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 June 30, 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 incorporation (I.R.S. Employer
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 ___
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 ___
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes ___ No _X_
At August 4, 2006, 350,742,466 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 and Six-Month Periods Ended June 30, 2006 and 2005 3
Consolidated Balance Sheets -
As of June 30, 2006 and December 31, 2005 4
Consolidated Statements of Cash Flows -
Six-Month Periods Ended June 30, 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 21
Item 3 Quantitative and Qualitative Disclosures About Market Risk 41
Item 4 Controls and Procedures 43
PART II OTHER INFORMATION 45
Item 1 Legal Proceedings 45
Item 1A Risk Factors 45
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds 45
Item 3 Defaults Upon Senior Securities 45
Item 4 Submission of Matters to a Vote of Security Holders 45
Item 5 Other Information 46
Item 6 Exhibits 46
Signatures 47
2
PART I - FINANCIAL INFORMATION
ITEM 1. UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
CELGENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE-MONTH PERIOD ENDED SIX-MONTH PERIOD ENDED
JUNE 30, JUNE 30,
------------------------ ------------------------
2006 2005 2006 2005
--------- --------- --------- ---------
Revenues:
Net product sales $ 176,401 $ 105,383 $ 336,644 $ 203,028
Collaborative agreements and other revenue 3,953 25,721 7,846 30,950
Royalty revenue 16,885 14,597 34,590 24,119
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Total revenues 197,239 145,701 379,080 258,097
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Expenses:
Cost of goods sold 26,799 18,196 56,943 30,800
Research and development 57,018 49,028 111,542 89,065
Selling, general and administrative 82,830 41,367 149,727 79,173
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Total expenses 166,647 108,591 318,212 199,038
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Operating income 30,592 37,110 60,868 59,059
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Other income and expense:
Interest and other income, net 9,487 6,716 15,732 5,538
Equity in losses of affiliated company 1,375 640 4,466 4,995
Interest expense 2,361 2,373 4,725 4,747
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Income before income taxes 36,343 40,813 67,409 54,855
--------------------------------------------------------------------------------------------------------------
Income tax provision (benefit) 26,735 29,967 41,777 (4,205)
--------------------------------------------------------------------------------------------------------------
Net income $ 9,608 $ 10,846 $ 25,632 $ 59,060
==============================================================================================================
Net income per common share:
Basic $ 0.03 $ 0.03 $ 0.07 $ 0.18
Diluted $ 0.03 $ 0.03 $ 0.07 $ 0.16
See accompanying Notes to Consolidated Financial Statements
3
CELGENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
JUNE 30, 2006 DECEMBER 31, 2005
------------- -----------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 120,918 $ 123,316
Marketable securities available for sale 636,838 600,944
Accounts receivable, net of allowance of $4,871 and $3,739
at June 30, 2006 and December 31, 2005, respectively 84,379 77,913
Inventory 31,289 20,242
Deferred income taxes 116,920 113,059
Other current assets 87,721 37,363
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Total current assets 1,078,065 972,837
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Property, plant and equipment, net 88,294 77,477
Investment in affiliated company 13,913 17,017
Intangible assets, net 97,673 96,988
Goodwill 35,692 33,815
Deferred income taxes 41,472 31,260
Other assets 17,574 17,243
-------------------------------------------------------------------------------------------------------------
Total assets $ 1,372,683 $ 1,246,637
=============================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 22,362 $ 16,414
Accrued expenses 74,348 92,908
Income taxes payable 38,162 14,715
Current portion of deferred revenue 7,125 6,473
Other current liabilities 3,916 5,127
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Total current liabilities 145,913 135,637
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Long-term convertible notes 399,967 399,984
Deferred revenue, net of current portion 60,479 59,067
Other non-current liabilities 20,693 16,174
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Total liabilities 627,052 610,862
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COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value per share, 5,000,000 shares
authorized; none outstanding at June 30, 2006 and December 31, 2005 -- --
Common stock, $.01 par value per share, 575,000,000 shares
authorized; issued 354,115,488 and 344,125,158 shares
at June 30, 2006 and December 31, 2005, respectively 3,541 3,441
Common stock in treasury, at cost; 3,754,071 and 1,953,282 shares
at June 30, 2006 and December 31, 2005, respectively (129,784) (50,601)
Additional paid-in capital 1,024,612 853,601
Accumulated deficit (145,122) (170,754)
Accumulated other comprehensive income (loss) (7,616) 88
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Total stockholders' equity 745,631 635,775
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Total liabilities and stockholders' equity $ 1,372,683 $ 1,246,637
=============================================================================================================
See accompanying Notes to Consolidated Financial Statements
4
CELGENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
SIX-MONTH PERIOD ENDED
JUNE 30,
-------------------------
2006 2005
--------- ---------
Net income $ 25,632 $ 59,060
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization of long-term assets 12,101 6,708
Provision for accounts receivable allowances 9,306 5,381
Realized/Unrealized loss (gain) on marketable securities available for sale and
cash equivalents 3,704 (423)
Unrealized loss on foreign exchange forward contract 316 --
Unrealized loss on value of EntreMed warrants 270 6,875
Equity losses of affiliated company 4,466 640
Non-cash write off of in-process research and development -- 4,355
Non-cash share-based compensation expense 35,607 (23)
Excess tax benefit from stock-based compensation arrangements (40,294) --
Amortization of premium/discount on marketable securities available for sale, net (1,461) 962
Loss on asset disposals 161 51
Amortization of debt issuance cost 1,221 1,221
Deferred income taxes (15,287) (42,425)
Shares issued for employee benefit plans 6,518 3,506
Other 536 141
Change in current assets and liabilities, excluding the impact of acquisition:
Increase in accounts receivable (16,649) (15,188)
Increase in inventory (13,824) (9,463)
Increase in other operating assets (46,717) (11,793)
Increase (decrease) in accounts payable, accrued expenses and other liabilities (63,034) 14,210
Increase in income tax payable 66,736 4,458
Decrease in deferred revenue (1,156) (1,892)
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Net cash (used in) provided by operating activities (31,848) 26,361
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Cash flows from investing activities:
Capital expenditures (17,371) (9,092)
Business acquisition -- (8,429)
Proceeds from sales and maturities of marketable securities available for sale 299,019 188,622
Purchases of marketable securities available for sale (339,175) (288,605)
Investment in affiliated company (2,000) (10,500)
Purchases of investment securities (625) --
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Net cash used in investing activities (60,152) (128,004)
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Cash flows from financing activities:
Net proceeds from exercise of common stock options and warrants 45,932 22,674
Excess tax benefit from share-based compensation arrangements 40,294 --
Repayment of capital lease and note obligations -- (4)
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Net cash provided by financing activities 86,226 22,670
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Effect of currency rate changes on cash and cash equivalents 3,376 (2,464)
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Net increase (decrease) in cash and cash equivalents (2,398) (81,437)
Cash and cash equivalents at beginning of period 123,316 135,227
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Cash and cash equivalents at end of period $ 120,918 $ 53,790
=====================================================================================================================
See accompanying Notes to Consolidated Financial Statements
5
CELGENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS)
SIX-MONTH PERIOD ENDED
JUNE 30,
----------------------------
2006 2005
------------ ------------
Supplemental schedule of non-cash investing
and financing activity:
Change in net unrealized loss on marketable
securities available for sale $ (5,687) $ (42,388)
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Matured shares tendered for stock option
exercises and employee tax withholdings $ (84,394) $ --
------------ ------------
Conversion of convertible notes $ 17 $ --
------------ ------------
Supplemental disclosure of cash flow information:
Interest paid $ 3,500 $ 3,500
------------ ------------
Income taxes paid $ 23,576 $ 34,543
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See accompanying Notes to Consolidated Financial Statements
6
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 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(R) to Novartis Pharma AG, or Novartis; a licensing agreement with
Novartis which entitles the Company to royalties on FOCALINTM XR 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 Celgene Cellular Therapeutics.
The accompanying unaudited consolidated financial statements 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. Pursuant
to such rules and regulations, certain information and footnote disclosures
normally included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
condensed or omitted. 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 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. NEW ACCOUNTING PRINCIPLES
In June 2006, the Financial Accounting Standards Board, or FASB, issued FASB
Interpretation No. 48, Accounting for Uncertainty in Income Taxes--an
interpretation of FASB Statement No. 109. This Interpretation clarifies the
accounting for uncertainty in income taxes recognized in an enterprise's
financial statements in accordance with FASB No. 109 and prescribes a
recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in a
tax return. This Interpretation also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosure, and transition. This Interpretation is effective for the Company
beginning January 1, 2007. We are in the process of analyzing the impact that
this Interpretation may have on the Company's consolidated financial statements.
Therefore, we are not in a position to conclude whether the adoption of this
Interpretation will have a material impact on the Company's consolidated
financial statements.
In February 2006, the FASB, issued Financial Accounting Standard No. 155,
"Accounting for Certain Hybrid Financial Instruments - an amendment of FASB
Statements No. 133 and 140," which permits a fair value
7
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
remeasurement for any hybrid financial instrument that contains an embedded
derivative that would otherwise require bifurcation. This accounting standard is
effective for the Company beginning January 1, 2007. We have not yet determined
the effect, if any, the adoption of FAS 155 may have on our financial position
and results of operations.
3. 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 total number of potential common shares excluded from the diluted earnings
per share computation because their inclusion would have been anti-dilutive was
35,718,208 and 37,201,144 shares for the three-month periods ended June 30, 2006
and 2005, respectively. The total number of potential common shares excluded for
the six-month periods ended June 30, 2006 and 2005 was 35,803,816 and 4,354,864
shares, respectively.
The following represents the reconciliation of the basic and diluted earnings
per share computations for the three and six months ended June 30, 2006 and
2005:
--------------------------------------------------------------------------------------------------------------
Three-Month Period Ended Six-Month Period Ended
June 30, June 30,
2006 2005 2006 2005
--------------------------------------------------------------------------------------------------------------
Income available to common stockholders:
Net income $ 9,608 $ 10,846 $ 25,632 $ 59,060
Interest expense on convertible debt, net of tax -- -- -- 2,786
----------------------------------------------------------
Net income available to common stockholders $ 9,608 $ 10,846 $ 25,632 $ 61,846
Weighted average number of common
shares outstanding (IN THOUSANDS):
Basic 347,696 334,282 345,841 332,762
Effect of dilutive securities:
Options, warrants and other incentives 22,664 17,741 23,267 16,658
Convertible debt -- -- -- 33,024
--------------------------------------------------------------------------------------------------------------
Diluted 370,360 352,023 369,108 382,444
Earnings per share:
Basic $ 0.03 $ 0.03 $ 0.07 $ 0.18
Diluted $ 0.03 $ 0.03 $ 0.07 $ 0.16
==============================================================================================================
8
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
4. 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 which became
effective 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 33,020,957 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 has been converted into
common stock.
5. 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 June 30, 2006 and December 31, 2005 were
as follows:
------------------------------------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
June 30, 2006 Cost Gain Loss Value
------------------------------------------------------------------------------------------------------------
Cash equivalents (1)
--------------------
Government sponsored enterprises $ 64,739 $ 37 $ -- $ 64,776
------------------------------------------------------------
Available-for-sale marketable securities
----------------------------------------
Mortgage backed obligations 71,962 161 (879) 71,244
U.S. treasury securities 103,718 13 (1,152) 102,579
Government sponsored enterprises 265,766 4 (6,988) 258,782
Corporate debt securities 18,502 11 (1,802) 16,711
Other asset backed securities 31,678 1,442 (4) 33,116
Auction rate notes 121,375 -- -- 121,375
Marketable equity securities 20,212 12,819 -- 33,031
------------------------------------------------------------
Total available-for-sale marketable securities 633,213 14,450 (10,825) 636,838
------------------------------------------------------------
Total marketable securities $ 697,952 $ 14,487 $ (10,825) $ 701,614
============================================================================================================
(1) Marketable securities with maturities of three months or less at time of
purchase are classified as cash equivalents.
9
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
------------------------------------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
December 31, 2005 Cost Gain Loss Value
------------------------------------------------------------------------------------------------------------
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 enterprises 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
-----------------------------------------------------------
Total available-for-sale marketable securities $ 595,262 $ 14,852 $ (9,170) $ 600,944
============================================================================================================
Government sponsored enterprises include fixed asset-backed securities issued 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 enterprises 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 widening credit spreads.
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 six
months ended June 30, 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 $3.6 million impairment loss related to these
securities due to reductions in their future estimated cash flows.
As of June 30, 2006, the duration of the Company's debt securities classified as
cash equivalents and marketable securities available for sale were as follows:
---------------------------------------------------------------------------
Amortized Fair
Cost Value
---------------------------------------------------------------------------
Duration of one year or less $ 380,386 $ 379,991
Duration of one through three years 70,995 69,755
Duration of three through five years 193,561 186,331
Duration of five through seven years 30,045 29,693
Duration greater than seven years 2,753 2,813
----------------------------
Total $ 677,740 $ 668,583
===========================================================================
6. INVENTORY
Inventory at June 30, 2006 and December 31, 2005 consisted of the following:
---------------------------------------------------------------------------
June 30, December 31,
2006 2005
---------------------------------------------------------------------------
Raw materials $ 6,776 $ 5,044
Work in process 4,845 1,644
Finished goods 19,668 13,554
------------ ------------
Total $ 31,289 $ 20,242
===========================================================================
10
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
7. 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. On June 14, 2006, the
stockholders of the Company approved an amendment to the 1998 Incentive Plan to
increase the aggregate number of shares of Common Stock that may be subject to
awards thereunder from 62,000,000 to 84,000,000 shares, 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-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 an option to purchase 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 market 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 22,641,254 at
June 30, 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
11
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
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."
The following table illustrates the effect on net income and net income per
common share applicable to common stockholders for the three and six-month
periods ended June 30, 2005, as if the Company had applied the fair value
recognition provisions for stock-based compensation of SFAS 123, as amended:
Three Months Ended Six Months Ended
June 30, 2005 June 30, 2005
--------------------------------------------------------------------------------------------------------
Net income as reported $ 10,846 $ 59,060
Add: stock-based employee compensation expense included in
reported income, net of tax (38) (13)
Add: stock-based employee compensation expense determined
under fair-value-based method (1) (4,888) 8,240
------------------------------------
Basic pro forma net income $ 5,920 $ 67,287
Interest expense on convertible debt, net of tax -- 2,786
------------------------------------
Diluted, pro forma net income $ 5,920 $ 70,073
Net income per common share:
Basic, as reported $ 0.03 $ 0.18
Basic, pro forma $ 0.02 $ 0.20
Diluted, as reported $ 0.03 $ 0.16
Diluted, pro forma $ 0.02 $ 0.18
========================================================================================================
(1) Six months ended June 30, 2005 reflects an adjustment recorded in the first
quarter of 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 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 that 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 costs in the Consolidated
Statement of Operations for the three and six-month periods ended June 30, 2006
were $20.7 million and $35.5 million, respectively, in connection with the
adoption of SFAS 123R. Charges for the three-month period ended June 30, 2006 of
$0.4 million, $3.4 million and $16.9 million were recorded in cost of goods
sold, research and development and selling, general and administrative expenses,
respectively. Charges for the six-month period
12
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
ended June 30, 2006 of $0.9 million, $7.3 million and $27.3 million were
recorded in cost of goods sold, research and development and selling, general
and administrative expenses, respectively. No amounts of share-based
compensation cost were capitalized as inventory or other assets during the three
and six months ended June 30, 2006. Included in stock-based compensation expense
for the three and six-month periods ended June 30, 2006 was compensation expense
related to non-qualified stock options of $15.7 million and $25.0 million,
respectively. The tax benefit (i.e., deferred tax asset) recorded associated
with the non-qualified stock option expense was $6.5 million and $10.3 million
respectively.
As a result of adopting SFAS 123R at the beginning of 2006, the Company's net
income was lower by $14.2 million and $25.2 million for the three and six-month
periods ended June 30, 2006, respectively, than if it had continued to account
for share-based compensation under APB 25. Basic and diluted earnings per share
for the three-month period ended June 30, 2006 would have been $0.07 and $0.06
per share, respectively, if the Company had not adopted SFAS 123R, compared to a
reported basic and diluted earnings per share of $0.03 and $0.03 per share,
respectively. Basic and diluted earnings per share for the six-month period
ended June 30, 2006 would have been $0.15 and $0.14 per share, respectively, if
the Company had not adopted SFAS 123R, compared to a reported basic and diluted
earnings per share of $0.07 and $0.07 per share, respectively.
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 which 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 Consolidated Statement of Cash Flows.
Cash received from stock option exercises for the six-month period ended June
30, 2006 was $45.9 million and the excess tax benefit recognized was $40.3
million. Cash received from stock option exercises for the six-month period
ended June 30, 2005 was $22.7 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 and six-month periods ended June 30, 2006 was $16.80 per share and
$16.58 per share, respectively. The weighted-average grant-date fair value of
the stock options granted during the three and six-month periods ended June 30,
2005 was $7.00 per share and $6.10 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 assumptions:
13
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, Six Months Ended June 30,
2006 2005 2006 2005
------------------------------------------------------------------------------------------------------------
Risk-free interest rate 4.50% - 5.19% 3.46% - 4.00% 4.50% - 5.19% 3.46% - 4.00%
Expected volatility 44% - 52% 41% 40% - 52% 41%
Weighted average expected volatility 50% 41% 49% 41%
Expected term (years) 3.1 - 5.0 4.5 3.1 - 5.0 4.5
Expected dividend yield 0% 0% 0% 0%
============================================================================================================
The fair value of stock options granted is estimated using the Black-Scholes
option pricing model. The fair value of stock options granted after January 1,
2006 is amortized on a straight-line basis. The fair value of stock options
granted before January 1, 2006 is amortized using the graded vesting attribution
approach. Compensation cost is amortized over the requisite service periods of
the awards, which are generally the vesting periods.
For grants during the three and six-month periods ended June 30, 2006, the
risk-free interest rate is based on the U.S. Treasury zero-coupon curve.
Expected volatility of stock option awards is estimated based on the implied
volatility of greater than one-year publicly traded options. The use of implied
volatility was based upon the availability of actively traded options on the
Company's common stock and the assessment that implied volatility is more
representative of future stock price trends than historical volatility. Prior to
the adoption of SFAS 123R, the Company calculated expected volatility using only
historical stock price volatility. The expected term of an employee share option
is the period of time for which the option is expected to be outstanding. The
Company has made a determination of expected term by analyzing employees'
historical exercise experience from its history of grants and exercises in the
Company's option database 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 six months ended June 30, 2006 under all plans
are as follows:
14
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
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 2,697,251 41.22 -- --
Exercised (9,988,927) 9.10 -- --
Forfeited (897,307) 13.43 -- --
Expired (20,000) 6.69 -- --
-------------------------------
Outstanding at June 30, 2006 42,385,395 $ 16.50 6.6 $ 1,311,068
-------------------------------------------------------------
Vested or expected to vest at June 30, 2006 41,677,200 $ 16.43 6.6 $ 1,291,886
-------------------------------------------------------------
Vested at June 30, 2006 28,191,773 $ 14.42 5.9 $ 930,754
=============================================================
The total intrinsic value of stock options exercised during the six months ended
June 30, 2006 and 2005 was $310.8 million and $61.7 million, respectively. The
Company utilizes newly issued shares to satisfy the exercise of stock options.
As of June 30, 2006, there was $73.6 million of total unrecognized compensation
cost related to stock options granted under the plans. That cost will be
recognized over an expected weighted-average period of 1.2 years.
The following table summarizes information concerning options outstanding under
the 1998 and 1995 Incentive Plans at June 30, 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 6,873,508 $ 2.11 3.3 6,629,249 $ 2.03 3.2
5.01 - 10.00 9,005,810 6.79 5.2 7,869,583 6.76 5.0
10.01 - 15.00 8,510,480 12.84 7.4 3,602,655 12.86 6.8
15.01 - 20.00 4,437,116 16.54 7.3 2,103,248 16.61 5.9
20.01 - 30.00 4,862,171 25.12 8.0 2,196,779 26.19 6.5
30.01 - 45.91 8,696,310 36.66 8.8 5,790,259 34.71 9.4
--------------------------------------------------------------------------------------------------
42,385,395 $ 16.50 6.6 28,191,773 $ 14.42 5.9
==================================================================================================
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 minimum statutory applicable
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
15
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
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
June 30, 2006, the Company has issued 10,876,300 stock options to executives
that contain the reload features noted above, of which 2,383,231 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.
8. 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 is $0.4 million at
June 30, 2006.
The Company recorded equity in losses of affiliated company of $1.4 million and
$0.6 million for the three-month periods ended June 30, 2006 and 2005,
respectively. The Company's equity in losses of affiliated company for the
six-month period ended June 30, 2006 was $4.5 million and included $3.1 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. The loss for the six-month period ended June 30, 2005 was $5.0 million
and included $4.4 million related to a write-down of a portion of the Company's
investment ascribed to in-process research and development at the time of the
initial investment. The investment in EntreMed had a carrying value of
approximately $13.9 million at June 30, 2006, which is above the estimated fair
value of the Company's 7,864,864 shares of EntreMed common stock by
approximately $0.9 million based on the closing share price of EntreMed common
stock on June 30, 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 June 30, 2006 no adjustment to its investment
is required.
16
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
A summary of the Company's investment and equity in losses of affiliates
follows:
As of
June 30, 2006
-------------
Interest in EntreMed equity (1) $ 4,176
Excess of investment over share of EntreMed equity (2) 9,737
-------------
Total investment $ 13,913
================================================================================
Three-Month Six-Month
Period Ended Period Ended
June 30, 2006 June 30, 2006
------------------------------
Celgene share of EntreMed, Inc. losses (1) (3) $ 1,309 $ 4,316
Amortization of intangibles 66 150
------------------------------
Equity in losses of affiliated company $ 1,375 $ 4,466
================================================================================
(1) The Company records its share of losses based on its common stock
ownership, which as of June 30, 2006 was 10.73%.
(2) Consists of intangible assets and goodwill of $452 and $9,284,
respectively.
(3) Year-to-date June 30, 2006 includes $3.1 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.
9. GOODWILL AND INTANGIBLE ASSETS
At June 30, 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
June 30, 2006 and December 31, 2005 were as follows:
---------------------------------------------------------------------------------------------------------------
Gross Cumulative Intangible Weighted
Carrying Accumulated Translation Assets, Average
June 30, 2006 Value Amortization Adjustment Net Life (Years)
---------------------------------------------------------------------------------------------------------------
Penn T supply agreements $ 99,841 $ (7,053) $ 674 $ 93,462 12.9
License 4,250 (154) -- 4,096 13.8
Technology 122 (7) -- 115 12.0
---------------------------------------------------------------------------------------------------------------
Total $ 104,213 $ (7,214) $ 674 $ 97,673 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 $2.2 million and $0.2 million for
the three-month periods ended June 30, 2006 and 2005, respectively, and $4.4
million and $0.4 million for the six-month periods ended June 30, 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 $8.9 million for 2006, and $8.5 million for each of the years
2007 through 2010.
17
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
The Company's reported goodwill of $35.7 million and $33.8 million at June 30,
2006 and December 31, 2005, respectively, relates to the acquisition of Penn T
on October 21, 2004. The $1.9 million increase from December 31, 2005 to June
30, 2006 represents the impact of foreign currency translation.
10. 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.
A summary of comprehensive income for the three and six-month periods ended June
30, 2006 and 2005 follows:
-------------------------------------------------------------------------------------------------------------------
Three-Month Period Ended Six-Month Period Ended
June 30, June 30,
2006 2005 2006 2005
-------------------------------------------------------------------------------------------------------------------
Net income $ 9,608 $ 10,846 $ 25,632 $ 59,060
----------------------------------------------------------------
Other comprehensive income (loss):
Unrealized losses on marketable
securities available for sale, net of tax (1,769) (5,425) (6,339) (36,270)
Deferred income tax (1) -- -- -- (14,775)
Less: reclassification adjustment for (gains)
losses included in net income 321 (214) 3,667 (423)
----------------------------------------------------------------
Total unrealized losses on marketable
securities available for sale, net of tax (1,448) (5,639) (2,672) (51,468)
Currency translation adjustments (4,554) (3,517) (5,032) (6,054)
----------------------------------------------------------------
Total other comprehensive loss (6,002) (9,156) (7,704) (57,522)
----------------------------------------------------------------
Comprehensive income (loss) $ 3,606 $ 1,690 $ 17,928 $ 1,538
===================================================================================================================
(1) Reflects the adjustment recorded in the first quarter of 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 losses on marketable securities available for sale for the
three-month periods ended June 30, 2006 and 2005 included a decrease in fair
value related to the Company's investment in Pharmion common stock of $1.9
million and $11.2 million, respectively, and $1.4 million and $36.9 million for
the six-month periods ended June 30, 2006 and 2005, respectively.
11. 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.
18
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
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 with
the completion of audit for this period.
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.
12. 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 financial reporting has been combined with the Human Pharmaceuticals
research organization as the strategic intent of the business has evolved to
focus on discovery, development and commercialization of stem cells in
pharmaceutical use.
13. 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 $11.0 million. At June 30, 2006, the remaining cost
to be incurred was $7.2 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,
(formerly known as "Penn T Limited") 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, CUK II
received a one-time payment of 39.6 million British pounds sterling, or U.S.
dollar equivalency of $77.0 million. The Company 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 its license termination rights. Under a separate letter agreement
simultaneously entered into by the parties, Pharmion also agreed to provide the
Company with an aggregate $8.0 million over a three-year period commencing
January 1, 2005 and ending December 31, 2007 to support the two companies'
existing thalidomide research and development efforts.
Pursuant to EITF 00-21, the Company has determined that the agreements
constitute a single unit of accounting and pursuant to SAB No. 101, as amended
by SAB No. 104, the Company has recorded the payments received
19
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
as deferred revenue and is amortizing such payments on a straight line basis
over an estimated useful life of 13 years, which is the estimated life of the
supply agreement. The remaining payments to be received under the thalidomide
research and development letter agreement (i.e., $4.0 million at June 30, 2006)
will be recorded as deferred revenue as such payments are received and amortized
over the remaining useful life.
To support the further clinical development of thalidomide, Pharmion has
provided research funding under various agreements of $12.0 million through June
30, 2006 and is required to fund an additional $1.3 million in 2006 and $2.7
million in 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. On June 30, 2006, the
remaining minimum purchase requirements under the agreement totaled $67.9
million, consisting of the following subsequent extensions:
o July 1, 2006 - December 31, 2006 $ 620
o January 1, 2007 - December 31, 2007 29,050
o January 1, 2008 - December 31, 2008 30,525
o January 1, 2009 - March 31, 2009 7,725
-------
$67,920
=======
20
PART I - FINANCIAL INFORMATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
We are a global 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 was approved by the U.S. Food and Drug Administration, or
FDA, in December 2005 for treatment of myelodysplastic syndromes, or MDS, in
transfusion dependent patients with the 5q chromosomal deletion and in June 2006
for treatment in combination with dexamethasone of previously treated multiple
myeloma; and, THALOMID(R) (thalidomide), which is approved in erythema nodosum
leprosum, an inflammatory complication of leprosy, and which gained FDA approval
in May 2006 for treatment in combination with dexamethasone of newly diagnosed
multiple myeloma patients. 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 commercial potential of REVLIMID(R) and THALOMID(R), the depth
of our product pipeline, near-term regulatory activities and clinical data
reported at major medical conferences provide the catalysts 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: Our
REVLIMID(R) launch strategy has included among other things: registering
physicians in the RevAssistsm 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 about multiple myeloma and MDS; partnering with contracted pharmacies
to ensure safe and rapid distribution of REVLIMID(R); and, implementing an
expanded access program to provide many previously treated multiple myeloma
patients with free access to REVLIMID(R) while the FDA reviewed our Supplemental
New Drug Application, or sNDA, for that indication. While these initiatives
appear to be resulting in a highly visible and successful product launch, our
near-term focus continues to be on ensuring REVLIMID's rapid market penetration
in both MDS and multiple myeloma. 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
21
may be some lag time before being added to each plan's formulary. If REVLIMID(R)
sales do not materialize as expected, we may have difficulty meeting our
near-term revenue and earnings projections.
THE ABILITY TO ADVANCE CLINICAL AND REGULATORY PROGRAMS: A growing body of
clinical data suggests that our proprietary IMiDs(R) compounds may be effective
in treating a number of diseases. A major objective of our on-going clinical
programs is to broaden our knowledge about the full potential of REVLIMID(R) and
our other IMiDs(R) compounds and to continue to evaluate them in a broad range
of hematological malignancies and other cancers. An immediate focus is on
evaluating REVLIMID(R) as a treatment of chronic lymphocytic leukemia and
aggressive non-Hodgkin's lymphomas. Our continued growth will depend, in part,
on international regulatory approvals and the progress of our clinical programs
across a broad range of hematological malignancies and other cancers. Currently,
our Marketing Authorization Applications, or MMA's, for REVLIMID(R) in both MDS
with the 5q chromosomal deletion and multiple myeloma are under review by the
European Medicines Agency, or EMEA.
COMPETITIVE RISKS: While competition could reduce THALOMID(R) sales and limit
REVLIMID(R) launch results, 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 distribution of thalidomide, which all
physicians, patients and pharmacies prescribing receiving or dispensing
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.
RESULTS OF OPERATIONS-
THREE-MONTH PERIOD ENDED JUNE 30, 2006 VS. THREE-MONTH PERIOD ENDED
JUNE 30, 2005
TOTAL REVENUE: Total revenue and related percentages for the three-month periods
ended June 30, 2006 and 2005 were as follows:
--------------------------------------------------------------------------------
Three-Month Period Ended
June 30,
(IN THOUSANDS $) 2006 2005 % Change
--------------------------------------------------------------------------------
Net product sales:
REVLIMID(R) $ 63,020 $ -- N/A
THALOMID(R) 107,193 94,447 13.5 %
ALKERAN(R) 4,452 9,119 (51.2%)
Focalin(R) 1,666 1,577 5.6%
Other 70 240 (70.8%)
----------------------------
Total net product sales 176,401 105,383 67.4%
Collaborative agreements
and other revenue 3,953 25,721 (84.6%)
Royalty revenue 16,885 14,597 15.7%
----------------------------
Total revenue $ 197,239 $ 145,701 35.4%
================================================================================
22
NET PRODUCT SALES:
REVLIMID(R) was approved by the FDA in December 2005 for treatment of
transfusion dependent MDS in patients with the 5q chromosomal deletion and in
June 2006 for treatment in combination with dexamethasone of previously treated
patients with multiple myeloma. As a result, sales for this product are
reflected only in the 2006 period. REVLIMID(R) net sales increased sequentially
from $32.4 million in the three-month period ended March 31, 2006 to $63.0
million in the three-month period ended June 30, 2006. Prescription trends in
the three-month period ended June 30, 2006 were similar to the three-month
period ended March 31, 2006, with MDS prescriptions accounting for a majority of
dispenses during the period followed by some use in multiple myeloma and a broad
range of cancer indications accounting for the remainder. Named patient sales
outside of the United States totaled 7.1% of REVLIMID(R) net sales during the
three-month period ended June 30, 2006.
Supported by the FDA's approval of newly diagnosed multiple myeloma and newly
presented data, THALOMID(R) net sales were higher in the three-month period
ended June 30, 2006, compared to the three-month period ended June 30, 2005.
Price increases implemented as we move towards a cost of therapy pricing
structure as opposed to a price per milligram basis also contributed to the
increase. Sales volumes decreased due to 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 and distributor chargebacks as further discussed
below. Included in the three-month period ended June 30, 2006 were sales of
approximately $2.6 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 June 30, 2005.
ALKERAN(R) net sales were lower in the three-month period ended June 30, 2006,
compared to the three-month period ended June 30, 2005, due to a decrease in
sales volumes and higher gross to net sales accruals for sales returns,
partially offset by price increases. We believe the decrease in sales volumes
stems largely from supply disruptions, which has lead to inconsistent supplies
of ALKERAN(R) IV and consequently inconsistent end-market buying patterns. These
factors may continue to contribute to variability in revenues, for the remainder
of this year.
Net sales of Focalin(R), which is sold exclusively to Novartis and is dependent
on the timing of orders from Novartis for their commercial distribution, were
slightly higher in the three-month period ended June 30, 2006, compared to the
three-month period ended June 30, 2005.
GROSS TO NET SALES ACCRUALS: Gross to net sales accruals are recorded for sales
returns, sales discounts, Medicaid rebates and distributor charge-backs and
service fees. 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. See Critical Accounting Policies for further discussion.
23
Gross to net sales accruals and the balance in the related allowance accounts
for the three-month period ended June 30, 2006 and 2005, were as follows:
----------------------------------------------------------------------------------------------------------------------------------
Distributor
Sales Medicaid chargebacks
2006 Returns Discounts rebates and services Total
----------------------------------------------------------------------------------------------------------------------------------
Balance at March 31, 2006 $ 8,338 $ 1,787 $ 24,143 $ 7,343 $ 41,611
Allowances for sales made during the quarter 8,370 4,327 115 13,072 25,884
Allowances for sales made during prior periods 15,436 -- -- -- 15,436
Credits issued for prior year sales (13,849) (85) (11,732) -- (25,666)
Credits issued for sales during 2006 (6,658) (4,277) (5,301) (12,786) (29,022)
--------------------------------------------------------------------
Balance at June 30, 2006 $ 11,637 $ 1,752 $ 7,225 $ 7,629 $ 28,243
==================================================================================================================================
----------------------------------------------------------------------------------------------------------------------------------
Distributor
Sales Medicaid chargebacks
2005 Returns Discounts rebates and services Total
----------------------------------------------------------------------------------------------------------------------------------
Balance at March 31, 2005 $ 7,682 $ 980 $ 9,826 $ 3,815 $ 22,303
Allowances for sales made during the quarter 5,113 2,610 7,115 23,807 8,969
Allowances for sales made during prior periods -- -- -- -- --
Credits issued for prior year sales (2,589) (21) (2,628) -- (5,238)
Credits issued for sales during 2005 (2,936) (2,516) (2,158) (7,914) (15,524)
--------------------------------------------------------------------
Balance at June 30, 2005 $ 7,270 $ 1,053 $ 12,155 $ 4,870 $ 25,348
==================================================================================================================================
Sales returns allowances increased in the three-month period ended June 30,
2006, compared to the three-month period ended June 30, 2005, primarily due to
unexpectedly high THALOMID(R) returns from one large retail pharmacy chain. The
returns from this customer were the result of efforts to more aggressively
manage inventory at its pharmacies, the Company's requirement to purchase full
cartons of up to ten sleeves of THALOMID(R) capsules with each order and,
S.T.E.P.S.(R) related restrictions, which limited the chain's ability To
transfer inventories between its locations. For the past several years, we have
experienced sales returns of approximately 4% of sales. As a result of the
higher returns activity, we recorded additional allowances, during the
three-month period ended June 30, 2006, to increase our reserve to approximately
9% of all estimated THALOMID(R) pharmacy inventories. We introduced single
sleeve units, beginning June 7, 2006 (rather than requiring full carton
purchases) and we amended our product returns policy to include a product
returns handling fee. These measures have been designed to allow customers to
more effectively manage their inventories, since they can now order smaller
quantities, as well as limit our product returns exposure. Initial third quarter
2006 sales returns activity suggests that the second quarter 2006 activity was
an isolated event. We will however, continue to monitor the situation and will
adjust our sales returns accrual accordingly. Also, contributing to the increase
in sales returns allowances, to a lesser extent, were higher returns of expired
ALKERAN(R) IV product from one wholesale distributor.
Medicaid rebate allowances decreased in the three-month period ended June 30,
2006, compared to the three-month period ended June 30, 2005, primarily due to
the impact of the new Medicare, Part D legislation, which became effective
January 1, 2006. Our Medicaid rebate accruals are based on the Medicaid Unit
Rebate Amount formula established by the Center for Medicaid and Medicare
Services using the estimated Medicaid dispense quantities. We base the estimated
Medicaid dispense quantities on the previous quarter actual Medicaid dispenses,
which individual states typically begin reporting to us 45-days after the close
of each quarter. While it was anticipated that many patients who had been
eligible
24
to receive THALOMID(R) through Medicaid would eventually be covered through
Medicare, Part D there was insufficient data to reasonably estimate the impact
of the new legislation during the first quarter of 2006. Therefore, we followed
our customary practice and based our first quarter 2006 accrual on the prior
quarter actual Medicaid dispenses. During the three-month period ended June 30,
2006, we received sufficient data regarding actual first quarter 2006 Medicaid
dispenses to allow us to adjust the Medicaid rebate accrual to reflect the
impact of the new legislation and resulting shift in patient population. As a
result, the three-month period ended June 30, 2006 reflects an accrual for sales
during the second quarter of 2006 of $6.0 million, offset by a reduction of the
prior quarter accrual of $5.9 million.
Distributor chargebacks increased in the three-month period ended June 30, 2006,
compared to the three-month period ended June 30, 2005, primarily due to
increased ALKERAN(R) IV sales to certain public health services, or PHS, pricing
eligible customers.
OTHER REVENUES: Revenues from collaborative agreements and other sources for the
three-month periods ended June 30, 2006 and 2005 included: $2.8 million and $3.5
million, respectively, related to our collaboration with Pharmion Corporation;
and $1.1 million and $1.4 million, respectively, related to umbilical cord blood
enrollment, collection and storage fees generated through our LifeBank USASM
business. The decrease in Pharmion collaboration related revenues was due to the
completion of the April 2003 agreement whereby Pharmion agreed to provide us an
aggregate $8.0 million in research funding for further clinical development of
THALOMID(R). The agreement, which ended December 31, 2005, required Pharmion to
pay us $0.5 million in the three-month period ended June 30, 2005. The
three-month period ended June 30, 2005 also included a $20.0 million milestone
payment from Novartis for the NDA approval of Focalin(TM) XR and approximately a
$0.8 million license fee payment from EntreMed, Inc. related to its licensing of
our tubulin inhibitors compounds.
Royalty revenue for the three-month periods ended June 30, 2006 and 2005
included: $16.0 million and $14.3 million, respectively, of royalties received
from Novartis on sales of their entire family of Ritalin(R) drugs and FocalinTM
XR; $0.3 million and $0.1 million, respectively, of royalties received from
Pharmion Corporation on their commercial sales of THALOMID(R); and $0.2 million
of other miscellaneous royalties in both periods. The three-month period ended
June 30, 2006 also included royalties of $0.4 million related to the S.T.E.P.S.
(R) licensing rights provided to manufacturers of isotretinoin.
COST OF GOODS SOLD: Cost of goods sold and related percentages for the
three-month periods ended June 30, 2006 and 2005 were as follows:
--------------------------------------------------------------------------------
Three-Month Period Ended
June 30,
(IN THOUSANDS $) 2006 2005
--------------------------------------------------------------------------------
Cost of goods sold $ 26,799 $ 18,196
Increase from prior year $ 8,603 $ 4,102
Percentage increase from prior year 47.3 % 29.1%
Percentage of net product sales 15.2 % 17.3 %
================================================================================
Cost of goods sold were higher in the three-month period ended June 30, 2006,
compared to the three-month period ended June 30, 2005, primarily due to higher
royalties on THALOMID(R) as a result of higher net sales and higher ALKERAN(R)
costs. ALKERAN(R) costs increased due to higher per unit costs. 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. Cost of goods
25
sold as a percentage of net product sales were lower in the three-month period
ended June 30, 2006, compared to the three-month period ended June 30, 2005
primarily due to the impact of REVLIMID(R) sales, which has a much lower per
unit costs than THALOMID(R), and price increases implemented since June 30,
2005, partially offset by higher ALKERAN(R) costs, higher gross to net sales
accruals and higher royalties on THALOMID(R).
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.
Research and development expenses and related percentages for the three-month
periods ended June 30, 2006 and 2005 were as follows:
--------------------------------------------------------------------------------
Three-Month Period Ended
June 30,
(IN THOUSANDS $) 2006 2005
--------------------------------------------------------------------------------
Research and development expenses $ 57,018 $ 49,028
Increase from prior year $ 7,990 $ 10,390
Percentage increase from prior year 16.3% 26.9%
Percentage of total revenue 28.9% 33.6%
================================================================================
Research and development expenses were higher in the three-month period ended
June 30, 2006, compared to the three-month period ended June 30, 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 multiple myeloma, MDS,
chronic lymphocytic leukemia and non-Hodgkin's lymphoma; higher medical
education expenses, which support educating and training the medical community
on MDS and multiple myeloma; and higher expenses to support ongoing development
of other compounds such as CC-10004, CC-4047, CC-11006, CC-11050 and CC-401.
Included in the three-month period ended June 30, 2006 was share-based
compensation expense of $3.4 million resulting from the application of Statement
of Financial Accounting Standards, or SFAS, No. 123R, "Share-Based Payments," or
SFAS 123R, which became effective January 1, 2006.
Research and development expenses in the three-month period ended June 30, 2006
consisted of approximately $22.0 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; $9.4 million spent on biopharmaceutical discovery and
development programs; and $2.9 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-11050, and our kinase and ligase inhibitor programs as
well as the placental stem cell program. In the three-month period ended June
30, 2005, approximately $20.6 million was spent on human pharmaceutical clinical
programs; $16.7 million was spent on other human pharmaceutical programs,
including toxicology, analytical research and development, drug discovery,
quality and regulatory affairs; $9.2 million was spent on biopharmaceutical
discovery and development programs; and $2.5 million was spent on placental stem
cell and biomaterials programs.
26
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 ---- 2-3 years
Phase III --- 2-5 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
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 June 30, 2006 and 2005 were as follows:
--------------------------------------------------------------------------------
Three-Month Period Ended
June 30,
(IN THOUSANDS $) 2006 2005
--------------------------------------------------------------------------------
Selling, general and administrative expenses $ 82,830 $ 41,367
Increase from prior year $ 41,463 $ 15,645
Percentage increase from prior year 100.2% 60.8%
Percentage of total revenue 42.0% 28.4%
================================================================================
Selling, general and administrative expenses were $41.5 million higher in the
three-month period ended June 30, 2006, compared to the three-month period ended
June 30, 2005, and included for the first time share-based compensation expense
of $16.9 million resulting from the application of SFAS 123R. Also contributing
to the increase were higher commercial expenses primarily related to sales and
marketing for REVLIMID(R) in the United States and higher general administrative
expenses primarily related to costs incurred in connection with our
international expansion in Europe, Japan, Australia and Canada, increased
professional and other miscellaneous outside service fees and higher
personnel-related expenses.
INTEREST AND OTHER INCOME, NET: Interest and other income, net was $9.5 million
for the three-month period ended June 30, 2006 and included interest income and
net realized gains on our cash and marketable securities portfolio of $8.5
million and foreign exchange gains of $1.6 million, partially offset by losses
recorded for changes in the estimated value of our investment in EntreMed, Inc.
warrants of $0.3 million and an other-than-temporary impairment loss on
marketable securities available for sale of $0.3 million. Interest and other
income, net was $6.7 million for the three-month period ended June 30, 2005 and
primarily consists of interest and net realized gains on our cash and marketable
securities portfolio.
27
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 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 $1.4 million
and $0.6 million for the three-month periods ended June 30, 2006 and 2005,
respectively.
INTEREST EXPENSE: Interest expense was $2.4 million for each of the three-month
periods ended June 30, 2006 and 2005 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 June 30, 2006 was $26.7 million and reflects an underlying
effective tax rate for 2006 of 71%. The income tax provision for the three-month
period ended June 30, 2005 was $30.0 million and reflects an underlying
effective tax rate of 70%. 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 June 30, 2006 and 2005 were as follows:
--------------------------------------------------------------------------------
Three-Month Period Ended
June 30,
(IN THOUSANDS $) 2006 2005
--------------------------------------------------------------------------------
Net income $ 9,608 $ 10,846
Per common share amounts:
Basic $ 0.03 $ 0.03
Diluted $ 0.03 $ 0.03
Weighted average number of shares of
common stock utilized to calculate
per common share amounts:
Basic 347,696 334,282
Diluted 370,360 352,023
================================================================================
Net income was lower in the three-month period ended June 30, 2006, compared to
the three-month period ended June 30, 2005, primarily due to inclusion in the
2006 period of $20.7 million of share-based compensation expense resulting from
the application of SFAS 123R, which became effective January 1, 2006. Also
contributing to the decrease were higher operating expenses, partially offset by
higher revenues of $51.5 million.
28
RESULTS OF OPERATIONS-
SIX-MONTH PERIOD ENDED JUNE 30, 2006 VS. SIX-MONTH PERIOD ENDED JUNE 30, 2005
TOTAL REVENUE: Total revenue and related percentages for the six-month periods
ended June 30, 2006 and 2005 were as follows:
--------------------------------------------------------------------------------
Six-Month Period Ended
June 30,
(IN THOUSANDS $) 2006 2005 % Change
--------------------------------------------------------------------------------
Net product sales:
REVLIMID(R) $ 95,463 $ -- N/A
THALOMID(R) 214,404 182,838 17.3%
ALKERAN(R) 22,747 16,858 34.9%
Focalin(R) 3,767 2,803 34.4%
Other 263 529 (50.3%)
-----------------------------
Total net product sales 336,644 203,028 65.8%
Collaborative agreements
and other revenue 7,846 30,950 (74.6%)
Royalty revenue 34,590 24,119 43.4%
-----------------------------
Total revenue $ 379,080 $ 258,097 46.9%
================================================================================
NET PRODUCT SALES:
REVLIMID(R) was approved by the FDA in December 2005 for treatment of MDS in
patients with the 5q chromosomal deletion and in June 2006 for treatment in
combination with dexamethasone of previously treated multiple myeloma patients.
During the six-month period ended June 30, 2006, the majority of dispenses were
for the treatment of patients with MDS followed by some use in the treatment of
patients with multiple myeloma and a broad range of cancer indications accounted
for the remainder of dispenses. Named patient sales outside of the United States
totaled 5.5% of REVLIMID(R) net sales during the six-month period ended June 30,
2006.
Supported by the FDA's approval of newly diagnosed multiple myeloma and newly
presented data, THALOMID(R) net sales were higher in the six-month period ended
June 30, 2006, compared to the six-month period ended June 30, 2005. Price
increases implemented as we move towards a cost of therapy pricing structure as
opposed to a price per milligram basis also contributed to the increase. Sales
volumes decreased due to 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 and distributor chargebacks. Included in the six-month period ended June
30, 2006 were sales of approximately $5.5 million from our U.K. subsidiary,
Celgene U.K. Manufacturing II, Limited, or CUK II, to Pharmion Corporation,
compared to sales of $3.0 million for the six-month period ended June 30, 2005.
ALKERAN(R) net sales were higher in the six-month period ended June 30, 2006,
compared to the six-month period ended June 30, 2005, due to an increase in
sales volumes as well as price increases implemented since June 30, 2005(R).
Partially offsetting the increase in ALKERAN(R) sales were higher gross to net
sales accruals for sales returns and distributor chargebacks. While ALKERAN 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, supply disruptions have lead to inconsistent supplies of ALKERAN(R) IV
and consequently have resulted in inconsistent end-market buying patterns. These
factors may continue to contribute to variability in revenues for the remainder
of this year.
29
Net sales of Focalin(R), which is sold exclusively to Novartis and is dependent
on the timing of orders from Novartis for their commercial distribution, were
higher in the six-month period ended June 30, 2006, compared to the six-month
period ended June 30, 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
service fees. 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. See Critical Accounting Policies for further discussion.
Gross to net sales accruals and the balance in the related allowance accounts
for the six-month periods ended June 30, 2006 and 2005, were as follows:
----------------------------------------------------------------------------------------------------------------------------------
Distributor
Returns and Medicaid chargebacks
2006 allowances Discounts rebates and services Total
----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2005 $ 5,017 $ 1,447 $ 20,960 $ 6,778 $ 34,202
Allowances for sales made during the quarter 17,458 8,487 11,827 26,953 64,725
Allowances for sales made during prior periods 22,979 -- -- -- 22,979
Credits issued for prior year sales (25,021) (1,479) (20,261) (6,314) (53,075)
Credits issued for sales during 2006 (8,796) (6,703) (5,301) (19,788) (40,588)
--------------------------------------------------------------------
Balance at June 30, 2006 $ 11,637 $ 1,752 $ 7,225 $ 7,629 $ 28,243
==================================================================================================================================
----------------------------------------------------------------------------------------------------------------------------------
Distributor
Returns and Medicaid chargebacks
2005 allowances Discounts rebates and services Total
----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2004 $ 9,600 $ 837 $ 5,534 $ 3,721 $ 19,692
Allowances for sales made during the quarter 9,774 4,901 14,192 14,176 43,043
Allowances for sales made during prior periods -- -- -- -- --
Credits issued for prior year sales (7,102) (832) (5,413) (3,264) (16,611)
Credits issued for sales during 2005 (5,002) (3,853) (2,158) (9,763) (20,776)
--------------------------------------------------------------------
Balance at June 30, 2005 $ 7,270 $ 1,053 $ 12,155 $ 4,870 $ 25,348
==================================================================================================================================
Sales returns allowances increased in the six-month period ended June 30, 2006,
compared to the six-month period ended June 30, 2005, primarily due to unusually
high THALOMID(R) returns from one large retail pharmacy chain. The returns from
this customer were the result of efforts to more aggressively manage inventory
at its pharmacies, the Company's requirement to purchase full cartons of up to
ten sleeves of THALOMID(R) capsules with each order and, S.T.E.P.S.(R) related
restrictions, which limited the chain's ability to transfer inventories between
its locations. For the past several years, we have experienced sales returns of
approximately 4% of sales. As a result of the higher returns activity, we
recorded additional allowances, during the six-month period ended June 30, 2006,
to increase our reserve to approximately 9% of all estimated THALOMID(R)
pharmacy inventories. We introduced single sleeve units, beginning June 7, 2006
(rather than requiring full carton purchases) and we
30
amended our product returns policy to include a product returns handling fee.
These measures have been designed to allow customers to more effectively manage
their inventories, since they can now order smaller quantities, as well as limit
our product returns exposure. Initial third quarter 2006 sales returns activity
suggests that the first half of 2006 activity was an isolated event. We will
however, continue to monitor the situation and will adjust our sales returns
accrual accordingly. Also, contributing to the increase in sales returns
allowances, to a lesser extent, were higher returns of expired ALKERAN(R) IV
product from one wholesale distributor.
Medicaid rebate allowances decreased in the six-month period ended June 30,
2006, compared to the six-month period ended June 30, 2005, primarily due to the
impact of the new Medicare, Part D legislation, which became effective January
1, 2006. As a result of the new legislation many patients who had been eligible
to receive THALOMID(R) through Medicaid coverage are now covered under Medicare,
Part D.
Distributor chargebacks increased in the six-month period ended June 30, 2006,
compared to the six-month period ended June 30, 2005, primarily due to increased
ALKERAN(R) IV sales to certain public health services, or PHS, pricing eligible
customers.
OTHER REVENUES: Revenues from collaborative agreements and other sources for the
six-month periods ended June 30, 2006 and 2005 included: $5.5 million and $7.1
million, respectively, related to our collaboration with Pharmion Corporation;
and $2.3 million and $2.4 million, respectively, related to umbilical cord blood
enrollment, collection and storage fees generated through our LifeBank USASM
business. The decrease in Pharmion collaboration related revenues was mainly due
to the completion of the April 2003 agreement whereby Pharmion agreed to provide
us an aggregate $8.0 million in research funding for further clinical
development of THALOMID(R). The agreement, which ended December 31, 2005,
required Pharmion to pay us $1.0 million in the six-month period ended June 30,
2005. The six-month period ended June 30, 2005 also included a $20.0 million
milestone payment from Novartis for the NDA approval of FocalinTM XR, a $0.9
million license fee payment from EntreMed, Inc. related to its licensing of our
tubulin inhibitors compounds and a $0.5 million license fee payment from the
manufacturers of isotretinoin related to the licensing of our S.T.E.P.S.(R)
technology.
Royalty revenue for the six-month periods ended June 30, 2006 and 2005 included:
$33.3 million and $23.5 million, respectively, of royalties received from
Novartis on sales of their entire family of Ritalin(R) drugs and Focalin(TM) XR;
$0.5 million and $0.2 million, respectively, of royalties received from Pharmion
Corporation on their commercial sales of THALOMID(R); and $0.4 million of other
miscellaneous royalties in both periods. The six-month period ended June 30,
2006 also included royalties of $0.4 million related to the S.T.E.P.S. (R)
licensing rights provided to manufacturers of isotretinoin. The increase in
Ritalin(R) and FocalinTM XR royalty revenue was due to increased sales by
Novartis in the once-a-day attention deficit disorder market.
31
COST OF GOODS SOLD: Cost of goods sold and related percentages for the six-month
periods ended June 30, 2006 and 2005 were as follows:
--------------------------------------------------------------------------------
Six-Month Period Ended
June 30,
(IN THOUSANDS $) 2006 2005
------------ ------------
Cost of goods sold $ 56,943 $ 30,800
Increase from prior year $ 26,143 $ 2,311
Percentage increase from prior year 84.9% 8.1%
Percentage of net product sales 16.9% 15.2%
================================================================================
Cost of goods sold were higher in the six-month period ended June 30, 2006,
compared to the six-month period ended June 30, 2005, primarily due to higher
royalties on THALOMID(R) as a result of higher net sales and 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 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. Cost of goods sold as a percentage of net product sales were
higher in the six-month period ended June 30, 2006, compared to the six-month
period ended June 30, 2005, primarily due to higher ALKERAN(R) costs, higher
gross to net sales accruals and higher royalties on THALOMID(R), partially
offset by the impact of REVLIMID(R) sales, which have much lower per unit costs
than THALOMID(R) and price increases implemented since June 30, 2005.
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.
Research and development expenses and related percentages for the six-month
periods ended June 30, 2006 and 2005 were as follows:
--------------------------------------------------------------------------------
Six-Month Period Ended
June 30,
(IN THOUSANDS $) 2006 2005
--------------------------------------------------------------------------------
Research and development expenses $ 111,542 $ 89,065
Increase from prior year $ 22,477 $ 12,699
Percentage increase from prior year 25.2% 16.6%
Percentage of total revenue 29.4% 34.5%
================================================================================
Research and development expenses were higher in the six-month period ended June
30, 2006, compared to the six-month period ended June 30, 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 multiple myeloma, MDS, chronic
lymphocytic leukemia and non-Hodgkin's lymphoma; higher medical education
expenses, which support educating and training the medical community on MDS and
multiple myeloma; and higher expenses to support ongoing development of other
compounds such as CC-10004, CC-4047, CC-11006, CC-11050 and CC-401. Included in
the six-month period ended June 30, 2006 was share-based compensation
32
expense of $7.3 million resulting from the application of Statement of Financial
Accounting Standards, or SFAS, No. 123R, "Share-Based Payments," or SFAS 123R,
which became effective January 1, 2006.
Research and development expenses in the six-month period ended June 30, 2006
consisted of $41.7 million spent on human pharmaceutical clinical programs;
$45.4 million spent on other pharmaceutical programs, including toxicology,
analytical research and development, drug discovery, quality and regulatory
affairs; $18.9 million spent on biopharmaceutical discovery and development
programs; and $5.5 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-11050, and our kinase and ligase inhibitor programs as well as the
placental stem cell program. In the six-month period ended June 30, 2005, $36.1
million was spent on human pharmaceutical clinical programs; $29.7 million was
spent on other human pharmaceutical programs, including toxicology, analytical
research and development, drug discovery, quality and regulatory affairs; $18.1
million was spent on biopharmaceutical discovery and development programs; and
$5.2 million was spent on placental stem cell and biomaterials programs.
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
six-month periods ended June 30, 2006 and 2005 were as follows:
--------------------------------------------------------------------------------
Six-Month Period Ended
June 30,
(IN THOUSANDS $) 2006 2005
--------------------------------------------------------------------------------
Selling, general and administrative expenses $ 149,727 $ 79,173
Increase from prior year 70,554 $ 27,515
Percentage increase from prior year 89.1% 53.3%
Percentage of total revenue 39.5% 30.7%
================================================================================
Selling, general and administrative expenses were $70.6 million higher in the
six-month period ended June 30, 2006, compared to the six-month period ended
June 30, 2005, and included for the first time, share-based compensation expense
of $27.2 million resulting from the application of SFAS 123R. Also contributing
to the increase were higher commercial expenses primarily related to sales and
marketing for REVLIMID(R) launch activities in the United States and higher
general administrative expenses primarily related to costs incurred in
connection with our international expansion in Europe, Japan, Australia and
Canada, increased professional and other miscellaneous outside service fees and
higher personnel-related expenses.
INTEREST AND OTHER INCOME, NET: Interest and other income, net was $15.7 million
for the six-month period ended June 30, 2006 and included interest income and
net realized gains on our cash and marketable securities portfolio of $16.4
million, foreign exchange gains of $3.1 million and other miscellaneous income
of $0.1 million, partially offset by losses recorded for changes in the
estimated value of our investment in EntreMed, Inc. warrants of $0.3 million and
an other-than-temporary impairment loss on marketable securities available for
sale of $3.6 million. Interest and other income, net was $5.5 million for the
six-month period ended June 30, 2005 and included interest income and net
realized gains on our cash and marketable securities portfolio of $12.6 million,
partially offset by losses
33
recorded for changes in the estimated value of our investment in EntreMed, Inc.
warrants of $6.9 million and foreign exchange losses of approximately $0.2
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 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 $4.5 million
and $5.0 million for the six-month periods ended June 30, 2006 and 2005,
respectively. Equity losses recorded for the six-month period ended June 30,
2005, included $4.4 million for 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 $4.7 million for each of the six-month
periods ended June 30, 2006 and 2005 and primarily reflects six 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 six-month
period ended June 30, 2006 was $41.8 million and reflects an underlying
effective tax rate for 2006 of 71%, 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 six-month period ended June 30, 2005 was $4.2 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 six-month period ended June 30, 2005 would have
been $38.4 million, which reflects an underlying effective tax rate of 70%. 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 six-month periods
ended June 30, 2006 and 2005 were as follows:
--------------------------------------------------------------------------------
Six-Month Period Ended
June 30,
(IN THOUSANDS $) 2006 2005
--------------------------------------------------------------------------------
Net income $ 25,632 $ 59,060
Per common share amounts:
Basic $ 0.07 $ 0.18
Diluted $ 0.07 $ 0.16
Weighted average number of shares of common stock
utilized to calculate per common share amounts:
Basic 345,841 332,762
Diluted 369,108 382,444
================================================================================
34
Net income and per common share amounts were lower in the six-month period
ended June 30, 2006, compared to the six-month period ended June 30, 2005,
primarily due to inclusion in the 2006 period of $35.5 million of share-based
compensation expense resulting from the application of SFAS 123R, which became
effective January 1, 2006, and inclusion in the 2005 period of the one-time
benefit of $42.6 million recognized from the elimination of deferred tax asset
valuation allowances. Also contributing to the decrease were higher operating
expenses, partially offset by higher revenues.
LIQUIDITY AND CAPITAL RESOURCES
OPERATING ACTIVITIES: Net cash used in operating activities was $31.8 million
for the six-month period ended June 30, 2006, compared to net cash provided by
operating activities of $26.4 million for the six-month period ended June 30,
2005. The decrease was primarily due to higher working capital levels and SFAS
123R requirements to classify 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) as financing cash flows in
the Statement of Cash Flows, offset by higher earnings excluding the effects of
certain non-cash items including share-based compensation expense totaling $35.5
million recorded in the six-month period ended June 30, 2006 in connection with
our adoption of SFAS 123(R) effective January 1, 2006 and the deferred tax
benefit recognized in the 2005 period in connection with the reversal of certain
deferred tax asset valuation allowances.
CHANGES IN WORKING CAPITAL ITEMS
ACCOUNTS RECEIVABLE: Accounts receivable, net increased $6.5 million during
the six-month period ended June 30, 2006 as a result of higher net sales. Our
days of sales outstanding, or DSO, at June 30, 2006 improved by approximately
17 days compared to the DSO at December 31, 2005. The decrease in our DSO was
primarily due to the timing of collections at certain large customers.
INVENTORY: Inventory increased $11.1 million during the six-month period
ended June 30, 2006, primarily due to an increase in ALKERAN(R) inventories
resulting from the timing of our purchases from GSK. REVLIMID(R) and
THALOMID(R) inventories also increased, but to a lesser extent. The increase
in REVLIMID(R) inventories was related to initial stocking in connection with
the product launch as well as, the manufacture of validation lots needed to
qualify secondary manufacturers. The increase in THALOMID(R) inventories was
related to the introduction of single sleeve selling units so that customers
can more effectively manage their inventory levels.
OTHER OPERATING ASSETS: Other operating assets increased $50.4 million during
the six-month period ended June 30, 2006 primarily due to an increase in
prepaid expenses, miscellaneous other receivables and in the amounts due from
Novartis under the FOCALIN(R) license agreement. Prepaid expenses increased
primarily due to higher prepaid insurance amounts and the inclusion of $33.3
million of prepaid taxes. Miscellaneous other receivables increased primarily
due to timing differences related to amounts outstanding in connection with
employee stock option exercises.
ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER LIABILITIES: Accounts payable,
accrued expenses and other liabilities decreased $9.3 million for the
six-month period ended June 30, 2006 primarily due to timing differences
related to employee tax withholdings and an increase in the gross to net
sales accruals. Additionally effecting cash usage is the payment of employee
withholding taxes associated with the exercise of certain stock options which
allow the employee to pay the exercise price and minimum withholding taxes by
tendering mature shares. From a cash flow perspective, these transactions
results in the use of cash, since the Company pays the minimum withholding
tax.
35
However, from a balance sheet perspective, the payment of the minimum
withholding taxes is offset by a corresponding transaction to record treasury
stock for the tendered shares.
INCOME TAXES PAYABLE: Income taxes payable increased $23.4 million during the
six-month period ended June 30, 2006 and reflects a current provision for
income taxes of $57.1 million and the reclassification of approximately $9.8
million of prepaid taxes to other current assets, offset by the tax benefit
on stock option exercises of $43.5 million.
INVESTING ACTIVITIES: Net cash used in investing activities was $60.2 million
for the six-month period ended June 30, 2006, compared to net cash used in
investing activities of $128.0 million for the six-month period ended June 30,
2005. Included in the six-month period ended June 30, 2006 were cash outflows of
$17.4 million for capital expenditures, $40.2 million for net purchases of
marketable securities available for sale, $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) and $0.6 million for the
purchase of other non-marketable investment securities. Included in the
six-month period ended June 30, 2005 were cash outflows of $9.1 million for
capital expenditures, $8.4 million for working capital adjustments and
acquisition costs related to our October 2004 acquisition of Penn T Limited,
$100.0 million for net purchases of marketable securities available for sale and
$10.5 million for the exercise of warrants to purchase 7,000,000 shares of
EntreMed common stock. The increase in capital expenditures is due to our
on-going international expansion, particularly the construction of a
manufacturing facility in Neuchatel, Switzerland as well as, on-going expansion
at our corporate headquarters in Summit, New Jersey.
FINANCING ACTIVITIES: Net cash provided by financing activities was $86.2
million for the six-month period ended June 30, 2006, compared to net cash
provided by financing activities of $22.7 million for the six-month period ended
June 30, 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 Consolidated 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 Consolidated Statement
of Cash Flows. Cash received from stock option exercises for the six-month
period ended June 30, 2006 was $45.9 million and the excess tax benefit
recognized was $40.3 million. Cash received from stock option exercises for the
six-month period June 30, 2005 was $22.7 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 cash received from 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.
36
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.
The following table sets forth our contractual obligations as of June 30, 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 4.4 6.1 5.3 2.9 18.7
ALKERAN(R) agreements 0.6 67.3 -- -- 67.9
Other contract commitments 3.6 6.5 1.0 -- 11.1
--------------------------------------------------------------------
Total $ 8.6 $ 479.9 6.3 $ 2.9 $ 497.7
==============================================================================================================
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 significant changes and or expanded discussion of
such critical accounting policies are contained herein:
REVENUE RECOGNITION ON COLLABORATION AGREEMENTS: We have formed collaborative
research and development agreements and alliances with other pharmaceutical and
bio-technology companies. These agreements are in the form of research and
development and license agreements. The agreements are for both early- and
late-stage compounds and are focused on specific disease areas. For the
early-stage compounds, the agreements are relatively short-term agreements that
are renewable depending on the success of the compounds as they move through
preclinical development. The agreements call for nonrefundable upfront payments,
milestone payments on achieving significant milestone events, and in some cases
ongoing research funding. The agreements also contemplate royalty payments on
sales if and when the compound receives FDA marketing approval.
Our revenue recognition policies for all nonrefundable upfront license fees and
milestone arrangements are in accordance with the guidance provided in the
Securities and Exchange Commission's Staff Accounting Bulletin, or SAB, No. 101,
"Revenue Recognition in Financial Statements," as amended by SAB No. 104,
"Revenue Recognition," or SAB 104. In addition, we follow the provisions of
Emerging Issues Task Force Issue, or EITF, 00-21, "Revenue Arrangements with
Multiple Deliverables," or EITF 00-21, for multiple element revenue arrangements
entered into or materially amended after June 30, 2003. EITF 00-21 provides
guidance on how to determine when an arrangement that involves multiple
revenue-generating activities or deliverables should be divided into separate
units of accounting for revenue
37
recognition purposes, and if this division is required, how the arrangement
consideration should be allocated among the separate units of accounting. If the
deliverables in a revenue arrangement constitute separate units of accounting
according to the EITF's separation criteria, the revenue-recognition policy must
be determined for each identified unit. If the arrangement is a single unit of
accounting, the revenue-recognition policy must be determined for the entire
arrangement.
Under arrangements where the license fees and research and development
activities can be accounted for as a separate unit of accounting, nonrefundable
upfront license fees are deferred and recognized as revenue on a straight-line
basis over the expected term of our continued involvement in the research and
development process. Revenues from the achievement of research and development
milestones, if deemed substantive, are recognized as revenue when the milestones
are achieved, and the milestone payments are due and collectible. Milestones are
considered substantive if all of the following conditions are met: (1) the
milestone is nonrefundable; (2) achievement of the milestone was not reasonably
assured at the inception of the arrangement; (3) substantive effort is involved
to achieve the milestone; and, (4) the amount of the milestone appears
reasonable in relation to the effort expended, the other milestones in the
arrangement and the related risk associated with achievement of the milestone.
If any of these conditions are not met, we would recognize a proportionate
amount of the milestone payment upon receipt as revenue that correlates to work
already performed and the remaining portion of the milestone payment will be
deferred and recognized as revenue as we complete our performance obligations.
GROSS TO NET SALES ACCRUALS FOR SALES RETURNS, MEDICAID REBATES AND CHARGEBACKS:
Our gross to net sales accruals are primarily driven by sales of THALOMID(R).
THALOMID(R) is distributed under our S.T.E.P.S.(R), or System for Thalidomide
Education and Prescribing Safety, distribution program. Among other things,
S.T.E.P.S.(R), which is a proprietary comprehensive education and
risk-management distribution program, requires prescribers, patients and
dispensing pharmacies to participate in a registry and an order cannot be filled
unless the physician, patient and pharmacy have all obtained an appropriate
registration number. Automatic refills are not permitted under the program. Each
prescription may not exceed a 28-day supply and a new prescription is required
with each order.
Although we invoice through traditional pharmaceutical wholesalers, all
THALOMID(R) orders are drop-shipped directly to the prescribing pharmacy
overnight. Wholesaler stocking of this product is prohibited. In addition, we do
not offer commercial discounts on our products to pharmacies or hospitals and,
therefore, have no commercial distributor chargebacks. Our chargebacks result
from the difference between the wholesaler price and the lower federal ceiling
price available to federally funded healthcare providers, such as Veterans
Affairs and the U.S. Department of Defense.
SALES RETURN: We base our sales returns accrual, which primarily relates to
THALOMID(R) sales returns, on actual returns history and the trend experience
for lots where product is still being returned. Under this methodology, we track
actual returns by individual production lots. Returns on closed lots, that is,
lots no longer eligible for return credits, are analyzed to determine historical
returns experience. Returns on open lots, that is, lots still eligible for
return credits, are monitored and compared with historical return trend rates.
Any changes from the historical trend rates are considered in determining
current sales return accruals. We do not use information from external sources
in estimating our product returns. The requirements under our S.T.E.P.S.(R)
distribution process make factors other than the historical experience less
significant when estimating our sales returns accruals for THALOMID(R). As
indicated above, THALOMID(R) is drop-shipped directly to the prescribing
pharmacy and, as a result, wholesalers do not stock the product. Consequently,
the product return exposure normally associated with traditional pharmaceutical
product distribution channels is not applicable to us. In addition, since
THALOMID(R) has a relatively long shelf life, typically two years, short-dated
inventory has not historically been an issue. The impact that
38
external factors such as price changes from competitors and introductions of new
and generic competing products could have on our sales returns accruals is
highly judgmental and difficult to quantify. Our sales returns have not been
impacted thus far by such external factors; however we continue to monitor such
factors. Our sales returns and allowances accruals were $21.3 million, $16.3
million and $12.7 million in 2005, 2004 and 2003, respectively, which equates to
an accrual rate of 3.9%, 4.2% and 4.5% of gross product sales in each of the
three respective years. A 10% change in our returns rate would have resulted in
a $2.1 million decrease in our 2005 reported revenue.
MEDICAID REBATES: The Medicaid rebate formula, which is established by the
Center for Medicare and Medicaid Services, provides for price increases based on
increases in the Consumer Price Index-All Urban Consumers, or CPI-U. Price
increases in excess of the allowable increase results in a higher unit rebate
amount, or URA. Our Medicaid rebate accruals are computed using the Medicaid
URA, as determined under the Medicaid rebate formula, applied to the estimated
Medicaid dispense quantities. Actual Medicaid dispense quantities are reported
by individual states on a 45-60 day quarter-end lag. Differences in Medicaid
rebate accruals resulting from differences in the estimated Medicaid dispense
quantities and actual Medicaid dispense quantities are adjusted in the following
period. As a result of THALOMID(R) price increases in excess of allowable
amounts, the Medicaid URA and consequently the Medicaid rebate accrual for 2006
increased as a percentage of gross product sales, as compared to the accrual
for 2005.
DISTRIBUTOR CHARGEBACKS: As indicated above, we do not offer commercial
discounts on our products to pharmacies or hospitals and, therefore, have no
commercial distributor chargebacks. Our distributor chargebacks result from the
difference between the wholesaler price and the lower federal ceiling price, or
FCP, available to federally funded healthcare providers, such as Veteran Affairs
and the U.S. Department of Defense. Under our S.T.E.P.S.(R) distribution
program, we can determine which pharmacies are eligible for the lower FCP
pricing and, therefore, we record the actual chargeback allowance amount at the
time of sale. Like the Medicaid URA calculation, which is impacted by price
increases in excess of the allowable amount, the FCP is further reduced for
price increases in excess of allowable CPI-U increases and, as in the case of
Medicaid rebate accruals, the THALOMID(R) price increases in excess of allowable
amounts has resulted in higher distributor chargeback accruals in 2006, as
compared to 2005.
OTHER GROSS TO NET SALES ACCRUALS: We record sales discounts accruals based on
payment terms extended to customers and we record distributor services accruals
based on actual fees paid to wholesale distributors for services provided.
SHARE-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 7 to the Consolidated Financial Statements included in this quarterly
report for additional information).
OTHER-THAN-TEMPORARY IMPAIRMENTS OF AVAILABLE-FOR-SALE MARKETABLE SECURITIES: A
decline in the market value of any available-for-sale marketable security below
its cost that is deemed to be other-than-
39
temporary results in a reduction in carrying amount to fair value. The
impairment is charged to earnings and a new cost basis for the security
established. The determination of whether an available-for-sale marketable
security is other-than-temporarily impaired requires significant judgment on our
part and requires consideration of available quantitative and qualitative
evidence in evaluating the potential impairment. Our marketable securities
consist primarily of debt securities whose fair value is affected by interest
rate and credit rating changes. The fair value of certain debt securities were
negatively impacted by interest rate increases during 2006. If the cost of an
investment exceeds its fair value, factors evaluated to determine whether the
investment is other-than-temporarily impaired include: significant deterioration
in the issuer's earnings performance, credit rating, asset quality, business
prospects of the issuer, adverse changes in the general market conditions in
which the issuer operates, length of time that the fair value has been below our
cost, our expected future cash flows from the security 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. Assumptions associated with
these factors are subject to future market and economic conditions, which could
differ from our assessment. During 2006, we determined that certain securities
had sustained an other-than-temporary impairment and, as a result, during the
three- and six-month periods ended June 30, 2006, we recognized impairment
losses which were recorded in interest and other income, net of $0.3 million and
$3.6 million, respectively.
INVESTMENT IN 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 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 $13.9 million
at June 30, 2006, which is above the estimated fair value of our 7,864,864
shares of EntreMed common stock by approximately $0.9 million based on the
closing share price of EntreMed common stock on June 30, 2006.
The investment is reviewed to determine whether an other-than-temporary decline
in value of the investment has been sustained. If the investment is determined
to have sustained an other-than-temporary decline in 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. Based on a review conducted during the quarter ended June 30,
2006, it was determined that a write-down in our investment in EntreMed was not
required.
ACCOUNTING FOR LONG-TERM INCENTIVE PLANS: In 2003, we established a Long-Term
Incentive Plan, or LTIP, designed to provide key officers and executives with
performance-based incentive opportunities contingent upon achievement of
pre-established corporate performance objectives, and payable only if employed
at the end of the performance cycle. The 2004 performance cycle, or the 2006
Plan, began on January 1, 2004 and will end on December 31, 2006; the 2005
performance cycle, or the 2007 Plan, began on January 1, 2005 and will end on
December 31, 2007; and the 2006 performance cycle, or the 2008 Plan, which will
end on December 31, 2008.
40
Performance measures for all Plans are based on the following components: 25% on
earnings per share, 25% on net income and 50% on revenue. Payouts for the 2007
and 2008 Plans may be in the range of 0% to 200% of a certain percent of a
participant's salary, while the payout range for the 2006 plan is 0% to 150%.
Upon a change in control, participants will be entitled to an immediate payment
equal to their target award, or, if higher, an award based on actual performance
through the date of the change in control.
Assuming achievement of 100% of the established targets or threshold, the
aggregate payout under the Plans would be $8.0 million and the maximum aggregate
payout under the Plans is $14.6 million. We accrue the long-term incentive
liability over each three-year cycle. At June 30, 2006, the recorded liability
for the long-term incentive plans was $5.7 million.
Accruals recorded for the LTIP entail making certain assumptions concerning
future earnings per share, net income and revenues, the actual results of which
could be materially different than the assumptions used. Accruals for the LTIP
are reviewed on a regular basis and revised accordingly so that the liability
recorded reflects updated estimates of future payouts. In estimating the
accruals management considers actual results to date for the performance period,
expected results for the remainder of the performance period, operating trends,
product development, pricing and competition.
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 June 30, 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.
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
June 30, 2006, we were party to a foreign currency forward
41
contract to buy U.S. dollars and sell Swiss francs for a notional amount of
$128.5 million. The forward contract expires on October 11, 2006 and is an
economic hedge of a U.S. dollar payable of a Swiss foreign entity, which is
re-measured through earnings each period based on changes in the spot rate. The
fair value of the forward contract at June 30, 2006 was a net loss of
approximately $0.9 million and was recorded in accrued expenses with the change
in fair value recorded in current year's earnings. Assuming that the June 30,
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 $15.1 million. However, since the
contract hedges 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 June 30, 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 for use in meeting 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 2006, we determined that
certain securities had sustained an other-than-temporary impairment due to a
reduction in its future estimated cash flow and, as a result, during the three-
and six-month periods ended June 30, 2006, we recognized impairment losses of
$0.3 million and $3.6 million, respectively.
As of June 30, 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
(IN THOUSANDS $) Year Years Years Years Years Total
------------------------------------------------------------------------------------------------------------------
Principal amount $ 381,029 $ 70,254 $ 203,580 $ 30,500 $ 2,900 $688,263
Fair value $ 379,991 $ 69,755 $ 186,331 $ 29,693 $ 2,813 $668,583
Average interest rate 4.8% 5.0% 4.4% 2.8% N/A 4.6%
PHARMION COMMON STOCK: At June 30, 2006, we held a total of 1,939,600 shares of
Pharmion Corporation common stock, which had an estimated fair value of
approximately $33.0 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 $12.8 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.
INVESTMENT IN AFFILIATED COMPANIES: At June 30, 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
$13.9 million at June 30, 2006, which is above the estimated fair value of our
7,864,864 shares of EntreMed common stock by approximately $0.9 million based on
the closing share price of EntreMed common stock on June 30, 2006. Under the
equity method, the investment is reviewed to determine whether an
other-than-temporary decline in value of the investment
42
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 June 30, 2006, the warrants had a fair value of $0.4 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. Under the terms of the purchase
agreement, the noteholders can convert the outstanding notes at any time into an
aggregate 33,020,957 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 June 30, 2006, the fair value of our convertible notes exceeded the carrying
value of $400.0 million by approximately $1.1 billion, which we believe reflects
the increase in the market price of our common stock to $47.43 per share as of
June 30, 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.
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
43
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.
44
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
The Company held its Annual Meeting of Stockholders on June 14, 2006. At this
meeting stockholders of the Company were asked to elect ten directors,
approve an amendment to our 1998 Stock Incentive Plan to increase the number
of shares of common stock that may be subject to awards from 62,000,000 to
84,000,000, remove the limit on the number of shares of our Common Stock
which may be subject to awards of restricted stock and performance-based
awards denominated in shares of our Common Stock under the 1998 Stock
Incentive Plan, provide that each share of our Common Stock subject to awards
of restricted stock or performance-based awards denominated in shares of
common stock under the 1998 Stock Incentive Plan be counted as 1.6 shares
against the Share Limit and to ratify the appointment of KPMG LLP as our
registered public accounting firm for the fiscal year ending December
31, 2006. All ten nominated directors were elected, the amendments to our
1998 Stock Incentive Plan were approved and the proposal regarding the
appointment of KPMG LLP as auditors was approved. The election of directors
and other proposals were approved by the following votes:
A. Election of Directors:
Number of Shares
----------------
Name For Withheld
---- --- --------
John W. Jackson 298,477,070 4,643,634
Sol J. Barer, Ph.D 298,469,470 4,651,234
Robert J. Hugin 296,158,550 6,962,154
Jack L. Bowman 292,213,685 10,907,019
Michael D. Casey 291,407,023 11,713,681
Rodman L. Drake 301,490,983 1,629,721
Arthur Hull Hayes, Jr., M.D 298,132,015 4,988,689
Gilla Kaplan, Ph.D 301,115,554 2,005,150
Richard C.E. Morgan 289,179,274 13,941,430
Walter L. Robb, Ph.D 298,015,926 5,104,778
B. Amendment to our 1998 Stock Incentive Plan:
Number of Shares
----------------
For Against Abstained
--- ------- ---------
196,095,782 42,657,838 254,197
45
C. Appointment of KPMG LLP as auditors:
Number of Shares
----------------
For Against Abstained
--- ------- ---------
299,699,295 1,727,888 253,954
Item 5. Other Information - None
Item 6. Exhibits
10.1 1998 Stock Incentive Plan, Amended and Restated as of
April 19, 2006
10.2 Amendment No. 2 to the 1998 Stock Incentive Plan
31.1 Certification by the Company's Chief Executive Officer
dated August 9, 2006.
31.2 Certification by the Company's Chief Financial Officer
dated August 9, 2006.
32.1 Certification by the Company's Chief Executive Officer
pursuant to 18 U.S.C. Section 1350 dated August 9, 2006.
32.2 Certification by the Company's Chief Financial Officer
pursuant to 18 U.S.C. Section 1350 dated August 9, 2006.
46
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 August 9, 2006 By: /s/Robert J. Hugin
----------------------- ---------------------------------------
Robert J. Hugin
President, Chief Operating Officer and
Chief Financial Officer
DATE August 9, 2006 By: /s/James R. Swenson
----------------------- ---------------------------------------
James R. Swenson
Controller