Savient Pharmaceuticals 10-Q 2005
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended March 31, 2004
Commission File Number 0-15313
SAVIENT PHARMACEUTICALS, INC.
(Exact name of registrant as specified in its charter)
One Tower Center, East Brunswick, New Jersey 08816
(Address of principal executive offices)
(Registrants telephone number, including area code)
(Former name, former
address and former fiscal year,
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No o
Indicate the number of shares outstanding of each of the issuers classes of Common Stock, as of the latest practicable date.
Common Stock, par value $.01 per share, outstanding as of May 3, 2004: 59,941,551
Savient Pharmaceuticals, Inc. is filing this Amendment No. 1 to Quarterly Report on Form 10-Q/A for the quarter ended March 31, 2004 to reflect the restatement of its unaudited financial statements for the quarterly period ended March 31, 2004. As previously announced in its Current Report on Form 8-K filed on January 6, 2005 with the Securities and Exchange Commission (the SEC), the restatement results from a change in the manner in which Savient recognizes revenue for certain of its product sales, as more fully described in Part I, Item 1, Note 7 of this Form 10-Q/A. The change described above will have no effect on Savients previously reported results for the full year ended December 31, 2003.
This Form 10-Q/A has not been updated except as required to reflect the effects of the restatement. This Form 10-Q/A includes changes to Part I, Items 1, 2 and 4, and Part II, Item 6. Except as identified in the prior sentence, no other items included in the original Form 10-Q have been amended, and such items remain in effect as of the filing date of the original Form 10-Q. Additionally, this Form 10-Q/A does not purport to provide an update or a discussion of any other developments at the Company subsequent to the original filing.
SAVIENT PHARMACEUTICALS, INC. AND SUBSIDIARIES
The accompanying notes are an integral part of these consolidated financial statements.
SAVIENT PHARMACEUTICALS, INC. AND SUBSIDIARIES
The accompanying notes are an integral part of these consolidated financial statements.
SAVIENT PHARMACEUTICALS, INC. AND SUBSIDIARIES
The accompanying notes are an integral part of this consolidated financial statement.
SAVIENT PHARMACEUTICALS, INC. AND SUBSIDIARIES
The accompanying notes are an integral part of these consolidated financial statements.
SAVIENT PHARMACEUTICALS, INC.
Throughout these Notes to Consolidated Financial Statements, all amounts and comparisons reflect balances and amounts on a restated basis. For information on the restatements, see Note 7, Restatement.
Note 1: Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of management, the unaudited interim financial statements furnished herein include all adjustments necessary for a fair presentation of the Companys financial position at March 31, 2004 and the results of its operations and cash flows for the three months ended March 31, 2004 and 2003. All such adjustments are of a normal and recurring nature. Interim financial statements are prepared on a basis consistent with the Companys annual financial statements. Results of operations for the three month period ending March 31, 2004 are not necessarily indicative of the operating results that may be expected for the year ending December 31, 2004.
The consolidated balance sheet as of December 31, 2003 has been derived from the audited financial statements at that date but does not include all of the information and notes required by accounting principles generally accepted in the United States of America for complete financial statements.
For further information, refer to the consolidated financial statements and notes thereto included in the Companys Annual Report on Form 10-K for the year ended December 31, 2003.
Note 2: Inventories
Inventories are stated at the lower of cost or market. Cost is determined using the weighted-average method. If inventory costs exceed expected market value due to obsolescence or unmarketability, reserves are recorded for the difference between the cost and the market value. These reserves are determined based on estimates.
Inventories at March 31, 2004 and December 31, 2003 are summarized below:
Note 3: Net Product Sales
Product sales are recognized when title to the product has transferred to our customers in accordance with the terms of sale, and when collectability is probable, net of discounts, sales incentives, sales allowances and sales returns. The terms of sale offered to customers include transfer of title upon delivery, transfer of title upon delivery to the customers shipper or carrier, and transfer of title upon shipping.
Through December 31, 2003, sales returns have been minimal and insignificant to the Companys results of operations. In the three months ended March 31, 2004, the Company recorded a sales return
SAVIENT PHARMACEUTICALS, INC.
allowance of $1,085,000 to cover anticipated returns of the 10-mg Oxandrin tablet. No allowance regarding other products, where a right to return exists, is deemed necessary as a result of longer shelf lives and higher inventory turnover. The Company will continue to monitor all products to assure that future allowances for returns are recorded as appropriate. The Companys estimate of the allowance for returns will be based on a variety of factors including actual return experience of that product or similar products, estimated sales by the Companys wholesaler customers and other relevant factors. Changes in facts and circumstances and the demand for the Companys products could result in material changes in the amount of product returned to the Company, and actual results may differ materially from the Companys estimates. The Company will regularly review the factors that influence its estimates and, if necessary, make adjustments when it believe that actual product returns may differ from established reserves.
Note 4: Earnings Per Share of Common Stock
The Company has applied Statement of Financial Accounting Standards (SFAS) No. 128, Earnings Per Share in its calculation and presentation of earnings per share - basic and diluted. Basic earnings per share are computed by dividing income available to common stockholders (the numerator) by the weighted average number of common shares (the denominator) for the period. The computation of diluted earnings per share is similar to basic earnings per share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potentially dilutive common shares had been issued.
The numerator in calculating both basic and diluted earnings per common share for each period presented is the reported net income. The denominator is based on the following weighted average number of common shares:
The difference between basic and diluted weighted average common shares resulted from the assumption that the dilutive stock options outstanding were exercised. For the three months ending March 31, 2004 and 2003, options to purchase 6,298,000 shares and 9,880,000 shares, respectively, were not included in the diluted earnings per share calculation as their effect would have been anti-dilutive.
Note 5: Stock-based compensation
As permitted by SFAS No. 123, Accounting for Stock Based Compensation, the Company accounts for stock-based compensation arrangements with employees in accordance with provisions of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. Compensation expense for stock options issued to employees is based on the difference on the date of grant between the fair value of the Companys stock and the exercise price of the option. No stock-based employee compensation cost is reflected in net income, as all options granted had an exercise price equal to the market value of the underlying common stock at the date of grant. The Company accounts for equity instruments issued to nonemployees in accordance with the provisions of SFAS No. 123 and Emerging
SAVIENT PHARMACEUTICALS, INC.
Issues Task Force (EITF) Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction With Selling, Goods or Services. All transactions in which goods or services are the consideration received for the issuance of equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable.
The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based compensation:
Note 6 : Commitments and Contingencies
The Company has received notification of claims filed that certain of its products may infringe certain third-party patents in the normal course of operations. Management believes that these claims have no merit, and the Company intends to defend them vigorously and does not expect significant adverse impact on its financial position, results of operations or cash flows as a result of the outcome. However, were an unfavorable ruling to occur in any subsequent period, there exists the possibility of a material adverse impact on the operating results. No accrual can be determined at this time.
On December 20, 2002, a purported shareholder class action was filed against the Company and three of its officers. The action is pending under the caption A.F.I.K. Holding SPRL v. Fass, No. 02-6048 (HAA) in the U.S. District Court for the District of New Jersey and alleges violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. Plaintiff purports to represent a class of shareholders who purchased shares of the Company between April 19, 1999 and August 2, 2002. The complaint asserts that the Companys financial statements were materially false and misleading because the Company restated its earnings and financial statements for the years ended 1999, 2000 and 2001, as reflected in the Companys Form 8-K and accompanying press release issued August 2, 2002. Five virtually identical actions were filed in January and February 2003. In September 2003, the actions were consolidated and co-lead plaintiffs and co-lead counsel were appointed in accordance with the Private Securities Litigation Reform Act. The lead plaintiffs filed an amended consolidated complaint in March, 2004.
SAVIENT PHARMACEUTICALS, INC.
On October 27, 2003, the Company received a letter addressed to the Board of Directors from attorneys for a purported stockholder of the Company demanding that Savient commence legal proceedings to recover its damages against directors who served on the Companys board immediately prior to the June 2003 Annual Meeting of Stockholders, Fulbright & Jaworski L.L.P., Arthur Andersen LLP, the partners of Arthur Andersen responsible for the audit of Savients financial statements for 1999, 2000 and 2001, as well as all other officers and directors responsible for the alleged wrongdoing. The letter claims that some or all of these persons were responsible for the material overstatement of Savients assets, earnings and net worth, and that these persons caused Savient to disseminate false and misleading press releases and filings with the SEC. An advisory committee to the Board, consisting of directors who were not directors prior to the June 2003 Annual Meeting of Stockholders, is currently investigating the demand.
The Company intends to vigorously defend against all allegations of wrongdoing. The Company has referred these claims to its directors and officers insurance carrier, which has reserved its rights as to coverage with respect to these actions.
The Company is obligated under certain circumstances to indemnify certain customers for certain or all expenses incurred and damages suffered by them as a result of any infringement of third-party patents. In addition the Company is obligated to indemnify its officers and directors against all reasonable costs and expenses related to stockholder and other claims pertaining to actions taken in their capacity as officers and directors which are not covered by the Companys directors and officers insurance policy. These indemnification obligations are in the regular course of business and in most cases do not include a limit on a maximum potential future payments, nor are there any recourse provisions or collateral that may offset the cost. As of March 31, 2004, the Company has not recorded a liability for any obligations arising as a result of these indemnification obligations.
The United States Internal Revenue Service is conducting an audit of the Companys tax return for the year ended December 31, 2002. The Company is also subject to other ongoing tax audits in the City of New York and State of New Jersey. Although there can be no assurances, the Company believes any adjustments that may arise as a result of these audits will not have a material adverse effect on its financial position.
The Company has historically recognized product revenues when product shipped and collectability was probable, net of discounts, sales incentives, sales allowances and reserves for sales returns. However, the Company has determined that its contracts with its most significant U.S.-based customers have included terms that transfer title to product upon delivery. These contracts cover the majority of the Companys sales to U.S. drug wholesalers beginning in 2003. In general, the Companys shipping methods take up to five business days from shipment until delivery. As a result, some revenues were recognized up to five days earlier than permitted under generally accepted accounting principles. This correction does not affect the amount of revenue that the Company will ultimately recognize, although it will affect (by one to five days) the timing of revenue recognition. As a result, some shipments made during the final week of a quarter should have been recognized in the subsequent quarter.
The Company has restated its previously issued financial statements for the quarterly period ended March 31, 2004.
SAVIENT PHARMACEUTICALS, INC.
The following tables disclose the impact of the restatement:
PHARMACEUTICALS, INC. AND SUBSIDIARIES
SAVIENT PHARMACEUTICALS, INC. AND SUBSIDIARIES
Statements in this Quarterly Report on Form 10-Q concerning Savients business outlook or future economic performance; anticipated profitability, revenues, expenses or other financial items; introductions and advancements in development of products, and plans and objectives related thereto; and statements concerning assumptions made or expectations as to any future events, conditions, performance or other matters, are forward-looking statements as that term is defined under the Federal Securities Laws. Forward-looking statements are subject to risks, uncertainties and other factors which could cause actual results to differ materially from those stated in such statements. Such risks, uncertainties and factors include, but are not limited to, the timing of the introduction of a generic version of Oxandrin, changes and delays in product development plans and schedules, changes and delays in product approval and introduction, customer acceptance of new products, development, introduction or consumer acceptance of competing products, changes in pricing or other actions by competitors, patents owned or licensed by Savient and its competitors, changes in healthcare reimbursement, risk of operations in Israel, risk of product liability, governmental regulation, dependence on third parties to manufacture products and commercialize products and general economic conditions, as well as other risks detailed in our filings with the Securities and Exchange Commission, including our Annual Report on Form 10-K, for the year ended December 31, 2003.
The unaudited interim financial statements as of March 31, 2004 and for the three month period ended March 31, 2004 included in this Form 10-Q/A have been restated as discussed in Item 1, Part I, Note 7 of this Form 10-Q/A. For purposes of this Form 10-Q/A, and in accordance with Rule 12b-15 under the Securities Exchange Act of 1934, as amended, each item of the Form 10-Q for the quarter ended March 31, 2004, as originally filed with the Securities and Exchange Commission on May 10, 2004 (the Original Form 10-Q) that was affected by the restatement has been amended and restated to the extent affected. The disclosure contained in the Original Form 10-Q has not been updated or modified except for updates made to Part I, Items 1, 2 and 4, and Part II, Item 6, solely to reflect the impact of the restatement and related matters.
We are engaged in the research, development, manufacture and marketing of pharmaceutical products that address unmet medical needs in both niche and larger market segments. We distribute our products on a worldwide basis primarily through a direct sales force in the United States (including both Savient employees and representatives of a contract sales organization), the United Kingdom (for our oral liquid products) and Israel and primarily through third-party license and distribution relationships elsewhere. Through a combination of internal research and development, acquisitions, collaborative relationships and licensing arrangements, Savient has assembled a diverse portfolio of therapeutic products, many of which are currently being marketed, several of which are in registration or clinical trials and one of which is in pre-clinical development.
Savient, formerly known as Bio-Technology General Corp., was founded in 1980 to develop, manufacture and market novel therapeutic products. In September 2002, we acquired Rosemont Pharmaceuticals Limited (Rosemont), a specialty pharmaceutical company located in the United Kingdom that develops, manufactures and markets pharmaceutical products in oral liquid form. Savients overall administration, finance, business development, human clinical studies, U.S. sales and marketing activities, quality assurance and regulatory affairs are primarily coordinated at its headquarters in East Brunswick, New Jersey. Pre-clinical studies, research and development activities and manufacturing of our biotechnology-derived products are primarily carried out through Bio-Technology General (Israel) Ltd.
(BTG-Israel), our wholly-owned subsidiary in Israel. Development, manufacture, distribution and sale of our oral liquid products are carried out through Rosemont in the United Kingdom.
Our financial results have been heavily dependent on Oxandrin since we introduced it in December 1995. Sales of Oxandrin accounted for 57% and 44% of our total product sales in the first quarter of 2004 and 2003, respectively. Sales of Oxandrin accounted for 54%, 48% and 46% of our total product sales in 2001, 2002 and 2003, respectively, with the 2002 amount being adversely affected by our change to selling directly to wholesalers rather than through a third-party distributor. In connection with our focus on increasing market acceptance of Oxandrin for the treatment of disease-related weight loss conditions and our commitment to pharmacovigilance, we sponsored a clinical study to investigate the interaction between Oxandrin and warfarin, the active ingredient in many widely-used anti-coagulant drugs. Warfarin is a narrow therapeutic index drug. Therefore, careful titration is required in order to prevent excessive anti-coagulation, which could cause uncontrolled bleeding, or inadequate anti-coagulation, with the risk of failing to prevent the consequences of thromboembolic events such as life-threatening blood clots. The study demonstrated that when warfarin was co-administered with oxandrolone, the usual dose of warfarin necessary to achieve appropriate therapeutic effect should be decreased by 80-85% at the maximum Oxandrin dosage level of 20mg. We submitted the results of this study to the United States Food and Drug Administration (FDA), amended the Oxandrin package insert prescribing information and communicated the package insert change to healthcare professionals in a Dear Healthcare Professional letter in accordance with FDA instructions to ensure that patient safety would not be compromised. In February 2004 we filed a Citizens Petition with the FDA requesting that, in the interest of public health, the FDA establish specific bio-equivalence requirements for oral products containing oxandrolone, the active pharmaceutical ingredient of Oxandrin, because of several unique aspects of such product, including serious safety issues regarding interactions between oxandrolone and anti-coagulant drugs containing the active ingredient warfarin. Given the likely variability in bioavailability of other potential oxandrolone drugs and the careful dose titration required for warfarin in order to prevent excessive anti-coagulation or inadequate anti-coagulation, and their respective risks, we requested in our petition that any company wishing to introduce an oxandrolone product into the U.S. market should, prior to the issuance of marketing approval, be required to also conduct a clinical study to investigate the interaction between their product and warfarin and demonstrate that it is identical to the interaction between Oxandrin and warfarin. As of the date of this report, we have received no indication that the FDA has taken any action on the petition. Several companies have filed drug master files with the FDA relating to a generic oxandrolone product, and while we cannot predict when generic competition for Oxandrin will begin, it is possible the FDA may approve one or more generic versions of Oxandrin as early as mid-2004. The introduction of generic oxandrolone products would materially adversely affect our Oxandrin sales, could materially adversely affect our results of operations, cash flows, financial condition and profitability and may require us to scale back our business activities in certain areas.
We expect that sales of our human growth hormone (hGH) product to our Japanese distributor will continue to decrease due to continuing pricing pressure from the Japanese Ministry of Health. We expect sales of Delatestryl to decrease significantly as a result of the FDAs allowance of the reintroduction of a generic version of Delatestryl into the market in March 2004. We began to depreciate our new manufacturing facility and certain equipment in January 2004. We estimate that depreciation expense will aggregate approximately $3,500,000 to $4,000,000 annually once all equipment at this facility is placed in service. As a result, cost of sales as a percentage of product sales will increase in 2004 as compared to 2003. In light of the possible reduction in our revenues due to the foregoing, we have reduced our research and development activities. We currently intend only to pursue the development of Prosaptide through the completion of Phase II trials, at which point we will look to license commercialization rights to one or more third parties, and the development of Puricase. We are awaiting FDA approval of our sodium hyaluronate for osteoarthritis product (Savient HA) and assessing its commercial potential.
Our discussion and analysis of financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP. Applying GAAP requires our judgment in determining the appropriateness of acceptable accounting principles and methods of application in diverse and complex economic activities. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of revenues, expenses, assets and liabilities, and related disclosure of contingent assets and liabilities. Our critical accounting policies are discussed in our Annual Report on Form 10-K for the year ended December 31, 2003 in the section Managements Discussion and Analysis of Financial Condition and Results of Operations. We base our estimates on historical experience and other assumptions we believe are reasonable under the circumstances. In addition to the critical accounting policies referred to above, we have identified the following additional critical accounting policy:
Net Product Sales. We recognize product sales when title to the product has transferred to our customers in accordance with the terms of sale, and when collectability is probable, net of discounts, sales incentives, sales allowances and sales returns. The terms of sale offered to customers include transfer of title upon delivery, transfer of title upon delivery to the customers shipper or carrier, and transfer of title upon shipping.
Through December 31, 2003, sales returns have been minimal and insignificant to our results of operations. In the three months ended March 31, 2004, we recorded a sales return allowance of $1,085,000 to cover anticipated returns of the 10-mg Oxandrin tablet. No allowance regarding other products, where a right to return exists, is deemed necessary as a result of longer shelf lives and higher inventory turnover. We will continue to monitor all products to assure that future allowances for returns are recorded as appropriate. Our estimate of the allowance for returns will be based on a variety of factors including actual return experience of that product or similar products, estimated sales by our wholesaler customers and other relevant factors. Changes in facts and circumstances and the demand for our products could result in material changes in the amount of product returned to us, and actual results may differ materially from our estimates. We will regularly review the factors that influence our estimates and, if necessary, make adjustments when we believe that actual product returns may differ from established reserves.
The following tables set forth for the fiscal periods indicated the percentage of revenues represented by certain items reflected on our statements of operations.
Savient has historically derived its revenues from product sales as well as from collaborative arrangements with third parties, under which Savient may earn up front contract fees, may receive funding for additional research (including funding from the Office of the Chief Scientist of the State of Israel (Chief Scientist)), is reimbursed for producing certain experimental materials, may be entitled to certain milestone payments, may sell product at specified prices and may receive royalties on sales of product. We anticipate that product sales will constitute the majority of our revenues in the future. Revenues have in the past displayed and will in the immediate future continue to display significant variations due to changes in demand for our products, new product introductions by Savient and its competitors, the obtaining of new research and development contracts and licensing arrangements, the completion or termination of such contracts and arrangements, the timing and amounts of milestone payments, and the timing of regulatory approvals of products.
The decrease in the value of the U.S. dollar against the British pound sterling positively impacted Rosemonts revenues measured in U.S. dollars and negatively impacted Rosemonts expenses measured in U.S. dollars. This decrease also positively impacted our overall net income.
The following table summarizes Savients sales of its commercialized products as a percentage of total product sales for the periods indicated:
We believe that our product mix will vary from period to period based on the purchasing patterns of our customers and our focus on: (i) increasing market penetration of our existing products; (ii) expanding into new markets; and (iii) commercializing additional products. In particular, quarterly fluctuations in sales of Oxandrin can have a significant impact on our quarterly results of operations.
The following table summarizes our U.S., United Kingdom and other international product sales as a percentage of total product sales for the period indicated:
Comparison of Three Months Ended March 31, 2004 and March 31, 2003.
Revenues. Total revenues increased 19.4% in the three months ended March 31, 2004 to $33,403,000 from $27,976,000 in the three months ended March 31, 2003. The increase in total revenues from the comparable prior period was mainly due to the increase in product sales.
Product sales, net increased by $5,251,000, or 19.5%, in the three months ended March 31, 2004 from the comparable prior period in 2003. The increase in product sales, net was attributable to the increase in sales of Oxandrin and oral liquid pharmaceutical products, partially offset by decreases in sales of human growth hormone and Delatestryl.
Oxandrin sales in the three months ended March 31, 2004 were $18,423,000, an increase of $6,560,000 or 55.3%, from the three months ended March 31, 2003. The increase in Oxandrin sales in the first quarter of 2004 as compared to the first quarter of 2003 is due in large part to increased end-user demand, interim price increases since the first quarter of 2003, increased wholesaler purchases in anticipation of an announced April 2004 price increase and the completion, in the first quarter of 2003, of our transition to a direct to wholesaler sales model, which adversely affected sales in the first quarter of 2003, partially offset by a provision for returns of expiring 10-mg product. Until the fourth quarter of 2002, Savient sold its Oxandrin to Accredo Health, Incorporated and its predecessors, which then sold the product to wholesalers. With the introduction of the 10-mg tablet, Savient began to sell Oxandrin directly to wholesalers, although Accredo continued to distribute the 2.5-mg Oxandrin tablet through the first quarter of 2003 until it completed the liquidation of its inventory position in March 2003. Oxandrin sales in the first
quarter of 2003 were lower than actual demand as Accredo reduced its then inventory levels by selling more product to wholesalers than it purchased from Savient. Historically, we have experienced almost no returns on the 2.5-mg Oxandrin tablet because of its five year shelf-life. However, the 10-mg tablet currently only has a two-year shelf life. In the first quarter of 2004 we recorded a sales return allowance of $1,085,000 to cover anticipated returns of the 10-mg Oxandrin tablet that was produced in the second half of 2002 for the initial launch of the 10-mg tablet. We will continue to monitor the product to assure that future reserves for returns are recorded as appropriate. Changes in facts and circumstances and the demand for Oxandrin could result in material changes in the amount of Oxandrin returned to us, and actual results may differ materially from our estimates.
Sales of human growth hormone were $1,928,000 in the first quarter of 2004, a decrease of $2,502,000, or 56.5%, from the comparable period in 2003. Sales to our European distributor decreased to $1,360,000 in 2004 from $2,700,000 in 2003. Sales to our Japanese distributor were $1,375,000 in the first quarter of 2003; we had no sales to this distributor in the same period in 2004.
Sales of oral liquid pharmaceutical products in the three months ended March 31, 2004 were $7,204,000, an increase of $1,582,000, or 28.1%, compared to the first quarter of 2003. A portion of the increase was attributable to the decrease in the value of the U.S. dollar against the British pound sterling. Measured in pounds sterling, Rosemonts sales in the three months ended March 31, 2004 increased 12% over the three months ended March 31, 2003.
Sales of Delatestryl in the three months ended March 31, 2004 were $2,704,000, a decrease of $446,000, or 14.2%, compared to the first quarter of 2003. Sales in the first quarter of 2003 were favorably impacted by customer purchases in anticipation of a price increase. In addition, a competing generic product was reintroduced into the market in March 2004. We expect our Delatestryl sales for the remainder of 2004 to be significantly lower than our 2003 sales of $12,343,000 due to the reintroduction of the competing generic product. Changing wholesaler expectations of market demand for Delatestryl and the availability of supply of Delatestryl and competing products have caused significant volatility in Delatestryl sales in recent years and quarters.
Contract fees in the three month periods ended March 31, 2004 and 2003 represent mainly contract fees received in prior periods but recognized in the three months ended March 31, 2004 and 2003 in accordance with SAB 101.
Royalties were $932,000 in the three months ended March 31, 2004, as compared to $523,000 in the same period last year. These revenues consist mainly of royalties from Mircette, Silkis and insulin products. Royalties from Mircette were $662,000 in the first quarter of 2004 compared to $386,000 in the same period of 2003. Mircette royalties are initially based on estimates using actual sales in prior quarters, since Mircette sales are reported to us on a quarterly basis approximately 90 days following the end of a quarter; we true up actual sales and our estimates in the following quarter once actual sales numbers are received. A generic version of Mircette was introduced in 2003.
Other revenues were primarily generated from partial research and development funding by the Chief Scientist of the State of Israel in the first quarter of 2004 and contract manufacturing for third parties in the first quarter of 2003.
Research and development expense increased 34.4% in the three months ended March 31, 2004 to $8,664,000 from $6,448,000 in the three months ended March 31, 2003. The increase was mainly attributable to increases in the clinical trial and product development expenses related to Prosaptide, Puricase, Soltamox, our oral liquid formulation of tamoxifen, an off-patent drug for the treatment of both advanced and early stage breast cancers, other oral liquid products and Oxandrin, partially offset by a reduction in research and pre-clinical activities and associated compensation costs.
Marketing and sales expense in the three months ended March 31, 2004 increased by 1.4% to $6,666,000 from $6,571,000 last year. As a percentage of product sales, marketing and sales expense decreased to approximately 20.7% in the first quarter of 2004 from 24.4% for the three months ended March 31, 2003, primarily because our product sales grew faster than our marketing and sales expense. These expenses primarily related to the sales and marketing force in the United States that the Company established to promote distribution of Oxandrin in the United States and Rosemonts marketing and sales force.
General and administrative expense increased by 6.4% in the three months ended March 31, 2004 to $5,372,000 from $5,051,000 in the comparable prior period. The $321,000 increase in general and administrative expense was mainly attributable to increases in insurance premiums, consulting expenses and compensation expenses, partially offset by a decrease in legal expenses relating to patent litigation and the stockholder class action litigation.
Cost of sales increased by 92.8% in the three months ended March 31, 2004 to $8,651,000 from $4,486,000 in the three months ended March 31, 2003. Cost of sales as a percentage of product sales increased to 26.9% in the three months ended March 31, 2004 from 16.6% in the comparable period last year. The major portion of the increase is attributable to expenses of $2,331,000 for the three months ended March 31, 2004 relating to the operation of the new Beer Tuvia manufacturing facility. Comparable costs had been capitalized during the three months ended March 31, 2003, as the facility was not yet ready for its intended use. Additionally, depreciation of the Beer Tuvia facility, including certain equipment placed in service, commenced during the three months ended March 31, 2004, resulting in an additional charge to cost of sales of $563,000. The remaining $1,283,000 of the increase is attributable principally to the cost of increased sales and, to a lesser extent, the under-absorption of production-related overhead at the Rosemont manufacturing facility attributable to a 3-month shutdown to allow for an upgrade of its manufacturing facility in order to obtain FDA approval to enable Rosemont to manufacture oral liquid products for supply into the U.S. market. Excluding the depreciation charges and the expenses that in the 2003 period were capitalized, cost of sales as a percentage of product sales would have been 17.8%. Oxandrin and human growth hormone have a relatively low cost of manufacture as a percentage of product sales, while BioLon, Delatestryl and Rosemonts products have higher costs to manufacture as a percentage of product sales. Cost of sales as a percentage of product sales varies from year to year and quarter to quarter depending on the quantity and mix of products sold. We expect cost of sales to continue to increase in 2004 as we begin to depreciate more of the equipment for our new manufacturing facility as it comes into service. We currently anticipate that depreciation on the entire facility, including all equipment, will aggregate approximately $3,500,000 to $4,000,000 annually.
Amortization of Intangibles Associated with Acquisition. In connection with the acquisition of Rosemont, we recorded intangibles of $80,800,000, consisting of developed products, trademarks and patents. These intangibles are being amortized, using the straight-line method, over the estimated useful life of approximately 20 years. We recorded $1,013,000 of amortization of these intangibles in the first quarter of 2004 and 2003.
Commissions and royalties expense was $1,403,000 in the three months ended March 31 2004, as compared to $411,000 in the three months ended March 31, 2003, an increase of $992,000, or 241.4%, compared to the first quarter of 2003. The increase is principally due to commissions paid to Ross on their purchases of Oxandrin for the long-term care market. Prior to March 31, 2003, Ross had instead been able, under its agreement with Savient, to purchase Oxandrin at a discount (with the discount being classified as a sales allowance) from Savient and sell it to Accredo for resale to Accredos customers. The remainder of commission and royalties expense consists primarily of royalties to entities from which Savient licensed certain of its products and to the Chief Scientist.
Other income, net decreased by $309,000 from the comparable prior period, mainly due to the fact that interest expense was capitalized in the first quarter of 2003 but expensed in the first quarter of 2004 and lower interest rates.
Income Taxes. Provision for income taxes for the three months ended March 31, 2004 was $529,000, representing approximately 31.0% of income before income taxes, as compared to $1,396,000, or 31.9% of income before income taxes, in the comparable period last year. Savients consolidated effective tax rate differs from the U.S. statutory rate because the U.K. and Israel statutory rates differ from the U.S. statutory rate and various tax benefits, tax credits and similar items which reduce the effective tax rate.
Earnings per Common Share. Savient had approximately 894,000 additional basic weighted average shares outstanding for the three month period ended March 31, 2004 as compared to the same period in 2003. The increased number of basic shares was primarily the result of the issuance, subsequent to March 31, 2003, of shares pursuant to the Companys employee stock purchase plan. Diluted weighted average shares in 2004 was 60,331,000, an approximately 1,436,000 share increase over 2003, due to the increase in the actual number of shares outstanding and option grants in 2003 and 2004, as well as the fact that more outstanding options were considered common equivalents in the first quarter of 2004 because their exercise price was below the average fair market value of the common stock for the first quarter of 2004, which average fair market value was higher than in the comparable period in 2003.
Our working capital at March 31, 2004 was $40,024,000, as compared to $38,913,000 at December 31, 2003.
Our cash flows have fluctuated significantly due to the impact of net income, capital spending, working capital requirements, the issuance of common stock and other financing activities. We expect that cash flow in the near future will be primarily determined by the levels of net income, working capital requirements and financings, if any, undertaken by Savient. Net cash increased by $2,879,000 and $7,081,000 in the three months ended March 31, 2004 and 2003, respectively.
Net cash provided by operating activities was $5,372,000 and $9,767,000 in the three months ended March 31, 2004 and 2003, respectively. Net income was $1,178,000 and $2,982,000 in the same periods, respectively. In the three months ended March 31, 2004, net cash provided by operating activities was greater than net income primarily due to a decrease in accounts receivable of $3,474,000, depreciation and amortization of $1,510,000 and amortization of intangible assets associated with acquisition of $1,013,000 and an increase in accounts payable of $1,096,000, partially offset by a decrease in other current liabilities of $2,616,000. In the three months ended March 31, 2003, net cash provided by operating activities was greater than net income primarily due to a decrease in accounts receivable of $14,447,000, depreciation and amortization of $1,032,000 and amortization of intangible assets associated with acquisition of $1,013,000, partially offset by a decrease in accounts payable and other current liabilities of $7,592,000 and $2,514,000, respectively.
Net cash used in investing activities was $1,610,000 and $1,190,000 in the three months ended March 31, 2004 and 2003, respectively. Net cash used in investing activities included capital expenditures of $1,155,000 and $1,738,000 in these periods, respectively, primarily for the upgrade of Rosemonts manufacturing facility in 2004 and the new manufacturing facility in Israel in 2003, and an investment in Marco Hi-Tech JV, Ltd of $500,000 in 2004. The remainder of the net cash used in investing activities was primarily for purchases and sales of short-term investments.
Net cash used in financing activities was $1,329,000 and $1,325,000 in the three months ended March 31, 2004 and 2003, respectively, representing in both 2004 and 2003, respectively, repayment of
$1,753,000 and $1,668,000 of debt, partially offset by net proceeds from issuance of common stock primarily pursuant to our employee stock purchase plan.
In April 1999, BTG-Israel purchased a manufacturing facility in Israel for approximately $6,500,000 (including local taxes and legal fees). Basic construction of a modern biologics production facility designed to meet FDA cGMP requirements for biologics and devices was completed at the end of 2001. Facility qualification activities conducted during 2002 and 2003 were substantially completed by the end of 2003. Manufacture of sodium hyaluronate for our BioLon and Savient HA products and the filling of our BioLon and Savient HA syringes have been transferred to the new facility, and process validation for Bio-Hep-B manufacture in the new facility is in progress. Production of products cannot be relocated to the new facility until the new facility has received all necessary regulatory approvals, which Savient anticipates will continue through 2005, depending on product and territory. Through March 31, 2004, Savient has spent approximately $42,000,000 to complete construction of the production facility (including capitalized interest but excluding the cost of purchasing the facility and post-completion validation), and approximately $14,631,000 for qualification activities. All of the $1,019,000 spent on qualification activities in the first quarter of 2003 was capitalized, as the facility was not yet ready for its intended use, while the $2,331,000 spent on qualification activities in the first quarter of 2004 was expensed as incurred. Depreciation of this facility began in January 2004. In June 2000 BTG-Israel entered into a $20,000,000 credit facility with Bank Hapoalim B.M. to finance a portion of the cost of completing its new manufacturing facility. Loans under the facility bear interest at the rate of LIBOR plus 1%. The credit facility is secured by the assets of BTG-Israel and has been guaranteed by Savient. At March 31, 2004, Savient had outstanding long-term borrowings of $10,555,000 under the facility, of which $5,000,000 is due during the remainder of 2004 and the remaining $5,555,000 is due in 2005. Borrowings are repaid monthly in equal installments.
In June 2003, Rosemont commenced an upgrade of its manufacturing facility in order to obtain FDA approval to enable Rosemont to manufacture oral liquid products for supply into the U.S. market. The total capital cost for this project is estimated to be approximately $2,000,000, of which approximately $1,600,000 was expended through March 31, 2004, including approximately $870,000 in the three months ended March 31, 2004, and an additional approximately $200,000 was committed at March 31, 2004. The remaining amount will be spent during 2004.
We believe that our cash resources as of March 31, 2004, together with anticipated product sales, will be sufficient to fund our ongoing operations for the foreseeable future. There can, however, be no assurance that product sales will occur as anticipated, that current agreements with third party distributors of our products will not be canceled, that the Chief Scientist will continue to provide funding at current levels or at all, that we will not use a substantial portion of our cash resources to acquire businesses, products and/or technologies, or that unanticipated events requiring the expenditure of funds will not occur. The satisfaction of Savients future cash requirements will depend in large part on the timing and effect of the introduction of generic version(s) of Oxandrin into the market, the status of commercialization of Savients products, Savients ability to enter into additional research and development and licensing arrangements, and Savients ability to obtain additional equity and debt financing, if necessary. There can be no assurance that Savient will be able to obtain additional funds or, if such funds are available, that such funding will be on favorable terms. Savient continues to seek additional collaborative research and development and licensing arrangements in order to provide revenue from sales of certain products and funding for a portion of the research and development expenses relating to the products covered, although there can be no assurance that it will be able to obtain such agreements.
Savient maintains disclosure controls and procedures, as such term is defined under Securities Exchange Act Rule 13a-15(e), that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. In designing and evaluating the disclosure controls and procedures, Savients management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and Savients management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Savient has carried out an evaluation, as of the end of the period covered by this report, under the supervision and with the participation of Savients management, including Savients Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of Savients disclosure controls and procedures.
During the course of their review of the financial information included in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2004, Grant Thornton LLP, our independent auditors, informed our management and our audit committee that they identified deficiencies in our internal controls relating to our communication with and supervision of our accounting staff at our Israeli subsidiary, Bio-Technology General (Israel) Ltd. These deficiencies were identified in connection with the manner in which the accounting staff at our Israeli subsidiary accounted for inter-company revenues and costs of good sold during the second quarter of 2004. Grant Thornton has informed us that they believe that these deficiencies constitute a material weakness in our internal controls. However, we have no reason to believe that this weakness resulted in any material inaccuracies to our financial statements in that the transaction in question has been properly accounted for in the financial statements included in this report.
In response to this situation, we implemented the following steps to remediate this weakness in our internal controls:
· prohibiting the accounting staff of our subsidiaries to change accounting policies or methodologies without prior review and approval from our chief financial officer;
· requiring the accounting staff at each of our subsidiaries to prepare a standardized financial reporting package that must be prepared and provided to us as part of the process of closing financial records at the end of each quarter; and
· causing the appropriate members of our financial reporting staff to visit with the accounting staff of each of our subsidiaries to ensure proper education and compliance with these new policies.
We believe that the steps taken to date have adequately addressed the material weakness. We will continue with our ongoing evaluation and will improve our disclosure controls as necessary to assure their effectiveness.
Additionally, as previously announced in our Current Report on Form 8-K filed on January 6, 2005 with the SEC, we have determined that our contracts with our most significant U.S.-based customers have included terms that transfer title to the product upon delivery. The contracts cover the majority of our sales to U.S. drug wholesalers beginning in 2003. In general, our shipping methods take up to five business days from shipment until delivery. As a result, some revenues may have been recognized up to five days earlier than permitted under generally accepted accounting principles. This correction does not affect the amount of revenue that we will ultimately recognize, although it will affect (by one to five days) the timing of revenue recognition. As a result, some shipments made during the final week of a quarter should have been recognized in the subsequent quarter.
We have concluded that the lack of internal controls relating to shipping terms under customer contracts and related revenue recognition constituted a material weakness in the design and operation of our internal controls. In a letter to the audit committee of our board of directors dated January 6, 2005 (and delivered to us on February 14, 2005), Grant Thornton informed us that it has reached the same conclusion. Prior to receiving this letter from Grant Thornton, we had instituted additional procedures and controls to remediate this material weakness, including:
· establishing and improving communications guidelines between departments;
· reviewing customer billing terms and determinations of revenue recognition;
· instituting periodic reviews of material agreements for customer billing terms and determination of actual delivery dates for shipments; and
· modifying our accounting policies and procedures manual related to revenue recognition and including requirements for approval of changes in agreements and related revenue recognition implications.
As a result of the remediation steps described above, we have concluded that the above described material weakness relating to shipping terms and related revenue recognition has been remediated.
No other change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended March 31, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 6. Exhibits and Reports on Form 8-K
(2) Reports on Form 8-K
Current Report on Form 8-K dated February 20, 2004, announcing the Companys financial results for the year ended December 31, 2003.
Current Report on Form 8-K dated February 20, 2004, containing the transcript of the Companys year end earnings conference call.
Current Report on Form 8-K dated May 4, 2004, as amended, containing the Companys press release announcing it first quarter 2004 financial results.
Current Report on Form 8-K dated May 4, 2004, containing the transcript of the Companys first quarter earnings conference call.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.