Gilead Sciences 10-K 2005
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 0-19731
GILEAD SCIENCES, INC.
(Exact name of registrant as specified in its charter)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK $.001 PAR VALUE
(Title of Class)
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 o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether registrant is an accelerated filer (as defined in Rule 12B-2 of the Act). Yes x No o
The aggregate market value of the voting stock held by non-affiliates of the registrant based upon the closing price of the Common Stock on the Nasdaq Stock Market on June 30, 2004 was $14,064,813,000.*
The number of shares outstanding of the Registrants Common Stock on February 28, 2005 was 449,881,860.**
DOCUMENTS INCORPORATED BY REFERENCE
Specified portions of Registrants Definitive Proxy Statement filed with the Commission pursuant to Regulation 14A in connection with the 2005 Annual Meeting are incorporated by reference into Part III of this Report.
* Based on a closing price of $33.50 per share. Excludes 10,577,134 shares of the registrants common stock held by executive officers, directors and stockholders whose ownership exceeds 5% of the Common Stock outstanding at June 30, 2004. Exclusion of such shares should not be construed to indicate that any such person possesses the power, direct or indirect, to direct or cause the direction of the management or policies of the Registrant or that such person is controlled by or under common control with the Registrant.
** On September 3, 2004, the Registrant implemented a two-for-one stock split in the form of a stock dividend. All share and per share amounts for all periods presented have been restated to reflect this stock split.
We own or have rights to various trademarks, copyrights and trade names used in our business including the following: GILEAD®, GILEAD SCIENCES®, HEPSERA®, VIREAD®, VISTIDE®, DAUNOXOME®, AMBISOME®, EMTRIVA®, TRUVADA®. MACUGEN® is a registered trademark belonging to Eyetech Pharmaceuticals, Inc., SUSTIVA® is a registered trademark of Bristol-Myers Squibb Company and TAMIFLU® is a registered trademark belonging to Hoffmann-La Roche. This report also includes other trademarks, service marks and trade names of other companies.
This report includes forward-looking statements. In particular, statements about our expectations, beliefs, plans, objectives or assumptions of future events or performance are contained or incorporated by reference in this report. We have based these forward-looking statements on our current expectations about future events. While we believe these expectations are reasonable, forward-looking statements are inherently subject to risks and uncertainties, many of which are beyond our control. Our actual results may differ materially from those suggested by these forward-looking statements for various reasons, including those discussed in this report under the heading Risk Factors That Affect Gilead beginning at page 15. Given these risks and uncertainties, you are cautioned not to place undue reliance on forward-looking statements. The forward-looking statements included in this report are made only as of the date hereof. We do not undertake and specifically decline any obligation to update any of these statements or to publicly announce the results of any revisions to any forward looking statements to reflect future events or developments. When used in the report, unless otherwise indicated, we, our and us refers to Gilead and its subsidiaries.
Gilead Sciences, Inc. is a biopharmaceutical company that discovers, develops and commercializes therapeutics to advance the care of patients suffering from life-threatening diseases. We are a multinational company with eight approved products. We focus our research and clinical programs on anti-infectives. We are seeking to add to our existing portfolio of products through our internal discovery and clinical development programs and through an active product acquisition and in-licensing strategy.
Our worldwide headquarters are in Foster City, California and our European headquarters are in Paris, France. We were incorporated in Delaware on June 22, 1987.
· Viread is an oral formulation of a nucleotide analogue reverse transcriptase inhibitor, dosed once a day as part of combination therapy to treat human immunodeficiency virus (HIV) infection in adults. We sell Viread in the United States through our U.S. commercial team and wholesalers, in the major European countries through our European commercial team and distributors, and in Japan through our corporate partner, Japan Tobacco. We have an exclusive, worldwide license to patent rights and related technology for Viread from the Institute of Organic Chemistry and Biochemistry (part of the Academy of Sciences of the Czech Republic) and Rega Stichting v.z.w. (together, IOCB/REGA).
· Emtriva is an oral formulation of a nucleoside analogue reverse transcriptase inhibitor, dosed once a day as part of a combination therapy to treat HIV infection in adults. We sell Emtriva in the United States through our U.S. commercial team and wholesalers and in the major European countries through our European commercial team and distributors. We have an exclusive, worldwide license to patent rights and related technology for Emtriva from Emory University.
· Truvada is an oral tablet dosed once a day as part of a combination therapy to treat HIV infection in adults. It is a fixed-dose combination of our anti-HIV medications Emtriva and Viread. Truvada combines 200 mg of emtricitabine (Emtriva) and 300 mg of tenofovir disoproxil fumarate (Viread). Truvada is currently sold in the United States through our U.S. commercial team and wholesalers. Our international commercial team began launching Truvada in the European Union following recent
regulatory approval in February 2005. We have an exclusive, worldwide license to patent rights and related technology for the components of Truvada from IOCB/REGA and Emory University.
· AmBisome is a proprietary liposomal formulation of amphotericin B, a powerful antifungal agent to treat serious invasive fungal infections caused by various fungal species. By delivering amphotericin B in our proprietary liposomal formulation, AmBisome reduces the rate and severity of kidney toxicity and injection-related reactions associated with amphotericin B and allows patients to receive higher doses of amphotericin B. AmBisome is approved for sale in more than 45 countries, including the United States and the countries of the European Union. In more than 20 of the countries where AmBisome is approved, including the United States, we are authorized to promote AmBisome for empirical treatment of fungal infections, that is, treatment of patients where a strong suspicion, without definite confirmation, exists for a potentially life-threatening invasive fungal infection. In the remaining countries, AmBisome is approved for use either as first-line treatment of serious invasive fungal infection or as second-line treatment after conventional amphotericin B therapy fails or when conventional amphotericin B cannot be tolerated. We market AmBisome in the major countries of Europe and co-promote AmBisome in the United States with Fujisawa Healthcare, Inc. (Fujisawa).
· Hepsera is an oral formulation of a nucleotide analogue hepatitis B virus (HBV) DNA polymerase inhibitor, dosed once a day to treat chronic hepatitis B. Hepsera is approved for sale in the United States for the treatment of chronic hepatitis B in adults with evidence of active viral replication and either evidence of persistent elevations in serum aminotransferases (ALT or AST) or histologically active liver disease. Our U.S. commercial team and wholesalers sell Hepsera in the United States. We sell Hepsera in the major European Union countries through our European commercial team and distributors. We have licensed the rights to commercialize Hepsera solely for the treatment of hepatitis B in China, Japan, Korea, Taiwan, the rest of Asia, Latin America and certain other territories to GlaxoSmithKline (GSK), which launched Hepsera in Japan, South Korea and Taiwan in 2004. We have an exclusive, worldwide license to patent rights and related technology for adefovir dipivoxil from IOCB/REGA.
· Vistide is an antiviral medication for the treatment of cytomegalovirus (CMV) retinitis in patients with AIDS. CMV retinitis is a condition characterized by lesions that form on a patients retina that affects persons with weakened immune systems and is most common in patients with AIDS. Vistide is approved for sale and is sold in the United States by our U.S. commercial team, and by Gileads ex-U.S. partner, Pfizer Inc. (Pfizer) (formerly Pharmacia Corporation), in 25 countries for the treatment of CMV retinitis in patients with AIDS.
· DaunoXome is a liposomal formulation of the anticancer agent daunorubicin. It is approved for sale and has been sold in more than 20 countries for the treatment of AIDS-related Kaposis sarcoma. It is sold in the United States by our U.S. commercial team and by independent distributors abroad. In December 2003, we decided to discontinue selling this product; however, in 2004, we subsequently received unanticipated requests in Europe to reconsider selling DaunoXome. We are continuing to sell this product in a limited number of countries and are currently evaluating our supply and sales strategy with regard to this product.
· Macugen is an anti-angiogenic injection for the treatment of neovascular age-related macular degeneration (AMD). The drug is an inhibitor of vascular endothelial growth factor (VEGF), which is known to play a role in the development of certain ophthalmic diseases. Macugen was approved by the FDA in the United States in December 2004 and began selling in January 2005. The product is not yet approved outside the United States. Macugen was developed by Eyetech Pharmaceuticals, Inc.
(Eyetech), using technology licensed from us. Eyetech holds the exclusive rights to manufacture and sell Macugen worldwide, subject to Eyetechs obligation to pay us a percentage of the net revenues that Eyetech generates from Macugen sales. The patents to the technology we license to Eyetech expire in 2017 in the United States and Europe.
· Tamiflu is an oral pill for the treatment and prevention of influenza A and B. Tamiflu is in a class of prescription drugs called neuraminidase inhibitors. Tamiflu is approved in more than 60 countries, including the United States, Japan and the countries of the European Union for treatment of influenza in children and adults. Tamiflu is also approved in the United States and the European Union for the prevention of influenza in adolescents and adults. We developed Tamiflu with F. Hoffmann-LaRoche Ltd (Roche), and Roche has the exclusive right to manufacture and sell Tamiflu worldwide, subject to its obligation to pay us a percentage of the net revenues that Roche generates from Tamiflu sales, subject to reduction for certain defined manufacturing costs.
The following table lists aggregate product sales for our major products (in thousands):
See Note 16 of the Consolidated Financial Statements for financial information about each geographic area in which our products are marketed.
We are seeking to add to our existing portfolio of products through our internal discovery and clinical development programs and through an active product acquisition and in-licensing strategy, such as our acquisition of Triangle Pharmaceuticals, Inc. completed in January 2003. We have research scientists in Foster City and San Dimas, California and Durham, North Carolina engaged in the discovery and development of new molecules and technologies that we hope will lead to new medicines and novel formulations of existing drugs. Our therapeutic focus is in the area of life threatening infectious diseases. This research includes working with our proprietary nucleotide analogues to develop treatments for viral infections, particularly HIV and hepatitis C infection. In total, our research and development (R&D) expenses for 2004 were $223.6 million, compared with $181.8 million for 2003 and $141.9 million for 2002.
Our research efforts in the area of hepatitis C viral infection (HCV) include our collaborations with Chiron Corporation (Chiron), Genelabs Technologies (Genelabs) and Achillion Pharmaceuticals, Inc. (Achillion). In August 2003, we entered into an agreement with Chiron, to research, develop and commercialize small molecule therapeutics against certain HCV drug targets. In October 2004, we entered into a research and development agreement with Genelabs Technologies (Genelabs) to discover, develop and commercialize nucleoside, RNA polymerase inhibitors for the treatment of HCV infection. In November 2004, we entered into a research and development agreement with Achillion to discover and commercialize novel inhibitors of HCV replication. In addition, we have several in-house programs
designed to discover small molecule inhibitors of HCV RNA polymerase and HCV protease. While we believe that small molecule therapeutics for the treatment of HCV infection could one day lead to better treatment outcomes for patients, such programs will require extensive investments and will take many years. See Note 10 of consolidated financial statements for further discussion.
We have U.S. and international commercial sales operations. We have marketing subsidiaries in Australia, Canada, France, Germany, Greece, Ireland, Italy, New Zealand, Portugal, Spain and in the United Kingdom.
Our commercial teams promote our HIV and HBV products, Viread, Emtriva, Truvada and Hepsera, through direct field contact with physicians, hospitals, clinics and other healthcare providers who are involved in the treatment of patients with HIV (for our HIV products) or chronic hepatitis B (for Hepsera). The teams also promote AmBisome to infectious disease specialists, hematologists, intensive care units, hospitals, home health care providers and cancer specialists.
In some countries outside of the United States, we have agreements with third-party distributors, including distributors in certain countries where we have marketing operations, to promote, sell and distribute our products. These international distribution agreements generally provide that the distributor has the exclusive right to sell one or more of our products in a particular country or several countries for a specified period of time.
In December 2002, we announced a program pursuant to which we sell Viread at our cost to all countries in Africa and to the fifteen other countries designated Least Developed by the United Nations. We expanded this program in August 2004 to include Truvada. We are taking steps to ensure that the Viread and Truvada products sold under this program are used to serve patients in the developing world and are not diverted to other markets. See International Distribution.
As part of our business strategy, we establish collaborations with other companies to assist in the clinical development and/or commercialization of certain of our products and product candidates and to provide support for our research programs. We also evaluate opportunities for acquiring products or rights to products and technologies that are complementary to our business from other companies. The description and accounting for each of these relationships can be found in Note 10 to our consolidated financial statements included in this report. The following list is representative of our collaborative relationships:
Bristol-Myers Squibb Company
In December 2004, we entered into a collaboration agreement with Bristol-Myers Squibb Company (BMS) to develop and commercialize the fixed-dose combination of Gileads Truvada and BMSs Sustiva® (efavirenz) in the United States. Structured as a joint venture, Gilead and BMS formed the limited liability company, Bristol-Myers Squibb & Gilead Sciences, LLC. If approved, the new product would be the first complete Highly Active Antiretroviral Therapy (HAART) treatment regimen for HIV available in a fixed-dose combination taken once daily. Fixed-dose combinations contain multiple medicines formulated together and may help simplify HIV therapy for patients and providers. Through the joint venture, the companies will work in partnership to complete development and U.S. regulatory filings for this fixed-dose regimen. Subject to receiving marketing approval of the fixed-dose regimen, the companies will share responsibility for commercializing the product in the United States. Both companies will provide funding and field-based sales representatives in support of promotional efforts for the combination product. Under the terms of the collaboration, Gilead and BMS will grant royalty-free sublicenses to the joint venture for the use of their respective company-owned technologies and will, in return, be granted a license to use jointly created intellectual property. Gileads and BMS ownership interests in the joint venture, which reflect their respective economic interests, are based on the fraction of the net selling price of the fixed-dose combination product attributable to Truvada and Sustiva, respectively, and will be adjusted on an annual basis. Since the net selling price for Truvada may change over time relative to the net selling price of Sustiva, both joint venturers respective economic interests in the joint venture may vary annually.
To supplement our research and development efforts, as part of our regular business we enter into arrangements with universities and medical research institutions. These arrangements often provide us with rights to patents, patent applications and technology owned by these institutions in return for payments and fees relating to our use of these rights.
Emory University and University of Georgia Research Foundation, Inc.
Emtricitabine. In April 1996, Triangle obtained, and in January 2003, we acquired as part of our acquisition of Triangle, an exclusive worldwide license to all of Emory Universitys rights to purified forms of emtricitabine for use in the HIV and the HBV fields. We are obligated to make certain milestone and royalty payments to Emory, including annual minimum royalties beginning the third year after the first FDA registration is granted for an anti-HIV product incorporating the emtricitabine technology in the United States and the third year after the first registration is granted for an anti-HBV product incorporating the emtricitabine technology in certain major market countries, for the HIV and HBV indications, respectively. In 2002, Triangle began paying license maintenance fees because development milestones had not yet been achieved.
In May 1999, Emory and GSK settled their litigation pending in the United States District Court relating to emtricitabine, and we became the exclusive licensee of all U.S. and foreign patents and patent applications filed by Burroughs Wellcome Co. on the use of emtricitabine to treat hepatitis B. Under settlement agreements, we are obligated to pay royalties to GSK on net sales of products containing emtricitabine. In addition, we and Emory also received access to development and clinical data and drug substance held by GSK relating to emtricitabine.
In May 2002, Emory, GSK and Shire Pharmaceuticals Group, plc (Shire) settled worldwide patent disputes involving lamivudine and emtricitabine. Under the terms of the settlement, Emory received an exclusive license from Shire under Shires patents relating to emtricitabine and methods for its use and manufacture and Shire and GSK received exclusive licenses under Emorys patents relating to lamivudine. Under the terms of our license agreement with Emory, we automatically acquired an exclusive sublicense
to the Shire patents relating to emtricitabine granted under the terms of the settlement, thereby resolving all previously pending patent disputes regarding emtricitabine.
In 1994, we entered into an agreement with the M.D. Anderson Cancer Center relating to Hepsera. Under this agreement, we currently pay M.D. Anderson Cancer Center a percentage of net revenues based upon our sales of Hepsera. The agreement with M.D. Anderson Cancer Center terminates the later of patent expiration or ten years from first commercial sale.
In 1991 and 1992, we entered into agreements with IOCB/REGA relating to Viread, Hepsera and Vistide and subsequently amended the agreements in 2004 to include Truvada. Under these agreements, we received from IOCB/REGA the exclusive right to manufacture, use and sell the nucleotide compounds covered by these agreements. Under the agreements, we pay a percentage of net revenues based upon sales of Viread, Truvada, Hepsera and Vistide to IOCB/REGA. The agreements with IOCB/REGA terminate on an individual country basis on the later of patent expiration or ten years from first commercial sale. In addition, IOCB/REGA may terminate the licenses for a particular product in a key market in the absence of commercial sales of that product within 12 months after regulatory approval.
University License Equity Holdings, Inc.
We have an ongoing collaborative arrangement with University License Equity Holdings, Inc., (ULEHI), the successor to University Technology Corporation and its predecessor University Research Corporation, a technology holding company for the University of Colorado at Boulder, relating to its SELEX technology to identify aptamers. Under this arrangement, ULEHI has granted us all of its present and future rights to inventions covered by patents and patent applications for SELEX technology, improvements to SELEX technology it makes or discovers, oligonucleotides or other molecules it makes using SELEX technology and computer software related to SELEX technology. We are required to pay ULEHI certain variable royalties based on revenues generated from sales of products derived using the SELEX technology, including those revenues based our license agreement with Eyetech relating to Macugen
The Bill & Melinda Gates Foundation & Family Health International
In October 2002, we entered into an agreement with the Bill & Melinda Gates Foundation and Family Health International (FHI) to provide Viread for FHIs multinational clinical trial evaluating Vireads effectiveness as a method of reducing the risk of HIV infection among sexually active adults who are regularly exposed to HIV. The clinical trials, to be conducted by FHI, are funded by a $6.5 million, three-year grant from the Gates Foundation.
In November 2002, we entered into a collaborative agreement with the Medical Research Council (MRC) of the United Kingdom, Boehringer Ingelheim GmBH and GSK in connection with a five-year clinical study conducted by the MRC on antiretroviral HIV therapy in Africa. The trial is called the DART Trial (Development of AntiRetroviral Therapy in Africa) and is aimed at studying clinical versus laboratory monitoring practices and structured treatment interruptions versus continuous antiretroviral therapy in adults with HIV infection in sub-Saharan Africa. We have agreed to provide Viread at no cost for the DART study.
In January 2003, we entered into an agreement with the Institute for One World Health, pursuant to which we will provide AmBisome at our cost for a Phase 3 clinical trial evaluating AmBisome for the treatment of visceral leishmaniasis with paromomycin in India, which has the greatest global burden of visceral leishmaniasis. The clinical trial will be conducted by the Institute for One World Health in partnership with the World Health Organization.
We have various agreements with distributors in Europe, Asia, Latin America, the Middle East and Africa that grant these distributors the exclusive right to sell Viread, Emtriva, Hepsera, AmBisome and DaunoXome in a particular country or countries for a specified period of time. Most of these agreements also provide for collaborative efforts between us and the distributor for obtaining regulatory approval for the product in the particular country and for marketing the product in the country. Most of these agreements establish a price that the distributor must pay for our product and require us to deliver quantities of the product ordered by the distributor.
We manufacture AmBisome in commercial quantities in two separate but adjacent facilities in San Dimas, California. The Medicines Control Agency of the United Kingdom and the FDA have approved the commercial production of AmBisome in the facilities in which it is produced. To import AmBisome into the European Union, we own a manufacturing facility in Dublin, Ireland where we perform quality control testing, final labeling, packaging and distribution for the European Union and elsewhere.
We use commercially available materials and equipment to manufacture these products. Currently, we obtain the amphotericin B and the cholesterol that we use to manufacture AmBisome from single approved suppliers.
AmBisome is sold as a freeze-dried product. We currently freeze-dry AmBisome at our San Dimas manufacturing facility and also use a third party to freeze-dry additional product as needed. Given our current projections for AmBisome demand, we believe we have sufficient capacity to meet future demand. We also have the option of installing additional freeze-drying capacity in San Dimas should such additional supply become necessary. If we were unable to install additional freeze-drying capacity in San Dimas or locate appropriate third parties to meet this need, our ability to meet increased AmBisome demand would be diminished.
We manufacture Macugen in commercial quantities at our FDA approved facilities in San Dimas, California, under our manufacturing agreement with Eyetech. We use commercially available materials and equipment to manufacture this product. Currently, Eyetech provides the raw materials used in the manufacture of Macugen, including pegaptanib sodium, the active ingredient in Macugen, through single approved suppliers contracted by Eyetech.
As part of the manufacturing process, we currently produce and fill Macugen at our San Dimas manufacturing facility. Given Eyetechs current projections for Macugen demand, we believe we have sufficient capacity to meet future demand. We also have the option of installing additional production and filling capacity in San Dimas should such additional supply become necessary. If we were unable to install additional production and filling capacity in San Dimas or locate appropriate third parties to meet this need, our ability to meet increased Macugen demand would be diminished.
Macugen is sold in liquid form and is filled into syringes in our San Dimas facilities. These syringes are supplied by a single approved supplier contracted by Eyetech.
We contract with third parties to manufacture our antiviral drugs for clinical and commercial purposes, including Viread, Emtriva, Truvada, Hepsera and Vistide.
We manufacture tenofovir disoproxil fumarate bulk drug substance through two contract manufacturers. Viread tablets are manufactured through two contract manufacturers.
We manufacture emtricitabine bulk drug substance through two contract manufacturers. Emtriva tablets are manufactured by one contract manufacturer for us and a second contract manufacturer is currently being qualified.
We manufacture Truvada tablets through a single contract manufacturer for the United States and a second contract manufacturer is currently being qualified.
We have obtained qualification in the United States and European Union for two contract manufacturers for adefovir dipivoxil bulk drug substance. We have two contract manufacturers for Hepsera tablet commercial supply in Europe. Of these two contract manufacturers, one is also qualified for commercial supply in the United States and the second is currently being qualified.
We have two suppliers that have been approved by the FDA and the European Union to manufacture cidofovir bulk drug substance, which is used in Vistide. We have a single FDA and EMEA approved supplier for Vistide drug product.
Roche is responsible for the manufacturing of Tamiflu. In January 2002, Roche announced that, due to production problems, the liquid suspension form of Tamiflu approved for treatment of children as young as one year-old was not available; however, the liquid suspension form of Tamiflu was returned to market in time for the 2002-2003 flu season. These production issues did not affect availability of the tablet form of Tamiflu for adults and adolescents 13 years and older. In Japan, where the 2002-2003 flu season was particularly severe, Roches sublicensee, Chugai Corporation, was unable to meet the heightened demand satisfactorily. In January 2003, Chugai issued a press release attributing this failure, in part, to manufacturing problems. In November 2003, Chugai announced a recall of Tamiflu, resulting in reduced net sales and royalties from Roche in 2003. However, royalty income on Tamiflu net sales increased substantially in 2004 due primarily to a severe flu season in the United States in late 2003.
We have no commercial-scale manufacturing facilities for our antiviral products. For our future antiviral products, we will need to develop additional manufacturing capabilities and establish additional third party suppliers to manufacture sufficient quantities of our product candidates to undertake clinical trials and to manufacture sufficient quantities of any products that are approved for commercial sale. If we are unable to develop manufacturing capabilities internally or contract for large scale manufacturing with third parties on acceptable terms for our future antiviral products, our ability to conduct large-scale clinical trials and meet customer demand for commercial products would be adversely affected.
We believe that the technology we use to manufacture our products and compounds is proprietary. For our antiviral products, we have disclosed all necessary aspects of this technology to contract manufacturers to enable them to manufacture the products and compounds for us. We have agreements with these manufacturers that are intended to restrict them from using or revealing this technology, but we cannot be certain that these manufacturers will comply with these restrictions. In addition, these manufacturers could develop their own technology related to the work they perform for us that we may need to manufacture our products or compounds. We could be required to enter into an agreement with that manufacturer if we wanted to use that technology ourselves or allow another manufacturer to use that
technology. The manufacturer could refuse to allow us to use their technology or could demand terms to use their technology that are not acceptable.
We believe that we are in compliance with all material environmental regulations related to the manufacture of our products.
Patents and other proprietary rights are very important to our business. If we have a properly designed and enforceable patent it can be more difficult for our competitors to use our technology to create competitive products and more difficult for our competitors to obtain a patent that prevents us from using technology we create. As part of our business strategy, we actively seek patent protection both in the United States and internationally and file additional patent applications, when appropriate, to cover improvements in our compounds, products and technology. We also rely on trade secrets, internal know-how, technological innovations and agreements with third parties to develop, maintain and protect our competitive position. Our ability to be competitive will depend on the success of this strategy.
We have a number of patents, patent applications and rights to patents related to our compounds, products and technology, but we cannot be certain that issued patents will be enforceable or provide adequate protection or that pending patent applications will result in issued patents. The following table shows the actual or estimated expiration dates in the United States and Europe for the primary patents and for patents that may issue under pending applications that cover the compounds in our marketed products and our product candidates:
Patents covering Viread, Hepsera, Vistide, Emtriva and Truvada are held by third parties. We acquired exclusive rights to these patents in the agreements we have with these parties. See Collaborative Relationships and Academic and Consulting Relationships. Patents do not cover the active ingredients in AmBisome. Instead, we hold patents to the liposomal formulations of this compound and also protect formulations through trade secrets. We do not have patent filings covering all forms of Hepsera in China or in certain other Asian countries, although we do have applications pending in various Asian countries, including China, that relate to specific forms and formulations of Hepsera. Asia is a major market for HBV therapies.
We may obtain patents for our compounds many years before we obtain marketing approval for them. Because patents have a limited life, which may begin to run prior to the commercial sale of the related product, the commercial value of the patent may be limited. However, we may be able to apply for patent term extensions. For example, extensions for the patents on Vistide have been granted in the United States and a number of European countries, compensating in part for delays in obtaining marketing approval. Similar patent term extensions may be available for other products that we are developing, but we cannot be certain we will obtain them.
It is also very important that we do not infringe patents or proprietary rights of others and that we do not violate the agreements that grant proprietary rights to us. If we do infringe patents or violate these agreements, we could be prevented from developing or selling products or from using the processes
covered by those patents or agreements, or we could be required to obtain a license from the third party allowing us to use their technology. We cannot be certain that, if required, we could obtain a license to any third-party technology or that we could obtain one at a reasonable cost. If we were not able to obtain a required license, we could be adversely affected. Because patent applications are confidential for at least some period of time, including sometimes in the United States until a patent issues, there may be pending patent applications from which patents will eventually issue and prevent us from developing or selling certain products unless we can obtain a license to use the patented technology.
Patents relating to pharmaceutical, biopharmaceutical and biotechnology products, compounds and processes such as those that cover our existing compounds, products and processes and those that we will likely file in the future, do not always provide complete or adequate protection. Future litigation or reexamination proceedings regarding the enforcement or validity of our existing patents or any future patents could invalidate our patents or substantially reduce their protection. In addition, our pending patent applications and patent applications filed by our collaborative partners may not result in the issuance of any patents or may result in patents that do not provide adequate protection. As a result, we may not be able to prevent third parties from developing the same compounds and products that we have developed or are developing. In addition, certain countries do not permit enforcement of our patents, and manufacturers are able to sell generic versions of our products in those countries.
We also rely on unpatented trade secrets and improvements, unpatented internal know-how and technological innovation. In particular, a great deal of our liposomal manufacturing expertise, which is a key component of our liposomal technology, is not covered by patents but is instead protected as a trade secret. We protect these rights mainly through confidentiality agreements with our corporate partners, employees, consultants and vendors. These agreements provide that all confidential information developed or made known to an individual during the course of their relationship with us will be kept confidential and will not be used or disclosed to third parties except in specified circumstances. In the case of employees, the agreements provide that all inventions made by the individual while employed by us will be our exclusive property. We cannot be certain that these parties will comply with these confidentiality agreements, that we have adequate remedies for any breach, or that our trade secrets will not otherwise become known or be independently discovered by our competitors. Under some of our research and development agreements, inventions discovered in certain cases become jointly owned by us and our corporate partner and in other cases become the exclusive property of one of us. It can be difficult to determine who owns a particular invention and disputes could arise regarding those inventions.
Our products and development programs target a number of diseases and conditions, including viral and fungal infections. There are many commercially available products for these diseases and a large number of companies and institutions are spending considerable amounts of money and other resources to develop additional products to treat these diseases. Our current products compete with other available products based primarily on:
· acceptance by doctors;
· patient compliance;
· patent protection;
· ease of use;
· insurance and other reimbursement coverage;
· marketing; and
· adaptability to various modes of dosing.
Any other products we market in the future will also compete with products offered by our competitors. If our competitors introduce data that show improved characteristics of their products, improve or increase their marketing efforts or simply lower the price of their products, sales of our products could decrease. We also cannot be certain that any products we may develop in the future will compare favorably to products offered by our competitors or that our existing or future products will compare favorably to any new products that are developed by our competitors. Our ability to be competitive also depends upon our ability to attract and retain qualified personnel, to obtain patent protection or otherwise develop proprietary products or processes and to secure sufficient capital resources for the substantial period that it takes to develop a product.
Our HIV Products. The HIV competitive landscape is becoming more crowded and complicated as treatment trends continue to evolve. A growing number of anti-HIV drugs are currently sold or are in advanced stages of clinical development. Of the twenty-six branded drugs available in the United States, Zerit (stavudine, d4T) sold by Bristol-Myers Squibb (BMS) and the fixed combination products, Combivir (AZT and 3TC), Trizivir (AZT, 3TC, ABC), each sold by GSK, represent the most direct competition for our HIV products. These companies are in the process of launching formulations of existing drugs now indicated by the FDA for once-daily oral dosing, including GSKs 300 mg dose of Epivir (lamivudine, 3TC). Other recently approved antiretroviral products include Epzicom (fixed dose combination of Ziagen and Epivir from GSK approved in the United States and European Union), Fuzeon (injectable integrase inhibitor from Roche/Trimeris), Reyataz (atazanivir sulfate, a once-a-day protease inhibitor from BMS) and Tipranavir (non-peptidic protease inhibitor from Boehringer-Ingelheim). GSK has filed an application for approval of a once-daily dose of Ziagen (abacavir sulfate). Other companies competing in the HIV therapeutic category are Pfizer, Merck and Abbott.
BMSs Videx EC (didanosine) became the first generic HIV product in the United States in 2004. GSKs Retrovir (AZT) is expected to face generic competition as early as in 2005 in the United States. The effect of this on the overall U.S. market for HIV products is unknown, but price decreases for all HIV products may result.
AmBisome. AmBisome faces strong competition from several current and expected competitors. Current competitors include:
· conventional amphotericin B, made by BMS and numerous generic manufacturers;
· caspofungin, a product developed by Merck, which is marketed as Cancidas in the United States and as Caspofungin elsewhere;
· voriconazole, developed by Pfizer, which is marketed as Vfend; and
· other lipid-based amphotericin B products approved for sale in the United States and throughout Europe, including Abelcet, sold by Enzon Corp. in the United States, Canada and Japan and by Medeus Pharma Ltd. in Europe, and Amphotec, sold by InterMune Pharmaceuticals, Inc.
Presently unapproved but expected competitors include a class of treatments called echinocandins, including Fujisawas micafungin, which received marketing approval in Japan in October 2002 and is under review for regulatory approval in the United States and Canada, and anidulafungin, from Vicuron, Inc.
(formerly Versicor, Inc.) product candidate, which is being evaluated in multiple late-stage clinical trials. Finally, Schering Plough is developing Noxafil (posaconazole), which is currently in Phase 3 trials. Competition from these current and expected competitors has eroded and is likely to continue to erode the revenues we receive from sales of AmBisome.
Hepsera. Hepsera faces significant competition from existing and expected therapies for treating patients who are infected with HBV. Most significantly:
· Entecavir, an oral nucleoside analogue developed by BMS, is expected to be launched in late 2005 as a once daily oral antiviral. BMS has filed for approval with the U.S. FDA and has a Prescription Drug User Fee Act (PDUFA) action date of April 2005.
· Epivir-HBV (lamivudine) was developed by GSK in collaboration with Shire Pharmaceuticals, and is sold in all major countries throughout North and South America, Europe and Asia. It is an orally administered nucleoside analogue that inhibits HBV DNA polymerase.
· Intron-A (interferon alfa-2b) is sold by Schering Plough in major countries throughout North and South America, Europe and Asia. Intron-A is an injectable drug with immunomodulatory effects.
Hepsera may also face competition from clinical-stage candidates, including Idenixs LdT, an oral nucleoside analogue currently in Phase 3 trials, as well as Roches Pegasys (pegylated interferon alfa-2a), which is expected to be approved for chronic hepatitis B in the United States in late 2005.
Tamiflu. Tamiflu competes with Relenza, an anti-flu drug that is sold by GSK. Relenza is a neuraminidase inhibitor that is delivered as an orally-inhaled dry powder. Generic competitors include Amantadine, an oral tablet that inhibits the replication of the influenza A virus and Rimantadine, also an oral antiviral.
Vistide. Vistide competes with a number of drugs that also treat CMV retinitis, including ganciclovir, sold in intravenous and oral formulations by Roche and as an ocular implant by Bausch & Lomb Incorporated; valganciclovir, also marketed by Roche; foscarnet, an intravenous drug sold by AstraZeneca; and, formivirsen, a drug injected directly into the eye sold by CibaVision.
A number of companies are pursuing the development of technologies competitive with our research programs. These competing companies include specialized pharmaceutical firms and large pharmaceutical companies acting either independently or together with biopharmaceutical companies. Furthermore, academic institutions, government agencies and other public and private organizations conducting research may seek patent protection and may establish collaborative arrangements for competitive products and programs.
We anticipate that we will face increased competition in the future as our competitors introduce new products to the market and new technologies become available. We cannot determine if existing products or new products that our competitors develop will be more effective or more effectively marketed and sold than any that we develop. Competitive products could render our technology and products obsolete or noncompetitive before we recover the money and resources we used to develop these products.
Our operations and activities are subject to extensive regulation by numerous government authorities in the United States and other countries. In the United States, drugs are subject to rigorous FDA regulation. The Federal Food, Drug and Cosmetic Act and other federal and state statutes and regulations govern the testing, manufacture, safety, effectiveness, labeling, storage, record keeping, approval, advertising and promotion of our products. As a result of these regulations, product development and the product approval process is very expensive and time consuming.
The FDA must approve a drug before it can be sold in the United States. The general process for this approval is as follows:
Before we can test a drug candidate in humans, we must study the drug in laboratory experiments and in animals to generate data to support the drugs potential safety and benefits. We submit this data to the FDA in an investigational new drug application (IND) seeking their approval to test the compound in humans.
If the FDA accepts the investigational new drug application, we study the drug in human clinical trials to determine if the drug is safe and effective. These clinical trials involve three separate phases that often overlap, can take many years and are very expensive. These three phases, which are themselves subject to considerable regulation, are as follows:
· Phase 1. The drug is given to a small number of healthy human subjects or patients to test for safety, dose tolerance, pharmacokinetics, metabolism, distribution and excretion.
· Phase 2. The drug is given to a limited patient population to determine the effect of the drug in treating the disease, the best dose of the drug, and the possible side effects and safety risks of the drug.
· Phase 3. If a compound appears to be effective and safe in Phase 2 clinical trials, Phase 3 clinical trials are commenced to confirm those results. Phase 3 clinical trials are long-term, involve a significantly larger population, are conducted at numerous sites in different geographic regions and are carefully designed to provide reliable and conclusive data regarding the safety and benefits of a drug. It is not uncommon for a drug that appears promising in Phase 2 clinical trials to fail in the more rigorous and reliable Phase 3 clinical trials.
FDA Approval Process
If we believe that the data from the Phase 3 clinical trials show an adequate level of safety and effectiveness, we will file a new drug application (NDA) with the FDA seeking approval to sell the drug for a particular use. The FDA will review the NDA and often will hold a public hearing where an independent advisory committee of expert advisors asks additional questions regarding the drug. This committee makes a recommendation to the FDA that is not binding on the FDA but is generally followed by the FDA. If the FDA agrees that the compound has met the required level of safety and effectiveness for a particular use, it will allow us to sell the drug in the United States for that use. It is not unusual, however, for the FDA to reject an application because it believes that the drug is not safe enough or effective enough or because it does not believe that the data submitted is reliable or conclusive.
At any point in this process, the development of a drug could be stopped for a number of reasons including safety concerns and lack of treatment benefit. We cannot be certain that any clinical trials that we are currently conducting, or any that we conduct in the future, will be completed successfully or within any specified time period. We may choose, or the FDA may require us, to delay or suspend our clinical trials at any time if it appears that the patients are being exposed to an unacceptable health risk or if the drug candidate does not appear to have sufficient treatment benefit.
The FDA may also require us to complete additional testing, provide additional data or information, improve our manufacturing processes, procedures or facilities or may require extensive post-marketing testing and surveillance to monitor the safety or benefits of our product candidates if it determines that our new drug application does not contain adequate evidence of the safety and benefits of the drug. In
addition, even if the FDA approves a drug, it could limit the uses of the drug. The FDA can withdraw approvals if it does not believe that we are complying with regulatory standards or if problems are uncovered or occur after approval.
In addition to obtaining FDA approval for each drug, we obtain FDA approval of the manufacturing facilities for any drug we sell, including those of companies who manufacture our drugs for us as well as our own and these facilities are subject to periodic inspections by the FDA. The FDA must also approve foreign establishments that manufacture products to be sold in the United States and these facilities are subject to periodic regulatory inspection. Manufacturing facilities located in California, including our San Dimas facility and Foster City facility, also must be licensed by the State of California in compliance with local regulatory requirements.
Drugs that treat serious or life-threatening diseases and conditions that are not adequately addressed by existing drugs may be designated as fast track products by the FDA and may be eligible for accelerated six-month review and accelerated approval, as was the case for Viread and Truvada. Drugs receiving accelerated approval must be monitored in post-marketing clinical trials in order to confirm the safety and benefits of the drug.
We are also subject to other federal, state and local regulations regarding workplace safety and protection of the environment. We use hazardous materials, chemicals, viruses and various radioactive compounds in our research and development activities and cannot eliminate the risk of accidental contamination or injury from these materials. Any misuse or accidents involving these materials could lead to significant litigation, fines and penalties.
Drugs are also subject to extensive regulation outside of the United States. In the European Union, there is a centralized approval procedure that authorizes marketing of a product in all countries in the European Union (which includes most major countries in Europe). If this procedure is not used, under a decentralized system, an approval in one country of the European Union can be used to obtain approval in another country of the European Union under a simplified application process. After approval under the centralized procedure, pricing and reimbursement approvals are also required in most countries. Vistide, Viread, Hepsera, Emtriva and in February 2005, Truvada, were approved by the European Union under the centralized procedure. Viread as an HIV drug was reviewed for accelerated approval in the European Union. Hepsera received a traditional review, as did Emtriva. In March 2004, we applied for marketing applications of Truvada for the treatment of HIV in the European Union and we began our European launch of Truvada following regulatory approval received in February 2005.
Pricing and Reimbursement
Insurance companies, health maintenance organizations (HMOs), other third-party payors and federal and state governments seek to limit the amount we can charge for our drugs. For example, in certain foreign markets, pricing negotiations are often required to obtain approval of a product, and in the United States there have been, and we expect that there will continue to be, a number of federal and state proposals to implement drug price control. In addition, managed care organizations are becoming more common in the United States and will continue to seek lower drug prices. The announcement of these proposals or efforts can cause our stock price to decrease, and if these proposals are adopted, our revenues could decrease.
Our ability to sell our drugs also depends on the availability of reimbursement from governments and private insurance companies. Governments and insurance companies often demand rebates or predetermined discounts from list prices. We expect that products we are developing, particularly for HIV/AIDS indications, will be subject to reimbursement issues. We cannot be certain that any of our products that obtain regulatory approval will be reimbursed by governments or insurance companies.
Regulatory approval of prices is required in most foreign countries. Certain countries will condition their approval of a product on the agreement of the seller not to sell that product for more than a certain price in that country and in the past have required price reductions after or in connection with product approval. Certain foreign countries also require that the price of an approved product be reduced after that product has been marketed for a period of time. We cannot be certain that regulatory authorities in the future will not establish lower prices or that any regulatory action reducing the price of our products in any one country will not have the practical effect of requiring us to reduce our prices in other countries. Some European governments, notably Germany and Italy, have implemented, or are considering, legislation that would require pharmaceutical companies to sell their products subject to reimbursement at a mandatory discount. Such mandatory discounts would reduce the revenue we receive from our drug sales. In certain developing countries that are significantly affected by HIV and AIDS, parallel importing and generic competition may occur and adversely affect revenues from sales of or market share of Viread. In addition, governments could take regulatory action to disallow the pricing of combination products such as Truvada to be the sum of the prices of the component drugs being marketed in a particular country.
As of February 28, 2005, we had approximately 1,654 full-time employees. We believe that we have good relations with our employees.
Our website address is www.gilead.com. We make available free of charge through our website, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, our directors and officers Section 16 reports, other required SEC filings and all amendments to these reports as soon as reasonably practicable after filing, by providing a hyperlink to the EDGAR website containing our reports.
In evaluating our business, you should carefully consider the following risks in addition to the other information in this report. Any of the following risks could materially and adversely affect our business, operating results and financial condition.
Substantially all of our revenues are derived from sales of a limited number of products. If we are unable to maintain or continue growing sales of our HIV products or to maintain sales of AmBisome, our results of operations may be adversely affected.
We are currently dependent on sales of our HIV products, especially Viread, and AmBisome, to support our existing operations. Although Viread comprised 86% of HIV product sales in 2004, it is important to consider Viread, Emtriva and Truvada collectively as future sales of these three products are intimately tied to one another. Together sales of HIV products and AmBisome accounted for approximately 90% of our total product revenues for the year ended December 31, 2004. If we are unable to continue growing our HIV product revenues or maintain AmBisome sales, our results of operations are likely to suffer and we may need to scale back our operations. HIV product sales for the year ended December 31, 2004 were $908.4 million, or 69% of our total revenues and AmBisome product sales and royalties for the year ended December 31, 2004 were $224.7 million, or 17% of our total revenues. We may not be able to continue the growth rate of sales of our HIV products or the current sales level of AmBisome for the reasons stated in this risk factor section and, in particular, the following reasons:
· We face significant competition from businesses that have substantially greater resources than we do, such as Merck and Pfizer, which released new products that compete with AmBisome, and GlaxoSmithKline which markets fixed-dose combination products which compete with Truvada. Our competitors have more products and have operated in the fields we compete in for longer than we have. AmBisome sales volumes in 2004 were relatively flat when compared to 2003.
· As our HIV products and AmBisome are used over a longer period of time in many patients and in combination with other products, and additional studies are conducted, new issues with respect to safety, resistance and interactions with other drugs may arise which could cause us to provide additional warnings on our labels, narrow our approved indications or halt sales of a product, each of which could reduce our revenues.
· As a product matures, private insurers and government reimbursers often reduce the amount they will reimburse patients for these products, which increases pressure on us to reduce prices.
· A large part of the market for our HIV products are patients who are already taking other HIV drugs. If we are not successful in encouraging physicians to change patients prescriptions to our HIV products, the sales of our HIV products will be limited.
· As generic HIV products are introduced into the major markets, our ability to maintain pricing may be affected.
If we fail to commercialize new products or expand the indications for existing products, our prospects for future revenues and our stock price may be adversely affected.
If we do not introduce new products or increase revenues from our existing products, we will not be able to grow our revenues. If we fail to increase our sales of our HIV products, we may not be able to increase revenues and expand our research and development efforts. We may not be successful in our efforts in collaboration with Bristol Myers Squibb Company to formulate a once-a-day one pill combination of Truvada and Sustiva. Failure to achieve any of these objectives when expected, or at all, may have a material adverse effect on our business and results of operations.
If significant safety issues arise for our marketed products, our sales may decline, which would adversely affect our results of operations.
The data that support the marketing approvals for our products and that form the basis for the safety warnings in our product labels were obtained in controlled clinical trials of limited duration, and, in some cases, from limited post-approval use. While both components of Truvada (Emtriva and Viread) have been studied individually, safety and efficacy studies of Truvada are still ongoing. Following approval, our products are used over longer periods of time by many patients taking numerous other medicines, many of whom have underlying health problems and would not be monitored for dosing compliance. As drugs are used over longer periods of time by more patients, we have found and expect to continue to find new issues such as safety, resistance or drug interaction issues, which may require us to provide additional warnings on our labels or narrow our approved indications, each of which could reduce the market acceptance of these products. If serious safety, resistance or interaction issues arise with our marketed products, sales of these products could be limited or halted by us or by regulatory authorities.
Our operations depend on compliance with complex FDA and comparable international regulations. Failure to obtain broad approvals on a timely basis or to achieve continued compliance could delay or halt commercialization of our products.
The products that we develop must be approved for marketing and sale by regulatory authorities and, once approved, are subject to extensive regulation by the FDA and comparable regulatory agencies in other countries. We are continuing clinical trials for AmBisome, Viread, Hepsera, Emtriva and Truvada for currently approved and additional uses. We anticipate that we will file for marketing approval in additional countries and for additional products over the next several years. These products may fail to receive marketing approval on a timely basis, or at all.
In addition, our marketed products and how we manufacture and sell these products are subject to extensive continued regulation and review. Discovery of previously unknown problems with our marketed products or problems with our manufacturing or promotional activities may result in restrictions on our
products, including withdrawal of the products from the market. If we fail to comply with applicable regulatory requirements, we could be subject to penalties including fines, suspensions of regulatory approvals, product recalls, seizure of products and criminal prosecution.
Recently, the formation of an independent drug safety office was announced which is tasked with monitoring the safety of approved products. This new office may increase the difficulty and length of time required for new drugs to obtain marketing approval and the office may create more post-approval obligations with which we would be required to comply.
Results of clinical trials are uncertain and may not support continued development of a product pipeline, which would adversely affect our prospects for future revenue growth.
We are required to demonstrate the safety and effectiveness of products we develop in each intended use through extensive preclinical studies and clinical trials. The results from preclinical and early clinical studies do not always accurately predict results in later, large-scale clinical trials. Even successfully completed large-scale clinical trials may not result in marketable products. If any of our products under development fail to achieve their primary endpoint in clinical trials or if safety issues arise, commercialization of that drug candidate could be delayed or halted. In addition, clinical trials involving our commercial products could raise new safety issues for our existing products and reduce our revenues.
Manufacturing problems could delay product shipments and regulatory approvals, which may adversely affect our results of operations.
We depend on third parties to perform manufacturing activities effectively and on a timely basis. If these third parties fail to perform as required, this could impair our ability to deliver our products on a timely basis or cause delays in our clinical trials and applications for regulatory approval, and these events could harm our competitive position. The manufacturing process for pharmaceutical products is highly regulated, and regulators may shut down manufacturing facilities that they believe do not comply with regulations. We and our manufacturers are subject to the FDAs current Good Manufacturing Practices, which are extensive regulations governing manufacturing processes, stability testing, record-keeping and quality standards and similar regulations are in effect in other countries. In addition, our manufacturing operations are subject to routine inspections by regulatory agencies.
For Viread, Hepsera, Vistide, Emtriva and Truvada, we rely on third parties for the manufacture of bulk drug substance and final drug product for clinical and commercial purposes. In addition, Roche is responsible for manufacturing Tamiflu. These third-party manufacturers may develop problems over which we have no control and these problems may adversely affect our business. For example, in January 2002, Roche announced that due to production problems the liquid suspension form of Tamiflu approved for treatment of children as young as one year old was not available. In Japan, where the 2002-2003 flu season was particularly severe, Roches sublicensee, Chugai Corporation, was unable to meet heightened demand satisfactorily. In January 2003, Chugai issued a press release attributing this failure, in part, to manufacturing problems. These problems in Japan reduced the net sales of Tamiflu and our royalty from Roche in 2002 and 2003.
We manufacture AmBisome at our facilities in San Dimas, California. These are our only formulation and manufacturing facilities in the United States. We own a manufacturing facility in Ireland that conducts quality control testing, labeling and packaging. In addition, we use third parties as alternate contract suppliers to fill and freeze dry certain batches of product. In the event of a natural disaster, including an earthquake, equipment failure, strike or other difficulty, we may be unable to replace this manufacturing capacity in a timely manner and would be unable to manufacture AmBisome to meet market needs.
We may not be able to obtain materials necessary to manufacture our products, which could limit our ability to generate revenues.
Many of the materials that we utilize in our operations are made at only one facility. For example, we depend on single suppliers for high quality amphotericin B, distearoylphosphatidylcholine and high quality cholesterol, each of which is used in the manufacture of one or more of our liposomal products. Because the suppliers of key components and materials must be named in the new drug application filed with the FDA for a product, significant delays can occur if the qualification of a new supplier is required. If delivery of material from our suppliers were interrupted for any reason, we may be unable to ship Viread, AmBisome, Hepsera, Emtriva, Truvada or Vistide, or to supply any of our products in development for clinical trials.
We depend on relationships with other companies for sales and marketing performance and revenues. Failure to maintain these relationships would negatively impact our business.
We rely on a number of significant collaborative relationships with major pharmaceutical companies for our sales and marketing performance. These include collaborations with Fujisawa and Sumitomo for AmBisome, GSK for Hepsera, Roche for Tamiflu, Pfizer for Vistide, Japan Tobacco for Viread, Emtriva and Truvada and our recently announced joint venture with Bristol-Myers Squibb to develop and commercialize a fixed-dose combination of Truvada and Sustiva. In certain countries, we rely on international distributors for sales of AmBisome, Viread and Emtriva and in some European countries, we intend to rely only on international distributors for sales of Hepsera. Some of these relationships also involve the clinical development of these products by our partners. Reliance on collaborative relationships poses a number of risks, including:
· we are not able to control whether our corporate partners devote sufficient resources to our programs or products;
· disputes may arise in the future with respect to the ownership of rights to technology developed with corporate partners;
· disagreements with corporate partners could lead to delays, in or termination of, the research, development or commercialization of product candidates, or result in litigation or arbitration;
· contracts with our corporate partners may fail to provide significant protection or may fail to be effectively enforced if one of these partners fails to perform;
· corporate partners have considerable discretion in electing whether to pursue the development of any additional products and may pursue alternative technologies or products either on their own or in collaboration with our competitors;
· corporate partners with marketing rights may choose to devote fewer resources to the marketing of our products than they do to products of their own development; and
· our distributors and corporate partners may be unable to pay us.
Given these risks, there is a great deal of uncertainty regarding the success of our current and future collaborative efforts. If these efforts fail, our product development or commercialization of new products could be delayed or revenue from existing products could decline.
Under our April 2002 licensing agreement with GSK, we gave GSK the right to control clinical and regulatory development and commercialization of Hepsera in territories in Asia, Africa and Latin America. These include major markets for Hepsera, such as China, Japan, Taiwan and Korea. The success of Hepsera in these territories will depend almost entirely on the efforts of GSK. In this regard, GSK promotes EpivirHBV, a product that competes with Hepsera. Consequently, GSKs marketing strategy for Hepsera may be influenced by its promotion of EpivirHBV. We receive royalties from GSK equal to
a percentage of GSKs net sales of Hepsera as well as net sales of GSKs EpivirHBV. If GSK fails to devote sufficient resources to, or does not succeed in developing or commercializing Hepsera in its territories, our potential revenues from sales of Hepsera may be substantially reduced.
Expenses associated with clinical trials and sales fluctuations as a result of inventory levels held by wholesalers may cause our earnings to fluctuate, which could adversely affect our stock price.
The clinical trials required for regulatory approval of our products, as well as clinical trials we are required to conduct after approval, are extremely expensive. It is difficult to accurately predict or control the amount or timing of these expenses. Uneven and unexpected spending on these programs may cause our operating results to fluctuate from quarter to quarter. In addition, approximately 81% of our product sales in the United States are to three distributors, AmerisourceBergen Corp., Cardinal Health, Inc. and McKesson Corp. Inventory levels held by these and other wholesalers may fluctuate significantly which could cause our sales to them and as a result, our operating results, to fluctuate unexpectedly from quarter to quarter. For example, based on our review of NDC Health Corp. prescription trends, IMS Health Inc. inventory data and actual Viread sales, we believe that in the quarter ended June 30, 2003, wholesalers built up inventory levels by an estimated 1.2 months. We believe this inventory build-up was followed by an equivalent or possibly greater inventory reduction during the quarter ended September 30, 2003. We do not know if the inventory management agreements we entered into this year with our three major U.S. wholesalers will continue to be effective in matching inventory levels to end user demand, as we rely on the wholesalers to estimate end user demand.
Approximately half of our product sales occur outside the United States, and currency fluctuations may cause our earnings to fluctuate, which could adversely affect our stock price.
A significant percentage of our product sales are denominated in foreign currencies. Increases in the value of the U.S. dollar against these foreign currencies in the past have reduced, and in the future may reduce, our U.S. dollar equivalent sales and negatively impact our financial condition and results of operations. We use foreign currency forward contracts to hedge a percentage of our forecasted international sales, primarily those denominated in the Euro currency. We also hedge a portion of our accounts receivable balances denominated in foreign currencies, which reduces but does not eliminate our exposure to currency fluctuations between the date a sale is recorded and the date that cash is collected. Additionally, to mitigate the impact of currency rate fluctuations on our cash outflows for certain foreign currency-denominated raw materials purchases, we enter into foreign exchange forward contracts to hedge our foreign currency-denominated accounts payable. Although we use forward contracts to reduce the impact of foreign currency fluctuations on our future results, these efforts may not be successful and any such fluctuations could adversely affect our results of operations.
We face credit risks from our European customers that may adversely affect our results of operations.
We are particularly subject to credit risk from our European customers. Our European product sales to government owned or supported customers in Greece, Italy, Portugal and Spain are subject to significant payment delays due to government funding and reimbursement practices. Our accounts receivable from government owned or supported customers in these countries totaled $231.9 million as of December 31, 2004. If significant changes were to occur in the reimbursement practices of European governments or if government funding becomes unavailable, we may not be able to collect on amounts due to us from these customers and our results of operations would be adversely affected.
Our plan to supply Viread and Truvada at our cost to certain developing countries may expose us to liability that would have a material adverse affect on our results of operations and financial condition.
We have launched a distribution program pursuant to which we will supply Viread and Truvada at our cost to all countries in Africa and to the fifteen other countries designated Least Developed by the United Nations. The supply and distribution of drugs in a resource-poor environment is a complicated
undertaking. As this program develops, we could face unforeseen challenges and risks, which could give rise to unforeseen liabilities. For example, patients in less developed countries using Viread and Truvada may not be as closely supervised by a doctor as they would be in more developed nations. Accordingly, there may be an increased likelihood of Viread- or Truvada-related complications going undetected or untreated, which could result in significant liability to Gilead.
Our product revenues could be reduced by imports from countries where our products are available at lower prices.
Prices for our products are based on local market economics and competition and sometimes differ from country to country. Our sales in countries with relatively higher prices may be reduced if products can be imported into those countries from lower price markets. There have been cases in which pharmaceutical products were sold at steeply discounted prices in the developing world and then re-exported to European countries where they could be re-sold at much higher prices. If this happens with our products, particularly Viread and Truvada, which we have agreed to provide at our cost to all countries in Africa and to the fifteen other countries designated Least Developed Countries by the United Nations, our revenues would be adversely affected.
In addition, in the European Union, we are required to permit cross border sales. This allows buyers in countries where government-approved prices for our products are relatively high to purchase our products legally from countries where they must be sold at lower prices. Additionally, some U.S. consumers have been able to purchase products, including HIV medicines, from Internet pharmacies in other countries at substantial discounts. Such cross-border sales could adversely affect our revenues.
In some countries, we may be required to grant compulsory licenses for our HIV products or face generic competition for our HIV products.
In a number of developing countries, government officials and other groups have suggested that pharmaceutical companies should make drugs for HIV infection available at a low cost. Alternatively, governments in those countries could require that we grant compulsory licenses to allow competitors to manufacture and sell their own versions of our products, thereby reducing our sales. Certain countries do not permit enforcement of our patents, and manufacturers are able to sell generic versions of our products in those countries. Compulsory licenses or sales of generic versions of our products could significantly reduce our sales and adversely affect our results of operations.
Our existing products are subject to reimbursement from government agencies and other third parties. Pharmaceutical pricing and reimbursement pressures may reduce profitability.
Successful commercialization of our products depends, in part, on the availability of governmental and third party payor reimbursement for the cost of such products and related treatments. Government health administration authorities, private health insurers and other organizations generally provide reimbursement. Government authorities and third-party payors increasingly are challenging the price of medical products and services, particularly for innovative new products and therapies. This has resulted in lower average sales prices. For example, a majority of our sales of AmBisome and Vistide, and a significant percentage of our sales of Viread and Hepsera, are subject to reimbursement by government agencies, resulting in significant discounts from list price and rebate obligations. Our business may be adversely affected by an increase in U.S. or international pricing pressures. These pressures can arise from rules and practices of managed care groups, judicial decisions and governmental laws and regulations related to Medicare, Medicaid and health care reform, pharmaceutical reimbursement policies and pricing in general.
In Europe, the success of Hepsera, Tamiflu, Emtriva, Viread and Truvada will also depend largely on obtaining and maintaining government reimbursement because in many European countries, including the United Kingdom and France, patients will not use prescription drugs that are not reimbursed by their
governments. In addition, negotiating prices with governmental authorities can delay commercialization by twelve months or more. We also expect that the success of our products in development, particularly in Europe, will depend on the ability to obtain reimbursement. Even if reimbursement is available, reimbursement policies may adversely affect our ability to sell our products on a profitable basis. For example, in Europe as in many international markets, governments control the prices of prescription pharmaceuticals and expect prices of prescription pharmaceuticals to decline over the life of the product or as volumes increase. In 2004, as well as in previous years, we have seen significant price decreases for our products across much of Europe. We believe that this will continue into the foreseeable future as governments struggle with escalating health care spending. As a result of these pricing practices, it may become difficult to maintain our historic levels of profitability or to achieve expected rates of growth.
Our results of operations could be adversely affected by future health care reforms.
In the United States in recent years, new legislation has been proposed at the federal and state levels that would effect major changes in the health care system, either nationally or at the state level. These proposals have included prescription drug benefit proposals for Medicare beneficiaries recently passed by Congress. Additionally, some states have enacted health care reform legislation. Further federal and state developments are possible. The impact of proposed legislation and other reforms is unclear, but it may result in pricing and reimbursement restrictions, which could adversely impact our revenues.
We may not be able to obtain effective patents to protect our technologies from use by competitors and patents of other companies could require us to stop using or pay for the use of required technology.
Our success will depend to a significant degree on our ability to:
· obtain patents and licenses to patent rights;
· preserve trade secrets; and
· operate without infringing on the proprietary rights of others.
We have a number of U.S. and foreign patents, patent applications and rights to patents related to our compounds, products and technology. There is a risk, however, that issued patents will not be enforceable or provide adequate protection or that pending patent applications will not result in issued patents. Patent applications are confidential for at least some period of time, sometimes in the United States until a patent issues. As a result, we may not know if our competitors filed patent applications for technology covered by our pending applications or if we were the first to invent the technology that is the subject of our patent applications. Competitors may have filed patent applications or received patents and may obtain additional patents and proprietary rights that block or compete with our patents.
We do not have patent filings in China or certain other Asian countries covering all forms of adefovir dipivoxil, the active ingredient in Hepsera. Asia is a major market for therapies for HBV, the indication for which Hepsera has been developed. We may obtain patents for certain products many years before marketing approval is obtained for those products.
Because patents have a limited life, which may begin to run prior to the commercial sale of the related product, the commercial value of the patent may be limited. However, we may be able to apply for patent term extensions. In addition, patents may not provide adequate protection in certain countries in Africa and Asia, including China.
Our competitors may file patent applications covering our technology. If so, we may have to participate in interference proceedings or litigation to determine the right to a patent. Litigation and interference proceedings are expensive even if we are ultimately successful.
As part of the approval process of some of our products, the FDA has determined that the products would be granted an exclusivity period during which other manufacturers applications for approval of
generic versions of our product will not be granted. Generic manufactures often wait to challenge the patents protecting products that have been granted exclusivity until one year prior to the end of the exclusivity period. As we near the end of exclusivity periods granted to our products, our patents may be subject to challenges for which we may need to spend significant resources to defend and we may not be able to defend our patents successfully.
Our success depends in large part on our ability to operate without infringing upon the patents or other proprietary rights of third parties. If we infringe the patents of others, we may be prevented from commercializing products or may be required to obtain licenses from these third parties. We may not be able to obtain alternative technologies or any required license on reasonable terms or at all. If we fail to obtain such licenses or alternative technologies, we may be unable to develop or commercialize some or all of our products.
In addition, we use significant proprietary technology and rely on unpatented trade secrets and proprietary know-how to protect certain aspects of our production and other technologies. Our trade secrets may become known or independently discovered by our competitors.
We may face significant liability resulting from our products that may not be covered by insurance and successful claims could materially reduce our earnings.
The testing, manufacturing, marketing and use of our commercial products, as well as products in development, involve substantial risk of product liability claims. These claims may be made directly by consumers, healthcare providers, pharmaceutical companies or others. Although we maintain product liability insurance, a successful product liability claim against us may not be covered by our insurance or could require us to pay amounts beyond that provided by our insurance, either of which could impair our financial condition and our ability to clinically test and to market our products.
Expensive litigation may reduce our earnings.
We are named as a defendant in a number of lawsuits regarding use of average wholesale price and reimbursement rates under Medicaid. We have also been named in lawsuits alleging violations of the federal securities laws. Adverse results from these lawsuits could result in material damages which could significantly reduce our earnings or cash flows.
Changes in our effective income tax rate could reduce our earnings.
Various factors may have favorable or unfavorable effects on our effective income tax rate. These factors include, but are not limited to, interpretations of existing tax laws, changes in tax laws and rates, future levels of research and development spending, changes in accounting rules, future levels of capital expenditures, changes in the mix of earnings in the various tax jurisdictions in which we operate and changes in overall levels of pre-tax earnings. The impact on our income tax provision resulting from the above-mentioned factors may be significant and could have a negative impact on our results of operations.
Recently adopted changes in accounting for stock options may affect our earnings.
The Financial Accounting Standards Board (FASB) recently issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (SFAS 123R), which is required to be implemented by the third quarter of 2005, provides new guidance on the accounting for stock options. Under the new accounting guidance, we will be required to record additional compensation expense related to stock options and other equity incentives. Although we are currently evaluating various option valuation methodologies including the Black-Scholes method, binomial method or other methods allowed under FAS 123R, the impact on our earnings resulting from this new standard will be significant and may have a negative impact on our results of operations.
Our corporate headquarters, including our principal executive offices and some of our research facilities, are located in Foster City, California. At this location, we own approximately 496,000 square feet of space in 16 proximately located buildings. We currently occupy 10 of the 16 buildings and also have a tenant occupying some of the remaining buildings. In addition, we lease two office buildings with approximately 141,000 square feet of space to house commercial and clinical development activities. The leases for the two buildings expire in June 2009 and 2010, respectively, after which Gilead has the option to renew for two five-year terms. In addition, from June 2004 to May 2007, Gilead has the option to purchase the two buildings at specified amounts.
We also occupy facilities in San Dimas, California. At this location, we lease approximately 102,500 square feet of space, which houses research and development activities, manufacturing and certain administrative functions. These leases expire in November 2013, with no renewal options at present. In addition, we lease an adjacent warehouse facility with about 53,000 square feet of space that we use for product distribution and administrative functions. This lease expires in November 2013, with no renewal options.
In Durham, North Carolina, we lease approximately 101,000 square feet of administrative office and laboratory space, of which we sublease approximately 21,000 square feet to third parties. This lease expires in October 2009, after which Gilead has the option to renew the lease for two seven-year terms.
In addition, we lease approximately 141,000 square feet of space (in the aggregate) for our sales and marketing, regulatory, finance, information technology and human resource operations in Europe and Australia, including a prepaid, 999-year lease for our 13,000 square foot manufacturing and distribution facility in Ireland. The other leases have various expiration dates.
We believe that our facilities are adequate and suitable for at least our current and near-term future needs.
The complaints in each of the following cases allege that a large number of defendants, including Gilead, overcharged the governmental entity named as the plaintiff for pharmaceutical products furnished to participants in the Medicaid program. In general, the complaints assert claims under federal and state law, except for the Alabama state action, which includes only state law claims, and seek treble damage and attorneys fees. The litigations are all at a preliminary stage and it is not possible to predict the outcome. Indeed, to date Gilead has not been served with process in any of these cases except County of Westchester v. Abbott Laboratories, et al. We intend to defend these cases vigorously. As the outcome of these cases cannot be predicted at this time, no amounts have been accrued.
(1) County of Westchester v. Abbott Laboratories, et al., now pending as part of multi-district litigation in the United States District Court for the District of Massachusetts. This lawsuit was filed against Gilead and approximately 40 other defendants on August 14, 2003. It was amended to include approximately 80 defendants on January 26, 2005.
(2) City of New York v. Abbott Laboratories et al., pending as part of multi-district litigation in the United States District Court for the District of Massachusetts. This lawsuit was filed against Gilead and approximately 43 other defendants on August 4, 2004. It was amended to approximately 73 defendants on January 26, 2005.
(3) County of Rockland v. Abbott Laboratories, et al., pending as part of multi-district litigation in the United States District Court for the District of Massachusetts. This lawsuit did not originally name
Gilead as a defendant, but was amended to include claims against Gilead as well as approximately 77 other defendants on January 26, 2005.
(4) State of Alabama v. Abbott Laboratories et al., pending in the Circuit Court of Montgomery County, Alabama. This lawsuit was filed against Gilead and approximately 77 other defendants on January 26, 2005.
A purported class action complaint was filed on November 10, 2003 in the United States District Court for the Northern District of California against Gilead and certain of our executive officers. The complaint alleges that the defendants violated federal securities laws, specifically Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 of the Securities and Exchange Commission, by making certain allegedly false and misleading statements and omissions. The plaintiff seeks unspecified damages on behalf of a purported class of purchasers of Gileads securities during the period from July 14, 2003 through October 28, 2003. Other similar actions were subsequently filed and the court issued an order consolidating the lawsuits into a single action on December 22, 2003. On February 9, 2004, the court issued an order appointing lead plaintiffs in the consolidated action. On April 30, 2004, lead plaintiffs, on behalf of the purported class, filed their consolidated amended complaint. On June 21, 2004, Gilead and individual defendants filed their motion to dismiss the consolidated amended complaint. On January 25, 2005, the Court granted defendants motion to dismiss with leave to amend.
In December 2003, two purported shareholder derivative lawsuits were filed by individual shareholders on behalf of Gilead against its directors and certain executive officers in the Superior Court of the State of California, County of San Mateo alleging, among other things, that defendants violated the California Corporations Code and breached fiduciary duties to Gilead. Gilead is named as a nominal defendant. The plaintiffs seek unspecified damages on behalf of Gilead in connection with alleged insider trading during the period between July 14, 2003 and October 28, 2003 and defendants alleged breach of their fiduciary duties, abuse of control, waste and mismanagement. The two cases were consolidated into a single action on January 15, 2004. A third, similar case was filed on February 4, 2004 and later consolidated with the prior two cases. Plaintiffs have filed a consolidated complaint, which was amended two times, most recently on November 22, 2004. Gilead demurred to each consolidated complaint, and the court granted each demurrer. On December 14, 2004, plaintiffs filed a motion for leave to file a third consolidated amended complaint and on January 7, 2005, the Court granted the plaintiffs motion, rendering that complaint the operative complaint. We intend to demur to this complaint. A trial is scheduled for June 13, 2005.
We are also a party to various other legal actions that arose in the ordinary course of our business. We do not believe that any of these other legal actions will have a material adverse impact on our business, results of operations or financial position.
No matters were submitted to a vote of securities holders during the quarter ended December 31, 2004.
ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is traded on The Nasdaq Stock Market under the symbol GILD. The following table sets forth for the periods indicated the high and low intra-day sale prices per share of our common stock on The Nasdaq Stock Market. These prices represent quotations among dealers without adjustments for retail mark-ups, markdowns or commissions, and may not represent prices of actual transactions.
On September 3, 2004, we implemented a two-for-one stock split in the form of stock dividends. All share and per share amounts for all periods presented have been restated to reflect this stock split.
As of February 28, 2005, we had 449,881,860 shares of common stock outstanding held by approximately 477 stockholders of record. We have not paid cash dividends on our common stock since our inception and we do not anticipate paying any in the foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
GILEAD SCIENCES, INC.
GILEAD SCIENCES, INC.
(1) During 2004, Gilead recorded a gain of $20.6 million related to our warrants in Eyetech which completed its initial public offering. Also in 2004, we recorded a make-whole payment of $7.4 million related to the redemption of our $345.0 million 2% convertible senior debt. During 2003, Gilead completed the acquisition of all of the net assets of Triangle for an aggregate purchase price of $525.2 million. Approximately $488.6 million of the purchase price was allocated to purchased in-process research and development. Also during 2003, we recorded an income tax benefit of $111.6 million related to the reduction of the valuation allowance on certain of our net deferred tax assets. During 2002, we sold all of our shares of OSI common stock and recognized a loss on the sale of marketable securities of $16.0 million. These shares were partial consideration for the sale of our oncology assets in 2001. During 2001, we completed the sale of our oncology assets and related technology to OSI Pharmaceuticals, Inc. and recorded a non-operating gain of $157.8 million. In 2001, we also recorded a non-operating gain of $8.8 million from the sale of our 49 percent interest in Proligo.
(2) Gilead adopted Statement of Financial Accounting Standards Nos. 133 and 138, collectively referred to as SFAS 133, Accounting for Derivative Instruments and Hedging Activities, in the first quarter of 2001. The change was accounted for as a change in accounting principle. Effective in the first quarter of 2000, Gilead adopted the SECs Staff Accounting Bulletin No. 101 (SAB 101), Revenue Recognition in Financial Statements, and the change was also accounted for as a change in accounting principle.
(3) On February 22, 2001, March 8, 2002 and September 3, 2004, Gilead implemented two-for-one stock splits in the form of a stock dividend. All share and per share amounts for all periods presented have been restated to reflect these stock splits.
(4) No cash dividends have been declared or paid on our common stock.
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Our operating results for 2004 marked another year of growth with total revenues reaching $1.32 billion and higher ending cash, cash equivalents and marketable securities of $1.25 billion, driven in large part by operating cash flows of $511.4 million for the year. Although several factors contributed to our improved financial performance over 2003, two important drivers were the continued growth experienced by our HIV products portfolio (which is comprised of Viread, Emtriva and Truvada), as well as the maintenance of AmBisome revenues amidst increasing competition. Given increased international sales and a favorable foreign currency environment in Europe, Viread sales increased 38% year over year and comprised 63% of 2004 total product sales. In August 2004, we launched Truvada, which is the co-formulation of Viread and Emtriva, in the United States. We began launching Truvada in the European Union following regulatory approval in February 2005. Over time, depending on the treatment regimens prescribed by physicians, we expect to see Truvada sales partially replace product sales of Viread and Emtriva. To further increase our future sales of HIV products, we entered into a joint venture collaboration agreement with BMS in December 2004 to develop and commercialize the fixed-dose combination of Gileads Truvada and BMS Sustiva in the United States. Understanding the importance of having a clear view of our wholesalers channel inventory, we signed inventory management agreements with our three major U.S. wholesalers in 2004. In keeping with our strategy of active product acquisition and in-licensing, we rounded out 2004 by entering into collaboration agreements in the area of HCV.
Our operating results for 2003 were impacted by the acquisition of all of the assets of Triangle in January 2003. We completed this acquisition to expand our antiviral pipeline. Triangle was a development stage company with a particular focus on potential therapies for HIV, including AIDS, and HBV. The aggregate purchase price was $525.2 million and included cash paid of $463.1 million, the fair value of stock options assumed of $41.3 million, direct transaction costs of $14.2 million and employee related costs of $6.6 million. Approximately $488.6 million of the consideration paid was allocated to purchased in-process research and development and represented the fair value of Triangles incomplete research and development programs that had not yet reached technological feasibility and had no alternative future use as of the acquisition date. As a result of this transaction and the related purchased in-process research and development charge, our operating loss for 2003 was $158.7 million. This acquisition was important to us not only for the compounds we acquired, but also for the opportunity it provided us to create Truvada, our co-formulation of Viread and Emtriva, into a single pill that can be dosed once a day. See Note 3 to the consolidated financial statements for further information on the Triangle acquisition.
On September 3, 2004, Gilead completed a two-for-one stock split, effected in the form of a stock dividend, to stockholders of record as of August 12, 2004. Accordingly, all share and per share amounts for all periods presented have been restated to reflect this stock split. In addition, certain prior year amounts have also been reclassified to conform to the current year presentation.
Managements discussion and analysis should be read in conjunction with the consolidated financial statements and notes included elsewhere in this report.
The following discussion contains forward-looking statements that involve risks and uncertainties. The Risk Factors discussion should be read in conjunction with the consolidated financial statements and notes included elsewhere in this report.
This discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, allowance for doubtful accounts, inventories, clinical trial accruals and our tax provision. We base our estimates on historical experience and on various other market-specific assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results, however, may differ significantly from these estimates.
We believe the following critical accounting policies reflect the more significant judgments and estimates used in the preparation of our consolidated financial statements:
We recognize revenue from product sales when there is persuasive evidence an arrangement exists, delivery to the customer has occurred, the price is fixed or determinable and collectibility is reasonably assured. We record estimated reductions to revenue for expected returns of expired products, distributor fees, government rebate programs, such as Medicaid reimbursements and customer incentives, such as cash discounts for prompt payment. Estimates for distributor fees are based on contractually determined fixed percentages of sales. Estimates for government rebate programs and cash discounts are based on contractual terms, historical utilization rates and expectations regarding future utilization rates for these programs. Estimates for product returns, including new products, are based on an on-going analysis of industry and historical return patterns. This includes monitoring the feedback that we receive from our sales force regarding customer use and satisfaction, reviewing inventory data available to us through our U.S. wholesaler inventory management agreements to assist us in monitoring channel inventory levels, the purchase of third-party data to monitor prescriptions as well as, for new products, a review of our other long shelf life products we have sold through the same or similar channels. Further, we monitor the activities and clinical trials of our key competitors and assess the potential impact on our future sales and return expectations where necessary. Expected returns for our marketed drugs are generally low because the shelf life for these products ranges from 24 months for Truvada and up to 36 months for AmBisome and Viread in the United States. If conditions become more competitive for any of the markets served by our drugs or if other circumstances change, we may take actions to increase our product return estimates or we may offer additional customer incentives. This would result in an incremental reduction of future revenue at the time the return estimate is changed or new incentives are offered.
Contract revenue for research and development is recorded as performance occurs and the earnings process is completed based on the performance requirements of the contract. Nonrefundable contract fees for which no further performance obligations exist, and where there is no continuing involvement by Gilead, are recognized on the earlier of when the payments are received or when collection is reasonably assured.
Revenue from non-refundable up-front license fees and milestone payments where we continue to have involvement such as through a development collaboration or an obligation to supply product is recognized as performance occurs and our obligations are completed. In accordance with the specific terms of Gileads obligations under these types of arrangements, revenue is recognized as the manufacturing obligation is fulfilled or ratably over the development period. Revenue associated with substantive at-risk milestones is recognized based upon the achievement of the milestones as defined in the
respective agreements. Advance payments received in excess of amounts earned are classified as deferred revenue.
Allowance for Doubtful Accounts
We also maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. This allowance is based on our analysis of several factors including, but not limited to, contractual payment terms, historical payment patterns of our customers and individual customer circumstances, an analysis of days sales outstanding by customer and geographic region, and a review of the local economic environment and its potential impact on government funding and reimbursement practices. If the financial condition of our customers or the economic environment in which they operate were to deteriorate, resulting in an inability to make payments, additional allowances may be required. Our allowance for doubtful accounts balance as a percentage of total accounts receivable did not materially change from December 31, 2003 to December 31, 2004. We believe that the allowance for doubtful accounts is adequate to cover anticipated losses under current conditions; however, significant deterioration in any of the above factors, especially with respect to the government funding and reimbursement practices in the European market could materially change these expectations and result in an increase to our allowance for doubtful accounts.
We write down our inventory based on historical review of the quantity of bad batches experienced during the manufacturing process and expectations of production and inventory levels. We also perform quality control reviews of our individual raw material batches. We generally do not record inventory write-offs based on estimated obsolescence or risk of competition primarily because the shelf life of our products is long. However, if our current assumptions about future production or inventory levels, demand or competition were to change or if actual market conditions are less favorable than those projected by management, inventory write-downs may be required which could negatively impact our product gross margins and results of operations.
Clinical Trial Accruals
We record accruals for estimated clinical and preclinical study costs. Most of our clinical and preclinical studies are performed by third party contract research organizations (CROs). These costs are a significant component of research and development expenses. During 2004, 2003 and 2002, we incurred $24.7 million, $15.0 million and $23.9 million, respectively, of CRO costs. We accrue costs for clinical studies performed by CROs on a straight-line basis over the term of the service period and adjust our estimates, if required, based upon our on-going review of the level of effort actually incurred by the CRO. Initially we estimate that the work performed under the contracts occurs ratably over the periods to the expected milestone, event or total contract completion date. The expected completion dates are estimated based upon the terms of the contracts and past experience with similar contracts. These estimates may or may not match the actual services performed by the organizations as determined by patient enrollment levels and other measures of activities specified in the contract. As a result, we validate our accruals quarterly through written vendor confirmations and detailed reviews of the activities performed for our significant contracts. Based upon the results of these validation processes, we assess the appropriateness of our accruals and make any adjustments we deem necessary to ensure that our expenses reflect the actual effort incurred by the CROs. Generally, a significant portion of the total costs are associated with start up activities for the trial and patient enrollment. Gilead extensively outsources its clinical trial activities and usually performs only a small portion of the start-up activities in-house. As a result, CROs typically perform most of the total start-up activities for our trials, including document preparation, site identification, screening and preparation, pre-study visits, training and program management. On a
budgeted basis, these costs are typically 20% to 30% of the total contract value. On an actual basis, this percentage range is significantly wider as many of our contracts are either expanded or reduced in scope compared to the original budget while the start-up costs for the particular trial do not change significantly. Start-up costs usually occur within a few months after the contract has been established and are milestone or event driven in nature. The remaining activities and related costs, such as patient monitoring and administration, generally occur ratably throughout the life of the individual contract or study. Most contracts are negotiated as fixed unit prices and can vary in length between six months for a single dose Phase 1 study and up to two years or more for a more complex Phase 3 study. The average length of contract in 2004, 2003 and 2002 has been at the upper end of this range in order to provide long term safety and efficacy data to support the commercial launches of Viread, Truvada, Hepsera and Emtriva. Through December 31, 2004, differences between actual and estimated activity levels for any particular study were not significant enough to require a material adjustment. All of our material CRO contracts are terminable by us upon written notice and Gilead is generally only liable for actual effort expended by the CRO at any point in time during the contract, regardless of payment status. Amounts paid in advance of services being performed will be refunded if a contract is terminated. However, if management does not receive complete and accurate information from our vendors or has underestimated activity levels associated with a study at a given point in time, we would have to record additional and potentially significant research and development expenses in future periods.
We develop our income tax provision including deferred tax assets and liabilities, based on significant management judgment. We evaluate the realizibility of our deferred tax assets on a quarterly basis. We record a valuation allowance to reduce our deferred tax assets to the amounts that are likely to be realized. We consider future taxable income, ongoing tax planning strategies and our historical financial performance in assessing the need for a valuation allowance. If we expect to realize deferred tax assets for which we have previously recorded a valuation allowance, we would reduce the valuation allowance in the period in which such determination is first made. Such an adjustment was made in the fourth quarter of 2003 and 2004 when we determined that it was more likely than not that certain of our deferred tax assets would be realized, and therefore, we released the related valuation allowance. This resulted in an income tax benefit for 2003 and 2004 of approximately $111.6 million and $14.2 million, respectively. Similarly, if we determine that we would not be able to realize all or part of our deferred tax assets for which we have no valuation allowance, we would increase the valuation allowance in the period in which such determination is first made. Our future effective income tax rate may be affected by such factors as changes in tax laws or rates, changes in the interpretation of these laws, the impact of accounting for employee stock options beginning in the second half of 2005, and overall changes in future levels of earnings and research and development and capital spending.
Management has discussed the development and selection of these critical accounting policies with the Audit Committee of Gileads Board of Directors and the Audit Committee has reviewed the disclosure presented above relating to them.
We had total revenue of $1.32 billion in 2004, $867.9 million in 2003 and $466.8 million in 2002. Included in total revenue are product sales, royalty revenue and contract revenue includes revenue earned from research and development (R&D) and manufacturing collaborations.
Product sales consisted of the following (in thousands):
Product sales increased 49% in 2004 compared to 2003 and 97% in 2003 compared to 2002, due primarily to the increase in the volume of sales within our HIV products. A significant percentage of our product sales continue to be denominated in foreign currencies. We use forward contracts to hedge a percentage of our forecasted international sales, primarily those denominated in the Euro. This reduces, but does not eliminate, fluctuations in sales due to changes in foreign currency exchange rates. Losses on these revenue hedges reduced increases in product sales by $2.5 million in 2004, $2.8 million in 2003 and $1.0 million in 2002, due to fluctuations in exchange rates. However, product sales (mainly Viread and AmBisome) benefitted overall, primarily from the increases in the exchange rates for the Euro and the British Pound in comparison with the U.S. dollar: $43.7 million when comparing 2004 to 2003 and $43.6 million when comparing 2003 to 2002.
Prior to 2004, we experienced significant fluctuations in U.S. distribution channel inventory levels due to speculative purchasing by the major wholesalers. As a result, we experienced increased quarter over quarter sales volatility from these purchasing patterns. In order to help alleviate these fluctuations, in July 2004, we entered into inventory management agreements (IMAs) with AmerisourceBergen Drug Corporation, Cardinal Health, Inc. and McKesson Corporation, three major pharmaceutical wholesalers that distribute more than 90 percent of the portfolio of products that we sell in the United States. These agreements were implemented to limit speculative buying and to help ensure that wholesaler purchasing is more consistent with customer demand and more predictable. Under these agreements, we agreed to pay the wholesalers a fee in exchange for product distribution and inventory management services, market research information, return goods processing assistance and counterfeit product detection services. Such fees are recorded as a reduction to product sales in the consolidated statements of operations. Additionally, under the terms of the agreements, each wholesaler has agreed not to exceed specified maximum levels of inventory on hand. As of the end of December 2004, we believe that these three major wholesalers have inventories on-hand for all Gilead products of less than one months supply, which is in compliance with the contractually specified levels.
Viread, Emtriva and Truvada were approved for sale in the United States in October 2001, July 2003 and August 2004, respectively. Viread and Emtriva were approved for sale in the European Union in February 2002 and October 2003, respectively. Sales of Viread were 63%, 68% and 53% of total product sales in 2004, 2003 and 2002, respectively. Of the Viread sales in 2004, $437.5 million were U.S. sales, an increase of 23% versus 2003, and $345.4 million were international sales, an increase of 64% versus 2003. Of the Viread sales in 2003, $355.9 million were U.S. sales, an increase of 113% versus 2002, and $210.6 million were international sales, an increase of 258% versus 2002. Since Emtrivas introduction in July 2003, sales increased significantly from $10.0 million in 2003 to $57.6 million in 2004. Also, since August 2004 when Truvada was approved for sale in the United States, product sales have totaled $67.9 million through December 31, 2004. Total HIV product sales in 2004 were $27.4 million higher compared to 2003 due to the favorable European currency environment, the majority of which relates to
Viread sales. We believe that as our product sales mix changes with patients who are currently taking Viread and/or Emtriva switching to Truvada, looking at our HIV products sales collectively is a more relevant basis for period-over-period comparison. Sales of HIV products as a percentage of total product sales were 73%, 69% and 53% for 2004, 2003 and 2002, respectively. In 2005, we expect sales from our HIV products to be $1.2 billion to $1.25 billion for the full year.
Sales of AmBisome were 17%, 24% and 44% of total product sales in 2004, 2003 and 2002, respectively. As our HIV and HBV product sales continue to increase, AmBisome sales are decreasing as a percentage of total product sales. Of the AmBisome sales in 2004, $11.4 million were U.S. sales, a decrease of 17% versus 2003, and $200.3 million were international sales, an increase of 9% versus 2003. Of the AmBisome sales in 2003, $13.8 million were U.S. sales, a decrease of 10% versus 2002, and $184.6 million were international sales, an increase of 8% over 2002. Reported AmBisome sales for 2004 were $16.3 million higher due to the favorable currency environment compared to 2003. On a volume basis, AmBisome sales in the United States decreased 2% from 2003 while sales volume in Europe increased slightly by 1% compared to 2003. When analyzing the decrease in U.S. sales, it is important to note that while U.S. product sales decreased 17% when comparing 2004 to 2003, volume decreased only 2%. Our discussion of U.S. AmBisome sales relates solely to our sales of AmBisome to Fujisawa which is recorded at our manufacturing cost. In 2004, due to greater manufacturing efficiencies, our per unit manufacturing cost for AmBisome decreased, thereby decreasing revenues reported for our sales to Fujisawa. Royalties that we earn on sales of AmBisome by Fujisawa are discussed below. With continuing competition, we expect AmBisome sales for 2005 to be in the range of $195 million to $205 million.
We recorded royalty revenues of $63.4 million in 2004, compared with $25.2 million in 2003 and $20.4 million in 2002. During this three-year period, our most significant source of royalty revenue resulted from sales of Tamiflu by Roche and sales of AmBisome in the United States by Fujisawa under a co-promotion arrangement with us. Royalty revenues earned on sales of Tamiflu were $44.6 million, $12.0 million and $3.4 million in 2004, 2003 and 2002, respectively. Royalty revenues earned on sales of AmBisome by Fujisawa were $13.0 million, $12.5 million and $15.7 million in 2004, 2003 and 2002, respectively. As it is difficult to estimate third party product sales, we record royalty revenue from Roche one quarter in arrears. Due to a severe influenza epidemic in the United States in late 2003 through early 2004, our royalty revenues increased substantially during the first and second quarters of 2004. Increased awareness and discussion about the supply of influenza treatments in 2004 has further increased Roches sales of Tamiflu and consequently, our royalties for the third and fourth quarters of 2004.
Total contract revenue was $19.0 million in 2004, compared with $6.3 million in 2003 and $22.5 million in 2002. In 2004, contract revenue consisted primarily of $10.0 million in research and milestone revenue earned from Eyetech Pharmaceuticals which included $7.6 million net milestone payments earned upon the filing of new drug applications by Eyetech in Europe and the United States for Macugen (pegaptanib sodium injection). In 2003, the primary source of contract revenue consisted of $2.2 million in license fees earned in conjunction with our licensing agreement with Eyetech for Macugen. In 2002, contract revenue primarily consisted of $8.1 million due to our licensing of the SELEX process patent estate to Archemix, which, due to collectibility concerns, we recognized on a cash basis, and $8.0 million in milestone payments from Roche for the European prophylaxis and treatment approvals of Tamiflu.
In December 2001, we completed the sale of our oncology assets to OSI. Under the terms our agreement, we are entitled to additional payments from OSI of up to $30.0 million in either cash or a combination of cash and OSI stock if and when OSI reaches certain development milestones for NX 211, the most advanced of the oncology product candidates sold to OSI. Under a related manufacturing
agreement, we produce NX 211 and GS 7904L, the two liposomal products included in the sales at our manufacturing facility in San Dimas, California. In 2004, 2003 and 2002, we recognized $1.4 million, $1.1 million and $3.3 million, respectively, of contract revenue under this manufacturing agreement.
Cost of Goods Sold and Product Gross Margins
The following table indicates cost of goods sold and product gross margins (in thousands):
Our gross margin was relatively flat from 2003 to 2004 as the positive impact of improvements in certain manufacturing processes and a favorable foreign currency environment was offset by changes in product sales mix. Comparing 2003 to 2002, gross margin improved primarily due to a change in product mix as Viread, a higher margin product, contributed more significantly to net product sales in 2003.
Changes in foreign currency exchange rates impact gross margins since we price our products in the currency of the country into which the products are sold while a significant majority of our manufacturing costs are in U.S. dollars. For example, an increase in the value of these foreign currencies relative to the U.S. dollar will positively impact gross margins since our manufacturing costs will remain approximately the same while our revenues after being translated into U.S. dollars, will increase. Although the weakening U.S. dollar has positively impacted gross revenues and gross margins in 2004, 2003 and 2002, the full effect of the foreign currency exchange rates has been moderated by our hedging program on forecasted international sales. Except for the potential impact of unpredictable and uncontrollable changes in exchange rates relative to the U.S. dollar and the mix of product sales between our various HIV products, Hepsera and AmBisome, we expect gross margins in 2005 to be consistent with those of 2004, within the range of 85-86%.
The following table summarizes our research and development expenses into these major components (in thousands):
The three major categories of research and development (R&D) expenses consist of personnel costs, including salaries and benefits, clinical studies performed by contract research organizations, materials and supplies, and overhead allocations consisting of various support and facilities related costs. Research costs typically consist of preclinical and toxicology work. Clinical development costs include Phase 1, 2, 3 and 4 clinical trials as well as expanded access programs. Pharmaceutical development costs consist of product formulation and chemical analysis. Prior to 2004, clinical development consisted only of clinical trial expenses for Phases 1 through 3 and Phase 4 in the United States. Phase 4 European clinical trials were included in sales, general and administrative (SG&A). During 2004, in order to better reflect the nature of the European Phase 4 clinical trials, we began recording these clinical trial expenses as research and development. In order to be consistent with the current year presentation, $16.9 million and $7.1 million of expenses were reclassified from selling, general and administrative to research and development expenses for the years ended December 31, 2003 and 2002, respectively.
The $41.8 million increase in R&D expenses in 2004 over 2003 was primarily attributable to increased salaries of $10.2 million due largely to higher headcount, increased contract research organization costs of $9.7 million associated with increased clinical activities, as well as $13.0 million research and license fees paid by us in relation to hepatitis C collaboration agreements effective in the fourth quarter of 2004. The new 2004 collaborations were entered into with Achillion and Genelabs and required us to pay aggregate license fees of $13.0 million which were expensed as R&D as the underlying technology had no alternative future use. The increase in 2004 R&D activity was partially offset by a decrease in spending due to the discontinuation of our two programs, GS 9005 and GS 7340, that focused on the development of certain HIV investigational products. It is also important to note that our 2003 R&D expenses included a reimbursement to Gilead of $13.2 million from the settlement of a contractual dispute with a vendor.
The $39.9 million increase in R&D spending in 2003 versus 2002 was primarily attributable to increased salaries of $14.4 million due largely to higher headcount, increased clinical supplies costs of $7.0 million and increased clinical trials costs associated with the development of Emtriva and Truvada, the co-formulation of Viread and Emtriva. Also as mentioned above, in 2003, we settled a contractual dispute with a vendor that resulted in reimbursement to us of $13.2 million that was recorded to research and development expense.
In 2005, we expect R&D expenses to be approximately $240 million to $260 million. This estimated increase in expenses over 2004 levels reflects increased spending on our internal research and development efforts as well as costs associated with post-marketing studies to support our products, but excludes any expenses we may incur associated with potential collaborations or strategic acquisitions, including license and milestone fees or cost sharing arrangements, and the impact of accounting for employee stock based compensation beginning in the second half of 2005.
Industry reports indicate that a biopharmaceutical company generally takes 10 to 15 years (an average of 12 years) to research, develop and bring to market a new prescription medicine in the United States. These averages are generally consistent with the projects that we undertake internally, although our recent product development timelines have been on a slightly more accelerated basis. Drug development in the United States is a process that includes several steps defined by the FDA. The process begins with the filing of an IND, which, if successful, allows opportunity for clinical study of the potential new medicine. Clinical development typically involves three phases of study: Phase 1, 2 and 3, and generally accounts for an average of seven years of a drugs total development time. The most significant costs associated with clinical development are the Phase 3 trials as they tend to be the longest and largest studies conducted during the drug development process. We currently have products in development that are in Phase 3 studies. The successful development of our products is highly uncertain. Completion dates and R&D expenses can vary significantly for each product and are difficult to predict. Even after successful development and FDA approval of a product, we undertake additional studies to try to expand the products label and market potential. For a more complete discussion of the risks and uncertainties
associated with completing the development of products, see the Risk Factors That Affect Gilead section of Item I above.
Selling, General and Administrative Expenses
The following table highlights the year to year changes in selling, general and administrative expenses (in thousands):
SG&A expenses for the year ended December 31, 2004 were $302.8 million compared to $233.3 million for the year ended December 31, 2003, which includes the reclassification of phase IV clinical trial expenses incurred in 2003 to R&D of $16.9 million. The significant increase in expenses in 2004 compared to 2003 is primarily due to increased salaries of $14.2 million due largely to higher headcount, increased consulting fees of $5.9 million related to Sarbanes-Oxley compliance and business strategy consulting, as well as increased costs of $12.6 million relating to speakers programs, grants and journal advertising. The remainder of the increase in SG&A expenses in 2004 compared to 2003 is due to our increased global marketing efforts and increased infrastructure required to support the growth of our business. During 2004, as part of our infrastructure investments, we implemented a reorganization of our sales and marketing functions into a newly created commercial division. In conjunction with this reorganization, we created and filled the new position of executive vice-president, commercial operations who will have responsibility over global commercial operations and strategy for our product portfolio.
The increase in expenses in 2003 compared to 2002, which includes the reclassification of phase IV clinical trial expenses to R&D of $7.1 million, is primarily due to increased salaries of $13.4 million due largely to higher headcount, an increase in hedging costs of $10.6 million, increased costs of $9.0 million relating to marketing meetings and grants, as well as increased general and directors and officers insurance of $6.4 million. The remainder of the increase in SG&A expenses is due to our global sales and marketing efforts including the expansion of our U.S. and European sales forces and increased infrastructure required to support the growth of our business.
In 2005, we expect SG&A expenses to be approximately $350 million to $370 million primarily due to the anticipated launch costs for Truvada in the European Union, as well as ongoing investment in our global commercial organization through hiring and promotional programs, but excludes any expenses we may incur associated with potential collaborations or strategic acquisitions and the impact of applying the new standard on the accounting for employee stock based compensation beginning in the second half of 2005.
Purchased In-process Research and Development
In connection with the acquisition of the net assets of Triangle completed in January 2003, we recorded purchased in-process research and development expenses of $488.6 million in the first quarter of 2003. The charge was due to Triangles incomplete research and development programs that had not yet reached technological feasibility and had no alternative future use as of the acquisition date.
The value of the purchased in-process research and development was determined by estimating the related future net cash flows between 2003 and 2020 using a present value risk adjusted discount rate of 15.75%. This discount rate is a significant assumption and is based on our estimated weighted average cost of capital adjusted upward for the risks associated with the projects acquired. The projected cash flows from the acquired projects were based on estimates of revenues and operating profits related to the projects considering the stage of development of each potential product acquired, the time and resources needed to complete the development and approval of each product, the life of each potential commercialized product and associated risks including the inherent difficulties and uncertainties in
developing a drug compound including obtaining FDA and other regulatory approvals, and risks related to the viability of and potential alternative treatments in any future target markets. A summary of these programs at the acquisition date, and updated for subsequent developments through February 2005, is as follows:
During 2003, we recorded an asset impairment charge of $10.2 million on certain of our long-lived assets, primarily leasehold improvements, manufacturing and laboratory equipment. This non-cash charge was driven by the decision in December 2003 to terminate our liposomal research and development activities in San Dimas and discontinue the DaunoXome product line. The impairment was based on our analysis of the undiscounted cash flows to be generated from the affected assets as compared to their carrying value. As the carrying value exceeded the related estimated undiscounted cash flows, we wrote the carrying value of the long-lived assets down to their estimated fair value.
In 2004, subsequent to our decision to discontinue the DaunoXome product line, we received unanticipated requests in Europe asking Gilead to reconsider selling DaunoXome. As a result of these requests, management decided to continue selling this product in certain countries and we are still evaluating our supply and sales strategy with respect to DaunoXome. In accordance with U.S. generally accepted accounting principles, the new cost basis for the impaired assets was not adjusted for these new facts and circumstances.
Pursuant to our agreement with Eyetech entered into in March 2000, we received a warrant to purchase 791,667 shares of Eyetech series B convertible preferred stock, exercisable at a price of $6.00 per share. In January 2004, Eyetech completed an initial public offering of its common stock at which time we adjusted the fair value of the warrant resulting in a gain of $20.6 million. At that time, the fair value of the warrant was estimated using the Black-Scholes valuation model with a volatility rate of 50% and a discount rate of 2.8%. At the end of the first quarter of 2004, we exercised the warrant on a net basis using shares of Eyetech common stock as consideration for the exercise price and subsequently held 646,841 shares of Eyetech common stock. In the second quarter of 2004, we sold all of the Eyetech shares we owned and realized a gain of approximately $2.3 million, which is included in interest and other income, net, for the year ended December 31, 2004.
In July 2002, we sold all of our remaining shares of OSI common stock for approximately $22.0 million. These shares were partial consideration for the sale of our oncology assets to OSI in December 2001, at which time they were recorded at a fair market value of approximately $38.0 million. In connection with the sale of these remaining shares, we recognized a non-operating loss of approximately $16.0 million in the year ended December 31, 2002.
Make-Whole Payment on Debt Redemption
In October 2004, Gilead called for the redemption of all its outstanding 2% convertible senior notes due December 15, 2007 on November 20, 2004. The convertible senior notes were called under a provisional redemption based upon the market price of Gilead common stock exceeding certain thresholds. The aggregate principal amount outstanding of the notes was $345.0 million. The convertible senior notes were redeemable at a redemption price equal to 100% of the principal amount of the notes, plus a cash payment equal to accrued and unpaid interest to the redemption date and a cash make-whole payment equal to $60 per $1,000 principal value of the notes less interest actually paid or accrued and unpaid from the date of issuance of the notes to the redemption date. Interest on the convertible senior notes ceased to accrue on the redemption date, and the only remaining right of the holders thereafter was to receive the redemption payment, including accrued and unpaid interest to the redemption date and the make-whole payment. Alternatively, note holders could elect to convert their notes into shares of Gilead common stock at a price of $23.50 per share, or 42.55 shares of Gilead common stock per $1,000 principal amount of the notes. Holders of substantially all of the outstanding notes converted their notes into shares of Gileads common stock prior to the November 20, 2004 redemption date. As a result of these conversions, 14,676,952 shares of
common stock were issued to these note holders. In connection with the redemption, Gilead paid aggregate make-whole payments of $7.4 million to note holders.
Interest and Other Income, net
We recorded interest and other income of $18.9 million in 2004, compared with $13.0 million in 2003 and $22.3 million in 2002. The increase in 2004 compared to 2003 is primarily attributable to the higher cash balances and yields over the past year. The decrease in 2003 compared to 2002 is attributable to the significant decline in interest rates and a lower average cash balance due to the acquisition of the net assets of Triangle and the purchase of our Foster City campus, partially offset by positive cash flow from operations. Interest income in 2005 will depend principally upon prevailing interest rates and the level of our cash, cash equivalent and marketable securities balances.
We incurred interest expense of $7.3 million in 2004, compared with $21.9 million in 2003 and $13.9 million in 2002. The decrease in 2004 over 2003 is primarily due to the conversion of our $250.0 million 5% convertible subordinated debt into shares of our common stock in December 2003. The only outstanding debt during most of 2004 consisted of our $345.0 million 2% convertible senior debt issued in December 2002. In November 2004, we converted our 2% convertible senior notes. The significant increase in 2003 over 2002 is due to the full year of interest on our $345.0 million 2% convertible senior notes which were issued in December 2002. Interest expense for 2003 and 2002 consisted primarily of interest on the $250.0 million 5.0% convertible subordinated notes, which were converted into shares of our common stock in December 2003. We expect interest expense in 2005 to decrease as compared with 2004 primarily due to the conversion of the $345.0 million 2% convertible senior notes in November 2004.
Provision for (Benefit from) Income Taxes
Our provision for (benefit from) income taxes was $207.1 million, ($95.5) million and $1.3 million in 2004, 2003 and 2002, respectively. The 2004 effective income tax rate of 31.5% differs from the U.S. federal statutory rate of 35% generally due to state taxes being more than offset by the recognition of previously unbenefitted net operating losses, tax credit carryforwards and certain earnings being taxed in foreign tax rate jurisdictions with lower tax rates for which no U.S. taxes have been provided because such earnings are planned to be permanently reinvested outside the United States.
The tax benefit in 2003 includes the reversal of our valuation allowance against certain of our deferred tax assets. In December of 2003, we concluded that it was more likely than not that we would realize a portion of the benefit related to our deferred tax assets. Accordingly, we reduced the valuation allowance against the assets and recorded a tax benefit of $111.6 million. The recognition of these deferred tax assets had no impact on our cash flows. Partially offsetting this tax benefit was income tax expense associated with income earned by our foreign subsidiaries, foreign losses benefitted at lower tax rates and the non-tax deductibility of purchased in-process research and development. We had significant net operating loss carryforwards which were used to reduce our U.S. tax liability. Excluding the benefit relating to the reversal of our valuation allowance, and the write off of purchased in-process research and development, our effective tax rate for 2003 was 5%.
The income tax expense in 2002 was primarily associated with income earned by our foreign subsidiaries as we had significant net operating losses in the United States. The provision for 2002 was reduced by a change in the U.S. income tax law. This law allowed net operating loss carryforward deductions to offset 100% of alternative minimum taxable income, resulting in a reduction of U.S. income tax recorded in previous years of $1.3 million.
On October 22, 2004, the American Jobs Creation Act (the AJCA) was signed into law. The AJCA allows for a deduction of 85% of certain foreign earnings that are repatriated, as defined in the AJCA. We may elect to apply this provision to qualifying earnings repatriations in fiscal 2005. We have started an evaluation of the effects of the repatriation provision; however, we do not expect to be able to complete this evaluation until after Congress or the Treasury Department provide additional clarifying language on key elements of the provision. We expect to complete our evaluation of the effects of the repatriation provision within a reasonable period of time following the publication of the additional clarifying language. The range of possible amounts that we are considering for repatriation under this provision is between zero and $500 million (maximum amount allowable to us as defined in the AJCA). Currently, the related potential range of impact on income taxes cannot be reasonably estimated.
Cash, cash equivalents and marketable securities totaled $1.25 billion at December 31, 2004, up from $707.0 million at December 31, 2003. In 2004, the increase of $547.0 million was primarily due to net cash provided by operations of $511.4 million and proceeds from issuances of stock under employee stock plans of $78.8 million, partially offset by capital expenditures of $51.4 million. In 2003, the cash decrease of $235.4 million from 2002 was primarily due to the acquisition of Triangle, for which the net cash impact was $375.5 million, the purchase of our Foster City campus for $123.0 million and capital expenditures of $38.6 million, partially offset by proceeds from issuance of stock under employee stock plans of $83.8 million.
Working capital at December 31, 2004 was $1.60 billion compared to $1.08 billion at December 31, 2003. Significant changes in working capital during 2004 included a $144.5 million decrease in current deferred tax assets more than offset by a $118.8 million increase in accounts receivable and a $37.9 million increase in inventory. The $144.5 million decrease in current deferred tax assets was primarily due to the utilization of net operating losses and tax credit carryforwards to offset taxable income. The accounts receivable increase of $118.8 million was primarily due to increased sales of Viread in the United States and Europe and sales from our new product, Truvada, launched in the United States in the latter half of 2004. The $37.9 million increase in inventory was primarily due to an increase in the purchase of raw materials and the production of Viread and Truvada inventory to meet increasing sales demand.
Current liabilities in 2004 increased by $67.6 million from 2003 primarily due to the following: a $15.0 million increase in Medicaid rebate obligations associated with higher sales of Viread; a $14.4 million increase in deferred revenue primarily due to royalties received from Roche; a $12.9 million increase in the liability associated with the fair value of our forward currency contracts as the U.S. dollar continued to weaken against European currencies; an $11.9 million increase in accounts payable primarily due to increases in our raw material purchases in support of Viread and Truvada sales growth; a $9.7 million increase for increased compensation costs and employee benefits with added headcount; and an increase of $4.1 million for distributors fees owed but not yet paid under the inventory management agreements entered into in July 2004. The increase in current liabilities was partially offset by a $4.3 million decrease in accrued clinical and preclinical expenses as a result of decreasing activity associated with the clinical trial programs for Viread and Hepsera towards the end of 2004.
In 2004, we made capital expenditures of $51.4 million compared to $38.6 million in 2003 and $17.6 million in 2002. These expenditures were primarily for domestic and international facilities improvements, including approximately $26.0 million associated with the completion of our pilot plant in Foster City which will be used to develop our drug processes and prepare materials to supply clinical trials, as well as additional spending for laboratory and manufacturing equipment to accommodate our growth. Capital expenditures related to research and development were between 55% and 65% of the $51.4 million spent in 2004, 50% and 60% of the $38.6 million spent in 2003 and 20% to 25% of the $17.6 million spent
in 2002. We expect our capital spending for 2005 to be $55 million to $65 million due to increased infrastructure needs and higher R&D spending.
We believe that our existing capital resources, supplemented by cash generated from our operations, will be adequate to satisfy our capital needs for the foreseeable future. Our future capital requirements will depend on many factors, including:
· the commercial performance of our current and future products,
· the progress and scope of our research and development efforts, including preclinical studies, and clinical trials,
· the cost, timing and outcome of regulatory reviews,
· the expansion of our sales and marketing capabilities,
· administrative expenses,
· the possibility of acquiring manufacturing capabilities or additional office facilities,
· the possibility of acquiring other companies or new products,
· the establishment of additional collaborative relationships with other companies, and
· defense costs associated with, settlements of and adverse results of litigation.
We may in the future require additional funding, which could be in the form of proceeds from equity or debt financings, such as from our universal shelf registration statement filed in December 2003 for the potential issuance of up to $500.0 million of our securities, or additional collaborative agreements with corporate entities. If such funding is required, we cannot assure that it will be available on favorable terms, if at all.
We have established a variety of subsidiaries in various countries for the purpose of conducting business in those locations. All of these subsidiaries are consolidated in our financial statements. We do not have any variable interest entities that are unconsolidated in our financial statements. We are also not involved in any non-exchange traded commodity contracts accounted for at fair value. We have no commercial commitments with related parties, except for employee loans.
We have contractual obligations in the form of capital and operating leases, non-cancelable raw material supply arrangements and clinical research organization contracts. The following table summarizes these contractual obligations at December 31, 2004 (in thousands):
(1) At December 31, 2004, we had firm capital project commitments of approximately $2.0 million relating to facilities improvement. In addition, we have budgeted significant capital expenditures for 2005, mainly due to anticipated increased infrastructure needs and higher R&D spending. We may have more capital spending in future years.
(2) At December 31, 2004, we had firm commitments to purchase active pharmaceutical ingredients. The amounts disclosed only represent minimum purchase requirements. Actual purchases may differ significantly from these amounts.
(3) At December 31, 2004, we had several clinical studies in various clinical trial phases. Our most significant expenditures are to contract research organizations. Although most contracts are cancelable, we generally have not cancelled contracts. These amounts reflect commitments based on existing contracts and do not reflect any future modifications to existing contracts and anticipated or potential new contracts.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (SFAS 123R), which is a revision of SFAS 123. SFAS 123R supercedes APB 25 and amends SFAS 95, Statement of Cash Flows. SFAS 123R requires all share-based payments to employees and directors, including grants of stock options, to be recognized in the statement of operations based on their fair values, beginning with the first interim or annual period after June 15, 2005, with early adoption permitted. The pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition. We expect to adopt SFAS 123R in our third quarter of fiscal 2005, beginning July 1, 2005. Under SFAS 123R, we must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at date of adoption. The transition methods include prospective and retroactive adoption options. Under the retroactive options, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of SFAS 123R, while the retroactive methods would record compensation expense for all unvested stock options and restricted stock beginning with the first period restated. We are currently evaluating the requirements of SFAS 123R as well as option valuation methodologies related to our employee and director stock options and employee stock purchase plan. Although we have not yet determined the method of adoption or the effect of adopting SFAS 123R, we expect that the adoption of SFAS 123R will have a material impact on our consolidated results of operations and earnings per share. The impact of adoption of SFAS 123R cannot be predicted at this time because it will depend on, among other things, the levels of share-based payments granted in the future, the method of adoption and the option valuation method used. SFAS 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. While we cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees and directors exercise stock options), the amount of operating cash flows recognized in prior periods related to tax deductions were $22.0 million, $132.3 million and $0.4 million in 2004, 2003 and 2002, respectively. Current estimates of option values using the Black-Scholes method may not be indicative of results from valuation methodologies ultimately adopted by Gilead.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Currency Exchange Risk
Our operations include manufacturing and sales activities in the United States as well as sales activities in Europe and Australia. As a result, our financial results could be significantly affected by factors such as changes in foreign currency exchange rates or weak economic conditions in the foreign markets in which we distribute our products. Our operating results are exposed to changes in exchange rates between the U.S. dollar and various foreign currencies, the most significant of which are the Euro, the British pound and the Australian dollar. When the U.S. dollar strengthens against these currencies, the relative value of sales made in the respective foreign currency decreases. Conversely, when the U.S. dollar weakens, the relative amounts of such sales increase. Overall, we are a net receiver of foreign currencies and, therefore, benefit from a weaker U.S. dollar and are adversely affected by a stronger U.S. dollar relative to those foreign currencies in which we transact significant amounts of business.
To mitigate the impact of changes in currency exchange rates on cash flows from our foreign currency sales transactions, we enter into foreign exchange forward contracts to hedge our foreign currency-denominated net monetary assets or liabilities.
A significant percentage of our product sales are denominated in foreign currencies. Increases in the value of the U.S. dollar against these foreign currencies in the past have reduced, and in the future may reduce, our U.S. dollar return on these sales and negatively impact our financial condition. Prior to 2002, we did not hedge our exposure to the impact of fluctuating foreign exchange rates on forecasted sales. In January 2002, we began to use forward contracts to hedge a percentage of our forecasted international sales, primarily those denominated in the Euro currency. In recent years, due to the weakening of the U.S. dollar, foreign currency exchange fluctuations have positively impacted product sales and gross margin; however, the full impact of the favorable foreign currency environment has been moderated by the hedge contracts that we had entered into.
The following table summarizes the notional amounts, average currency exchange rates and fair values of our open foreign exchange forward contracts at December 31, 2004. All contracts have maturities of one year or less. Average rates are stated in terms of the amount of foreign currency per U.S. dollar. Fair values represent estimated settlement amounts at December 31, 2004 (notional amounts and fair values in U.S. dollars in thousands):
The total notional amount of $580.7 million and fair value of ($28.0) million on our open foreign exchange forward contracts at December 31, 2004 compares with a total notional amount of $405.0 million and fair value of ($14.5) million on our open foreign exchange forward contracts at December 31, 2003. The significant increase in outstanding contracts from 2003 to 2004 is primarily attributed to the projected increase in revenues over the forecast periods.
Interest Rate Risk
Our portfolio of available-for-sale investment securities and our fixed-rate liabilities create an exposure to interest rate risk. With respect to the investment portfolio, we adhere to an investment policy that requires us to limit amounts invested in securities based on duration, industry group, investment type
and issuer, except for securities issued by the U.S. government. The goals of our investment policy, in order of priority, are as follows:
· Safety and preservation of principal and diversification of risk;
· Liquidity of investments sufficient to meet cash flow requirements; and
· Competitive after-tax rate of return.
The following table summarizes the expected maturities and average interest rates of our fixed-rate interest-bearing assets and fixed-rate liabilities at December 31, 2004 (dollars in thousands).
(1) Long-term obligations consist of capital leases and operating leases (net of noncancelable subleases). The interest portion of payments due is included.
Our accounts receivable balance at December 31, 2004 was $371.2 million compared to $235.2 million at December 31, 2003 and $125.0 million at December 31, 2002. The growth in our accounts receivable balances was primarily due to higher product sales for Viread in the United States and Europe. In certain countries where payments are typically slow, primarily Greece, Italy, Portugal and Spain, our accounts receivable balances are significant. In most cases, these slow payment practices reflect the pace at which governmental entities reimburse our customers. This, in turn, may increase the credit risk related to certain of our customers. Sales to customers in countries that tend to be relatively slow paying have in the past increased, and in the future may further increase, the average length of time that accounts receivable are outstanding. At December 31, 2004, our past due accounts receivable for Greece, Italy, Portugal and Spain totaled approximately $166.6 million, of which approximately $100.5 million was more than 120 days past due. To date, we have not experienced significant losses with respect to the collection of our accounts receivable and we believe that substantially all our accounts receivable balances are collectible. We perform credit evaluations of our customers financial condition and generally have not required collateral.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements required by this item are set forth beginning at page 52 of this report and are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
An evaluation as of December 31, 2004 was carried out under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, which are defined under SEC rules as controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Securities Exchange Act of 1934 (Exchange Act) is recorded, processed, summarized and reported within required time periods. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective.
(b) Managements Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Securities Exchange Act Rule 13a-15(f). Our internal control system is designed to provide reasonable assurance regarding the preparation and fair presentation of financial statements for external purposes in accordance with generally accepted accounting principles. All internal control systems, no matter how well designed, have inherent limitations and can provide only reasonable assurance that the objectives of the internal control system are met.
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Based on our evaluation, we concluded that our internal control over financial reporting was effective as of December 31, 2004.
Ernst & Young LLP, an independent registered public accounting firm that has audited our consolidated financial statements included herein, has issued an audit report on our assessment of internal control over financial reporting.
(c) Changes in Internal Control over Financial Reporting
Our management, including our Chief Executive Officer and Chief Financial Officer, has evaluated any changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2004, and has concluded that there was no change during such quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item concerning our directors and executive officers is incorporated by reference to the sections of our Definitive Proxy Statement filed with the SEC pursuant to Regulation 14A in connection with the 2005 Annual Meeting (the Proxy Statement) under the headings Nominees, Executive Officers, Board of Directors, Audit Committee and Compliance with Section 16(a) of the Securities Exchange Act of 1934.
Gileads written Code of Ethics applies to all of its directors and employees, including its executive officers. The Code of Ethics is available on Gileads website at http://www.investors.gilead.com. Changes to or waivers of the Code of Ethics will be disclosed on the same website.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to the sections of our Proxy Statement under the headings Executive Compensation and Compensation Committee Report.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this Item is incorporated by reference to the section of our Proxy Statement under the heading Security Ownership of Certain Beneficial Owners and Management.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference to the sections of our Proxy Statement under the headings Compensation Committee Interlocks and Insider Participation, Certain Transactions and Executive Compensation.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is incorporated by reference to the sections of our Proxy Statement under the heading Principal Accountant Fees and Services.
(a) The following documents are filed as part of this Form 10-K:
(1) Index list to Financial Statements:
(2) Schedule II is included on page 96 of this report. All other schedules are omitted because they are not required or the required information is included in the financial statements or notes thereto.
The following exhibits are filed herewith or incorporated by reference: