Gilead Sciences 10-K 2006
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission File No. 0-19731
GILEAD SCIENCES, INC.
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code: 650-574-3000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.001 PAR VALUE PER SHARE
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark 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. ¨
Indicate by check mark whether registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant based upon the closing price of the Common Stock on the Nasdaq Stock Market on June 30, 2005 was $19,536,330,000.*
The number of shares outstanding of the Registrants Common Stock on February 28, 2006 was 462,284,636.
DOCUMENTS INCORPORATED BY REFERENCE
Specified portions of the registrants proxy statement, which will be filed with the Commission pursuant to Regulation 14A in connection with the registrants 2006 Annual Meeting of Stockholders, to be held on May 10, 2006, are incorporated by reference into Part III of this Report.
GILEAD SCIENCES, INC.
2005 Form 10-K Annual Report
Table of Contents
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® and TRUVADA®. MACUGEN® is a registered trademark belonging to OSI Pharmaceuticals, Inc., SUSTIVA® and VIDEX® are registered trademarks and BARACLUDE is a trademark of Bristol-Myers Squibb Company. TAMIFLU® is a registered trademark belonging to F. Hoffmann-La Roche Ltd. RETROVIR®, TRIZIVIR® and COMBIVIR® are registered trademarks and EPZICOM is a trademark of GlaxoSmithKline Inc. CANCIDAS® is a registered trademark belonging to Merck & Co., Inc. This report also includes other trademarks, service marks and trade names of other companies.
This Annual Report on Form 10-K, including the Managements Discussion and Analysis of Financial Condition and Results of Operations, contains forward looking statements regarding future events and our future results that are subject to the safe harbors created under the Securities Act of 1933 (the Securities Act) and the Securities Exchange Act of 1934 (the Exchange Act). Words such as expect, anticipate, target, goal, project, intend, plan, believe, seek, estimate, continue, may, variations of such words, and similar expressions are intended to identify such forward-looking statements. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses, and other characterizations of future events or circumstances are forward-looking statements. We have based these forward looking statements on our current expectations about future events. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Our actual results may differ materially from those suggested by these forward looking statements for various reasons, including those identified below, under Risk Factors beginning at page 19. 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. Except as required under federal securities laws and the rules and regulations of the U.S. Securities and Exchange Commission (SEC), 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 after the distribution of this report, whether as a result of new information, future events, changes in assumptions or otherwise.
ITEM 1. BUSINESS
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 revenues from nine approved products and marketing operations in twelve countries. We focus our research and clinical programs on anti-infectives. We seek 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. As used in this Annual Report on Form 10-K, Gilead, we, our, us and words of similar import are references to Gilead Sciences, Inc. and its consolidated subsidiaries.
Our worldwide headquarters are in Foster City, California. We were incorporated in Delaware on June 22, 1987. The mailing address of our headquarters is 333 Lakeside Drive, Foster City, California 94404, and our telephone number at that location is 650-574-3000. Our website is www.gilead.com. Through a link on the Investors section of our website (under Financial Information), we make available the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the SEC: our Annual Reports on Form 10-K; Quarterly Reports on Form 10-Q; Current Reports on Form 8-K; and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. All such filings are available free of charge.
The following table lists aggregate product sales for our major products (in thousands):
See Item 8, Note 16 to our consolidated financial statements on pages 92 through 93 included in this Annual Report on Form 10-K, for our product sales by geographic area.
Royalties from Other Products
Commercialization and Distribution
We have U.S. and international commercial sales operations, with marketing subsidiaries in Australia, Canada, France, Germany, Greece, Ireland, Italy, New Zealand, Portugal, Spain, the United Kingdom and the United States.
Our commercial teams promote our HIV and HBV products, Viread, Truvada, Emtriva 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). We sell our HIV products and Hepsera in the United States exclusively through our wholesale channel. Our corporate partner, Astellas, promotes and sells AmBisome for us in the United States. We sell our HIV products, Hepsera and AmBisome in major European countries through our European commercial team and distributors.
We promote, sell and distribute our products in countries outside of the United States and Europe, including countries in Asia, Latin America, the Middle East and Africa. In certain territories, we enter into agreements with third party distributors granting them the exclusive right to sell our products in a particular territory for a specified period of time. Most of these agreements provide for collaborative efforts between the distributor and us for obtaining regulatory approval for the product in the specified territory. These agreements generally grant the distributor the right to market the product in the territory and generally establish a price that the distributor must pay for our product and require us to deliver quantities of the product ordered by the distributor.
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:
Our HIV Products. The HIV landscape is becoming more competitive and complex 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 approximately 25 branded drugs available in the United States, our HIV products primarily compete with the fixed-dose combination products in the nucleotide/nucleoside reverse transcriptase inhibitors (NRTI) class, including Combivir (AZT and 3TC); Epzicom (3TC and ABC) and Trizivir (AZT/3TC/ABC), each sold by GSK. Other companies with HIV products competing in the same NRTI class include Bristol-Myers Squibb Company (BMS) and Roche, although our HIV products also compete broadly with HIV products from Boehringer Ingelheim, Merck & Co., Inc. (Merck) and Abbott Laboratories.
BMSs Videx EC (didanosine) became the first generic HIV product in the United States in 2004. GSKs Retrovir (AZT) also now faces generic competition in the United States as a result of the launch of generic AZT in 2005. There has been little impact from generic didanosine or generic AZT on the price of Gileads HIV products, but price decreases for all HIV products may result.
AmBisome. AmBisome faces strong competition from several current and expected competitors. Competition from these current and expected competitors may erode the revenues we receive from sales of AmBisome. AmBisome primarily competes with Vfend (voriconazole) developed by Pfizer and caspofungin, a product developed by Merck that is marketed as Cancidas in the United States and as Caspofungin elsewhere. AmBisome also competes with other lipid-based amphotericin B products, including Abelcet (amphotericin B lipid complex injection), sold by Enzon Pharmaceuticals, Inc in the United States, Canada and Japan and by
Medeus Pharma Ltd. in Europe, and Amphotec (amphotericin B cholesteryl sulfate complex for injection), sold by Three Rivers Pharmaceuticals, LLC worldwide. BMS and numerous generic manufacturers sell conventional amphotericin B, which also competes with AmBisome.
Presently, unapproved but expected competitors are from a class of treatments called echinocandins, including Astellas 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 Pfizer (formerly Vicuron, Inc.), a product candidate that is being evaluated in multiple late-stage clinical trials. Finally, Schering Plough is developing Noxafil (posaconazole), which is currently in Phase 3 trials and has recently received a positive opinion from European regulators.
We are aware of reports of at least three lipid formulations that claim similarity to AmBisome becoming available outside of the United States, including the anticipated entry of one such formulation in Greece in 2006. The impact on such formulations on sales of AmBisome is unknown although these formulations may compete in the same markets as AmBisome.
Hepsera. Hepsera faces significant competition from existing and expected therapies for treating patients who are infected with HBV. Hepsera competes primarily with the antiviral products, Baraclude (entecavir), an oral nucleoside analogue developed by BMS and launched in the United States in 2005, and Epivir-HBV (lamivudine), developed by GSK in collaboration with Shire Pharmaceuticals (Shire) and sold in all major countries throughout North and South America, Europe and Asia. Hepsera may also face competition from clinical-stage candidates, including telbivudine, an oral nucleoside analogue, developed by Novartis Pharmaceuticals Corporation (Novartis) and Idenix Pharmaceuticals Limited (Idenix) which is currently under review for approval in the United States and Europe, and pradefovir mesylate, an oral antiviral compound developed by Valeant Pharmaceuticals International which is currently in Phase 2 trials.
Hepsera also competes with established immunomodulatory therapies, including Intron-A (interferon alfa-2b), which is sold by Schering Plough in major countries throughout North and South America, Europe and Asia, and Pegasys (pegylated interferon alfa-2a), an injectable drug similar to Intron-A sold by Roche for the treatment of HBV.
Vistide. Vistide competes with a number of drugs that also treat CMV retinitis, including Cytovene IV and Cytovene (ganciclovir), sold in intravenous and oral formulations by Roche and as an ocular implant by Bausch & Lomb Incorporated; Valcyte (valganciclovir), also marketed by Roche; Foscavir (foscarnet), an intravenous drug sold by AstraZeneca; and Vitravene (fomivirsen), a drug injected directly into the eye sold by CibaVision.
Tamiflu. Tamiflu competes with Relenza (zanamivir), an anti-influenza drug that is sold by GSK. Relenza is a neuraminidase inhibitor that is delivered as an orally-inhaled dry powder. Generic competitors include amantadine and rimantadine, both oral tablets that only inhibit the replication of the influenza A virus. BioCryst Pharmaceuticals, Inc. is developing injectable formulations of peramivir, an influenza neuraminidase inhibitor, for the treatment of influenza, which is currently in preclinical trials.
Macugen. Macugen competes primarily with Visudyne (verteporfin for injection), which is sold by Novartis Pharmaceuticals Corporation and used in connection with photodynamic therapy. Genentech, Inc. is developing Lucentis (ranibizumab), which is currently in Phase 3 trials pending FDA approval and if approved, will compete directly with Macugen.
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.
As part of our business strategy, we establish collaborations with other companies, universities and medical research institutions 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, universities and medical research institutions. More information regarding these relationships, including their financial and accounting impact on our business can be found in Item 8, Note 11 to our consolidated financial statements on pages 80 through 84 included in this Annual Report on Form 10-K.
The following list is representative of our commercial collaborations:
Developing World Collaborations
The following list is representative of our developing world collaborations:
The following list is representative of our research collaborations:
Research and Development
In addition to entering into collaborations with other companies, universities and medical research institutions, we seek to add to our existing portfolio of products through our internal discovery and clinical development programs and through an active in-licensing and product acquisition strategy, such as our acquisition of Triangle 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.
Our internal research is focused on the discovery and development of treatments for viral infections, particularly by HIV, HBV and HCV. In HIV, we filed an Investigational New Drug (IND) application in December 2005 for GS 9160, one of our internal integrase clinical candidates, and initiated a Phase 1 clinical study in healthy volunteers in February 2006. In January 2006, we also announced that we have completed a Phase 1/2 study of GS 9137, a novel HIV integrase inhibitor licensed from Japan Tobacco, and based on the results of this study, Gilead anticipates initiating a Phase 2 clinical trial during the second quarter of 2006. In hepatitis B, we are progressing with the enrollment of two Phase 3 studies comparing the efficacy and safety of tenofovir DF, the active pharmaceutical ingredient in Viread, versus Hepsera in patients with hepatitis B and anticipate completing enrollment during the second half of 2006. In addition, using technology licensed from Chiron, 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 hepatitis C could one day lead to better treatment outcomes for patients, such programs will require extensive investments and will take many years. In total, our research and development expenses for 2005 were $277.7 million, compared with $223.6 million for 2004 and $181.8 million for 2003.
Patents and Proprietary Rights
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 U.S. and foreign 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:
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 Commercial Collaborations. 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. Although we do not have patent filings covering all forms of adefovir dipivoxil, the active ingredient in Hepsera, in China or in certain other countries in Asia, we do have applications pending in various countries in Asia, including China, that relate to specific forms and formulations of 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 we obtain marketing approval 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. For example, extensions for the patents on Vistide have been granted in the United States and in 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 until a patent issues, 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. If competitors file patents applications covering our technology, 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.
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 in Africa and Asia, including China, do not permit enforcement of our patents, and manufacturers are able to sell generic versions of our products in those countries.
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 manufacturers often wait to challenge the patents protecting products that have been granted exclusivity until one year prior to the end of the exclusivity period. From time to time, we have received notices from manufacturers indicating that they intend to import chemical intermediates possibly for use in making our products. It is, therefore, possible that generic manufacturers are considering attempts to seek FDA approval for a similar or identical drug through an Abbreviated New Drug Application, which is the application form typically used by manufacturers seeking approval of a generic drug. If our patents are subject to challenges, we may need to spend significant resources to defend such challenges and we may not be able to defend our patents successfully.
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.
Manufacturing and Raw Materials
We do not own any commercial-scale manufacturing facilities for our antiviral products. We contract with third parties to manufacture our antiviral drugs for clinical and commercial purposes, including Viread, Truvada, Emtriva, Hepsera, Vistide and Tamiflu.
We use four third party contract manufacturers to manufacture tenofovir disoproxil fumarate, the active pharmaceutical ingredient for Viread. For each of emtricitabine, the active pharmaceutical ingredient in Emtriva, adefovir dipivoxil, the active pharmaceutical ingredient in Hepsera, and cidofovir, the active pharmaceutical ingredient in Vistide, we have two third party contract manufacturers manufacturing the active pharmaceutical ingredient.
Viread, Truvada and Hepsera tableting is performed by two third party contract manufacturers. Both manufacturing sites have been qualified and are approved to supply product to the United States, the European Union and other markets. Emtriva capsulation is completed by two third party contract manufacturers. Of these two manufacturers, one is approved to supply product to the United States, European Union and other markets. The second manufacturer has been qualified, and we expect submission for regulatory approval in 2006. We use a single third party manufacturer to supply Vistide drug product.
We are in the process of installing additional filling and packaging capabilities at our facilities in San Dimas, California and Dublin, Ireland, which, upon regulatory approval, will allow us to fill and package drug product for Viread, Truvada, Emtriva and Hepsera into their finished forms.
Roche, by itself and through third parties, is responsible for the manufacturing of Tamiflu. Under our agreement with Roche, through a joint manufacturing committee composed of representatives from Gilead and Roche, we have the opportunity to review Roches existing manufacturing capacity for Tamiflu and global plans for manufacturing Tamiflu.
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 product that is 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 manufacture AmBisome in commercial quantities at our facilities in San Dimas. 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 amphotericin B, the active pharmaceutical ingredient in AmBisome, 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 and fill AmBisome at our San Dimas manufacturing facility and also use a third party to freeze-dry and fill 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.
We manufacture Macugen in commercial quantities at our FDA approved facilities in San Dimas, under our manufacturing agreement with OSI. We use commercially available materials and equipment to produce and fill this product. Currently, OSI provides syringes and the raw materials used in the manufacture of Macugen, including pegaptanib sodium, the active pharmaceutical ingredient in Macugen, through single approved suppliers contracted by OSI.
Given OSIs current projections for Macugen demand, we believe we have sufficient capacity to meet future demand. We are in the process of installing additional production and filling capacity in San Dimas. If we are
unsuccessful in our installation of 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.
Many of the materials that we utilize in our operations are made at only one facility. Since the suppliers of key components and materials must be named in the NDA 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.
Seasonal Operations and Backlog
Worldwide product sales do not reflect any significant degree of seasonality. However, our contract and royalty revenue, which represented about 11% of our total revenues in 2005, is affected by seasonality. For example, royalty revenue that we receive from Roches sale of Tamiflu can be impacted by the severity associated with flu seasons and planning in response to the avian influenza pandemic threat.
For the most part, we operate in markets characterized by short lead times and the absence of significant backlogs. We do not believe that backlog information is material to our business as a whole.
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 IND application seeking their approval to test the compound in humans.
If the FDA accepts the IND 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:
FDA Approval Process
When we believe that the data from the Phase 3 clinical trials show an adequate level of safety and effectiveness, we will file an 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 and makes recommendations regarding the drug. This committee makes a recommendation to the FDA that is not binding 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 Phase 4 non-registrational studies to explore scientific questions to further characterize safety and efficacy during commercial use of our drug. The FDA may also require us to 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 NDA 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 and for which the development program is designed to address the unmet medical need may be designated as fast track products by the FDA and may be eligible for accelerated and priority review. Drugs for the treatment of HIV that are designated for use under the Presidents Emergency Plan for AIDS Relief (PEPFAR) may also qualify for an expedited or priority review. Viread and Truvada received accelerated approval and priority reviews. 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 of the European Union (which includes most major countries in Europe). If this procedure is not used, approval in one country of the
European Union can be used to obtain approval in another country of the European Union under two simplified application processes, the mutual recognition procedure or the decentralized procedure, both of which rely on the principle of mutual recognition. After receiving regulatory approval through any of the European registration procedures, pricing and reimbursement approvals are also required in most countries.
Pricing and Reimbursement
Successful commercialization depends, in part, on the availability of governmental and third-party payor reimbursement for the cost of our products. Government authorities and third-party payors increasingly are challenging the price of medical products and services, particularly for innovative new products and therapies. As such, our business may be adversely affected by an increase in global pricing pressures.
In the United States, there have been a number of legislative and regulatory changes to the healthcare system that could impact the pricing of our products. In December 2003, President Bush signed into law new Medicare prescription drug coverage legislation. Part of the legislation authorizes the Centers for Medicare & Medicaid Services, or CMS, the agency within the Department of Health and Human Services that administers Medicare, to implement a new Medicare Part D coverage benefit for prescription drugs. The prescription drug program began on January 1, 2006. Many factors influence the possible impact to Gilead. Not all drugs in a class may be covered. Further, payment levels under the new Medicare program may be lower than the previous Medicare payment. Medicare patients will have to pay co-insurance, which may influence which products are recommended by physicians and selected by patients. Program enrollment is mandatory for those who are dually eligible for both Medicaid and Medicare. There is no assurance that our drugs will be recognized under the new Medicare Part D program for outpatient prescription drugs or paid at levels that reflect current or historical levels. Further, federal Medicare proposals, along with State Medicaid drug payment changes and healthcare reforms could also lower payment for our products. Our results of operations could be materially adversely affected by the reimbursement changes emerging in 2006, 2007 and beyond from the Medicare prescription drug coverage legislation. To the extent that private insurers such as Blue Cross and Blue Shield or managed care programs follow Medicaid coverage and payment developments, the adverse effects of lower Medicare payment may be magnified by private insurers adopting lower payment. 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
In Europe, the success of Viread, Truvada, Emtriva, Hepsera and Tamiflu will depend largely on obtaining and maintaining government reimbursement because in many European countries, patients will not use prescription drugs that are not reimbursed by their governments. 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. As new drugs come to market, we may face 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.
The testing, manufacturing, marketing and use of our products, as well as products in development involve substantial risk of product liability claims. We maintain product liability insurance; however, 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.
Health Care Fraud and Abuse Laws
We are subject to various federal and state laws pertaining to health care fraud and abuse, including anti-kickback laws and false claims laws. Anti-kickback laws make it illegal for a prescription drug manufacturer to solicit, offer, receive or pay any remuneration in exchange for, or to induce, the referral of business, including the purchase or prescription of a particular drug. Due to the breadth of the statutory provisions and the increasing attention being given to them by law enforcement authorities, it is possible that certain of our practices may be challenged under anti-kickback or similar laws. False claims laws prohibit anyone from knowingly and willingly presenting, or causing to be presented for payment to third-party payors (including Medicare and Medicaid), claims for reimbursed drugs or services that are false or fraudulent, claims for items or services not provided as claimed or claims for medically unnecessary items or services. Our sales and marketing activities may be subject to scrutiny under these laws. Violations of fraud and abuse laws may be punishable by criminal and/or civil sanctions, including fines and civil monetary penalties, as well as the possibility of exclusion from federal health care programs (including Medicare and Medicaid). If the government were to allege against or convict us of violating these laws, there could be a material adverse effect on our results of operations.
Governments in developing countries could require that we grant compulsory licenses to allow competitors to manufacture and sell their own versions of our products, thereby reducing our product sales. Certain offices of the government of Brazil have expressed concern over the affordability of our HIV products and declared that they are considering issuing compulsory licenses to permit the manufacture of otherwise patented products for HIV infection, including Viread. We are currently engaged in discussions with the Brazilian government regarding the affordability of our HIV products. In addition, concerns over the cost and availability of Tamiflu as fear grows about a potential avian flu pandemic have generated international discussions over potential compulsory licensing of our Tamiflu patents. In addition, Roche may issue voluntary licenses to permit third party manufacturing of Tamiflu. For example, Roche has granted a sublicense to Shanghai Pharmaceutical (Group) Co., Ltd. for China and a sublicense to Indias Hetero Drugs Limited for India and certain developing countries. Should one or more compulsory licenses be issued permitting generic manufacturing to override Gileads Tamiflu patents, or should Roche issue additional voluntary licenses to permit third-party manufacturing of Tamiflu, those developments could reduce royalties received from Roches sales of Tamiflu. Compulsory licenses or generic versions of our products could significantly reduce our sales and adversely affect our results of operations, particularly if generic versions of our products are imported into territories where we have existing commercial sales.
As of January 31, 2006, we had approximately 1,900 full-time employees. We believe that we have good relations with our employees.
We seek to comply with all applicable statutory and administrative requirements concerning environmental quality. We have made, and will continue to make, expenditures for environmental compliance and protection. Expenditures for compliance with environmental laws have not had, and are not expected to have, a material effect on our capital expenditures, results of operations or competitive position.
ITEM 1A. RISK FACTORS
In evaluating our business, you should carefully consider the following risks in addition to the other information in this Annual Report on Form 10-K. Any of the following risks could materially and adversely affect our business, results of operations and financial condition. We note these factors for investors as permitted by the Private Securities Litigation Reform Act of 1995. It is not possible to predict or identify all such factors and, therefore, you should not consider any of the above risks to be a complete statement of all the potential risks or uncertainties that we face.
Substantially all of our revenues are derived from sales of a limited number of products. If we are unable to maintain or continue increasing sales of our HIV products, our results of operations may be adversely affected.
We are currently dependent on sales of our HIV products, especially Viread and Truvada, to support our existing operations. Our HIV products are exclusively of the nucleoside class of antiviral therapeutics. Were the treatment paradigm for HIV to change, causing nucleoside-based therapeutics to fall out of favor, or if we are unable to continue increasing our HIV product sales, our results of operations would likely suffer and we would likely need to scale back our operations, including our spending on research and development efforts. HIV product sales for the year ended December 31, 2005 were $1.39 billion, or 69% of our total revenues, and sales of Viread and Truvada comprised 56% and 41%, respectively, of total HIV product sales in 2005. We may not be able to continue the growth rate of sales of our HIV products for the reasons stated in this risk factor section and, in particular, for the following reasons:
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 increase our total 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 face difficulties in our collaboration efforts with BMS to commercialize a once-a-day single pill combination of Truvada and Sustiva. For example, regulatory approval for the NDA that we expect to file with the FDA in the second quarter of 2006 may not be granted on a timely basis, or at all.
We face significant competition.
We face significant competition from businesses that have substantially greater resources than we do. In addition, our competitors have more products and have operated in the fields in which we compete for longer than we have. Our HIV products compete primarily with products from GSK, which markets fixed-dose combination products that compete with Truvada. For AmBisome, we are encountering significant competition from new products produced by Merck and Pfizer. In addition, we are aware of reports of at least three lipid
formulations that claim similarity to AmBisome becoming available outside of the United States, including the anticipated entry of one such formulation in Greece in 2006. For Hepsera, we have encountered increased competition with the launch of BMSs Baraclude (entecavir) and there is the potential for future competition from telbivudine, developed by Novartis and Idenix, which is awaiting approval in the United States and Europe. These companies may significantly impede our ability to be successful with our antiviral products and AmBisome.
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. Safety and efficacy studies of Viread and Emtriva, dosed as separate products, are ongoing and have been underway for a longer period of time than the safety and efficacy studies of Truvada (Viread and Emtriva together), which are also underway. 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 Viread, Truvada, Emtriva, AmBisome and Hepsera 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.
We depend on contract research organizations and our 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.
Gilead extensively outsources its clinical trial activities and usually performs only a small portion of the start-up activities in-house. We rely on third party contract research organizations (CROs) to perform most of our clinical studies, including document preparation, site identification, screening and preparation, pre-study visits, training and program management. If there is any dispute or disruption in our relationship with our CROs, our clinical trials may be delayed. In addition, 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 fails to achieve its 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, which could in turn 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.
We depend on third party manufacturers to manufacture Viread, Truvada, Emtriva, Hepsera and Vistide, including the Truvada and Viread made available to physicians and treatment programs at cost in developing countries under our Access Program. We rely on these third parties for the manufacture of both the active pharmaceutical ingredient and final drug product for clinical and commercial purposes. In addition, Roche, either by itself or through third parties, 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.
We manufacture AmBisome and Macugen 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 and Macugen 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 AmBisome. Because the suppliers of key components and materials must be named in the NDA 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, poor performance by these companies or disputes with these other companies could 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 Astellas and Sumitomo for AmBisome, GSK for Hepsera, Roche for Tamiflu, Pfizer for Vistide, OSI and Pfizer for Macugen and Japan Tobacco for Viread, Truvada and Emtriva and our joint venture with BMS to develop and commercialize a fixed-dose regimen of Truvada and Sustiva. In many countries, we rely on international distributors for sales of Viread,
Truvada, Emtriva, AmBisome and Hepsera outside the United States. 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:
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 The Republic of Korea. The success of Hepsera in these territories will depend almost entirely on the efforts of GSK. In this regard, GSK promotes Epivir-HBV/Zeffix, a product that competes with Hepsera. Consequently, GSKs marketing strategy for Hepsera may be influenced by its promotion of Epivir-HBV. We receive royalties from GSK equal to a percentage of GSKs net sales of Hepsera as well as net sales of GSKs Epivir-HBV/Zeffix. 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 from quarter to quarter. Uneven and unexpected spending on these programs may cause our operating results to fluctuate from quarter to quarter. In addition, during the year ended December 31, 2005, approximately 89% of our product sales in the United States were to three wholesalers, AmerisourceBergen Corp., Cardinal Health, Inc. and McKesson Corp. Inventory levels held by those wholesalers can cause our operating results to fluctuate unexpectedly if our sales to wholesalers do not match end user demand. The U.S. wholesalers with whom we have entered into inventory management agreements may not be completely effective in matching inventory levels to end user demand, as they make estimates to determine end user demand.
Approximately half of our product sales occurs 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, primarily the Euro. Increases in the value of the U.S. dollar against 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. Our hedging program only hedges a portion of our total exposure and significant foreign exchange rate fluctuations within a short period of time could still adversely affect our results of operations.
We face credit risks from our European customers that may adversely affect our results of operations.
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 $221.9 million as of December 31, 2005. Historically, receivables tended to accumulate over a period of time and were settled as large lump sum payments as government funding became available. 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 to certain developing countries under our Access Program may expose us to unforeseen liabilities and risks.
We have launched our Access Program pursuant to which we will supply Viread and Truvada at our cost to all 97 developing countries. 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 under our Access Program, 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 products, 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 products or face generic competition for our 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 product sales. Certain offices of the government of Brazil have expressed concern over the affordability of our HIV products and declared that they are considering issuing compulsory licenses to permit the manufacture of otherwise patented products for HIV infection, including Viread. We are currently engaged in discussions with the Brazilian government regarding the affordability of our HIV products. In addition, concerns over the cost and availability of Tamiflu as fear grows about a potential avian flu pandemic have generated international discussions over potential compulsory licensing of our Tamiflu patents. Furthermore, Roche may issue voluntary licenses to permit third party manufacturing of Tamiflu. For example, Roche has granted a sublicense to Shanghai Pharmaceutical (Group) Co., Ltd. for China and a sublicense to Indias Hetero Drugs Limited for India and certain developing countries. Should one or more compulsory licenses be issued permitting generic manufacturing to override Gileads Tamiflu patents, or should Roche issue additional voluntary licenses to permit third party manufacturing of Tamiflu, those developments could reduce royalties received from Roches sales of Tamiflu. 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, particularly if generic versions of our products are imported into territories where we have existing commercial sales.
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 majority of our sales of Truvada, 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 Viread, Truvada, Emtriva, Hepsera, AmBisome and Tamiflu 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. As new drugs come to market, we may face 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 both the United States and some foreign jurisdictions, there have been a number of legislative and regulatory changes to the healthcare system that could impact the pricing of our products. In the United States, in December 2003, President Bush signed into law new Medicare prescription drug coverage legislation. Part of the legislation authorizes the Centers for Medicare & Medicaid Services, or CMS, the agency within the Department of Health and Human Services that administers Medicare, to implement a new Medicare Part D coverage benefit
for prescription drugs. The prescription drug program began on January 1, 2006. Many factors influence the possible impact to Gilead. Not all drugs in a class may be covered. Further, payment levels under the new Medicare program may be lower than the previous Medicare payment. Medicare patients will have to pay co-insurance, which may influence which products are recommended by physicians and selected by patients. Program enrollment is mandatory for those who are dually eligible for both Medicaid and Medicare. There is no assurance that our drugs will be recognized under the new Medicare Part D program for outpatient prescription drugs or paid at levels that reflect current or historical levels. Further, federal Medicare proposals, along with State Medicaid drug payment changes and healthcare reforms could also lower payment for our products. Our results of operations could be materially adversely affected by the reimbursement changes emerging in 2006, 2007 and beyond from the Medicare prescription drug coverage legislation. To the extent that private insurers such as Blue Cross and Blue Shield or managed care programs follow Medicaid coverage and payment developments, the adverse effects of lower Medicare payment may be magnified by private insurers adopting lower payment. 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:
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 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.
Patents do not cover the active ingredients in AmBisome. In addition, 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, certain countries in Africa and Asia, including China do not permit enforcement of our patents, and manufacturers are able to sell generic versions of our products in those countries.
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 manufacturers often wait to challenge the patents protecting products that have been granted exclusivity until one year prior to the end of the exclusivity period. From time to time, we have received notices from manufacturers indicating that they intend to import chemical intermediates possibly
for use in making our products. It is, therefore, possible that generic manufacturers are considering attempts to seek FDA approval for a similar or identical drug through an Abbreviated New Drug Application, which is the application form typically used by manufacturers seeking approval of a generic drug. If our patents are subject to challenges, we may need to spend significant resources to defend such challenges 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 lawsuits regarding the use of average wholesale price and reimbursement rates under Medicaid. We have also been named as a defendant in a lawsuit alleging violations of the federal securities laws. Adverse results from these lawsuits could result in material damages that 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, our adoption of the Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (SFAS 123R) relating to the accounting for stock options and other share-based payments, changes in tax laws and rates, future levels of research and development spending, changes in accounting standards, 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 will significantly reduce our earnings.
The Financial Accounting Standards Board (FASB) recently issued SFAS 123R, under which we will be required to record additional compensation expense related to stock options and other equity incentives in 2006 and beyond. The impact on our earnings resulting from this new standard will have a significant negative impact on our reported results of operations compared to the results we have reported under prior accounting standards on stock options and other share-based payments.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Our primary facilities, located in Foster City, California, house our executive offices and administrative, research and development activities. At this location, we own 16 buildings and lease 2 buildings.
We lease facilities in San Dimas, California, to house some of our manufacturing, warehousing, research and development activities. In addition, we also lease facilities in Durham, North Carolina, to house some of our administrative, research and development activities.
Outside of the United States, we lease facilities in the Cambridge area in the United Kingdom to house our administrative, sales and marketing activities. Our commercial, medical and administrative groups that were previously based in Paris, France have been relocated to leased facilities in the London area in the United Kingdom.
We also lease facilities in the Dublin area of Ireland to house our manufacturing and distribution facilities. We partly own and partly lease this space. In addition, we have leased facilities to house our sales and marketing activities in France, Spain, Portugal, Italy, Greece, Australia, Germany and Canada.
We believe that our existing properties, including both owned and leased sites, are in good condition and suitable for the conduct of our business. We believe our capital resources are sufficient to purchase, lease or construct any additional facilities required to meet our long-term growth needs.
Information pertaining to legal proceedings can be found in Item 8, Note 13 to our consolidated financial statements on pages 87 and 88 of this Annual Report on Form 10-K and is incorporated by reference herein.
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 a stock dividend. All share and per share amounts for all periods presented have been restated to reflect this stock split.
As of February 28, 2006, we had 462,284,636 shares of common stock outstanding held by approximately 472 stockholders of record.
We have not paid cash dividends on our common stock since our inception. We currently expect to retain earnings for use in the operation and expansion of our business, and therefore do not anticipate paying any cash dividends in the near future.
GILEAD SCIENCES, INC.
SELECTED CONSOLIDATED FINANCIAL DATA
(in thousands, except per share data)
GILEAD SCIENCES, INC.
SELECTED CONSOLIDATED FINANCIAL DATA(Continued)
We adopted SFAS 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.
On each of 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.
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
The following Managements Discussion and Analysis (MD&A) is intended to help the reader understand the results of operations and financial condition of Gilead. MD&A is provided as a supplement to, and should be read in conjunction with our financial statements and the accompanying notes to the financial statements.
Gilead experienced another year of increasing revenues, profits and cash flows due to the successful launches and adoption of our drugs for the treatment of the human immunodeficiency virus (HIV) and the hepatitis B virus (HBV), as well as the maintenance of our product sales for AmBisome. We have been able to increase market share due to the favorable and consistent safety and efficacy profile that has been demonstrated to date on our products, including Viread, Truvada and Emtriva. The increase in market share on our HIV products helped contribute to a 53% increase in 2005 HIV product sales to $1.39 billion from 2004, while the continued adoption of Hepsera increased 2005 product sales to $186.5 million, an increase of 66% from 2004. We intend to build upon the successes of these products by continuing to engage in long-term clinical studies to differentiate our products. Additionally, within the HIV franchise, we intend to work with patients, physicians and key opinion leaders to educate them on the benefits of earlier treatment that is expected to help expand the treated-patient population. As we continue to gather positive data on the safety and efficacy of Truvada, which we launched in various European countries in 2005, we believe that the uptake of Truvada will continue to be a driving force in increasing our HIV product sales.
Over the last few years, we have also focused on creating what we believe is a solid foundation for long-term growth by looking for opportunities to acquire or in-license innovative technologies or drug candidates and developing those technologies alongside our in-house initiatives. In 2005, we entered into a collaboration with Japan Tobacco Inc. (Japan Tobacco) and made advances on the Phase 1/2 clinical trial based on the HIV integrase inhibitor we licensed from them. Additionally, we demonstrated bioequivalence on a formulation of the fixed-dose combination of Truvada and Bristol-Myers Squibb Companys (BMS) Sustiva (the triple product) as well as began dosing patients in a Phase 1 study with the HCV drug candidate we licensed from Achillion Pharmaceuticals. Internally, we made significant progress in the enrollment of two Phase 3 studies comparing the efficacy and safety of tenofovir versus Hepsera in patients with HBV. We also filed an Investigational New Drug application in December 2005 for GS 9160, one of our internal integrase clinical candidates, and initiated a Phase 1 clinical study in healthy volunteers in February 2006. We intend to sustain the long-term growth of our business by continuing to discover and commercialize new drugs in the antivirals area, especially in the HIV and hepatitis C virus (HCV) areas. We also plan on exploring other therapeutic areas with significant unmet medical needs for licensing or acquisition opportunities that fit with our core competencies and complement our long-term growth strategy.
Part of our ability to grow consists of building a strong global organization. During the year, we relocated our European commercial, medical and administrative headquarters from France to the United Kingdom, thereby uniting these functions with the regulatory, safety and information technology groups already headquartered in the United Kingdom. We also made strategic expansion of our global sales and marketing activities for 2005.
As our revenues continued to increase, and as we continued to see collection improvements in certain European regions over the last two years, cash and investment management continued to be an important priority. In addition to re-examining our cash and investments portfolio, investment policies and strategies, we also used our cash for various collaborative activities. During the third quarter of 2005, along with Royalty Pharma, we purchased the royalty interest owned by Emory University in emtricitabine for $525.0 million. Furthermore, in December 2005, leveraging our strong financial position and results, we entered into a $500.0 million credit facility with a syndicate of banks consisting of a $300.0 million term loan and a $200.0 million revolving credit facility. The term loan, which we used to facilitate a one-time repatriation of qualified foreign earnings under the American Jobs Creation Act (AJCA), resulted in a $25.1 million income tax benefit that we recorded in 2005. We have not yet drawn any amounts under the revolving facility but the facility will give us flexibility to use our
funds for future corporate development initiatives, including licensing opportunities and potential acquisitions, while allowing us to meet our ongoing working capital and infrastructure needs.
Our focus for 2006 will be to continue building upon our current infrastructure, continuing to advance our drug candidates through the clinic and executing on our operational goals of promoting our products safety and efficacy data to drive higher patient adoption. We also intend to build a stronger working relationship with F. Hoffmann-La Roche Ltd (Roche) with respect to Tamiflu under our amended agreement to jointly drive more effective marketing and supply chain strategies to meet the increasing demand for Tamiflu. We will also focus significant resources in preparing for the launch of the co-formulated Truvada-Sustiva product in the United States. Moreover, we are working with Merck & Co., Inc. (Merck) and BMS on arrangements to launch the co-formulated product outside of the United States. Finally, we will continue to strengthen our global infrastructure to better support our growing employee and customer base, including expanding certain aspects of our manufacturing capabilities as well as upgrading our facilities and information systems.
Critical Accounting Policies, Estimates and Judgments
This discussion and analysis of financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. 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, prepaid royalties, 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 our 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 inventory management agreements with U.S. wholesalers to assist us in monitoring channel inventory levels, purchasing third-party data to monitor prescriptions as well as, for new products, comparing these products against our other products with same or similar sales 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 lives for these products in the United States ranges from 24 months for Truvada and Hepsera, and up to 36 months for Viread and AmBisome. 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 (R&D) 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 to occur of when the payments are received or when collection is reasonably assured.
Revenues 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 are recognized as performance occurs and our obligations are completed. In accordance with the specific terms of Gileads obligations under these types of arrangements, revenues are recognized as the obligation is fulfilled or ratably over the development or manufacturing period. Revenues associated with substantive at-risk milestones are 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, 2004 to December 31, 2005. 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 record write downs of the value of our inventory based on review of the historical 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 relating to 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, additional inventory write-downs may be required, which could negatively impact our product gross margins and results of operations.
We capitalize royalties that we have prepaid at cost, specifically those related to the emtricitabine royalties we paid to Emory for the HIV indication, based on the present value of the future royalty obligation that we would expect to pay to Emory assuming certain expected levels of our product sales incorporating the emtricitabine technology. The net book value of our prepaid asset was determined using our best estimate of relevant future product sales available at the time we consummated the transaction; however, we review at least annually, the expected future performance of our products and indicators that would support a write-down in the net recoverable value of our asset. We amortize our prepaid royalties based on an effective royalty rate that we derive from forecasted HIV product sales incorporating emtricitabine. Our product sales forecasts are prepared annually and determined using our best estimates of future activity. If a previously unanticipated and significant change occurs to our sales forecasts, including the introduction of a competing product by us or one of our competitors into the same HIV market as emtricitabine, we would prospectively update the royalty rate used to amortize our prepaid royalties which may increase future royalty expense. We review our royalty rate at least annually and would adjust the rate based on any significant new facts or circumstances that may arise.
Clinical Trial Accruals
We record accruals for estimated clinical study costs. Most of our clinical studies are performed by third party contract research organizations (CROs). These costs are a significant component of R&D expenses. During
2005, 2004 and 2003, we incurred CRO costs of $21.1 million, $24.7 million and $15.0 million, respectively. We accrue costs for clinical studies performed by CROs on a straight-line basis over the service periods specified in the contracts and adjust our estimates, if required, based upon our on-going review of the level of effort and costs actually incurred by the CRO. We validate our accruals quarterly with our vendors and perform detailed reviews of the activities related to 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 clinical trial 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 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 executed 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 contracts in 2005, 2004 and 2003 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. 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. Through December 31, 2005, differences between actual and estimated activity levels for any particular study were not significant enough to require a material adjustment. 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 R&D expenses in future periods.
We estimate our income tax provision, including deferred tax assets and liabilities, based on significant management judgment. We evaluate the realization of all or a portion 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 more likely than not 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 adjustments were made in the fourth quarter of 2005 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 2005 and 2004 of approximately $8.2 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, regulations and/or rates, changing interpretation of existing laws or regulations, changes in our international organization, and changes in overall levels of income before tax.
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 disclosures presented above relating to them.
Results of Operations
We had total revenues of $2.03 billion in 2005, $1.32 billion in 2004 and $867.9 million in 2003. Included in total revenues are product sales, royalty revenue and contract revenue including revenue earned from manufacturing collaborations.
Product sales consisted of the following (in thousands):
Total product sales increased by 46% in 2005 compared to 2004 and 49% in 2004 compared to 2003, in each case, primarily due to an increase in the volume of sales of 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 Euro. This reduces, but does not eliminate, fluctuations in sales due to changes in foreign currency exchange rates.
Viread, Truvada and Emtriva were approved for sale in the United States in October 2001, August 2004 and July 2003, respectively. Viread, Truvada and Emtriva were approved for sale in the European Union in February 2002, February 2005 and October 2003, respectively. Sales of Truvada commenced in the United States in the third quarter of 2004 and country-specific launches in Europe began in 2005.
HIV product volume increased by 37% in 2005 compared to 2004 and by 55% in 2004 compared to 2003. HIV product volume growth in the United States were 18% and 44% in 2005 and 2004, respectively, whereas volume increases outside the United States were 71% and 77% in 2005 and 2004, respectively.
Sales of Viread in 2005 remained relatively consistent with sales levels in 2004, resulting from the continued strong performance of Viread offset by the impact of patients switching from a Viread-containing regimen to one containing Truvada in countries where Truvada is available. Sales of Viread in 2004 increased by 38% compared to 2003, primarily driven by volume increases in the United States and across most European countries.
Sales of Truvada increased in the United States in 2005, the first full year of Truvada sales. Truvada patients come primarily from patients new to therapy, and secondarily, from patients switching from other regimens, including those containing Viread or Emtriva.
Sales of Emtriva in 2005 decreased by 18% compared to 2004, primarily driven by the impact of patients switching from an Emtriva-containing regimen to one containing Truvada in countries where Truvada is available.
In 2006, we expect sales from our HIV products to be in the range of $1.675 billion to $1.750 billion. This does not include future product sales, if any, that may result should the triple product be approved for commercial sale in the United States, as we cannot predict whether the triple product will be approved by the U.S. Food and Drug Administration (FDA).
AmBisome product sales increased by 4% in 2005 compared to 2004, primarily driven by an increase in overall sales volume of 15%, partially offset by lower pricing in most regions outside of the United States. Product sales increased by 7% in 2004 over the prior year due primarily to higher sales volume outside of the United States and a stronger European currency, partially offset by lower pricing in many regions outside of the United States. Our discussion of U.S. AmBisome product sales relates solely to our sales of AmBisome to Astellas Pharma Inc. (Astellas), as successor to Fujisawa USA, Inc., which are 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 Astellas. Royalties that we earn on sales of AmBisome by Astellas are discussed under Royalty Revenue below. As a result of pricing pressures in Europe and increased competition, we expect AmBisome product sales for 2006 to be in the range of $205.0 million to $215.0 million.
Sales of Hepsera increased by 66% in 2005 compared to 2004 and by 123% in 2004 compared to 2003, primarily driven by sales volume growth in both Europe and the United States. Volume also increased with respect to our sales of Hepsera to GlaxoSmithKline (GSK). We sell Hepsera to GSK at our manufacturing cost in connection with GSKs distribution activities in Asia. Royalties we earn on sales of Hepsera by GSK are recorded as royalty revenue. We expect Hepsera sales for 2006 to be in the range of $200.0 million to $210.0 million, which takes into account the impact of existing and potential competitor products in the United States and Europe.
We recorded royalty revenues of $196.9 million in 2005, compared with $63.4 million in 2004 and $25.2 million in 2003. During this three-year period, our most significant sources of royalty revenues were from sales of Tamiflu by Roche and sales of AmBisome in the United States by Astellas.
In November 2005, Gilead resolved its dispute with Roche relating to our 1996 development and license agreement and agreed to terminate the related arbitration pending between Gilead and Roche. As part of the terms of the dispute resolution, Gilead and Roche have established joint committees to oversee manufacturing, commercial and pandemic planning for the product and we have the option to co-promote Tamiflu in specialized areas in the United States. Related to the dispute resolution, Roche also paid us $80.7 million that we recognized as royalty revenue in 2005, which consisted of $18.2 million relating to disputed royalties from 2001 to 2003, $11.8 million relating to the reimbursement of the 2004 contractual cost of goods adjustment that had previously reduced our earned royalties, and $50.7 million relating to the updating of royalties payable to Gilead for the first nine months of 2005 based on current year royalty rates instead of the prior years effective royalty rate. Excluding the amounts received in connection with the dispute resolution, the significant year over year increase for Tamiflu royalties in 2005 was primarily due to higher royalties received from Roche for higher Tamiflu sales caused by the significant 2004/2005 flu season, particularly in Japan, and the fulfillment of orders for pandemic
readiness supplies in certain countries in 2005. Royalty revenues earned from Roche, including the amounts recognized from the dispute resolution in 2005, were $161.6 million, $44.6 million and $12.0 million for 2005, 2004 and 2003, respectively.
Comparing 2004 to 2003, royalty revenues earned from sales of Tamiflu by Roche also increased substantially due to a severe influenza epidemic in the United States from late 2003 through early 2004. Increased awareness and discussion about the supply of influenza treatments in 2003/2004 also increased Roches sales of Tamiflu and consequently, our royalties in 2004. As it is difficult to estimate third party product sales, similar to our other out-licensing arrangements other than our arrangement with Astellas, under which royalties are recorded one month in arrears, we record royalty revenue from Roche one quarter in arrears.
Royalty revenue earned on sales of AmBisome by Astellas have remained consistent at $13.0 million for both 2005 and 2004, a slight increase from $12.5 million in 2003.
Total contract revenues were $22.2 million in 2005, compared with $19.0 million in 2004 and $6.3 million in 2003. In 2005, contract revenues consisted primarily of a $7.0 million milestone payment earned from OSI Pharmaceuticals, Inc. (OSI), as successor to Eyetech Pharmaceuticals, Inc., upon its first commercial sale of Macugen in the United States in 2005 as well as revenue earned from various contract manufacturing projects. In 2004, contract revenues consisted primarily of $10.0 million in research and milestone revenue earned from OSI, which included $7.6 million recognized upon the filing of new drug applications by OSI in Europe and the United States for Macugen.
Cost of Goods Sold and Product Gross Margin
The following table indicates total product sales and cost of goods sold (in thousands) and product gross margin:
Our product gross margin for 2005 was slightly lower than that for 2004 due to product mix changes as patients continue to switch from Viread, a higher margin product, to Truvada. Our product gross margin was relatively consistent from 2003 to 2004 as the positive impact of improvements in certain manufacturing processes and a favorable foreign currency environment in 2004 was offset by changes in product sales mix.
As a result of Royalty Pharma and our purchase of the royalty interest owned by Emory in emtricitabine in July 2005, we capitalized $341.3 million in prepaid royalties, representing our 65% share of the $525.0 million purchase price. In the third quarter of 2005, we have begun to amortize this prepaid royalty to cost of goods sold over the remaining life of the underlying patent based on an effective royalty rate derived from our forecasted sales. We recorded royalties to Royalty Pharma based on actual emtricitabine net sales relative to Royalty Pharmas 35% ownership interest in the underlying Emory royalty interest. Although we expect this transaction to have a favorable impact on our emtricitabine product gross margin in the long-term, the impact to our overall product gross margin in 2005 was not significant.
We expect our product gross margin in 2006 to be generally consistent with that of 2005. This excludes the impact of the potential launch of the triple product as we cannot predict whether or when the triple product will be approved by the FDA. Although we expect the launch of the triple product will decrease our product gross margin percentage, there will be no impact to our net profit. This is due to the fact that as the majority owner of
our joint venture with BMS, we will consolidate 100% of the triple product revenue. However, we will earn the full product margin of the Truvada portion of the triple product but earn zero product margin on the Sustiva portion of the triple product.
Research and Development Expenses
The following table summarizes our R&D expenses into these major components (in thousands):
R&D expenses consist primarily of personnel costs, including salaries and benefits, clinical studies performed by CROs, materials and supplies, licenses and fees and overhead allocations consisting of various support and facilities related costs. Our R&D activities are separated into three main categories: research, clinical development and pharmaceutical development. Research costs typically consist of preclinical and toxicology costs. Clinical development costs include costs for Phase 1, 2, 3 and 4 clinical trials. Pharmaceutical development costs consist of product formulation and chemical analysis costs.
The $54.2 million increase in R&D expenses in 2005 compared to 2004 was primarily attributable to a $15.0 million payment made to Emory in connection with the amendment of our existing license agreement with Emory related to our obligation to develop emtricitabine for the hepatitis B indication, a $15.0 million payment made to Japan Tobacco related to the execution of our HIV integrase license agreement for GS 9137, increased salaries from additional headcount of $8.9 million and increased clinical and product development activities associated with our HCV, HBV and HIV programs. The payments made to Emory and Japan Tobacco were expensed as the underlying technology was incomplete and had no alternative future use, and in the case of Emory, no significant R&D activities are expected in the next several years.
The $41.8 million increase in R&D expenses in 2004 as compared to 2003 was primarily attributable to increased salaries of $10.2 million due largely to higher headcount, $13.0 million in research and license fees paid in relation to the HCV collaboration agreements we entered into with Achillion Pharmaceuticals (Achillion) and Genelabs Technologies (Genelabs) during 2004, as well as increased CRO costs of $9.7 million associated with increased clinical activities. The payments made to Achillion and Genelabs were expensed as the underlying technology had no alternative future use. The increase in 2004 R&D expenses compared to 2003 was partially offset by a decrease in spending due to the discontinuation of our two internal programs, GS 9005 and GS 7340, that focused on the development of certain HIV investigational products. Our 2003 R&D expenses included a reimbursement to Gilead of $13.2 million from the settlement of a contractual dispute with a vendor.
In 2006, we expect R&D expenses to increase over 2005 levels reflecting increased spending on our internal and collaborative R&D efforts relating to our expectation that pipeline products will progress into more advanced clinical trials, increased headcount as well as the impact of expensing share-based payments.
Selling, General and Administrative Expenses
The following table summarizes our SG&A expenses (in thousands):
SG&A expenses for 2005 were $379.2 million, an increase of $76.5 million compared to 2004. The significant increase was primarily due to an increase in salaries of $12.8 million due largely to higher headcount, an increase in market research, speakers programs and symposia costs of $9.2 million, $8.4 million of severance and relocation expenses associated with the relocation of our European commercial, medical and administrative headquarters from France to the United Kingdom, an increase in medical education costs of $5.6 million, an increase in journal advertising costs of $4.6 million, as well as a general expansion of our sales and marketing activities worldwide. These increases were partially offset by a decrease in bad debt expense of $5.7 million as a result of higher collections in certain European countries.
SG&A expenses in 2004 were $302.8 million compared to $233.3 million for 2003, which includes the reclassification of Phase 4 clinical trial expenses to R&D as mentioned above. The significant increase in expenses in 2004 compared to 2003 is primarily related to an increase in salaries of $14.2 million due largely to higher headcount, an increase in consulting fees of $5.9 million related to Sarbanes-Oxley compliance and business strategy consulting, as well as an increase in costs of $12.6 million relating to speakers programs, grants and journal advertising. The remainder of the increase in SG&A expenses in 2004 as compared to 2003 was generally due to our increased global marketing efforts and expanded 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 responsible for global commercial operations and strategy for our product portfolio.
In 2006, we expect SG&A expenses to increase primarily due to the anticipated costs associated with launching and supporting Truvada in various countries, costs related to our ongoing investment in our global commercial organization through hiring and promotional programs as well as the impact of expensing share-based payments.
Purchased In-process Research and Development
In connection with the acquisition of the net assets of Triangle Pharmaceuticals, Inc. (Triangle) completed in January 2003, we recorded purchased in-process R&D expenses of $488.6 million in the first quarter of 2003. The charge was due to Triangles incomplete R&D 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 R&D 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 follows, updated for subsequent changes in status of development:
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 R&D 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 although we are 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.
Gain on Warrant
Pursuant to our agreement with Eyetech Pharmaceuticals, Inc. (Eyetech), as predecessor to OSI, that we 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, in 2004.
Make-Whole Payment on Convertible Debt Redemption
In October 2004, we called for the redemption of all our 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 Gilead 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, we made aggregate make-whole payments of $7.4 million to note holders.
Interest and Other Income, net
We recorded interest and other income, net of $47.1 million in 2005, $18.9 million in 2004 and $13.0 million in 2003. The increases in 2005 and 2004 are primarily attributable to the higher cash balances over the previous year. Interest income in 2006 will depend principally upon prevailing interest rates and the level of our cash, cash equivalent and marketable securities balances.
We incurred interest expense of $0.4 million in 2005, compared with $7.3 million in 2004 and $21.9 million in 2003. The decrease in 2005 over 2004 is primarily attributable to the conversion of our $345.0 million 2% convertible senior notes into shares of our common stock in November 2004. The decrease in 2004 over 2003 is primarily due to the conversion of our $250.0 million 5% convertible subordinated notes into shares of our common stock in December 2003. We expect interest expense in 2006 to increase as a result of the interest we will be paying under the $300.0 million five-year term loan that we entered into in December 2005.
Minority Interest in Joint Venture
The minority interest reflects BMSs interest in the operating results of our joint venture with BMS in the United States. The operations of the joint venture commenced in 2005 with activities primarily focusing on the the triple product and achieving bioequivalence with the various co-formulations. With the achievement of a successful formulation in the fourth quarter of 2005, we expect a significant increase in activities during 2006, especially if FDA and commercial approval is obtained.
Provision for (Benefit from) Income Taxes
Our provision for (benefit from) income taxes was $347.9 million, $207.1 million and ($95.5) million in 2005, 2004 and 2003, respectively. The 2005 effective income tax rate of 29.9% differs from the U.S. federal statutory rate of 35% due generally to the recognition of previously unbenefitted net operating losses and tax credit carryforwards, certain earnings from operations in jurisdictions with lower tax rates than the United States and in jurisdictions for which no U.S. taxes have been provided because such earnings are planned to be reinvested indefinitely outside the United States and the benefit derived from the qualifying dividend made under the American Jobs Creation Act (AJCA), partially offset by state taxes.
On October 22, 2004, the AJCA was signed into law. The AJCA allows for a deduction of 85% of certain qualified foreign earnings that are repatriated, as defined in the AJCA. We elected to apply this provision to qualifying earnings that were repatriated in 2005. The earnings repatriation resulted in a one-time tax provision benefit of approximately $25.1 million, which includes the reversal of the deferred tax liability previously accrued on unremitted foreign earnings of $13.1 million at December 31, 2004.
The 2004 effective income tax rate of 31.5% differs from the U.S. federal statutory rate of 35% due generally to the recognition of previously unbenefitted net operating losses and tax credit carryforwards and certain earnings from operations in jurisdictions with lower tax rates than the United States and in jurisdictions for which no U.S. taxes have been provided because such earnings are planned to be reinvested indefinitely outside the United States, partially offset by state taxes.
The tax benefit in 2003 includes the reversal of our valuation allowance against certain of our deferred tax assets. In December 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 our recorded tax benefit was income tax expense associated with income earned by our foreign subsidiaries, foreign losses at lower tax rates and the non-tax deductibility of purchased in-process R&D. We had significant net operating loss carryforwards that 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 R&D, our effective tax rate for 2003 was 5%.
Liquidity and Capital Resources
The following table summarizes our cash, cash equivalents and marketable securities, our working capital, and our statements of cash flows (in thousands):
Cash, Cash Equivalents and Marketable securities
Cash, cash equivalents and marketable securities totaled $2.32 billion at December 31, 2005, an increase of 85% from December 31, 2004. Cash, cash equivalents and marketable securities totaled $1.25 billion at December 31, 2004, an increase of 77% from December 31, 2003. The increase of $1.07 billion in 2005 and $547.0 million in 2004 was primarily due to:
These increases were partially offset by capital expenditures of $46.9 million in 2005 and $51.4 million in 2004.
Working capital at December 31, 2005 was $2.64 billion compared to $1.60 billion at December 31, 2004. Significant factors that resulted in an increase in 2005 working capital were:
These increases were partially offset by:
Working capital at December 31, 2004 was $1.60 billion compared to $1.08 billion at December 31, 2003. Significant factors that resulted in an increase in 2004 working capital were:
The increases in the 2004 working capital were partially offset by:
Cash Provided by Operating Activities
Cash provided by operating activities was primarily driven by increases in our net income, which has been and is expected to continue to be our primary recurring source of cash. The increase in cash provided by operating activities during the year ended December 31, 2005 of $715.1 million is primarily attributed to our product sales growth, increased cash collections from customers as well as payments received related to the resolution of our dispute with Roche, partially offset by the $341.3 million of prepaid royalties that we made to Emory.
Cash Used in Investing Activities
Cash used in investing activities primarily related to purchases, sales and maturities of available-for-sale securities and capital expenditures. We used $691.9 million of cash for investing activities during 2005, compared to $490.8 million during 2004 and $727.3 million in 2003. Increases in cash used in investing activities were primarily due to increases in cash and cash equivalents balances year over year. Net cash used in investing activities for purchases of available-for-sale securities increased in 2005 to $644.0 million, compared to $439.5 million in 2004 and $190.2 million in 2003. Cash used in investing activities was higher in 2003 compared to 2004, due to the $375.5 million we paid for the acquisition of Triangles net assets and the $123.0 million paid for the purchase of our Foster City facilities.
Capital expenditures made in 2005 related primarily to expanding certain aspects of our manufacturing capabilities as well as upgrading our facilities. Our capital expenditures in 2004 were primarily for facilities improvements, including approximately $26.0 million associated with the completion of our pilot plant in Foster City to 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.
Cash Provided by Financing Activities
Cash provided by financing activities in 2005 primarily related to proceeds from our $300.0 million term loan as well as stock option exercises and stock purchases made under our employee stock plans. We also received $143.3 million, $78.8 million and $83.8 million in 2005, 2004 and 2003, respectively, relating to stock option exercises and stock purchases under our employee stock purchase plan.
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:
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 2004 for the potential issuance of up to $500.0 million of our securities. If such funding is required, we cannot assure that it will be available on favorable terms, if at all.
In December 2005, we entered into an agreement with a syndicate of banks, to provide for a five-year $500.0 million senior credit facility. The $500.0 million facility comprised an uncollateralized $300.0 million term loan and an uncollateralized $200.0 million revolving credit facility. The proceeds from the term loan were used in December 2005 to facilitate a qualified intercompany cash dividend distribution of $280.0 million from Gilead Biopharmaceutics Ireland Corporation (GBIC), a wholly-owned Irish subsidiary of Gilead, to the U.S. parent company, Gilead Sciences, Inc., as part of the repatriation of our qualified foreign earnings under the provisions of the AJCA. Under the terms of the $300.0 million term loan, the minimum principal payments to be repaid at the end of each calendar quarter, beginning March 31, 2006, are $15.0 million. As of December 31, 2005, there were no amounts outstanding under the $200.0 million revolving credit facility. The capacity of the revolving credit facility will increase to a maximum of $500.0 million as the $300.0 million term loan is repaid. We have the ability to irrevocably cancel any unutilized portion of the revolving credit facility, in whole or in part.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that are currently material or reasonably likely to be material to our financial position or results of operations.
Our contractual obligations consist of capital and operating leases, as well as purchase obligations primarily in the form of capital commitments, purchase obligations for active pharmaceutical ingredients and inventory-related items and clinical trials contracts. The following table summarizes our enforceable and legally binding obligations, future commitments and obligations related to all contracts that we are likely to continue regardless
of the fact that they are cancelable as of December 31, 2005. The following table summarizes these contractual obligations at December 31, 2005 (in thousands):
Recent Accounting Pronouncements
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 supersedes Accounting Principles Board Opinion (APB) 25 and amends SFAS No. 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 income statement based on their fair values, beginning with the first quarterly period after June 15, 2005, with early adoption permitted. On April 14, 2005, the Securities and Exchange Commission adopted a new rule that amended the compliance date for SFAS 123R such that we are allowed to adopt the new standard effective January 1, 2006. The pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition under SFAS 123R. We adopted SFAS 123R on January 1, 2006.
Under SFAS 123R, we must determine the appropriate fair value model and related assumptions to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at the date of adoption. The transition methods include modified prospective and retroactive adoption methods. The modified 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 have determined that we will adopt the modified prospective method and continue to use the Black-Scholes option valuation model. Based on our preliminary analysis, we expect that the adoption of SFAS 123R will have a material impact on our income statement and earnings per share. We currently estimate the impact to be approximately $0.15 to $0.17 per diluted share for 2006. SFAS 123R also requires the benefit of tax deductions in excess of recognized compensation cost to be reported in the statement of cash flows as a financing cash flow, rather than as an operating cash flow as required under current accounting literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption.
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 countries outside the United States, including 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.
We enter into foreign exchange forward contracts to mitigate the impact of changes in currency exchange rates on cash flows from our sales denominated in foreign currency, as well as foreign currency-denominated net monetary assets and 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. We use forward contracts to hedge a percentage of our forecasted international sales, primarily those denominated in the Euro currency. In recent years, foreign currency exchange fluctuations have both positively and negatively impacted product sales and gross margin; however, the full impact of the foreign currency fluctuations have been moderated by our hedge program.
The following table summarizes the notional amounts, average currency exchange rates and fair values of our open foreign exchange forward contracts at December 31, 2005. 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, 2005 (notional amounts and fair values in U.S. dollars in thousands):
The total notional amount of $732.0 million and fair value of $11.3 million on our open foreign exchange forward contracts at December 31, 2005 compares with a 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. The significant increase in the notional amount of outstanding contracts from 2004 to 2005 is primarily attributed to the projected increase in product sales over the forecasted periods.
Interest Rate Risk
Our portfolio of available-for-sale investment securities and our variable-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 and 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:
The following table summarizes the expected maturities and average interest rates of our interest-generating assets and interest-bearing liabilities at December 31, 2005 (dollars in thousands):
International Credit Risk
Our accounts receivable balance at December 31, 2005 was $396.1 million compared to $371.2 million at December 31, 2004. The growth in our accounts receivable balances was primarily due to higher product sales for Viread and Truvada 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, 2005, our past due accounts receivable for Greece, Italy, Portugal and Spain totaled $156.9 million, of which $81.0 million was more than 120 days past due based on contractual terms of the receivables. To date, we have not experienced significant losses with respect to the collection of our accounts receivable and we believe that substantially all of 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 58 of this report and are incorporated herein by reference.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
An evaluation as of December 31, 2005 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 Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our evaluation, we concluded that our internal control over financial reporting was effective as of December 31, 2005.
Our independent registered public accounting firm, Ernst & Young LLP, has audited the consolidated financial statements included in this Annual Report on Form 10-K and have issued a report on managements assessment of our internal control over financial reporting as well as on the effectiveness of our internal control over financial reporting as of December 31, 2005. The report on the audit of internal control over financial reporting appears below.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders of Gilead Sciences, Inc.
We have audited managements assessment, included in the accompanying Managements Report on Internal Control Over Financial Reporting included in Item 9A, that Gilead Sciences, Inc. maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Gilead Sciences, Inc.s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on managements assessment and an opinion on the effectiveness of Gilead Sciences, Inc.s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, managements assessment that Gilead Sciences, Inc. maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Gilead Sciences, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Gilead Sciences, Inc. as of December 31, 2005 and 2004, and the related consolidated statements of operations, stockholders equity and cash flows for each of the three years in the period ended December 31, 2005, and the related financial statement schedule and our report dated February 17, 2006 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
Palo Alto, California
February 17, 2006
(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, 2005, 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 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 our 2006 Annual Meeting of Stockholders (the Proxy Statement) under the headings Nominees, Executive Officers, 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 (under Corporate Governance). 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 Compensation of Executive Officers, Report of the Compensation Committee on Executive Compensation, Compensation Committee Interlocks and Insider Participation and Performance Measurement Comparison.
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 Certain Relationships and Related Party Transactions and Compensation of Executive Officers.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this item is incorporated by reference to the section of our Proxy Statement under the heading Principal Accounting Fees and Services.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this Annual Report on Form 10-K:
(1) Index list to Financial Statements:
(2) Schedule II is included on page 98 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:
GILEAD SCIENCES, INC.
CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2005, 2004 and 2003
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders of Gilead Sciences, Inc.
We have audited the accompanying consolidated balance sheets of Gilead Sciences, Inc. as of December 31, 2005 and 2004, and the related consolidated statements of operations, stockholders equity, and cash flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the management of Gilead Sciences, Inc. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Gilead Sciences, Inc. at December 31, 2005 and 2004, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Gilead Sciences, Inc.s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 17, 2006 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
Palo Alto, California
February 17, 2006
Consolidated Balance Sheets
(in thousands, except per share amounts)
See accompanying notes.
Consolidated Statements of Operations
(in thousands, except per share amounts)
See accompanying notes.
Consolidated Statement of Stockholders Equity
See accompanying notes.
Consolidated Statements of Cash Flows