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 September 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 (I.R.S. Employer Identification
incorporatio or organization) 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 November 1, 2006, 352,441,666 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 Nine-Month Periods Ended September 30, 2006 and 2005 3
Consolidated Balance Sheets -
As of September 30, 2006 and December 31, 2005 4
Consolidated Statements of Cash Flows -
Nine-Month Periods Ended September 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 22
Item 3 Quantitative and Qualitative Disclosures About Market Risk 43
Item 4 Controls and Procedures 45
PART II OTHER INFORMATION 46
Item 1 Legal Proceedings 46
Item 1A Risk Factors 46
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds 46
Item 3 Defaults Upon Senior Securities 46
Item 4 Submission of Matters to a Vote of Security Holders 46
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 Nine-Month Period Ended
September 30, September 30,
------------------------------ ------------------------------
2006 2005 2006 2005
-------------- ------------- ------------- -------------
Revenues:
Net product sales $ 223,105 $ 113,900 $ 559,749 $ 316,928
Collaborative agreements and other revenue 4,186 4,879 12,032 35,829
Royalty revenue 17,548 10,727 52,138 34,846
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Total revenues 244,839 129,506 623,919 387,603
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Expenses:
Cost of goods sold 34,205 23,199 91,148 53,999
Research and development 66,756 49,348 178,298 138,413
Selling, general and administrative 89,597 46,941 239,318 126,114
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Total expenses 190,558 119,488 508,764 318,526
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Operating income 54,281 10,018 115,155 69,077
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Other income and expense:
Interest and other income, net 10,392 6,979 26,118 12,517
Equity in losses of affiliated company 736 980 5,202 5,975
Interest expense 2,361 2,374 7,086 7,121
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Income before income taxes 61,576 13,643 128,985 68,498
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Income tax provision 41,139 12,975 82,916 8,770
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Net income $ 20,437 $ 668 $ 46,069 $ 59,728
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Net income per common share:
Basic $0.06 $0.00 $0.13 $0.18
Diluted $0.05 $0.00 $0.12 $0.16
See accompanying Notes to Consolidated Financial Statements
3
CELGENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
SEPTEMBER 30, 2006 DECEMBER 31, 2005
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(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 243,665 $ 123,316
Marketable securities available for sale 628,809 600,944
Accounts receivable, net of allowance of $6,495 and $3,739
at September 30, 2006 and December 31, 2005, respectively 109,856 77,913
Inventory 36,058 20,242
Deferred income taxes 111,180 113,059
Other current assets 85,002 37,363
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Total current assets 1,214,570 972,837
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Property, plant and equipment, net 97,760 77,477
Investment in affiliated company 13,514 17,017
Intangible assets, net 98,261 96,988
Goodwill 36,792 33,815
Deferred income taxes 49,204 31,260
Other assets 16,718 17,243
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Total assets $ 1,526,819 $ 1,246,637
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LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 35,158 $ 16,414
Accrued expenses 92,833 92,908
Income taxes payable 64,896 14,715
Current portion of deferred revenue 7,064 6,473
Other current liabilities 4,346 5,127
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Total current liabilities 204,297 135,637
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Long-term convertible notes 399,962 399,984
Deferred revenue, net of current portion 61,367 59,067
Other non-current liabilities 22,915 16,174
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Total liabilities 688,541 610,862
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COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value per share, 5,000,000 shares
authorized; none outstanding at September 30, 2006 and December 31, 2005 -- --
Common stock, $.01 par value per share, 575,000,000 shares
authorized; issued 355,877,715 and 344,125,158 shares
at September 30, 2006 and December 31, 2005, respectively 3,559 3,441
Common stock in treasury, at cost; 3,743,797 and 1,953,282 shares
at September 30, 2006 and December 31, 2005, respectively (129,789) (50,601)
Additional paid-in capital 1,083,844 853,601
Accumulated deficit (124,684) (170,754)
Accumulated other comprehensive income 5,348 88
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Total stockholders' equity 838,278 635,775
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Total liabilities and stockholders' equity $ 1,526,819 $ 1,246,637
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See accompanying Notes to Consolidated Financial Statements
4
CELGENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
NINE-MONTH PERIOD ENDED
SEPTEMBER 30,
---------------------------------
2006 2005
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Net income $ 46,069 $ 59,728
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization of long-term assets 18,647 9,771
Provision for accounts receivable allowances 15,587 8,377
Unrealized loss (gain) on marketable securities available for sale and cash equivalents 3,992 (341)
Unrealized gain on foreign exchange forward contracts (3,549) -
Unrealized loss on value of EntreMed warrants 298 6,875
Equity losses of affiliated company 4,865 5,975
Non-cash share-based compensation expense 58,802 32
Amortization of premium/discount on marketable securities available for sale, net (2,374) 1,395
Loss on asset disposals 168 218
Amortization of debt issuance cost 1,832 1,832
Deferred income taxes (23,350) (68,718)
Shares issued for employee benefit plans 6,518 3,506
Other 739 (35)
Change in operating assets and liabilities, excluding the impact of acquisition:
Increase in accounts receivable (51,358) (24,018)
Increase in inventory (13,650) (7,438)
Increase in other operating assets (45,439) (10,796)
Increase (decrease) in accounts payable, accrued expenses and other liabilities (28,993) 29,542
Increase in income tax payable 56,178 42,467
Decrease in deferred revenue (2,154) (3,749)
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Net cash provided by operating activities 42,828 54,623
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Cash flows from investing activities:
Capital expenditures (31,919) (22,637)
Business acquisition - (8,429)
Proceeds from sales and maturities of marketable securities available for sale 563,548 356,135
Purchases of marketable securities available for sale (581,060) (476,968)
Investment in affiliated company (2,000) (10,500)
Other investments (625) (122)
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Net cash used in investing activities (52,056) (162,521)
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Cash flows from financing activities:
Net proceeds from exercise of common stock options and warrants 67,982 37,921
Excess tax benefit from share-based compensation arrangements 57,799 --
Repayment of capital lease and note obligations -- (6)
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Net cash provided by financing activities 125,781 37,915
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Effect of currency rate changes on cash and cash equivalents 3,796 (2,939)
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Net increase (decrease) in cash and cash equivalents 120,349 (72,922)
Cash and cash equivalents at beginning of period 123,316 135,227
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Cash and cash equivalents at end of period $ 243,665 $ 62,305
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See accompanying Notes to Consolidated Financial Statements
5
CELGENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
(Unaudited)
(Dollars in thousands)
NINE-MONTH PERIOD ENDED
SEPTEMBER 30,
------------------------------------
2006 2005
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Supplemental schedule of non-cash investing and
financing activity:
Change in net unrealized loss on marketable
securities available for sale $ 7,986 $ (49,062)
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Matured shares tendered for stock option exercises
and employee tax withholdings $ (85,876) $ (47,363)
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Conversion of convertible notes $ 22 $ 8
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Supplemental disclosure of cash flow information:
Interest paid $ 5,250 $ 5,250
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Income taxes paid $ 24,071 $ 36,168
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See accompanying Notes to Consolidated Financial Statements
6
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 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. The Company's revenues 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 FOCALIN(R) 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 current report on Form 8-K filed with the Securities
and Exchange Commission on November 3, 2006 to update its previously issued
financial statements for all years shown in the Company's 2005 Annual Report on
Form 10-K to reflect the realignment of our organizational and reportable
business segments into a single segment.
The Company is changing the presentation of how it reflects deferred income
taxes and changes in income tax payable within the cash flows from the
operations section of the consolidated statement of cash flows. The change in
presentation will better align the deferred income tax amount with the deferred
tax amount reflected in the consolidated statement of operations and the change
in income taxes payable with the amount of current expense. The consolidated
statement of cash flows for the nine-months ended September 30, 2006 and 2005
was prepared on this basis. Additionally our 2006 Form 10-K will include
reclassifications of certain amounts in 2005 and 2004 within the operating
activities section of cash flows to conform to this presentation. This change in
presentation does not impact previously reported cash flows from operations,
financing or investing activities for those years.
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 (575,000,000 shares of common stock and
5,000,000 shares of preferred stock). 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
7
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
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 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.
In September 2006, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 108 ("SAB 108"), which provides guidance on the
consideration of the effects of prior period misstatements in quantifying
current year misstatements for the purpose of a materiality assessment. SAB 108
provides for the quantification of the impact of correcting all misstatements,
including both the carryover and reversing effects of prior year misstatements,
on the current year financial statements. If a misstatement is material to the
current year financial statements, the prior year financial statements should
also be corrected, even though such revision was, and continues to be,
immaterial to the prior year financial statements. Correcting prior year
financial statements for immaterial errors would not require previously filed
reports to be amended. Such correction should be made in the current period
filings. SAB 108 is effective for fiscal years ending on or after November 15,
2006. We are currently evaluating the impact that the adoption of SAB 108 will
have on our consolidated financial statements.
3. EARNINGS PER SHARE
Basic earnings per share is computed by dividing net income by the
weighted-average number of common shares outstanding during the period. Diluted
earnings per 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
1,872,512 and 35,071,174 shares for the three-month periods ended September 30,
2006 and 2005, respectively. The total number of potential common shares
excluded for the nine-month periods ended September 30, 2006 and 2005 was
2,893,814 and 3,547,470 shares, respectively.
8
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
The following represents the reconciliation of the basic and diluted earnings
per share computations for the three and nine months ended September 30, 2006
and 2005:
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Three-Month Period Ended Nine-Month Period Ended
September 30, September 30,
2006 2005 2006 2005
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Income available to common stockholders:
Net income for basic EPS $ 20,437 $ 668 $ 46,069 $ 59,728
Interest expense on convertible debt, net of tax 1,393 -- 4,178 4,179
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Net income for diluted EPS $ 21,830 $ 668 $ 50,247 $ 63,907
Weighted average number of common shares
outstanding (IN THOUSANDS):
Basic 351,200 336,596 347,687 334,054
Effect of dilutive securities:
Options, warrants and other incentives 20,637 23,128 22,384 22,926
Convertible debt 33,021 -- 33,021 33,024
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Diluted 404,858 359,724 403,092 390,004
Earnings per share:
Basic $ 0.06 $ 0.00 $ 0.13 $ 0.18
Diluted $ 0.05 $ 0.00 $ 0.12 $ 0.16
=============================================================================================================================
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 33,020,545 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. Subsequent to the June 2003 issuance date, an
immaterial amount of principal has been converted into common stock.
9
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
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 September 30, 2006 and December 31, 2005
were as follows:
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Gross Gross Estimated
Amortized Unrealized Unrealized Fair
September 30, 2006 Cost Gain Loss Value
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CASH EQUIVALENTS (1)
Government sponsored enterprises $151,343 $ 24 $ -- $151,367
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AVAILABLE-FOR-SALE MARKETABLE SECURITIES
Mortgage-backed obligations 83,397 252 (515) 83,134
U.S. treasury securities 53,767 -- (544) 53,223
Government sponsored enterprises 273,666 -- (3,785) 269,881
Corporate debt securities 13,489 16 (975) 12,530
Other asset backed securities 21,149 1,594 -- 22,743
Auction rate notes 145,500 -- -- 145,500
Marketable equity securities 20,212 21,586 -- 41,798
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Total available-for-sale marketable securities 611,180 23,448 (5,819) 628,809
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Total marketable securities $762,523 $ 23,472 $ (5,819) $780,176
================================================================================================================================
(1) Marketable debt securities with maturities of three months or less at time
of purchase are classified as cash equivalents.
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Gross Gross Estimated
Amortized Unrealized Unrealized Fair
December 31, 2005 Cost Gain Loss Value
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AVAILABLE-FOR-SALE MARKETABLE SECURITIES
Mortgage-backed obligations $ 86,478 $ 365 $ (524) $ 86,319
U.S. treasury securities 24,391 14 (614) 23,791
Government sponsored 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
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Total available-for-sale marketable securities $595,262 $ 14,852 $ (9,170) $600,944
================================================================================================================================
Government sponsored enterprises include fixed asset-backed securities issued by
the Federal National Mortgage Association 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 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 nine
months ended September 30, 2006, the Company determined that certain securities
had sustained an other-than-temporary impairment and recognized a $3.8 million
impairment loss related to these securities due to reductions in their future
estimated cash flows.
10
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
As of September 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 $449,108 $448,928
Duration of one through three years 79,428 78,755
Duration of three through five years 191,343 188,269
Duration of five through seven years 19,967 19,961
Duration greater than seven years 2,465 2,465
---------------------
Total $742,311 $738,378
================================================================================
6. INVENTORY
Inventory at September 30, 2006 and December 31, 2005 consisted of the
following:
--------------------------------------------------------------------------------
September 30, December 31,
2006 2005
--------------------------------------------------------------------------------
Raw materials $ 9,045 $ 5,044
Work in process 3,783 1,644
Finished goods 23,230 13,554
--------------------------
Total $36,058 $20,242
================================================================================
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
11
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
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 22,696,267 at
September 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 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 nine-month
periods ended September 30, 2005, as if the Company had applied the fair value
recognition provisions for stock-based compensation of SFAS 123, as amended:
12
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
Three Months Ended Nine Months Ended
September 30, 2005 September 30, 2005
--------------------------------------------------------------------------------------------------------------------------
Net income as reported $ 668 $59,728
Add: stock-based employee compensation expense included in
reported income, net of tax 32 19
Add: stock-based employee compensation expense determined under
fair-value-based method (1) (6,407) 1,834
----------------------------------------------
Basic pro forma net income $(5,707) $61,581
Interest expense on convertible debt, net of tax -- 4,179
----------------------------------------------
Diluted, pro forma net income $(5,707) $65,760
Net income per common share:
Basic, as reported $ -- $ 0.18
Basic, pro forma $ (0.02) $ 0.18
Diluted, as reported $ -- $ 0.16
Diluted, pro forma $ (0.02) $ 0.17
=========================================================================================================================
(1) Nine months ended September 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 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.
13
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
The following table summarizes the impact of adopting SFAS 123R effective
January 1, 2006:
------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, 2006 September 30, 2006
------------------------------------------------------------------------------------------------------------------------------
Cost of good sold $ 413 $ 1,332
Research and development 2,689 10,038
Selling, general and administrative 20,091 47,325
------------------------------------------------
Total share-based compensation expense 23,193 58,695
Tax benefit related to share-based compensation expense (7,783) (18,049)
------------------------------------------------
Effect on net income $ 15,410 $ 40,646
Effect on earnings per share:
Basic $ 0.04 $ 0.12
Diluted $ 0.04 $ 0.10
==============================================================================================================================
Included in stock-based compensation expense for the three and nine-month
periods ended September 30, 2006 was compensation expense related to
non-qualified stock options of $19.0 million and $44.0 million, respectively.
No amounts of share-based compensation cost were capitalized as inventory or
other assets during the three and nine months ended September 30, 2006. As of
September 30, 2006, there was $81.2 million of total unrecognized compensation
cost related to stock options granted under the plans. That cost will be
recognized over an expected remaining weighted-average period of 1.1 years.
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 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 nine-month
period ended September 30, 2006 was $68.0 million and the excess tax benefit
recognized was $57.8 million. Cash received from stock option exercises for the
nine-month period ended September 30, 2005 was $37.9 million. Pursuant to SFAS
123R, tax benefits resulting from the exercise of stock options, which have been
presented as operating cash flows prior to the adoption of SFAS 123R are not
reclassified to financing activities, but rather shall continue to be presented
as operating cash flows.
The weighted-average grant-date fair value of the stock options granted during
the three and nine-month periods ended September 30, 2006 was $20.03 per share
and $16.82 per share, respectively. The weighted-average grant-date fair value
of the stock options granted during the three and nine-month periods ended
September 30, 2005 was $8.14 per share and $7.12 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:
14
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
----------------------------------------------------------------------------------------------------------------------------
Three Months Ended September 30, Nine Months Ended September 30,
2006 2005 2006 2005
----------------------------------------------------------------------------------------------------------------------------
Risk-free interest rate 4.63% - 4.92% 3.56% - 4.34% 4.50% - 5.24% 3.56% - 4.34%
Expected volatility 46% - 51% 41% 40% - 52% 41%
Weighted average expected volatility 48% 41% 49% 41%
Expected term (years) 4.1 - 4.9 3.5 3.1- 5.0 4.0
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 nine-month periods ended September 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.
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.
15
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
Stock option transactions for the nine months ended September 30, 2006 under all
plans are as follows:
Weighted
Weighted Average Aggregate
Average Remaining Intrinsic
Exercise Contractual Value
Options Price Per Share Term (years) (In Thousands)
----------------------------------------------------------------------------------------------------------------------------
Outstanding at December 31, 2005 50,594,378 $ 13.70 6.9 $ 909,083
Changes during the year:
Granted 2,899,614 41.40 -- --
Exercised (11,690,742) 9.20 -- --
Forfeited (1,119,977) 14.11 -- --
Expired (97,281) 11.71 -- --
-----------------------------
Outstanding at September 30, 2006 40,585,992 $ 16.93 6.3 $ 1,070,722
------------------------------------------------------------------
Vested or expected to vest at September 30, 2006 40,026,077 $ 16.87 6.3 $ 1,058,234
------------------------------------------------------------------
Vested at September 30, 2006 27,886,806 $ 14.68 5.7 $ 798,094
==================================================================
The total intrinsic value of stock options exercised during the nine months
ended September 30, 2006 and 2005 was $370.2 million and $163.3 million,
respectively. The Company primarily utilizes newly issued shares to satisfy the
exercise of stock options.
The following table summarizes information concerning options outstanding under
the 1998 and 1995 Incentive Plans at September 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 Per Share Term (yrs.) Vested Price Per Share Term (yrs.)
-----------------------------------------------------------------------------------------------------------------------------
$ 0.04 - $ 5.00 6,327,512 $ 2.05 3.1 6,318,512 $ 2.04 3.1
5.01 - 10.00 8,334,634 6.78 4.9 7,310,085 6.75 4.7
10.01 - 15.00 8,120,025 12.84 7.1 4,063,590 12.90 6.6
15.01 - 20.00 4,271,223 16.52 6.9 1,996,794 16.58 5.5
20.01 - 30.00 4,784,135 25.15 7.5 2,542,375 25.69 6.3
30.01 - 48.59 8,748,463 36.86 8.2 5,655,450 34.71 8.9
------------------------------------------------------------------------------------------------------
40,585,992 $ 16.93 6.3 27,886,806 $ 14.68 5.7
======================================================================================================
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
16
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 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
September 30, 2006, the Company has issued 10,876,300 stock options to
executives that contain the reload features noted above, of which 2,127,063
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 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 was $0.3 million
at September 30, 2006.
Including the February 2, 2006 investment, the Company holds a total of
7,864,864 shares of EntreMed, Inc. common stock and 432,432 warrants to purchase
additional shares of EntreMed common stock at September 30, 2006. Since the
Company also holds 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 applies the equity method of
accounting to its common stock investment.
The Company recorded equity in losses of affiliated company of $0.7 million and
$1.0 million for the three-month periods ended September 30, 2006 and 2005,
respectively. The Company's equity in losses of affiliated company for the
nine-month period ended September 30, 2006 was $5.2 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 nine-month period ended September 30, 2005
was $6.0 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. At September 30, 2006, the investment in
EntreMed had a carrying value of approximately $13.5 million and a fair value of
$14.6 million.
A summary of the Company's investment and equity in losses of affiliates
follows:
As of
September 30, 2006
----------------------
Interest in EntreMed equity (1) $ 3,853
Excess of investment over share of EntreMed equity (2) 9,661
----------------------
Total investment $ 13,514
================================================================================
17
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
Three-Month Nine-Month
Period Ended Period Ended
September 30, 2006 September 30, 2006
--------------------------------------------
Celgene share of EntreMed, Inc.
losses (1)(3) $ 661 $4,976
Amortization of intangibles 75 226
--------------------------------------------
Equity in losses of affiliated
company $ 736 $5,202
================================================================================
(1) The Company records its share of losses based on its common stock
ownership, which as of September 30, 2006 was 10.73%.
(2) Consists of intangible assets and goodwill of $377 and $9,284,
respectively.
(3) Year-to-date September 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 September 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
September 30, 2006 and December 31, 2005 were as follows:
----------------------------------------------------------------------------------------------------------
Gross Intangible Weighted
Carrying Accumulated Assets, Average
September 30, 2006 Value Amortization Net Life (Years)
----------------------------------------------------------------------------------------------------------
Penn T supply agreements $103,667 $ (9,538) $ 94,129 12.9
License 4,250 (230) 4,020 13.8
Technology 122 (10) 112 12.0
----------------------------------------------------------------------------------------------------------
Total $108,039 $ (9,778) $ 98,261 13.0
==========================================================================================================
----------------------------------------------------------------------------------------------------------
Gross Intangible Weighted
Carrying Accumulated Assets, Average
December 31, 2005 Value Amortization Net Life (Years)
----------------------------------------------------------------------------------------------------------
Penn T supply agreements $ 95,278 $ (2,659) $ 92,619 12.9
License 4,250 -- 4,250 13.8
Technology 122 (3) 119 12.0
----------------------------------------------------------------------------------------------------------
Total $ 99,650 $ (2,662) $ 96,988 13.0
==========================================================================================================
The $8.4 million increase in gross carrying value of intangible assets from
December 31, 2005 to September 30, 2006 represents the impact of foreign
currency translation.
Amortization of acquired intangible assets was approximately $2.3 million and
$0.2 million for the three-month periods ended September 30, 2006 and 2005,
respectively, and $6.7 million and $0.6 million for the nine-month periods ended
September 30, 2006 and 2005, respectively. Assuming no changes in the gross
carrying amount of intangible assets and holding exchange rates constant, the
amortization of intangible assets for the next five fiscal years is estimated to
be $9.0 million for 2006, and $8.8 million for each of the years 2007 through
2010.
The Company's reported goodwill of $36.8 million and $33.8 million at September
30, 2006 and December 31, 2005, respectively, relates to the acquisition of Penn
T on October 21, 2004. The $3.0 million increase from December 31, 2005 to
September 30, 2006 represents the impact of foreign currency translation.
18
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
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 after tax effects of changes in net unrealized
gains (losses) on marketable securities classified as available for sale.
A summary of comprehensive income for the three and nine-month periods ended
September 30, 2006 and 2005 follows:
------------------------------------------------------------------------------------------------------------------------------
Three-Month Period Ended Nine-Month Period Ended
September 30, September 30,
2006 2005 2006 2005
------------------------------------------------------------------------------------------------------------------------------
Net income $ 20,437 $ 668 $ 46,069 $ 59,728
----------------------------------------------------------------------
Other comprehensive income (loss):
Unrealized losses on marketable
securities available for sale, net of tax 7,936 (3,971) 1,597 (40,241)
Deferred income tax (1) -- -- -- (14,775)
Less: reclassification adjustment for (gains)
losses included in net income 319 82 3,986 (341)
----------------------------------------------------------------------
Total unrealized gains (losses) on marketable
securities available for sale, net of tax 8,255 (3,889) 5,583 (55,357)
Currency translation adjustments 4,710 (1,677) (323) (7,731)
----------------------------------------------------------------------
Total other comprehensive income (loss) 12,965 (5,566) 5,260 (63,088)
----------------------------------------------------------------------
Comprehensive income (loss) $ 33,402 $ (4,898) $ 51,329 $ (3,360)
==============================================================================================================================
(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 gains and on marketable securities available for sale for the
three and nine-month periods ended September 30, 2006 included an increase in
fair value related to the Company's investment in Pharmion common stock of $8.8
million and $7.3 million respectively. The unrealized losses on marketable
securities available for sale for the three and nine-month periods ended
September 30, 2005 included a decrease in fair value related to Pharmion common
stock of $2.7 million and $39.6 million, 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.
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 an audit for this period.
19
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
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 October 2006, the Company became a limited partner of Burrill Life Sciences
Capital Fund III, L.P. and agreed to invest $20.0 million over a 10-year period,
of which $1.4 million was invested on October 4, 2006. The fund will invest in
start-up companies conducting business in life sciences such as biotechnology,
pharmaceuticals, medical technology, devices, diagnostics plus health and
wellness.
In October 2006, the Company invested $4.4 million in Royalty Pharma Strategic
Partners, LP to participate in a rights offering for an additional interest.
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 September 30, 2006, the remaining
cost to be incurred was $6.9 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 research and development funding totaling $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.
20
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED)
Pursuant to EITF 00-21, the Company has determined that the agreements with
Pharmion 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 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., $3.3 million at September 30, 2006,
which consists of $0.6 million in 2006 and $2.7 million in 2007) will be
recorded as deferred revenue as such payments are received and amortized over
the remaining useful life.
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 September 30, 2006, the
remaining minimum purchase requirements under the agreement totaled $67.3
million, consisting of the following subsequent extensions:
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
--------
$ 67,300
14. SUBSEQUENT EVENTS
In November 2006, the Company issued 20,000,000 shares of its common stock at a
public offering price of $51.60 per share with gross proceeds of $1.032 billion
and proceeds, net of the Underwriters' discount of $1.007 billion.
21
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 patients with transfusion-dependent
anemia due to Low- or Intermediate-1-risk myelodysplastic syndromes, or MDS,
associated with a deletion 5q cytogenetic abnormality with or without additional
cytogenetic abnormalities and in June 2006 for treatment in combination with
dexamethasone for multiple myeloma patients who have received at least one prior
therapy; 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 use for treating multiple myeloma and
other cancers. The sales growth of REVLIMID(R) and 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 both at major medical conferences and in peer-reviewed publications
provide the catalysts for our 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); partnering with contracted pharmacies to ensure, to the maximum
extent possible, safe and rapid distribution of REVLIMID(R); and, transitioning
previously treated multiple myeloma patients from our expanded access program
that provided many previously treated multiple myeloma patients with free access
to REVLIMID(R) to commercial paying patients as a result of the June 2006
Supplemental New Drug Application, or sNDA, approval of REVLIMID for treatment
in combination with dexamethasone for multiple myeloma patients who have
received at least one prior therapy. 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 multiple
myeloma and MDS. 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
22
acceptance of regulators, physicians, patients, payors 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 payors. As an oral cancer agent, REVLIMID(R) qualifies as a
Medicare, Part D drug. Each Part D plan will review REVLIMID(R) for addition to
their formulary. As with all new products introduced into the market, there may
be some lag time before being added to each plan's formulary, which may impact
our commercial performance.
THE ABILITY TO ADVANCE CLINICAL AND REGULATORY PROGRAMS: 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 MAA's,
for REVLIMID(R) in both multiple myeloma and MDS with the 5q chromosomal
deletion are under review by the European Medicines Agency, or EMEA. Future
international commercial opportunities are dependent on unpredictable regulatory
timelines. In addition, a major objective of our on-going clinical programs is
to broaden our knowledge about the full potential of REVLIMID(R) and our other
proprietary IMiDs(R) compounds and to continue to evaluate them in a broad range
of hematological malignancies and other cancers. Our near-term focus is on
evaluating REVLIMID(R) as a treatment of chronic lymphocytic leukemia and
aggressive non-Hodgkin's lymphomas.
COMPETITIVE RISKS: While competition could limit REVLIMID(R) launch results and
reduce THALOMID(R) sales, 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 safe distribution and appropriate use 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 SEPTEMBER 30, 2006 VS.
THREE-MONTH PERIOD ENDED SEPTEMBER 30, 2005
TOTAL REVENUE: Total revenue and related percentages for the three-month periods
ended September 30, 2006 and 2005 were as follows:
--------------------------------------------------------------------------------
Three-Month Period Ended
September 30,
(IN THOUSANDS $) 2006 2005 % Change
--------------------------------------------------------------------------------
Net product sales:
REVLIMID(R) $101,314 $ -- N/A
THALOMID(R) 108,370 99,134 9.3%
ALKERAN(R) 12,171 13,945 (12.7%)
Focalin(R) 1,178 326 261.3%
Other 72 495 (85.5%)
-----------------------
Total net product sales 223,105 113,900 95.9%
Collaborative agreements
and other revenue 4,186 4,879 (14.2%)
Royalty revenue 17,548 10,727 63.6%
-----------------------
Total revenue $244,839 $129,506 89.1%
================================================================================
23
NET PRODUCT SALES:
REVLIMID(R) was approved by the FDA in December 2005 for treatment of patients
with transfusion-dependent anemia due to Low- or Intermediate-1-risk MDS,
associated with a deletion 5q cytogenetic abnormality with or without additional
cytogenetic abnormalities and in June 2006 for treatment in combination with
dexamethasone for multiple myeloma patients who have received at least one prior
therapy. As a result, sales for this product are reflected only in the 2006
period. REVLIMID(R) net sales increased sequentially from $63.0 million in the
three-month period ended June 30, 2006 to $101.3 million in the three-month
period ended September 30, 2006. This increase was primarily due to new patient
prescriptions aided slightly by transitioning patients from our expanded access
program, which provided patients with free access to REVLIMID(R), to commercial
paying patients and, to a much lesser extent, the impact of one-time inventory
stocking related to the introduction of 15 and 25 milligram capsules, slightly
offset by a decrease resulting from patients switching from multiple capsule
dosing regimens to the single 15 and 25 milligram capsule regimen. Multiple
myeloma accounted for approximately 60% of dispenses during the three-month
period ended September 30, 2006, followed by MDS, which accounted for
approximately 35% of dispenses and a broad range of cancer indications accounted
for the remainder of dispenses. Named patient sales outside of the United States
totaled 8.7% of REVLIMID(R) net sales during the three month period ended
September 30, 2006. We expect continued incremental benefit from the named
patient sales leading up to a potential European approval in 2007.
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 September 30, 2006, compared to the three-month period ended September 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, largely offset by lower
Medicaid rebate accruals. Included in both the three-month periods ended
September 30, 2006 and 2005 were sales of approximately $2.8 million from our
U.K. subsidiary to Pharmion Corporation under a manufacturing supply agreement
as amended December 3, 2004.
ALKERAN(R) net sales were lower in the three-month period ended September 30,
2006, compared to the three-month period ended September 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 near-term.
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 three-month period ended September 30, 2006, compared to the
three-month period ended September 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.
24
Gross to net sales accruals and the balance in the related allowance accounts
for the three-month period ended September 30, 2006 and 2005 were as follows:
------------------------------------------------------------------------------------------------------------------------------------
Distributor
Sales Returns Medicaid charge-backs and
2006 Discounts rebates services Total
-------------------------------------------------------------------------------------------------- ---------------------------------
Balance at June 30, 2006 $11,637 $ 1,752 $ 7,225 $ 7,629 $ 28,243
Allowances for sales made during the quarter 6,346 5,015 4,289 16,645 32,295
Allowances for sales made during prior periods
2,479 -- -- -- 2,479
Credits issued for prior year sales (5,454) -- (86) -- (5,540)
Credits issued for sales during 2006 (3,513) (4,708) (4,458) (14,521) (27,200)
----------------------------------------------------------------------------------
Balance at September 30, 2006 $11,495 $ 2,059 $ 6,970 $ 9,753 $ 30,277
====================================================================================================================================
------------------------------------------------------------------------------------------------------------------------------------
Distributor
Sales Medicaid charge-backs and
2005 Returns Discounts rebates services Total
------------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 2005 $ 7,270 $ 1,053 $ 12,155 $ 4,870 $ 25,348
Allowances for sales made during the quarter 5,252 2,811 9,448 11,162 28,673
Allowances for sales made during prior periods
-- -- -- -- --
Credits issued for prior year sales (2,088) -- (191) -- (2,279)
Credits issued for sales during 2005 (4,174) (2,744) (9,966) (9,390) (26,274)
----------------------------------------------------------------------------------
Balance at September 30, 2005 $6,260 $ 1,120 $11,446 $ 6,642 $ 25,468
====================================================================================================================================
Sales returns and discounts allowances increased in the three-month period ended
September 30, 2006, compared to the three-month period ended September 30, 2005,
primarily due to higher gross sales. Also contributing to the increase in sales
returns allowances were higher returns of expired ALKERAN(R) IV product.
Medicaid rebate allowances decreased in the three-month period ended September
30, 2006, compared to the three-month period ended September 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 during the
prior year period are now covered under Medicare, Part D. Partially offsetting
the THALOMID(R) decrease are Medicaid rebate allowances included in the current
year period for REVLIMID(R) sales.
Distributor chargebacks increased in the three-month period ended September 30,
2006, compared to the three-month period ended September 30, 2005, primarily due
to THALOMID(R) price increases, which reduces the federal ceiling price, or FCP,
available to federally funded healthcare providers and thus, increases the
distributor chargeback amount. Also contributing to the increase in allowances
for distributor chargeback are accruals for REVLIMID(R) sales.
OTHER REVENUES: Revenues from collaborative agreements and other sources totaled
$4.2 million for the three-month period ended September 30, 2006, compared to
$4.9 million for the three-month period ended September 30, 2005. The decrease
was primarily due to lower Pharmion collaboration related revenues.
Royalty revenue for the three-month period ended September 30, 2006 totaled
$17.5 million and primarily included $16.7 million received from Novartis on
sales of their entire family of Ritalin(R) drugs and Focalin(TM) XR. Royalty
revenue for the three-month period ended September 30, 2005 totaled $10.7
25
million and included $10.4 million from Novartis. Novartis royalty revenue
increased due to higher Focalin(TM) XR product sales.
COST OF GOODS SOLD: Cost of goods sold and related percentages for the
three-month periods ended September 30, 2006 and 2005 were as follows:
--------------------------------------------------------------------------------
Three-Month Period Ended
September 30,
(IN THOUSANDS $) 2006 2005
--------------------------------------------------------------------------------
Cost of goods sold $34,205 $23,199
Increase from prior year $11,006 $ 8,033
Percentage increase from prior year 47.4% 53.0%
Percentage of net product sales 15.3% 20.4%
================================================================================
Cost of goods sold were higher in the three-month period ended September 30,
2006, compared to the three-month period ended September 30, 2005, primarily due
to higher royalties on THALOMID(R) as a result of higher net sales, higher
ALKERAN(R) costs and inclusion of costs associated with REVLIMID(R) sales.
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 lower in the three-month period ended
September 30, 2006, compared to the three-month period ended September 30, 2005
primarily due to the impact of REVLIMID(R) sales, which have a lower per unit
cost than THALOMID(R), partially offset by higher ALKERAN(R) costs 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 September 30, 2006 and 2005 were as follows:
--------------------------------------------------------------------------------
Three-Month Period Ended
September 30,
(IN THOUSANDS $) 2006 2005
--------------------------------------------------------------------------------
Research and development expenses $66,756 $49,348
Increase from prior year $17,408 $ 9,194
Percentage increase from prior year 35.3% 22.9%
Percentage of total revenue 27.3% 38.1%
================================================================================
Research and development expenses were higher in the three-month period ended
September 30, 2006, compared to the three-month period ended September 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 information and education expenses, which support educating and training
the medical community on hematological cancers such as multiple myeloma and MDS;
and higher expenses to support ongoing development of other compounds such as
CC-10004, CC-11050, CC-4047, CC-11006, CC-11050 and CC-401. Included in the
three-month period ended September 30, 2006 was share-based compensation expense
of $2.7 million resulting from the application of Statement of
26
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 September 30,
2006 consisted of approximately $24.9 million spent on human pharmaceutical
clinical programs; $28.5 million spent on other pharmaceutical programs,
including toxicology, analytical research and development, drug discovery,
quality and regulatory affairs; $9.9 million spent on biopharmaceutical
discovery and development programs; and $3.5 million spent on placental stem
cell and biomaterials programs. These expenditures support ongoing clinical
progress in multiple proprietary development programs for REVLIMID(R) and
THALOMID(R), and for other compounds such as: CC-10004, our lead
anti-inflammatory compound that inhibits PDE-4, which results in the inhibition
of multiple proinflammatory mediators such as TNF-alpha and, which is currently
being evaluated in Phase II clinical trials in the treatment of psoriasis;
CC-4047, CC-11006 and CC-11050 which are currently being evaluated in healthy
volunteer Phase I clinical trials; and our kinase and ligase inhibitor programs
as well as the placental stem cell program. In the three-month period ended
September 30, 2005, approximately $18.9 million was spent on human
pharmaceutical clinical programs; $18.4 million was spent on other human
pharmaceutical programs, including toxicology, analytical research and
development, drug discovery, quality and regulatory affairs; $9.4 million was
spent on biopharmaceutical discovery and development programs; and $2.6 million
was spent on placental stem cell and biomaterials programs.
As total revenue increases, research and development expense may continue to
decrease as a percentage of total revenue, however the actual dollar amount may
continue to increase as earlier stage compounds are moved through the
preclinical and clinical stages. Generally, the time to completion of each phase
is estimated as follows for oncology indications and can be longer for
non-oncology indications:
Phase I ----- 1-2 years
Phase II ---- 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 consist 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 consist 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.
27
Selling, general and administrative expenses and related percentages for the
three-month periods ended September 30, 2006 and 2005 were as follows:
--------------------------------------------------------------------------------
Three-Month Period Ended
September 30,
(IN THOUSANDS $) 2006 2005
--------------------------------------------------------------------------------
Selling, general and administrative expenses $ 89,597 $ 46,941
Increase from prior year $ 42,656 $ 19,191
Percentage increase from prior year 90.9% 69.2%
Percentage of total revenue 36.6% 36.2%
================================================================================
Selling, general and administrative expenses were higher in the three-month
period ended September 30, 2006, compared to the three-month period ended
September 30, 2005 due to $20.1 million of share-based compensation expense
resulting from the application of SFAS 123R beginning in 2006, higher commercial
expenses primarily related to sales and marketing for REVLIMID(R) in the United
States and higher general administrative expenses primarily related to personnel
and professional and other outside service costs incurred in connection with our
international expansion in Europe, Japan, Australia and Canada.
INTEREST AND OTHER INCOME, NET: Interest and other income, net was $10.4 million
for the three-month period ended September 30, 2006 and primarily consisted of
interest income and net realized gains on our cash and marketable securities
portfolio of $9.5 million and foreign exchange gains of $1.1 million partially
offset by an other-than-temporary impairment loss on marketable securities
available for sale of $0.3 million. Interest and other income, net was $7.0
million for the three-month period ended September 30, 2005 and primarily
consists of interest and net realized gains on our cash and marketable
securities portfolio.
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, net.
Under the equity method of accounting, we recorded equity losses of $0.7 million
and $1.0 million for the three-month periods ended September 30, 2006 and 2005,
respectively.
INTEREST EXPENSE: Interest expense was $2.4 million for each of the three-month
periods ended September 30, 2006 and 2005 and primarily reflects three months of
interest expense and amortization of debt issuance costs on the $400 million
convertible notes issued on June 3, 2003.
INCOME TAX PROVISION (BENEFIT): The income tax provision for the three-month
period ended September 30, 2006 was $41.1 million and reflects an effective tax
rate for the quarter of 67%. The income tax provision for the three-month period
ended September 30, 2005 was $13.0 million based on an effective tax rate for
the nine-month period ended September 30, 2005 of 75%. Our underlying tax rate
will continue to exceed the statutory rate for
28
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 September 30, 2006 and 2005 were as follows:
--------------------------------------------------------------------------------
Three-Month Period Ended
September 30,
(IN THOUSANDS $) 2006 2005
--------------------------------------------------------------------------------
Net income $ 20,437 $ 668
Per common share amounts:
Basic $ 0.06 $ 0.00
Diluted $ 0.05(1) $ 0.00
Weighted average number of shares of
common stock utilized to calculate per
common share amounts:
Basic 351,200 336,596
Diluted 404,858 359,724
================================================================================
(1) In computing diluted earnings per share, the numerator has been adjusted to
add-back the after-tax amount of interest recognized in the period associated
with our convertible debt.
Net income was higher in the three-month period ended September 30, 2006,
compared to the three-month period ended September 30, 2005 due to higher net
product sales, primarily due to the approval of REVLIMID(R) 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, partially
offset by $23.2 million of share-based compensation expense resulting from the
application of SFAS 123R, which became effective January 1, 2006, and increased
operating expenses required to support the Company's on-going expansion.
RESULTS OF OPERATIONS-
NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2006 VS.
NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2005
TOTAL REVENUE: Total revenue and related percentages for the nine-month periods
ended September 30, 2006 and 2005 were as follows:
------------------------------------------------------------------------------------------------------------------------------------
Nine-Month Period Ended
September 30,
(IN THOUSANDS $) 2006 2005 % Change
------------------------------------------------------------------------------------------------------------------------------------
Net product sales:
REVLIMID(R) $196,777 $ -- N/A
THALOMID(R) 322,774 281,972 14.5%
ALKERAN(R) 34,918 30,803 13.4%
Focalin(R) 4,945 3,129 58.0%
Other 335 1,024 (67.3%)
-----------------------------------
Total net product sales 559,749 316,928 76.6%
Collaborative agreements
and other revenue 12,032 35,829 (66.4%)
Royalty revenue 52,138 34,846 49.6%
-----------------------------------
Total revenue $623,919 $387,603 61.0%
====================================================================================================================================
29
NET PRODUCT SALES:
REVLIMID(R) was approved by the FDA in December 2005 for treatment of patients
with transfusion-dependent anemia due to Low- or Intermediate-1-risk MDS,
associated with a deletion 5q cytogenetic abnormality with or without additional
cytogenetic abnormalities and in June 2006 for treatment in combination with
dexamethasone for multiple myeloma patients who have received at least one prior
therapy. As a result, sales for this product are reflected only in the 2006
period. During the nine-month period ended September 30, 2006, multiple myeloma
and MDS indications accounted for approximately 94% of the commercial dispenses
(with the percentage of multiple myeloma and MDS prescriptions being about
equal) and a broad range of other cancer indications accounted for the remaining
dispenses. Named patient sales outside of the United States totaled 7.2% of
REVLIMID(R) net sales during the nine-month period ended September 30, 2006. We
expect continued incremental benefit from the named patient sales leading up to
a potential Europen approval in 2007.
Supported by the FDA's approval of newly diagnosed multiple myeloma and newly
presented data, THALOMID(R) net sales were higher in the nine-month period ended
September 30, 2006, compared to the nine-month period ended September 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, partially offset by
lower Medicaid rebate accruals. Included in the nine-month period ended
September 30, 2006 were sales of approximately $8.3 million from our U.K.
subsidiary to Pharmion Corporation under a manufacturing supply agreement as
amended December 3, 2004, compared to sales of $5.8 million for the nine-month
period ended September 30, 2005.
ALKERAN(R) net sales were higher in the nine-month period ended September 30,
2006, compared to the nine-month period ended September 30, 2005, due to an
increase in sales volumes as well as price increases implemented since September
30, 2005. Partially offsetting the increase in ALKERAN(R) sales were higher
gross to net sales accruals for sales returns and distributor chargebacks. While
ALKERAN(R) use in combination therapies for the treatment of hematological
diseases continues to grow driven by clinical data reported at major medical
conferences around the world, 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 near-term.
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 nine-month period ended September 30, 2006, compared to the
nine-month period ended September 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.
30
Gross to net sales accruals and the balance in the related allowance accounts
for the nine-month periods ended September 30, 2006 and 2005 were as follows:
------------------------------------------------------------------------------------------------------------------------------------
Returns and Distributor
allowances Medicaid chargebacks and
2006 Discounts rebates services Total
------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2005 $ 5,017 $ 1,447 $ 20,960 $ 6,778 $ 34,202
Allowances for sales made during 2006 23,805 13,502 16,116 43,135 96,558
Allowances for sales made during prior periods
25,457 -- -- 463 25,920
Credits issued for prior year sales (30,475) (1,479) (20,348) (6,314) (58,616)
Credits issued for sales during 2006 (12,309) (11,411) (9,758) (34,309) (67,787)
-----------------------------------------------------------------------
Balance at September 30, 2006 $ 11,495 $ 2,059 $ 6,970 $ 9,753 $ 30,277
====================================================================================================================================
------------------------------------------------------------------------------------------------------------------------------------
Returns and Distributor
allowances Medicaid chargebacks and
2005 Discounts rebates services Total
------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2004 $ 9,600 $ 837 $ 5,534 $ 3,721 $ 19,692
Allowances for sales made during 2005 15,026 7,712 23,640 25,338 71,716
Allowances for sales made during prior periods
-- -- -- -- --
Credits issued for prior year sales (9,191) (831) (5,605) (3,264) (18,891)
Credits issued for sales during 2005 (9,175) (6,598) (12,123) (19,153) (47,049)
-----------------------------------------------------------------------
Balance at September 30, 2005 $ 6,260 $ 1,120 $ 11,446 $ 6,642 $ 25,468
====================================================================================================================================
Sales returns allowances increased in the nine-month period ended September 30,
2006, compared to the nine-month period ended September 30, 2005, primarily due
to unusually high THALOMID(R) returns from one large retail pharmacy chain
during the first half of the year. The returns from this customer were the
result of efforts to more aggressively manage inventory at its pharmacies, the
Company's requirement for the pharmacy 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 customer'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. In addition, 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. At September 30, 2006, our sales returns reserve
was about 9% of all estimated THALOMID(R) pharmacy inventories. 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.
Sales discounts increased in the nine-month period ended September 30, 2006,
compared to the nine-month period ended September 30, 2005, due to higher net
sales.
Medicaid rebate allowances decreased in the nine-month period ended September
30, 2006, compared to the nine-month period ended September 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 during the
prior year period
31
are now covered under Medicare, Part D. Partially offsetting the THALOMID(R)
decrease are Medicaid rebate allowances included in the current year period for
REVLIMID(R) sales.
Distributor chargebacks increased in the nine-month period ended September 30,
2006, compared to the nine-month period ended September 30, 2005, primarily due
to THALOMID(R) price increases, which reduces the federal ceiling price, or FCP,
available to federally funded healthcare providers and thus, increases the
distributor chargeback amount and an increase in ALKERAN(R) IV sales to certain
public health services, or PHS, pricing eligible customers. Also contributing to
increase in allowances for distributor chargeback are accruals for REVLIMID(R)
sales.
OTHER REVENUES: Revenues from collaborative agreements and other sources totaled
$12.0 million for the nine-month period ended September 30, 2006, compared to
$35.8 million for the nine-month period ended September 30, 2005. The decrease
was primarily due to inclusion in the nine-month period ended September 30, 2005
of a $20.0 million milestone payment from Novartis for the NDA approval of
Focalin(TM) XR and $1.4 million of other license fee payments. Also contributing
to the decrease were lower Pharmion collaboration related revenues in the
nine-month period ended September 30, 2006.
Royalty revenue for the nine-month period ended September 30, 2006 totaled $52.1
million and primarily included $50.0 million received from Novartis on sales of
their entire family of Ritalin(R) drugs and Focalin(TM) XR. Royalty revenue for
the nine-month period ended September 30, 2005 totaled $34.8 million and
included $33.9 million from Novartis. Novartis royalty revenue increased
primarily due to higher Focalin(TM) XR product sales.
COST OF GOODS SOLD: Cost of goods sold and related percentages for the
nine-month periods ended September 30, 2006 and 2005 were as follows:
--------------------------------------------------------------------------------
Nine-Month Period Ended
September 30,
(IN THOUSANDS $) 2006 2005
--------------------------------------------------------------------------------
Cost of goods sold $ 91,148 $ 53,999
Increase from prior year $ 37,149 $ 10,344
Percentage increase from prior year 68.8% 23.7%
Percentage of net product sales 16.3% 17.0%
================================================================================
Cost of goods sold were higher in the nine-month period ended September 30,
2006, compared to the nine-month period ended September 30, 2005, primarily due
to higher ALKERAN(R) costs. ALKERAN(R) costs tend to experience variability
depending on the purchase price of the specific units sold during a given
period. Also contributing to the increase in cost of goods sold were higher
royalties on THALOMID(R) as a result of higher net sales and inclusion of costs
associated with REVLIMID(R) sales. Cost of goods sold as a percentage of net
product sales were lower in the nine-month period ended September 30, 2006,
compared to the nine-month period ended September 30, 2005 primarily due to the
impact of REVLIMID(R) sales, which have a lower per unit cost than THALOMID(R),
partially offset by higher ALKERAN(R) costs 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.
32
Research and development expenses and related percentages for the nine-month
periods ended September 30, 2006 and 2005 were as follows:
--------------------------------------------------------------------------------
Nine-Month Period Ended
September 30,
(IN THOUSANDS $) 2006 2005
--------------------------------------------------------------------------------
Research and development expenses $ 178,298 $ 138,413
Increase from prior year $ 39,885 $ 21,893
Percentage increase from prior year 28.8% 18.8%
Percentage of total revenue 28.6% 35.7%
================================================================================
Research and development expenses were higher in the nine-month period ended
September 30, 2006, compared to the nine-month period ended September 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 information and education expenses, which support educating and training
the medical community on hematological cancers such as multiple myeloma and MDS;
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 nine-month
period ended September 30, 2006 was share-based compensation expense of $10.0
million resulting from the application of SFAS 123R, which became effective
January 1, 2006.
Research and development expenses in the nine-month period ended September 30,
2006 consisted of $66.7 million spent on human pharmaceutical clinical programs;
$73.8 million spent on other pharmaceutical programs, including toxicology,
analytical research and development, drug discovery, quality and regulatory
affairs; $28.8 million spent on biopharmaceutical discovery and development
programs; and $9.0 million spent on placental stem cell and biomaterials
programs. These expenditures support ongoing clinical progress in multiple
proprietary development programs for REVLIMID(R) and THALOMID(R), and for other
compounds such as: CC-10004, our lead anti-inflammatory compound that inhibits
PDE-4, which results in the inhibition of multiple proinflammatory mediators
such as TNF-alpha and, which is currently being evaluated in Phase II clinical
trials in the treatment of psoriasis; CC-4047, CC-11006 and CC-11050 which are
currently being evaluated in healthy volunteer Phase I clinical trials; and our
kinase and ligase inhibitor programs as well as the placental stem cell program.
In the nine-month period ended September 30, 2005, $55.0 million was spent on
human pharmaceutical clinical programs; $48.1 million was spent on other human
pharmaceutical programs, including toxicology, analytical research and
development, drug discovery, quality and regulatory affairs; $27.5 million was
spent on biopharmaceutical discovery and development programs; and $7.8 million
was spent on placental stem cell and biomaterials programs.
SELLING, GENERAL AND ADMINISTRATIVE: Selling expenses consist 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 consist 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.
33
Selling, general and administrative expenses and related percentages for the
nine-month periods ended September 30, 2006 and 2005 were as follows:
-------------------------------------------------------------------------------------
Nine-Month Period Ended
September 30,
(IN THOUSANDS $) 2006 2005
-------------------------------------------------------------------------------------
Selling, general and administrative expenses $ 239,318 $ 126,114
Increase from prior year 113,204 $ 46,706
Percentage increase from prior year 89.8% 58.8%
Percentage of total revenue 38.4% 32.5%
=====================================================================================
Selling, general and administrative expenses were higher in the nine-month
period ended September 30, 2006, compared to the nine-month period ended
September 30, 2005 due to $47.3 million of share-based compensation expense
resulting from the application of SFAS 123R beginning in 2006, higher commercial
expenses primarily related to sales and marketing for REVLIMID(R) in the United
States and higher general administrative expenses primarily related to personnel
and professional and other outside service costs incurred in connection with our
international expansion in Europe, Japan, Australia and Canada.
INTEREST AND OTHER INCOME, NET: Interest and other income, net was $26.1 million
for the nine-month period ended September 30, 2006 and included interest income
and net realized gains on our cash and marketable securities portfolio of $25.9
million, foreign exchange gains of $4.2 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 $3.8 million. Interest and other income, net was $12.5 million for the
nine-month period ended September 30, 2005 and included interest income and net
realized gains on our cash and marketable securities portfolio of $19.6 million,
partially offset by losses 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, net.
Under the equity method of accounting, we recorded equity losses of $5.2 million
and $6.0 million for the nine-month periods ended September 30, 2006 and 2005,
respectively. Equity losses recorded for the nine-month period ended September
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).
34
INTEREST EXPENSE: Interest expense was $7.1 million for each of the nine-month
periods ended September 30, 2006 and 2005 and primarily reflects nine 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 nine-month
period ended September 30, 2006 was $82.9 million and reflects an effective tax
rate of 64%. The tax provision has been 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 provision for the nine-month period ended September 30, 2005 was
$8.8 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 nine-month period ended
September 30, 2005 would have been $51.4 million, which reflects an underlying
effective tax rate of 75%. 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 nine-month periods
ended September 30, 2006 and 2005 were as follows:
--------------------------------------------------------------------------------------------------
Nine-Month Period Ended
September 30,
(IN THOUSANDS $) 2006 2005
--------------------------------------------------------------------------------------------------
Net income $ 46,069 $ 59,728
Per common share amounts:
Basic $ 0.13 $ 0.18
Diluted $ 0.12(1) $ 0.16(1)
Weighted average number of shares of common stock
utilized to calculate per common share amounts:
Basic 347,687 334,054
Diluted 403,092 390,004
==================================================================================================
(1) In computing diluted earnings per share, the numerator has been adjusted to
add-back the after-tax amount of interest recognized in the period associated
with our convertible debt.
Net income and per common share amounts were lower in the nine-month period
ended September 30, 2006, compared to the nine-month period ended September 30,
2005, primarily due to inclusion in the 2006 period of $58.7 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. Offsetting the decrease in net income were
higher revenues in the nine-month period ended September 30, 2006, partially
offset by higher operating expenses.
LIQUIDITY AND CAPITAL RESOURCES
OPERATING ACTIVITIES: Net cash provided by operating activities was $42.8
million for the nine-month period ended September 30, 2006, compared to net cash
provided by operating activities of $54.6 million for the nine-month period
ended September 30, 2005. The decrease was primarily due to higher working
capital levels as described below 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 Consolidated Statement of Cash Flows in
2006, partially offset by higher earnings excluding the effects of certain
non-cash items including share-based compensation expense totaling $58.7 million
recorded in the nine-month period ended September 30, 2006 in connection with
our
35
application of SFAS 123(R) beginning 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 $31.9 million during
the nine-month period ended September 30, 2006 as a result of higher net
sales. Our days of sales outstanding, or DSO, at September 30, 2006 improved
by approximately 9 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 $15.8 million during the nine-month period
ended September 30, 2006. ALKERAN(R) inventories increased $9.2 million due
to the timing of our purchases from GSK. ALKERAN(R) inventories tend to
fluctuate depending on the purchase price of the specific units purchased
during a given period. REVLIMID(R) inventories increased $4.4 million related
to initial stocking in connection with the product launch and the
introduction of the 15 milligram and 25 milligram strength capsules.
THALOMID(R) and Focalin(R) inventories also increased, but to a lesser
extent. 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 $47.6 million during
the nine-month period ended September 30, 2006 primarily due to an increase
in prepaid expenses and in the amounts due from Novartis under the FOCALIN(R)
license agreement. Prepaid expenses increased primarily due to higher prepaid
insurance amounts and inclusion of $31.7 million of prepaid taxes.
ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER LIABILITIES: Accounts payable,
accrued expenses and other liabilities increased $17.9 million for the
nine-month period ended September 30, 2006 primarily due to accounts payable
timing differences.
INCOME TAXES PAYABLE: Income taxes payable increased $50.2 million during the
nine-month period ended September 30, 2006 and reflects a current provision
for income taxes of $106.3 million and the reclassification of approximately
$7.6 million of prepaid taxes to other current assets, offset by the excess
tax benefit on stock option exercises of $63.9 million.
INVESTING ACTIVITIES: Net cash used in investing activities was $52.1 million
for the nine-month period ended September 30, 2006, compared to net cash used in
investing activities of $162.5 million for the nine-month period ended September
30, 2005. Included in the nine-month period ended September 30, 2006 were cash
outflows of $31.9 million for capital expenditures, $17.5 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 nine-month period ended September 30, 2005 were cash outflows of $22.6
million for capital expenditures, $8.4 million for working capital adjustments
and acquisition costs related to our October 2004 acquisition of Penn T Limited,
$120.8 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 $125.8
million for the nine-month period ended September 30, 2006, compared to net cash
provided by financing activities of $37.9 million for the nine-month period
ended September 30, 2005. Prior to the adoption of SFAS 123R, we presented
36
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 nine-month period ended September 30, 2006 was $68.0 million and the
excess tax benefit recognized was $57.8 million. Cash received from stock option
exercises for the nine-month period September 30, 2005 was $37.9 million.
Pursuant to SFAS 123R tax benefits resulting from the exercise of stock options,
which have been presented as operating cash flows prior to the adoption of SFAS
123R are not reclassified to financing activities, but rather continue to be
presented as operating cash flows.
In November 2006, we issued 20,000,000 shares of our common stock at a public
offering price of $51.60 per share with gross proceeds of $1.032 billion and
proceeds, net of the Underwriters' discount of $1.007 billion.
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.
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 for the year ended December 31,
2005 contained in our Current Report on Form 8-K filed with the SEC on November
3, 2006.
In October 2006, the Company became a limited partner of Burrill Life Sciences
Capital Fund III, L.P. and agreed to invest $20.0 million over a 10-year period,
of which $1.4 million was paid as of October 4, 2006. The partnership agreement
does not specify future contribution dates; therefore we have included the
remaining contributions in 'less than 1 year' for presentation purposes. The
fund will invest in start-up companies conducting business in life sciences such
as biotechnology, pharmaceuticals, medical technology, devices, diagnostics plus
health and wellness.
In October 2006, the Company invested $4.4 million in Royalty Pharma Strategic
Partners, LP to participate in a rights offering for an additional interest.
37
The following table sets forth our contractual obligations as of September 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 4.6 6.0 5.3 2.3 18.2
ALKERAN(R) agreements - 67.3 - - 67.3
Other contract commitments (1) 28.1 5.5 0.5 - 34.1
-------------------------------------------------------------------------------
Total $ 32.7 $ 478.8 $ 5.8 $ 2.3 $ 519.6
=====================================================================================================================
(1) Includes our recent commitments with respect to Burrill Life Sciences and
Royalty Pharma
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 for the year ended December 31, 2005
included in our Current Report on Form 8-K filed on November 3, 2006. Our
critical accounting policies are disclosed in the Management's Discussion and
Analysis of Financial Condition and Results of Operation in our Current Report
on Form 8-K filed on November 3, 2006. 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
biotechnology 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, or EITF, Issue 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 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
38
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 have been 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 RETURNS: 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. 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
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 $49.3 million and $15.0
million for the nine-month period ended September 30, 2006 and 2005,
respectively, which equates to an accrual rate of 7.2% and 3.9% of gross product
sales in each of the respective periods. A 10% increase in our returns rate
would have resulted in a $4.9 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
39
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. Medicaid rebate allowances decreased in the three-month period
ended September 30, 2006, compared to the three-month period ended September 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
during the prior year period are now covered under Medicare, Part D. Partially
offsetting the THALOMID(R) decrease are Medicaid rebate allowances included in
the current year period for REVLIMID(R) sales.
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-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
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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, we recognized an impairment
loss of $3.8 million for the nine-month period ended September 30, 2006 which
was recorded in interest and other income, net.
INVESTMENT IN AFFILIATED COMPANY: We hold 7,864,864 shares of EntreMed, Inc.
common stock and 432,432 warrants to purchase additional shares of EntreMed
common stock at a conversion price of $2.3125 per warrant. Since we also hold
3,350,000 shares of EntreMed voting preferred shares that are convertible into
16,750,000 shares of common stock, we determined that we have significant
influence over the investee and are applying the equity method of accounting to
our common stock investment. The warrants are being accounted for at fair value
using the Black-Scholes model with changes in fair value recorded through
interest and other income (expense), net.
The investment in EntreMed had a carrying value of approximately $13.5 million
and a fair value of $14.6 million at September 30, 2006.
If the carrying value of our investment were to exceed its fair value, we would
review it 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.
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.
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, the aggregate payout
under the Plans would be $8.1 million and the maximum aggregate payout under the
Plans is $18.7 million. We accrue the long-term incentive liability over each
three-year cycle. At September 30, 2006, the recorded liability for the
long-term incentive plans was $6.5 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
41
actual results to date for the performance period, expected results for the
remainder of the performance period, operating trends, product development,
pricing and competition.
EFFECTIVE TAX RATE: The Company's underlying effective tax rate is approximately
69% for the nine months ended September 30, 2006. The effective tax rate exceeds
the statutory tax rate primarily due to share based compensation expense related
to incentive stock options (ISO's) for which tax benefits may not be realized
and certain expenses being incurred in taxing jurisdictions outside the United
States for which the Company does not presently receive a tax benefit. The
Company operates under an incentive tax holiday in Switzerland that expires in
2015 and exempts the Company from certain Swiss taxes. Likewise, expenses
currently being incurred there do not provide a tax benefit. To the extent we
receive approvals in markets outside the United States and, manufacture and
generate taxable income subject to our Swiss tax holiday, we would expect our
effective tax rate to be lower in the future.
At March 31, 2005, the Company determined it was more likely than not that the
Company will generate sufficient taxable income to realize the benefits of its
deferred tax assets and as a result, eliminated certain deferred tax valuation
allowances, which resulted in the Company recording an income tax benefit in
2005 of $42.6 million and an increase to additional paid-in capital of $30.2
million. The decision to eliminate the deferred tax valuation allowances was
based on an external Independent Data Monitoring Committee's, or IDMC, analyses
of two Phase III Special Protocol Assessment multiple myeloma trials and the
conclusion that these trials exceeded the pre-specified stopping rule. The IDMC
found a statistically significant improvement in time to disease progression --
the primary endpoint of these Phase III trials -- in patients receiving
REVLIMID(R) plus dexamethasone compared to patients receiving dexamethasone
alone. This, in concert with our nine consecutive quarters of profitability, led
to the conclusion that it was more likely than not that we will generate
sufficient taxable income to realize the benefits of our deferred tax assets.
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 deferred tax assets, including its 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
and, to the extent future expectations change, we would have to assess the
recoverability of our deferred tax assets at that time. At September 30, 2006,
it was more likely than not that the Company would realize its deferred tax
assets, net of valuation allowances.
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.
42
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 September 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
September 30, 2006, we were party to a foreign currency forward 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 September 30, 2006 was a net gain of approximately $3.3 million and
was recorded in other current assets with the change in fair value recorded in
current year's earnings. Assuming that the September 30, 2006 exchange rates
between U.S. dollar and Swiss franc were to adversely change by a hypothetical
ten percent, the change in the fair value of the contract would decrease by
approximately $13.9 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 September 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 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 their future estimated cash flows and as a result, we recognized an
impairment loss of $3.8 million for the nine-month period ended September 30,
2006.
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As of September 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 to 3 3 to 5 5 to 7 Over 7 Total
(IN THOUSANDS $) 1 Year Years Years Years Years
------------------------------------------------------------------------------------------------------------------------
Principal amount $ 450,489 $ 78,828 $ 201,563 $ 20,500 $ 2,900 $754,280
Fair value $ 448,928 $ 78,755 $ 188,269 $ 19,961 $ 2,465 $738,378
Average interest rate 4.6% 4.6% 4.3% N/A N/A 4.4%
PHARMION COMMON STOCK: At September 30, 2006, we held a total of 1,939,600
shares of Pharmion Corporation common stock, which had an estimated fair value
of approximately $41.8 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 $21.6 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 September 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
$13.5 million and a fair value of $14.6 million at September 30, 2006. Under the
equity method, the investment is reviewed to determine whether an
other-than-temporary decline in value of the investment has been sustained. If
it is determined that the investment has sustained an other-than-temporary
decline in its value, the investment will be written down to its fair value.
Such an evaluation is judgmental and dependent on the specific facts and
circumstances. See our discussion of Critical Accounting Policy contained in
Item 2, Management's Discussion and Analysis of Financial Condition and Results
of Operation for factors that are considered in determining whether an
other-than-temporary decline in value has occurred.
We also hold warrants to purchase an additional 432,432 shares of EntreMed
common stock at a conversion price of $2.3125 per warrant. The warrants are
being accounted for at fair value with changes in fair value recorded through
earnings. At September 30, 2006, the warrants had a fair value of $0.3 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 33,020,545 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.
44
At September 30, 2006, the fair value of our convertible notes exceeded the
carrying value of $400.0 million by approximately $1.0 billion, which we believe
reflects the increase in the market price of our common stock to $43.30 per
share as of September 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
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.
45
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 - None
Item 5. Other Information - None
Item 6. Exhibits
31.1 Certification by the Company's Chief Executive Officer dated
November 8, 2006.
31.2 Certification by the Company's Chief Financial Officer dated
November 8, 2006.
32.1 Certification by the Company's Chief Executive Officer
pursuant to 18 U.S.C. Section 1350 dated November 8, 2006.
32.2 Certification by the Company's Chief Financial Officer
pursuant to 18 U.S.C. Section 1350 dated November 8, 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 November 8, 2006 By: /s/Robert J. Hugin
----------------------------------- ----------------------------------------------
Robert J. Hugin
President, Chief Operating Officer and
Chief Financial Officer
DATE November 8, 2006 By: /s/James R. Swenson
----------------------------------- ----------------------------------------------
James R. Swenson
Controller
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