the material
overstatement of the Company's assets, earnings and net worth, and that these
persons caused the Company to disseminate false and misleading press releases
and filings with the Securities and Exchange Commission. A special committee
to the Board, consisting of directors who were not directors prior to the June
2003 Annual Meeting of Stockholders, has investigated this demand and has
determined that litigation relating to this matter should not proceed.
The Company intends to vigorously defend against all allegations of
wrongdoing. The Company has referred these claims to its directors and
officers insurance carrier, which has reserved its rights as to coverage with
respect to these actions.
In the second quarter of 2004, the Company recorded retirement expense of
$2,110,000, reflecting a provision for a retirement payment and other related
benefits in connection with the Company's previously disclosed retirement
agreement with its former Chief Executive Officer. In June 2004, this former
executive elected to receive his retirement payment in one lump sum. The
Company made the payment on July 15, 2004.
The Company is obligated under certain circumstances to indemnify certain
customers for certain or all expenses incurred and damages suffered by them as
a result of any infringement of third-party patents. In addition, the Company
is obligated to indemnify its officers and directors against all reasonable
costs and expenses related to stockholder and other claims pertaining to
actions taken in their capacity as officers and directors which are not
covered by the Company's directors and officers insurance policy. These
indemnification obligations are in the regular course of business and in most
cases do not include a limit on maximum potential future payments, nor are
there any recourse provisions or collateral that may offset the cost. As of
September 30, 2004, the Company has not recorded a liability for any
obligations arising as a result of these indemnification obligations.
The United States Internal Revenue Service is conducting an audit of the
Company's federal income tax return for the year ended December 31, 2002. The
Company is also subject to an ongoing tax audit by the State of New Jersey. In
addition, the State of Israel, Ministry of Finance, Income Tax Authority, is
conducting a tax audit of the Company's wholly owned subsidiary, Bio-
Technology General (Israel) Ltd., for the years ended December 31, 2000, 2001,
and 2002. Although there can be no assurances, the Company believes that any
adjustments that may arise as a result of these audits will not have a
material adverse effect on the Company's financial position or results of
operations.
11
SAVIENT PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. SUBSEQUENT EVENT
On October 27, 2004, the Company announced that it was reducing its
workforce by nine percent. On October 25, 2004, the Company began notifying 40
of its employees that, in connection with the workforce reduction, their
employment would be terminated under a plan of termination. The Company
completed the workforce reduction on October 27, 2004, and it estimates that
the costs of the workforce reduction will be approximately $1.3 million. These
costs consist primarily of severance-related costs, all of which are expected
to result in future cash expenditures. The Company expects to record the
charge for these costs in the fourth quarter of 2004.
9. RESTATEMENT
The Company has historically recognized product revenues when product
shipped and collectability was probable, net of discounts, sales incentives,
sales allowances and reserves for sales returns. However, the Company has
determined that its contracts with its most significant U.S.-based customers
have included terms that transfer title to product upon delivery. These
contracts cover the majority of the Company's sales to U.S. drug wholesalers
beginning in 2003. In general, the Company's shipping methods take up to five
business days from shipment until delivery. As a result, some revenues were
recognized up to five days earlier than permitted under generally accepted
accounting principles. This correction does not affect the amount of revenue
that the Company will ultimately recognize, although it will affect (by one to
five days) the timing of revenue recognition. As a result, some shipments made
during the final week of a quarter should have been recognized in the
subsequent quarter.
The Company has restated its previously issued financial statements for the
quarterly period and nine months ended September 30, 2004.
The following tables disclose the impact of the restatement:
SAVIENT PHARMACEUTICALS, INC. AND SUBSIDIARIES
RESTATEMENT OF CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
NINE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, 2004 SEPTEMBER 30, 2004
--------------------------- ---------------------------
AS PREVIOUSLY AS PREVIOUSLY
REPORTED AS RESTATED REPORTED AS RESTATED
------------- ----------- ------------- -----------
Product sales, net............... $ 71,041 $ 70,135 $24,408 $23,593
Total revenues................... 77,552 76,646 26,371 25,556
Cost of product sales............ 25,857 25,782 9,624 9,556
Total expenses................... 93,821 93,746 29,696 29,628
Operating income (loss).......... (16,269) (17,100) (3,325) (4,072)
Income (loss) before income taxes (16,952) (17,783) (3,312) (4,059)
Income taxes..................... 18,136 18,136 1,150 1,150
Net income (loss)................ $(35,088) $(35,919) $(4,462) $(5,209)
======== ======== ======= =======
Earnings (loss) per common share:
Basic ......................... $ (0.59) $ (0.60) $ (0.07) $ (0.09)
Diluted ........................ $ (0.59) $ (0.60) $ (0.07) $ (0.09)
12
SAVIENT PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. RESTATEMENT -- (CONTINUED)
SAVIENT PHARMACEUTICALS, INC. AND SUBSIDIARIES
RESTATEMENT OF CONSOLIDATED BALANCE SHEET
(UNAUDITED)
(IN THOUSANDS)
SEPTEMBER 30, 2004
----------------------------
AS PREVIOUSLY
REPORTED AS RESTATED
------------- -----------
Accounts receivable, net ................. $ 13,093 $ 11,962
Inventories .............................. 21,573 21,648
Total current assets .................. 63,397 62,341
Total assets ......................... $250,433 $249,377
======== ========
Other current liabilities ................ 19,041 18,816
Total current liabilities ................ 44,791 44,566
Total liabilities ........................ 97,050 96,825
Accumulated deficit ...................... (67,019) (67,850)
Total stockholders' equity ............ 153,383 152,552
Total liabilities and stockholders'
equity............................... $250,433 $249,377
======== ========
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
You should read the following discussion and analysis of our financial
condition and results of operations together with our consolidated financial
statements and the related notes appearing in Item 1 of this Quarterly Report
on Form 10-Q. The following discussion and analysis and other portions of this
Quarterly Report on Form 10-Q contain forward-looking statements within the
meaning of Section 21E of the Securities Exchange Act of 1934. All statements,
other than statements of historical facts, included in this report regarding
our strategy, expected future financial position, results of operations, cash
flows, financing plans, discovery and development of products, potential
acquisitions, strategic alliances, intellectual property, competitive
position, plans and objectives of management are forward-looking statements.
Words such as "anticipate," "believe," "estimate," "expect," "intend," "plan,"
"will" and other similar expressions help identify forward-looking statements,
although not all forward-looking statements contain these identifying words.
In particular, the statements regarding our new strategic direction and its
potential effects on our business are forward-looking statements. These
forward-looking statements involve substantial risks and uncertainties and are
based on our current expectations, assumptions, estimates and projections
about our business and the biopharmaceutical and specialty pharmaceutical
industries in which we operate. We may not actually achieve the plans,
intentions or expectations disclosed in our forward-looking statements, and
you should not place undue reliance on our forward-looking statements. Actual
results or events could differ materially from the plans, intentions and
expectations disclosed in the forward-looking statements that we make. We have
included important factors in the cautionary statements included in this
report, particularly in the section entitled "Risk Factors That May Affect
Results," that we believe could cause actual results or events to differ
materially from the forward-looking statements that we make. Our forward-
looking statements do not reflect the potential impact of any future
acquisitions, mergers, dispositions, joint ventures or investments we may
make. We do not assume any obligation to update any forward-looking
statements.
The unaudited interim financial statements as of September 30, 2004 and for
the three and nine month periods ended September 30, 2004 included in this
Form 10-Q/A have been restated as discussed in Item 1, Part I, Note 9 of this
Form 10-Q/A. For purposes of this Form 10-Q/A, and in accordance with Rule
12b-15 under the Securities Exchange Act of 1934, as amended, each item of the
Form 10-Q for the quarter ended September 30, 2004, as originally filed with
the Securities and Exchange Commission on November 8, 2004 (the "Original Form
10-Q") that was affected by the restatement has been amended and restated to
the extent affected. The disclosure contained in the Original Form 10-Q has
not been updated or modified except for updates made to Part I, Items 1, 2 and
4, and Part II, Item 6, solely to reflect the impact of the restatement and
related matters.
OVERVIEW
We are engaged in the research, development, manufacture and marketing of
pharmaceutical products that address unmet medical needs in both niche and
larger market segments. Our products are distributed on a worldwide basis. In
the United States, we distribute our products through wholesalers and market
our products to physicians through a sales force that includes both our own
employees and representatives of a contract sales organization. In the United
Kingdom, we distribute our oral liquid pharmaceutical products directly to
hospitals and through wholesalers to retail customers, and we market our
products primarily to physicians through our own sales force. In Israel, we
distribute our products directly to hospitals, HMOs and retailers, and we
market our products to physicians through our own sales force. We distribute
our products primarily through third-party license and distribution
relationships elsewhere in the world. Through a combination of internal
research and development, acquisitions, collaborative relationships and
licensing arrangements, we have assembled a diverse portfolio of therapeutic
products and product candidates, many of which are currently being marketed,
several of which are in registration or clinical trials and one of which is
pre-clinical.
We were founded in 1980 as Bio-Technology General Corp. to develop,
manufacture and market novel therapeutic products. In September 2002, we
acquired Rosemont Pharmaceuticals Limited, a specialty pharmaceutical company
located in the United Kingdom. Rosemont develops, manufactures and markets
pharmaceutical products in oral liquid form. We coordinate our overall
administration, finance, business development, human clinical studies, U.S.
sales and marketing activities, quality assurance and regulatory
14
affairs primarily at our corporate headquarters in East Brunswick, New Jersey.
We carry out the development, manufacture, distribution and sale of our oral
liquid pharmaceutical products through Rosemont in the United Kingdom. We
currently carry out research and development activities and manufacturing of
our biotechnology-derived products primarily through Bio-Technology General
(Israel) Ltd., our wholly owned subsidiary in Israel, which we refer to as
BTG-Israel. As described below under the caption "New Strategic Direction," we
are in the process of exploring a potential divestiture of our Israeli
business operations, including BTG-Israel.
Our financial results have been heavily dependent on Oxandrin sales since we
introduced the product in December 1995. Sales of Oxandrin accounted for 40%
of our net product sales in the first nine months of 2004 and 49% of our net
product sales in the first nine months of 2003. Sales of Oxandrin accounted
for 46% of our net product sales in 2003, 48% in 2002 and 54% in 2001.
Oxandrin net sales in the first nine months of 2004 were adversely impacted by
returns during the period and provisions for future returns. Oxandrin sales in
2002 were adversely affected by our change to selling directly to wholesalers
rather than through a third-party distributor. Several companies have filed
drug master files with the FDA relating to a generic drug with oxandrolone,
the same active pharmaceutical ingredient in Oxandrin. Although we cannot
predict when generic competition for Oxandrin will begin, it is possible that
the FDA may approve one or more generic versions of Oxandrin as early as the
fourth quarter of 2004. The introduction of generic oxandrolone products would
likely cause a significant decrease in our revenues from sales of Oxandrin,
which would adversely affect us financially and could require us to scale back
some of our business activities.
In February 2004, we filed a Citizens Petition with the FDA requesting that,
in the interest of public health, the FDA establish specific bio-equivalence
requirements for oral products containing oxandrolone. This petition cited a
serious safety concern in patients concomitantly using Oxadrin and
anticoagulant drugs containing warfarin. In addition, this petition cited
concerns related to the physical-chemical properties of the oxandralone drug
substance which are important for manufacturing quality assurance and place
oxandralone in the FDA-defined category of "problem drugs" in terms of
manufacturing. We requested in our petition that any company wishing to
introduce an oxandrolone product into the U.S. market should, prior to the
issuance of marketing approval, be required to also conduct a clinical study
to investigate the interaction between that product candidate and warfarin and
demonstrate that it is identical to the interaction between Oxandrin and
warfarin. We have since filed with the FDA affidavits supporting our petition.
In each of August and September 2004, two opposition comment letters to our
petition were filed with the FDA. In August 2004, the FDA issued a letter to
us stating that extensive review of the questions raised in our petition will
be required before the FDA will respond. Since August 2004, we have received
no further communication from the FDA regarding our petition.
We expect that sales of our human growth hormone product to our Japanese
distributor will be relatively stable in the coming years, as moderate
increases in sales volume will be partially offset by price decreases
resulting from continuing pricing pressure from the Japanese Ministry of
Health.
Sales of Delatestryl have decreased significantly as a result of the FDA's
allowance of the reintroduction of a generic version of Delatestryl into the
market in March 2004, and could continue to decrease further in the future.
We began to depreciate our new manufacturing facility in Be'er Tuvia, Israel
and certain equipment in January 2004. We estimate that depreciation expense
will aggregate approximately $3,500,000 to $4,000,000 annually once all
equipment at the Be'er Tuvia facility is placed in service. As a result, cost
of product sales as a percentage of product sales will increase in 2004 as
compared to 2003.
NEW STRATEGIC DIRECTION
In July 2004, we announced a change in our strategic business plan to
reposition our company to focus on the full development of our pipeline
products. This will include an enhanced focus on the clinical development of
our two product candidates currently in Phase 2 clinical trials - Prosaptide
for neuropathic pain in patients with HIV/AIDS, and Puricase for severe,
refractory gout. We also intend to concentrate on an active in-licensing
program to access and develop novel compounds in clinical stage development.
15
As part of this new plan, we are proceeding with the process of exploring a
potential divestiture of our Israeli business operations, including BTG-
Israel. We expect that this divestiture would include existing
biopharmaceutical product licensing arrangements outside of Israel, such as
our human growth hormone product, Tev-Tropin, that we have licensed in the
United States to Teva Pharmaceuticals, Ltd. We also expect that this
divestiture would include products that are currently manufactured in Israel
such as our Nuflexxa and Euflexxa products that are based on sodium
hyaluronate and our BioLon product. Early in the fourth quarter of 2004, we
made a confidential information memorandum available to prospective acquirers.
We believe that a sale of our Israeli business operations on favorable terms
should provide the incremental resources that we will require to fund the
advancement of our drug development programs. However, we cannot assure you
that we will be successful in completing such a divestiture or that any such
divesture will generate sufficient proceeds to adequately fund our future
operations.
Based upon our current business outlook and the change in our strategic
direction, the likelihood of our being able to fully realize our deferred
income tax benefits against future income is uncertain. Accordingly, in the
second quarter of 2004 we recorded a $16,272,000 valuation allowance against
our deferred income tax assets and a corresponding provision for income taxes.
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of
operations are based on our consolidated financial statements, which we have
prepared in accordance with accounting principles generally accepted in the
United States. Applying these principles requires our judgment in determining
the appropriateness of acceptable accounting principles and methods of
application in diverse and complex economic activities. The preparation of
these financial statements requires us to make estimates and judgments that
affect the reported amounts of revenues, expenses, assets and liabilities, and
related disclosure of contingent assets and liabilities. We base our estimates
on historical experience and other assumptions that we believe are reasonable
under the circumstances.
We discuss our critical accounting policies in our Annual Report on Form 10-
K for the year ended December 31, 2003 in the section entitled "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Critical Accounting Policies and the Use of Estimates." In addition to the
critical accounting policies discussed in our Annual Report on Form 10-K, we
have identified the following additional critical accounting policies:
Net Product Sales. We recognize product sales when title to the product has
transferred to our customers in accordance with the terms of sale, and when
collectability is probable, net of discounts, sales incentives, sales
allowances and sales returns. The terms of sale offered to customers include
transfer of title upon delivery, transfer of title upon delivery to the
customer's shipper or carrier, and transfer of title upon shipping.
Through December 31, 2003, sales returns had been minimal and insignificant
to our results of operations. However, beginning in the first quarter of 2004
and continuing through the second quarter, we became aware that retail
customers of our wholesalers were preparing to return expired product,
primarily 2.5-mg Oxandrin and 10-mg Oxandrin. Historically, we had experienced
virtually no returns of the 2.5-mg Oxandrin tablet because of the product's
five-year shelf life. The 10-mg Oxandrin tablet, which was introduced in the
second half of 2002, currently has a two-year shelf life. Through the first
six months of 2004, we issued credits to our wholesalers in the amount of
$1,732,000 and recorded a provision for estimated future product returns
totalling $2,957,000.
In the third quarter of 2004, we issued credits to our wholesalers in the
amount of $1,563,000. We also determined that the rate of product returns was
greater than that estimated in the previous quarter. On the basis of this
information, we increased our estimates for future product returns and
recorded an additional provision totalling $5,036,000 in the third quarter of
2004. For the nine months ended September 30, 2004, the aggregate provision
for returns was $11,288,000. As of September 30, 2004, our provision for
future returns, which may occur over several years, was $7,993,000.
16
We will continue to monitor our product returns. We regularly review the
factors that influence our estimates including:
o actual returns experience;
o the demand for our products;
o estimated inventory levels of our wholesaler customers; and
o other relevant factors.
If necessary, we make adjustments when we believe that actual product returns
may differ from established reserves. Changes in facts and circumstances and
the demand for our products could result in material changes in the amount of
returned product, and actual results may differ materially from our estimates.
Inventory obsolescence. We state inventories at the lower of cost or
market. We determine cost using the weighted-average method. If inventory
costs exceed expected market value due to obsolescence or quantities in excess
of expected demand, we record reserves for the difference between the cost and
the market value. We determine these reserves based on estimates. The reserves
at September 30, 2004 were $2,200,000. In addition, we established loss
contract reserves of $874,000 in the third quarter of 2004 for outstanding
purchase orders and the resolution of other commitments that will be in excess
of expected demand.
Our inventories include Oxandrin inventories that we believe would
potentially be in excess of expected product demand if the FDA approves a
generic form of the product in the near term. The amount of such potential
excess will vary depending upon the timing of the approval of a generic
product, the number of generic products that are approved and the rate by
which generic sales reduce demand for branded Oxandrin. If generic approval
occurs during the fourth quarter of 2004, we estimate that such potential
excess may be up to $7.0 million.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated the percentage of
revenues represented by certain items reflected on our statements of
operations.
NINE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
2004 2004
(RESTATED) 2003 (RESTATED) 2003
---------- ----- ---------- -----
Revenues:
Products sales, net ..................... 91.5% 94.0% 92.3% 95.1%
Contract fees ........................... 0.9 1.2 0.9 1.0
Royalties ............................... 6.3 2.6 4.1 2.5
Other revenues .......................... 1.3 2.2 2.7 1.4
----- ----- ----- -----
Total revenues ........................ 100.0% 100.0% 100.0% 100.0%
----- ----- ----- -----
Expenses:
Research and development ................ 28.5 27.4 24.5 34.1
Marketing and sales ..................... 23.1 18.8 20.2 16.0
General and administrative .............. 24.5 19.2 23.5 18.8
Retirement .............................. 2.8 -- -- --
Cost of product sales ................... 33.6 15.7 37.4 14.4
Amortization of intangibles associated
with acquisition........................ 4.0 3.3 4.0 3.0
Commissions and royalties ............... 5.9 4.2 6.3 5.1
----- ----- ----- -----
Total expenses ........................ 122.4 88.6 115.9 91.4
----- ----- ----- -----
Operating (loss) income .................. (22.4) 11.4 (15.9) 8.6
Other (expense) income, net .............. (0.9) 4.2 0.1 10.4
(Loss) income before income taxes ........ (23.3) 15.6 (15.8) 19.0
Income taxes ............................. 23.7 5.0 4.5 6.1
----- ----- ----- -----
Net (loss) income ........................ (47.0)% 10.6% (20.3)% 12.9%
===== ===== ===== =====
17
We have historically derived our revenues from product sales as well as from
collaborative arrangements with third parties. The sources of revenue under
our third-party arrangements include up front contract fees, funding for
additional research, reimbursement for producing certain experimental
materials, milestone payments and royalties on sales of product. Our funding
for additional research conducted by our BTG-Israel subsidiary includes
funding that we have historically received from the Office of the Chief
Scientist of the State of Israel. We anticipate that product sales will
constitute the majority of our revenues for the foreseeable future.
Our revenues and expenses have in the past displayed, and may in the future
continue to display, significant variations. These variations may result from
a variety of factors, including:
o the amount and timing of product sales;
o changing demand for our products;
o our inability to provide adequate supply for our products;
o changes in wholesaler buying patterns;
o returns of expired product;
o changes in government or private payor reimbursement policies for our
products;
o increased competition from new or existing products, including generic
products;
o the timing of the introduction of new products;
o the timing and realization of milestone and other payments from
licensees;
o the timing and amount of expenses relating to research and development,
product development and manufacturing activities;
o the extent and timing of costs of obtaining, enforcing and defending
intellectual property rights; and
o any charges related to acquisitions.
The decrease in the value of the U.S. dollar relative to the British pound
sterling had the effect of increasing our revenues as measured in U.S. dollars
by $905,000 for the three months ended September 30, 2004 and by $2,555,000
for the nine months ended September 30, 2004. The decrease in the value of the
U.S. dollar relative to the British pound sterling had a negative effect on
our expenses as measured in U.S. dollars. This decrease also had the effect of
reducing our net loss for the three months ended September 30, 2004 by
$314,000 and our net loss for the nine months ended September 30, 2004 by
$790,000.
The following table summarizes net sales of our commercialized products as a
percentage of net product sales for the periods indicated:
NINE MONTHS ENDED SEPTEMBER 30, THREE MONTHS ENDED SEPTEMBER 30,
---------------------------------- ----------------------------------
2004 2004
(RESTATED) 2003 (RESTATED) 2003
--------------- --------------- --------------- ---------------
(DOLLARS IN THOUSANDS)
Oxandrin............................. $27,958 40.0% $42,851 49.2% $ 9,441 40.0% $16,867 52.5%
Oral liquid pharmaceutical products.. 24,537 35.0 18,859 21.6 8,685 36.8 6,815 21.2
Human growth hormone................. 8,075 11.5 12,392 14.2 3,578 15.2 4,230 13.2
Delatestryl.......................... 4,210 6.0 7,185 8.3 477 2.0 2,593 8.1
BioLon............................... 4,153 5.9 4,860 5.6 1,071 4.6 1,404 4.4
Other................................ 1,202 1.6 963 1.1 341 1.4 203 0.6
------- ----- ------- ----- ------- ----- ------- -----
Total............................. $70,135 100.0% $87,110 100.0% $23,593 100.0% $32,112 100.0
======= ===== ======= ===== ======= ===== ======= =====
We believe that our product mix will vary from period to period based on the
purchasing patterns of our customers and our focus on:
o increasing market penetration of our existing products;
18
o expanding into new markets; and
o commercializing additional products.
In particular, quarterly fluctuations in sales of Oxandrin have had a
significant impact on our quarterly results of operations, and we expect this
to continue in future periods.
The following table summarizes our U.S., United Kingdom and other
international product sales as a percentage of total product sales for the
periods indicated:
NINE MONTHS ENDED SEPTEMBER 30, THREE MONTHS ENDED SEPTEMBER 30,
---------------------------------- ----------------------------------
2004 2004
(RESTATED) 2003 (RESTATED) 2003
--------------- --------------- --------------- ---------------
(DOLLARS IN THOUSANDS)
United States........ $32,168 45.8% $50,289 57.7% $ 9,918 42.0% $19,767 61.6%
United Kingdom....... 23,533 33.6 18,633 21.4 8,416 35.6 7,244 22.5
Other international.. 14,434 20.6 18,188 20.9 5,259 22.4 5,101 15.9
------- ----- ------- ----- ------- ----- ------- -----
Total............. $70,135 100.0% $87,110 100.0% $23,593 100.0% $32,112 100.0%
======= ===== ======= ===== ======= ===== ======= =====
COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 2004 AND SEPTEMBER 30, 2003
Revenues. Total revenues decreased by $16,047,000, or 17.3%, in the nine
months ended September 30, 2004 to $76,646,000 from $92,693,000 in the nine
months ended September 30, 2003. The decrease in total revenues resulted
primarily from the decrease in product sales, net, and other revenues,
partially offset by an increase in royalties.
Product sales, net decreased by $16,975,000, or 19.5%, in the nine months
ended September 30, 2004 to $70,135,000 from $87,110,000 in the nine months
ended September 30, 2003. The decrease resulted primarily from decreases in
net sales of Oxandrin, human growth hormone, Delatestryl, and BioLon,
partially offset by an increase in sales of Rosemont's oral liquid
pharmaceutical products.
Sales of Oxandrin in the nine months ended September 30, 2004 were
$27,958,000, a decrease of $14,893,000 or 34.8%, from $42,851,000 in the first
nine months of 2003. This decrease resulted principally from the negative
impact of returns of expiring product, from a provision for future returns and
from lower purchases by wholesalers, primarily in the second quarter, as they
completed the reduction in their inventory levels. Oxandrin prescription
volumes remained steady in the first nine months of 2004. These decreases were
partially offset by price increases since the first quarter of 2003.
Through December 31, 2003, Oxandrin sales returns had been minimal and
insignificant to our results of operations. However, beginning in the first
quarter of 2004 and continuing through the second quarter, we became aware
that retail customers of our wholesalers were preparing to return expired
product, primarily 2.5-mg Oxandrin and 10-mg Oxandrin. Historically, we had
experienced virtually no returns of the 2.5-mg Oxandrin tablet because of the
product's five-year shelf life. The 10-mg Oxandrin tablet, which was
introduced in the second half of 2002, currently has a two-year shelf life.
For the nine months ended September 30, 2004, the aggregate provision for
returns was $11,288,000. As of September 30, 2004, our provision for future
returns was $7,993,000.
We will continue to monitor our product returns. We regularly review the
factors that influence our estimates including:
o actual returns experience;
o the demand for our products;
o estimated inventory levels of our wholesaler customers; and
o other relevant factors.
If necessary, we make adjustments when we believe that actual product
returns may differ from established reserves. Changes in facts and
circumstances and the demand for our products could result in
19
material changes in the amount of returned product, and actual results may
differ materially from our estimates.
Sales of oral liquid pharmaceutical products in the nine months ended
September 30, 2004 were $24,537,000, an increase of $5,678,000, or 30.1%, from
$18,859,000 in the first nine months of 2003. A portion of the increase was
attributable to the decrease in the value of the U.S. dollar relative to the
British pound sterling. Measured in pounds sterling, Rosemont's sales in the
nine months ended September 30, 2004 increased by 15.6% over sales in the
first nine months of 2003.
Sales of human growth hormone in the nine months ended September 30, 2004
were $8,075,000, a decrease of $4,317,000, or 34.8%, from $12,392,000 in the
first nine months of 2003. Sales to our European distributor increased to
$6,307,000 in the first nine months of 2004 from $6,028,000 in the first nine
months of 2003. Sales to our Japanese distributor were $5,427,000 the first
nine months of 2003. We had no sales to this distributor in the same period in
2004.
Sales of Delatestryl in the nine months ended September 30, 2004 were
$4,210,000, a decrease of $2,975,000, or 41.4%, from $7,185,000 in the first
nine months of 2003. The decrease in sales was attributable to the
reintroduction of a competing generic product into the market in March 2004.
We expect our Delatestryl sales for the remainder of 2004 to be significantly
lower than our 2003 sales of $12,343,000 as a result of the reintroduction of
this competing generic product.
Sales of BioLon in the nine months ended September 30, 2004 were $4,153,000,
a decrease of $707,000 or 14.5%, from $4,860,000 in the first nine months of
2003. In March 2004 we terminated our exclusive distribution agreement with
Akorn, Inc. relating to the distribution of BioLon in the United States. We
are currently seeking a new partner to market BioLon in the United States.
Contract fees were $672,000 in the nine months ended September 30, 2004 and
$1,070,000 in the nine months ended September 30, 2003. These amounts
represent mainly contract fees received in prior periods but earned and
recognized in the nine months ended September 30, 2004 and 2003 in accordance
with SAB 101.
Royalties in the nine months ended September 30, 2004 were $4,848,000, an
increase of $2,423,000, or 100%, from $2,425,000 in the first nine months of
2003. These revenues consist principally of royalties that we receive from
third-party sales of our Mircette, Silkis and insulin products. The increase
in royalties in the first nine months of 2004 was primarily attributable to
fees of $2,250,000 that we earned in the second quarter of 2004 as a result of
the achievement of sales milestones under our license agreement with Diosynth
b.v. relating to our insulin product.
Other revenues decreased by $1,097,000, or 52.5%, in the nine months ended
September 30, 2004 as compared to the same period in 2003, primarily
attributable to a decrease in partial research and development funding from
the Office of the Chief Scientist of the State of Israel.
Research and development expense decreased by $3,573,000, or 14.1%, in the
nine months ended September 30, 2004 to $21,811,000 from $25,384,000 in the
nine months ended September 30, 2003. The prior year included Prosaptide
toxicology studies and the expense for the production of clinical supplies for
both Puricase and Prosaptide. Partially offsetting the absence of these
expenses in 2004 were the costs to prepare Soltamox, our oral liquid
formulation of tamoxifen, an off-patent drug for the treatment of both
advanced and early stage breast cancers, for a U.S. regulatory filing and
additional bioequivalence trials for Rosemont products.
Marketing and sales expense increased by $319,000, or 1.8%, in the nine
months ended September 30, 2004 to $17,709,000 from $17,390,000 in the nine
months ended September 30, 2004. The increase is primarily attributable to
pre-marketing expenses for Nuflexxa in the United States.
General and administrative expense increased by $927,000, or 5.2%, in the
nine months ended September 30, 2004 to $18,766,000 from $17,839,000 in the
nine months ended September 30, 2003. The increase was primarily attributable
to increases in consulting expenses related to our implementation of
provisions of the Sarbanes-Oxley Act and the development of our new strategic
plan offset, in part, by lower legal expenses.
20
Retirement expense of $2,110,000 in the nine months ended September 30, 2004
includes a provision for a retirement payment and other related benefits in
connection with our previously disclosed retirement agreement with our former
Chief Executive Officer. In June 2004, this former executive elected to
receive his retirement payment in one lump sum. We made the payment on July
15, 2004.
Cost of product sales increased by $11,226,000, or 77.1%, in the nine months
ended September 30, 2004 to $25,782,000 from $14,556,000 in the nine months
ended September 30, 2003. Cost of product sales as a percentage of product
sales increased from 16.7% in the nine months ended September 30, 2003 to
36.8% in the nine months ended September 30, 2004. The increase is principally
attributable to:
o reductions in net product sales as a result of returns of expiring
product and provisions for future returns;
o expenses of $6,032,000 primarily for process validation and similar
qualification activities relating to the operation of our manufacturing
facility in Be'er Tuvia;
o depreciation of $2,162,000 related to our Be'er Tuvia facility beginning
in January 2004;
o a reserve of $1,676,000 that we recorded against Delatestryl inventories
that were in excess of projected demand for the product; and
o loss contract reserves of $874,000.
In the first nine months of 2003, we capitalized the costs of operating the
Be'er Tuvia facility and did not record depreciation on the facility because
it was not yet ready for its intended use.
Cost of product sales as a percentage of product sales also varies from year
to year and quarter to quarter depending on the quantity and mix of products
sold. Oxandrin and human growth hormone have relatively low manufacturing
costs relative to their sales prices; whereas BioLon, Delatestryl and
Rosemont's products have higher manufacturing costs relative to their sales
prices.
Amortization of intangibles associated with acquisition. In connection with
our acquisition of Rosemont, we recorded intangibles of $80,800,000,
consisting of developed products, trademarks and patents. We are amortizing
these intangibles using the straight-line method over the estimated useful
life of approximately 20 years. We recorded $3,038,000 of amortization of
these intangibles in the first nine months of 2004 and 2003.
Commissions and royalties expense was $4,530,000 in the nine months ended
September 30, 2004, compared to $3,935,000 in the nine months ended September
30, 2003. The increase of $595,000, or 15.1%, is primarily attributable to
increased commissions paid to the Ross Products Division of Abbott
Laboratories, or Ross, on their purchases of Oxandrin for the long-term care
market, partially offset by a decrease in royalties that we were required to
pay for our Delatestryl and Mircette products due to a decrease in the sales
of those products. Ross co-promotes Oxandrin with us in the United States to
residents of long-term care facilities, who are particularly at risk for
losing lean body mass. Prior to March 31, 2003, Ross had instead been able,
under its agreement with us, to purchase Oxandrin from us at a discount which
was classified as a sales allowance.
Other expense, net was $683,000 for the nine months ended September 30,
2004, compared to other income, net, of $3,938,000 for the nine months ended
September 30, 2003. The change is primarily attributable to the write down in
the value of our investment in Marco Hi-Tech JV, Ltd. In 2003, we agreed to
invest an aggregate of $1,500,000 in Marco preferred stock and acquired an
option to market Marco's Huperzine-A product candidate for the treatment of
Alzheimer's disease. As of March 31, 2004, we had invested $1,000,000 in
Marco. In the second quarter of 2004, we elected not to make our final
$500,000 investment in Marco. As a result, our preferred stock has converted
into Marco common stock and our option to market Huperzine-A has terminated.
Although we will continue to hold the Marco common stock, based on our
assessment of the status of the development of Marco's product candidate, we
have written down the entire amount of our $1,000,000 investment in Marco. In
addition, other income for the nine months ended September 30, 2003 included
$3,354,000 of unamortized contract fees. During the third quarter of 2003, we
agreed to terminate a distribution agreement with DuPuy Orthopaedics, Inc.
that provided DuPuy with
21
distribution rights to our Arthrease product to treat osteoarthritis. As a
result of the termination of this agreement, we recognized as other income the
remaining contract fees paid by DuPuy that we had previously deferred in
accordance with SAB 101.
Income taxes. Provision for income taxes for the nine months ended
September 30, 2004 was $18,136,000, compared to $4,636,000 for the nine months
ended September 30, 2003. The increase in provision for income taxes was
primarily attributable to the $16,272,000 valuation allowance that we recorded
in the second quarter of 2004 to reflect the uncertainty of our being able to
use the benefits of our deferred tax assets in the future based upon our
current business outlook and the change in our strategic direction.
COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 2004 AND SEPTEMBER 30, 2003
Revenues. Total revenues decreased by $8,225,000, or 24.3%, in the three
months ended September 30, 2004 to $25,556,000 from $33,781,000 in the three
months ended September 30, 2003. The decrease was primarily attributable to
the decrease in product sales, net, partially offset by an increase in
royalties.
Product sales, net, decreased by $8.519,000, or 26.5%, in the three months
ended September 30, 2004 to $23,593,000 from $32,112,000 in the third quarter
of 2003. The decrease was primarily attributable to decreases in the net sales
of Oxandrin, Human growth hormone, Delatestryl, and BioLon, partially offset
by an increase in the sales of Rosemont's oral liquid pharmaceutical products.
Sales of Oxandrin in the three months ended September 30, 2004, net of
product returns and provision for future returns, were $9,441,000,
representing a significant decrease from $16,867,000 in the third quarter of
2003. The decrease is primarily due to the effects of the returns and the
provision for future returns.
Sales of oral liquid pharmaceutical products in the three months ended
September 30, 2004 were $8,685,000, an increase of $1,870,000, or 27.4%, from
$6,815,000 in the third quarter of 2003. A portion of the increase was
attributable to the decrease in the value of the U.S. dollar relative to the
British pound sterling. Measured in pounds sterling, Rosemont's sales in the
three months ended September 30, 2004 increased by 14.3% over the sales in the
third quarter of 2003.
Sales of human growth hormone were $3,578,000 in the three months ended
September 30, 2004, a decrease of $652,000, or 15.4%, from $4,230,000 in the
third quarter of 2003. Sales to our European distributor increased to
$3,227,000 in the third quarter of 2004 from $1,757,000 in the third quarter
of 3003. Sales to our Japanese distributor were $2,126,000 in the third
quarter of 2003. We had no sales to this distributor in the third quarter of
2004.
Sales of Delatestryl in the three months ended September 30, 2004 were
$477,000, a decrease of $2,116,000, or 81.6%, from $2,593,000 in the third
quarter of 2003. The decrease in sales was attributable to the reintroduction
of a competing generic product into the market in March 2004. We expect our
Delatestryl sales for the remainder of 2004 to be significantly lower than our
2003 sales of $12,343,000 as a result of the reintroduction of this competing
generic product.
Contract fees were $222,000 in the three months ended September 30, 2004 and
$327,000 in the three months ended September 30, 2003. These amounts represent
mainly contract fees received in prior periods but recognized in the three-
month periods ended September 30, 2004 and 2003 in accordance with SAB 101.
Royalties in the three months ended September 30, 2004 were $1,044,000, an
increase of $189,000, or 22.1%, from $855,000 in the third quarter of 2003.
The increase was primarily attributable to higher insulin product fees
partially offset by a decrease in royalties earned on sales of our Mircette.
Other revenues increased by $210,000, or 43.1%, in the three months ended
September 30, 2004 as compared to the same period in 2003, primarily
attributable to the receipt of a grant from the Office of the Chief Scientist
of the State of Israel.
Research and development expense decreased by $5,263,000, or 45.7%, in the
three months ended September 30, 2004 to $6,265,000 from $11,528,000 in the
three months ended September 30, 2003. The prior year included Prosaptide
toxicology studies and the expense for the production of clinical supplies for
22
both Puricase and Prosaptide. Partially offsetting the absence of these
expenses in 2004 were the costs to prepare Soltamox for a U.S. regulatory
filing and additional bioequivalence trials for Rosemont products.
Marketing and sales expense decreased by $237,000, or 4.4%, in the three
months ended September 30, 2004 to $5,175,000 from $5,412,000 in the three
months ended September 30, 2003. The decrease is primarily attributable to a
reduction in Oxandrin marketing expense. As a percentage of product sales,
marketing and sales expense increased to 21.9% in the three months ended
September 30, 2004 from 16.9% in the third quarter of 2003, primarily as a
result of the decrease in net product sales.
General and administrative expense decreased by $344,000, or 5.5%, in the
three months ended September 30, 2004 to $5,999,000 from $6,343,000 in the
three months ended September 30, 2003. The decrease was primarily attributable
to lower legal expenses, partially offset by higher consulting expenses
related to our implementation of provisions of the Sarbanes-Oxley Act.
Cost of product sales increased by $4,680,000, or 96%, in the three months
ended September 30, 2004 to $9,556,000 from $4,876,000 in the three months
ended September 30, 2003. Cost of product sales as a percentage of product
sales increased from 15.2% in the three months ended September 30, 2003 to
40.5% in the three months ended September 30, 2004. The increase is
principally attributable to:
o reductions in net product sales as a result of expiring product and
provisions for future returns;
o a reserve of $1,676,000 that we recorded against Delatestryl inventories
that were in excess of projected demand for the product;
o expenses of $1,213,000 primarily for process validation and similar
qualification activities relating to the operation of our manufacturing
facility in Be'er Tuvia;
o loss contract reserves of $874,000; and
o depreciation of $646,000 related to our Be'er Tuvia facility which began
operation in January 2004.
In 2003, we capitalized the costs of operating the Be'er Tuvia facility and
did not record depreciation on the facility because it was not yet ready for
its intended use.
Amortization of intangibles associated with acquisition. We recorded
$1,013,000 of amortization of intangibles related to our acquisition of
Rosemont in the three months ended September 30, 2004 and September 30, 2003.
Commissions and royalties expense decreased by $84,000, or 4.9%, in the
three months ended September 30, 2004 to $1,620,000 from $1,704,000 in the
three months ended September 30, 2003, primarily as a result of a decrease in
the sales of Delatestryl and Mircette.
Other income, net was $13,000 for the three months ended September 30, 2004,
compared to $3,517,000 for the three months ended September 30, 2003. Other
income in the three months ended September 30, 2003 relates primarily to the
recognition of $3,354,000 of unamortized DuPuy contract fees.
Income taxes. Provision for income taxes for the three months ended
September 30, 2004 was $1,150,000, compared to $2,064,000 for the three months
ended September 30, 2003. The decrease was primarily attributable to lower
taxable earnings in the United States and Israel offset, in part, by higher
taxable earnings in the United Kingdom.
LIQUIDITY AND CAPITAL RESOURCES
Our working capital at September 30, 2004 was $17,775,000, compared to
$38,913,000 at December 31, 2003.
Our cash flows have fluctuated significantly as a result of changes in our
revenues, operating expenses, capital spending, working capital requirements,
the issuance of common stock and other financing activities. We expect that
cash flow in the near future will be primarily determined by the levels of our
net income, working capital requirements and financings, if any, that we may
undertake. Net cash increased by $4,765,000 in the nine months ended September
30, 2004.
23
Net cash provided by operating activities was $9,073,000 in the nine months
ended September 30, 2004, compared to $13,309,000 in the nine months ended
September 30, 2003. Net loss was $35,919,000 in the nine months ended
September 30, 2004, compared to net income of $9,853,000 in the nine months
ended September 30, 2003. In the nine months ended September 30, 2004, net
cash provided by operating activities was greater than our net loss
principally as a result of the non-cash effect on net income of the
$16,272,000 provision for income tax that we recorded in connection with the
corresponding valuation allowance against our U.S. deferred tax assets. Net
cash provided by operating activities also differed from our net loss in the
first nine months of 2004 because of a decrease in accounts receivable, net of
$21,413,000, depreciation and amortization of $4,848,000, amortization of
intangible assets associated with acquisition of $3,038,000, an increase in
accounts payable of $1,038,000 and the $1,000,000 write down in the value of
our investment in Marco Hi-Tech JV, Ltd. The decrease in accounts receivable
in the nine months ended September 30, 2004 is attributable principally to the
decrease in product sales in the second quarter of 2004, to the collection of
accounts receivable that were outstanding as of December 31, 2003 and a non-
cash provision for product returns of $7,993,000. In addition, we recorded
non-cash inventory reserves of $2,200,000 in the first nine months of 2004.
Net cash used in investing activities was $202,000 in the nine months ended
September 30, 2004, compared to $6,529,000 in the nine months ended September
30, 2003. Net cash used in investing activities included capital expenditures
of $2,377,000 in the first nine months of 2004 and $6,975,000 in the first
nine months of 2003. We incurred these capital expenditures in the first nine
months of 2004 primarily for the upgrade of Rosemont's manufacturing facility
and in the first nine months of 2003 primarily for the construction of our
Be'er Tuvia manufacturing facility.
Net cash used in financing activities was $3,943,000 in the nine months
ended September 30, 2004, compared to $2,405,000 in the nine months ended
September 30, 2003. These amounts primarily reflected repayment of $5,262,000
of debt in the first nine months of 2004 and $4,238,000 in the first nine
months of 2003, in each case partially offset by net proceeds from our
issuance of common stock primarily pursuant to our employee stock purchase
plan.
In June 2000 BTG-Israel entered into a $20,000,000 credit facility with Bank
Hapoalim B.M. to finance a portion of the costs of completing the construction
of our Be'er Tuvia manufacturing facility. Loans under the credit facility
bear interest at the rate of LIBOR plus 1%. The credit facility is secured by
the assets of BTG-Israel and is guaranteed by us. At September 30, 2004, we
had outstanding borrowings of $7,222,000 under the credit facility, of which
$1,666,000 is due during the remainder of 2004 and the remaining $5,556,000 is
due in 2005. Borrowings are repaid monthly in equal installments.
In June 2003, Rosemont commenced a modification of its manufacturing
facility to obtain FDA approval for the manufacture of oral liquid
pharmaceutical products for supply into the U.S. market. We estimated the
total capital cost for this project to be approximately $2,000,000. We have
subsequently increased that estimate to $2,500,000 as a result of additional
identified requirements and the negative effects of currency fluctuations. We
expended approximately $2,200,000 of this amount through September 30, 2004,
including approximately $300,000 in the three months ended September 30, 2004.
At September 30, 2004, we had committed approximately $200,000 in additional
expenditures that we expect to complete during the remainder of 2004.
We believe that our cash resources as of September 30, 2004, together with
anticipated product sales and anticipated proceeds from the divestiture of our
Israeli business operations, will be sufficient to fund our ongoing operations
and debt service obligations for the foreseeable future. However, we may fail
to achieve our anticipated liquidity levels as a result of unexpected events
or failure to achieve our goals. Our future capital requirements will depend
on many factors, including the following:
o our ability to divest our Israeli business operations on attractive terms
or at all;
o the timing and amount of product sales, particularly our continued
ability to sell Oxandrin prior to the introduction of generic versions of
the product;
o continued progress in our research and development programs, particularly
with respect to Prosaptide and Puricase;
24
o the timing of, and the costs involved in, obtaining regulatory approvals,
including regulatory approvals for Prosaptide, Puricase and any other
product candidates that we may seek to develop in the future and
regulatory approval to enable Rosemont to manufacture oral liquid
pharmaceutical products for supply into the U.S. market;
o fluctuations in foreign exchange rates for sales denominated in
currencies other than the U.S. dollar;
o the quality and timeliness of the performance of our third-party
suppliers and distributors;
o the cost of commercialization activities, including product marketing,
sales and distribution;
o the costs involved in preparing, filing, prosecuting, maintaining, and
enforcing patent claims and other patent-related costs, including
litigation costs and the results of such litigation;
o the outcome of pending purported class action and other related, or
potentially related, actions and the litigation costs with respect to
such actions; and
o our ability to establish and maintain collaborative arrangements.
If we are required to seek additional funding for our operations, we cannot
assure you that we will be able to obtain additional funds or, if such funds
are available, that such funding will be on acceptable terms. We continue to
seek additional collaborative research and development and licensing
arrangements in order to provide revenue from sales of certain products and
funding for a portion of the research and development expenses relating to the
products covered. However, we cannot assure you that we will be able to enter
into any such agreements.
25
RISK FACTORS THAT MAY AFFECT RESULTS
You should carefully consider the risks and uncertainties described below.
If any of the following risks or uncertainties actually occurs, our business,
prospects, financial condition and operating results would likely suffer,
possibly materially.
RISKS RELATING TO OUR NEW STRATEGIC DIRECTION
WE ARE REPOSITIONING OUR COMPANY TO FOCUS ON PRODUCT DEVELOPMENT, INCLUDING
AN ENHANCED FOCUS ON THE CLINICAL DEVELOPMENT OF PROSAPTIDE AND PURICASE, OUR
TWO PRODUCT CANDIDATES CURRENTLY IN PHASE 2 CLINICAL TRIALS. IF WE ARE UNABLE
TO COMMERCIALIZE EITHER OR BOTH OF THESE PRODUCT CANDIDATES, OR EXPERIENCE
SIGNIFICANT DELAYS OR UNANTICIPATED COSTS IN DOING SO, OUR BUSINESS WILL BE
MATERIALLY HARMED. WE WILL FACE SIMILAR DRUG DEVELOPMENT RISKS FOR ANY OTHER
PRODUCT CANDIDATES THAT WE MAY DEVELOP IN THE FUTURE.
In July 2004, we announced a change in our strategic business plan to
reposition our company to focus on the full development of our pipeline
products. This will include an enhanced focus on the clinical development of
Prosaptide and Puricase, our two product candidates currently in Phase 2
clinical trials, and an active in-licensing program to access and develop
novel compounds in clinical stage development.
Our ability to commercialize Prosaptide, Puricase and any other product
candidate that we may develop in the future will depend on several factors,
including:
o successfully completing pre-clinical studies and clinical trials;
o receiving marking approvals from the FDA and similar foreign regulatory
authorities;
o establishing commercial manufacturing arrangements with third-party
manufacturers, to the extent we do not manufacture the product candidates
ourselves;
o launching commercial sales of the product, whether alone or in
collaboration with others; and
o acceptance of the product in the medical community and with third-party
payors.
In July 2003, we commenced a Phase 2 clinical trial of Prosaptide in
patients with HIV-associated peripheral neuropathy to supplement the findings
of a previous Phase 2 clinical trial in patients with diabetes mellitus. We
currently expect to complete this Phase 2 clinical trial in the third quarter
of 2005. In February 2004 we initiated a Phase 2 clinical trial of Puricase,
which we anticipate will be completed in late 2004.
We cannot assure you that either of these clinical trails will be
successful. Even if these trials are successful, we will be required to
conduct additional clinical trials before a New Drug Application, or NDA, can
be filed with the FDA for marketing approval of these product candidates.
Clinical testing is expensive, difficult to design and implement, can take
many years to complete and is uncertain as to outcome. Success in early phases
of clinical trials does not ensure that later clinical trials will be
successful, and interim results of a clinical trial do not necessarily predict
final results. A failure of one or more of our clinical trials can occur at
any stage of testing. We may experience numerous unforeseen events during, or
as a result of, the clinical trial process that could delay or prevent our
ability to receive regulatory approval or commercialize Prosaptide or
Puricase, including:
o regulators or institutional review boards may not authorize us to
commence a clinical trial or conduct a clinical trial at a prospective
trial site;
o our clinical trials may produce negative or inconclusive results, and we
may decide, or regulators may require us, to conduct additional
preclinical testing or clinical trials or we may abandon projects that we
expect to be promising;
o enrollment in our clinical trials may be slower than we currently
anticipate, or participants may drop out of our clinical trials;
o we might have to suspend or terminate our clinical trials if the
participating patients are being exposed to unacceptable health risks;
26
o regulators or institutional review boards may require that we hold,
suspend or terminate clinical research for various reasons, including
noncompliance with regulatory requirements;
o the cost of our clinical trials may be greater than we currently
anticipate;
o any regulatory approval we ultimately obtain may be limited or subject to
restrictions or post-approval commitments that render the product not
commercially viable; and
o the effects of our product candidates may not be the desired effects or
may include undesirable side effects or the product candidates may have
other unexpected characteristics.
If we are required to conduct additional clinical trials or other testing of
our product candidates beyond those that we currently contemplate, if we are
unable to successfully complete our clinical trials or other testing or if the
results of these trials or tests are not positive or are only modestly
positive, we may:
o be delayed in obtaining marketing approval for our product candidates;
o not be able to obtain marketing approval;
o obtain approval for indications that are not as broad as intended; or
o not obtain marketing approval before other companies are able to bring
competitive products to market.
Our product development costs will also increase if we experience delays in
testing or approvals. We do not know whether our ongoing clinical trials will
be completed on schedule. Similarly, we do not know whether our planned
clinical trials will begin as planned, will need to be restructured or will be
completed on schedule, if at all. Significant delays in clinical trials could
also allow our competitors to bring products to market before we do and impair
our ability to commercialize our products or product candidates.
OUR NEW STRATEGIC FOCUS INCLUDES AN IN-LICENSING PROGRAM TO ACCESS AND
DEVELOP NOVEL COMPOUNDS IN CLINICAL STAGE DEVELOPMENT. WE MAY NOT BE
SUCCESSFUL IN OUR EFFORTS TO EXPAND OUR PORTFOLIO OF PRODUCTS IN THIS MANNER.
As part of the change in our strategic business plan, we announced that we
intend to concentrate on an active in-licensing program to access and develop
novel compounds in clinical stage development. To date, we have had limited
success in in-licensing compounds, and we may continue to have difficulty in
this area for a number of reasons. In particular, the licensing and
acquisition of pharmaceutical products is a competitive area. Numerous
companies are also pursuing strategies to license or acquire products similar
to those that we may pursue. These companies may have a competitive advantage
over us due to their size, cash resources and greater clinical development and
commercialization capabilities. Other factors that may prevent us from
licensing or otherwise acquiring suitable product candidates include the
following:
o we may be unable to identify suitable products or product candidates
within our areas of expertise;
o we may be unable to license or acquire the relevant technology on terms
that would allow us to make an appropriate return on our investment in
the product; or
o companies that perceive us to be their competitors may be unwilling to
assign or license their product rights to us.
If we are unable to develop suitable potential product candidates by
obtaining rights to novel compounds from third parties, our business will
suffer.
THE DIVESTITURE OF OUR ISRAELI BUSINESS OPERATIONS WILL BE COMPLEX, TIME-
CONSUMING AND EXPENSIVE, AND MAY DISRUPT OR DISTRACT OUR MANAGEMENT AND OTHER
EMPLOYEES. IF WE ARE UNABLE TO DIVEST THESE OPERATIONS ON FAVORABLE TERMS, WE
MAY NOT ACHIEVE THE EXPECTED BENEFITS OF OUR NEW STRATEGIC DIRECTION.
Also as part of the change in our strategic business plan, we are proceeding
with the process of exploring a potential divestiture of our Israeli business
operations, including our Bio-Technology General (Israel) Ltd. subsidiary. We
believe that this divestiture would provide the incremental resources required
to fund the advancement of our drug development programs. However, divestiture
of our operations in Israel
27
will be complex, time-consuming and expensive, and may disrupt or distract our
management and other employees. We may not be able to sell our Israeli
operations for an attractive price or at all. This divestiture could involve
substantial transaction costs and we may not ultimately achieve expected
benefits and cost reductions.
RISKS RELATED TO OUR BUSINESS
A SIGNIFICANT PORTION OF OUR REVENUES IS REPRESENTED BY SALES OF OXANDRIN.
SALES OF OXANDRIN HAVE DECLINED SUBSTANTIALLY DURING THE FIRST NINE MONTHS OF
2004 AS COMPARED TO 2003. OXANDRIN MAY BEGIN FACING GENERIC COMPETITION AS
EARLY AS THE FOURTH QUARTER OF 2004, WHICH WOULD LIKELY CAUSE A SIGNIFICANT
FURTHER DECREASE IN OXANDRIN SALES.
Net sales of Oxandrin for the first nine months of 2004 amounted to $28.0
million, representing approximately 40% of our net product sales for that
period. Net sales of Oxandrin amounted to $57.6 million in 2003, representing
46% of net product sales, $45.9 million in 2002 representing 48% of net
product sales, and $47.2 million in 2001 representing 54% of net product
sales. Several companies have filed drug master files with the FDA relating to
a generic drug with the same active pharmaceutical ingredient as Oxandrin.
While we cannot predict when generic competition for Oxandrin will begin, it
is possible that the FDA may approve one or more generic versions of Oxandrin
as early as the fourth quarter of 2004. The introduction of these generic
products would likely cause a significant decrease in our Oxandrin revenues,
which would adversely affect us financially and could require us to scale back
some of our business activities.
OXANDRIN SALES IN PARTICULAR REPORTING PERIODS MAY BE AFFECTED BY
WHOLESALERS' BUYING PATTERNS AND PRODUCT RETURNS.
We make a significant portion of our sales of Oxandrin in the United States
to major drug wholesalers. These sales are affected by fluctuations in the
buying patterns of these wholesalers and the corresponding changes in
inventory levels that they maintain. These changes may not reflect underlying
prescriber demand and can be influenced by price concessions or announcements
of price increases in future periods. We believe that Oxandrin sales in the
second quarter of 2004 were negatively affected by reduced purchases by
wholesalers as they reduced their inventory levels. Our Oxandrin sales in
future periods may be further reduced if wholesalers continue to reduce
inventories. This may be more likely if and when a generic version of Oxandrin
is introduced.
OUR RESULTS OF OPERATIONS HAVE BEEN ADVERSELY AFFECTED BY RECENT RETURNS OF
OXANDRIN. FUTURE RETURNS OF OXANDRIN OR OTHER PRODUCTS COULD ALSO AFFECT OUR
RESULTS OF OPERATIONS.
In 2004, we experienced returns of expiring Oxandrin for the first time.
Accordingly, our revenues from Oxandrin sales were reduced by approximately
$11.3 million as a result of returns and sales return allowances that we
recorded in the first nine months of 2004. As of September 30, 2004, $8.0
million of that amount remains as an allowance for future product returns. We
will continue to monitor our products to assure that future reserves for
returns are provided as appropriate. Future product returns in excess of our
reserves would reduce our revenues and adversely affect our results of
operations.
WE WILL NEED SUBSTANTIAL CAPITAL TO DEVELOP AND COMMERCIALIZE PRODUCTS, AND
WE MAY BE UNABLE TO OBTAIN ADDITIONAL CAPITAL. IF WE ARE UNABLE TO OBTAIN
ADDITIONAL FINANCING, OUR BUSINESS, RESULTS OF OPERATIONS AND FINANCIAL
CONDITION MAY BE ADVERSELY AFFECTED.
The development and commercialization of products requires substantial
funds. In addition, we may require cash to acquire new product candidates. In
recent periods, we have satisfied our cash requirements primarily through
product sales. Historically, we have also obtained capital through:
o funding of projects through collaborative research and development
arrangements;
o contract fees;
o government of Israel funding of a portion of research and development
projects, mainly through the office of the Chief Scientist of the
Ministry of Industry and Trade; and
o equity and debt financings.
28
We cannot assure you that these financing alternatives will be available in
the future to satisfy our cash requirements. Our BTG-Israel subsidiary has
applied to the Office of the Chief Scientist for funding of a portion of its
research and development activities, but we cannot assure you that the Chief
Scientist will continue to provide funding to BTG-Israel. If we are successful
in divesting our Israeli business operations, future funding from the Office
of the Chief Scientist would not be available to us.
We expect that the repositioning of our company will require significant
additional capital resources. Although we believe that a divestiture of our
Israeli business operations on favorable terms would provide the incremental
resources required to fund the advancement of our drug development programs,
these goals may not be achieved due to unexpected events or our failure to
achieve our goals, including as a result of:
o our ability to divest our Israeli business operations on attractive terms
or at all;
o the timing and amount of product sales, particularly our continued
ability to sell Oxandrin prior to the introduction of generic versions of
the product;
o continued progress in our research and development programs, particularly
with respect to Prosaptide and Puricase;
o the timing of, and the costs involved in, obtaining regulatory approvals,
including regulatory approvals for Prosaptide, Puricase and any other
product candidates that we may seek to develop in the future and
regulatory approval to enable Rosemont to manufacture oral liquid
pharmaceutical products for supply into the U.S. market;
o fluctuations in foreign exchange rates for sales denominated in
currencies other than the U.S. dollar;
o the quality and timeliness of the performance of our third-party
suppliers and distributors;
o the cost of commercialization activities, including product marketing,
sales and distribution;
o the costs involved in preparing, filing, prosecuting, maintaining and
enforcing patent claims and other patent-related costs, including
litigation costs and the results of such litigation;
o the outcome of pending purported class action and other related, or
potentially related, actions and the litigation costs with respect to
such actions; and
o our ability to establish and maintain collaborative arrangements.
We cannot assure you that we will be able to obtain additional funds or, if
such funds are available, that such funding will be on acceptable terms. If we
raise additional funds by issuing equity securities, dilution to our then
existing stockholders will result. If we raise additional funds through the
issuance of debt securities or borrowings, we may incur substantial interest
expense and could become subject to financial and other covenants that could
restrict our ability to take specified actions, such as incurring additional
debt or making capital expenditures. If adequate funds are not available, we
may be required to significantly curtail one or more of our commercialization
efforts or development programs or obtain funds through arrangements with
collaborative partners or others on less favorable terms than might otherwise
be available.
WE OPERATE IN A HIGHLY COMPETITIVE MARKET. OUR COMPETITORS MAY DEVELOP
ALTERNATIVE TECHNOLOGIES OR MORE EFFECTIVE PRODUCTS BEFORE WE ARE ABLE TO DO
SO.
The pharmaceutical and biotechnology industries are intensely competitive.
The technological areas in which we work continue to evolve at a rapid pace.
Our future success will depend upon our ability to compete in the research,
development and commercialization of products and technologies in our areas of
focus. Competition from pharmaceutical, chemical and biotechnology companies,
universities and research institutions is intense and we expect it to
increase. Many of these competitors are substantially larger than we are and
have substantially greater capital resources, research and development
capabilities and experience and manufacturing, marketing, financial and
managerial resources than we do. Acquisitions of competing companies by large
pharmaceutical companies or other companies could enhance the financial,
marketing and other resources available to these competitors.
29
Rapid technological development may result in our product candidates in
development becoming obsolete before we can begin marketing these product
candidates or before we are able to recover a significant portion of the
research, development and commercialization expenses incurred in the
development of those products. For example, since our launch of Oxandrin in
December 1995 through December 2000, a significant portion of Oxandrin sales
has been for treatment of patients suffering from AIDS-related weight loss.
These patients' need for Oxandrin may decrease as a result of the development
of more effective treatments, such as protease inhibitors. In fact, since
January 2001, growth in the AIDS-related weight loss market has slowed
substantially. As a result, we are working to expand the use of Oxandrin to
treat involuntary weight loss associated with other conditions, such as
cancer, burns, non-healing wounds and chronic obstructive pulmonary disease.
However, we may not be successful in our efforts.
Our products must compete with others to gain market acceptance and market
share. An important factor will be the timing of market introduction of
competitive products. Accordingly, the relative speed with which we and
competing companies can develop products, complete the clinical testing and
approval processes, and supply commercial quantities of the products to the
market will be an important element of market success. Significant competitive
factors include:
o capabilities of our collaborators;
o product safety and efficacy;
o timing and scope of regulatory approval;
o product availability;
o marketing and sales capabilities;
o reimbursement coverage from insurance companies and others;
o the amount of clinical benefits and side effects of our product
candidates relative to their cost;
o the method of administering a product;
o price; and
o patent protection.
Our competitors may develop more effective or more affordable products or
achieve earlier product development completion, patent protection, regulatory
approval or product commercialization than we do. Our competitors' achievement
of any of these goals could have a material adverse effect on our business.
These companies also compete with us to attract qualified personnel and to
attract third parties for acquisitions, joint ventures or other
collaborations.
MANUFACTURING OUR PRODUCTS REQUIRES US TO MEET STRINGENT QUALITY CONTROL
STANDARDS. IN ADDITION, WE DEPEND ON THIRD PARTIES TO MANUFACTURE MANY OF OUR
PRODUCTS, AND PLAN TO RELY ON THIRD PARTIES TO MANUFACTURE ANY FUTURE
PRODUCTS. IF WE OR THESE THIRD PARTIES FAIL TO MEET APPLICABLE QUALITY
REQUIREMENTS, OUR REVENUES AND PRODUCT DEVELOPMENT EFFORTS MAY BE MATERIALLY
ADVERSELY AFFECTED.
The manufacture of our products involves a number of technical steps and
requires us or our third-party suppliers to meet stringent quality control
specifications imposed by us or by governmental regulatory bodies. In the
event of a natural disaster, equipment failure, strike, war or other
difficulty, we may be unable to manufacture our products in a manner necessary
to fulfill demand. Our inability to fulfill demand may permit our licensees
and distributors to terminate their agreements, seek alternate suppliers or
manufacture the products themselves.
Further, we depend on third parties for the supply of many of our products.
The divestiture of our Israeli business operations will likely increase our
reliance on third parties for the supply of our products. Failure of any third
party to meet applicable regulatory requirement may adversely affect our
profit margins or result in unforeseen delays or other problems beyond our
control. For example, in July 2001, Bristol-Myers Squibb Company ceased
manufacturing Delatestryl for us when it closed the manufacturing facility at
which it produced Delatestryl. Risks involved with engaging third-party
suppliers include:
30
o reliance on the third party for regulatory compliance and quality
assurance;
o the possible breach of the manufacturing agreement by the third party or
the inability of the third party to meet our production schedules because
of factors beyond our control, such as shortages in qualified personnel;
and
o the possibility of termination or nonrenewal of the agreement by the
third party, based on its own business priorities, at a time that is
costly or inconvenient for us.
Additional delays or difficulties with our third-party suppliers could
significantly delay the manufacture of one or more of our products. If that
occurs, we may have to seek alternative sources of supply, which we may not be
able to obtain at commercially acceptable rates, if at all. If we cannot enter
into alternative supply arrangements, we may have to abandon or sell product
lines on unsatisfactory terms. Any of the foregoing may adversely affect our
financial results, possibly materially.
THE MANUFACTURE AND PACKAGING OF PHARMACEUTICAL PRODUCTS ARE SUBJECT TO THE
REQUIREMENTS OF THE FDA AND SIMILAR FOREIGN REGULATORY BODIES. IF WE OR OUR
THIRD-PARTY SUPPLIERS FAIL TO SATISFY THESE REQUIREMENTS, OUR BUSINESS
OPERATIONS MAY BE MATERIALLY HARMED.
The manufacturing process for pharmaceutical products is highly regulated.
Manufacturing activities must be conducted in accordance with the FDA's
current good manufacturing practices, or cGMP, and comparable requirements of
foreign regulatory bodies. For example, Rosemont is currently upgrading its
manufacturing facility to obtain FDA approval, so that it can sell oral liquid
formulations in the United States. Similarly, the FDA must approve our Be'er
Tuvia manufacturing facility before we can sell products manufactured in that
facility in the United States. Failure by us or our third-party suppliers to
comply with applicable regulations, requirements, or guidelines could result
in sanctions being imposed on us, including fines, injunctions, civil
penalties, failure of regulatory authorities to grant marketing approval of
our products, delays, suspension or withdrawal of approvals, license
revocation, seizures or recalls of product, operating restrictions and
criminal prosecutions, any of which could significantly and adversely affect
our business. Other than by contract, we do not have control over the
compliance by our third-party suppliers with these regulations and standards.
Changes in manufacturing processes or procedures, including changes in the
location where a product is manufactured or changes in a third-party supplier
may require prior FDA or other governmental review or approval or revalidation
of the manufacturing process. This review or revalidation may be costly and
time-consuming.
Because there are a limited number of manufacturers that operate under
applicable regulatory requirements, it may be difficult for us to change a
third-party supplier if we were otherwise required to do so. Similarly,
because of the applicable requirements, we may not be able to quickly and
efficiently replace our manufacturing capacity if we are unable to manufacture
our products at our facilities.
In October 2003 the FDA issued an approvable letter with respect to our
Nuflexxa product candidate for the treatment of pain associated with
osteoarthritis of the knee. The FDA stated in the letter that final FDA
approval was subject to satisfactory inspection of our new manufacturing
facility in Israel and finalization of product labeling. In December 2003 we
filed with the FDA an amendment to our pre-market approval application,
detailing the manufacture of Nuflexxa, in our new facility. The FDA
inspection, which is a prerequisite to obtaining final FDA approval to market
Nuflexxa in the United States, took place in August 2004. We expect a final
determination from the FDA within the next few months. If we do not receive
regulatory approval for the Be'er Tuvia facility, we would likely be unable to
meet the anticipated increased demand for our products.
During 2003 we transferred BioLon and Savient HA manufacturing to the Be'er
Tuvia facility. We expect to transfer human growth hormone manufacturing
operations to the Be'er Tuvia facility in 2004 and 2005 and file for
regulatory approval for the transfer during 2005. The manufacture of each
product at the Be'er Tuvia facility must be approved by applicable regulatory
authorities, including the FDA for products shipped to the U.S., prior to the
resumption of manufacturing of that product at the Be'er Tuvia facility. Prior
to transferring the manufacturing for each product to the Be'er Tuvia
facility, we plan to build inventory of
31
such product that we believe will be adequate to meet demand over the period
required to transfer the manufacturing operations and have them inspected and
approved. If it takes longer than expected to complete the transfer or obtain
regulatory approval or demand for our product exceeds our expectations, our
ability to meet our customers' requirements for their products will be
adversely affected.
WE HAVE LIMITED MARKETING CAPABILITY AND EXPERIENCE AND RELY ON THIRD
PARTIES TO MARKET MANY OF OUR PRODUCTS. IF THESE THIRD PARTIES DO NOT MEET OUR
PERFORMANCE EXPECTATIONS, OUR SALES MAY BE ADVERSELY AFFECTED.
We depend on third-party licensees to distribute and market many of our
products, including Bio-Tropin, Biolon, Mircette, Silkis, Bio-Hep-B, Nuflexxa,
Euflexxa and insulin products. The success of these arrangements depends on
each licensee's own financial, competitive, marketing and strategic
considerations, which include the relative advantages, including patent and
proprietary positions, of alternate products being marketed or developed by
others. Furthermore, the amounts of any payments to be received by us under
our license agreements from sales of product by licensees will depend on the
extent to which our licensees devote resources to the development and
commercialization of the products. Although we believe that our licensees have
an economic motivation to commercialize their products, we have no effective
control over the licensees' commercialization efforts.
We established a sales and marketing force in the United States during the
second half of 1995 to promote distribution of Oxandrin and our other products
in the United States. Our Rosemont subsidiary has a sales force that markets
Rosemont's products in the United Kingdom. In Israel, we maintain a small
sales force to market our products in the Israeli market. In all other
territories, we do not yet have an established sales force and rely on third
parties to market our products.
Turnover in our sales and marketing employees adversely affects our product
sales, as it can take several months to find and train new sales and marketing
employees. Competition for experienced sales and marketing employees is
intense, and we compete with companies with greater resources and larger
product lines. During 2003 we experienced significant difficulty in
maintaining our sales and marketing force in the United States as a result of
a number of factors, including the limited number of products we market in the
United States, the expected introduction of generic versions of Oxandrin, our
inability to in-license additional products for our sales and marketing team
to sell and the uncertainty created by the proposed acquisition of us by Teva
Pharmaceutical Industries Ltd. As a result, in November 2003, we engaged a
contract sales organization to fill territories for which we had lost and
could not replace sales and marketing employees. The successful marketing of
our products will be dependent on the efforts of this contract sales
organization, over which we will have little or no control.
The Ross Products Division of Abbott Laboratories, or Ross, markets Oxandrin
under a co-promotion agreement with us for the treatment of weight loss by
residents of long-term care facilities. According to IMS Health data, the
long-term care market represented approximately 16% of Oxandrin wholesaler to
end-user sales in 2003, and 14% in each of 2001 and 2002. Prescriptions in the
long-term care market decreased by 16.4% in 2003 compared to 2002. Since
January 1, 2004, prescriptions in the long-term care market have not further
decreased. To date, the average prescription written for the long-term care
market involves a lower dose of Oxandrin than the average prescription written
for the AIDS market. As a result, the rate of growth in Oxandrin sales may be
less than the rate of growth in prescriptions. Ross has the right to terminate
our Oxandrin co-promotion agreement at any time upon six months notice. If
Ross elects to do so, our Oxandrin sales could be adversely affected until we
are able to replace the Ross sales force. However, we may not be able to do so
successfully.
WE MAY NOT BE SUCCESSFUL IN ESTABLISHING ADDITIONAL STRATEGIC ALLIANCES,
WHICH COULD ADVERSELY AFFECT OUR ABILITY TO DEVELOP AND COMMERCIALIZE PRODUCTS
AND SERVICES.
Part of our new strategic plan to focus on product development involves
entering into new strategic alliances for the development and
commercialization of products and services when we believe that doing so will
maximize product value. For example, if the results of our ongoing Phase 2
clinical trial for Prosaptide are favorable, we may seek a collaborator in the
commercialization of the product candidate, rather than continue to develop it
on our own. We may also seek a collaborator for Puricase.
32
If we are unsuccessful in reaching an agreement with a suitable collaborator
for our current or future product candidates, we may fail to meet our business
objectives for the applicable product or program. We face significant
competition in seeking appropriate collaborators. Moreover, these alliance
arrangements are complex to negotiate and time-consuming to document. We may
not be successful in our efforts to establish additional strategic alliances
or other alternative arrangements. The terms of any additional strategic
alliances or other arrangements that we establish may not be favorable to us.
Moreover, such strategic alliances or other arrangements may not be
successful.
The risks that we are likely to face in connection with any future strategic
alliances include the following:
o Strategic alliance agreements are typically for fixed terms and are
subject to termination under various circumstances, including, in many
cases without cause.
o Our collaborators may change the focus of their development and
commercialization efforts.
o We may rely on our collaborators to manufacture the products covered by
our alliances.
o The areas of research, development and commercialization that we may
pursue, either alone or in collaboration with third parties, may be
limited as a result of non-competition provisions of our strategic
alliance agreements.
o Our collaborators may develop and commercialize, either alone or with
others, products and services that are similar to or competitive with the
products and services that are the subject of the alliance with us.
OUR SALES DEPEND ON PAYMENT AND REIMBURSEMENT FROM THIRD-PARTY PAYORS, AND A
REDUCTION IN THE PAYMENT OR REIMBURSEMENT RATE COULD RESULT IN DECREASED USE
OR SALES OF OUR PRODUCTS.
Most patients will rely on Medicare and Medicaid, private health insurers
and other third-party payors to pay for their medical needs, including any
drugs we or our collaborators may market. If third-party payors do not provide
adequate coverage or reimbursement for any products that we may develop, our
revenues and prospects for profitability will suffer. The U.S. Congress
recently enacted a limited prescription drug benefit for Medicare recipients
in the Medicare Prescription Drug and Modernization Act of 2003. While the
program established by this statute may increase demand for our products, if
we participate in this program our prices will be negotiated with drug
procurement organizations for Medicare beneficiaries and are likely to be
lower than we might otherwise obtain. Non-Medicare third-party drug
procurement organizations may also base the price they are willing to pay on
the rate paid by drug procurement organizations for Medicare beneficiaries.
A primary trend in the United States healthcare industry is toward cost
containment. In addition, in some foreign countries, particularly the
countries of the European Union, the pricing of prescription pharmaceuticals
is subject to governmental control. In these countries, pricing negotiations
with governmental authorities can take six to 12 months or longer after the
receipt of regulatory marketing approval for a product. To obtain
reimbursement or pricing approval in some countries, we may be required to
conduct a clinical trial that compares the cost effectiveness of our product
candidates or products to other available therapies. The conduct of such a
clinical trial could be expensive and result in delays in commercialization of
our products.
Third-party payors are challenging the prices charged for medical products
and services, and many third-party payors limit reimbursement for newly
approved healthcare products. In particular, third-party payors may limit the
indications for which they will reimburse patients who use any products we may
develop. Cost control initiatives could decrease the price we might establish
for products that we may develop, which would result in lower product revenues
to us.
Beginning in the second quarter of 2003, three states with budget crises -
New York, California, and Florida - have eliminated or limited reimbursement
of prescription drugs for HIV and AIDS, including Oxandrin, under their AIDS
Drug Assistance Programs, which has adversely affected and is expected to
continue to adversely affect sales of Oxandrin in those states. Efforts and
discussions are ongoing with these
33
state agencies to reverse these recent changes, but to date we have not been
successful and we cannot predict whether we will be successful in the future.
If we are not successful, our Oxandrin sales in this HIV/AIDS related
involuntary weight loss market will continue to be adversely impacted.
WE HAVE RECENTLY MADE SIGNIFICANT CHANGES IN OUR SENIOR MANAGEMENT TEAM. IF
WE FAIL TO ATTRACT AND KEEP SENIOR MANAGEMENT AND KEY SCIENTIFIC PERSONNEL, WE
MAY BE UNABLE TO SUCCESSFULLY DEVELOP OR COMMERCIALIZE OUR PRODUCT CANDIDATES.
We have recently made significant changes in our senior management team. On
July 13, 2004, Christopher Clement, who had been our president and chief
operating officer, became our president and chief executive officer. On May
28, 2004, Philip K. Yachmetz joined us as senior vice president and general
counsel and on August 23, 2004, Lawrence A. Gyenes joined us as senior vice
president, chief financial officer and treasurer. Our success will depend in
part on our ability to attract, retain and motivate highly qualified personnel
and to maintain continuity and stability within our management team.
There is a great deal of competition from other companies and research and
academic institutions for the limited number of scientists with expertise in
the areas of our activities. If we cannot continue to attract and retain, on
acceptable terms, the qualified personnel necessary for the continued
development of our business, we may not be able to sustain our operations and
execute on our business plan. We generally do not enter into employment
agreements with any of our scientific personnel. In addition, we do not
maintain, and have no current intention of obtaining, "key man" life insurance
on any of our employees.
ECONOMIC, POLITICAL AND OTHER RISKS ASSOCIATED WITH FOREIGN OPERATIONS COULD
ADVERSELY AFFECT OUR INTERNATIONAL SALES.
We significantly expanded our international operations with the acquisition
of Rosemont on September 30, 2002. Our product sales outside the United States
accounted for approximately 53% of our total product sales for the first nine
months of 2004 and 44% of our total product sales in 2003. Because we sell our
products worldwide, our businesses are subject to risks associated with doing
business internationally, including:
o difficulties in staffing and managing foreign operations;
o changes in a country's or region's political or economic conditions;
o longer payment cycles of foreign customers and difficulty of collecting
receivables in foreign jurisdictions;
o trade protection measures and import or export licensing requirements;
o less familiarity with business customs and practices;
o the imposition of tariffs and import and export controls;
o the impact of possible recessionary environments in economies outside the
United States;
o unexpected changes in regulatory requirements;
o currency exchange rate fluctuations;
o differing labor laws and changes in those laws;
o differing protection of intellectual property and changes in that
protection;
o differing tax laws and changes in those laws; and
o differing regulatory requirements and changes in those requirements.
We do not currently engage in currency hedging transactions. However,
depending on our sales from international operations and our perception as to
currency volatility, we may choose to limit our exposure by the purchase of
forward foreign exchange contracts or similar hedging strategies. The currency
exchange strategy that we adopt may not be successful in avoiding exchange-
related losses. In addition, the above-listed
34
factors may cause a decline in our future international revenue and,
consequently, may harm our business. We may not be able to sustain or increase
revenue that we derive from international sources.
OUR BUSINESS MAY BE ADVERSELY AFFECTED BY DEVELOPMENTS IN ISRAEL.
We currently conduct significant research, development and biologics
production activities in Israel. These activities are affected by economic,
military and political conditions in Israel and in the Middle East in general.
Since the establishment of the State of Israel in 1948, a number of armed
conflicts have taken place between Israel and its Arab neighbors. These
hostilities have caused security and economic problems in Israel. In addition,
since October 2000, there has been a significant increase in violence,
primarily in the West Bank and Gaza Strip. During the course of military
operations, Israel's military reserves, which include a number of our
employees and executives, may be called up, which could adversely affect our
ability to conduct our business.
Any major hostilities involving Israel could adversely affect our research,
development and production operations. Ongoing or revived hostilities related
to Israel could adversely affect us. For example, from the fourth quarter of
2001 until September 2002, we were required to stop U.S. shipments of BioLon
sterilized by our Israeli contractor because the FDA was unable to inspect the
new manufacturing facility of this contractor as a result of the violence in
Israel at the time. Additionally, in recent years the FDA has from time to
time suspended inspections of manufacturing facilities in Israel as a result
of violence in Israel. For example, the FDA cancelled its scheduled April 2003
visit to Israel in light of the then existing situation with Iraq. Any such
action could delay FDA inspection of the Be'er Tuvia facility and, therefore,
use of such facility to manufacture products for the U.S. market.
As discussed elsewhere in these risk factors, we are in the process of
exploring a potential divestiture of our Israeli business operations. The
risks associated with owning operations in Israel may reduce the number of
prospective buyers for our Israeli operations, and could adversely affect the
price we would receive in a divestiture.
WE MAY INCUR SUBSTANTIAL PRODUCT LIABILITY.
The testing and marketing of our products entail an inherent risk of product
liability and associated adverse publicity. Pharmaceutical product liability
exposure could be extremely large and pose a material risk. Although we have
so far been able to obtain indemnification from pharmaceutical companies
commercializing our products, other companies with which we collaborate may
not agree to do so. Furthermore, the companies that agree to these
indemnification obligations may not have adequate financial resources to
satisfy their obligation.
To the extent we elect to test or market products independently, we will
bear the risk of product liability directly. We currently have $20 million of
product liability insurance coverage in place. We cannot assure you that we
will be able to maintain existing insurance or obtain additional insurance on
acceptable terms, or at all. It is possible that a single product liability
claim could exceed our insurance coverage limits, and multiple claims are
possible. Any successful product liability claim made against us could
substantially reduce or eliminate any stockholders' equity we may have and
could materially harm our financial results. Product liability claims,
regardless of their merits, could be costly and divert management's attention,
and adversely affect our reputation and the demand for our products.
THE ULTIMATE OUTCOME OF PENDING SECURITIES LITIGATION IS UNCERTAIN.
After the restatement of our financial statements for the years ended
December 31, 1999, 2000 and 2001 and the first two quarters of 2002, we and
some of our current and former officers were named in a series of similar
purported securities class action lawsuits. The complaints in theses actions
allege violations of U.S. securities law through alleged material
misrepresentations and omissions and seek an unspecified award of damages.
In addition, members of our board of directors prior to June 2003 and Arthur
Andersen LLP, our prior auditor, were named in derivative actions that
claimed, among other things, that our directors breached their fiduciary
duties by failing to implement and maintain an adequate internal accounting
control system. While these derivative suits were dismissed by the court, we
have received a letter on behalf of a purported
35
stockholder demanding that we commence an action against most of our
directors, certain former directors, Arthur Andersen and others who were
responsible for the actions that resulted in the restatement of our financial
statements. A special committee of our board of directors, consisting of
directors who were not directors prior to our June 2003 annual meeting of
stockholders, has investigated this demand and has determined that litigation
relating to this matter should not proceed.
We intend to contest the pending securities actions against us vigorously.
However, an adverse decision in these cases could adversely affect us
financially. We have referred these claims to our directors and officers
insurance carrier, which has reserved its rights as to coverage with respect
to these actions.
RISKS RELATING TO INTELLECTUAL PROPERTY
IF WE ARE UNABLE TO OBTAIN AND MAINTAIN PROTECTION FOR THE INTELLECTUAL
PROPERTY RELATING TO OUR TECHNOLOGY AND PRODUCTS, THE VALUE OF OUR TECHNOLOGY
AND PRODUCTS WILL BE ADVERSELY AFFECTED.
Our success will depend in large part on our ability to obtain and maintain
protection in the United States and other countries for the intellectual
property covering or incorporated into our technology and products. The patent
situation in the field of biotechnology and pharmaceuticals is highly
uncertain and involves complex legal and scientific questions. We may not be
able to obtain additional issued patents relating to our technology or
products. Even if issued, patents may be challenged, narrowed, invalidated or
circumvented, which could limit our ability to stop competitors from marketing
similar products or limit the length of term of patent protection we may have
for our products. Changes in either patent laws or in interpretations of
patent laws in the United States and other countries may diminish the value of
our intellectual property or narrow the scope of our patent protection.
Our patents also may not afford us protection against competitors with
similar technology. Because patent applications in the United States and many
foreign jurisdictions are typically not published until 18 months after
filing, or in some cases not at all, and because publications of discoveries
in the scientific literature often lag behind actual discoveries, neither we
nor our licensors can be certain that we or they were the first to make the
inventions claimed in issued patents or pending patent applications, or that
we or they were the first to file for protection of the inventions set forth
in these patent applications.
IF WE ARE UNABLE TO PROTECT THE CONFIDENTIALITY OF OUR PROPRIETARY
INFORMATION AND KNOW-HOW, THE VALUE OF OUR TECHNOLOGY AND PRODUCTS COULD BE
ADVERSELY AFFECTED.
In addition to patented technology, we rely upon unpatented proprietary
technology, processes and know-how. We seek to protect this information in
part by confidentiality agreements with our employees, consultants and third
parties. These agreements may be breached, and we may not have adequate
remedies for any such breach. In addition, our trade secrets may otherwise
become known or be independently developed by competitors. If our confidential
information or trade secrets become publicly known, they may lose their value
to us.
IF WE INFRINGE OR ARE ALLEGED TO INFRINGE INTELLECTUAL PROPERTY RIGHTS OF
THIRD PARTIES, IT WILL ADVERSELY AFFECT OUR BUSINESS.
Our research, development and commercialization activities, as well as any
product candidates or products resulting from these activities, may infringe
or be claimed to infringe patents or patent applications under which we do not
hold licenses or other rights. Third parties may own or control these patents
and patent applications in the United States and abroad. These third parties
could bring claims against us or our collaborators that would cause us to
incur substantial expenses and, if successful against us, could cause us to
pay substantial damages. Further, if a patent infringement suit were brought
against us or our collaborators, we or they could be forced to stop or delay
research, development, manufacturing or sales of the product or product
candidate that is the subject of the suit.
As a result of patent infringement claims, or in order to avoid potential
claims, we or our collaborators may choose or be required to seek a license
from the third party and be required to pay license fees or royalties or both.
These licenses may not be available on acceptable terms, or at all. Even if we
or our collaborators were able to obtain a license, the rights may be
nonexclusive, which could result in our
36
competitors gaining access to the same intellectual property. Ultimately, we
could be prevented from commercializing a product, or be forced to cease some
aspect of our business operations, if, as a result of actual or threatened
patent infringement claims, we or our collaborators are unable to enter into
licenses on acceptable terms. This could harm our business significantly.
There has been substantial litigation and other proceedings regarding patent
and other intellectual property rights in the pharmaceutical and biotechnology
industries. In addition to infringement claims against us, we may become a
party to other patent litigation and other proceedings, including interference
proceedings declared by the United States Patent and Trademark Office and
opposition proceedings in the European Patent Office or in another patent
office, regarding intellectual property rights with respect to our products
and technology. The cost to us of any patent litigation or other proceeding,
even if resolved in our favor, could be substantial. Some of our competitors
may be able to sustain the costs of such litigation or proceedings more
effectively than we can because of their substantially greater financial
resources. Uncertainties resulting from the initiation and continuation of
patent litigation or other proceedings could adversely affect our ability to
compete in the marketplace. Patent litigation and other proceedings may also
absorb significant management time.
WE CURRENTLY ARE, AND IN THE FUTURE MAY BE, INVOLVED IN COSTLY LEGAL
PROCEEDINGS TO ENFORCE OR PROTECT OUR INTELLECTUAL PROPERTY RIGHTS OR TO
DEFEND AGAINST CLAIMS THAT WE INFRINGE THE INTELLECTUAL PROPERTY RIGHTS OF
OTHERS.
Litigation is inherently uncertain, and an adverse outcome could subject us
to significant liability for damages or invalidate our proprietary rights.
Legal proceedings that we initiate to protect our intellectual property rights
could also result in counterclaims or countersuits against us. Any litigation,
regardless of its outcome, could be time-consuming and expensive to resolve
and could divert our management's time and attention. Any intellectual
property litigation also could force us to take specific actions, including:
o cease selling products or undertaking processes that are claimed to be
infringing a third party's intellectual property;
o obtain licenses to make, use, sell, offer for sale or import the relevant
technologies from the intellectual property's owner, which licenses may
not be available on reasonable terms, or at all;
o redesign those products or processes that are claimed to be infringing a
third party's intellectual property; or
o pursue legal remedies with third parties to enforce our indemnification
rights, which may not adequately protect our interests.
We are currently a party to several lawsuits and disputes regarding
intellectual property, including:
o with Genentech, relating to human growth hormone in Israel;
o with Novo Nordisk, relating to human growth hormone in the United States;
and
o with Barr Laboratories, relating to Mircette in the United States.
These lawsuits, which are described in greater detail in our Annual Report
on Form 10-K for the year ended December 31, 2003 in the section titled "Item
3. Legal Proceedings", have diverted, and are expected to continue to divert,
the efforts and attention of our key management and technical personnel. We
have incurred, and expect to continue to incur, substantial legal fees and
expenses in connection with these lawsuits. As a result, these lawsuits,
regardless of their eventual outcomes, have been, and will continue to be,
costly and time-consuming. Furthermore, we could be involved in similar
disputes or litigation with other third parties in the future. An adverse
decision in any intellectual property litigation could have a material adverse
effect on our business, results of operations and financial condition.
37
REGULATORY RISKS
WE ARE SUBJECT TO STRINGENT GOVERNMENTAL REGULATION, AND OUR FAILURE TO
COMPLY WITH APPLICABLE REGULATIONS COULD ADVERSELY AFFECT OUR ABILITY TO
CONDUCT OUR BUSINESS.
Virtually all aspects of our business are subject to extensive regulation by
numerous federal and state governmental authorities in the United States, such
as the FDA, as well as by foreign countries where we manufacture or distribute
our products. Of particular significance are the requirements covering
research and development, testing, manufacturing, quality control, labeling
and promotion of pharmaceutical products for human use. All of our products,
manufacturing processes and facilities require governmental licensing or
approval prior to commercial use. A pharmaceutical product cannot be marketed
in the United States until it has been approved by the FDA, and then can only
be marketed for the indications and claims approved by the FDA. As a result of
these requirements, the length of time, the level of expenditures and the
laboratory and clinical information required for approval of an NDA are
substantial. The approval process applicable to products of the type being
developed by us usually takes five to seven years from the commencement of
human clinical trials and typically requires substantial expenditures. We and
our collaborators may encounter significant delays or excessive costs in our
or their respective efforts to secure necessary approvals or licenses. Before
obtaining regulatory approval for the commercial sale of our products, we are
required to conduct pre-clinical and clinical trials to demonstrate that the
product is safe and efficacious for the treatment of the target indication.
The timing of completion of clinical trials depends on a number of factors,
many of which are outside our control. In addition, we and our collaborators
may encounter delays or rejections based upon changes in the policies of
regulatory authorities. The FDA and foreign regulatory authorities have
substantial discretion to terminate clinical trials, require additional
testing, delay or withhold registration and marketing approval, and mandate
product withdrawals.
Failure to obtain requisite governmental approvals, or failure to obtain
approvals of the scope requested, could delay or preclude us or our
collaborators from marketing our products, could limit the commercial use of
the products and could also allow competitors time to introduce competing
products ahead of product introductions by us. Even after regulatory approval
is obtained, use of the products could reveal side effects that, if serious,
could result in suspension of existing approvals and delays in obtaining
approvals in other jurisdictions.
Regulation by governmental authorities in the United States and other
countries is a significant factor affecting the timing of the
commercialization of our products and our ongoing research and development
activities. The timing of regulatory approvals is not within our control. To
date, the length of time required to obtain regulatory approval of genetically
engineered products has been significantly longer than expected, both for us
and the biotechnology industry in general. We believe that these delays have
in the past negatively impacted our ability to attract funding and that, as a
result, the terms of such financings have been less favorable to us than they
might otherwise have been had our product revenues provided sufficient funds
to finance the large costs of taking a product from discovery through
commercialization. As a result, we have had to license the commercialization
of many of our products to third parties in exchange for research funding and
royalties on product sales, resulting in lower revenues than if we had
commercialized the products on our own.
Failure to comply with applicable regulatory requirements can, among other
things, result in significant fines or other sanctions, termination of
clinical trials, suspension of regulatory approvals, product recalls, seizure
of products, imposition of operating restrictions and criminal prosecutions.
While we have developed and instituted a corporate compliance program based on
current best practices, we cannot assure you that we or our employees have
been or will be in compliance with all potentially applicable federal and
state regulations.
Further, FDA policy or similar policies of regulatory agencies in other
countries may change and additional governmental requirements may be
established that could prevent or delay regulatory approval of our products.
We cannot predict what effect changes in regulations, enforcement positions,
statutes or legal interpretation, when and if promulgated, adopted or enacted,
may have on our business in the future. Changes could, among other things,
require changes to manufacturing methods or facilities, expanded or different
labeling, new approvals, the recall, replacement or discontinuance of certain
products, additional record
38
keeping and expanded scientific substantiation. These changes, or new
legislation, could adversely affect our business.
RISKS RELATING TO AN INVESTMENT IN OUR COMMON STOCK
OUR STOCK PRICE IS VOLATILE, WHICH COULD ADVERSELY AFFECT YOUR INVESTMENT.
Our stock price is volatile. The market price of our common stock may be
influenced many factors, including:
o our ability to successfully implement our new strategic direction;
o announcements of technological innovations or new commercial products by
us or our competitors;
o announcements by us or our competitors of results in pre-clinical testing
and clinical trials;
o regulatory developments;
o patent or proprietary rights developments;
o public concern as to the safety or other implications of biotechnology
products;
o changes in our earnings estimates and recommendations by securities
analysts;
o period-to-period fluctuations in our financial results; and
o general economic, industry and market conditions.
The volatility of our common stock imposes a greater risk of capital losses
on our stockholders than would a less volatile stock. In addition, volatility
makes it difficult to ascribe a stable valuation to a stockholder's holdings
of our common stock. The stock market in general and the market for
biotechnology companies in particular have also experienced significant price
and volume fluctuations that are often unrelated to the operating performance
of particular companies. In the past, following periods of volatility in the
market price of the securities of biopharmaceutical companies, securities
class action litigation has often been instituted against these companies.
Such litigation would result in substantial costs and a diversion of
management's attention and resources, which could adversely affect our
business.
FUTURE EXERCISES OF OUTSTANDING STOCK OPTIONS OR THE ISSUANCE OF SHARES IN
ACQUISITIONS OR OTHER TRANSACTIONS COULD LEAD TO SALES OF OUR COMMON STOCK AND
ADVERSELY REDUCE THE MARKET PRICE OF OUR COMMON STOCK.
The market price of our common stock could be adversely affected by future
exercises of outstanding stock options and the issuance of common stock in
acquisitions of businesses, products or other technologies. At September 30,
2004, options to purchase an aggregate of approximately 8 million shares of
common stock were outstanding. A portion of these options have exercise prices
below the current market price of the common stock. Shares of common stock
issuable upon exercise of these outstanding options will be freely tradable
without restriction, unless held by one of our affiliates. The sale of a
significant amount of these shares at one time could adversely affect the
market price of our common stock.
WE EXPECT OUR QUARTERLY RESULTS TO FLUCTUATE, WHICH MAY CAUSE VOLATILITY IN
OUR STOCK PRICE.
Our revenues and expenses have in the past and may in the future continue to
display significant variations. These variations may result from a variety of
factors, including:
o the amount and timing of product sales;
o changing demand for our products;
o our inability to provide adequate supply for our products;
o changes in wholesaler buying patterns;
o returns of expired product;
39
o changes in government or private payor reimbursement policies for our
products;
o increased competition from new or existing products, including generic
products;
o the timing of the introduction of new products;
o the timing and realization of milestone and other payments from
licensees;
o the timing and amount of expenses relating to research and development,
product development and manufacturing activities;
o the extent and timing of costs of obtaining, enforcing and defending
intellectual property rights; and
o any charges related to acquisitions.
Because many of our expenses are fixed, particularly in the short-term, any
decrease in revenues will adversely affect our earnings until revenues can be
increased or expenses reduced. For example, in 1999, the first five months of
2000 and the second half of 2001, our revenues and earnings were adversely
affected by Accredo's decision to reduce the amount of Oxandrin inventory it
carried. We also expect our revenues and earnings to be adversely affected
once a generic version of Oxandrin is introduced. Because of fluctuations in
revenues and expenses, it is possible that our operating results for a
particular quarter or quarters will not meet the expectations of public market
analysts and investors, which could cause the market price of our common stock
to decline. We believe that period-to-period comparisons of our operating
results are not a good indication of our future performance and stockholders
should not rely on those comparisons to predict our future operating or share
price performance.
EFFECTING A CHANGE OF CONTROL OF OUR COMPANY COULD BE DIFFICULT, WHICH MAY
DISCOURAGE OFFERS FOR SHARES OF OUR COMMON STOCK.
Our certificate of incorporation and the Delaware General Corporation Law
contain provisions that may delay or prevent an attempt by a third party to
acquire control of us. These provisions include the requirements of Section
203 of the Delaware General Corporation Law. In general, Section 203 prohibits
designated types of business combinations, including mergers, for a period of
three years between us and any third party that owns 15% or more of our common
stock. This provision does not apply if:
o our board of directors approves of the transaction before the third party
acquires 15% of our stock;
o the third party acquires at least 85% of our stock at the time its
ownership goes past the 15% level; or
o our board of directors and two-thirds of the shares of our common stock
not held by the third party vote in favor of the transaction.
We have also adopted a stockholder rights plan intended to deter hostile or
coercive attempts to acquire us. Under the plan, if any person or group
acquires more than 20% of our common stock without approval of our board of
directors under specified circumstances, our other stockholders have the right
to purchase shares of our common stock, or shares of the acquiring company, at
a substantial discount to the public market price. As a result, the plan makes
an acquisition much more costly to a potential acquirer.
Our certificate of incorporation also authorizes us to issue up to 4 million
shares of preferred stock in one or more different series with terms fixed by
our board of directors. Stockholder approval is not necessary to issue
preferred stock in this manner. Issuance of these shares of preferred stock
could have the effect of making it more difficult for a person or group to
acquire control of us. No shares of our preferred stock are currently
outstanding. While our board of directors has no current intention or plan to
issue any preferred stock, issuance of these shares could also be used as an
anti-takeover device.
WE ARE EXPOSED TO POTENTIAL RISKS FROM RECENT LEGISLATION REQUIRING
COMPANIES TO EVALUATE CONTROLS UNDER SECTION 404 OF THE SARBANES-OXLEY ACT OF
2002.
We are evaluating our internal controls to allow management to report on,
and our Registered Independent Public Accounting Firm to attest to, our
internal controls, as required by Section 404 of the Sarbanes-Oxley Act. We
are performing the system and process evaluation and testing required in an
effort to comply with the management certification and auditor attestation
requirements of Section 404. While we
40
anticipate being able to fully implement the requirements relating to internal
controls and all other aspects of Section 404 in a timely fashion:
o we cannot be certain as to the timing of completion of our evaluation,
testing and remediation actions or their effects on our operations in
part because there is no precedent available by which to measure
compliance adequacy,
o as described in Item 4 of this form 10-Q/A, we have identified a
"material weakness" in our internal controls relating to shipping terms
under customer contracts and related revenue recognition, and
o we also previously disclosed a "material weakness" in our internal
controls relating to our communication with and supervision of our
accounting staff at our Israeli subsidiary.
We have implemented steps to remediate these weaknesses in our internal
controls and we believe we have enhanced our internal control procedures in
such a manner so as to prevent reoccurrences of these deficiencies.
However, to the extent we have not fully remediated these weaknesses or if
we experience additional material weaknesses in the future, we may not be able
to comply with the requirements of Section 404. We have instituted new
procedures that include additional reviews of customer billings to ensure that
revenue is recognized according to the terms of sale in our contracts. In
addition, we have identified the need to consider the mix and the possible
addition of staff with accounting research and tax expertise and are taking
steps to improve the segregation of duties among the relatively small number
of our employees who deal with general, administrative and financial matters
at each of our three primary business locations. If we are not able to
implement policy or adequately segregate functions, particularly as they
relate to inventory management, sales order processing, treasury, payroll and
procurement processing functions, we may not be able to comply with the
requirements of Section 404. If we are not able to implement the requirements
of Section 404 in a timely manner or with adequate compliance, we might be
subject to sanctions or investigations by regulatory authorities, such as the
Securities and Exchange Commission or the NASDAQ National Market. Any such
action could adversely affect our financial results and the market price of
our common stock.
41
ITEM 4. CONTROLS AND PROCEDURES
Our management, with the participation of our chief executive officer and
chief financial officer, evaluated the effectiveness of our disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Exchange Act) as of September 30, 2004. In designing and evaluating our
disclosure controls and procedures, management recognized that any controls
and procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving their objectives and our management
necessarily applied its judgment in evaluating the cost-benefit relationship
of possible controls and procedures.
During the course of their review of the financial information included in
our Quarterly Report on Form 10-Q for the quarter ended June 30, 2004, Grant
Thornton LLP, our independent auditors, informed our management and our audit
committee that they identified deficiencies in our internal controls relating
to our communication with and supervision of our accounting staff at our
Israeli subsidiary, Bio-Technology General (Israel) Ltd. These deficiencies
were identified in connection with the manner in which the accounting staff at
our Israeli subsidiary accounted for inter-company revenues and costs of good
sold during the second quarter of 2004. Grant Thornton informed us that they
believe that these deficiencies constituted a "material weakness" in our
internal controls. However, we have no reason to believe that this weakness
resulted in any material inaccuracies to our financial statements in that the
transaction in question had been properly accounted for in the financial
statements included in our Quarterly Report on Form 10-Q for the quarter ended
June 30, 2004.
In response to this situation, we implemented the following steps to
remediate this weakness in our internal controls:
o prohibiting the accounting staff of our subsidiaries to change accounting
policies or methodologies without prior review and approval from our
chief financial officer;
o requiring the accounting staff at each of our subsidiaries to prepare a
standardized financial reporting package that must be prepared and
provided to us as part of the process of closing financial records at the
end of each quarter; and
o causing the appropriate members of our financial reporting staff to visit
with the accounting staff of each of our subsidiaries to ensure proper
education and compliance with these new policies.
We believe that the steps taken to date have addressed the material weakness
that affected our disclosure controls and procedures as reported in our
Quarterly Report on Form 10-Q for the quarter ended June 30, 2004. We will
continue with our ongoing evaluation and will improve our disclosure controls
as necessary to assure their effectiveness.
Additionally, as previously announced in our Current Report on Form 8-K
filed on January 6, 2005 with the SEC, we have determined that our contracts
with our most significant U.S.-based customers have included terms that
transfer title to the product upon delivery. These contracts cover the
majority of our sales to U.S. drug wholesalers beginning in 2003. In general,
our shipping methods take up to five business days from shipment until
delivery. As a result, some revenues may have been recognized up to five days
earlier than permitted under generally accepted accounting principles. This
correction does not affect the amount of revenue that we will ultimately
recognize, although it will affect (by one to five days) the timing of revenue
recognition. As a result, some shipments made during the final week of a
quarter should have been recognized in the subsequent quarter.
We have concluded that the lack of internal controls relating to shipping
terms under customer contracts and related revenue recognition constituted a
material weakness in the design and operation of our internal controls. In a
letter to the audit committee of our board of directors dated January 6, 2005
(and delivered to us on February 14, 2005), Grant Thornton informed us that it
has reached the same conclusion. Prior to receiving this letter from Grant
Thornton, we had instituted additional procedures and controls to remediate
this material weakness, including:
o establishing and improving communications guidelines between departments;
o reviewing customer billing terms and determinations of revenue
recognition;
42
o instituting periodic reviews of material agreements for customer billing
terms and determination of actual delivery dates for shipments; and
o modifying our accounting policies and procedures manual related to
revenue recognition and including requirements for approval of changes in
agreements and related revenue recognition implications.
As a result of the remediation steps described above, we have concluded that
the above described material weakness relating to shipping terms and related
revenue recognition has been remediated.
No other change in our internal control over financial reporting (as defined
in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the
fiscal quarter ended September 30, 2004 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
43
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS
(a) Exhibits
The exhibits listed in the Exhibit Index are included in this report.
44
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.
SAVIENT PHARMACEUTICALS, INC.
(Registrant)
By: /s/ Christopher Clement
--------------------------------------------
Christopher Clement
President and Chief Executive Officer
(Principal Executive Officer)
/s/ Lawrence A. Gyenes
--------------------------------------------
Lawrence A. Gyenes
Senior Vice President, Chief Financial
Officer and Treasurer
(Principal Financial and Accounting Officer)
Dated: February 22, 2005
45
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- ----------- --------------------------------------------------------------------------------------------------------------------
3.1 Certificate of Incorporation, as amended (1)
3.2 By-laws, as amended (2)
10.1 Employment agreement dated August 23, 2004, between Lawrence A. Gyenes and the Registrant (3)
31.1 Certification of principal executive officer pursuant to Rule 13a-14(a)/15d-14(a) under the Securities Exchange Act
of 1934, as amended
31.2 Certification of the principal financial officer pursuant to Rule 13a-14(a)/15d-14(a) under the Securities Exchange
Act of 1934, as amended
32.1 Statement pursuant to 18 U.S.C. ss.1350
32.2 Statement pursuant to 18 U.S.C. ss.1350
- ---------------
(1) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the quarter ended June 30, 1994.
(2) Incorporated by reference from the Registrant's Current Report on Form 8-K,
dated October 7, 1998.
(3) Incorporated by reference from the Registrant's Current Report on Form 8-K,
dated August 27, 2004.
46