FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
(Mark one)
[x] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended March 31, 2006
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 0-16132
CELGENE CORPORATION
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(Exact name of registrant as specified in its charter)
Delaware 22-2711928
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification
Number)
86 Morris Avenue, Summit, NJ 07901
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (908) 673-9000.
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
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Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (check
one):
Large accelerated X Accelerated Non-accelerated
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Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes No X
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At May 5, 2006, 347,408,258 shares of Common Stock par value $.01 per share,
were outstanding.
CELGENE CORPORATION
INDEX TO FORM 10-Q
TABLE OF CONTENTS
PAGE NO.
PART I FINANCIAL INFORMATION --------
Item 1 Unaudited Consolidated Financial Statements
Consolidated Statements of Operations -
Three-Month Periods Ended March 31, 2006 and 2005 3
Consolidated Balance Sheets -
As of March 31, 2006 and December 31, 2005 4
Consolidated Statements of Cash Flows -
Three-Month Periods Ended March 31, 2006 and 2005 5
Notes to Unaudited Consolidated Financial Statements 7
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 20
Item 3 Quantitative and Qualitative Disclosures About Market Risk 29
Item 4 Controls and Procedures 32
PART II OTHER INFORMATION 33
Item 1 Legal Proceedings 33
Item 1A Risk Factors 33
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds 33
Item 3 Defaults Upon Senior Securities 33
Item 4 Submission of Matters to a Vote of Security Holders 33
Item 5 Other Information 33
Item 6 Exhibits 33
Signatures 34
2
PART I - FINANCIAL INFORMATION
ITEM 1. UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
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CELGENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars in thousands, except per share amounts)
THREE-MONTH PERIOD ENDED
MARCH 31,
-------------------------
2006 2005
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Revenue:
Net product sales $ 160,243 $ 97,645
Collaborative agreements and other revenue 3,893 5,229
Royalty revenue 17,705 9,522
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Total revenue 181,841 112,396
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Expenses:
Cost of goods sold 30,144 12,604
Research and development 54,524 40,037
Selling, general and administrative 66,897 37,806
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Total expenses 151,565 90,447
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Operating income 30,276 21,949
Other income and expense:
Interest and other income (expense), net 6,246 (1,178)
Equity in losses of affiliated company 3,091 4,355
Interest expense 2,365 2,374
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Income before income taxes 31,066 14,042
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Income tax provision (benefit) 15,042 (34,172)
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Net income $ 16,024 $ 48,214
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Net income per common share:
Basic $ 0.05 $ 0.15
Diluted $ 0.04 $ 0.13
See accompanying Notes to Consolidated Financial Statements
3
CELGENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share amounts)
MARCH 31, 2006 DECEMBER 31, 2005
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(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 194,468 $ 123,316
Marketable securities available for sale 578,109 600,944
Accounts receivable, net of allowance of $4,458 and $3,739
at March 31, 2006 and December 31, 2005, respectively 90,310 77,913
Inventory 16,214 20,242
Deferred income taxes 117,588 113,059
Other current assets 43,535 37,363
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Total current assets 1,040,224 972,837
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Property, plant and equipment, net 83,276 77,477
Investment in affiliated company 15,288 17,017
Intangible assets, net 95,874 96,988
Goodwill 34,189 33,815
Deferred income taxes 33,460 31,260
Other assets 17,475 17,243
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Total assets $ 1,319,786 $ 1,246,637
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LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 24,718 $ 16,414
Accrued expenses 74,688 92,908
Income taxes payable 14,884 14,715
Current portion of deferred revenue 6,549 6,473
Other current liabilities 2,723 5,127
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Total current liabilities 123,562 135,637
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Long-term convertible notes 399,975 399,984
Deferred revenue, net of current portion 58,266 59,067
Other non-current liabilities 19,399 16,174
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Total liabilities 601,202 610,862
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COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value per share, 5,000,000 shares
authorized; none outstanding at March 31, 2006 and December 31, 2005 -- --
Common stock, $.01 par value per share, 575,000,000 shares
authorized; issued 348,125,432 and 344,125,158 shares
at March 31, 2006 and December 31, 2005, respectively 3,481 3,441
Common stock in treasury, at cost; 1,761,719 and 1,953,282 shares
at March 31, 2006 and December 31, 2005, respectively (45,765) (50,601)
Additional paid-in capital 917,212 853,601
Accumulated deficit (154,730) (170,754)
Accumulated other comprehensive income (loss) (1,614) 88
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Total stockholders' equity 718,584 635,775
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Total liabilities and stockholders' equity $ 1,319,786 $ 1,246,637
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See accompanying Notes to Consolidated Financial Statements
4
CELGENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
THREE-MONTH PERIOD ENDED
MARCH 31,
-------------------------
2006 2005
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Net income $ 16,024 $ 48,214
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of long-term assets 5,592 3,191
Provision for accounts receivable allowances 4,276 622
Realized loss (gain) on marketable securities available for sale 3,346 (209)
Unrealized loss on marketable securities available for sale classified as cash equivalents 16 --
Unrealized loss (gain) on value of EntreMed warrants (107) 6,875
Equity losses of affiliated company 3,091 4,355
Non-cash share-based compensation expense 14,889 62
Excess tax benefit from stock-based compensation arrangements (21,586) --
Amortization of premium/discount on marketable securities available for sale, net (337) 505
Loss on asset disposals 147 --
Amortization of debt issuance cost 611 611
Amortization of discount on note obligation 13 --
Deferred income taxes (8,501) (42,664)
Shares issued for employee benefit plans 6,518 --
Other 408 --
Change in current assets and liabilities:
Increase in accounts receivable (16,795) (3,798)
Decrease (increase) in inventory 3,770 (9,140)
(Increase) decrease in other operating assets (2,956) 75
Decrease in accounts payable and accrued expenses (14,568) (5,159)
Increase (decrease) in income tax payable 23,233 (7,954)
Decrease in deferred revenue (1,381) (688)
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Net cash provided by (used in) operating activities 15,703 (5,102)
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Cash flows from investing activities:
Capital expenditures (9,447) (4,151)
Business acquisition -- (8,429)
Proceeds from sales and maturities of marketable securities available for sale 235,067 39,827
Purchases of marketable securities available for sale (214,821) (86,806)
Investment in affiliated company (2,000) (10,500)
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Net cash provided by (used in) investing activities 8,799 (70,059)
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Cash flows from financing activities:
Net proceeds from exercise of common stock options and warrants 23,101 13,883
Excess tax benefit from share-based compensation arrangements 21,586 --
Repayment of capital lease and note obligations -- (3)
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Net cash provided by financing activities 44,687 13,880
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Effect of currency rate changes on cash and cash equivalents 1,963 (1,601)
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Net increase (decrease) in cash and cash equivalents 71,152 (62,882)
Cash and cash equivalents at beginning of period 123,316 135,227
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Cash and cash equivalents at end of period $ 194,468 $ 72,345
=======================================================================================================================
See accompanying Notes to Consolidated Financial Statements
5
CELGENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS)
THREE-MONTH PERIOD ENDED
MARCH 31,
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2006 2005
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Supplemental schedule of non-cash investing and
financing activity:
Change in net unrealized loss on marketable
securities available for sale $ (2,911) $(30,845)
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Matured shares tendered for stock option exercises
and employee tax withholdings (376) --
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Conversion of convertible notes 9 --
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Supplemental disclosure of cash flow information:
Interest paid $ 1,750 $ 1,750
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Income taxes paid 296 17,532
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See accompanying Notes to Consolidated Financial Statements
6
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
1. ORGANIZATION AND BASIS OF PRESENTATION
Celgene Corporation and its subsidiaries (collectively "Celgene" or the
"Company") is an integrated biopharmaceutical company primarily engaged in the
discovery, development and commercialization of innovative therapies designed to
treat cancer and immune-inflammatory diseases through regulation of cellular,
genomic and proteomic targets. The Company's commercial stage programs include
pharmaceutical sales of REVLIMID(R), THALOMID(R), and ALKERAN(R) and sales of
Focalin(TM) to Novartis Pharma AG, or Novartis; a licensing agreement with
Novartis which entitles the Company to royalties on FOCALIN XR(TM) and the
entire RITALIN(R) family of drugs; a licensing and product supply agreement with
Pharmion for its sales of thalidomide; and sales of bio-therapeutic products and
services through its Cellular Therapeutics subsidiary.
The unaudited consolidated financial statements included herein have been
prepared from the books and records of the Company pursuant to the rules and
regulations of the Securities and Exchange Commission for reporting on Form
10-Q. Certain information and footnote disclosures normally included in complete
consolidated financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
condensed or omitted pursuant to such rules and regulations. Certain
reclassifications have been made to the prior period's consolidated financial
statements in order to conform to the current period's presentation. The interim
consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company's
latest annual report on Form 10-K for the year ended December 31, 2005.
Interim results may not be indicative of the results that may be expected for
the full year. In the opinion of management, these financial statements include
all normal and recurring adjustments considered necessary for a fair
presentation of these interim statements.
In December 2005, the Company's Board of Directors approved a two-for-one stock
split payable in the form of a 100 percent stock dividend. Stockholders received
one additional share for every share they owned as of the close of business on
February 17, 2006. The additional shares were distributed on February 24, 2006.
As a result, the total number of authorized shares of capital stock increased
from 280,000,000 to 580,000,000 and shares of common stock outstanding increased
from 172,057,726 to 344,115,452 as of the close of business on February 24,
2006. All share and per share amounts in the consolidated financial statements
have been restated to reflect the two-for-one stock split effective February 17,
2006.
2. EARNINGS PER SHARE
Basic earnings per common share is computed by dividing net income available to
common stockholders by the weighted-average number of common shares outstanding
during the period. Diluted earnings per common share is computed by dividing net
income adjusted to add back the after-tax amount of interest recognized in the
period associated with any convertible debt issuance that may be dilutive by the
weighted-average number of common shares outstanding during the period increased
to include all additional common shares that would have been outstanding
assuming potentially dilutive common shares had been issued and any proceeds
thereof used to repurchase common stock at the average market price during the
period. The proceeds used to repurchase common stock are assumed to be the sum
of the amount to be paid to the Company upon exercise of options, the amount of
compensation cost attributed to future services and not yet recognized and, if
applicable, the amount of income taxes that would be credited to or deducted
from paid-in capital upon exercise. The potential common shares related to the
June 2003 convertible note issuance were included in the earnings per share
calculation for the three-month periods ended March 31, 2006 and 2005.
The total number of potential common shares excluded from the diluted earnings
per share computation because their inclusion would have been anti-dilutive was
832,473 and 5,678,454 for the three-month periods ended March 31, 2006 and 2005,
respectively.
7
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
The following represents the reconciliation of the basic and diluted earnings
per share computations for the three-month periods ended March 31, 2006 and
2005:
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Three-Month Period Ended
March 31,
2006 2005
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Income available to common stockholders:
Net income $ 16,024 $ 48,214
Interest expense on convertible debt, net of tax 1,393 1,393
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Net income available to common stockholders $ 17,417 $ 49,607
Weighted average number of common shares
outstanding (IN THOUSANDS):
Basic 343,966 331,225
Effect of dilutive securities:
Options 23,245 17,136
Warrants 214 332
Convertible debt 33,022 33,024
Restricted shares and other
long-term incentives 252 499
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Diluted 400,699 382,216
Earnings per share:
Basic $ 0.05 $ 0.15
Diluted $ 0.04 $ 0.13
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3. CONVERTIBLE DEBT
In June 2003, the Company issued an aggregate principal amount of $400.0 million
of unsecured convertible notes. The notes have a five-year term and a coupon
rate of 1.75% payable semi-annually on June 1 and December 1. Each $1,000
principal amount of convertible notes is convertible into 82.5592 shares of
common stock, or a conversion rate of $12.1125 per share, which represented a
50% premium to the closing price on May 28, 2003 of the Company's common stock
of $8.075, after adjusting prices for the two-for-one stock splits affected on
February 17, 2006 and October 22, 2004. The debt issuance costs related to these
convertible notes, which totaled approximately $12.2 million, are classified
under "Other Assets" on the consolidated balance sheet and are being amortized
over five years, assuming no conversion. Under the terms of the purchase
agreement, the noteholders can convert the outstanding notes at any time into an
aggregate 33,021,617 shares of common stock at the conversion price. In
addition, the noteholders have the right to require the Company to redeem the
notes in cash at a price equal to 100% of the principal amount to be redeemed,
plus accrued interest, prior to maturity in the event of a change of control and
certain other transactions defined as a "fundamental change," in the indenture
governing the notes. The Company registered the notes and common stock issuable
upon conversion of the notes with the Securities and Exchange Commission, and is
required to use reasonable best efforts to keep the related registration
statement effective for the defined period. Subsequent to the June 2003 issuance
date, an immaterial amount of principal was converted into common stock.
4. MARKETABLE SECURITIES AVAILABLE FOR SALE
The amortized cost, gross unrealized holding gains, gross unrealized holding
losses and estimated fair value of available-for-sale securities by major
security type and class of security at March 31, 2006 and December 31, 2005 were
as follows:
8
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
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Gross Gross Estimated
Amortized Unrealized Unrealized Fair
March 31, 2006 Cost Gain Loss Value
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CASH EQUIVALENTS (1)
Government sponsored agency securities $121,571 $ 19 $ (5) $121,585
Corporate debt securities 18,834 2 -- 18,836
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Total available-for-sale cash equivalents 140,405 21 (5) 140,421
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AVAILABLE-FOR-SALE MARKETABLE SECURITIES
Mortgage backed obligations 79,057 251 (779) 78,529
U.S. treasury securities 103,319 -- (965) 102,354
Government sponsored agency securities 231,581 2 (5,501) 226,082
Corporate debt securities 18,514 13 (1,842) 16,685
Other asset backed securities 37,701 229 (47) 37,883
Auction rate notes 81,625 -- -- 81,625
Marketable equity securities 20,212 14,739 -- 34,951
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Total available-for-sale marketable securities 572,009 15,234 (9,134) 578,109
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Total marketable securities $712,414 $ 15,255 $ (9,139) $718,530
=======================================================================================================================
(1) Marketable securities with maturities of three months or less at time of
purchase are classified as cash equivalents.
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Gross Gross Estimated
Amortized Unrealized Unrealized Fair
December 31, 2005 Cost Gain Loss Value
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AVAILABLE-FOR-SALE MARKETABLE SECURITIES
Mortgage backed obligations $ 86,478 $ 365 $ (524) $ 86,319
U.S. treasury securities 24,391 14 (614) 23,791
Government sponsored agency securities 183,315 25 (3,538) 179,802
Corporate debt securities 18,526 29 (2,652) 15,903
Other asset backed securities 29,765 164 (1,842) 28,087
Auction rate notes 232,575 -- -- 232,575
Marketable equity securities 20,212 14,255 -- 34,467
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Total available-for-sale marketable securities $595,262 $ 14,852 $ (9,170) $600,944
=======================================================================================================================
Government sponsored agency securities include fixed asset-backed securities
issues by Fannie Mae and the Federal Home Loan Bank. Other asset-backed
securities are securities backed by collateral other than mortgage obligations.
Unrealized losses for mortgage-backed obligations, U.S. treasury securities and
government sponsored agency securities were primarily due to increases in
interest rates. Unrealized losses for corporate debt and other asset-backed
securities were primarily due to increases in interest rates as well as
downgrades by corporate bond rating agencies. The Company has more than
sufficient liquidity and the intent to hold these securities until the market
value recovers. Moreover, the Company does not believe it is probable that it
will be unable to collect all amounts due according to the contractual terms of
the individual investments. In the quarter ended March 31, 2006, the Company
determined that certain securities with an amortized cost basis of $11.0 million
had sustained an other-than-temporary impairment and recognized a $3.3 million
impairment loss related to these securities due to reductions in their future
estimated cash flows.
9
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
As of March 31, 2006, the duration of the Company's debt securities classified
as cash equivalents and marketable securities available for sale were as
follows:
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Amortized Fair
Cost Value
----------------------------------------------------------------------
Duration of one year or less $377,101 $376,869
Duration of one through three years 82,481 81,293
Duration of three through five years 215,383 208,854
Duration of five through seven years 14,380 13,735
Duration greater than seven years 2,857 2,828
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Total $692,202 $683,579
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5. INVENTORY
Inventory at March 31, 2006 and December 31, 2005 consisted of the following:
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March 31, December 31,
2006 2005
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Raw materials $ 5,687 $ 5,044
Work in process 2,148 1,644
Finished goods 8,379 13,554
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Total $16,214 $20,242
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6. SHARE-BASED COMPENSATION
The Company has a shareholder approved 1998 equity incentive plan, or the 1998
Incentive Plan, that provides for the granting of options, restricted stock
awards, stock appreciation rights, performance awards and other share-based
awards to employees and officers of the Company to purchase not more than an
aggregate of 62,000,000 shares of common stock under the 1998 Incentive Plan, as
amended, subject to adjustment under certain circumstances. The Management
Compensation and Development Committee of the Board of Directors, or the
Compensation Committee, determines the type, amount and terms, including
vesting, of any awards made under the Incentive Plan. The 1998 Incentive Plan
will terminate in 2008.
With respect to options granted under the 1998 Incentive Plan, the exercise
price may not be less than the market price of the common stock on the date of
grant. In general, options granted under the 1998 Incentive Plan vest over
periods ranging from immediate vesting to four-year vesting and expire ten years
from the date of grant, subject to earlier expiration in case of termination of
employment. The vesting period for options and restricted stock awards granted
under the 1998 Incentive Plan is subject to certain acceleration provisions if a
change in control, as defined in the 1998 Incentive Plan, occurs. Plan
participants may elect to exercise options at any time during the option term.
However, any shares so purchased which have not vested as of the date of
exercise shall be subject to forfeiture, which will lapse in accordance with the
established vesting time period.
In June 1995, the stockholders of the Company approved the 1995 Non-Employee
Directors' Incentive Plan, which, as amended, provides for the granting of
non-qualified stock options to purchase an aggregate of not more than 7,700,000
shares of common stock (subject to adjustment under certain circumstances) to
directors of the Company who are not officers or employees of the Company, or
Non-Employee Directors. Each new Non-Employee Director, upon the date of
election or appointment, receives an option to purchase 20,000 shares of common
stock, which vest in four equal annual installments commencing on the first
anniversary of the date of grant. As amended in 2003, continuing Non-Employee
Directors receive quarterly grants of 3,750 options aggregating 15,000 options
annually, which vest in full one year from the date of grant. The 1995
Non-
10
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
Employee Directors' Incentive Plan also provides for a discretionary grant upon
the date of each annual meeting of an additional option to purchase up to 5,000
shares to a Non-Employee Director who serves as a member (but not a chairman) of
a committee of the Board of Directors and up to 10,000 shares to a Non-Employee
Director who serves as the chairman of a committee of the Board of Directors.
All options are granted at an exercise price that equals the fair value of the
Company's common stock at the grant date and expire ten years after the date of
grant. This plan terminates on June 30, 2015. In December 2005, in recognition
of the significance of the REVLIMID(R) regulatory approval, continuing
Non-Employee Directors received the 2006 annual stock option award of 15,000
shares, which were granted at an exercise price equal to the fair value of the
Company's common stock on December 29, 2005 and vest pursuant to the standard
terms of the plan.
Stock options available for future grants under all plans were 2,879,440 at
March 31, 2006.
Historically, the Company applied the intrinsic-value-based method of accounting
prescribed by Accounting Principles Board, or APB, Opinion No. 25, "Accounting
for Stock Issued to Employees," or APB 25, and related interpretations. As such,
compensation expense for grants of stock options to employees or members of the
Board of Directors would be recorded on the date of grant only if the current
market price of the Company's stock exceeded the exercise price. Statement of
Financial Accounting Standards, or SFAS, No. 123 "Accounting For Stock-Based
Compensation," or SFAS 123, established accounting and disclosure requirements
using a fair-value-based method of accounting for stock-based employee
compensation plans. As permitted by SFAS 123, the Company elected to continue to
apply the intrinsic-value-based method of APB 25 described above, and adopted
only the disclosure requirements of SFAS 123, as amended by SFAS No. 148,
"Accounting For Stock-Based Compensation - Transition and Disclosure."
In December 2004, the Financial Accounting Standards Board, or FASB, issued SFAS
No. 123R, "Share-Based Payment", or SFAS 123R. SFAS 123R, which replaces SFAS
123, and supersedes APB 25, requires compensation cost relating to share-based
payment transactions be recognized in financial statements based on the fair
value for all awards granted after the date of adoption as well as for existing
awards for which the requisite service has not been rendered as of the date of
adoption. The modified prospective transition method as prescribed by SFAS 123R
does not require restatement of prior periods to reflect the impact of adopting
SFAS 123R.
The Company adopted SFAS 123R effective January 1, 2006 and has selected the
Black-Scholes method of valuation for share-based compensation. The Company has
adopted the modified prospective application method under which the provisions
of SFAS 123R apply to new awards and to awards modified, repurchased, or
cancelled after the adoption date. Additionally, compensation cost for the
portion of the awards for which the requisite service has not been rendered that
are outstanding as of the adoption date is recognized in the Consolidated
Statement of Operations over the remaining service period after the adoption
date based on the award's original estimate of fair value. SFAS 123R eliminates
alternatives provided under SFAS 123 to recognize compensation cost over the
requisite service period as if all awards would be earned and to reverse such
compensation costs as awards are actually forfeited. Instead, SFAS 123R requires
compensation costs to be recognized based on the estimated number of awards
expected to vest. Changes in the estimated forfeiture rates are reflected
prospectively. Total share-based compensation expense recorded in the
Consolidated Statement of Operations for the three-month period ended March 31,
2006 was $14.8 million. The charge was recorded in all appropriate cost centers
and, has resulted in charges of $0.5 million, $3.9 million and $10.4 million
classified in cost of goods sold, research and development and selling, general
and administrative expenses, respectively. Included in stock-based compensation
expense for the three-month period ended March 31, 2006 was compensation expense
related to non-qualified stock options of $9.0 million. The tax benefit (i.e.,
deferred tax asset) recorded associated with the non-qualified stock option
expense was $3.7 million.
As a result of adopting SFAS 123R at the beginning of 2006, the Company's net
income was lower by $11.1 million than if it had continued to account for
share-based compensation under APB 25. Basic and diluted earnings per share for
11
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
the three-month period ended March 31, 2006 would have been $0.08 and $0.07 per
share, respectively, if the Company had not adopted SFAS 123R, compared to
reported basic and diluted earnings per share of $0.05 and $0.04 per share,
respectively.
The following table illustrates the effect on net income and net income per
common share applicable to common stockholders for the three months ended March
31, 2005, as if the Company had applied the fair value recognition provisions
for stock-based compensation of SFAS 123, as amended:
Three Months Ended
March 31, 2005
-------------------------------------------------------------------------
Net income as reported $ 48,214
Add: stock-based employee compensation expense
included in reported income, net of tax 25
Add: stock-based employee compensation expense
determined under fair-value-based method (1) 13,128
--------
Basic pro forma net income $ 61,367
Interest expense on convertible debt, net of tax 1,393
--------
Diluted, pro forma net income $ 62,760
Net income per common share:
Basic, as reported $ 0.15
Basic, pro forma $ 0.19
Diluted, as reported $ 0.13
Diluted, pro forma $ 0.16
==================================================================
(1) Reflects adjustment recorded as of March 31, 2005 to eliminate
related valuation allowances of $17.7 million based on the
Company's determination that it was more likely than not that
certain benefits of its deferred tax assets would be realized.
In November 2005, the FASB issued FASB Staff Position 123(R)-3, "Transition
Election Related to Accounting for the Tax Effects of Share-based Payment
Awards," or FSP 123R- 3. FSP 123R-3 provides an elective alternative transition
method of calculating the additional paid-in capital pool, or APIC Pool, of
excess tax benefits available to absorb tax deficiencies recognized subsequent
to the adoption of SFAS 123R to the method otherwise required by paragraph 81 of
SFAS 123R. The Company may take up to one year from the effective date of FSP
123R-3 to evaluate its available alternatives and make its one-time election.
The Company is evaluating the impact of the adoption of this FSP in connection
with its adoption of SFAS 123R.
Prior to the adoption of SFAS 123R, the Company presented all tax benefits of
deductions resulting from the exercise of stock options as operating cash flows
in the Statement of Cash Flows. SFAS 123R requires excess tax benefits (i.e.,
the tax benefit recognized upon exercise of stock options in excess of the
benefit recognized from recognizing compensation cost for those options) to be
classified as financing cash flows in the Statement of Cash Flows. Cash received
from stock option exercises for the three-month period ended March 31, 2006 was
$23.1 million and the excess tax benefit recognized was $21.6 million. Cash
received from stock option exercises for the three-month period ended March 31,
2005 was $13.9 million. Pursuant to SFAS 123R, tax benefits resulting from the
exercise of stock options, which have been presented as operating cash flows
prior to the adoption of SFAS 123R are not reclassified to financing activities,
but rather shall continue to be presented as operating cash flows.
The weighted-average grant-date fair value of the stock options granted during
the three months ended March 31, 2006 was $15.08 per share and, the
weighted-average grant-date fair value of the stock options granted during the
three months ended March 31, 2005 was $5.31 per share adjusted for the February
17, 2006 two-for-one stock split. The Company estimated the fair value of
options granted using a Black-Scholes option pricing model with the following
weighted-average assumptions:
12
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
-------------------------------------------------------------------------
Three Months Ended March 31,
2006 2005
-------------------------------------------------------------------------
Risk-free interest rate 4.50% 4.17%
Expected stock price volatility 40% 41%
Expected term until exercise (years) 5.0 4.5
Expected dividend yield 0% 0%
=========================================================================
For grants during the three-month period ended March 31, 2006, the risk-free
interest rate is based on the U.S. Treasury zero coupon curve. Expected
volatility is based on implied volatility, which is determined from the market
price of the Company's publicly traded options. The expected term until exercise
is based on historical exercise activity and management estimates. Forfeiture
rates are estimated based on historical data.
In December 2005, in recognition of the significance of the REVLIMID(R)
regulatory approval, the Board of Directors approved a resolution to grant the
2006 annual stock option awards under the 1998 Incentive Plan in 2005. All stock
options awarded were granted fully vested. Half of the options granted had an
exercise price of $34.05 per option, which was at a 5% premium to the closing
price of the Company's common stock of $32.43 per share on the grant date of
December 29, 2005; the remaining options granted had an exercise price of $35.67
per option, which was at a 10% premium to the closing price of the Company's
common stock of $32.43 per share on the grant date of December 29, 2005. The
Board's decision to grant these options was in recognition of the REVLIMID(R)
regulatory approval and in response to a review of the Company's long-term
incentive compensation programs in light of changes in market practices and
recently issued changes in accounting rules resulting from the issuance of SFAS
123R, which the Company adopted effective in the first quarter of 2006. In
addition, the Company granted certain options to key employees at exercise
prices equal to the market price of the Company's common stock on the date of
grant that also vested immediately. Management believes that granting these
options prior to the adoption of FASB No. 123R will result in the Company not
being required to recognize cumulative compensation expense of approximately
$70.8 million for the four-year period ending December 31, 2009.
Stock option transactions for the three months ended March 31, 2006 under all
plans are as follows:
Weighted
Weighted Average Aggregate
Average Remaining Intrinsic
Exercise Contractual Value
Options Price Term (years) (In Thousands)
-----------------------------------------------------------------------------------------------------------------------
Outstanding at December 31, 2005 50,594,378 $ 13.70 6.9 $ 909,083
Changes during the year:
Granted 338,901 35.86 -- --
Exercised (3,973,489) 6.11 -- --
Forfeited (764,005) 13.96 -- --
Expired -- -- -- --
-------------------------------------------------------------
Outstanding at March 31, 2006 46,195,785 $ 14.49 6.8 $ 1,373,401
-------------------------------------------------------------
Vested or expected to vest at March 31, 2006 45,918,898 $ 14.47 6.8 $ 1,366,124
-------------------------------------------------------------
Vested at March 31, 2006 32,011,418 $ 14.01 6.1 $ 967,065
=============================================================
13
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
The total intrinsic value of stock options exercised during the three months
ended March 31, 2006 and 2005 was $121.2 million and $32.3 million,
respectively. The Company utilizes newly issued shares to satisfy the exercise
of stock options.
As of March 31, 2006, there was approximately $48.3 million of total
unrecognized compensation cost related to stock options granted under the plans.
That cost is expected to be recognized over a weighted-average period of 1.3
years. No compensation cost related to stock options was capitalized for the
three months ended March 31, 2006.
The following table summarizes information concerning options outstanding under
the 1998 and 1995 Incentive Plans at March 31, 2006:
---------------------------------------------------------------------------------------------------------------------------
Options Outstanding Options Vested
------------------------------------------------- -------------------------------------------------
Weighted Weighted Weighted Weighted
Average Average Average Average
Range of Exercise Number Exercise Remaining Number Exercise Remaining
Prices Outstanding Price Term (yrs.) Vested Price Term (yrs.)
---------------------------------------------------------------------------------------------------------------------------
$ 0.04 - 5.00 7,775,013 $ 2.21 3.8 6,853,201 $ 1.91 3.5
5.01 - 10.00 10,865,802 6.88 5.6 9,261,947 6.81 5.3
10.01 - 15.00 10,467,312 12.66 7.7 4,923,520 12.44 7.2
15.01 - 20.00 5,550,717 16.51 7.0 2,810,696 16.36 5.3
20.01 - 30.00 4,901,646 25.11 8.2 2,181,054 26.23 6.8
30.01 - 35.67 6,635,295 34.70 9.7 5,981,000 34.78 9.7
---------------------------------------------------------------------------------------------------
46,195,785 $ 14.49 6.8 32,011,418 $ 14.01 6.1
===================================================================================================
Stock options granted to executives at the vice-president level and above under
the 1998 Incentive Plan, after September 18, 2000, contained a reload feature
which provided that if (1) the optionee exercises all or any portion of the
stock option (a) at least six months prior to the expiration of the stock
option, (b) while employed by the Company and (c) prior to the expiration date
of the 1998 Incentive Plan and (2) the optionee pays the exercise price for the
portion of the stock option exercised or pays applicable minimum statutory
withholding taxes by using common stock owned by the optionee for at least six
months prior to the date of exercise, the optionee shall be granted a new stock
option under the 1998 Incentive Plan on the date all or any portion of the stock
option is exercised to purchase the number of shares of common stock equal to
the number of shares of common stock exchanged by the optionee to exercise the
stock option or to pay withholding taxes thereon. The reload stock option will
be exercisable on the same terms and conditions as apply to the original stock
option except that (x) the reload stock option will become exercisable in full
on the day which is six months after the date the original stock option is
exercised, (y) the exercise price shall be the fair value (as defined in the
1998 Incentive Plan) of the common stock on the date the reload stock option is
granted and (z) the expiration of the reload stock option will be the date of
expiration of the original stock option. As of March 31, 2006, the Company has
issued 10,876,300 stock options to executives that contain the reload features
noted above, of which 5,803,019 options are still outstanding. The 1998
Incentive Plan was amended to eliminate the reload feature for all stock options
granted on or after October 1, 2004.
14
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
7. INVESTMENT IN AFFILIATED COMPANY
On March 31, 2005, the Company exercised warrants to purchase 7,000,000 shares
of EntreMed, Inc. common stock. Since the Company also held 3,350,000 shares of
EntreMed voting preferred shares that are convertible into 16,750,000 shares of
common stock, the Company determined that it has significant influence over its
investee and began applying the equity method of accounting to its common stock
investment effective March 31, 2005.
On February 2, 2006 the Company, along with a group of investors, entered into a
private placement transaction to invest $30.0 million in EntreMed in return for
newly issued EntreMed common stock and warrants to purchase additional shares of
EntreMed common stock at a conversion price of $2.3125 per warrant. The
Company's portion of the investment was $2.0 million for which it received
864,864 shares of EntreMed common stock and 432,432 warrants. The fair value of
the warrants computed using the Black-Scholes model was $0.6 million and, the
remaining value of $1.4 million was ascribed to the equity investment. The
warrants are being accounted for at fair value with changes in fair value
recorded through earnings. The value of the EntreMed warrants increased by $0.1
million to $0.7 million during the three-month period ending March 31, 2006.
The Company recorded equity in losses of affiliated company of $3.1 million and
$4.4 million for the three-month periods ended March 31, 2006 and 2005,
respectively. The loss in the three-month period ended March 31, 2005 relates to
a charge to write down a portion of the Company's investment ascribed to
in-process research and development at the time of our initial investment. The
investment in EntreMed had a carrying value of approximately $15.3 million at
March 31, 2006, which is below the estimated fair value of the Company's
7,864,864 shares of EntreMed common stock by approximately $5.2 million based on
the closing share price of EntreMed common stock on March 31, 2006.
The investment is reviewed to determine whether an other-than-temporary decline
in value of the investment has been sustained. If it is determined that the
investment has sustained an other-than-temporary decline in its value, the
investment will be written down to its fair value. Such an evaluation is
judgmental and dependent on the specific facts and circumstances. Factors that
the Company considers in determining whether an other-than-temporary decline in
value has occurred include: the market value of the security in relation to its
cost basis, the period of time that the market value is below cost, the
financial condition of the investee and the intent and ability to retain the
investment for a sufficient period of time to allow for recovery in the market
value of the investment. The Company evaluates information that it is aware of
in addition to quoted market prices, if any, in determining whether an
other-than-temporary decline in value exists. After reviewing these factors, the
Company has determined that as of March 31, 2006 no adjustment to its investment
is required.
A summary of the Company's investment and equity in losses of affiliates
follows:
As of
March 31, 2006
--------------
Interest in EntreMed equity (1) $ 4,828
Excess of investment over share of EntreMed equity (2) 10,460
------------
Total investment $ 15,288
=============================================================================
Three-Month
Period Ended
March 31, 2006
--------------
Celgene share of EntreMed, Inc. losses (1)(3) $ 3,007
Amortization of intangibles 84
------------
Equity in losses of affiliated company $ 3,091
=============================================================================
(1) The Company records its share of losses based on its common stock
ownership, which as of March 31, 2006 was 10.75%.
(2) Consists of intangible assets and goodwill of $841 and $9,619,
respectively.
(3) Includes $2.4 million related to the Company's share of EntreMed's
in-process research and development write-down related to its
acquisition of Miikana Therapeutics Inc. on January 10, 2006.
15
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
8. GOODWILL AND INTANGIBLE ASSETS
At March 31, 2006, the Company's intangible assets primarily related to the
October 21, 2004 acquisition of Penn T and are being amortized over their
estimated useful lives. In December 2005, the Company recognized a $4.3 million
intangible for a licensing agreement with Children's Medical Center Corporation,
which is being amortized over the patent life of the related product. The gross
carrying value and accumulated amortization by major intangible asset class at
March 31, 2006 and December 31, 2005 were as follows:
-----------------------------------------------------------------------------------------------------------------------------
Gross Cumulative Intangible Weighted
Carrying Accumulated Translation Assets, Average
March 31, 2006 Value Amortization Adjustment Net Life (Years)
-----------------------------------------------------------------------------------------------------------------------------
Penn T supply agreements $ 99,841 $ (4,920) $ (3,337) $ 91,584 12.9
License 4,250 (77) -- 4,173 13.8
Technology 122 (5) -- 117 12.0
-----------------------------------------------------------------------------------------------------------------------------
Total $ 104,213 $ (5,002) $ (3,337) $ 95,874 13.0
=============================================================================================================================
-----------------------------------------------------------------------------------------------------------------------------
Gross Cumulative Intangible Weighted
Carrying Accumulated Translation Assets, Average
December 31, 2005 Value Amortization Adjustment Net Life (Years)
-----------------------------------------------------------------------------------------------------------------------------
Penn T supply agreements $ 99,841 $ (2,787) $ (4,435) $ 92,619 12.9
License 4,250 -- -- 4,250 13.8
Technology 122 (3) -- 119 12.0
-----------------------------------------------------------------------------------------------------------------------------
Total $ 104,213 $ (2,790) $ (4,435) $ 96,988 13.0
=============================================================================================================================
Amortization of acquired intangible assets was approximately $2.2 million and
$0.3 million for the three-month periods ended March 31, 2006 and 2005,
respectively. Assuming no changes in the gross carrying amount of intangible
assets, the amortization of intangible assets for the next five fiscal years is
estimated to be approximately $8.5 million for 2006, and $8.2 million for each
of the years 2007 through 2010.
At March 31, 2006, the Company's recorded goodwill related to the acquisition of
Penn T on October 21, 2004. The changes in the carrying value of goodwill are
summarized as follows:
Goodwill
----------
Balance, December 31, 2005 $ 33,815
Foreign currency translation 374
---------
Balance, March 31, 2006 $ 34,189
9. COMPREHENSIVE INCOME
The components of comprehensive income, which represents the change in equity
from non-owner sources, consists of net income (losses), changes in currency
translation adjustments and the change in net unrealized gains (losses) on
marketable securities classified as available for sale.
16
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
A summary of comprehensive income for the three-month periods ended March 31,
2006 and 2005 follows:
---------------------------------------------------------------------------
Three-Month Period Ended
March 31,
2006 2005
---------------------------------------------------------------------------
Net income $ 16,024 $ 48,214
---------------------------
Other comprehensive income loss:
Unrealized losses on marketable
securities available for sale, net of tax (4,569) (30,845)
Deferred income tax (1) -- (14,775)
Less: reclassification adjustment for (gains)
losses included in net income 3,345 (209)
---------------------------
Unrealized losses on marketable
securities available for sale, net of tax (1,224) (45,829)
Currency translation adjustments (478) (2,538)
---------------------------
Total other comprehensive loss (1,702) (48,367)
---------------------------
Comprehensive income (loss) $ 14,322 $ (153)
===========================================================================
(1) Reflects the adjustment recorded as of March 31, 2005 to eliminate related
valuation allowances based on the Company's determination that it was more
likely than not that certain benefits of its deferred tax assets would be
realized.
The unrealized loss on marketable securities available for sale for the
three-month period ended March 31, 2005 included a decrease in fair value
related to the shares of Pharmion common stock of $25.6 million and the change
in fair value during the three-month period ended March 31, 2006 was immaterial.
10. INCOME TAXES
The Company periodically evaluates the likelihood of the realization of deferred
tax assets, and reduces the carrying amount of these deferred tax assets by a
valuation allowance to the extent it believes a portion will not be realized.
The Company considers many factors when assessing the likelihood of future
realization of its deferred tax assets, including recent cumulative earnings
experience by taxing jurisdiction, expectations of future taxable income, the
carryforward periods available to it for tax reporting purposes, and other
relevant factors. Significant judgment is required in making this assessment.
In the first quarter of 2006, the Company recorded a tax benefit of
approximately $6.1 million primarily related to the resolution of certain tax
positions taken on the Company's income tax returns in tax years 2000-2002.
At March 31, 2005, the Company determined it was more likely than not that
certain benefits of its deferred tax assets would be realized based on favorable
clinical data related to REVLIMID(R) (Lenalidomide) during the quarter in
concert with the Company's nine consecutive quarters of profitability. This led
to the conclusion that it was more likely than not that the Company will
generate sufficient taxable income to realize the benefits of its deferred tax
assets. As a result of eliminating the related valuation allowances, the Company
recorded an income tax benefit in 2005 of $42.6 million and an increase to
additional paid-in capital of $30.2 million.
17
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
11. SEGMENTS
Effective January 1, 2006, the Company has combined the Human Pharmaceuticals
and Stem Cell Therapies segments into a single segment. The decision to combine
the segments was based on how the Company's chief operating decision makers use
internal financial information for evaluating performance and deciding how to
allocate resources among the Company's various functions.
The Stem Cell Therapies segment originated in December 2002, with the Company's
acquisition of Anthrogenesis Corp. Anthrogenesis, which operates as Celgene
Cellular Therapeutics, or CCT, was organized into three main units: (1) stem
cells banking for transplantation, (2) private stem cell banking and (3) the
development of biomaterials for organ and tissue repair. Effective January 1,
2006, CCT has been integrated with the Company's Human Pharmaceuticals
technological and research organizations. It is anticipated that integration of
CCT within the Human Pharmaceutical segment will result in new methods for
expanding and maintaining placental stem cell populations; facilitate the
identification and characterization of placental stem cell sub-populations; and,
in development of improved methods for extracting, processing, configuring and
storing stem cells and biomaterials derived from placental tissue with potential
broad therapeutic applications in cancer, as well as autoimmune, cardiovascular,
neurological, and degenerative diseases.
12. AGREEMENTS
In connection with the Company's acquisition of Penn T, the Company entered into
a Technical Services Agreement with Penn Pharmaceutical Services Limited, or
PPSL, and Penn Pharmaceutical Holding Limited pursuant to which PPSL provides
the services and facilities necessary for the manufacture of THALOMID(R) and
other thalidomide formulations. The total cost to be incurred over the five-year
minimum agreement period is approximately $11.0 million. At March 31, 2006, the
remaining cost to be incurred was approximately $7.4 million.
In December 2004, following the Company's acquisition of Penn T Limited, its
wholly-owned subsidiary Celgene UK Manufacturing II Limited, or CUK II, entered
into an amended thalidomide supply agreement with Pharmion whereby in exchange
for a reduction in Pharmion's purchase price of thalidomide to 15.5% of its net
sales of thalidomide, we received a one-time payment of $77.0 million. Pursuant
to another December 2004 agreement, we also received a one-time payment of $3.0
million in return for granting license rights to Pharmion to develop and market
thalidomide in additional territories and eliminating certain of our license
termination rights. Under the agreements, as amended, the territory licensed to
Pharmion is for all countries other than the United States, Canada, Mexico,
Japan and all provinces of China other than Hong Kong. The agreements with
Pharmion terminate upon the ten-year anniversary following receipt of the first
regulatory approval for thalidomide in the United Kingdom. Amounts under the
agreement are recorded as deferred revenue and will be recognized on a
straight-line basis over 13 years.
To support the further clinical development of thalidomide, Pharmion has also
provided research funding under various agreements of approximately $10.7
million through March 31, 2006 and is required to fund an additional $2.7
million in each of 2006 and 2007.
In March 2003, we entered into a supply and distribution agreement with
GlaxoSmithKline to distribute, promote and sell ALKERAN(R) (melphalan), a
therapy approved by the FDA for the palliative treatment of multiple myeloma and
carcinoma of the ovary. Under the terms of the agreement, we purchase ALKERAN(R)
tablets and ALKERAN(R) for infusion from GSK and distribute the products in the
United States under the Celgene label. The agreement requires us to purchase
certain minimum quantities each year under a take-or-pay arrangement. The
agreement has been extended through March 31, 2009.
18
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
On March 31, 2006, the remaining minimum purchase requirements under the
agreement totaled $90.7 million, consisting of $2.4 million from the initial
agreement and the following subsequent extensions:
o April 1, 2006 - December 31, 2006 $21,000,000
o January 1, 2007 - December 31, 2007 $29,050,000
o January 1, 2008 - December 31, 2008 $30,525,000
o January 1, 2009 - March 31, 2009 $ 7,725,000
19
PART I - FINANCIAL INFORMATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
INTRODUCTION
We are a multi-national integrated biopharmaceutical company primarily engaged
in the discovery, development and commercialization of innovative therapies
designed to treat cancer and immune-inflammatory related diseases. Our lead
products are: REVLIMID(R), which gained recent U.S. Food and Drug
Administration, or FDA, approval in myelodysplastic syndromes, or MDS, patients
with the 5q chromosomal deletion and is under review by the FDA for multiple
myeloma, and THALOMID(R) (thalidomide), which is currently marketed for the
treatment of erythema nodosum leprosum, or ENL, and under review by the FDA for
the treatment of multiple myeloma. Over the past several years, THALOMID(R) net
sales have grown steadily driven mainly by its off-label use for treating
multiple myeloma and other cancers. The sales growth of THALOMID(R) has enabled
us to make substantial investments in research and development, which has
advanced our broad portfolio of drug candidates in our product pipeline,
including a pipeline of IMiDs(R) compounds, which are a class of compounds
proprietary to us and having certain immunomodulatory and other biologically
important properties. We believe that the sales growth of THALOMID(R), the
growth potential for REVLIMID(R), the depth of our product pipeline, near-term
regulatory activities and clinical data reported at major medical conferences
provide the catalyst for future growth.
FACTORS AFFECTING FUTURE RESULTS
Future operating results will depend on many factors, including demand for our
products, regulatory approvals of our products, the timing and market acceptance
of new products launched by us or competing companies, the timing of research
and development milestones, challenges to our intellectual property and our
ability to control costs. See also the Risk Factors discussion in Part I, Item
1A of our 2005 Annual Report on Form 10-K. Some of the more salient factors that
we are focused on are: the ability of REVLIMID(R) to successfully penetrate
relevant markets; competitive risks; and our ability to advance clinical and
regulatory programs.
THE ABILITY OF REVLIMID(R) TO SUCCESSFULLY PENETRATE RELEVANT MARKETS:
REVLIMID(R) was approved by the FDA on December 27, 2005 for the treatment of
certain myelodysplastic syndromes associated with a deletion 5q cytogenetic
abnormality and we have begun to execute our product launch strategies, which
includes among other things: registering physicians in the RevAssist(sm)
program, which is a proprietary risk-management distribution program tailored
specifically to help ensure the safe use of REVLIMID(R); sponsoring numerous
medical education programs designed to educate physicians on MDS; and partnering
with contracted pharmacies to ensure safe and rapid distribution of REVLIMID(R).
In addition, we have implemented an expanded access program to provide many
patients with relapsed or refractory multiple myeloma free access to REVLIMID(R)
while the FDA reviews our Supplemental New Drug Application, or sNDA, for that
indication. We do not, however, have long-term data on the use of the product
and cannot predict whether REVLIMID(R) will gain widespread acceptance, which
will mostly depend on the acceptance of regulators, physicians, patients and
opinion leaders. The success of REVLIMID(R) will also depend, in part, on
prescription drug coverage by government health agencies, commercial and
employer health plans, and other third-party payers. As an oral cancer agent,
REVLIMID(R) qualifies as a Medicare Part D drug. Each Part D plan will review
REVLIMID(R) for addition to their formulary. As with all new products introduced
into the market, there may be some lag time before being added to each plan's
formulary.
20
COMPETITIVE RISKS: The landscape for the treatment of multiple myeloma and other
cancer and immune-inflammatory related diseases is highly competitive. While
competition could reduce THALOMID(R) sales and limit REVLIMID(R) launch
expectations, we do not believe that competing products will eliminate
REVLIMID(R) and THALOMID(R) use entirely. In addition, generic competition could
reduce THALOMID(R) sales. However, we own intellectual property which includes,
for example, U.S. patents covering our S.T.E.P.S.(R) distribution program for
the safer delivery of thalidomide, which all patients receiving thalidomide in
the United States must follow. We also have exclusive rights to several issued
patents covering the use of THALOMID(R) in oncology and other therapeutic areas.
Even if generic competition were able to enter the market, we expect
REVLIMID(R), which is now available commercially, to at least partially replace
THALOMID(R) sales.
ABILITY TO ADVANCE CLINICAL AND REGULATORY PROGRAMS: A major objective of our
on-going clinical trials programs is to broaden our knowledge about the full
potential of REVLIMID(R) and to continue to evaluate the drug in a broad range
of hematological malignancies and other cancers. The significant near-term
regulatory catalysts that we are focused on include: the FDA's decision
regarding our sNDA for THALOMID(R) in multiple myeloma (a Prescription Drug User
Fee Act, or PDUFA, date of May 25, 2006 has been set); the FDA's decision
regarding our sNDA for REVLIMID(R) in relapsed or refractory multiple myeloma (a
PDUFA date of June 30, 2006 has been set); and from an international
perspective, the European Medicines Agency, or EMEA, acceptance of our
Marketing Authorization Application, or MAA, for REVLIMID(R) in MDS with the 5q
chromosomal deletion and Multiple Myeloma.
RESULTS OF OPERATIONS-
THREE-MONTH PERIOD ENDED MARCH 31, 2006 VS. THREE-MONTH
PERIOD ENDED MARCH 31, 2005
TOTAL REVENUE: Total revenue and related percentages for the three-month periods
ended March 31, 2006 and 2005 were as follows:
----------------------------------------------------------------------------------------------------------
Three-Month Period Ended
March 31,
(IN THOUSANDS $) 2006 2005 % Change
----------------------------------------------------------------------------------------------------------
Net product sales:
REVLIMID(R) $ 32,443 $ - N/A
THALOMID(R) 107,211 88,391 21.3%
ALKERAN(R) 18,295 7,739 136.4%
Focalin(TM) 2,101 1,226 71.4%
Other 193 289 (33.2%)
------------------------------
Total net product sales 160,243 97,645 64.1%
Collaborative agreements
and other revenue 3,893 5,229 (25.5%)
Royalty revenue 17,705 9,522 85.9%
------------------------------
Total revenue $ 181,841 $ 112,396 61.8%
==========================================================================================================
NET PRODUCT SALES:
REVLIMID(R) was approved by the FDA on December 27, 2005 and consequently sales
for this product are reflected only in the 2006 period. Nearly 70% of
REVLIMID(R) dispenses during the period were for
21
the treatment of patients with MDS. Multiple myeloma accounted for the majority
of the remaining dispenses.
THALOMID(R) net sales were higher in the three-month period ended March 31,
2006, compared to the three-month period ended March 31, 2005, primarily due to
price increases implemented as we move towards a cost of therapy pricing
structure as opposed to a price per milligram basis. Sales volumes decreased due
to changes in sales mix (i.e., capsule strength) resulting from continued
average daily dose declines as well as a slight decrease in the total number of
prescriptions. Partially offsetting the increase in THALOMID(R) sales were
higher gross to net sales accruals for sales returns, Medicaid rebates and
distributor chargebacks. Included in the three-month period ended March 31, 2006
were sales of approximately $2.2 million from our U.K. subsidiary, Celgene U.K.
Manufacturing II, Limited, or CUK II, to Pharmion Corporation, compared to sales
of $1.5 million for the three-month period ended March 31, 2005.
ALKERAN(R) net sales were higher in the three-month period ended March 31, 2006,
compared to the three-month period ended March 31, 2005, due to an increase in
sales volumes as well as price increases implemented since March 31, 2005.
ALKERAN(R) use in combination therapies for the treatment of hematological
diseases continues to grow driven by clinical data reported at major medical
conferences around the world.
Net sales of Focalin(TM), which is sold exclusively to Novartis and is dependent
on the timing of orders from Novartis for their commercial distribution, were
higher in the three-month period ended March 31, 2006, compared to the
three-month period ended March 31, 2005, due to increased end-market demand.
GROSS TO NET SALES ACCRUALS: Gross to net sales accruals are recorded for sales
returns, sales discounts, Medicaid rebates and distributor charge-backs and
services. Allowance for sales returns are based on the actual returns history
for consumed lots and the trend experience for lots where product is still being
returned. Sales discounts accruals are based on payment terms extended to
customers. Medicaid rebate accruals are based on historical payment data and
estimates of future Medicaid beneficiary utilization. Distributor charge-back
accruals are based on the differentials between product acquisition prices paid
by wholesalers and lower government contract pricing paid by eligible customers
covered under federally qualified programs. Distributor services accruals are
based on actual fees paid to wholesale distributors for services provided.
Gross to net sales accruals for the three-month periods ended March 31, 2006 and
2005 were as follows:
----------------------------------------------------------------------------------------------------------------
Three-Month Period Ended
March 31,
(IN THOUSANDS $) 2006 2005 % Change
----------------------------------------------------------------------------------------------------------------
Gross product sales $ 206,598 $ 116,881 76.8%
Less: Gross to net sales accruals
Returns and allowances 16,602 4,661 256.2%
Discounts 4,160 2,291 81.6%
Medicaid rebates 11,712 7,077 65.5%
Distributor charge-backs 12,978 5,207 149.2%
Distributor services 903 - N/A
------------------------------
Total net product sales $ 160,243 $ 97,645 61.8%
================================================================================================================
Gross to net sales adjustments were higher in the three-month period ended March
31, 2006, compared to the three-month period ended March 31, 2005, in general,
due to higher gross sales. In addition, lower
22
safety stocking at retail pharmacies resulted in higher accruals for returns
allowances and price increases implemented since March 31, 2005 resulted in
higher accruals for distributor chargebacks.
OTHER REVENUES:
Revenues from collaborative agreements and other sources for the three-month
periods ended March 31, 2006 and 2005 included: $2.7 million and $3.6 million,
respectively, related to our sponsored research, license and other agreements
with Pharmion Corporation; and $1.2 million and $1.0 million, respectively,
related to umbilical cord blood enrollment, collection and storage fees
generated through our LifeBank USA(SM) business. The three-month period ended
March 31, 2005 also included $0.6 million from other miscellaneous license and
research and development agreements.
Royalty revenue for the three-month periods ended March 31, 2006 and 2005
included: $17.3 million and $9.3 million, respectively, of royalties received
from Novartis on sales of their entire family of Ritalin(R) drugs and Focalin
XR(TM); $0.2 million and $0.1 million, respectively, of royalties received from
Pharmion Corporation on their commercial sales of THALOMID(R); and $0.2 million
and $0.1 million, respectively, of other miscellaneous royalties. The increase
in Ritalin(R) and Focalin XR(TM) royalty revenue was due to market share gains
by Novartis in the once-a-day attention deficit disorder market.
COST OF GOODS SOLD: Cost of goods sold and related percentages for the
three-month periods ended March 31, 2006 and 2005 were as follows:
--------------------------------------------------------------------------------
Three-Month Period Ended
March 31,
(IN THOUSANDS $) 2006 2005
--------------------------------------------------------------------------------
Cost of goods sold $ 30,144 $ 12,604
Increase from prior year $ 17,540 N/A
Percentage increase from prior year 139.2% N/A
Percentage of net product sales 18.8% 12.9%
================================================================================
Cost of goods sold and cost of goods sold as a percentage of net product sales
were higher in the three-month period ended March 31, 2006, compared to the
three-month period ended March 31, 2005, primarily due to higher ALKERAN(R)
costs. ALKERAN(R) costs increased due to higher per unit costs and, to a lesser
extent, higher sales volumes. Under the ALKERAN(R) supply and distribution
agreement with GlaxoSmithKline, or GSK, we are required to purchase certain
minimum quantities each year. Purchases made after the minimum quantities have
been reached are at a lower purchase price. As a result, ALKERAN(R) costs tend
to experience variability depending on the purchase price of the specific units
sold during a given period.
RESEARCH AND DEVELOPMENT: Research and development expenses consist primarily of
salaries and benefits, contractor fees (paid principally to contract research
organizations to assist in our clinical development programs), costs of drug
supplies for our clinical and preclinical programs, costs of other consumable
research supplies, regulatory and quality expenditures and allocated facilities
charges such as depreciation, utilities and property taxes.
23
Research and development expenses and related percentages for the three-month
periods ended March 31, 2006 and 2005 were as follows:
--------------------------------------------------------------------------------
Three-Month Period Ended
March 31,
(IN THOUSANDS $) 2006 2005
--------------------------------------------------------------------------------
Research and development expenses $ 54,524 $ 40,037
Increase from prior year $ 14,487 N/A
Percentage increase from prior year 36.2% N/A
Percentage of total revenue 30.0% 35.6%
================================================================================
Research and development expenses were higher in the three-month period ended
March 31, 2006, compared to the three-month period ended March 31, 2005,
primarily due to higher clinical research and development expenses, which among
other things support multiple Phase II and Phase III programs evaluating
REVLIMID(R) across a broad range of hematological cancers, including chronic
lymphocyte leukemia and non-Hodgkin's lymphoma; higher medical education
expenses, which support educating and training the medical community on MDS; and
higher expenses to support ongoing development of other compounds such as
CC-10004, CC-4047, CC-11006, CC-10050, CC-401 and CC-8490. Included in the
three-month period ended March 31, 2006 was share-based compensation expense of
$3.9 million resulting from the adoption of Statement of Financial Accounting
Standards, or SFAS, No. 123R, "Share-Based Payments," or SFAS 123R, effective
January 1, 2006.
Research and development expenses in the three-month period ended March 31, 2006
consisted of approximately $19.7 million spent on human pharmaceutical clinical
programs; $22.7 million spent on other pharmaceutical programs, including
toxicology, analytical research and development, drug discovery, quality and
regulatory affairs; $9.5 million spent on biopharmaceutical discovery and
development programs; and $2.6 million spent on placental stem cell and
biomaterials programs. These expenditures support ongoing clinical progress in
multiple proprietary development programs for THALOMID(R) and REVLIMID(R), and
for other compounds such as: CC-10004, our lead anti-inflammatory compound,
CC-4047; CC-11006; CC-10050; and our kinase and ligase inhibitor programs as
well as the placental stem cell program. In the three-month period ended March
31, 2005, approximately $15.5 million was spent on human pharmaceutical clinical
programs; $13.0 million was spent on other human pharmaceutical programs,
including toxicology, analytical research and development, drug discovery,
quality and regulatory affairs; $8.9 million was spent on biopharmaceutical
discovery and development programs; and $2.6 million was spent on placental stem
cell and biomaterials programs.
As total revenue increases, research and development expense may continue to
decrease as a percentage of total revenue, however the actual dollar amount may
continue to increase as earlier stage compounds are moved through the
preclinical and clinical stages. Generally, the time to completion of each phase
is estimated as follows for oncology indications and can be longer for
non-oncology indications:
Phase I ----- 1-2 years
Phase II ---- 3-5 years
Phase III --- 2-3 years
Due to the significant risk factors and uncertainties inherent in preclinical
tests and clinical trials associated with each of our research and development
projects, the cost to complete such projects is not reasonably estimable. The
data obtained from these tests and trials may be susceptible to varying
24
interpretation that could delay, limit or prevent a project's advancement
through the various stages of clinical development, which would significantly
impact the costs incurred to bring a project to completion.
SELLING, GENERAL AND ADMINISTRATIVE: Selling expenses consisted primarily of
salaries and benefits for sales and marketing and customer service personnel and
other commercial expenses to support our sales force. General and administrative
expenses consisted primarily of salaries and benefits, outside services for
legal, audit, tax and investor activities and allocations of facilities costs,
principally for depreciation, utilities and property taxes.
Selling, general and administrative expenses and related percentages for the
three-month periods ended March 31, 2006 and 2005 were as follows:
--------------------------------------------------------------------------------
Three-Month Period Ended
March 31,
(IN THOUSANDS $) 2006 2005
--------------------------------------------------------------------------------
Selling, general and administrative expenses $ 66,897 $ 37,806
Increase from prior year $ 29,091 N/A
Percentage increase from prior year 76.9% N/A
Percentage of total revenue 36.8% 33.6%
================================================================================
Selling, general and administrative expenses were higher in the three-month
period ended March 31, 2006, compared to the three-month period ended March 31,
2005, primarily due to an increase of $15.1 million in commercial expenses
primarily related to sales and marketing expenses for REVLIMID(R) launch
activities in the United States and an increase of approximately $11.9 million
in general administrative expenses primarily related to costs incurred in
connection with our international expansion in Europe, Japan, Australia and
Canada and higher professional and other miscellaneous outside service fees and
higher personnel-related expenses. Included in the three-month period ended
March 31, 2006 was share-based compensation expense of $10.4 million resulting
from the adoption of SFAS 123R, effective January 1, 2006.
INTEREST AND OTHER INCOME (EXPENSE), NET: Interest and other income (expense)
was a net $6.2 million of income for the three-month period ended March 31, 2006
and included interest income and net realized gains (losses) on our cash and
marketable securities portfolio of $7.9 million, foreign exchange gains of $1.4
million, gains recorded for changes in the estimated value of our investment in
EntreMed, Inc. warrants of $0.1 million and other net miscellaneous income of
$0.1 million, offset by an other-than-temporary impairment loss on marketable
securities available for sale of $3.3 million. Interest and other income
(expense), was a net $1.2 million of expense for the three-month period ended
March 31, 2005 and included losses recorded for changes in the estimated value
of our investment in EntreMed, Inc. warrants of $6.9 million, other net
miscellaneous charges of $0.2, offset by interest income and net realized gains
(losses) on our cash and marketable securities portfolio of $5.9 million.
EQUITY IN LOSSES OF AFFILIATED COMPANY: On March 31, 2005, we exercised warrants
to purchase 7,000,000 shares of EntreMed, Inc. common stock and, since we also
hold 3,350,000 shares of EntreMed voting preferred shares convertible into
16,750,000 shares of common stock, we determined that we have significant
influence over EntreMed and began applying the equity method of accounting to
our common stock investment effective March 31, 2005.
On February 2, 2006 the Company invested an additional $2.0 million in EntreMed
in a private-placement transaction for which it received an additional 864,864
shares of EntreMed common stock and
25
432,432 warrants. The fair value of the warrants computed using the
Black-Scholes model was $0.6 million and, the remaining value of $1.4 million
was ascribed to the equity investment. The warrants are being accounted for at
fair value with changes in fair value recorded through interest and other income
(expense), net.
Under the equity method of accounting, we recorded equity losses of $3.1 million
and $4.4 million for the three-month periods ended March 31, 2006 and 2005,
respectively. Equity losses recorded for the three-month period ended March 31,
2005, related to the value of our investment ascribed to in-process research and
development and written-off as of March 31, 2005 (the initial date of the
investment).
INTEREST EXPENSE: Interest expense was $2.4 million for each of the three-month
periods ended March 31, 2006 and 2005 and primarily reflects three months of
interest expense and amortization of debt issuance costs on the $400 million
convertible notes issued on June 3, 2003.
INCOME TAX PROVISION (BENEFIT): The income tax provision for the three-month
period ended March 31, 2006 was $15.0 million and reflects an underlying
effective tax rate of 68%, adjusted for tax benefits of approximately $6.1
million primarily related to the resolution of certain tax positions taken on
our income tax returns for the tax years 2000 through 2002. The income tax
benefit for the three-month period ended March 31, 2005 was $34.2 million and
included the one-time benefit from eliminating deferred tax asset valuation
allowances totaling $42.6 million as of March 31, 2005. Excluding this benefit,
the income tax provision for the three-months ended March 31, 2005 would have
been $8.4 million, which reflects an underlying effective tax rate of 60%. Our
underlying tax rate will continue to exceed the statutory rate for the near term
as a result of certain expenses being incurred outside the United States for
which no tax benefit can be recorded.
NET INCOME: Net income and per common share amounts for the three-month periods
ended March 31, 2006 and 2005 were as follows:
--------------------------------------------------------------------------------
Three-Month Period Ended
March 31,
(IN THOUSANDS $) 2006 2005
--------------------------------------------------------------------------------
Net income $ 16,024 $ 48,214
Per common share amounts:
Basic $ 0.05 $ 0.15
Diluted $ 0.04 $ 0.13
Weighted average number of shares of
common stock utilized to calculate per
common share amounts:
Basic 343,966 331,225
Diluted 400,699 382,216
================================================================================
Net income and per common share amounts were lower in the three-month period
ended March 31, 2006, compared to the three-month period ended March 31, 2005,
primarily due to an increase of $61.1 million in operating expenses, which
includes $14.8 million of share-based compensation expense resulting from the
adoption of SFAS 123R, effective January 1, 2006, and an increase in the income
tax provision of $49.2 million, which is primarily due to the one-time benefit
of $42.6 million recognized in the prior year period from the elimination of
deferred tax asset valuation allowances, partially offset by higher revenues of
$69.4 million.
26
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $15.7 million for the three-month
period ended March 31, 2006, compared to net cash used in operating activities
of $5.1 million for the three-month period ended March 31, 2005. Operating cash
flows for the three-month period ended March 31, 2006 reflects our strong
operating performance, which included a period-over-period increase in total
revenue of 61.8% partially offset by higher operating expenses and an increase
in working capital levels. The decrease in operating cash flows during the
three-month period ended March 31, 2005 was largely due to income taxes paid
during the first quarter of 2005 totaling $17.5 million.
Net cash provided by investing activities was $8.8 million for the three-month
period ended March 31, 2006, compared to net cash used in investing activities
of $70.1 million for the three-month period ended March 31, 2005. Included in
the three-month period ended March 31, 2006 were cash inflows of $20.2 million
for net sales of marketable securities available for sale, offset by cash
outflows of $9.4 million for capital expenditures and $2.0 million for an
additional investment made in EntreMed, Inc., ($1.4 million investment in
EntreMed common stock and $0.6 million investment in EntreMed warrants).
Included in the three-month period ended March 31, 2005 were cash outflows of
$4.2 million for capital expenditures, $8.4 million for working capital
adjustments and acquisition costs related to our October 2004 acquisition of
Penn T Limited, $47.0 million for net purchases of marketable securities
available for sale and $10.5 for the exercise of warrants to purchase 7,000,000
shares of EntreMed common stock.
Net cash provided by financing activities was $44.7 million for the three-month
period ended March 31, 2006, compared to net cash provided by financing
activities of $13.9 million for the three-month period ended March 31, 2005.
Prior to the adoption of SFAS 123R, we presented all tax benefits of deductions
resulting from the exercise of stock options as operating cash flows in the
Statement of Cash Flows. SFAS 123R requires excess tax benefits (i.e., the tax
benefit recognized upon exercise of stock options in excess of the benefit
recognized from recognizing compensation cost for those option) to be classified
as financing cash flows in the Statement of Cash Flows. Cash received from stock
option exercises for the three-month period ended March 31, 2006 was $23.1
million and the excess tax benefit recognized was $21.6 million. Cash received
from stock option exercises for the three-month period March 31, 2005 was $13.9
million. Pursuant to SFAS 123R tax benefits resulting from the exercise of stock
options, which have been presented as operating cash flows prior to the adoption
of SFAS 123R are not reclassified to financing activities, but rather shall
continue to be presented as operating cash flows.
We expect increased research and product development costs, clinical trial
costs, expenses associated with the regulatory approval process, international
expansion costs and commercialization of products and capital investments.
However, existing cash, cash equivalents and marketable securities available for
sale, combined with expected net product sales and revenues from various
research, collaboration and royalties agreements are expected to provide
sufficient capital resources to fund our operations for the foreseeable future.
CONTRACTUAL OBLIGATIONS
Our major outstanding contractual obligations relate primarily to our
convertible note obligation, operating leases, ALKERAN(R) supply and
distribution agreement, Penn Pharmaceutical Services Limited technical services
agreement and certain other contractual commitments. For more information on
these contractual obligations see Item 7, "Management's Discussion and Analysis
of Financial Condition and Results of Operations," and Notes 9 and 18 of the
Notes to the Consolidated Financial Statements contained in our Annual Report on
Form 10-K for the fiscal year ended December 31, 2005.
27
The following table sets forth our contractual obligations as of March 31, 2006
by contractual due dates:
----------------------------------------------------------------------------------------------------------------
Contractual Due Dates
Less Than 1-3 3-5 More Than
(IN MILLIONS $) 1 Year Years Years 5 Years Total
-----------------------------------------------------------------------------------------------------------------
Convertible notes obligation $ - $ 400.0 $ - $ - $ 400.0
Operating leases 3.5 5.7 4.9 3.4 17.5
ALKERAN(R) agreements 23.4 67.3 - - 90.7
Other contract commitments 3.5 7.0 1.5 - 12.0
-----------------------------------------------------------------------
Total $ 30.4 $ 480.0 $ 6.4 $ 3.4 $ 520.2
=================================================================================================================
CRITICAL ACCOUNTING POLICIES
A critical accounting policy is one that is both important to the portrayal of
our financial condition and results of operation and requires management's most
difficult, subjective or complex judgments, often as a result of the need to
make estimates about the effect of matters that are inherently uncertain. Our
significant accounting policies are fully described in Note 1 of the Notes to
the Consolidated Financial Statements included in our Annual Report on Form 10-K
for the year ended December 31, 2005. Our critical accounting policies are
disclosed in the Management's Discussion and Analysis of Financial Condition and
Results of Operation section of our Annual Report on Form 10-K for the year
ended December 31, 2005. The only significant changes as it pertains to such
critical accounting policies are as follows:
STOCK-BASED COMPENSATION: We adopted the provisions of SFAS 123R effective
January 1, 2006, which requires that the cost resulting from all share-based
payment transactions be recognized in the financial statements at their fair
values. We adopted SFAS 123R using the modified prospective application method
under which the provisions of SFAS 123R apply to new awards and to awards
modified, repurchased, or cancelled after the adoption date. We use the
Black-Scholes option pricing model to estimate the fair value of options on the
date of grant which requires certain estimates by management including the
expected forfeiture rate and expected term of the options. Management also makes
decisions regarding the method of calculating the expected volatilities and the
risk free interest rate used in the model. Fluctuations in the market that
affect these estimates could have an impact on the resulting compensation cost.
Additionally, compensation cost for the portion of awards for which the
requisite service has not been rendered that are outstanding as of the adoption
date is recognized over the remaining service period after the adoption date
(see Note 6 to the Consolidated Financial Statements included in this quarterly
report for additional information).
OTHER-THAN-TEMPORARY IMPAIRMENTS OF EQUITY METHOD INVESTMENTS: On March 31,
2005, we exercised warrants to purchase 7,000,000 shares of EntreMed, Inc.
common stock and, since we also hold 3,350,000 shares of EntreMed voting
preferred shares convertible into 16,750,000 shares of common stock, we
determined that we have significant influence over EntreMed and began applying
the equity method of accounting to our common stock investment effective March
31, 2005. On February 2, 2006 we invested an additional $2.0 million in EntreMed
in a private-placement transaction for which we received an additional 864,864
shares of EntreMed common stock and 432,432 warrants. The value ascribed to the
equity investment was $1.4 million with the remaining $0.6 million assigned to
the warrants, which are being accounted for at fair value with changes in fair
value recorded through earnings.
The investment in EntreMed had a carrying value of approximately $15.3 million
at March 31, 2006, which is below the estimated fair value of our 7,864,864
shares of EntreMed common stock by a
28
pproximately $5.2 million based on the closing share price of EntreMed common
stock on March 31, 2006.
The investment is reviewed to determine whether an other-than-temporary decline
in value of the investment has been sustained. If it is determined that the
investment has sustained an other-than-temporary decline in its value, the
investment will be written-down to its fair value. Such an evaluation is
judgmental and dependent on the specific facts and circumstances. Factors that
we considered in determining whether an other-than-temporary decline in value
has occurred include: the market value of the security in relation to its cost
basis, the period of time that the market value is below cost, the financial
condition of the investee and our intent and ability to retain the investment
for a sufficient period of time to allow for recovery in the market value of the
investment. We evaluate information that we are aware of in addition to quoted
market prices, if any, in determining whether an other-than-temporary decline in
value exists.
CAUTIONARY STATEMENTS FOR FORWARD-LOOKING INFORMATION
The Management's Discussion and Analysis of Financial Condition and Results of
Operations provided above contains certain forward-looking statements which
involve known and unknown risks, delays, uncertainties and other factors not
under our control which may cause actual results, performance and achievements
to be materially different from the results, performance or other expectations
implied by these forward-looking statements. These factors include the results
of current or pending clinical trials, our products' failure to demonstrate
efficacy or an acceptable safety profile, actions by the FDA, the financial
condition of suppliers including their solvency and ability to supply product
and other factors detailed herein and in our other filings with the Securities
and Exchange Commission.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion provides forward-looking quantitative and qualitative
information about our potential exposure to market risk. Market risk represents
the potential loss arising from adverse changes in the value of financial
instruments. The risk of loss is assessed based on the likelihood of adverse
changes in fair values, cash flows or future earnings.
We have established guidelines relative to the diversification and maturities of
investments to maintain safety and liquidity. These guidelines are reviewed
periodically and may be modified depending on market conditions. Although
investments may be subject to credit risk, our investment policy specifies
credit quality standards for our investments and limits the amount of credit
exposure from any single issue, issuer or type of investment. Our investments
are also subject to interest rate risk and will decrease in value if market
interest rates increase. We do not use derivative instruments for trading
purposes. At March 31, 2006, our market risk sensitive instruments consisted of
a foreign currency denominated forward contract, marketable securities
available-for-sale, other equity investments and unsecured convertible notes
issued by us.
29
FOREIGN CURRENCY DENOMINATED FORWARD CONTRACT: We may periodically utilize
foreign currency denominated forward contracts to hedge currency fluctuations of
transactions denominated in currencies other than the functional currency. At
March 31, 2006, we were party to foreign currency forward contracts to buy U.S.
dollars and sell Swiss francs for a notional amount of $63.7 million. The
forward contracts expire on April 13, 2006 and are an economic hedge of a U.S.
dollar payable of a Swiss foreign entity, which is remeasured through earnings
each period based on changes in the spot rate. The fair value of the forward
contracts at March 31, 2006 and December 31, 2005 were net losses of
approximately $0.3 million and $0.2 million, respectively, and were recorded in
accrued expenses with the change in fair value recorded in current year's
earnings. Assuming that the March 31, 2006 exchange rates between the U.S.
dollar and the Swiss franc were to adversely change by a hypothetical ten
percent, the change in the fair value of the contract would decrease by
approximately $7.4 million. However, since the contracts hedge foreign currency
payables, any change in the fair value of the contracts would be offset by a
change in the underlying value of the hedged item.
MARKETABLE SECURITIES AVAILABLE FOR SALE: At March 31, 2006, our marketable
securities available for sale consisted of U.S. treasury securities, government
sponsored agency securities, auction rate notes, mortgage-backed obligations,
corporate debt securities, other asset-backed securities and 1,939,600 shares of
Pharmion Corporation common stock. Marketable securities available for sale are
carried at fair value, are held for an indefinite period of time and are
intended to be used to meet our ongoing liquidity needs. Marketable securities
with original maturities of three months or less when purchased are generally
classified as cash equivalents. Unrealized gains and losses on available for
sale securities, which are deemed to be temporary, are reported as a separate
component of stockholders' equity, net of tax. The cost of all debt securities
is adjusted for amortization of premiums and accretion of discounts to maturity.
The amortization, along with realized gains and losses, is included in interest
and other income, net. During the quarter ended March 31, 2006, we determined
that certain securities with an amortized cost basis of $11.0 million had
sustained an other-than-temporary impairment and recognized a $3.3 million
impairment loss related to these securities due to reductions in their future
estimated cash flows.
As of March 31, 2006, the principal amounts, fair values and related weighted
average interest rates of our investments in debt securities classified as
marketable securities available-for-sale were as follows:
------------------------------------------------------------------------------------------------------------------
Duration
----------------------------------------------------------------------
Less Than 1 1 to 3 3 to 5 5 to 7 Over 7 Years Total
(IN THOUSANDS $) Year Years Years Years
------------------------------------------------------------------------------------------------------------------
Principal amount $ 379,019 $81,308 $226,739 $14,500 $2,900 $704,466
Fair value $ 376,870 $81,293 $208,853 $13,735 $2,828 $683,579
Average interest rate 4.7% 4.7% 4.4% 1.5% N/A 4.5%
PHARMION COMMON STOCK: At March 31, 2006, we held a total of 1,939,600 shares of
Pharmion Corporation common stock, which had an estimated fair value of
approximately $35.0 million (based on the closing price reported by the National
Association of Securities Dealers Automated Quotations, or NASDAQ system, and
which exceeded the cost by approximately $14.8 million. The amount by which the
fair value exceeded the cost (i.e., the unrealized gain) was included in
Accumulated Other Comprehensive Income in the Stockholders' Equity section of
the Consolidated Balance Sheet. The fair value of the Pharmion common stock
investment is subject to market price volatility and any increase or decrease in
Pharmion's common stock quoted market price will have a similar percentage
increase or decrease in the fair value of our investment.
30
INVESTMENT IN AFFILIATED COMPANIES: At March 31, 2006, we held 7,864,864 shares
of EntreMed, Inc. common stock to which we are applying the equity method of
accounting. The investment in EntreMed had a carrying value of approximately
$15.3 million at March 31, 2006, which is below the estimated fair value of our
7,864,864 shares of EntreMed common stock by approximately $5.2 million based on
the closing share price of EntreMed common stock on March 31, 2006. Under the
equity method, the investment is reviewed to determine whether an
other-than-temporary decline in value of the investment has been sustained. If
it is determined that the investment has sustained an other-than-temporary
decline in its value, the investment will be written down to its fair value.
Such an evaluation is judgmental and dependent on the specific facts and
circumstances. See our discussion of Critical Accounting Policy contained in
Item 2, Management's Discussion and Analysis of Financial Condition and Results
of Operation for factors that are considered in determining whether an
other-than-temporary decline in value has occurred.
We also hold warrants to purchase an additional 432,432 shares of EntreMed
common stock at a conversion price of $2.3125 per warrant. The warrants are
being accounted for at fair value with changes in fair value recorded through
earnings. At March 31, 2006, the warrants had a fair value of $0.7 million and
are classified in other non-current assets. Since the warrants give us the
right, but not an obligation, to purchase the shares of EntreMed common stock,
the fair value of the warrants can never fall below zero and, the maximum
cumulative charge is $0.6 million, which is fair value of the warrants, computed
using the Black-Scholes model, on February 2, 2006, or the date of the
investment.
CONVERTIBLE DEBT: In June 2003, we issued an aggregate principal amount of
$400.0 million of unsecured convertible notes. The notes have a five-year term
and a coupon rate of 1.75% payable semi-annually on June 1 and December 1. Each
$1,000 principal amount of convertible notes is convertible into 82.5592 shares
of common stock, or a conversion rate of $12.1125 per share, which represented a
50% premium to the closing price on May 28, 2003 of our common stock of $8.075
per share, after adjusting prices for the two-for-one stock splits affected on
February 17, 2006 and October 22, 2004. The debt issuance costs related to these
convertible notes, which totaled approximately $12.2 million, are classified
under "Other Assets" on the consolidated balance sheet and are being amortized
over five years, assuming no conversion. Under the terms of the purchase
agreement, the noteholders can convert the outstanding notes at any time into an
aggregate 33,021,617 shares of common stock at the conversion price. In
addition, the noteholders have the right to require us to redeem the notes in
cash at a price equal to 100% of the principal amount to be redeemed, plus
accrued interest, prior to maturity in the event of a change of control and
certain other transactions defined as a "fundamental change," in the indenture
governing the notes. We registered the notes and common stock issuable upon
conversion of the notes with the Securities and Exchange Commission, and are
required to use reasonable best efforts to keep the related registration
statement effective for the defined period. Subsequent to the June 2003 issuance
date, an immaterial amount of principal was converted into common stock.
At March 31, 2006, the fair value of our convertible notes exceeded the carrying
value of $400.0 million by approximately $1.0 billion, which we believe reflects
the increase in the market price of our common stock to $44.22 per share as of
March 31, 2006. Assuming other factors are held constant, an increase in
interest rates generally results in a decrease in the fair value of fixed-rate
convertible debt, but does not impact the carrying value, and an increase in our
stock price generally results in an increase in the fair value of convertible
debt, but does not impact the carrying value.
31
ITEM 4 - CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. As of the end of the
period covered by this quarterly report, we carried out an evaluation,
under the supervision and with the participation of the Company's
management, including our Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures (as defined in the Securities
Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)). Based upon the
foregoing evaluation, our Chief Executive Officer and Chief Financial
Officer have concluded that our disclosure controls and procedures are
effective to ensure that information required to be disclosed by the
Company in the reports that it files or submits under the Exchange Act
is recorded, processed, summarized and reported within the time periods
specified in the rules and forms of the Securities and Exchange
Commission.
(b) Changes in Internal Control Over Financial Reporting. There have not
been any changes in our internal control over financial reporting
during the fiscal quarter to which this report relates that have
materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting.
32
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
We are not engaged in any material legal proceedings.
Item 1A. Risk Factors
The risk factors included in our Annual Report on Form 10-K for the fiscal year
ended December 31, 2005 have not materially changed.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds - None
Item 3. Defaults Upon Senior Securities - None
Item 4. Submission of Matters to a Vote of Security Holders
We held a Special Meeting of stockholders on February 16, 2006. At this meeting,
our stockholders were asked to approve an amendment to our Certificate of
Incorporation to increase the total number of shares of capital stock we are
authorized to issue from 280,000,000 to 580,000,000. The amendment to our
Certificate of Incorporation was approved by the following votes on a pre-split
basis:
NUMBER OF SHARES
FOR AGAINST ABSTAINED
----------- ---------------- ---------
105,167,061 1,160,152 160,644
Item 5. Other Information - None
Item 6. Exhibits
3.2 Bylaws of the Company.
10.1 Services Agreement effective May 1, 2006 between the
Company and John W. Jackson
10.2 Employment Agreement effective May 1, 2006 between the
Company and Sol J. Barer
10.3 Employment Agreement effective May 1, 2006 between the
Company and Robert J. Hugin
31.1 Certification by the Company's Chief Executive Officer
dated May 10, 2006.
31.2 Certification by the Company's Chief Financial Officer
dated May 10, 2006.
32.1 Certification by the Company's Chief Executive Officer
pursuant to 18 U.S.C. Section 1350 dated May 10, 2006.
32.2 Certification by the Company's Chief Financial Officer
pursuant to 18 U.S.C. Section 1350 dated May 10, 2006.
33
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CELGENE CORPORATION
DATE May 10, 2006 By:/s/Robert J. Hugin
---------------------------- --------------------------------
Robert J. Hugin
President, Chief Operating Officer and
Chief Financial Officer
DATE May 10, 2006 By:/s/James R. Swenson
---------------------------- --------------------------------
James R. Swenson
Controller
34