-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LV2z1dxIyCqLmazKijREOkUxtC5/P+Fy30nsLWCuIKJm81kGxLcs0JHixaoKMG9i Gz8gaPhbt4FDeq3XIs6roA== 0000950123-03-009392.txt : 20030813 0000950123-03-009392.hdr.sgml : 20030813 20030813170110 ACCESSION NUMBER: 0000950123-03-009392 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 20030630 FILED AS OF DATE: 20030813 FILER: COMPANY DATA: COMPANY CONFORMED NAME: OSI PHARMACEUTICALS INC CENTRAL INDEX KEY: 0000729922 STANDARD INDUSTRIAL CLASSIFICATION: IN VITRO & IN VIVO DIAGNOSTIC SUBSTANCES [2835] IRS NUMBER: 133159796 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-15190 FILM NUMBER: 03842193 BUSINESS ADDRESS: STREET 1: 58 SOUTH SERVICE RD. STREET 2: SUITE 110 CITY: MELVILLE STATE: NY ZIP: 11747 BUSINESS PHONE: 631-962-2000 MAIL ADDRESS: STREET 1: 58 SOUTH SERVICE RD. STREET 2: SUITE 110 CITY: MELVILLE STATE: NY ZIP: 11747 FORMER COMPANY: FORMER CONFORMED NAME: ONCOGENE SCIENCE INC DATE OF NAME CHANGE: 19920703 10-Q 1 y89178e10vq.txt FORM 10-Q FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2003 . ----------------------------------- OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to . ------------------- ----------------------- Commission file number 0-15190 --------------------------------------------------- OSI Pharmaceuticals, Inc. --------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 13-3159796 - -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 58 South Service Road, Suite 110, Melville, New York 11747 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code)
631-962-2000 ------------------------------------------------------------------------ (Registrant's telephone number, including area code) ------------------------------------------------------------------------ (Former name, former address and former fiscal year, if changed since last report.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ] APPLICABLE ONLY TO CORPORATE ISSUERS: At July 31, 2003 the registrant had outstanding 39,184,863 shares of common stock, $.01 par value. OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES PART I. FINANCIAL INFORMATION.................................................................................... 1 Item 1. Financial Statements............................................................................ 1 Consolidated Balance Sheets - June 30, 2003 (unaudited) and September 30, 2002............................................... 1 Consolidated Statements of Operations - For The Three Months Ended June 30, 2003 and 2002.............................................. 2 Consolidated Statements of Operations - For The Nine Months Ended June 30, 2003 and 2002 (Unaudited)................................... 3 Consolidated Statements of Cash Flows - For The Nine Months Ended June 30, 2003 and 2002 (Unaudited)................................... 4 Notes to Consolidated Financial Statements..................................................... 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...................................................................................... 17 Item 3. Quantitative and Qualitative Disclosures About Market Risk...................................... 34 Item 4. Controls and Procedures......................................................................... 35 PART II. OTHER INFORMATION....................................................................................... 37 Item 1. Legal Proceedings............................................................................... 37 Item 2. Changes in Securities and Use of Proceeds....................................................... 37 Item 3. Defaults Upon Senior Securities................................................................. 37 Item 4. Submission of Matters to a Vote of Security Holders............................................. 37 Item 5. Other Information............................................................................... 37 Item 6. Exhibits and Reports on Form 8-K................................................................ 37 SIGNATURES....................................................................................................... 39 EXHIBIT INDEX.................................................................................................... 40
i PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
JUNE 30, SEPTEMBER 30, 2003 2002 ----------- ------------- (UNAUDITED) ASSETS Current assets: Cash and cash equivalents .................................................... $ 58,212 $ 152,578 Investment securities ........................................................ 262,411 304,388 Restricted investment securities - short-term ................................ 7,963 7,938 Receivables, including amounts due from related parties of $2,918 and $3,000 at June 30, 2003 and September 30, 2002, respectively .................... 9,507 3,253 Interest receivable .......................................................... 2,106 3,728 Inventory .................................................................... 3,576 -- Prepaid expenses and other current assets .................................... 5,984 3,873 --------- --------- Total current assets ................................................ 349,759 475,758 Restricted investment securities - long-term ...................................... 8,499 11,373 Property, equipment and leasehold improvements - net .............................. 42,023 46,175 Debt issuance costs - net ......................................................... 4,536 5,145 Goodwill .......................................................................... 38,800 38,648 Other intangible assets - net ..................................................... 70,632 458 Other assets ...................................................................... 2,688 1,487 --------- --------- $ 516,937 $ 579,044 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses, including amounts due to related parties of $5,914 and $2,190 at June 30, 2003 and September 30, 2002, respectively ............................................................. $ 40,497 $ 22,062 Unearned revenue - current, including amounts received in advance from related parties of $5,000 and $7,687 as of June 30, 2003 and September 30, 2002, respectively.............................................................. 5,973 8,613 Loans and capital leases payable - current ................................... 109 527 --------- --------- Total current liabilities ........................................... 46,579 31,202 Other liabilities: Unearned revenue - long-term, representing amounts received in advance from related parties........................................................... 2,500 6,250 Convertible senior subordinated notes, and loans and capital leases payable-long-term.......................................................... 160,012 160,014 Contingent value rights (see note 5(a)) ...................................... 22,047 -- Accrued post-retirement benefit cost ......................................... 2,992 2,470 --------- --------- Total liabilities ................................................... 234,130 199,936 --------- --------- Stockholders' equity: Preferred stock, $.01 par value; 5,000 shares authorized; no shares issued at June 30, 2003 and September 30, 2002 ..................................... -- -- Common stock, $.01 par value; 200,000 shares authorized, 40,016 and 37,335 shares issued at June 30, 2003 and September 30, 2002, respectively....... 400 373 Additional paid-in capital ................................................... 744,280 708,435 Deferred compensation ........................................................ (348) (49) Accumulated deficit .......................................................... (456,610) (324,223) Accumulated other comprehensive income ....................................... 1,518 1,005 --------- --------- 289,240 385,541 Less: treasury stock, at cost; 940 shares at June 30, 2003 and September 30, 2002........................................................ (6,433) (6,433) --------- --------- Total stockholders' equity .......................................... 282,807 379,108 --------- --------- Commitments and contingencies $ 516,937 $ 579,044 ========= =========
See accompanying notes to consolidated financial statements. -1- OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS EXCEPT PER SHARE DATA)
THREE MONTHS ENDED JUNE 30, ----------------------- 2003 2002 -------- -------- Revenues: Sales commissions .......................................... $ 5,491 $ -- Product sales .............................................. 145 -- License and other revenues, including $1,250 and $2,083 from related parties in 2003 and 2002, respectively ..... 1,519 2,537 Collaborative program revenues, including $818 from related parties in 2002 ......................................... 867 1,974 -------- -------- 8,022 4,511 Expenses: Cost of product sales ...................................... 55 -- Research and development ................................... 24,301 25,805 Acquired in-process research and development (see note 5(a)) 31,290 -- Selling, general and administrative ........................ 23,336 8,977 Amortization of intangibles ................................ 3,922 315 -------- -------- 82,904 35,097 -------- -------- Loss from operations ................................. (74,882) (30,586) Other income (expense): Investment income - net .................................... 1,567 3,475 Interest expense ........................................... (1,605) (2,011) Other expense - net ........................................ (198) (317) -------- -------- Net loss ...................................................... $(75,118) $(29,439) ======== ======== Weighted average shares of common stock outstanding ........... 36,992 36,292 ======== ======== Basic and diluted net loss per common share ................... $ (2.03) $ (0.81) ======== ========
See accompanying notes to consolidated financial statements. -2- OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS EXCEPT PER SHARE DATA)
NINE MONTHS ENDED JUNE 30, ------------------------- 2003 2002 --------- --------- Revenues: Sales commissions ...................................................... $ 6,378 $ -- Product sales .......................................................... 145 -- License and other revenues, including $3,750 and $6,250 from related parties in 2003 and 2002, respectively ................. 4,478 8,042 Collaborative program revenues, including $6,187 and $6,011 from related parties in 2003 and 2002, respectively .............................. 9,085 9,131 --------- --------- 20,086 17,173 --------- --------- Expenses: Cost of product sales .................................................. 55 -- Research and development ............................................... 76,297 69,584 Acquired in-process research and development (see note 5) .............. 31,290 130,200 Selling, general and administrative .................................... 41,496 21,105 Amortization of intangibles ............................................ 4,666 930 --------- --------- 153,804 221,819 --------- --------- Loss from operations ............................................. (133,718) (204,646) Other income (expense): Investment income - net ................................................ 6,469 11,514 Interest expense ....................................................... (4,817) (3,359) Other income (expense) - net ........................................... (321) 155 --------- --------- Net loss .................................................................. $(132,387) $(196,336) ========= ========= Weighted average shares of common stock outstanding ....................... 36,618 35,855 ========= ========= Basic and diluted net loss per common share ............................... $ (3.62) $ (5.48) ========= =========
See accompanying notes to consolidated financial statements. -3- OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS)
NINE MONTHS ENDED JUNE 30, 2003 2002 --------- --------- Cash flow from operating activities: Net loss .................................................................. $(132,387) $(196,336) Adjustments to reconcile net loss to net cash used in operating activities: Gain on sale of diagnostic business .................................... -- (1,000) Loss (gain) on sale of investments ..................................... (391) 186 Loss on sale and disposal of equipment ................................. 26 6 Depreciation and amortization .......................................... 13,564 7,447 In-process research and development charge on acquisitions ............. 31,290 130,200 Non-cash compensation charges .......................................... 580 1,708 Changes in assets and liabilities, net of effects of acquisitions: Receivables ............................................................ (4,594) 2,760 Inventory .............................................................. (604) -- Prepaid expenses and other current assets .............................. (1,640) (2,579) Other assets ........................................................... 53 227 Accounts payable and accrued expenses .................................. 7,273 (394) Unearned revenue ....................................................... (7,058) (7,581) Accrued post-retirement benefit cost ................................... 522 303 --------- --------- Net cash used in operating activities ........................................ (93,366) (65,053) --------- --------- Cash flows from investing activities: Payments for acquisitions, net of cash acquired ........................... (193) (135,742) Payments for acquisition of marketing rights .............................. (46,009) -- Net proceeds from sale of diagnostic business ............................. -- 1,000 Purchases of investments (restricted and unrestricted) .................... (344,543) (329,432) Maturities and sales of investments (restricted and unrestricted) ......... 389,086 312,913 Net additions to property, equipment and leasehold improvements ........... (2,571) (13,632) Additions to compound library assets ...................................... (206) -- Investments in privately-owned companies .................................. (130) (770) --------- --------- Net cash used in investing activities ........................................ (4,566) (165,663) --------- --------- Cash flows from financing activities: Proceeds from issuance of convertible senior subordinated notes ........... -- 200,000 Debt issuance costs ....................................................... -- (6,974) Proceeds from exercise of stock options, stock warrants and employee stock purchase plan ........................................... 4,017 5,505 Payments on loans and capital leases - net ................................ (495) (432) --------- --------- Net cash provided by financing activities .................................... 3,522 198,099 --------- --------- Net decrease in cash and cash equivalents .................................... (94,410) (32,617) Effect of exchange rate changes on cash and cash equivalents ................. 44 (263) Cash and cash equivalents at beginning of year ............................... 152,578 225,150 --------- --------- Cash and cash equivalents at end of period ................................... $ 58,212 $ 192,270 ========= ========= Non-cash activities: Issuance of common stock to employees ..................................... $ 91 $ 450 ========= ========= Issuance of common stock to directors ..................................... $ 488 $ -- ========= ========= Issuance of common stock to consultants ................................... 286 -- ========= ========= Issuance of common stock in connection with acquisition ................... $ 31,245 $ 40,000 ========= ========= Issuance of contingent value rights in connection with acquisition ........ $ 22,047 $ -- ========= ========= Issuance of warrants in connection with acquisition ....................... $ 146 $ -- ========= ========= Issuance of common stock in satisfaction of deferred acquisition costs .... $ -- $ 375 ========= ========= Cash paid for interest .................................................... $ 3,221 $ 38 ========= =========
See accompanying notes to consolidated financial statements. -4- OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (1) Basis of Presentation In the opinion of management, the accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") for interim financial information and with the instructions to Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of only normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended June 30, 2003 and cash flows for the nine months ended June 30, 2003 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2003. For further information, refer to the consolidated financial statements and footnotes thereto included in the Annual Report on Form 10-K (the "Form 10-K"), as amended, relating to OSI Pharmaceuticals, Inc. and subsidiaries (the "Company") for the fiscal year ended September 30, 2002. Certain reclassifications have been made to the prior period financial statements to conform them to the current presentation. (2) Revenue Recognition Sales commissions represent commissions earned on the sales of the drug, Novantrone(R) (mitoxantrone for injection concentrate), in the United States for oncology indications pursuant to a Co-Promotion Agreement dated March 11, 2003 with Ares Trading S.A., an affiliate of Serono S.A. ("Serono"). Under the agreement, the Company has the exclusive rights to market and promote the drug for approved oncology indications in the United States. The drug is also approved for advanced forms of multiple sclerosis. Serono will continue to be responsible for the marketing of the multiple sclerosis indication of Novantrone(R) and will record all U.S. sales for all indications including oncology indications. Sales commissions from Novantrone(R) are recognized based on estimated net oncology sales in the period the sales occur. Sales commissions may be subject to further adjustment based on final information regarding the split between oncology and multiple sclerosis sales of Novantrone(R), as determined by an independent third party. Product sales represent sales of Gelclair(TM) Concentrated Oral Gel ("Gelclair") in accordance with an exclusive distribution agreement with Sinclair Pharmaceuticals, Ltd. ("Sinclair") to promote and distribute Gelclair(TM) in North America. The Company acquired the rights under this agreement on June 12, 2003 in connection with the acquisition of Cell Pathways, Inc. ("Cell Pathways"). Subsequently, Sinclair licensed its worldwide rights to Gelclair(TM) to Helsinn Healthcare S.A. in July 2003. In accordance with SFAS No. 48, "Revenue Recognition When Right of Return Exists", given the limited sales history of Gelclair(TM), the Company at this time defers the recognition of revenue on product shipments of Gelclair(TM) to wholesale customers until such time as the product is prescribed to the end user. -5- For each reporting period, the Company monitors shipments from wholesale customers to pharmacies and hospitals, wholesale customer reorder history and prescriptions filled by pharmacies based on prescription data from external, independent sources. When this data shows a flow of product through the supply chain to the end user, which indicates that returns are less likely to occur, product sales are recognized. The related cost of the product shipped to wholesale customers that has not been recognized as revenue has been reflected as inventory subject to return (see note 7). The unearned revenue related to shipments of Gelclair(TM) to wholesale customers was $538,000 as of June 30, 2003. The Company accounts for upfront nonrefundable technology access and other upfront fees over the term of the related research and development collaboration period in accordance with the guidance provided in the Securities and Exchange Commission's Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements," as amended. The Company received a total of $25.0 million in upfront fees from Genentech, Inc. and Roche in January 2001 which was originally being recognized on a straight-line basis evenly over the expected three-year term of the Company's required research and development efforts under the terms of the agreement. In the fourth quarter of fiscal 2002, the expected term was changed to four years to reflect the Company's revised estimate of the term of the continued involvement in the research and development efforts under the Tripartite Agreement with Genentech and Roche. In accordance with Accounting Principle Board Opinion No. 20, "Accounting Changes," the remaining unearned revenue is being recognized prospectively over the revised term. As a result, the Company recorded revenues of $1.3 million and $3.8 million for the three and nine months ended June 30, 2003, respectively. Collaborative program revenues represent funding arrangements for research and development in the field of biotechnology and are recognized when earned in accordance with the terms of the contracts and related research and development activities undertaken. (3) Stock Options In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure." SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation as originally provided by SFAS No. 123, "Accounting for Stock-Based Compensation." Additionally, SFAS No. 148 amends the disclosure provisions of SFAS No. 123 to require prominent disclosure in both the annual and interim financial statements about the method of accounting for stock-based compensation and the effect of the method used on reported results. The Company adopted the disclosure portion of this statement in the fiscal quarter ended March 31, 2003. The FASB recently decided that they will require stock-based employee compensation to be recorded as a charge to earnings beginning as early as 2004. Stock option grants are generally set at the closing price of the Company's common stock on the date of grant and the related number of shares granted are fixed at that point in time. Under the principles of APB Opinion No. 25, the Company does not recognize compensation expense associated with the grant of stock options. SFAS No. 123 requires the -6- use of option valuation models to determine the fair value of options granted after 1995. Pro forma information regarding net loss and net loss per share shown below was determined as if the Company had accounted for its employee stock options and shares sold under its stock purchase plan under the fair value method set forth in SFAS No. 123. The fair value of the options was estimated at the date of grant using a Black-Scholes option pricing model. For purposes of pro forma disclosures, the estimated fair value of the options is amortized over the options' vesting periods. The Company's pro forma information is as follows (in thousands, except per share information):
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, ----------------------------- ----------------------------- 2003 2002 2003 2002 ----------- ----------- ----------- ----------- Net loss ............................... $ (75,118) $ (29,439) $ (132,387) $ (196,336) Compensation cost determined under fair value method ........................ $ (5,033) $ (4,606) $ (14,334) $ (12,590) ----------- ----------- ----------- ----------- Pro forma net loss ..................... $ (80,151) $ (34,045) $ (146,721) $ (208,926) =========== =========== =========== =========== Basic and diluted loss per common share: Net loss ............................ $ (2.03) $ (0.81) $ (3.62) $ (5.48) Compensation cost ................... $ (0.14) $ (0.13) $ (0.39) $ (0.35) ----------- ----------- ----------- ----------- Pro forma net loss .................. $ (2.17) $ (0.94) $ (4.01) $ (5.83) =========== =========== =========== ===========
(4) Co-Promotion Agreement On March 11, 2003, the Company entered into the Co-Promotion Agreement with Serono to market and promote Novantrone(R) for approved oncology indications in the United States through December 2017. In consideration for these exclusive rights, the Company paid $45.0 million in cash. This payment and related professional fees are included in other intangible assets in the accompanying consolidated balance sheet as of June 30, 2003 and are being amortized on a straight-line basis through expiration of the Novantrone(R) patent in April 2006. In consideration for certain transition services required to be provided by Serono, the Company also paid a fee of $10.0 million, which was included in prepaid expenses and other current assets, and is being recognized over a four-month transition period from the effective date of the agreement. Under the terms of the agreement, the Company will also pay quarterly maintenance fees to Serono until the later of the expiration of the last valid patent claim or the first generic date, as defined in the agreement. Such maintenance fees will be expensed as incurred. The Company receives commissions on net sales of Novantrone(R) in the United States for oncology indications. -7- (5) Acquisitions (a) Cell Pathways, Inc. On June 12, 2003, the Company completed its acquisition of Cell Pathways pursuant to the terms of an Agreement and Plan of Merger dated February 7, 2003. The acquisition was structured as a merger of a wholly-owned subsidiary of the Company with and into Cell Pathways. The resulting subsidiary of the Company was merged with and into the Company on July 14, 2003. Cell Pathways was a development stage biotechnology company focused on the research and development of products to treat and prevent cancer, and the future commercialization of such products. The assets purchased and liabilities assumed by the Company included: (a) two drug candidates in clinical development, Aptosyn(R) (exisulind) and OSI-461 (formerly CP461), and the related technology platform and patent estate; (b) exclusive distribution rights to a marketed product, Gelclair(TM), in North America; (c) rights to Cell Pathways' leased facility in Horsham, Pennsylvania, as well as leasehold improvements and certain equipment; (d) inventory; and (e) certain other assets and liabilities. The Company also retained three Cell Pathways employees and entered into consulting agreements with former Cell Pathways employees. Certain of these agreements also provide, at the Company's discretion based on the successful integration of Cell Pathway's assets, the forgiveness of loans to these employees, which were acquired in the acquisition. The results of operations of Cell Pathways have been included in the consolidated statements of operations commencing as of June 12, 2003. Cell Pathways marketed and sold Gelclair(TM), the manufacturing rights of which were held by Sinclair. Gelclair(TM) is a bio-adherent oral gel that provides relief for the treatment of pain associated with oral mucositis, a debilitating side effect often seen in patients undergoing chemotherapy or radiation treatment. In January 2002, Cell Pathways entered into a ten-year exclusive distribution agreement with Sinclair to promote and distribute Gelclair(TM) in North America (United States, Canada and Mexico). Sinclair licensed its worldwide rights to Gelclair(TM) to Helsinn Healthcare S.A. in July 2003. Cell Pathways entered into a four-year marketing agreement with John O. Butler Company ("Butler"), underwhich Butler markets Gelclair(TM) to the dental market within the United States and will market in Canada if and when Gelclair(TM) is approved for marketing in Canada. In October 2002, Cell Pathways entered into a three-year agreement with Celgene Corporation ("Celgene") for the promotion of Gelclair(TM), primarily in the U.S. oncology market. On June 12, 2003, the Company entered into an agreement with Celgene by which the Company recovered full rights to market and promote Gelclair(TM) in the oncology setting in North America. This agreement requires the Company to make payments to Celgene upon the return of certain sales and marketing data and upon the first anniversary of the effective date provided the transition services, as defined in the agreement, have been provided to the Company. The agreement also provides for a milestone payment to Celgene upon the achievement of a specified amount of net sales of Gelclair(TM). As consideration for the merger, each share of Cell Pathways common stock was exchanged for (i) 0.0567 shares of the Company's common stock and (ii) a contingent value -8- right to receive 0.04 shares of the Company's common stock in the event a new drug application is accepted for filing with the U.S. Food and Drug Administration by June 12, 2008 for either of the two newly acquired clinical candidates, Aptosyn(R) or OSI-461. Based on the exchange ratio of 0.0567, approximately 2.2 million shares of the Company's common stock were issued to Cell Pathways' stockholders in connection with the merger. The 2.2 million common shares were valued at $31.2 million which was based on the average five-day closing price of the Company's common stock around the date of the announcement of the merger which occurred on February 10, 2003. Any outstanding options that were not exercised prior to the effective date of the merger were, in accordance with their terms, terminated. The Company assumed approximately 44,000 outstanding and unexercised warrants to purchase shares of Cell Pathways common stock under the same terms and conditions as the original Cell Pathways' warrants except that the exercise price of the warrants and the number of shares of the Company's common stock for which the warrants are exercisable were adjusted based on the exchange ratio described above. The acquisition was accounted for under the purchase method of accounting. The purchase price was allocated to the acquired assets and assumed liabilities based on the fair values as of the date of the acquisition. The excess of the fair value of the net identifiable assets acquired over the purchase price paid represented negative goodwill of approximately $49.3 million. Since a portion of the negative goodwill is a result of not recognizing contingent consideration (i.e., the contingent value rights), the maximum value of the contingent value rights at the date of the acquisition has been recorded as if it were a liability, thereby reducing the negative goodwill. The value of the contingent value rights of $22.0 million was based on the average five day closing price of the Company's common stock around the date of the announcement of the merger which occurred on February 10, 2003. The remaining negative goodwill of $27.3 million was allocated proportionately to reduce the value of the non-current assets acquired and the in-process research and development which was charged to operations. The preliminary purchase price was allocated as follows (in thousands): Acquired in-process R&D ............................. $ 31,290 Gelclair(TM) rights ................................. 28,809 Inventory ........................................... 2,972 Fixed assets ........................................ 400 Cash ................................................ 1,791 Prepaid expenses and other assets ................... 1,420 -------- Total assets and acquired in-process R&D ............ 66,682 Less liabilities assumed ............................ (11,677) -------- Common stock & contingent rights issued and cash paid $ 55,005 ========
The value assigned to the acquired in-process R&D was determined by identifying those acquired in-process research projects for which: (a) technological feasibility had not been established at the acquisition date, (b) there was no alternative future use, and (c) the fair value was estimable based on reasonable assumptions. The acquired in-process R&D was valued at $31.3 million after the allocation of the negative goodwill, expensed on the acquisition date, and included in the accompanying consolidated statements of operations for the three and nine -9- months ended June 30, 2003. The portion of the purchase price assigned to the acquired in-process R&D was allocated to the following two clinical candidates: Apotsyn(R) ($3.7 million), currently in a Phase III trial in combination with Taxotere(R) for the treatment of advanced non-small cell lung cancer, and OSI-461 ($27.6 million), a more potent, second-generation molecule that is currently being evaluated in dose ranging Phase I studies and a series of exploratory Phase II studies in chronic lymphocytic leukemia, renal cell carcinoma and prostate cancer. In addition, OSI-461 is being evaluated in a Phase II study for inflammatory bowel disease where there has been encouraging initial indications of activity in the form of symptom improvement and a remission. The value of the acquired in-process R&D was determined by estimating the projected net cash flows related to products under development, based upon the future revenues to be earned upon commercialization of such products. In determining the value of the in-process R&D, the assumed commercialization dates for these products ranged from 2005 to 2006. Given the risks associated with the development of new drugs, the revenue and expense forecasts were probability-adjusted to reflect the risk of advancement through the approval process. The risk adjustments applied were based on each compound's stage of development at the time of assessment and the historical probability of successful advancement for compounds at that stage. These modeled cash flows were discounted back to their net present value. The projected net cash flows from such projects were based on management's estimates of revenues and operating profits related to such projects. The value of the in-process R&D was based on the income approach that focuses on the income-producing capability of the assets. The underlying premise of this approach is that the value of an asset can be measured by the present worth of the net economic benefit (cash receipts less cash outlays) to be received over the life of the asset. Significant assumptions and estimates used in the valuation of in-process R&D included: the stage of development for each of the two projects; future revenues; growth rates for each product; product sales cycles; the estimated life of a product's underlying technology; future operating expenses; probability adjustments to reflect the risk of developing the acquired technology into commercially viable products; and a discount rate of 25% to reflect present value. (b) Gilead's Oncology Assets On December 21, 2001, the Company acquired certain assets from Gilead, pursuant to the terms of an Asset Purchase Agreement dated as of November 26, 2001. The results of operations of Gilead's oncology assets have been included in the consolidated statement of operations commencing as of the date of the closing. In consideration for the assets, the Company paid $135.7 million, which includes professional fees and the assumption of certain liabilities, and issued 925,000 shares of common stock, valued at $40.0 million. The acquisition was accounted for under the purchase method of accounting. The purchase price was allocated to the acquired assets and liabilities assumed based on the fair values as of the date of the acquisition. The value assigned to the acquired in-process R&D was determined by identifying those acquired in-process research projects for which: (a) technological feasibility had not been established at the acquisition date, (b) there was no -10- alternative future use, and (c) the fair value was estimable based on reasonable assumptions. The acquired in-process R&D was valued at $130.2 million and expensed at the acquisition date and is included in the accompanying consolidated statement of operations for the nine months ended June 30, 2002. (c) Unaudited Pro Forma Financial Information The following unaudited pro forma financial information presents a summary of the consolidated results of operations of the Company for the three and nine months ended June 30, 2003 and 2002, assuming the (i) Cell Pathways acquisition had taken place as of April 1, 2003 and 2002, respectively, and October 1, 2002 and 2001, respectively, and (ii) the acquisition of certain assets from Gilead Sciences, Inc. ("Gilead") had taken place as of October 1, 2001 (in thousands, except per share information):
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, ----------------------- ------------------------ 2003 2002 2003 2002 -------- -------- --------- -------- Revenues ................................................... $ 8,433 $ 4,814 $ 21,467 $ 17,795 Loss before non-recurring charge related to the acquisitions ............................................ $(54,245) $(31,228) $(122,832) $(97,648) Basic and diluted loss per share before non-recurring charge related to acquisitions ................................. $ (1.40) $ (0.81) $ (3.17) $ (2.54)
The unaudited pro forma financial information has been prepared for comparative purposes only. The pro forma information includes the historical unaudited results of Cell Pathways and certain assets from Gilead for the respective periods. The pro forma financial information includes adjustments to the Company's historical results to reflect the issuance of approximately 2.2 million shares of common stock and excludes the non-recurring charge of $31.3 million related to the acquired in-process R&D related to Cell Pathways and the issuance of 925,000 shares of common stock and the charge of $130.2 million related to the acquired in process R&D related to Gilead. The pro forma information does not purport to be indicative of operating results that would have been achieved had the acquisition taken place on the dates indicated or the results that may be obtained in the future. (6) Restricted Assets With respect to the convertible senior subordinated notes issued in February 2002, the Company originally pledged $22.9 million of U.S. government securities (the "Restricted Investment Securities") with maturities at various dates through November 2004. The aggregate amortized cost of the Restricted Investment Securities at June 30, 2003 and September 30, 2002 was $16.5 million and $19.3 million, respectively. With respect to the Company's facility leases at Oxford, England, and Horsham, Pennsylvania, which was assumed in connection with our acquisition of Cell Pathways (see note 5(a)), the Company has outstanding letters of credit issued by a commercial bank. The -11- collateral for these letters of credit are maintained in a restricted investment account. Included in cash and cash equivalents as of June 30, 2003 is $760,000, relating to restricted cash to secure these letters of credit. Included in investment securities as of June 30, 2003 and September 30, 2002 is $2.7 million and $3.0 million, respectively, relating to restricted investments to secure these letters of credit. (7) Inventory Inventory is comprised solely of Gelclair(TM) and is stated at the lower of cost or market, as determined using the first-in, first-out method. Inventory at June 30, 2003 and September 30, 2002, consisted of the following (in thousands):
JUNE 30, SEPTEMBER 30, 2003 2002 ------ ------------- Finished goods on hand........................................ $3,377 - Inventory subject to return................................... 199 - ------ ------ $3,576 - ====== ======
Inventory subject to return represents the amount of Gelclair(TM) shipped to wholesale customers which has not been recognized as revenue (see note 2). (8) Comprehensive Income (Loss) Comprehensive loss for the three and nine months ended June 30, 2003 and 2002 was as follows (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, ----------------------- ------------------------- 2003 2002 2003 2002 -------- -------- --------- --------- Net loss ..................................... $(75,118) $(29,439) $(132,387) $(196,336) Other comprehensive income (loss): Foreign currency translation adjustments 850 1,090 1,146 434 Unrealized holding gains (losses) arising during period ......................... 89 1,405 (239) (1,465) Less: Reclassification adjustment for (gains) losses realized in net loss ... (53) 19 (394) 199 -------- -------- --------- --------- 886 2,514 513 (832) -------- -------- --------- --------- Total comprehensive loss ..................... $(74,232) $(26,925) $(131,874) $(197,168) ======== ======== ========= =========
-12- The components of accumulated other comprehensive income were as follows (in thousands):
JUNE 30, SEPTEMBER 30, 2003 2002 ------ ------------- Cumulative foreign currency translation adjustment $ 826 $ (320) Unrealized gains on available-for-sale securities 692 1,325 ------ ------- Accumulated other comprehensive income ........... $1,518 $ 1,005 ====== =======
(9) Net Loss per Common Share A reconciliation between the numerators and the denominators of the basic and diluted net loss per share computation is as follows (in thousands except per share data):
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, ----------------------------- --------------------------- 2003 2002 2003 2002 ----------- ----------- ----------- --------- Net loss available for common stockholders ............................ $ (75,118) $ (29,439) $ (132,387) $(196,336) =========== =========== =========== ========= Weighted average common shares ............. 36,992 36,292 36,618 35,855 Effect of common share equivalents ......... -- -- -- -- ----------- ----------- ----------- --------- Weighted average common and potential common shares outstanding ...................... 36,992 36,292 36,618 35,855 =========== =========== =========== ========= Basic loss per share ....................... $ (2.03) $ (0.81) $ (3.62) $ (5.48) =========== =========== =========== ========= Diluted loss per share ..................... $ (2.03) $ (0.81) $ (3.62) $ (5.48) =========== =========== =========== =========
Basic and diluted net loss per share is computed by dividing the net loss by the weighted average number of common shares outstanding during the period. The diluted net loss per share presented excludes the effect of common share equivalents (stock options, convertible debt and warrants) and contingent shares pursuant to the contingent value rights since such inclusion in the computation would be anti-dilutive. Such common share equivalents (stock options, warrants and convertible debt, assuming all shares upon conversion would be dilutive) amounted to 4.3 million and 4.1 million for the three and nine months ended June 30, 2003, respectively. Such contingent shares amounted to 1.6 million for the three and nine months ended June 30, 2003. Such common share equivalents (stock options and convertible debt, assuming all shares upon conversion would be dilutive) amounted to 5.6 million and 4.3 million for the three and nine months ended June 30, 2002, respectively. (10) Consolidation of Facility In the fourth quarter of fiscal 2001, the Company announced its strategic decision to close down its Birmingham, England facility. The operations at the Birmingham, England facility ceased on March 31, 2002 and the Company completed closing down the facility in April 2003. In March 2003, the Company entered into a surrender agreement whereby the landlord released the Company of its obligations under the remaining facility leases in -13- consideration for a payment of approximately $662,000. This payment was made in April 2003. As a result of the terms of the surrender agreements, the Company recorded an adjustment to reduce the restructuring reserve by $180,000 in March 2003. The facility leases had an original expiration date of January 2006. As of June 30, 2003, the remaining restructuring reserve relating to the consolidation of the Birmingham, England facility was $95,000 relating to non-cancelable lease exit costs. The consolidation activity for the nine months ended June 30, 2003 was as follows (in thousands):
Lease Exit Costs ---------------- Balance at September 30, 2002 .......... $ 1,630 Cash paid .............................. (1,397) Change in estimates .................... (180) Foreign currency translation adjustments 42 ------- Balance at June 30, 2003 ............... $ 95 =======
(11) Sale of Diagnostics Business On November 30, 1999, the Company sold assets of its diagnostics business to The Bayer Corporation including the assets of the Company's wholly-owned diagnostics subsidiary, OSDI, Inc., based in Cambridge, Massachusetts. The assets sold included certain contracts, equipment and machinery, files and records, intangible assets, intellectual property, inventory, prepaid expenses and other assets primarily related to the operations of the diagnostics business. Under the terms of the sale, the Company received a contingent payment of $1.0 million in December 2001, which is included in other income for the nine months ended June 30, 2002. (12) Accounting for Goodwill and Other Intangible Assets Effective October 1, 2002, the Company fully adopted SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142 requires that goodwill and intangible assets determined to have indefinite lives no longer be amortized but instead be tested for impairment at least annually and whenever events or circumstances occur that indicate impairment might have occurred. SFAS No. 142 also requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives and reviewed for impairment in accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets to be Disposed Of." Under SFAS No. 121, intangible and other long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. As of September 30, 2002, the Company's intangible assets were $39.1 million, consisting of $36.5 million of goodwill, $2.1 million of acquired workforce, and $458,000 for a license to compound libraries. In accordance with SFAS No. 142, the goodwill has not been amortized as it was acquired in connection with the acquisition of certain oncology assets from Gilead, which occurred after July 1, 2001. Upon full adoption of SFAS No. 142, acquired -14- workforce no longer meets the definition of an identifiable intangible asset. As a result, the net balance of $2.1 million as of September 30, 2002 was reclassified to goodwill. The carrying amount of goodwill as of June 30, 2003, inclusive of the acquired workforce, was $38.8 million, which includes a $152,000 effect from foreign currency exchange rate fluctuations during the nine-month period ended June 30, 2003. As a result of its acquisition from Serono in March 2003 of the exclusive rights to market and promote the drug Novantrone(R) for the approved oncology indications in the United States, the Company recorded an intangible asset of $46.0 million, which is being amortized over the remaining 37-month life of the underlying patent. In connection with the acquisition of Cell Pathways, the Company assumed the exclusive rights to market, sell and distribute Gelclair(TM) in North America which Cell Pathways had acquired from Sinclair in January 2002 for a period of ten years. The Company recorded an identifiable intangible asset of $28.8 million which is being amortized over eight and a half years, the remaining term of the agreement. As of June 30, 2003, the Company's identifiable intangible assets were $70.6 million, consisting primarily of $41.7 million for the rights to market and promote Novantrone(R) and $28.7 million for the rights to market, sell and distribute Gelclair(TM). These identifiable intangible assets are subject to amortization. The Company reassessed the useful life of the license to compound libraries upon the adoption of SFAS No. 142 to make any necessary amortization period adjustments. No adjustments resulted from this assessment. Amortization expense for these intangible assets for the three and nine months ended June 30, 2003 was $3.9 million and $4.7 million, respectively. Amortization expense for the three and nine months ended June 30, 2002 was $54,000 and $159,000, respectively. Amortization expense is estimated to be $4.6 million for the remainder of fiscal 2003, $18.5 million in fiscal 2004, $18.3 million in fiscal 2005, and $11.4 million in fiscal 2006. Under the non-amortization approach, goodwill and certain other intangibles are not amortized into results of operations but instead are reviewed for impairment, written down, and charged to results of operations in periods in which the recorded value of goodwill and certain other intangibles is more than their implied fair value. The Company completed its impairment review of goodwill during the first quarter of fiscal 2003 and determined that no impairment charge was required upon adoption. A reconciliation of previously reported net loss and net loss per share to the amounts adjusted for the exclusion of acquired workforce amortization is as follows (in thousands except per share data): -15-
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED JUNE 30, JUNE 30, ----------------------------- ----------------------------- 2003 2002 2003 2002 ----------- ----------- ----------- ----------- Net loss .......................... $ (75,118) $ (29,439) $ (132,387) $ (196,336) Goodwill amortization ............. -- -- -- -- Acquired workforce amortization ... -- 261 -- 773 ----------- ----------- ----------- ----------- Adjusted net loss ................. $ (75,118) $ (29,178) $ (132,387) $ (195,563) =========== =========== =========== =========== Reported basic and diluted net loss per share ................. $ (2.03) $ (0.81) $ (3.62) $ (5.48) Goodwill amortization per share ... $ -- $ -- $ -- $ -- Acquired workforce amortization per share ...................... $ -- $ 0.01 $ -- $ 0.02 ----------- ----------- ----------- ----------- Adjusted basic and diluted net loss per share ...................... $ (2.03) $ (0.80) $ (3.62) $ (5.46) =========== =========== =========== ===========
(13) Amendment to Stock Option Plan On December 11, 2002, the Board of Directors approved an amendment to the 2001 Incentive and Non-Qualified Stock Option Plan (the "Stock Option Plan"). The amendment to the Stock Option Plan only affected the automatic, formula-based grants of non-qualified stock options to directors who are not employees of the Company. Under the amended formula, each individual who becomes a director on or after January 1, 2003 will receive an initial option to purchase 50,000 shares of common stock upon his or her election to the Board. Persons elected to the Board after June 13, 2001 but prior to January 1, 2003 were entitled to an initial grant of an option to purchase 30,000 shares of common stock upon their initial election. All persons elected to the Board after June 13, 2001 receive annual grants of options to purchase 7,500 shares upon reelection to the Board. Persons elected to the Board prior to June 13, 2001 will continue to be eligible, upon reelection to the Board, for annual grants of options to purchase shares of common stock in an amount which depends upon the number of years of service as a director (20,000 shares reducing to 7,500 shares). (14) Amendment to the Stock Purchase Plan for the Non-Employee Directors On December 11, 2002, the Board of Directors approved an amendment to the Company's Stock Purchase Plan for Non-Employee Directors which was adopted as of March 25, 1996 (the "Stock Purchase Plan"). Pursuant to the amended Stock Purchase Plan, fifty-percent of the annual retainer fee earned by each non-employee director will be paid to the director in the form of a restricted stock award. The restricted stock award will be made as of each annual stockholder meeting at which directors are elected beginning with the Annual Meeting of Stockholders which occurred on March 19, 2003. Annual restricted stock awards will vest in monthly installments over the one-year term for which the award is made. In the event a director's membership on the Board terminates prior to the end of such one-year term, any unvested portion of the director's restricted stock award will be forfeited. Shares of restricted stock awarded annually may not be sold or transferred by the director until the first anniversary of the date of grant of such award. Non-employee directors may elect to receive the remaining fifty-percent of the director's annual retainer in the form of shares of common stock under the Stock Purchase Plan as well. -16- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THREE AND NINE MONTHS ENDED JUNE 30, 2003 AND 2002 OVERVIEW We are a leading biotechnology company focused on the discovery, development and commercialization of high-quality oncology products that both extend life and improve the quality-of-life for cancer patients worldwide. We have established a balanced pipeline of oncology drug candidates that includes both next-generation cytotoxic chemotherapy agents and novel mechanism-based, gene-targeted therapies focused in the areas of signal transduction and apoptosis. We currently have six proprietary candidates in clinical development and two additional candidates in clinical development with Pfizer Inc. Over the past two quarters we added to our oncology product portfolio the right to market and promote Novantrone(R) for approved oncology indications in the United States and Gelclair(TM) Concentrated Oral Gel in North America. Our most advanced drug candidate, Tarceva(TM) (erlotinib HCl), is a small molecule inhibitor of the epidermal growth factor receptor, or HER1/EGFR. The protein product of the HER1/EGFR gene is a receptor tyrosine kinase that is over-expressed or mutated in many major solid tumors. We believe HER1/EGFR inhibitors represent an exciting new class of relatively safe and well tolerated anti-cancer agents that may have utility in treating a wide range of cancer patients. Tarceva(TM) is an oral once-a-day small molecule drug designed to specifically block the activity of the HER1/EGFR protein. Currently, we are developing Tarceva(TM) in a global alliance with Genentech, Inc. and Roche. If the drug receives regulatory approval, Genentech will lead the marketing effort in the United States and Roche will market it in the rest of the world. We will receive milestone payments from both Genentech and Roche, an equal profit share from U.S. sales, and royalties on sales outside of the United States. Tarceva(TM) has demonstrated encouraging indications of anti-tumor activity in single-agent, open label Phase I and Phase II trials in non-small cell lung cancer, broncioalveolar carcinoma ((BAC), a form of lung cancer), gliobastoma multiforme (an aggressive form of brain cancer), head and neck cancer and ovarian cancer. Tarceva(TM) is currently in Phase III clinical trials for non-small cell lung cancer and pancreatic cancer. In January 2003, we announced the completion of patient enrollment in the Phase III 2nd/3rd line non-small cell lung and pancreatic cancer trials. The alliance has now completed target enrollment in all four Phase III Tarceva(TM) trials, which involves a total of approximately 3,500 patients. In April 2003, we announced that based on data from a Phase I study in glioblastoma, we will continue with a comprehensive Phase II program for this indication. Behind Tarceva(TM) we have an additional drug candidate in Phase III and six drug candidates in earlier stages of clinical development. Aptosyn(R) (exisulind), our second Phase III drug candidate, was acquired with the acquisition of Cell Pathways, Inc. in June 2003 and is currently in a Phase III trial in combination with Taxotere(R) for the treatment of advanced non- -17- small cell lung cancer. We consider Aptosyn(R) to be a higher risk prototype drug candidate arising from the pro-apoptosis platform acquired from Cell Pathways. The second acquired product candidate, OSI-461 (formerly CP461), is a more potent second generation follow-on candidate in Phase I and Phase II trials. Our earlier stage drug candidates include three next generation cytotoxic chemotherapy agents (OSI-211, OSI-7904L and OSI-7836), which are being developed by us, and two signal transduction inhibitors (CP547,632 and CP-724,714) which are currently being developed by Pfizer. We will receive royalty payments on the latter two if they are successfully commercialized. Our next generation cytotoxic chemotherapy candidates are designed to improve upon currently marketed products in the same drug class. OSI-211 is a liposomal formulation of lurtotecan, a topoisomerase-I inhibitor, that is being developed to compete with topotecan (Hycamtin(R)). OSI-7904L is a liposomal formulation of a thymidylate synthase inhibitor, GW 1843, that is being developed as a potential competitor to 5-Fluorouracil (5-FU) and capecitabine (Xeloda(R)). OSI-7836 is a nucleoside analog being developed to compete with gemcitabine (Gemzar(R)). OSI-211 is in Phase II clinical trials, and OSI-7904L and OSI-7836 are in Phase I clinical trials. We have committed to move OSI-7904L forward into a Phase II program, with clinical trials in gastric cancer and combination Phase Ib trials with cisplatin and oxalplatin. OSI-461 is a second-generation molecule that is currently being evaluated in a dose ranging Phase I study and a series of exploratory Phase II studies in chronic lymphocytic leukemia, renal cell carcinoma and prostate cancer. Like Tarceva(TM), the two gene-targeted therapies are receptor tyrosine kinase inhibitors. CP-547,632 is a small molecule targeting the vascular endothelial growth factor receptor, or VEGFR, and CP-724,714 is a small molecule targeting HER2/erbB2. Both agents are currently in Phase I clinical trials. In order to support our clinical pipeline, we have established (through acquisition and internal investment) a high quality oncology clinical development and regulatory affairs capability and a pilot scale chemical manufacturing and process chemistry group. Behind our clinical pipeline we have an extensive, fully integrated small molecule drug discovery organization designed to generate a pipeline of high quality oncology drug candidates to move into clinical development. This research operation has been built upon our historical strengths in high throughput screening, chemical libraries, medicinal and combinatorial chemistry, and automated drug profiling technology platforms. With oncology as our focus, we have made the strategic decision to divest all non-oncology research programs by the end of 2003 and realign our internal research effort toward an oncology strategy focused on the discovery of novel anti-cancer drugs targeting defects in signal transduction and apoptosis that are necessary for the growth of many human tumors. We have created a subsididary for our diabetes and obesity programs. Our diabetes program includes a partnership with the Vanderbilt University Diabetes Center, a funded alliance with Tanabe Seiyaku Co. Ltd., and six proprietary gene-targeted discovery programs in the lead seeking and lead optimization phases, primarily focused in the glucose regulation and obesity fields. We have also transferred to this entity our existing diabetes teams comprised of approximately 25 employees. We are currently seeking a partner for the venture. If we are unable to obtain external funding for this newly formed entity, we will consider other alternatives to discontinue the diabetes program, including out-licensing our diabetes assets and reducing our employee headcount. In July 2002, we agreed to accelerate the conclusion of the phase-down period of our funded research alliance -18- with Anaderm Research Corporation, a wholly-owned subsidiary of Pfizer focused on the development of novel treatments for skin and hair conditions. As of March 31, 2003, we received the full $8.0 million phase-down fee for the complete transfer to Anaderm of all of our research related to this collaboration. We will also receive royalties on the sale of products for these treatments which may arise from compounds that we have identified. On June 12, 2003, we completed our acquisition of Cell Pathways. Cell Pathways was a development stage pharmaceutical company focused on the research and development of products to treat and prevent cancer, and the future commercialization of such products. Cell Pathways also marketed and sold Gelclair(TM), the manufacturing rights of which were held by Sinclair Pharmaceuticals Ltd. of the United Kingdom and subsequently licensed to Helsinn Healthcare S.A. in July 2003. The assets purchased and liabilities assumed by us included: (a) two drug candidates in clinical development: Aptosyn(R) and OSI-461 and the related technology platform and patent estate; (b) exclusive distribution rights to a marketed oncology device, Gelclair(TM); (c) rights to Cell Pathways' leased facility in Horsham, Pennsylvania, as well as leasehold improvements and certain equipment; (d) inventory; and (e) certain other assets and liabilities. As consideration for the merger, each share of Cell Pathways common stock was exchanged for (i) 0.0567 shares of OSI common stock and (ii) a contingent value right to receive 0.04 shares of OSI common stock in the event a new drug application is accepted for filing with the U.S. Food and Drug Administration by June 12, 2008 for either of the two newly acquired clinical candidates, Aptosyn(R) or OSI-461. Based on the exchange ratio of 0.0567, we issued approximately 2.2 million shares of OSI common stock to Cell Pathways' stockholders in connection with the merger. On March 11, 2003, we entered into an agreement to market and promote the drug Novantrone(R) for approved oncology indications in the United States pursuant to the terms of a Co-Promotion Agreement with Ares Tradings, S.A., an affiliate of Serono S.A. In consideration for exclusive marketing and promotion rights, we paid $45.0 million in cash. In consideration for certain transition services required to be provided by Serono during a four-month transition period starting on the effective date of the agreement, we also paid a fee of $10.0 million. Under the terms of the agreement, we pay quarterly maintenance fees to Serono until the later of the expiration of the last valid patent claim or the first generic date. We receive commissions on net sales of Novantrone(R) in the United States for oncology indications. Novantrone(R) is approved by the FDA for the treatment of acute nonlymphocytic leukemia, which includes myelogenous, promyelocytic, monocytic and erythroid acute leukemias, and the relief of pain associated with advanced hormone-refractory prostate cancer. The drug is also approved for certain advanced forms of multiple sclerosis. Serono will continue to be responsible for the marketing of the multiple sclerosis indication for Novantrone(R) and will record all U.S. sales in all indications. To support Novantrone(R), we are building commercial operations which will include a sales force and an associated marketing and sales management infrastructure. These exclusive rights to a high quality marketed oncology product allows us to seed a commercial organization and begin to build a revenue base. We believe the tangible and intangible benefits of this transaction are significant by opening up the possibility for future in-licensing and -19- co-promotion deals for other marketed products, increasing our ability to directly market in the United States our future pipeline products and further validating of our company as a quality development and commercialization partner for oncology development candidates. In addition, it may allow us to further explore our co-promotion rights for Tarceva(TM) in the United States with our partner, Genentech. CRITICAL ACCOUNTING POLICIES We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States. As such, we are required to make certain estimates, judgments and assumptions that we believe are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenue and expenses during the periods presented. Actual results could differ significantly from those estimates under different assumptions and conditions. We believe that the following discussion addresses our most critical accounting policies, which are those that are most important to the portrayal of our financial condition and results of operations and which require our most difficult and subjective judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Note 1 to the consolidated financial statements included in our annual report on Form 10-K, as amended, for the year ended September 30, 2002 includes a summary of the significant accounting policies used in the preparation of the consolidated financial statements. Revenue Recognition Sales commissions represent the commissions earned on Novantrone(R) sales for oncology uses pursuant to the Co-Promotion Agreement with Serono. Under the terms of the agreement, we have the exclusive rights to market and promote the drug for approved oncology indications in the United States. The drug is also approved for advanced forms of multiple sclerosis. Serono will continue to be responsible for the marketing of the multiple sclerosis indication of Novantrone(R) and will record all U.S. sales for all indications, including oncology indications. Sales commissions from Novantrone(R) are recognized based on estimated net oncology sales in the period the sales occur. Sales commissions are subject to further adjustment based on final information regarding the split between oncology and multiple sclerosis sales of Novantrone(R), as determined by an independent third party. Product sales represent revenues earned on sales of Gelclair(TM) which was acquired in our acquisition of Cell Pathways which became effective on June 12, 2003. In accordance with SFAS No. 48, "Revenue Recognition When Right of Return Exists", given the limited sales history of Gelclair(TM), we at this time defer the recognition of revenue on product shipments of Gelclair(TM) to wholesale customers until such time as the product is prescribed to the end user. For each reporting period, we monitor shipments from wholesale customers to pharmacies and hospitals, wholesale customer reorder history and prescriptions filled by pharmacies based on prescription data from external, independent sources. When this data -20- shows a flow of product through the supply chain to the end user, which indicates that returns are less likely to occur, product revenue is recognized. We recognize all nonrefundable upfront license fees, including upfront technology access fees, as revenue over the term of the related research collaboration period in accordance with the guidance provided in the Securities and Exchange Commission's Staff Accounting Bulletin No. 101 - "Revenue Recognition in Financial Statements," as amended, or SAB No. 101. Our most significant application of this policy, to date, is the $25.0 million in upfront fees received from Genentech and Roche in January 2001, which was originally being recognized evenly over the expected three-year term of our required research and development efforts under the terms of the agreement. The expected term is subject to change based upon the parties' continuous monitoring of current research data and their projections for the remaining development period. A change in this expected term impacts the period over which the remaining deferred revenue would be recognized. In the fourth quarter of fiscal 2002, the expected term was changed to four years to reflect the revised estimated timing of our research and development commitment for Tarceva(TM) under the alliance. The revision was a result of the review of the current research data available, current developments in the HER1/EGFR targeted therapy market and the involved parties' revised projections for the clinical development plan. As a result of this revision, we recorded revenues of $1.3 million and $3.8 million for the three and nine months ended June 30, 2003, respectively, compared to $2.1 million and $6.3 million had the upfront fees continued to be recognized over a three-year period. Collaborative program revenues represent funding arrangements for research and development in the field of biotechnology and are recognized when earned in accordance with the terms of the contracts and the related development activities undertaken. Accruals for Clinical Research Organizations and Clinical Site Costs We make estimates of costs incurred to date but not yet invoiced in relation to external clinical research organizations, or CROs, and clinical site costs. We analyze the progress of clinical trials, including levels of patient enrollment, invoices received and contracted costs when evaluating the adequacy of the accrued liabilities. Significant judgments and estimates must be made and used in determining the accrued balance in any accounting period. Actual results could differ significantly from those estimates under different assumptions. Accounting for Goodwill and Other Intangible Assets Effective October 1, 2002, we fully adopted SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142 requires that goodwill and certain other intangibles with indefinite useful lives, are not amortized into results of operations but instead are reviewed for impairment at least annually and written down, and charged to results of operations in periods in which the recorded value of goodwill and certain other intangibles is more than their implied fair value. We completed our impairment review of goodwill during the first quarter of fiscal -21- 2003 and determined that no impairment charge was required upon adoption. In addition, no indications of impairment were identified during the third quarter of fiscal 2003. Our identifiable intangible assets are subject to amortization. We reassessed the useful life of our intangible asset (license for compound libraries) upon adoption of SFAS No. 142 to make any necessary amortization period adjustments. SFAS No.142 requires that goodwill and intangible assets with indefinite useful lives are tested for impairment at least annually. SFAS No. 142 also requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives and reviewed for impairment in accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived Asset to be Disposed Of". Under SFAS No. 121, intangible and other long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. As a result of our acquisition from Serono in March 2003 of the exclusive rights to market and promote the drug Novantrone(R) for the approved oncology indications in the United States, we recorded an identifiable intangible asset with an estimated useful life through the expiration of the Novantrone(R) patent in April 2006. In connection with our acquisition of Cell Pathways, we assumed the exclusive rights to market, sell and distribute Gelclair(TM) in North America which Cell Pathways had acquired from Sinclair in January 2002 for a period of 10 years. As a result, we recorded an identifiable intangible asset which is being amortized over eight and a half years, the remaining term of the agreement. Accounting for the Impairment of Long-Lived Assets On October 1, 2002, we adopted the provisions of SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 requires, among other things, that long-lived assets be measured at the lower of carrying amount or fair value, less cost to sell, whether reported in continuing operations or in discontinued operations. Intangibles with determinable lives and other long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Our judgments regarding the existence of impairment indicators are based on historical and projected future operating results, changes in the manner of our use of the acquired assets or our overall business strategy, and market and economic trends. In the future, events could cause us to conclude that impairment indicators exist and that certain intangibles with determinable lives and other long-lived assets are impaired which may result in an adverse impact on our financial condition and results of operations. The adoption of SFAS No. 144 did not have an impact on our consolidated financial statements as of and for the nine-month period ended June 30, 2003. REVENUES Total revenues for the three and nine months ended June 30, 2003 were $8.0 million and $20.1 million, respectively, compared to revenues of $4.5 million and $17.2 million for the three and nine months ended June 30, 2002, respectively. We began recognizing Gelclair(TM) product sales on June 12, 2003, subsequent to the closing of our acquisition of Cell Pathways. Total product sales for the period June 12, 2003 to June 30, 2003 were $145,000. We expect -22- to launch our sales effort for this product in the fall of 2003. We estimate that our total fiscal 2004 product sales of Gelclair(TM) will be between $3.0 million to $4.0 million. We began recording Novantrone(R) sales commissions on March 11, 2003, subsequent to the execution of the Co-Promotion Agreement with Serono. Total estimated sales commissions for the three and nine months ended June 30, 2003 were $5.5 million and $6.4 million, respectively. Sales commissions are subject to further adjustment based on final information on the split between oncology and multiple sclerosis sales of Novantrone(R), as determined by an independent third party. We initiated our sales activity for Novatrone(R) during the third quarter. We estimate that our total fiscal 2004 sales commissions on Novantrone(R) oncology sales will be between $20 million and $30 million. License and other revenues decreased $1.0 million or 40% and $3.6 million or 44% for the three and nine months ended June 30, 2003, respectively, compared to the three and nine months ended June 30, 2002. These decreases were primarily due to the decrease in the amount of revenue recognized relating to the $25.0 million upfront fees received from Genentech and Roche (see note 2 to the accompanying unaudited consolidated financial statements). In accordance with the provisions of SAB No. 101, we were recognizing the $25.0 million received from Genentech and Roche evenly over the expected three-year development phase of our agreement. In the fourth quarter of fiscal 2002, we changed the expected term of the agreement to four years to reflect the revised estimated timing of our research and development commitment for Tarceva(TM) under the alliance. The revision was a result of the review of the current research data available, current developments in the HER1/EGFR targeted therapy market and the involved parties' revised projections for the clinical development plan. In accordance with Accounting Principles Board Opinion No. 20, "Accounting Changes," the remaining unearned revenue will be recognized prospectively over the revised term. As a result, we recorded revenues of $1.3 million and $3.8 million during the three and nine months ended June 30, 2003, respectively, compared to revenues of $2.1 million and $6.3 million in the comparable periods of fiscal 2002. The decreases were also due to a decrease in revenues of $100,000 and $799,000 for the three and nine month periods, respectively, related to certain administrative services provided to British Biotech plc and Gilead Sciences, Inc. during the transition periods following the acquisitions of certain assets of each company. Total collaborative program revenues decreased $1.1 million or 56% and $46,000 or 0.5% for the three and nine months ended June 30, 2003, respectively, compared to the three and nine months ended June 30, 2002. The decrease for the three months was primarily due to the phase-down of our collaboration with Anaderm. In July 2002, we entered into an agreement with Pfizer to accelerate the phase-down period of the collaboration with Anaderm so that it would terminate no later than April 23, 2003. In consideration for the work to be performed by us during the accelerated phase-down period, we received $4.5 million in September 2002 and $3.5 million in March 2003 upon the successful completion of the transition period. The $4.5 million was recognized as revenue ratably over the term of the transition period and the $3.5 million was recognized during the three months ended March 31, 2003 upon the successful completion of the transition. The decrease for the three months was also due to a decrease in activity related to our collaboration with Tanabe Seiyaku Co., Ltd., -23- which expires in September 2003 and is not expected to be renewed. As a result of our strategic decision to divest all non-oncology research programs, as well as the completion of the Anaderm collaboration in the second quarter of fiscal 2003, we expect collaborative revenues to continue to decrease. EXPENSES Total operating expenses of $82.9 million increased $47.8 million or 136% for the three months ended June 30, 2003 compared to the three months ended June 30, 2002. Excluding the acquired in-process R&D charge of $31.3 million recorded in the three months ended June 30, 2003, operating expenses increased $16.5 million or 47% for the three months ended June 30, 2003. Operating expenses of $153.8 million decreased $68.0 million or 31% for the nine months ended June 30, 2003 compared to the nine months ended June 30, 2002. Excluding the in-process R&D charges of $31.3 million and $130.2 million recorded in the nine months ended June 30, 2003 and 2002, respectively, operating expenses increased $30.9 million or 34% for the nine months ended June 30, 2003 compared to the nine months ended June 30, 2002. These in-process research and development charges relate to the acquisition of Cell Pathways in June 2003 and the acquisition of certain assets from Gilead in December 2001. We do not deem these charges to be indicative of the day-to-day operations of our company. Operating expenses primarily included (i) research and development expenses, which included expenses related to the development of our lead clinical candidate, Tarceva(TM), and proprietary and collaborative-based research; (ii) in-process R&D charges related to the acquisition of Cell Pathways in June 2003 and the acquisition of oncology assets acquired from Gilead in December 2001; (iii) selling, general and administrative expenses; and (iv) amortization of intangibles. Cost of products sold related to sales of Gelclair(TM) for the period June 12, 2003 to June 30, 2003 were $55,000 or 38% of product sales. There were no costs of products sold prior to June 12, 2003 since we acquired the rights to Gelclair(TM) on June 12, 2003 in connection with the Cell Pathways acquisition. The largest component of our total expenses is our ongoing investments in research and development and particularly the clinical development of our product pipeline. We currently have eight drug candidates in clinical development including our most advanced candidate, Tarceva(TM), which is currently in Phase III trials for non-small cell lung cancer and pancreatic cancer and in Phase II trials for glioblastoma. Aptosyn(R), an early-generation molecule acquired in connection with our acquisition of Cell Pathways, is currently in Phase III trials for non-small cell lung cancer. The other six drug candidates are in earlier stages of clinical development. OSI-461, which also was acquired in connection with our acquisition of Cell Pathways, is a second-generation molecule that is being evaluated in chronic lymphocytic leukemia, renal carcinoma and prostate cancer. Three candidates (OSI-211, OSI-7904L and OSI-7836) are next generation cytotoxic chemotherapy agents which are being developed by us. The other two candidates (CP-547,632 and CP-724,714) are gene-targeted therapies currently being developed by Pfizer and require no further research and development investment by us. We consider the active management and development of our clinical pipeline -24- to be crucial to the long-term success of the company. Due to the inherent risks associated with the drug discovery development, regulatory and approval process, we manage our overall research, development and in-licensing efforts in a manner designed to generate a constant flow of clinical candidates into development to offset both the advancement of products to the market and the anticipated attrition rate of drug candidates that fail in clinical trials or are terminated for business reasons. The table below summarizes the typical duration of each phase of clinical development and the typical cumulative probabilities of success for approval of drug candidates entering clinical development. The numbers are based upon industry survey data for small molecule drugs:
Estimated Cumulative Development Phase Estimated Completion Time Probability of Success - ----------------- ------------------------- ---------------------- Phase I 1-2 Years 20% Phase II 1-2 Years 30% Phase III 2-3 Years 65% Registration 6-15 months 85%
The actual probability of success for each drug candidate and clinical program will be impacted by a variety of factors, including the quality of the molecule, the validity of the target and disease indication, early clinical data, investment in the program, competition and commercial viability. Because we manage our pipeline in a dynamic manner, it is difficult to give accurate guidance on the anticipated proportion of our research and development investments assigned to any one program prior to the Phase III stage of development, as well as the future cash inflows from these programs. However, in fiscal 2003 we anticipate investing a total of approximately $35 million in pre-clinical research and approximately $75 million in clinical development. We consider this level of investment suitable to sustain one to two Phase III programs and two to four earlier clinical stage programs at any time and we manage our overall research and development investments toward this level of activity. Research and development expenses decreased $1.5 million or 6% for the three months ended June 30, 2003 compared to the three months ended June 30, 2002. Research and development expenses increased $6.7 million or 10% for the nine months ended June 30, 2003 compared to the nine months ended June 30, 2002. The decrease for the three months was primarily related to a shift from non-oncology programs to oncology programs as well as the timing of expenses related to our clinical development programs. The decrease for the three months ended June 30, 2003 was offset by increased investments in other proprietary cancer programs, including the oncology candidates recently acquired from Cell Pathways. Costs associated with the clinical development of Tarceva(TM) under our Tripartite Agreement with Genentech and Roche remained flat for the three months ended June 30, 2003 compared to the three months ended June 30, 2002. The increase for the nine months ended June 30, 2003 was due to an increase in costs associated with the clinical development of Tarceva(TM) and certain proprietary cancer programs, including oncology candidates recently acquired from Cell Pathways. This increase was offset by decreased investments in collaborative programs and our proprietary diabetes program. Included in research and development expenses for the nine months ended June 30, 2003 is a severance charge of $694,000. This charge related to a -25- reduction in our headcount in October 2002 as we refocused our business on oncology and away from services that we had historically provided to our former collaborative partners. Our most advanced development program is for Tarceva(TM). In January 2001, we entered into the alliance with Genentech and Roche for the global development and commercialization of Tarceva(TM). The significant perceived market potential for Tarceva(TM) has resulted in the alliance partnership committing to an unusually large and comprehensive global development plan for the candidate. The global development plan comprises four major phase III clinical trials in lung and pancreatic cancers and a large number of earlier stage trials in a variety of disease settings, including glioblastoma. In addition, numerous collaborative and investigator sponsored studies are ongoing in a number of other disease settings including bronchioloalveolar cell-carcinoma and gynecological malignancies. The alliance partners have committed to invest a combined $300 million in the global development plan to be shared equally by the three parties. Additional research and development investments can be made by the parties outside of the global development plan with the consent of the other parties. We estimate that we will invest an additional $10-$15 million in Tarceva(TM) research and development outside of the global development plan prior to the drug's targeted launch in the third quarter of calendar 2004. As of June 30, 2003, we have invested in excess of $67 million, representing our share of the costs incurred to date in the tripartite global development plan and additional investments outside the plan. Our share of the research and development expenses for Tarceva(TM) incurred for the three and nine months ended June 30, 2003 were $7.8 million and $28.4 million, respectively. We anticipate investing a majority of the remaining $43-48 million we have provisionally budgeted for this program over the next two years. Should Tarceva(TM) be successfully registered and launched we would anticipate a lower level but continued research and development investment in the product to support its commercial growth. For our second Phase III clinical candidate, Aptosyn(R), we expect the cost to complete the Phase III trials to be between $3.0 and $4.0 million. In connection with the acquisition of Cell Pathways, which was completed in June 2003, we recorded an in-process R&D charge of $31.3 million during the three months ended June 30, 2003, representing the estimated fair value of the acquired in-process technology that had not yet reached technological feasibility and had no alternative future use (see note 5(a) to the accompanying unaudited consolidated financial statements). The in-process R&D charge was assigned to the two development projects and related technology platform and patent estate, Aptosyn(R) ($3.7 million) and OSI-461 ($27.6 million) based on their value on the date of the acquisition. In determining the value of the in-process R&D, the assumed commercialization dates for these products ranged from 2005 to 2006. Significant assumptions and estimates used in the valuation of in-process R&D included: the stage of development for each of the two projects; future revenues; growth rates for each product; product sales cycles; the estimated life of a product's underlying technology; future operating expenses; probability adjustments to reflect the risk of developing the acquired technology into commercially viable products; and a discount rate of 25% to reflect present value. In connection with the acquisition of certain assets from Gilead in December 2001, we recorded an in-process R&D charge of $130.2 million during the three months ended -26- December 31, 2001, representing the estimated fair value of the acquired in-process technology that had not yet reached technological feasibility and had no alternative future use (see note 5(b) to the accompanying unaudited consolidated financial statements). The acquired in-process R&D was allocated to the following three oncology candidates: OSI-211, OSI-7904L and OSI-7836. The value of the acquired in-process R&D charges were determined by estimating the projected net cash flows related to products under development based upon the future revenues to be earned upon commercialization of such products. Given the risks associated with the development of new drugs, the revenue and expense forecasts were probability-adjusted to reflect the risk of advancement through the approval process. The risk adjustments applied were based on each compound's stage of development at the time of assessment and the historical probability of successful advancement for compounds at that stage. These modeled cash flows were discounted back to their net present value. The projected net cash flows from such projects were based on management's estimates of revenues and operating profits related to such projects. The in-process R&D was valued based on the income approach that focuses on the income-producing capability of the assets. The underlying premise of this approach is that the value of an asset can be measured by the present worth of the net economic benefit (cash receipts less cash outlays) to be received over the life of the asset. For each project, we need to successfully complete a series of clinical trials and to receive FDA or other regulatory approvals prior to commercialization. There can be no assurances that any of these candidates will ever reach feasibility or develop into products that can be marketed profitably, nor can there be any assurances that we will be able to develop and commercialize these products prior to the development of comparable products by our competitors. If it is determined that it is not cost beneficial to pursue the further development of any of these candidates, we may discontinue such further development of certain or all of these candidates. Selling, general and administrative expenses increased $14.4 million or 160% and $20.4 million or 97% for the three and nine months ended June 30, 2003, respectively, compared to the three and nine months ended June 30, 2002. The increases were due to (i) increased commercialization and marketing costs relating to Tarceva(TM) which are shared with Genentech in accordance with the terms of our collaboration with Genentech, (ii) additional management and administrative personnel to support our clinical trial programs, research and development efforts, (iii) additional management and personnel relating to the establishment of commercial operations to support Gelclair(TM) and Novantrone(R), and (iv) expenses for maintenance fees and transition support services provided by Serono relating to Novantrone(R) sales in oncology indications. The increase for the nine months ended June 30, 2003 was slightly offset by a decrease in relocation expenses relating to the consolidation of our Birmingham, England facility with our Oxford, England facility. Included in selling, general and administrative expenses for the nine months ended June 30, 2003 is a severance charge of $249,000 relating to a reduction in our headcount in October 2002. In connection with the exclusive rights to market and promote Novantrone(R) for approved oncology indications in the United States, we secured a short-term transitional arrangement with a contract sales organization comprising a core of sales representatives as we build our commercial operations. We expect selling, general and administrative costs to increase as we build commercial -27- operations which will include a sales force and an associated marketing and sales management infrastructure. The initial sales and marketing infrastructure will be comprised of approximately 60 sales and marketing personnel, of which approximately 30 will be detail sales representatives in the field. The balance of personnel will be management and support positions. Amortization of intangibles increased $3.6 million and $3.7 million for the three and nine months ended June 30, 2003, respectively, compared to the three and nine months ended June 30, 2002. The increase primarily related to $3.7 million and $4.4 million for the three and nine months ended June 30, 2003, respectively, in amortization expense for the exclusive rights to market and promote the drug Novantrone(R) for approved oncology indications in the United States. Also included in amortization for the three and nine months ended June 30, 2003, is $140,000 in amortization expense for the exclusive rights to market, sell and distribute Gelclair(TM) in North America. Offsetting these increases were a $249,000 and $737,000 decrease in amortization expense for the three months and nine months ended June 30, 2002, respectively, attributable to the full adoption of SFAS No. 142 on October 1, 2002, whereby we ceased amortizing the assembled workforce acquired from British Biotech and reclassified the balance of $2.1 million to goodwill. OTHER INCOME AND EXPENSE Net investment income decreased $1.9 million or 55% and $5.0 million or 44% for the three and nine months ended June 30, 2003, respectively, compared to the three and nine months ended June 30, 2002. The decrease was primarily attributable to a decrease in the average rate of return on our investments and to less funds available for investment during the respective periods. Interest expense decreased $406,000 or 20% for the three months ended June 30, 2003 compared to the three months ended June 30, 2002. Interest expense increased $1.5 million or 43% for the nine months ended June 30, 2003 compared to the nine months ended June 30, 2002. The increase was primarily due to the interest expense incurred on the convertible senior subordinated notes issued in February 2002, a portion of which were retired in August and September 2002. The convertible senior subordinated notes bear interest at 4% per annum, are payable semi-annually, and mature on February 1, 2009. For the three months ended June 30, 2003 and 2002, other expense-net was $198,000 and $317,000, respectively. Included in the three months ended June 30, 2003 and 2002 was the amortization of debt issuance costs of $203,000 and $249,000, respectively. For the nine months ended June 30, 2003 other expense-net was $321,000 compared to other income-net of $155,000 for the nine months ended June 30, 2002. Included in the nine months ended June 30, 2003 was amortization of debt issuance costs of $609,000 offset by realized gains from the sale of investments of $391,000. Included in the nine months ended June 30, 2002 was the $1.0 million contingent payment received from The Bayer Corporation in December 2001, in connection with the sale of the diagnostic business in November 1999, offset by realized losses from the sale of investments of $186,000 and amortization of debt issuance costs of $405,000. -28- LIQUIDITY AND CAPITAL RESOURCES At June 30, 2003, working capital, representing primarily cash, cash equivalents, and restricted and unrestricted short-term investments, aggregated $303.2 million compared to $444.6 million at September 30, 2002. This decrease of $141.4 million is primarily due to the payment for the exclusive rights to market and promote Novantrone(R) and related fees totaling $46.0 million, the transition services fees and maintenance fees paid to Serono as well as net operating cash burn for the period. On February 1, 2002, we issued $200.0 million aggregate principal amount of convertible senior subordinated notes in a private placement for net proceeds to us of approximately $193.0 million. The notes bear interest at 4% per annum, are payable semi-annually, and mature on February 1, 2009. We pledged $22.9 million of U.S. government securities which will be sufficient to provide for the payment in full of the first six scheduled interest payments on the notes when due. In August and September 2002, we retired a total of $40.0 million in principal amount of the notes for an aggregate purchase price of $26.2 million, including accrued interest. Should conditions warrant, we may from time-to-time continue to enter the market to repurchase additional notes. We expect to incur continued losses over the next several years as we continue our investment in Tarceva(TM) and other product candidates in our pipeline and build our commercial operations. The major expenses associated with the broad-based Phase III development program for Tarceva(TM) are expected to occur in fiscal 2003. We estimate that following the assimilation of both the acquisition of the Novantrone(R) rights and the Cell Pathways acquisition, our fiscal 2004 cash burn will be approximately $100-$110 million depending on the timing of certain expenses and excluding any sales revenues from Tarceva(TM). We currently estimate that our fiscal 2003 year ending cash position will be in excess of $250 million, assuming all acquisition and consolidation related costs occur in fiscal 2003. We have established a goal of achieving profitability and positive cash flow within 18 to 24 months of a successful market launch of Tarceva(TM). Although we believe that we have sufficient cash for operations for the next few years, if the market launch of Tarceva(TM) is delayed or if Tarceva(TM) does not receive FDA approval or if the approval process is delayed or takes longer than expected, such events could have a negative impact on our liquidity position, assuming our current cash burn. In addition, as we continue to pursue strategic in-licensing and acquisition opportunities that would bring additional products and clinical development candidates to our cancer pipeline, we will be required to use our available cash and/or equity securities. To achieve profitability, we, alone or with others, must successfully develop and commercialize our technologies and products, conduct pre-clinical studies and clinical trials, secure required regulatory approvals and obtain adequate assistance to successfully manufacture, introduce and market such technologies and products. The ability and time required to reach profitability is uncertain. We believe that our existing cash resources provide a strong financial base from which to fund our operations and capital requirements for at least the next few years. -29- COMMITMENTS AND CONTINGENCIES Our major outstanding contractual obligations relate to our convertible senior subordinated notes and our facility leases. The following table summarizes our significant contractual obligations at June 30, 2003 and the effect such obligations are expected to have on our liquidity and cash flow in future periods (in thousands):
2008 & 2003 2004 2005 2006 2007 THEREAFTER TOTAL -------- -------- -------- -------- -------- ---------- -------- Contractual Obligations: Senior convertible debt(a) $ 3,200 $ 6,400 $ 6,400 $ 6,400 $ 6,400 $ 169,600 $198,400 Operating leases ......... 2,017 7,860 7,932 6,659 5,385 58,237 88,090 Capital commitments ...... 3,455 499 -- -- -- -- 3,954 Loans and capital leases payable(b) .... 71 42 12 -- -- -- 125 -------- -------- -------- -------- -------- ---------- -------- Total contractual obligations ............ $ 8,743 $ 14,801 $ 14,344 $ 13,059 $ 11,785 $ 227,837 $290,569 ======== ======== ======== ======== ======== ========== ========
- ---------- (a) Includes interest payments at a rate of 4% per annum. (b) Includes interest payments. Other significant commitments and contingencies include the following: - We are committed to share equally with Genentech and Roche a combined $300 million in certain global development costs for Tarceva(TM). As of June 30, 2003 we have spent approximately two thirds of our commitment under the agreement. We are also committed to share certain commercialization cost relating to Tarceva(TM) with Genentech. - In connection with the acquisition of certain of Gilead's oncology assets in December 2001, we are obligated to pay up to an additional $30.0 million in either cash or a combination of cash and common stock upon achievement of certain milestones related to the development of OSI-211, the most advanced of Gilead's oncology product candidates acquired by us. - In connection with the acquisition of Cell Pathways in June 2003, we provided additional consideration in the form of five-year contingent value rights through which each share of Cell Pathways common stock will be eligible for an additional .04 share of OSI common stock in the event of a filing of a new drug application for either of the two clinical candidates acquired from Cell Pathways, OSI-461 or Aptosyn(R). - In connection with the exclusive distribution agreement to promote and distribute Gelclair(TM) in North America, we are committed to additional inventory purchases of $3.0 million and $5.0 million in 2003 and 2004 respectively, and annual marketing expenditures of $750,000, $500,000 and $250,000 for 2003 through 2006, 2007 through 2008 and 2009 through 2011 respectively. In addition we are obligated to spend $1.3 million annually for -30- direct sales force efforts. We could be responsible for milestone payments totaling $3.0 million related to achievement of certain sales, patent and clinical trial milestones. - In connection with our agreement with Celgene, we are required to make payments to Celgene upon the return of certain sales and marketing data and upon the first anniversary of the effective date provided that the transition services, as defined in the agreement, have been provided to us. The agreement also provides for a milestone payment to Celgene upon the achievement of a specified amount of net sales of Gelclair(TM). - In connection with our agreement with Serono to market and promote Novantrone(R) in approved oncology indications, we are required to pay quarterly maintenance fees to Serono until the later of the expiration of the last valid patent claim or the first generic date, as defined in the agreement, or unless the agreement is earlier terminated. - Under agreements with external CROs, over the next 12 months we will continue to incur expenses relating to the progress of Tarceva(TM) clinical trials. These disbursements can be based upon the achievement of certain milestones, patient enrollment, services rendered or as expenses are incurred by the CROs. - We have a retirement plan which provides postretirement medical and life insurance benefits to eligible employees, board members and qualified dependents. Eligibility is determined based on age and years of service. We have accrued postretirement benefit costs of $3.0 million at June 30, 2003. - Under certain collaboration agreements with pharmaceutical companies and educational institutions, we are required to pay royalties and/or milestones upon the successful development and commercialization of products. - Under certain license agreements, we are required to pay license fees for the use of technologies and products in our research and development activities. - We have outstanding letters of credit issued by a commercial bank. One is an irrevocable letter of credit related to our Oxford, England facility and expires annually with a final expiration date of September 27, 2007. The amount under this letter of credit is $2.2 million of which the full amount was available on June 30, 2003. Another is an irrevocable letter of credit related to our Horsham, Pennsylvania facility, whose lease we assumed through the acquisition of Cell Pathways. The letter expires annually with a final expiration date of September 22, 2008. The amount under this letter of credit is $400,000 of which the full amount was available on June 30, 2003. - In May 2003, we entered into a contract with a third-party contract sales organization for the outsourcing of sales representatives and other sales force -31- infrastructure. The commitment is approximately $3.3 million over a one-year period. RECENT ACCOUNTING PRONOUNCEMENTS In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities", effective for exit or disposal activities that are initiated after December 31, 2002. Under SFAS No. 146, a liability for a cost associated with an exit or disposal activity must only be recognized when the liability is incurred. Under the previous guidance of EITF 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity including Certain Costs Incurred in a Restructuring", we recognized a liability for an exit or disposal activity cost at the date of our commitment. We have not entered into any significant exit or disposal activities since the effectiveness of this statement. As such, SFAS No. 146 has not had an impact on our consolidated financial statements. In November 2002, the EITF reached a consensus on Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables." Issue 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of Issue 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003, that are not within the scope of higher level accounting literature. The adoption of Issue 00-21 is not expected to have a material impact on our financial statements In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN 45 requires a guarantor to include disclosure of certain obligations, and if applicable, at the inception of the guarantee, recognize a liability for the fair value of other certain obligations undertaken in issuing a guarantee. The recognition requirement is effective for guarantees issued or modified after December 31, 2002 and did not have a material impact on our consolidated financial statements. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure". SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation as originally provided by SFAS No. 123 "Accounting for Stock-Based Compensation". Additionally, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosure in both the annual and interim financial statements about the method of accounting for stock-based compensation and the effect of the method used on reported results. The transitional requirements of SFAS No. 148 are effective for all financial statements for fiscal years ending after December 15, 2002. We adopted the disclosure portion of this statement beginning in the fiscal quarter ended March 31, 2003. The application of the disclosure portion of this standard will have no impact on our consolidated financial position or results of operations. The FASB recently decided that it will require stock-based employee -32- compensation to be recorded as a charge to earnings beginning as early as 2004. We will continue to monitor its progress on the issuance of this standard. In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities." FIN 46 clarifies the application of Accounting Research Bulletin No. 51 to require consolidation of an entity if it is controlled through interests other than voting interests. FIN 46 applies immediately to any variable interest entities created after January 31, 2003 and to variable interest entities in which an interest is obtained after that date. The guidelines of this interpretation will become applicable for us in the fourth quarter of fiscal year 2003 for variable interest entities created before February 1, 2003. The interpretation requires variable interest entities to be consolidated if the equity investment at risk is not sufficient to permit an entity to finance its activities without support from other parties or the equity investors lack certain specified characteristics. The adoption of FIN 46 for variable interest entities created after January 31, 2003 did not have a material impact on our consolidated financial condition, results of operations or cash flows. We are continuing to review the provisions of FIN 46 to determine its impact, if any, on future reporting periods with respect to interests in variable interest entities created prior to February 1, 2003, and do not currently anticipate any material accounting or disclosure requirements under the provisions of the interpretation. In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities". SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under Statement of Financial Accounting Standard No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003 and is not expected to have an impact on us upon adoption. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 establishes standards for how a company classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify certain financial instruments as a liability (or as an asset in some circumstances). SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 did not have an impact on our consolidated financial statements. FORWARD LOOKING STATEMENTS A number of the matters and subject areas discussed in this Item 2 "Management's Discussion and Analysis of Financial Condition and Results of Operations," and elsewhere in this report that are not historical or current facts deal with potential future circumstances and developments. The discussion of these matters and subject areas is qualified by the inherent risks and uncertainties surrounding future expectations generally, and these discussions may materially differ from our actual future experience involving any one or more of these matters -33- and subject areas. These forward looking statements are also subject generally to the other risks and uncertainties that are described in our annual report on Form 10-K, as amended, for the fiscal year ended September 30, 2002. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our cash flow and earnings are subject to fluctuations due to changes in interest rates in our investment portfolio of debt securities, to the fair value of equity instruments held and to foreign currency exchange rates. We maintain an investment portfolio of various issuers, types and maturities. These securities are generally classified as available-for-sale and, consequently, are recorded on the balance sheet at fair value with unrealized gains or losses reported as a component of accumulated other comprehensive income (loss) included in stockholders' equity. With respect to the convertible senior subordinated notes, we pledged $22.9 million of U.S. government securities (restricted investment securities) with maturities at various dates through November 2004. Upon maturity, the proceeds of the restricted investment securities will be sufficient to pay the first six scheduled interest payments on the convertible senior subordinated notes when due. We consider our restricted investment securities to be "held-to-maturity," as defined by SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." These securities are reported at their amortized cost, which includes the direct costs to acquire the securities, plus the amortization of any discount or premium, and accrued interest earned on the securities. Our limited investments in certain biotechnology companies are carried on the equity method or cost method of accounting using the guidance of applicable accounting literature. Other-than-temporary losses are recorded against earnings in the same period the loss was deemed to have occurred. It is uncertain whether other-than-temporary losses will be material to our results of operations in the future. We do not currently hedge these exposures. We at times minimize risk by hedging the foreign currency exchange rates exposure through forward contracts as more fully described in note 12(d) to the consolidated financial statements contained in our annual report on Form 10-K, as amended, for the fiscal year ended September 30, 2002. We did not have any forward foreign exchange contracts as of or during the three and nine months ended June 30, 2003. At June 30, 2003, we maintained a portion of our cash and cash equivalents in financial instruments with original maturities of three months or less. We also maintained an investment portfolio containing financial instruments which are principally comprised of government and government agency obligations and corporate obligations and are subject to interest rate risk and will decline in value if interest rates increase. A hypothetical 10% change in interest rates during the three and nine months ended June 30, 2003 would have resulted in a $157,000 and $647,000 change in our net loss, respectively. We have not used or held derivative financial instruments in our investment portfolio. Our long-term debt totaled $160.0 million at June 30, 2003 and was primarily comprised of the convertible senior subordinated notes. The convertible senior subordinated notes bear interest at a fixed rate of 4%. Underlying market risk exists related to an increase in our stock price or an increase in interest rates which may make the conversion of the convertible senior subordinated notes to common stock beneficial to the convertible senior -34- subordinated notes holders. Conversion of the convertible senior subordinated notes would have a dilutive effect on any future earnings and book value per common share. ITEM 4. CONTROLS AND PROCEDURES Evaluation of our Disclosure Controls and Procedures. The Securities and Exchange Commission requires that as of the end of the period covered by this quarterly report on Form 10-Q the CEO and the CFO evaluate the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13(a)-15(e)), and report on the effectiveness of the design and operation of our disclosure controls and procedures. Accordingly, under the supervision and with the participation of our management, including our CEO and CFO, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this quarterly report on Form 10-Q. CEO/CFO Conclusions about the Effectiveness of the Disclosure Controls and Procedures. Based upon their evaluation of the disclosure controls and procedures, our CEO and CFO have concluded that, subject to the limitations noted below, our disclosure controls and procedures are effective to provide reasonable assurance that material information relating to the Company and its consolidated subsidiaries is made known to management, including the CEO and CFO, on a timely basis and particularly during the period in which this quarterly report on Form 10-Q was being prepared. Limitations on the Effectiveness of Controls. Our management, including the CEO and CFO, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple errors or mistakes. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. While we believe that our disclosure controls and procedures have been effective, in light of the foregoing we intend to continue to examine and refine our disclosure controls and procedures and to monitor ongoing developments in this area. -35- Changes in Internal Controls. There were no changes in our internal control over financial reporting (as defined in Rule 13(a)-15(f)) identified in connection with the evaluation of such internal control over financial reporting that occurred during the period covered by this quarterly report on Form 10-Q, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. -36- PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Not applicable. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS Not Applicable. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. ITEM 5. OTHER INFORMATION Not applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (A) EXHIBITS 3.1 Certificate of Incorporation, as amended, filed by OSI Pharmaceuticals, Inc. as an exhibit to the Form 10-K for the fiscal year ended September 30, 2001 (file no. 000-15190), and incorporated herein by reference. 3.2 Amended and Restated Bylaws, filed by OSI Pharmaceuticals, Inc. as an exhibit to the Form 10-K for the fiscal year ended September 30, 2001 (file no. 000-15190), and incorporated herein by reference. 10.1* Distribution Agreement, dated January 22, 2002, by and between Sinclair Pharmaceuticals Ltd. and Cell Pathways, Inc. (assumed by OSI Pharmaceuticals, Inc. upon the acquisition of Cell Pathways, Inc. on June 12, 2003). 10.2 Amendment No. 1 to Distribution Agreement, dated March 15, 2002, by and between Sinclair Pharmaceuticals Ltd. and Cell Pathways, Inc. (assumed by OSI Pharmaceuticals, Inc. upon the acquisition of Cell Pathways, Inc. on June 12, 2003). -37- 10.3* Amendment No. 2 to Distribution Agreement, dated October 15, 2002, by and between Sinclair Pharmaceuticals Ltd. and Cell Pathways, Inc. (assumed by OSI Pharmaceuticals, Inc. upon the acquisition of Cell Pathways, Inc. on June 12, 2003). 10.4 Amendment No. 3 to Distribution Agreement, dated June 9, 2003, by and between Sinclair Pharmaceuticals Ltd. and Cell Pathways, Inc. (assumed by OSI Pharmaceuticals, Inc. upon the acquisition of Cell Pathways, Inc. on June 12, 2003). 31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a). 31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a). 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350. 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350. - ---------- * Portions of this exhibit have been redacted and are subject to a confidential treatment request filed with the Secretary of the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended. (B) REPORTS ON FORM 8-K We filed a second amendment on May 6, 2003 to a current report which was filed on March 12, 2003 and amended on March 17, 2003, with the Securities and Exchange Commission via EDGAR, with respect to our co-promotion agreement with Serona for Novantrone(R). The earliest event covered by this report occurred on March 12, 2003. We filed a current report on May 14, 2003 with the Securities and Exchange Commission via EDGAR, with respect to our earnings release. The earliest event covered by this report occurred on May 14, 2003. We filed a current report on June 27, 2003 with the Securities and Exchange Commission via EDGAR, with respect to the completion of the merger agreement under which we acquired Cell Pathways by way of a stock-for-stock merger. The earliest event covered by this report occurred on June 12, 2003. -38- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. OSI PHARMACEUTICALS, INC. ------------------------------------- (Registrant) Date: August 13, 2003 /s/ Colin Goddard, Ph.D. ------------------------------------------ Colin Goddard, Ph.D. Chief Executive Officer Date: August 13, 2003 /s/ Robert L. Van Nostrand ------------------------------------------ Robert L. Van Nostrand Vice President and Chief Financial Officer (Principal Financial Officer) -39- INDEX TO EXHIBITS Exhibit - ------- 3.1 Certificate of Incorporation, as amended, filed by OSI Pharmaceuticals, Inc. as an exhibit to the Form 10-K for the fiscal year ended September 30, 2001 (file no. 000-15190), and incorporated herein by reference. 3.2 Amended and Restated Bylaws, filed by OSI Pharmaceuticals, Inc. as an exhibit to the Form 10-K for the fiscal year ended September 30, 2001 (file no. 000-15190), and incorporated herein by reference. 10.1* Distribution Agreement, dated January 22, 2002, by and between Sinclair Pharmaceuticals Ltd. and Cell Pathways, Inc. (assumed by OSI Pharmaceuticals, Inc. upon the acquisition of Cell Pathways, Inc. on June 12, 2003). 10.2 Amendment No. 1 to Distribution Agreement, dated March 15, 2002, by and between Sinclair Pharmaceuticals Ltd. and Cell Pathways, Inc. (assumed by OSI Pharmaceuticals, Inc. upon the acquisition of Cell Pathways, Inc. on June 12, 2003). 10.3* Amendment No. 2 to Distribution Agreement, dated October 15, 2002, by and between Sinclair Pharmaceuticals Ltd. and Cell Pathways, Inc. (assumed by OSI Pharmaceuticals, Inc. upon the acquisition of Cell Pathways, Inc. on June 12, 2003). 10.4 Amendment No. 3 to Distribution Agreement, dated June 9, 2003, by and between Sinclair Pharmaceuticals Ltd. and Cell Pathways, Inc. (assumed by OSI Pharmaceuticals, Inc. upon the acquisition of Cell Pathways, Inc. on June 12, 2003). 31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a). 31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a). 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. - ---------- * Portions of this exhibit have been redacted and are subject to a confidential treatment request filed with the Secretary of the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended. -40- EX-10.1 3 y89178exv10w1.txt DISTRIBUTION AGREEMENT EXHIBIT 10.1 PORTIONS OF THIS EXHIBIT HAVE BEEN REDACTED AND ARE THE SUBJECT OF A CONFIDENTIAL TREATMENT REQUEST FILED WITH THE SECRETARY OF THE SECURITIES AND EXCHANGE COMMISSION. CONFIDENTIAL DOCUMENT DISTRIBUTION AGREEMENT This Agreement ("Agreement") is made and entered into on January 22, 2002 between: SINCLAIR PHARMACEUTICALS LTD., a corporation duly organized and existing under the laws of England having its place of business at Borough Rd, Godalming, Surrey, United Kingdom GU7 2AB and Sinclair Pharma Srl, a corporation duly organized and existing under the laws of Italy having its place of business at Viale Marche, 15, 20125 Milano, Italy. Sinclair Pharmaceuticals Ltd and Sinclair Pharma Srl are hereinafter collectively referred to as "Company" and CELL PATHWAYS, INC., a corporation duly organized and existing under the laws of Delaware having a place of business at 702 Electronic Drive, Horsham, Pennsylvania, 19044 hereinafter referred to as "Distributor". Whereas Company has the exclusive rights to appoint exclusive distributors for the Product in the Territory as defined below and has the right to supply Products for that purpose. Whereas Distributor wishes to become the exclusive distributor of such Products in the Territory as set out herein. Now, therefore, the Parties hereto in consideration of the premises and mutual covenants and undertakings herein contained agree as follows: ARTICLE 1. DEFINITIONS 1.1 "Affiliate" of a Party hereto shall mean any entity which controls, is controlled by, or is under common control with such party. For purposes of this definition, a Party shall be deemed to control another entity if it owns or controls, directly or indirectly, more than fifty percent (50%) of the voting equity of the other entity (or other comparable ownership interest for an entity other than a corporation) or if it possesses, directly or indirectly, the ptoower to direct or cause the direction of the management and policies, whether through ownership of voting securities, by contract, or otherwise, of such other entity. 1.2 "Approved Indication" shall mean the "management and relief of oral pain, by adhering to the mucosal surface of the mouth for soothing of lesions of various etiologies." The Approved Indication will be deemed amended or changed in scope in accordance with any additional regulatory approvals of the Product in the Territory. 1.3 "Competing Product" shall mean any product other than the Products that is used for the Approved Indication. 1.4 "Effective Date" shall mean the date of receipt by Company of the payment of $1,000,000 referred to in Section 5.3. [*]CONFIDENTIAL TREATMENT REQUESTED 1 CONFIDENTIAL PORTION OMITTED AND FILED SEPARATELY WITH THE COMMISSION CONFIDENTIAL DOCUMENT 1.5 "Force Majeure" is any factor beyond a Party's control, including, without limitation, fire, explosion, accident, riot, flood, drought, storm, earthquake, lightning, frost, civil commotion, sabotage, vandalism, smoke, hail, embargo, act of God or the public enemy, other casualty, strike or lockout, or interference, prohibition or restriction imposed by any government or any officer or agent thereof. 1.6 "Forecast" shall mean forecasts of sales by Distributor as set forth in Section 3.3 of this Agreement. 1.7 "Forecast Range" shall mean for any calendar quarter a quantity +/- 50% of Forecast for that quarter. 1.8 "Know-how" shall mean technical or scientific information (1) regarding the Products which may be necessary, useful or advisable to enable Distributor to promote, market and sell the Products in the Territory, and as is or will be specified in the documentation which Company has delivered or will deliver to Distributor after the Effective Date and during the term of this Agreement; or (2) regarding the manufacture, packaging and labeling of the Product consistent with the Specifications. 1.9 "Net Sales I" shall mean Distributor's (or any sub-distributor's) gross sales of Products actually billed by Distributor or its Affiliates (or sub-distributors) to unrelated third party customers less (a) rejection or return of Products previously sold, and (b) any sales, excise, turnover and similar taxes and any duties and other governmental charges imposed upon the sale of Products. 1.10 "Net Sales II" shall mean Distributor's (or any sub-distributor's) gross sales of Products actually billed by Distributor or its Affiliates (or sub-distributors) to unrelated third party customers less (a) any direct or indirect credits and allowances and adjustments granted to such customers for the Products, including without limitation credits and allowances on account of price adjustments or on account of the rejection or return of Products previously sold, (b) any trade and/or cash discounts, rebates and distribution fees, and (c) any sales, excise, turnover and similar taxes and any duties and other governmental charges imposed upon the production, importation, use or sale of Products, and (d) transportation, insurance and handling charges on Product. 1.11 "Parties" shall mean Company and Distributor and Party shall mean either of them as the context indicates. 1.12 "Present Product" means Company's Product known as "GELCLAIR" in a box containing 21 packets with 15 ml of Product per packet. 1.13 "Products" in this Agreement shall mean Company's oral gel care formulation(s) for the Approved Indication, including but not limited to GELCLAIR(R) as presently manufactured by Company and any modification thereof which may be agreed between the Parties in future. "Products" does not include Company's product known as "ALOCLAIR". 1.14 "Purchase Price" shall mean the price of Product that Distributor pays Company for the Distributor's purchase of Product from Company. [*]CONFIDENTIAL TREATMENT REQUESTED 2 CONFIDENTIAL PORTION OMITTED AND FILED SEPARATELY WITH THE COMMISSION CONFIDENTIAL DOCUMENT 1.15 "Registration" shall mean any official marketing approval, authorization or license regarding the Products by the appropriate and competent authorities in the Territory, allowing the lawful marketing of the Products. 1.16 "Specifications" shall mean the specifications for Product, including its packaging, set forth in Appendix A hereof, which Appendix is incorporated in and made a part of this Agreement. Specifications shall not be modified without prior written agreement by the Parties. 1.17 "Territory" means the United States of America (including its territories and possessions), Canada and Mexico. 1.18 "Year" means calendar year. "Year 1" means 2002; "Year 2" means 2003; "Year 3" means 2004; etc. 1.19 "$" means United States Dollars. 1.20 "Aloclair" means a product also containing [ * ] which Company agrees will in no circumstances contain a concentration of [ * ] exceeding [ * ] of the concentration in Gelclair. Company warrants that Aloclair is characterized by a substantially [ * ]. Company warrants that the Aloclair product is unsuitable for the treatment of severe oral mucosal inflammation or injury, e.g., mucositis, stomatitis and oral surgery. ARTICLE 2. APPOINTMENT AND ACCEPTANCE 2.1 Subject to the following terms and conditions, which includes the payments set forth in this Agreement, the Company hereby appoints the Distributor as the exclusive distributor to market, sell and distribute Products in the Territory and the Distributor hereby accepts such appointment. Distributor shall have the exclusive right to market, sell and distribute Products, or have those Products marketed, sold or distributed on its behalf in the Territory. 2.2 Company shall not and shall cause its Affiliates not to, directly or indirectly knowingly supply the Product or Competing Product to any Person outside the Territory for resale or use in the Territory. Company shall promptly refer exclusively to Distributor all orders or inquiries received by Company in connection with the sale, marketing and/or distribution of the Product in the Territory. To the extent that either Party becomes aware of a Person outside the Territory re-selling Product in the Territory, each shall notify the other and the Parties shall use best efforts to cooperate and cause such unauthorized sale in the Territory to cease. 2.3 Distributor shall not and shall cause its Affiliates not to, directly or indirectly knowingly supply the Product or Competing Product to any Person in the Territory for resale or use outside the Territory. Distributor shall promptly refer exclusively to Company all orders or inquiries received by Distributor in connection with the sale, marketing and/or distribution of the Product outside the Territory. To the extent that either Party becomes aware of a Person in the Territory re-selling Product outside the Territory, each shall notify the other and the Parties shall use best efforts to cooperate and cause such unauthorized sale outside the Territory to cease. [*]CONFIDENTIAL TREATMENT REQUESTED 3 CONFIDENTIAL PORTION OMITTED AND FILED SEPARATELY WITH THE COMMISSION CONFIDENTIAL DOCUMENT 2.4 Distributor and its Affiliates shall not, directly or indirectly, or jointly or in conjunction with any other person, whether as principal, agent, shareholder, employee, independent contractor or in any other manner whatsoever, distribute, market or sell any Competing Product in the Territory during the term of this Agreement and 12 months thereafter. 2.5 Distributor and its Affiliates shall purchase their entire requirements for the Products from Company, subject to Section 3.9. 2.6 Company warrants that it has not made any written or oral agreement or undertaking with any other Person regarding the rights to distribute or sell Product or Competing Product in the Territory. 2.7 Company warrants that it has the exclusive rights to appoint exclusive distributors for the Product in the Territory as defined herein and that it has the right to supply Products for that purpose. 2.8 If within [ * ] Distributor has not established a reasonable level of prescriptions from the dental market, the Parties shall meet and discuss in good faith the matter but, if they are not able to agree on a mutually acceptable resolution of the problems within [ * ] of such meeting, Company shall be entitled [ * ] to distribute the Products to the dental market in the Territory independently of the Distributor using trademarks which are not confusingly similar to any trademarks used on Products which are sold to Distributor hereunder. ARTICLE 3. PURCHASE AND SUPPLY OF PRODUCTS 3.1 Within 90 days of the receiving from Distributor all necessary camera ready art work and product insert, Company shall provide Distributor [ * ] of the Present Product in accordance with the Specifications and within a further [ * ] shall provide Distributor [ * ] of the Present Product in accordance with the specifications. 3.2 By October 31, 2002, Distributor shall place an order for the Present Product of at least $2,000,000 at the price set forth in Section 5.1 below, which order shall be delivered by Company to Distributor on or before December 31, 2002. If Distributor fails to place the order referred to in this Section 3.2, Distributor shall be obliged to pay to Company the amount of $2,000,000 by December 31, 2002 in any event. 3.3 Upon the Effective Date, Distributor shall submit to Company a non-binding good faith estimate of its requirements of Product for the current Year broken down by quarters. Within and not later than September 30th of each Year of this Agreement, Distributor shall submit to Company a non-binding good faith estimate of its requirements of Product for the subsequent two Years broken down by quarters. The first Year of each two-Year estimate shall serve to amend the second Year of the previous two-Year estimate. The total amount and the quarterly breakdown estimated by Distributor for any Year, as amended by each annual estimate or as further amended in timely fashion, shall be known as the Forecast for such Year. [*]CONFIDENTIAL TREATMENT REQUESTED 4 CONFIDENTIAL PORTION OMITTED AND FILED SEPARATELY WITH THE COMMISSION CONFIDENTIAL DOCUMENT 3.4 Within and not later than ninety (90) days before the beginning of each calendar quarter during the term of this Agreement, Distributor shall place with Company a Firm Order for Product for that calendar quarter. Each Firm Order shall specify the quantity of Product ordered and the delivery date, provided that the terms and conditions of this Agreement shall prevail over any terms and conditions included in any purchase order used in ordering Product. Firm Orders for purchases for Products shall be submitted in writing to the Company at Company's address above or at such other address as Company may indicate in writing. Those orders shall bind Company if within the Forecast Range, and shall otherwise bind Company if accepted by it in writing if outside the Forecast Range. Company shall use reasonable efforts to accommodate orders higher than +50% of Forecast for any calendar quarter. 3.5 Distributor shall place the following minimum annual orders for the Products from Company at the prices referred to in Section 5.1 for the Present Product and such prices as may have been agreed between the Parties for other versions of the Products (if prices have not been agreed for other versions, Distributor shall be obliged to order the Present Product): ---------------------------------------------------------------------- Minimum Annual Order ---------------------------------------------------------------------- Year 1 $4,000,000, including $2,000,000 in respect of the quantities referred to in Section 3.1 and $2,000,000 for the order referred to in Section 3.2 ---------------------------------------------------------------------- Year 2 $ 3,000,000 ---------------------------------------------------------------------- Year 3 $ 5,000,000 ---------------------------------------------------------------------- Minimum annual orders for the fourth and subsequent Years of this Agreement shall have been negotiated in good faith and agreed upon by the Parties for each of those Years by each October 1st from October 1, 2004 onward (i.e., one Year at a time on a rolling basis). If the Parties are unable to agree upon a minimum annual order level for any Year after 2004 which is at least 80% of the minimum annual order level for the previous Year, either Party shall have the right to terminate this Agreement upon 90 days' notice in writing to the other Party. If Distributor fails, by the 31st December of Year 1, Year 2, or Year 3, to place orders for the Products from the Company exceeding the minimum annual order set out in this Section 3.5 for those Years (and Distributor has not rectified the situation by ordering the shortfall within 90 days of being given notice by the Company of such shortfall), Company may terminate this Agreement upon 90 days notice in writing to Distributor. 3.6 All Products shipped by or on behalf of Company to Distributor will comply with the Specifications and shall have at least 30 months until the date of product expiry from the date of delivery. The title to any consignment of the Products shall not pass to Distributor until Company has received payment in full for the price of the Products. Risk of loss or damage to any consignment of the Products shall pass to Distributor from the time Company notifies Distributor that the consignment is available for collection or from the time of delivery to the carrier at Company's (or its supplier's) premises, whichever is the earlier. The relevant batch release certificate and certificate of analysis shall accompany each delivery. [*]CONFIDENTIAL TREATMENT REQUESTED 5 CONFIDENTIAL PORTION OMITTED AND FILED SEPARATELY WITH THE COMMISSION CONFIDENTIAL DOCUMENT 3.6.1 Until such time as the title in the Products passes to the Distributor, the Distributor shall be entitled to resell or use the Products in the ordinary course of its business, but it shall be accountable to the Company for the proceeds of sale or otherwise of the Products (such that Distributor shall pay to Company such proportion of such proceeds owing to the Company), whether tangible or intangible, including insurance proceeds, and it shall keep all such proceeds (to the extent of the amounts owed to Company hereunder) separate from any monies or property of the Distributor and third parties, and in the case of tangible proceeds, properly stored, protected and insured; 3.7 If within a reasonable time (not to exceed 30 days after receiving any shipment at the Distributor's designated place of business in the United States) Distributor demonstrates to the satisfaction of Company that any of the Products shipped to it hereunder were defective at the time of delivery to Distributor's designated place of business, Company will replace such defective Products free of costs and delivery charges. As Company may direct, Distributor will either return the defective Products to Company with the freight costs to be at Company's expense or hold or otherwise dispose of such defective Products in accordance with Company's instructions. Company shall replace all Product which is defective hereunder within three (3) months from Company's receipt of such notice from Distributor. Company shall pay the cost of customs, insurance, and freight for any defective Product returned to it. In the event of any unresolved dispute between the Parties concerning the rejection by Distributor of all of or any part of the Product, the Product shall be submitted for testing to a mutually agreed-upon qualified independent laboratory. If the Parties are unable to agree upon such a laboratory, each will select a qualified independent laboratory and the two laboratories will select a third qualified independent laboratory which shall perform the testing. The parties agree to be bound by the findings of the laboratory. All costs associated with the investigation shall be paid by the unsuccessful party. 3.8 Company will use all reasonable efforts to supply or have supplied Distributor's requirements of Product and will keep Distributor closely informed if there should be any anticipated problem of supply. Company shall be solely responsible for providing all necessary equipment facilities and personnel to manufacture the Product in compliance with GMP and government regulatory requirements in the areas of the Territory where it is marketed, and Company shall comply with all such regulatory and legal requirements in the manufacture of Products both in such areas as well as in the country(s) of manufacture. 3.9 Under a mutually acceptable escrow agreement, Company agrees to deposit in escrow located in the United States copies of specifications and other documents containing the Know How relating to the commercial manufacture of Products, including formulation and packaging information, to enable Distributor to make or have made Products. The escrow agreement shall provide for Distributor's access to such escrowed materials in the event that Company or its nominee is unable or unwilling to meet its obligations under this Agreement to supply Distributor's requirements for Product for more than a 90-day period. In the event that Company notifies Distributor that it is able to recommence supply of the Present Product or Products to Distributor, Distributor shall within a reasonable time cease to make or have made the Products and thereafter shall purchase its entire requirements for the Products from Company. [*]CONFIDENTIAL TREATMENT REQUESTED 6 CONFIDENTIAL PORTION OMITTED AND FILED SEPARATELY WITH THE COMMISSION CONFIDENTIAL DOCUMENT In respect of any Products which Distributor makes or has made in accordance with this Section 3.9, Distributor shall pay a royalty to Company of [ * ] the Net Sales II of all such Products sold or otherwise disposed of on a commercial basis by Distributor. Distributor shall keep all such accounts and records as may be necessary for the calculation of such royalty and shall supply copies of such accounts and records to Company upon request. Distributor shall pay such royalty to Company for each calendar quarter within [ * ] of the end of that calendar quarter and at the same time shall supply to Company a detailed calculation of the royalty concerned. 3.10 Company shall provide batch release certificates and certificates of analysis with each shipment of Product to Distributor (including Product samples). 3.11 Company warrants that all Product provided or sold by it to Distributor under this Agreement shall: (a) conform to the Specifications; (b) be merchantable; (c) be manufactured in accordance with ISO requirements and any other applicable regulations and laws of the Territory and of the jurisdiction of manufacture; and (d) be fit for use by humans for the Approved Indication(s). 3.12 Company warrants that it has the capacity to supply conforming Product in accordance with the terms of the Agreement. ARTICLE 4. REGULATORY MATTERS 4.1 Company shall comply with all applicable laws and regulations in relation to the manufacturing and handling of the Product in the Territory and in any country outside the Territory where Company manufactures Product or has Product manufactured on its behalf. Distributor shall comply with all applicable regulations and laws in relation to the handling, storage, distribution and sale of the Product in those areas of the Territory where the Product is distributed and sold by Distributor. 4.2 Each Party will report to the other all adverse events (hereinafter called "AE"), customer complaints, technical or quality-related incidents and/or issues, which come to its attention relating to the Product, including any that come to a Party's attention through publications in journals or other media. Each party shall report any serious adverse events relating to Product, within 48 hours of receipt, to the other. 4.3 Distributor shall be responsible for preparing and submitting medical device reports ("MDRs") to the FDA or other responsible national governmental authorities in the Territory. Company shall review and evaluate all Product complaints forwarded by Distributor. If Distributor believes that an MDR report needs to be filed, Company shall fully investigate the complaint and shall provide all information necessary to Distributor for Distributor to file the MDR report. With respect to adverse events and the like occurring with the Product outside the [*]CONFIDENTIAL TREATMENT REQUESTED 7 CONFIDENTIAL PORTION OMITTED AND FILED SEPARATELY WITH THE COMMISSION CONFIDENTIAL DOCUMENT Territory, Company shall provide to Distributor all information relating to such complaints that may be or are subject to the FDA's reporting MDR requirements. Distributor shall evaluate this information and shall determine whether an MDR should be submitted. Company shall evaluate such events in relation to the standard operating procedures of Distributor's that will be adopted by Distributor and agreed upon by the parties. Company shall designate Distributor as agent to the FDA for these reporting purposes. 4.4 Within 15 days of the Effective Date of this Agreement, Company shall provide Distributor with copies of all documents relating to or constituting Company's 510(k) filing with the FDA. 4.5 Company agrees that it will not modify the Present Product or any other Product whose specifications have been agreed upon by the Parties without prior notification to and approval by Distributor (which approval shall not be unreasonably withheld) so that Distributor can ascertain whether Distributor will need to file any additional Rule 510(k) filings. 4.6 Company will register as the Product manufacturer with the FDA. Distributor will list Product with FDA as approved for marketing. 4.7 Each Party will maintain such records and procedures to ensure that any batch of Products can be effectively and completely recalled from the market in the event that such action is required. 4.8 If, for any reason, it shall become necessary to trace back or recall any particular lot of the Product, or to identify the customer or customers to whom units from such lot will have been delivered, each party shall co-operate fully with the other in doing so. In the event that either Party has reason to believe that one or more lots of the Product should be recalled or withdrawn from distribution in the Territory, such Party shall immediately notify the other Party in writing. To the extent permitted by the circumstances, the Parties will confer before initiating any recall, but the decision as to whether or not to initiate a recall of the Product and to notify regulatory authorities in the Territory shall be Distributor's alone. If the recall is required because of a modification or withdrawal of an approval from a competent regulatory authority or a failure of the Product to conform to its Specifications, Company shall promptly reimburse Distributor for the reasonable costs and expenses of such recall, and, at Distributor's option, Company shall replace the recalled Product free of additional charge, or credit or refund the Purchase Price of the recalled Product. If the recall is required because of a negligent act or omission of Distributor in handling, storage or distribution of the Product, then such recall shall be conducted by Distributor at its sole cost and expense and Distributor shall not be entitled to any such credits, replacements or refunds from Company. If such recall is required because of a joint act or omission of the Parties, Distributor shall conduct the recall, the Parties shall divide the cost of such a recall, and any replacement Product required by Distributor shall be provided by the Company to the Distributor at cost. 4.9 Each Party shall furthermore notify the other immediately of any information that it receives regarding any threatened or pending action by any Regulatory Authority which may affect the safety or efficacy claims of the Product within the Territory or the continued marketing of same. Upon receipt of any such information, the Parties shall consult with each other in an effort to arrive at a mutually acceptable procedure for taking appropriate action; provided, however, that nothing contained herein shall be construed as restricting either Party's right to [*]CONFIDENTIAL TREATMENT REQUESTED 8 CONFIDENTIAL PORTION OMITTED AND FILED SEPARATELY WITH THE COMMISSION CONFIDENTIAL DOCUMENT make a timely report of such matter to any Regulatory Authority in the Territory or to take any further action that either Party deems appropriate or is required by applicable law or regulation. 4.10 Distributor will provide a medical information service concerning the Products to the health professionals and patients in the Territory. ARTICLE 5. PAYMENTS 5.1 For quantities of Product beyond that set forth in Section 3.1, Company shall initially sell Present Product to Distributor at the price of [ * ] Ex Works Lecco, Italy. The price shall be revised [ * ] For the avoidance of doubt, there shall be no downward revision of the price due to changes in the above-mentioned index. If during any such two-Year period (or shorter initial period), the documented actual Product manufacturing cost [ * ] (hereinafter "extraordinary increase"), the then-current price will be adjusted accordingly, provided Product is being manufactured in accordance with best manufacturing practices (e.g., ISO standards). In the event of an extraordinary increase, however, Company shall supply to Distributor (or its agents) details of the manufacturing costs and methods to reasonably justify such an extraordinary increase. Distributor shall be entitled to audit such details on reasonable notice to Company. In the event of an extraordinary increase, the next increase at the end of the two Year period referred to above (or shorter initial period) shall be the percentage increase in the [ * ] from the date of the extraordinary increase to the end of the two Year period concerned (or shorter initial period). Further increases in price shall be made in the two Year period concerned (or shorter initial period) if supported as described above as a further extraordinary increase. If during any such two-Year period (or shorter initial period), the documented actual Product manufacturing cost decreases by more than [ * ](hereinafter "extraordinary decrease"), the Company will also make an extraordinary decrease in the price of the Present Product due to decreases in manufacturing costs but any such extraordinary decrease shall not take the price of the Present Product to less than [ * ] 5.2 Payment terms for conforming Product sold by Company under Section 5.1 are[ * ] from the date of the invoice (which date shall not be earlier than the time of Product delivery under Section 3.6). 5.3 The Distributor will pay Company $1,000,000 (one million dollars) (U.S.) on the Effective Date of this Agreement, and a further $2,000,000 (two million dollars) (U.S.) which latter payment will be credited against the amount that would otherwise be due from Distributor to Company in respect of the quantity of Product set forth in Section 3.1, based on the price set out in Section 5.1. 5.4. The Distributor will pay the Company $500,000 (five hundred thousand U.S. dollars) upon issuance of a United States Patent in the name of the Company or its Affiliates with claims covering the Products. [*]CONFIDENTIAL TREATMENT REQUESTED 9 CONFIDENTIAL PORTION OMITTED AND FILED SEPARATELY WITH THE COMMISSION CONFIDENTIAL DOCUMENT 5.5. Upon Distributor achieving [ * ] cumulative Net Sales I of Products, Distributor shall pay Company $1,000,000 (one million). 5.6 Upon Distributor achieving [ * ] cumulative Net Sales I of Products, Distributor shall pay Company $1,000,000 (one million). 5.7 Upon the results of the first clinical trial concerning the Products' efficacy appearing in a peer-reviewed journal, Distributor shall pay Company $500,000 (five hundred thousand) 5.8 All payments made by Distributor to Company shall be in U.S. Dollars and shall be made by transfer to the following U.S. Dollar bank account or such other bank account as Company may notify to Distributor from time to time. [ * ] 5.9 The Products to be supplied by Company pursuant to this Agreement shall be sold or otherwise supplied on an Ex Works basis (as defined in the International Chamber of Commerce's Incoterms 2000 edition), and accordingly Distributor shall, in addition to the price (where there is a price), be liable for arranging and paying all costs of transport (including insurance for transport). For the avoidance of doubt, the provisions of this Section 5.9 shall apply to Products supplied in accordance with Sections 3.1, 6.5, 6.6 and 6.7 as well as all other Products supplied under this Agreement. 5.10 If Distributor fails to pay the price for any Products within [ * ] of the date of the invoice therefor or fails to pay any other amount when due under this Agreement, Company shall be entitled (without limiting any other right or remedy it may have) to: (a) cancel or suspend any further delivery to the Distributor under any order until such time as the payment concerned is made; (b) sell or otherwise dispose of any Products which are the subject of any orders by Distributor, whether or not appropriated to the order; (c) charge Distributor interest on the amount due, both before and after any judgement, at the rate of 4 per cent per annum above the Prime Rate prevailing in the United States from time to time from the date the payment became due until actual payment is made. ARTICLE 6. PROMOTION/SALES OBLIGATIONS OF COMPANY 6.1 The Company shall use its reasonable endeavors to cooperate with and assist Distributor in its sales and marketing activities in the Territory. [*]CONFIDENTIAL TREATMENT REQUESTED 10 CONFIDENTIAL PORTION OMITTED AND FILED SEPARATELY WITH THE COMMISSION CONFIDENTIAL DOCUMENT 6.2 The Company shall from time to time supply Distributor [ * ] with specimens and artwork (including any electronic files of the same) of displays, promotional and advertising material and literature previously published or prepared by Company, provided that Company shall have no obligation to produce such material for Distributor. 6.3 The Company shall provide Distributor with technical assistance at its request if required and against remuneration as agreed in each case. 6.4 The Company shall assist Distributor if required in training personnel concerned with the marketing of the Products, if Distributor requests such assistance, subject to a maximum obligation on Company to provide the assistance of one person for seven working days under this Agreement. 6.5 The Company shall provide [ * ] reasonable quantities of Products for the execution of formal clinical trials by or on behalf of Distributor, protocols for which have been approved by Company which approval shall not unreasonably be withheld. 6.6 Company shall provide Product samples to Distributor [ * ] as follows: (a) [ * ] packets of Product delivered within 90 days of receiving from Distributor all necessary camera ready art work and product insert; and (b) samples equal to [ * ] of all firm commercial Product orders for the [ * ] of this Agreement; (c) samples equal to [ * ] of firm commercial Product orders for [ * ] of this Agreement; (d) All samples under Sections 6.6(a) - (c) shall be made in accordance with the Specifications and provided in boxes of seven 15 ml packets of Product labeled as "sample use only." [ * ]. 6.7 To the extent that Distributor desires additional samples beyond the amounts set forth in the preceding Section, Company will provide them at [ * ], provided that Distributor shall not be entitled to purchase as additional samples more than [ * ] (determined on a per-packet basis) in any given Year. 6.8 If Company or its licensed distributor intends to carry out a controlled and randomized clinical trial of the Products, Company shall provide Distributor a copy of the protocol at least 30 days prior to submission to any institutional review board or regulatory authority (or initiation of the trial if the protocol is not so submitted) to provide Distributor an opportunity to comment on the same. Company shall have no obligation to accept such comments of Distributor. Company shall provide to Distributor a copy of any data produced as a result of such clinical trials, provided Company has the right to do so. 6.9 Company agrees that it and its Affiliates and agents will not conduct or actively permit other distributors outside the Territory to conduct any clinical trial of the Product (or a Competing Product) in the Territory. [*]CONFIDENTIAL TREATMENT REQUESTED 11 CONFIDENTIAL PORTION OMITTED AND FILED SEPARATELY WITH THE COMMISSION CONFIDENTIAL DOCUMENT 6.10 Company agrees that if Distributor's purchases of Product from Company exceed [ * ] per year, Company shall as soon as practicable thereafter begin manufacturing Distributor's requirements of Product within the Territory at a location and facility that provides equal or better quality and equal or lower cost to Distributor (including duties) than currently provided under this Agreement. ARTICLE 7. OBLIGATIONS OF DISTRIBUTOR 7.1 Distributor shall use commercially reasonable efforts to launch the Product in the United States within 90 days of receipt of at least 50% of the quantity of conforming Product set forth in Section 3.1 above and 50% of the conforming samples set forth in Section 6.6(a) above, in Distributor's distribution center in the United States, provided that (1) Company has also supplied to Distributor all regulatory materials specified under Article 4 of Agreement; and (2) the U.S. government authorities have not otherwise precluded Product from being marketed and/or sold in the United States. In the event of any delay due to regulatory authorities or due to Force Majeure, Distributor shall immediately notify Company and the above-mentioned period for launch of the Products shall be extended for as long as any such delay continues. If Distributor has still not launched the Products within 30 days of the end of the 90 day period as referred to above or, if there have been delays as referred to in this Section 7.1, within 90 days of the end of the extended period as referred to in the previous sentence, Company may forthwith terminate this Agreement upon notice in writing to Distributor. 7.2 Distributor shall use all reasonable efforts to sell and distribute the Products in the Territory. With respect to countries in the Territory outside the United States (hereinafter "the non-U.S. Territory"), Distributor shall use all reasonable efforts to maximise its sales of the Products in such countries unless to do so would not be materially profitable to Distributor. In the event that Distributor decides to sell or distribute in the non-U.S. Territory (or any portion thereof), Company shall make all necessary regulatory filings required for Product approval at Company's expense in the part of the non-U.S. Territory concerned. 7.3 During the term of this Agreement, Distributor will spend at least U.S. $1,300,000 (one million three hundred thousand) annually on direct sales force expenses relating to Product. Distributor shall also spend at least the following amounts annually on marketing the Product: Year 1 - Year 5: US $750,000 Year 6 - Year 7: US $500,000 Year 8 - Year 10: US $250,000 With the sales force efforts outlined in this Section 7.3, Distributor shall be permitted to sell, promote, market and distribute other products in addition to Product with the same sales force efforts. [*]CONFIDENTIAL TREATMENT REQUESTED 12 CONFIDENTIAL PORTION OMITTED AND FILED SEPARATELY WITH THE COMMISSION CONFIDENTIAL DOCUMENT 7.4 Distributor furthermore agrees: (a) that as compliance with Section 7.3 above, to ensure that the Territory is covered by adequate and reasonable sales activities including sampling, promotion, distribution of technical and sales matter, demonstrations and other measures for promoting the sale of Products and to use commercially reasonable endeavors to achieve Forecast sales and to bear all expenses above arising in connection with its activities hereunder. (b) to ensure that the Products are sold with the name of the manufacturer, Sinclair Pharmaceuticals Limited, on the Product's label and literature. (c) not to disclose either during the term of this Agreement or thereafter to any third party any prices or technical or other information of a confidential nature received or obtained from the Company except insofar as may be required for the purpose of selling the Products and complying with any legal or regulatory requirements, and on termination of this Agreement to return all price lists and documents containing such information. (d) to procure at Distributor's own expense the execution of clinical trials to support marketing of Products if Distributor feels further trials are necessary for successful commercialization of the Products. For any such randomized and controlled clinical trials, Distributor shall provide Company a copy of the protocol at least 30 days prior to submission to any institutional review board or regulatory authority (or initiation of the trial if the protocol is not so submitted) to provide Company an opportunity to comment on the same. Distributor shall have no obligation to accept such comments of Company. Distributor shall provide to Company a copy of any data produced as a result of such clinical trials. 7.5 All scientific and clinical data related to Products generated by Distributor or its agents shall be disclosed to the Company. Distributor shall promptly deliver to the Company copies of any new scientific or clinical data related to the Products, as soon as it comes into its possession. Company shall be entitled (free of charge) to use such scientific and clinical data for any purpose. ARTICLE 8. PRODUCTS LIABILITY AND INSURANCE 8.1 Each Party shall defend, indemnify and hold harmless the other Party and the other's Affiliates, officers, directors, employees and agents, from and against all claims, liabilities, demands, damages, expenses and losses (including reasonable attorneys' fees and expenses) arising out of or connected with: (a) any breach by the Party of any of its representations, warranties or covenants under this Agreement; or (b) any materially wrongful acts or wrongful omissions contrary to law on the part of the Party or its authorized agents or employees. [*]CONFIDENTIAL TREATMENT REQUESTED 13 CONFIDENTIAL PORTION OMITTED AND FILED SEPARATELY WITH THE COMMISSION CONFIDENTIAL DOCUMENT 8.2 As to the Company's manufacture and Distributor's storage, handling, promotion and sale of Products under this Agreement, each Party agrees to maintain product liability insurance to cover its risks related to the Products and, upon the other Party's request, to provide the other Party with certificates of insurance attesting to the existence of such insurance. During the Term of this agreement and for a period of five (5) years thereafter, to satisfy the obligations in Sections 8.1 above, each Party shall obtain and maintain insurance coverage from a reputable arm's length insurer in an amount of not less than approximately $1.5 million per incident. Each Party shall add the other Party as an additional insured under its respective insurance policy. Each Party agrees, upon request, to advise the other of the status of the required insurance and of any change in such status. It is understood and agreed that furnishing of such insurance coverage will not relieve the Parties of their respective obligations under this Agreement. ARTICLE 9. TRADEMARKS 9.1 Company grants Distributor the exclusive right and license to use the trademarks GELCLAIR and SINCLAIR (hereinafter "Trademarks") in connection with the marketing, sale, manufacture (if Distributor manufactures Product under the provisions of Section 3.9 above) and distribution of the Products within the Territory, subject to the terms of this Section 9.1. Company further authorizes Distributor to grant sublicenses of the rights granted under this Section 9.1 to Affiliates on identical terms to those set out in this Section 9.1 and Distributor shall immediately inform Company of the identity of such Affiliates. Distributor shall be entitled to use the Trademarks in ways which are consistent with any regulatory approvals which Company may have for the Products in the Territory. Distributor shall not use the Trademarks in any way which would undermine or have a negative effect upon the reputation of the Company or the strength or validity of Company's rights in the Trademarks. Distributor's licence under this Section 9.1 is conditional on advertising using the Trademarks complying with all applicable laws in the Territory. Distributor shall discontinue all use of the Trademarks upon Company's request or upon termination of this Agreement. 9.2 Distributor shall use the Trademarks on or in connection only with those Products that conform to the Specifications. 9.3 To verify compliance with Article 9 hereof, Distributor will submit to Company samples of promotional materials and any packaging therefor that Distributor has prepared, and other items bearing the Trademarks that Distributor may have prepared, and Company, or its delegate, will inspect such material and inform Distributor of any objections thereto within 15 days. If Company registers no objection after the 15 day period, Company is deemed to have accepted such items as compliant. The Trademarks shall be the exclusive property of the Company, and Distributor shall not seek to register or have registered the Trademarks in the Territory. 9.4 Company agrees that it will file applications for registration of the marks GELCLAIR and SINCLAIR in all the countries in the Territory (if not already filed). Company will: (a) Provide Distributor with copies of all such filings and correspondence with the pertinent trademark registration authorities, and provide Distributor the opportunity to comment on the same prior to filing, provided that this obligation [*]CONFIDENTIAL TREATMENT REQUESTED 14 CONFIDENTIAL PORTION OMITTED AND FILED SEPARATELY WITH THE COMMISSION CONFIDENTIAL DOCUMENT will be satisfied by Company issuing a standing instruction to its trademark attorneys to copy all relevant correspondence to Distributor and if Distributor has not objected to any proposed action within 15 days, Distributor will be taken to have accepted the proposed action; (b) bear the expense and responsibility of such trademark registration filings, prosecution and maintenance, including filing any statements of use; and (c) not allow such trademark registrations to become abandoned without Distributor's permission (which is not to be unreasonably withheld). Distributor shall reasonably cooperate with Company in supplying Company with any appropriate information and specimens to support the trademark registrations filed for or obtained in accordance with the terms of this Agreement. 9.5 Company agrees that if the "Gelclair" Trademark is unavailable for use in the Territory or any portion thereof, the Parties shall agree upon an alternative trademark to be used on the Products and such trademark shall be owned by Company. The alternative trademark shall be deemed to fall within the definition of `Trademarks' given in Section 9.1 and the provisions of Sections 9.1 to 9.8 shall apply to the alternative trademark. 9.6 During the term of this Agreement, if either Party becomes aware of a possible third party infringement of a Trademark in the Territory (or any portion thereof) within the license grant in section 9.1, that Party shall immediately notify the other of the possible infringement so that the other Party can investigate the matter. Distributor shall, at its sole option, have the right to enforce such trademark rights against such a third-party infringer in such parts of the Territory as it sees fit using counsel of its own selection and at its own expense. Distributor shall also have the option of joining Company as a party to such an enforcement action, and Company will provide reasonable cooperation in such joinder and in any such enforcement action. If Company is made a party to such action, Distributor shall compensate Company for any reasonable costs, expenses or fees which Company incurs as a result of such action. In any such enforcement action initiated by Distributor, Distributor shall have the option to settle such an action on such terms as it deems reasonable. Any damages awarded as a result of any such infringement action, or any monies recovered in such a settlement shall, in order, first be used to compensate Distributor its costs of initiating and pursuing such an infringement action and second to compensate Distributor and Company for their lost sales as a result of such infringement in a proportion to reflect their respective loss of sales recovered. 9.7 Company warrants that it has no knowledge of any actual or potential Trademark infringement claim by a third party in the Territory that would, if successfully brought and prosecuted, impair the Company's ability to supply Distributor Product consistent with the terms of this Agreement or impair the Distributor's ability to distribute and sell Product in the Territory under the licensed Trademarks. If, at any time during the term of this Agreement either Party learns that any Product distributed or sold by Distributor under this Agreement is subject to a possible third-party claim of trademark infringement of any of the Trademarks, the Party learning of the claim shall promptly notify the other Party in writing. Company shall indemnify and hold Distributor harmless and accept all legal and financial responsibility for any liability, damage, loss, cost or expense arising out of any such trademark infringement claims in respect of the manufacture, use or sale of the Product bearing the Trademark(s), provided that such [*]CONFIDENTIAL TREATMENT REQUESTED 15 CONFIDENTIAL PORTION OMITTED AND FILED SEPARATELY WITH THE COMMISSION CONFIDENTIAL DOCUMENT liabilities are not related to any artwork or packaging that Distributor has asked Company to produce. Distributor shall promptly notify Company of any trademark infringement claims for Company to indemnify and at Company's cost, permit attorneys mutually agreeable to the Parties to handle and control such trademark infringement claims or suits. Distributor agrees to provide Company with reasonable assistance in defending such infringement action or in prosecuting any related action. 9.8 The Distributor and its Affiliates shall at the request of the Company execute such registered user or other agreements in respect of the use of the Trademarks in the Territory as the Company may reasonably require. Each Party will join with the other Party in registering the trademark licence granted hereunder with the registrars of trademarks in the Territory as may be required by the other Party. The Distributor and its Affiliates hereby agree that upon any amendment or termination of this Agreement the Distributor and its Affiliates will execute any documents that the Company may reasonably request for the purpose of applying for variation or cancellation of the entries with the registrars of the Distributor and its Affiliates as licensees of the Trademarks. 9.9 Distributor shall have the right to use the trademark "Cell Pathways" on the Product, and Company shall cooperate with Distributor to ensure that that mark (as well as any alternative mark under Section 9.5 above) appears on all packaging of Product supplied by Company to Distributor under this Agreement. ARTICLE 10. PATENTS 10.1 Company grants Distributor an exclusive license to use and sell (and to manufacture in the circumstances referred to in Section 3.9) Products under any patents owned or licensed to the Company claiming Product or improvements or modifications thereto, including such a license under any such patents that claim priority from Italian Patent Application No. MI20000A001732 filed July 28, 2000 and/or PCT/EP/01/08303 filed July 18, 2001. 10.2 Company agrees that as to any of its patent application filings in the Territory within the scope of the preceding section: (a) Company will file U.S, Canadian and Mexican patent applications claiming priority from Italian Patent Application No. MI20000A001732 filed July 28, 2000 and/or PCT/EP/01/08303 filed July 18, 2001. (b) Company will provide Distributor with copies of all such filings and correspondence to or from the pertinent patent granting authorities, and provide Distributor a reasonable opportunity to comment on correspondence to the patent authorities prior to filing, provided that this obligation will be satisfied by Company issuing a standing instruction to its patent attorneys to copy all relevant correspondence to Distributor and if Distributor has not objected to any proposed action within 15 days, Distributor will be taken to have accepted the proposed action; (c) Company will employ counsel mutually agreed upon by the parties; [*]CONFIDENTIAL TREATMENT REQUESTED 16 CONFIDENTIAL PORTION OMITTED AND FILED SEPARATELY WITH THE COMMISSION CONFIDENTIAL DOCUMENT (d) Such patent filings and prosecution will be at Company's expense; (e) Company will pay all maintenance fees and taxes to maintain any issued patents in force in the Territory, and will not allow such issued patents to become abandoned without Distributor's permission (which is not to be unreasonably withheld). 10.3 Company warrants that it or its Affiliates own and have title to Italian Patent Application No. MI20000A001732 filed July 28, 2000 and PCT/EP/01/08303 filed July 18, 2001, and have the right to file corresponding applications in the Territory consistent with this Agreement. Company also warrants that it or its Affiliates own and have title to Know-how regarding the Product, including its formulation, manufacturing, Specifications and the like. 10.4 During the term of this Agreement, if either Party becomes aware of a possible third-party infringement of a patent right within the license grant in section 10.1, that Party shall immediately notify the other of the possible infringement so that the other Party can investigate the matter. Distributor shall, at its sole option, have the right to enforce such patent rights against such a third-party infringer in such parts of the Territory as it sees fit using counsel of its own selection and at its own expense. Distributor shall also have the option of joining Company as a party to such an enforcement action, and Company will provide reasonable cooperation in such joinder and in any such enforcement action. If Company is made a party to such action, Distributor shall compensate Company for any reasonable costs, expenses or fees which Company incurs as a result of such action. In any such enforcement action initiated by Distributor, Distributor shall have the option to settle such an action on such terms as it deems reasonable. Any damages awarded as a result of any such infringement action, or any monies recovered in such a settlement shall, in order, first be used to compensate Distributor its costs of initiating and pursuing such an infringement action and second to compensate Distributor and Company for their lost sales as a result of such infringement in a proportion to reflect their respective loss of sales recovered. 10.5. Company warrants that it has no knowledge of any actual or potential patent infringement claim that would, if successfully brought and prosecuted, impair the Company's ability to supply Distributor Product consistent with the terms of this Agreement or impair the Distributor's ability to distribute and sell Product in the Territory. If, at any time during the term of this Agreement either Party learns that any Product manufactured by or on behalf of Company or distributed or sold by Distributor under this Agreement is subject to a possible third-party claim of patent infringement within the Territory, the Party learning of the claim shall promptly notify the other Party in writing. Company shall indemnify and hold Distributor harmless and accept all legal and financial responsibility for any liability, damage, loss, cost or expense arising out of any such patent infringement claims as referred to in this Section 10.5 in respect of the use or sale of the Product by Distributor hereunder. Distributor shall promptly notify Company of any claims for Company to indemnify and at Company's cost, permit attorneys mutually agreeable to the parties to handle and control such patent infringement claims or suits. Distributor agrees to provide Company with reasonable assistance in defending such infringement action or in prosecuting any related action. [*]CONFIDENTIAL TREATMENT REQUESTED 17 CONFIDENTIAL PORTION OMITTED AND FILED SEPARATELY WITH THE COMMISSION CONFIDENTIAL DOCUMENT ARTICLE 11. DURATION AND TERMINATION 11.1 This Agreement shall become effective upon the receipt by Company of the sum of $1,000,000 referred to in Section 5.3 and, subject to the provisions of this Article 11, shall remain in effect for a period of ten (10) years and be automatically renewed thereafter for successive one (1) year periods, unless notice of the election not to renew shall have been given in writing by either Party to the other not less than 180 days before the beginning of any such renewal period, provided however that the Parties hereto also agree that during the second 6 months of the eighth year of this Agreement they shall meet to determine whether at the end of the ten (10) years term of this Agreement the Agreement shall automatically be extended for a further five (5) year period after the first 10 year term has expired. 11.2 Without prejudice to any other rights or remedies it may have, Company may terminate this Agreement at the time and in the circumstances described in Section 7.1. In the event of such termination by the Company, Company may assign the Territory to another distributor immediately and payments made by Distributor under Section 5.3 above shall not be refundable to Distributor and any amounts owing from Distributor to Company under Section 5.3 at the time that Company notifies Distributor of termination shall forthwith be paid by Distributor to Company. 11.3 Without prejudice to any other rights or remedies it may have (but subject to Section 12 hereof), either Party may terminate this Agreement by prior notice in writing to the other Party ("the Other Party"): (a) if the Other Party is in material breach of a material provision this Agreement (including, without limitation, any default by Distributor in the payment when due of any sum owed by Distributor to Company) and, in the case of a breach capable of a remedy, the breach is not remedied within 90 days of the Other Party receiving written notice specifying the breach and requiring its remedy; or (b) in the event that the Other Party shall become bankrupt or insolvent, or if any reviewer or trustees shall be appointed for such Party or for all or substantially all of the property of such Other Party and such appointment shall not have been discharged within 30 days or such Other Party shall make an assignment for the benefit of its creditors, then the other Party may terminate this Agreement by tendering written notice to that effect; 11.4 Without prejudice to any other rights or remedies it may have, Company may terminate this Agreement in the circumstances described in Section 3.5. 11.5 Distributor may terminate this Agreement upon one year's written notice to the Company. 11.6 Upon termination of the Agreement for any reason, Distributor shall, at Company's written request which must be made within [ * ] sell to Company at Distributor's cost [ * ] any or all Products then in Distributor's inventory which are in saleable condition and shall return to Company all price lists, catalogues and other advertising literature furnished by Company to Distributor. Should Company not request to buy Distributor's inventory under this Section, Distributor shall be [*]CONFIDENTIAL TREATMENT REQUESTED 18 CONFIDENTIAL PORTION OMITTED AND FILED SEPARATELY WITH THE COMMISSION CONFIDENTIAL DOCUMENT permitted to sell such inventory, or otherwise dispose of it in the Territory in accordance with all applicable laws. 11.7 Distributor shall have no claim and compensation from Company in case of termination of this Agreement by Company under Sections 3.5, 7.1 or 11.3 above. In the event of termination by Company, Distributor shall have no claim against Company for loss of distribution rights, loss of goodwill or any similar loss. 11.8 Termination of this Agreement shall not affect rights which have accrued as of the date of termination or obligations to maintain confidentiality, which shall continue in force. ARTICLE 12. FORCE MAJEURE Neither Distributor nor Company shall have any liability hereunder if either is prevented from performing any of its obligations hereunder by reason of Force Majeure. Such affected Party shall give to the other Party prompt notice of any such event of Force Majeure, the date of commencement thereof and its probable duration and shall give a further notice in like manner upon the termination thereof. Each Party hereto shall endeavor with due diligence to resume compliance with its obligations hereunder at the earliest date and shall do all that it reasonably can to overcome or mitigate the effects of any such Force Majeure upon both Party's obligations under this Agreement. Should the Force Majeure continue for more than six (6) months, then the other Party shall have the right to cancel this Agreement and the Parties shall seek an equitable agreement on the Parties' reward of interests. To the extent that an event of Force Majeure occurs that inhibits Company's ability to supply Product for more than 90 days, there shall be no cancellation of this Agreement by Company and the provisions of Section 3.9 shall control. ARTICLE 13. MISCELLANEOUS PROVISIONS 13.1 The relationship between Company and Distributor hereunder is solely that of seller and purchaser. Distributor is not an agent of the Company for any purpose hereof. Distributor shall have no power or authority to bind Company in any manner and shall not hold itself out as the agent of the Company for any purpose. 13.2 To the extent that the Products are modified consistent with the terms of this Agreement (i.e., by mutual agreement of the Parties) the term "Products" as used herein shall be deemed to include the Products as so amended. 13.3 In the event of a conflict between the terms of this Agreement and Company's General Terms and Conditions of Sales, this Agreement shall govern. 13.4 The headings of this Agreement have been provided for convenience only and shall have no legal effect in connection with any interpretation of any of the provisions of this Agreement. If one or more provisions of this Agreement will be or should become invalid, this shall not affect the validity of the remaining provisions and the Parties shall replace the invalid provision by a valid and operable arrangement which achieves to the greatest extent possible the economic results intended by the invalid provision. [*]CONFIDENTIAL TREATMENT REQUESTED 19 CONFIDENTIAL PORTION OMITTED AND FILED SEPARATELY WITH THE COMMISSION CONFIDENTIAL DOCUMENT 13.5 Condition Precedent - This Agreement shall be of no force and effect until Company has received the sum of $1,000,000 referred to in Section 5.3. 13.6 In construing this Agreement:- -- words importing a person shall include a firm or corporation; -- words importing the singular shall include the plural and vice versa. 13.7 Any notice required to be given by either Party in this Agreement shall be duly given when mailed by registered mail, postage prepaid, or by Federal Express to the other party at its address set forth above or at such other address as shall have been designated by such other Party by written notice. 13.8 This Agreement cancels and supersedes all previous agreements relating to any matter covered by this Agreement, except for the confidentiality agreement between the Parties dated 18th October 2001. 13.9 Any dispute in connection with this Agreement shall be finally settled by arbitration in London by a single arbitrator in accordance with the rules of arbitration of the International Chamber of Commerce. ARTICLE 14. GOVERNING LAW This Agreement shall in all aspects be construed and operated as an English contract and in accordance with English law. IN WITNESS WHEREOF, the Parties have executed this Agreement in duplicate. SINCLAIR PHARMACEUTICALS LTD. CELL PATHWAYS INCORPORATED Signed by: Michael J. Flynn Signed by: Robert J. Towarnicki Signature: Signature: --------------------------- --------------------------- Position: President & CEO Position: President & C.E.O. Date: January ___, 2002 Date: January ___, 2002 SINCLAIR PHARMA SRL Signed by: Michael J. Flynn Signature: --------------------------- Position: President Date: January ___, 2002 [*]CONFIDENTIAL TREATMENT REQUESTED 20 CONFIDENTIAL PORTION OMITTED AND FILED SEPARATELY WITH THE COMMISSION APPENDIX A SPECIFICATIONS [*]CONFIDENTIAL TREATMENT REQUESTED CONFIDENTIAL PORTION OMITTED AND FILED SEPARATELY WITH THE COMMISSION Confidential [SINCLAIR LOGO] PAGE 1 OF 4 PRODUCT SPECIFICATION - -------------------------------------------------------------------------------- PRODUCT: GELCLAIR(R) [ * ] APPENDIX A PAGE 1 OF 5 [*]CONFIDENTIAL TREATMENT REQUESTED CONFIDENTIAL PORTION OMITTED AND FILED SEPARATELY WITH THE COMMISSION Confidential PAGE 2 OF 4 [ * ] APPENDIX A PAGE 2 OF 5 [*]CONFIDENTIAL TREATMENT REQUESTED CONFIDENTIAL PORTION OMITTED AND FILED SEPARATELY WITH THE COMMISSION Confidential BIOKOSMES S.R.L. ============================ MATERIAL SAFETY DATA SHEET ============================ - -------------------------------------------------------------------------------- 1. IDENTIFICATION - -------------------------------------------------------------------------------- CHEMICAL NAME: NOT APPLICABLE CHEMICAL FORMULA: AS PER INGREDIENT LIST MENTIONED ON THE PACKAGING CAS NO.: -------------------------------- DOT LABEL(S) ---------------------------- - -------------------------------------------------------------------------------- 2. PHYSICAL DATA - -------------------------------------------------------------------------------- APPEARANCE AND ODOR DESCRIPTION: gelified, straw-coloured solution and characteristic odour. SPECIFIC GRAVITY @ 25/25 C: 1,040 +/- 0,05 VAPOR PRESSURE: not measurable FLASH POINT: not measurable SOLUBILITY IN WATER: good solubility BOILING POINT: 99(degree)C PH @25 C: 6,0 +/- 0,5 - -------------------------------------------------------------------------------- 3. HAZARDOUS INGREDIENTS - -------------------------------------------------------------------------------- NO HAZARDOUS OR TOXIC INGREDIENTS. - -------------------------------------------------------------------------------- 4. PHYSICAL HAZARDOUS - -------------------------------------------------------------------------------- FIRE PROTECTION INFORMATION: not inflammable REACTIVITY DATA: STABILITY: stable from +5(degree)C to +40(degree)C INCOMPATIBILITY: -------------------------- APPENDIX A PAGE 3 OF 5 [*]CONFIDENTIAL TREATMENT REQUESTED CONFIDENTIAL PORTION OMITTED AND FILED SEPARATELY WITH THE COMMISSION Confidential HAZARDOUS COMPOSITION OR DECOMPOSITION: ----------------- HAZARDOUS POLYMERIZATION: will not occur PAGE 4 OF 4 BIOKOSMES S.R.L. ============================ MATERIAL SAFETY DATA SHEET ============================ - -------------------------------------------------------------------------------- 5. HEALTH HAZARDOUS - -------------------------------------------------------------------------------- THRESHOLD LIMIT VALUE: none known OSHA PERMISSIBLE EXPOSURE LIMIT: none PRIMARY ROUTES OF ENTRY: normally only a nuisance problem EFFECT OF OVEREXPOSURE: none known - -------------------------------------------------------------------------------- 6. EMERGENCY & FIRST AID PROCEDURES - -------------------------------------------------------------------------------- EYES: wash with water SKIN: wash with water INGESTION: emetic normally not recommended, if problems consult physician INHALATION: send away person from polluted zone, keeping in warm and well-aired room. Consult physician - -------------------------------------------------------------------------------- 7. SAFE HANDLING - -------------------------------------------------------------------------------- SPILL OR LEAK PROCEDURES Normally dry store. Away from high heat APPENDIX A PAGE 4 OF 5 [*]CONFIDENTIAL TREATMENT REQUESTED CONFIDENTIAL PORTION OMITTED AND FILED SEPARATELY WITH THE COMMISSION Confidential [ * ] APPENDIX A PAGE 5 OF 5 [*]CONFIDENTIAL TREATMENT REQUESTED CONFIDENTIAL PORTION OMITTED AND FILED SEPARATELY WITH THE COMMISSION EX-10.2 4 y89178exv10w2.txt AMENDMENT NO.1 TO DISTRIBUTION AGREEMENT EXHIBIT 10.2 DISTRIBUTION AGREEMENT AMENDMENT NO. 1 This is an amendment to the Distribution Agreement ("Distribution Agreement") made and entered into on January 22, 2002 between: SINCLAIR PHARMACEUTICALS LTD., a corporation duly organized and existing under the laws of England having its place of business at Borough Rd, Godalming, Surrey, United Kingdom GU7 2AB and Sinclair Pharma Srl, a corporation duly organized and existing under the laws of Italy having its place of business at Viale Marche, 15, 20125 Milano, Italy. Sinclair Pharmaceuticals Ltd and Sinclair Pharma Srl are hereinafter collectively referred to as "Company." and CELL PATHWAYS, INC., a corporation duly organized and existing under the laws of Delaware having a place of business at 702 Electronic Drive, Horsham, Pennsylvania, 19044 hereinafter referred to as "Distributor." The Definitions set forth in Article 1 of the Distribution Agreement are used in and control this Amendment No. 1. This Amendment No. 1 is effective as of March 15, 2002. The Company and Distributor have been working together under the Distribution Agreement to have the Present Product manufactured on behalf of Company and launched by Distributor in the United States. As they have been working together, they now understand that the Distribution Agreement has to be clarified so that the respective responsibilities of the parties are memorialized clearly for the purposes of regulatory compliance in the United States. Thus, the parties have agreed upon the following matters. A. Company has designated Michael Killeen as its U.S. agent under 21 C.F.R. Section 807.40(b), and Distributor agrees to this. Company will notify Distributor of any proposed change in U.S. Agent within 30 days of the change, and Distributor shall have the right to approve any such change, which approval shall not unreasonably be withheld. Company's U.S. Agent shall comply with the applicable F.D.A. rules and regulations and specifically shall assist F.D.A. (upon request) in communications with Company and its foreign manufacturer, respond to questions concerning Present Product that are imported, and scheduling inspections of the Company and its foreign manufacturer. Company shall ensure that its U.S. Agent shall reside or maintain a place of business in U.S. To the extent that the U.S. Agent is contacted by the F.D.A. regarding the Present Product , Company shall immediately notify Distributor of the nature of the contact and provide Distributor copies of all correspondence received. Company shall provide advance notice of any F.D.A. inspection or audit and Distributor shall be entitled to have a representative present at any such inspection or audit. B. Company has listed Denise Swift as its official correspondent on F.D.A. Form 2891, and Distributor agrees to this. Company will notify Distributor of any proposed change in official correspondent within 30 days of the change, and Distributor shall have the right to approve any such change, which approval shall not unreasonably be withheld. C. Distributor is registered with FDA as a distributor of the Present Product (F.D.A. Form 2891), and shall maintain that registration for as long as its obligations under the Distribution Agreement remain in effect. D. Company has listed Present Product Gelclair with F.D.A. (FDA Form 2892) and shall maintain that listing for as long as its obligations under the Distribution Agreement remain in effect. E. To clarify Company's obligations under Section 1.16 not to modify Specifications "without prior written agreement by the Parties," the parties agree that Distributor should be notified reasonably in advance of making any of proposed changes to Specifications, as well as any proposed changes to manufacturing methods, processes, or procedures. All such changes proposed by Company or its manufacturer shall be subject to advance written approval by the Distributor, and such approval shall not unreasonably be withheld. For clarity, such changes include, but are not limited to manufacturing location; process, equipment, and batch size; components, suppliers, grade and/or source; testing methods, finished product composition and specifications; and packaging and labeling changes. F. The parties agree that the packing specification attached (Appendix A) shall be treated as part of Appendix A to the Distribution Agreement and be deemed to be part of the Specifications under that agreement. IN WITNESS WHEREOF, the Parties have executed this Amendment No. 1 in duplicate. Sinclair Pharmaceuticals Ltd. Cell Pathways Incorporated Signed by: Michael J. Flynn Signed by: Robert J. Towarnicki /s/ /s/ - ------------------------- ----------------------------- Position: President & CEO Position: President & C.E.O. Date: April 17, 2002 Date: April 8, 2002 Sinclair Pharma Srl Signed by: Michael J. Flynn Position: President /s/ - -------------------- Date: April 17, 2002 2 APPENDIX A [Description of GelclairTM Master Label Form and depiction of GelclairTM packaging materials.] 3 EX-10.3 5 y89178exv10w3.txt AMENDMENT NO.2 TO DISTRIBUTION AGREEMENT EXHIBIT 10.3 Portions of this Exhibit have been redacted and are the subject of a confidential treatment request filed with the Secretary of the Securities and Exchange Commission. DISTRIBUTION AGREEMENT AMENDMENT NO. 2 This is the second amendment to the Distribution Agreement ("Distribution Agreement") made and entered into on January 22, 2002 between: SINCLAIR PHARMACEUTICALS LTD., a corporation duly organized and existing under the laws of England having its place of business at Borough Rd, Godalming, Surrey, United Kingdom GU7 2AB and Sinclair Pharma Srl, a corporation duly organized and existing under the laws of Italy having its place of business at Viale Marche, 15, 20125 Milano, Italy. Sinclair Pharmaceuticals Ltd and Sinclair Pharma Srl are hereinafter collectively referred to as "Company" and CELL PATHWAYS, INC., a corporation duly organized and existing under the laws of Delaware having a place of business at 702 Electronic Drive, Horsham, Pennsylvania, 19044 hereinafter referred to as "Distributor." The Definitions set forth in Article 1 of the Distribution Agreement are used in and control this Amendment No. 2. This Amendment No. 2 is effective as of October 15, 2002. The Company and Distributor agree that as to the order of "at least $2,000,000" specified in Section 3.1 of the Distribution Agreement, that order shall be satisfied by amending Distribution Agreement as follows: Distributor shall pay Company [ ** ] by October 31, 2002; Company shall deliver to Distributor [ ** ]of Present Product by December 31, 2002; Distributor shall pay Company [ ** ] by January 15, 2003; Company shall deliver to Distributor [ ** ]of Present Product by March 31, 2003, whereupon Distributor shall pay Company [ ** ]; and Company shall deliver to Distributor [ ** ]of Present Product by June 15, 2003, whereupon Distributor shall pay Company [ ** ]. Distributor shall send Company a purchase order substantially in the form attached on or before October 31, 2002 reflecting the terms above. The Company and Distributor further agree that Section 9.1 of the Distribution Agreement shall be amended to allow Distributor to sublicense the GELCLAIR and SINCLAIR marks for use on - --------------------------- [**] CONFIDENTIAL TREATMENT REQUESTED; CONFIDENTIAL PORTIONS OMITTED AND FILED SEPERATELY WITH THE COMMISSION. Product that are promoted on behalf of Distributor by third parties (e.g., John O. Butler Company under the dental Marketing Agreement between Butler and Company dated August 16, 2002 (or amendments thereto)(Cell Pathways' file C-1639)) in the Territory. Distributor shall oblige any sublicensee to perform its obligations as to trademark usage in accordance with the provisions of Article 9 of the Distribution Agreement. IN WITNESS WHEREOF, the Parties have executed this Amendment No. 2 in duplicate. SINCLAIR PHARMACEUTIALS LTD. CELL PATHWAYS INCORPORATED Signed by: Michael J. Flynn Signed by: Robert J. Towarnicki /s/ /s/ - --------------------------- ---------------------------- Position: President & C.E.O. Position: President & C.E.O. Date: October 15, 2002 Date: October 15, 2002 SINCLAIR PHARMA SRI Signed by: Michael J. Flynn Position: President /s/ - ---------------------- Date: October 15, 2002 3 EX-10.4 6 y89178exv10w4.txt AMENDMENT NO.3 TO DISTRIBUTION AGREEMENT EXHIBIT 10.4 DISTRIBUTION AGREEMENT AMENDMENT NO. 3 This is an amendment to the Distribution Agreement ("Distribution Agreement") made and entered into on January 22, 2002 between: SINCLAIR PHARMACEUTICALS LTD., a corporation duly organized and existing under the laws of England having its place of business at Borough Rd, Godalming, Surrey, United Kingdom GU7 2AB and Sinclair Pharma Srl, a corporation duly organized and existing under the laws of Italy having its place of business at Viale Marche, 15, 20125 Milano, Italy. Sinclair Pharmaceuticals Ltd and Sinclair Pharma Srl are hereinafter collectively referred to as "Company." and CELL PATHWAYS, INC., a corporation duly organized and existing under the laws of Delaware having a place of business at 702 Electronic Drive, Horsham, Pennsylvania, 19044 hereinafter referred to as "Distributor." The Definitions set forth in Article 1 of the Distribution Agreement are used in and control this Amendment No. 3. This Amendment No. 3 is effective as of June 9, 2003. The Distribution Agreement did not provide for the assignment by any party of its rights or obligations under the Distribution Agreement to any other person or company. The parties hereto now wish to amend the Distribution Agreement to provide for such assignment, so that Distributor may assign the Distribution Agreement to its merger partner, OSI Pharmaceuticals Inc., and Company may assign the Distribution Agreement to a party acquiring all or substantially all of its business in the Products. The parties hereto have agreed as follows: 1. Distributor is permitted to assign the Distribution Agreement, including all its past, present and future rights and obligations thereunder, to OSI Pharmaceuticals Inc. Such assignment shall take effect upon Distributor and OSI Pharmaceuticals Inc. giving written notification to Company of the assignment, or if appropriate, giving written notification to the assignee referred to in paragraph 2 below. 2. Company is permitted to assign the Distribution Agreement, including all its past, present and future rights and obligations thereunder, to a person or company which is acquiring or has acquired all or substantially all of its business in the Products (such person or company is referred to herein as the "Purchaser"). Such assignment shall take effect upon Company and Purchaser giving written notification to OSI Pharmaceuticals Inc. of the assignment, or if appropriate, giving written notification to Distributor. IN WITNESS WHEREOF, the parties hereto have executed this Amendment No. 2 in duplicate. SINCLAIR PHARMACEUTICALS LTD. CELL PATHWAYS INCORPORATED Signed by: Michael J. Flynn Signed by: Robert J. Towarnicki /s/ /s/ - --------------------------- --------------------------- Position: President & C.E.O. Position: President & C.E.O. Date: June 9, 2003 Date: June 9, 2003 SINCLAIR PHARMA SRI Signed by: Michael J. Flynn /s/ - ------------------- Position: President Date: June 9, 2003 2 EX-31.1 7 y89178exv31w1.txt 302 CERTIFICATION: CEO EXHIBIT 31.1 CERTIFICATION I, Colin Goddard, certify that: 1. I have reviewed this quarterly report on Form 10-Q of OSI Pharmaceuticals, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) [paragraph omitted pursuant to SEC Release Nos. 33-8238 and 34-47986]; c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and d) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 13, 2003 /s/ COLIN GODDARD, PH.D. ---------------------------------------- Colin Goddard, Ph.D. Chief Executive Officer EX-31.2 8 y89178exv31w2.txt 302 CERTIFICATION: CFO EXHIBIT 31.2 CERTIFICATION I, Robert L. Van Nostrand, certify that: 1. I have reviewed this quarterly report on Form 10-Q of OSI Pharmaceuticals, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) [paragraph omitted pursuant to SEC Release Nos. 33-8238 and 34-47986]; (c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and (d) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 13, 2003 /s/ ROBERT L. VAN NOSTRAND ------------------------------------------ Robert L. Van Nostrand Vice President and Chief Financial Officer EX-32.1 9 y89178exv32w1.txt 906 CERTIFICATION: CEO EXHIBIT 32.1 OSI PHARMACEUTICALS, INC. CERTIFICATION PURSUANT TO 18 U.S.C. Section 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of OSI Pharmaceuticals, Inc. (the "Company") on Form 10-Q for the period ended June 30, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Colin Goddard, Ph.D., Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. Date: August 13, 2003 /s/ Colin Goddard, Ph.D. ---------------------------------------- Colin Goddard, Ph.D. Chief Executive Officer EX-32.2 10 y89178exv32w2.txt 906 CERTIFICATION: CFO EXHIBIT 32.2 OSI PHARMACEUTICALS, INC. CERTIFICATION PURSUANT TO 18 U.S.C. Section 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of OSI Pharmaceuticals, Inc. (the "Company") on Form 10-Q for the period ended June 30, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Robert L. Van Nostrand, Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. Date: August 13, 2003 /s/ Robert L. Van Nostrand ------------------------------------------ Robert L. Van Nostrand Vice President and Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----