FORM 10-Q
| Mark One | |
| [X] | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE |
| SECURITIES EXCHANGE ACT OF 1934 | |
For the Quarterly Period ended March 31, 2005
OR
| [ ] | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE |
| SECURITIES ACT OF 1934 |
For the transition period from ______ to _______
Commission File Number 0-24249
PDI, INC.
(Exact name of Registrant as specified in its charter)
| Delaware | 22-2919486 | |
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| (State or other jurisdiction of | (I.R.S. Employer | |
| incorporation or organization) | Identification No.) |
Saddle River Executive Centre
1 Route 17 South
Saddle River, New Jersey 07458
(Address of principal executive offices)
(201) 258-8450
(Registrant’s telephone number, including area code)
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.
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Yes [X] |
No [ ] |
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act.)
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Yes [X] |
No [ ] |
As of May 4, 2005 the Registrant had a total of 14,866,101 shares of Common Stock, $.01 par value, outstanding.
1
INDEX
PDI, INC.
| PART I. FINANCIAL INFORMATION | ||||
| Page | ||||
| Item 1. | Consolidated Financial Statements (unaudited) | |||
| Balance Sheets | ||||
| March 31, 2005 and December 31, 2004 | 3 | |||
| Statements of Operations — Three Months | ||||
| Ended March 31, 2005 and 2004 | 4 | |||
| Statements of Cash Flows — Three Months | ||||
| Ended March 31, 2005 and 2004 | 5 | |||
| Notes to Consolidated Interim Financial Statements | 6 | |||
| Item 2. | Management’s Discussion and Analysis of Financial | |||
| Condition and Results of Operations | 23 | |||
| Item 3. | Quantitative and Qualitative Disclosures | |||
| About Market Risk | Not Applicable | |||
| Item 4. | Controls and Procedures | 33 | ||
| PART II. OTHER INFORMATION | ||||
| Item 1. | Legal Proceedings | 33 |
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| Item 6. | Exhibits | 36 | ||
| SIGNATURES | 37 | |||
2
PDI, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)
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March 31,
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December 31,
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2005
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2004
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| ASSETS | ||||||||
| Current assets: | ||||||||
| Cash and cash equivalents |
$
|
82,364 |
$
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81,000 | ||||
| Short-term investments | 12,959 | 28,498 | ||||||
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Accounts receivable, net of allowance for doubtful accounts of
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||||||||
| $116 and $74 as of March 31, 2005 and | ||||||||
| December 31, 2004, respectively | 27,551 | 26,662 | ||||||
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Unbilled costs and accrued profits on contracts in progress
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8,179 | 3,393 | ||||||
| Deferred training and other program costs | 1,244 | 740 | ||||||
| Other current assets | 11,888 | 11,818 | ||||||
| Deferred tax asset | 8,067 | 3,325 | ||||||
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| Total current assets | 152,252 | 155,436 | ||||||
| Net property and equipment | 17,788 | 17,170 | ||||||
| Deferred tax asset | 802 | 5,832 | ||||||
| Goodwill | 23,820 | 23,791 | ||||||
| Other intangible assets | 19,074 | 19,548 | ||||||
| Other long-term assets | 2,920 | 2,928 | ||||||
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| Total assets |
$
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216,656 |
$
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224,705 | ||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
| Current liabilities: | ||||||||
| Accounts payable |
$
|
4,805 |
$
|
7,217 | ||||
| Accrued returns | 1,659 | 4,316 | ||||||
| Accrued incentives | 7,997 | 16,282 | ||||||
| Accrued salaries and wages | 8,929 | 8,414 | ||||||
| Unearned contract revenue | 8,255 | 6,924 | ||||||
| Restructuring accruals | 79 | 161 | ||||||
| Income taxes and other accrued expenses | 18,962 | 15,966 | ||||||
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| Total current liabilities | 50,686 | 59,280 | ||||||
| Total long-term liabilities | - | - | ||||||
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| Total liabilities | 50,686 | 59,280 | ||||||
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| Commitments and Contingencies (note 12) | ||||||||
| Stockholders’ equity: | ||||||||
| Preferred stock, $.01 par value, 5,000,000 shares authorized, no | ||||||||
| shares issued and outstanding | - | - | ||||||
| Common stock, $.01 par value, 100,000,000 shares authorized: | ||||||||
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shares issued and outstanding,
March 31, 2005 – 14,696,341
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||||||||
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and December 31, 2004 – 14,665,945;
147,894 and 154,554
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||||||||
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restricted shares issued and outstanding, March 31, 2005
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||||||||
| and December 31, 2004, respectively | 148 | 148 | ||||||
| Additional paid-in capital | 117,082 | 116,737 | ||||||
| Retained earnings | 50,575 | 50,637 | ||||||
| Accumulated other comprehensive income | 25 | 76 | ||||||
| Unamortized compensation costs | (1,750 | ) | (2,063 | ) | ||||
| Treasury stock, at cost: 5,000 shares | (110 | ) | (110 | ) | ||||
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| Total stockholders’ equity | 165,970 |
|
165,425 | |||||
| Total liabilities & stockholders’ equity |
$
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216,656 |
$
|
224,705 | ||||
The accompanying notes are an integral part of these financial statements
3
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Three Months Ended March 31,
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2005
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2004 | |||||||
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| Revenue | ||||||||
| Service | $ | 82,024 | $ | 92,547 | ||||
| Product, net | – | 101 | ||||||
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| Total revenue | 82,024 | 92,648 | ||||||
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| Cost of goods and services | ||||||||
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Program expenses (including related party amounts of
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| $0 and $180 for the periods ended | ||||||||
| March 31, 2005 and 2004, respectively) | 63,981 | 65,988 | ||||||
| Cost of goods sold | – | 145 | ||||||
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| Total cost of goods and services | 63,981 | 66,133 | ||||||
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| Gross profit | 18,043 | 26,515 | ||||||
| Operating expenses | ||||||||
| Compensation expense | 9,004 | 10,216 | ||||||
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Other selling, general and administrative expenses
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9,814 | 6,490 | ||||||
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| Total operating expenses | 18,818 | 16,706 | ||||||
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| Operating (loss) income | (775 | ) | 9,809 | |||||
| Other income, net | 669 | 318 | ||||||
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| (Loss) income before (benefit) provision for taxes | (106 | ) | 10,127 | |||||
| (Benefit) provision for income taxes | (44 | ) | 4,152 | |||||
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| Net (loss) income | $ | (62 | ) |
$
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5,975 | |||
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| Basic net (loss) income per share | $ | (0.00 | ) |
$
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0.41 | |||
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| Diluted net (loss) income per share | $ | (0.00 | ) |
$
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0.40 | |||
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| Basic weighted average number of shares outstanding | 14,675 | 14,461 | ||||||
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| Diluted weighted average number of shares outstanding | 14,849 | 14,767 | ||||||
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The accompanying notes are an integral part of these financial statements
4
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Three Months Ended March 31,
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2005
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2004
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| Cash Flows From Operating Activities | ||||||||
| Net (loss) income |
$
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(62 | ) |
$
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5,975 | |||
| Adjustments to reconcile net (loss) income to net cash | ||||||||
| (used in) provided by operating activities: | ||||||||
| Depreciation and amortization | 1,486 | 1,512 | ||||||
| Reserve for inventory obsolescence and bad debt | 42 | 505 | ||||||
| Loss on disposal of assets | 91 | - | ||||||
| Deferred taxes, net | 288 | 7 | ||||||
| Stock compensation costs | 269 | 651 | ||||||
| Other changes in assets and liabilities: | ||||||||
| (Increase) decrease in accounts receivable | (930 | ) | 12,376 | |||||
| Decrease in inventory | - | 43 | ||||||
| Increase in unbilled costs | (4,786 | ) | (14,562 | ) | ||||
| Increase in deferred training | (504 | ) | (457 | ) | ||||
| Increase in other current assets | (70 | ) | (233 | ) | ||||
| Decrease in other long-term assets | 8 | - | ||||||
| (Decrease) increase in accounts payable | (2,412 | ) | 28 | |||||
| Decrease in accrued returns | (2,657 | ) | (288 | ) | ||||
| Decrease in accrued liabilities | (7,770 | ) | (4,755 | ) | ||||
| Decrease in restructuring liability | (82 | ) | (164 | ) | ||||
| Increase in unearned contract revenue | 1,331 | 6,695 | ||||||
| Increase (decrease) in income taxes and other accrued expenses | 2,996 | (1,058 | ) | |||||
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| Net cash (used in) provided by operating activities | (12,762 | ) | 6,275 | |||||
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| Cash Flows From Investing Activities | ||||||||
| Sales (purchases) of short-term investments | 15,488 | (48,036 | ) | |||||
| Cash paid for acquisition, including acquisition costs | (29 | ) | - | |||||
| Purchase of property and equipment | (1,721 | ) | (2,588 | ) | ||||
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| Net cash provided by (used in) investing activities | 13,738 | (50,624 | ) | |||||
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| Cash Flows From Financing Activities | ||||||||
| Net proceeds from exercise of stock options | 388 | 524 | ||||||
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| Net cash provided by financing activities | 388 | 524 | ||||||
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| Net increase (decrease) in cash and cash equivalents | 1,364 | (43,825 | ) | |||||
| Cash and cash equivalents – beginning | 81,000 | 113,288 | ||||||
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| Cash and cash equivalents – ending |
$
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82,364 |
$
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69,463 | ||||
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The accompanying notes are an integral part of these financial statements
5
1. Basis of Presentation
The accompanying unaudited interim consolidated financial statements and related notes should be read in conjunction with the consolidated financial statements of PDI, Inc. and its subsidiaries (the Company or PDI) and related notes as included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 as filed with the Securities and Exchange Commission (the SEC). The unaudited interim consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial reporting and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. The unaudited interim consolidated financial statements include all adjustments (consisting of normal recurring adjustments) which, in the judgment of management, are necessary for a fair presentation of such financial statements. Operating results for the three- month period ended March 31, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. Certain prior period amounts have been reclassified to conform with the current presentation with no effect on financial position, net income or cash flows.
2. Stock-Based Compensation
In June 2004, the Company’s shareholders approved the PDI, Inc. 2004 Stock Award and Incentive Plan (the 2004 Plan). The 2004 Plan had been approved by the Company’s Board of Directors (the Board) in March 2004. The 2004 Plan replaced the 2000 Omnibus Incentive Compensation Plan (the 2000 Plan) and the 1998 Stock Option Plan (the 1998 Plan). The total number of additional shares of the Company’s common stock reserved and available for delivery under the 2004 Plan is 893,916, which includes the number of stock shares that were available for issuance under the preceding plans as of the effective date of the 2004 Plan. The maximum number of shares as to which awards or options may at any time be granted under the 2004 Plan is approximately 2.9 million shares. Eligible participants under the 2004 Plan include officers and other employees of the Company, members of the Board and outside consultants, as specified under the 2004 Plan and designated by the Compensation Committee of the Board. Unless earlier terminated by action of the Board, the 2004 Plan will remain in effect until such time as no stock remains available for delivery under the 2004 Plan and the Company has no further rights or obligations with respect to outstanding awards under that plan. No participant may be granted more than the annual limit of 400,000 shares plus the amount of the participant’s unused annual limit relating to share-based awards as of the close of the previous year, subject to adjustment for stock splits and other extraordinary corporate events.
On February 9, 2005, upon approval of the Board, the Company accelerated the vesting of all outstanding unvested options for which the exercise price was greater than the fair market value of the Company’s common shares on that date. Included in the pro forma statement below is approximately $7.6 million of compensation expense related to the acceleration of the unvested underwater options. The total number of shares accelerated was 473,334 and they all pertained to grants that were issued during 2004. The weighted average exercise price of the accelerated options was $25.27 with exercise prices ranging from $24.61 to $31.62.
6
PDI, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS - continued
(unaudited)
At March 31, 2005, options for an aggregate of 1,302,011 shares were outstanding under the Company’s stock option plans and options to purchase 548,842 shares of common stock had been exercised since the Company’s inception.
On March 29, 2005, the Compensation and Management Development Committee of the Board (the Compensation Committee) approved the 2005 PDI, Inc. Long Term Incentive Plan (the LTI Plan), which permits the issuance of certain equity and equity-based incentive awards under the terms of the 2004 Plan. Under the provisions of the LTI Plan, as implemented under the 2004 Plan, the Company seeks to provide its eligible employees with equity awards based, in part, upon the attainment of certain financial performance goals during a three (3) year period (the Performance Period). The amount of these long term incentive awards which may be earned over the Performance Period will be based, in part, on the Company’s financial performance and the attainment of related individual performance goals during the prior calendar year.
To provide each participant with an equity stake in the Company, and the potential to create or increase his or her stock ownership in the Company, awards under the LTI Plan will be made through the following two methods: (i) stock-settled appreciation rights (SARs); and (ii) performance contingent shares of Company common stock (Performance Contingent Shares).
On March 29, 2005, the Company issued 93,486 SARs with a fair market value of approximately $20.10 to certain officers of the Company who are eligible under the LTI Plan. There was no compensation expense recorded in the first quarter as a result of issuing the SARs. The SARs have a five-year life. A Black-Scholes pricing model was used to determine the number of SARs that were issued to each LTI Plan participant.
Based upon the target performance goals set by the Company under the LTI Plan as of March 29, 2005, a total of 54,893 Performance Contingent Shares could be required to be issued by the Company upon the attainment of all LTI Plan performance goals by all eligible LTI Plan participants. There was no compensation expense recorded in the first quarter with respect to such Performance Contingent Shares as no shares of Company common stock were issued. Any Performance Contingent Shares awarded under the LTI Plan will be issued upon completion of the three (3) year Performance Period which commenced on March 29, 2005. The target number of Performance Contingent Shares which may be issued under the LTI Plan was estimated by dividing one-half of the total value of the award amount for each participant, as approved by the Compensation Committee, by the average market price for a share of Company common stock for the three (3) month period immediately preceding the commencement date of the Performance Period, which was calculated to be $20.13.
Under the terms of the LTI Plan, each participant’s target award of Performance Contingent Shares could increase by fifty percent (50%) to 82,340 shares if a pre-determined superior level of achievement is attained as of the end of the Performance Period.
Under the terms of the LTI Plan, a discretionary pool of 75,000 shares per year is available for awards to individuals who are not otherwise participating for the LTI Plan. Such awards may be made upon the recommendation of the Company’s chief executive officer with the approval of the Compansation Committee.
7
| As of March
31, |
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| 2005 |
2004 |
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| (in thousands,
except per share data) |
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| Net (loss) income, as
reported |
$ | (62 | ) | $ |
5,975 | |||
| Add: Stock-based employee compensation | ||||||||
| expense | ||||||||
| included in reported net income, net of | ||||||||
| related tax effects | 190 | 384 | ||||||
| Deduct: Total stock-based employee | ||||||||
| compensation | ||||||||
| expense determined under fair value based | ||||||||
| methods for all awards, net of related tax | ||||||||
| effects | (4,852 | ) | (748 | ) | ||||
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| Pro forma net (loss) income |
$
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(4,724 | ) |
$
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5,611 | |||
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| Net (loss) income per share | ||||||||
| Basic--as reported |
$
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(0.00 | ) |
$
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0.41 | |||
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| Basic--pro forma |
$
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(0.32 | ) |
$
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0.39 | |||
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| Diluted--as reported |
$
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(0.00 | ) |
$
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0.40 | |||
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| Diluted--pro forma |
$
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(0.32 | ) |
$
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0.38 | |||
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Compensation cost for the determination of pro forma net (loss) income - as adjusted and related per share amounts were estimated using the Black Scholes option pricing model, with the following assumptions: (i) there were no options issued for the quarter ended March 31, 2005; (ii) risk free interest rate of 2.80% at March 31, 2004; (iii) expected life of five years for the quarter ended March 31, 2004; (iv) expected dividends - $0 for the quarter ended March 31, 2004; and (v) volatility of 100% for the quarter ended March 31, 2004. The weighted average fair value of options granted during the quarter ended March 31, 2004 was $18.62.
Stock based employee compensation for the quarter ended March 31, 2005 was approximately $327,000, of which $269,000 pertained to the amortization of restricted stock. The remaining $58,000 pertained to severance payments relating to the unvested portion of stock options.
In March 2003, the Company initiated an option exchange program pursuant to which eligible employees (which excluded certain members of senior management) were offered an opportunity to exchange an aggregate of 357,885 outstanding stock options with exercise prices of $30.00 and above for either cash or shares of restricted stock, depending upon the number of options held by an eligible employee. Approximately 47,500 options, which were offered to, but did not participate in, the option exchange program, are subject to variable accounting. As such, the Company may record compensation expense if the market price of the Company’s common stock exceeds the exercise price of the non-tendered options before these options are terminated, exercised or forfeited. There was no such compensation expense in the periods ended March 31, 2005 or March 31, 2004. The non-tendered options have exercise prices ranging from $59.50 to $80.00 and a remaining life of 5.5 to 5.8 years.
3. Revenue Recognition and Associated Costs
The paragraphs that follow describe the guidelines that the Company adheres to in accordance with GAAP when recognizing revenue and cost of goods and services in its financial
8
statements. In accordance with GAAP, service revenue and product revenue and their respective direct costs have been shown separately on the income statement.
Historically, the Company has derived a significant portion of its service revenue from a limited number of clients. Concentration of business in the pharmaceutical services industry is common and the industry continues to consolidate. As a result, the Company is likely to continue to experience significant client concentration in future periods. For the three months ended March 31, 2005, and 2004, the Company’s three largest clients who each individually represented 10% or more of its service revenue, accounted for approximately 65.3% and 78.6%, respectively, of its service revenue.
Service revenue and program expenses
Service revenue is earned primarily by performing product detailing programs and other marketing and promotional services under contracts. Revenue is recognized as the services are performed and the right to receive payment for the services is assured. Revenue is recognized net of any potential penalties until the performance criteria relating to the penalties have been achieved. Performance incentives, as well as termination payments, are recognized as revenue in the period earned and when payment of the bonus, incentive or other payment is assured. Under performance based contracts, revenue is recognized when the performance based parameters are achieved.
Program expenses consist primarily of the costs associated with executing product detailing programs, performance based contracts or other sales and marketing services identified in the contract. Program expenses include personnel costs and other costs associated with executing a product detailing or other marketing or promotional program, as well as the initial direct costs associated with staffing a product detailing program. Such costs include, but are not limited to, facility rental fees, honoraria and travel expenses, sample expenses and other promotional expenses. Personnel costs, which constitute the largest portion of program expenses, include all labor related costs, such as salaries, bonuses, fringe benefits and payroll taxes for the sales representatives and sales managers and professional staff who are directly responsible for executing a particular program. Initial direct program costs are those costs associated with initiating a product detailing program, such as recruiting, hiring and training the sales representatives who staff a particular product detailing program. All personnel costs and initial direct program costs, other than training costs, are expensed as incurred for service offerings. Product detailing, marketing and promotional expenses related to the detailing of products the Company distributes are recorded as a selling expense and are included in other selling, general and administrative expenses in the consolidated statements of operations.
Reimbursable Out-of-Pocket Expenses
Reimbursable out-of-pocket expenses include those relating to travel and out-of pocket expenses and other similar costs, for which the Company is reimbursed at cost from its clients. In accordance with the requirements of Emerging Issues Task Force No. 01-14, “Income Statement Characterization of Reimbursements Received for Out-of-Pocket Expenses Incurred” (EITF 01-14), reimbursements received for out-of-pocket expenses incurred are characterized as revenue and an identical amount is included as program expenses in the consolidated statements of operations. For the quarters ended March 31, 2005 and 2004 reimbursable out-of-pocket expenses were approximately $7.4 million and $4.3 million, respectively.
9
Training Costs
Training costs include the costs of training the sales representatives and managers on a particular product detailing program so that they are qualified to properly perform the services specified in the related contract. For all contracts, training costs are deferred and amortized on a straight-line basis over the shorter of the life of the contract to which they relate or 12 months. When the Company receives a specific contract payment from a client upon commencement of a product detailing program expressly to compensate the Company for recruiting, hiring and training services associated with staffing that program, such payment is deferred and recognized as revenue in the same period that the recruiting and hiring expenses are incurred and amortization of the deferred training is expensed. When the Company does not receive a specific contract payment for training, revenue is recognized as the services are performed and the right to receive payment for the services is assured.
Product revenue and cost of goods sold
Product revenue is recognized when products are shipped and title is transferred to the customer. There was no product revenue for the quarter ended March 31, 2005. For the quarter ended March 31, 2004 product revenue was $101,000 which consisted of the sale of the Xylos Corporation (Xylos) wound care products (see Note 5 hereto).
Cost of goods sold includes all expenses for product distribution costs, acquisition and manufacturing costs of the product sold. There were no cost of goods sold for the quarter ended March 31, 2005. For the quarter ended March 31, 2004 cost of goods sold was $145,000, which consisted of the expenses associated with the sale of the Xylos wound care products.
4. Acquisition
On August 31, 2004, the Company acquired substantially all of the assets of Pharmakon, LLC in a transaction treated as an asset acquisition for tax purposes. The acquisition has been accounted for as a purchase, subject to the provisions of Statement of Financial Accounting Standards (SFAS) No. 141, “Business Combinations” (SFAS 141). The Company made payments to the members of Pharmakon, LLC on August 31, 2004 of $27.4 million, of which $1.5 million was deposited into an escrow account, and assumed approximately $2.6 million in net liabilities. Approximately $1.1 million in direct costs of the acquisition were also capitalized. Based upon the attainment of annual profit targets agreed upon at the date of acquisition, the members of Pharmakon, LLC received approximately $1.4 million in additional payments on April 1, 2005 for the year ended December 31, 2004. The Company has determined that this consideration meets the requirements to be capitalized as additional investment, rather than expensed as compensation. This amount was recorded as a current liability as of December 31, 2004, with a corresponding amount recorded to goodwill. Additionally, the members of Pharmakon, LLC can still earn up to an additional $6.7 million in cash based upon achievement of certain annual profit targets through December 2006. In connection with this transaction, the Company recorded $12.7 million in goodwill and $18.9 million in other identifiable intangibles.
Pharmakon is a healthcare communications company focused on the marketing of ethical pharmaceutical and biotechnology products. A primary reason for the acquisition of Pharmakon was the advancement of the Company’s goal to expand its presence in the growing and heavily
10
outsourced medical education market. Pharmakon’s emphasis is on the creation, design and implementation of interactive peer persuasion programs. The successful integration of Pharmakon and PDI may allow both businesses to leverage their account relationships and cross sell their services.
The following unaudited pro forma consolidated results of operations for the quarter ended March 31, 2004 assume that the Company and Pharmakon had been combined as of the beginning of the period presented. The pro forma results include estimates and assumptions which management believes are reasonable. However, pro forma results are not necessarily indicative of the results that would have occurred if the acquisition had been consummated as of the dates indicated, nor are they necessarily indicative of future operating results.
|
Three Months Ended
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|
March 31, 2004
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|
(in thousands, except for per share data)
|
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|
(unaudited)
|
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| Net sales – pro forma | $
|
98,881 | ||
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| Net income – pro forma | $
|
7,119 | ||
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| Pro forma diluted earnings per share | $
|
0.48 | ||
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5. Performance Based Contracts
Ceftin
In October 2000, the Company entered into an agreement (the Ceftin Agreement) with GlaxoSmithKline (GSK) for the exclusive U.S. sales, marketing and distribution rights for Ceftin® Tablets and Ceftin® for Oral Suspension, two dosage forms of a cephalosporin antibiotic, which agreement was terminated in February 2002 by mutual agreement of the parties. The Ceftin Agreement had a five-year term but was cancelable by either party without cause on 120 days’ notice. From October 2000 through February 2002, the Company marketed Ceftin to physicians and sold the products primarily to wholesale drug distributors, retail chains and managed care providers.
On August 21, 2001, the U.S. Court of Appeals overturned a preliminary injunction granted by the New Jersey District Court to GSK, which subsequently allowed for the entry of a generic competitor to Ceftin immediately upon approval by the FDA. The affected Ceftin patent had previously been scheduled to run through July 2003. The generic version of Ceftin was approved by the FDA in February 2002 and it began to be manufactured in March 2002.
The Ceftin Agreement was terminated by the Company and GSK under a mutual termination agreement entered into in December 2001. GSK resumed exclusive rights to Ceftin after the effective date of the termination of the Ceftin Agreement, and the Company believes that GSK currently sells Ceftin under its own label code. Pursuant to the termination agreement, the Company agreed to perform marketing and distribution services through February 28, 2002. As is common in the pharmaceutical industry, customers who purchased the Company’s Ceftin product were permitted to return unused product, after approval from the Company, up to six months
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before and one year after the expiration date for the product, but no later than December 31, 2004. The products sold by the Company prior to the Ceftin Agreement termination date of February 28, 2002 had expiration dates through June 2004. The Company also maintained responsibility for processing and payment of certain sales rebates through December 31, 2004.
On March 31, 2004, the Company signed an agreement and waiver with a large wholesaler by which the Company agreed to pay that wholesaler $10.0 million, and purchase $2.5 million worth of services from that wholesaler by March 31, 2006, in exchange for that wholesaler waiving, to the fullest extent permitted by law, all rights with respect to any additional returns of Ceftin to the Company.
The Company’s reserve of $1.7 million at March 31, 2005 consists almost entirely of services to be provided by the Company to a large wholesaler which the Company was able to negotiate in lieu of purchasing the $2.5 million worth of services as described above. The reserve has been calculated based on, with respect to wholesalers, reimbursing the wholesalers at the amount for which they purchased the product from the Company. The reserve as recorded by the Company is its best estimate based on its understanding of its obligations.
Lotensin
In May 2001, the Company entered into a copromotion agreement with Novartis Pharmaceuticals Corporation (Novartis) for the U.S. sales, marketing and promotion rights for Lotensin®, and Lotensin HCT®. Another product, Lotrel®, was promoted by the same sales force under the same agreement, but was a fee for service arrangement. On May 20, 2002, this agreement was replaced by two separate agreements, one for Lotensin and one for Lotrel-Diovan through the addition of Diovan® and Diovan HCT®. Both of these agreements ended December 31, 2003; however, the Lotrel-Diovan agreement was renewed on December 24, 2003 for an additional one year period. In February 2004, the Company was notified by Novartis of its intent to terminate the Lotrel-Diovan agreement, without cause, effective March 16, 2004. The Company was compensated under the terms of the agreement through the effective termination date. Even though the Lotensin agreement ended December 31, 2003, the Company also received royalty payments on the sales of Lotensin through December 31, 2004.
Xylos
In October 2002, the Company entered into an agreement with Xylos for the exclusive U.S. commercialization rights to the XCell line of wound care products. Pursuant to this agreement, the Company had certain minimum purchase requirements. The Company did have the right to terminate the agreement with 135 days’ notice to Xylos, beginning January 1, 2004. The Company began selling the Xylos products in January 2003; however, sales were significantly slower than anticipated and actual 2003 sales did not meet the Company’s forecasts. Based on these sales results, the Company concluded that sales of XCell were not sufficient enough to sustain the Company’s continued role as commercialization partner for the product and therefore, on January 2, 2004, the Company exercised its contractual right to terminate the agreement on 135 days’ notice to Xylos. The Company’s promotional activities in support of the brand concluded in January 2004, and the agreement was terminated effective May 16, 2004. The Company recorded a reserve for potential excess inventory during the third quarter of 2003 of $835,000 to reduce the value of the inventory to its estimated net realizable value. In 2002, the
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Company had acquired $1.0 million of preferred stock of Xylos and in 2004, the Company loaned $500,000 to Xylos. As discussed below in Note 6, the Company determined its $1.0 million investment and $500,000 short-term loan to Xylos were impaired as of December 31, 2004 and both were written down to zero.
Cellegy
On December 31, 2002, the Company entered into an exclusive licensing agreement (the Cellegy License Agreement) with Cellegy Pharmaceuticals, Inc. (Cellegy) for the exclusive North American rights for Fortigel™, a testosterone gel product in return for a $15.0 million initial licensing fee and the obligation to make an additional payment if the FDA approved Fortigel. In July 2003, Cellegy received a letter from the FDA rejecting its NDA for Fortigel.
As discussed in Note 12, the Company filed a complaint against Cellegy in December 2003 that alleged, among other things, that Cellegy fraudulently induced the Company to enter into the Cellegy License Agreement, and sought return of the $15.0 million initial licensing fee, plus additional damages caused by Cellegy’s conduct. On April 12, 2005, the Company announced that it had settled the lawsuit against Cellegy, which terminated the Cellegy License Agreement. The Company has no further financial obligations to Cellegy and all Fortigel product rights have been returned to Cellegy.
6. Other Assets
In October 2002, the Company acquired $1.0 million of preferred stock of Xylos. The Company recorded its investment in Xylos under the cost method and its ownership interest in Xylos is less than five percent. As discussed in Note 5, the Company served in 2003 as the exclusive distributor of the Xylos XCell product line, but on January 2, 2004, the Company terminated that arrangement effective May 16, 2004. In addition, the Company provided short term loans totaling $500,000 in the first half of 2004. As a result of continuing operating losses incurred by Xylos as well as negative developments regarding its inability to obtain appropriate financing, the Company concluded during the fourth quarter of 2004 that both the investment and the recoverability of the loan were impaired as of December 31, 2004. As a result, the $1.0 million investment was written down to zero in the fourth quarter of 2004 and the $500,000 loan was fully reserved during the fourth quarter as well.
In May 2004, the Company entered into a loan agreement with TMX Interactive, Inc. (TMX), a provider of sales force effectiveness technology. Pursuant to the loan agreement, the Company provided TMX with a term loan facility of $500,000 and a convertible loan facility of $500,000, each of which are due to be repaid on November 26, 2005. In connection with the convertible loan facility, the Company has the right to convert all, or, in multiples of $100,000, any part of the convertible note into common stock of TMX. In the first quarter of 2005, TMX provided services to PDI valued at $150,000. The receipt of these services was used as payment towards the loan and the balance of the loan receivable at March 31, 2005 is $850,000. Although TMX experienced losses in 2004 and the first quarter of 2005, the Company continues to believe that, based on current prospects and activities at TMX, its loans are not impaired and the amounts are recoverable as of March 31, 2005. However, if TMX continues to experience losses and is not able to generate sufficient cash flows through operations and financing, the Company may determine that it will be unable to recover its loans and would have to reserve them at that time.
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7. Loans to Stockholders/Officers
In November 1998, the Company agreed to lend $250,000 to an executive officer of which $100,000 was funded in November 1998, and the remaining $150,000 was funded in February 1999. This amount was recorded in other long-term assets. Such loan was payable on December 31, 2008 and bore interest at a rate of 5.5% per annum, payable quarterly in arrears. Payments of $100,000, $75,000 and $75,000, respectively, were made in February 2003, April 2004 and March 2005, and the loan has been fully repaid as of March 2005.
8. New Accounting Pronouncements