UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(X) Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the quarterly period
ended September 30, 1998
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 1-6247
ALZA CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 77-0142070
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
950 Page Mill Road
PO Box 10950
Palo Alto, California 94303-0802
(Address of principal executive offices)
Registrant's telephone number, including area code (650) 494-5000
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 ( )
Number of shares outstanding of each of the registrant's classes
of common stock as of October 30, 1998:
Common Stock, $0.01 par value - 87,121,964 shares
ALZA CORPORATION
FORM 10-Q for the Quarter Ended
September 30, 1998
INDEX
Part I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Statement of Income 3
Condensed Consolidated Balance Sheet 4
Condensed Consolidated Statement of Cash Flows 5
Notes to Condensed Consolidated Financial Statements 6-10
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 11-20
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 21
Part II. Other Information
Item 1. Legal Proceedings 21
Item 6. Exhibits and Reports on Form 8-K 21
Signatures 22
Exhibits
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
ALZA CORPORATION
Condensed Consolidated Statement of Income (unaudited)
(In millions, except per share amounts)
Quarter Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
_________________________________________________________________
Revenues:
Net sales $ 59.0 $ 36.5 $ 172.0 $ 100.4
Royalties, fees and other 63.0 41.9 164.1 131.8
Research and development 32.8 36.1 91.7 106.0
_________________________________________________________________
Total revenues 154.8 114.5 427.8 338.2
Expenses:
Costs of products shipped 30.1 22.0 92.5 64.9
Research and development 42.4 41.9 111.6 116.5
Selling, general and
administrative 31.2 11.0 66.3 35.1
Acquisition of in-process
research and development - 87.0 - 87.0
Contribution to Crescendo
Pharmaceuticals Corporation - 247.0 - 247.0
Asset write-down - 11.5 - 11.5
_________________________________________________________________
Total expenses 103.7 420.4 270.4 562.0
Operating income (loss) 51.1 (305.9) 157.4 (223.8)
Interest expense 14.1 13.8 42.3 41.3
Distribution to debenture
holders - 8.0 - 8.0
Interest and other income (5.9) (17.8) (18.6) (48.3)
_________________________________________________________________
Net interest and other
expense 8.2 4.0 23.7 1.0
_________________________________________________________________
Income (loss) before
income taxes 42.9 (309.9) 133.7 (224.8)
Provision for income taxes 15.0 16.6 46.8 49.0
_________________________________________________________________
Net income (loss) $ 27.9 $(326.5) $ 86.9 $(273.8)
================================================================
Earnings (loss) per share
Basic $ 0.32 $(3.83) $ 1.01 $ (3.22)
================================================================
Diluted $ 0.31 $(3.83) $ 0.97 $ (3.22)
================================================================
See accompanying notes.
ALZA Corporation
Condensed Consolidated Balance Sheet (unaudited)
(In millions)
September 30, December 31,
1998 1997
________________________________________________________________
ASSETS
Current assets:
Cash and cash equivalents $ 77.3 $ 65.0
Short-term investments 86.6 109.2
Receivables, net 144.1 119.2
Inventories, at cost:
Raw materials 12.8 16.5
Work in process 6.7 8.5
Finished goods 19.7 12.8
_______________________________________________________________
Total inventories 39.2 37.8
Prepaid expenses and other
current assets 28.6 26.8
_______________________________________________________________
Total current assets 375.8 358.0
Property, plant and equipment 459.0 401.8
Less accumulated depreciation
and amortization (111.7) (91.4)
_______________________________________________________________
Net property, plant and equipment 347.3 310.4
Deferred product and license
acquisition costs 245.5 147.2
Investments in long-term securities 314.1 361.6
Other assets 197.0 192.0
_______________________________________________________________
Total assets $1,479.7 $ 1,369.2
================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 25.8 $ 56.9
Accrued liabilities 49.3 45.9
Other current liabilities 5.1 1.8
_______________________________________________________________
Total current liabilities 80.2 104.6
5% convertible subordinated debentures 500.0 500.0
5 1/4% zero coupon convertible
subordinated debentures 417.3 402.6
Other long-term liabilities 66.3 60.8
Stockholders' equity:
Common stock and additional
paid-in capital 421.8 382.4
Accumulated other comprehensive
income (16.4) (4.8)
Retained earnings (deficit) 10.5 (76.4)
_______________________________________________________________
Total stockholders' equity 415.9 301.2
_______________________________________________________________
Total liabilities and
stockholders' equity $1,479.7 $ 1,369.2
================================================================
See accompanying notes.
ALZA CORPORATION
Condensed Consolidated Statement of Cash Flows (unaudited)
(In millions)
Nine Months Ended
September 30,
1998 1997
___________________
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 86.9 $(273.8)
Non-cash adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization 25.3 22.9
Amortization of product payments 10.4 1.7
Interest on 5 1/4% zero coupon convertible
subordinated debentures 15.9 15.2
(Increase) decrease in current assets (20.1) 6.4
Increase (decrease) in current liabilities (31.7) 18.3
Asset write-down - 11.5
Other 2.5 12.3
___________________
Net cash provided by (used in)
operating activities 89.2 (185.5)
CASH FLOWS FROM INVESTING ACTIVITIES:
Sales and maturities of available-for-sale
securities 243.4 596.5
Purchases of available-for-sale securities (192.8) (322.0)
Purchase of limited partners' interests in
ALZA TTS Research Partners, Ltd. (91.2) -
Capital expenditures (39.8) (23.6)
Product acquisition payments (13.5) (60.0)
Purchase of Therapeutic Discovery
Corporation's deferred tax asset - (23.0)
Other investing activities (17.3) (26.2)
___________________
Net cash (used in) provided by
investing activities (111.2) 141.7
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuances of common stock 38.1 16.3
Issuance of long-term debt - 6.5
Distribution of Crescendo Pharmaceuticals
Corporation shares to stockholders - (49.1)
Principal payments on long-term debt (3.8) (0.9)
___________________
Net cash provided by (used in)
financing activities 34.3 (27.2)
___________________
Net increase (decrease) in cash and
cash equivalents 12.3 (71.0)
Cash and cash equivalents at
beginning of period 65.0 187.7
___________________
Cash and cash equivalents at end of period $ 77.3 $ 116.7
===================
NONCASH INVESTING AND FINANCING ACTIVITIES
Investment in low-income housing
in exchange for long-term debt $ 10.1 $ 6.6
Acquisition of building in lieu of
repayment of note receivable 17.5 -
Accrued product and license acquisition costs 4.0 -
Conversion of 5 1/4% Debentures into
ALZA common stock 1.2 -
See accompanying notes.
ALZA CORPORATION
Notes to Condensed Consolidated Financial Statements (unaudited)
1. BASIS OF PRESENTATION
The information at September 30, 1998 and for the three and
nine months ended September 30, 1998 and 1997 is unaudited, and
includes all adjustments (consisting only of normal recurring
adjustments) that the management of ALZA Corporation ("ALZA")
believes necessary for fair presentation of the results for the
periods presented. Interim results are not necessarily
indicative of results for the full year. The condensed
consolidated balance sheet at December 31, 1997 was derived from
the audited balance sheet. The condensed consolidated financial
statements should be read in conjunction with the audited
consolidated financial statements and accompanying notes for the
year ended December 31, 1997 included in ALZA's 1997 Annual
Report to Stockholders.
Comprehensive Income
As of January 1, 1998, ALZA adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income"
("SFAS 130"), which establishes standards for reporting
comprehensive income and its components. Total comprehensive
income includes net income plus other comprehensive income which,
for ALZA, primarily comprises net unrealized gains or losses on
available-for-sale securities. Other comprehensive income (loss)
was $(1.7) million and $7.9 million for the quarters ended
September 30, 1998 and 1997, respectively, and $(11.6) million
and $(1.2) million for the nine months ended
September 30, 1998 and 1997, respectively. Total comprehensive
income (loss) was $26.2 million and $(318.6) million for the
quarters ended September 30, 1998 and 1997, respectively, and
$75.3 million and $(275.0) million for the nine months ended
September 30, 1998 and 1997, respectively. The adoption of SFAS
130 had no impact on ALZA's results of operations or financial
condition.
Supplemental Disclosures of Cash Flow Information
In early 1998, ALZA made a payment of $21.5 million to
Janssen Pharmaceutica, Inc. ("Janssen") related to the
modification, effective as of December 31, 1997, of a
development and commercialization agreement for an E-TRANS-
trademark- fentanyl product for the treatment of acute pain.
ALZA recorded a non-recurring charge for this item in the fourth
quarter of 1997, and the amount was included in accounts payable
at December 31, 1997.
New Accounting Standard
In June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 131, "Disclosures
about Segments of an Enterprise and Related Information" ("SFAS
131"). SFAS 131 establishes standards for annual and interim
disclosures of operating segments, products and services,
geographic areas and major customers. SFAS 131 is effective
beginning with the 1998 fiscal year end financial statements, and
will be applied retroactively, for
ALZA CORPORATION
Notes to Condensed Consolidated Financial Statements (unaudited)
comparison purposes, to the 1998 quarters in the 1999 quarterly
disclosures. ALZA expects to report two operating segments:
ALZA Pharmaceuticals, which will include net sales and costs of
products shipped for ALZA-marketed products, and internal
research and development costs; and Drug Delivery Systems, which
includes research, development and manufacturing for client
companies, and royalties and fees. The adoption of the new
standard will have no impact on ALZA's results of operations or
financial condition.
2. AGREEMENT TO ACQUIRE SEQUUS PHARMACEUTICALS, INC.
On October 5, 1998, ALZA and SEQUUS Pharmaceuticals, Inc.
("SEQUUS") announced that the companies have entered into a
definitive merger agreement under which ALZA will acquire SEQUUS.
Under the terms of the agreement, ALZA will acquire all of
SEQUUS' outstanding stock in a tax-free, stock-for-stock
transaction. SEQUUS stockholders will receive 0.4 shares of ALZA
Common Stock for each share of SEQUUS Common Stock. Based upon
SEQUUS' currently outstanding shares, ALZA expects to issue
approximately 12.7 million shares as a result of the acquisition.
ALZA expects to issue up to approximately 2.4 million additional
shares based upon outstanding SEQUUS stock options, warrants and
stock purchase rights. ALZA intends to account for the transaction
as a pooling of interests. SEQUUS' commercialized products are
Doxil-registered trademark- (doxorubicin HCl liposome injection),
an anticancer product, and Amphotec-registered trademark-
(amphotericin B cholesteryl sulfate complex for injection), an
antifungal product. The transaction, which is subject to
regulatory and SEQUUS stockholder approvals, is expected to close
in late 1998 or early 1999.
3. ACQUISITION OF LIMITED PARTNERS' INTERESTS IN ALZA TTS RESEARCH
PARTNERS, LTD.
On June 29, 1998, ALZA Development Corporation ("ADC"), a wholly-
owned subsidiary of ALZA, elected to exercise its option to acquire
all of the outstanding limited partnership interests in ALZA TTS
Research Partners, Ltd. (the "Partnership"), which was formed in
1982 to develop and commercialize products combining ALZA's
proprietary transdermal drug delivery technology with certain
generic compounds. The exercise price of $91.2 million was paid in
cash to the limited partners on August 14, 1998. ALZA had been
paying the Partnership four percent of net sales of Duragesic-
registered trademark- (fentanyl) CII and Testoderm-registered
trademark- (testosterone), two products developed by ALZA on behalf
of the Partnership. As a result of the exercise of the purchase
option, ALZA has all rights to these products, and therefore retains
all royalties paid by Janssen on sales of Duragesic, the full
transfer price and royalties from sales of Testoderm outside the
United States, and the full sales margin on Testoderm in the United
States. The purchase price was recorded as deferred product and
license acquisition cost and is being amortized over a period of 10
years beginning July 1, 1998.
ALZA CORPORATION
Notes to Condensed Consolidated Financial Statements (unaudited)
4. PER SHARE INFORMATION
Basic earnings per share is calculated by dividing net
income by the weighted average common shares outstanding for the
period. Diluted earnings per share is calculated by dividing net
income, as adjusted, by the weighted average common shares
outstanding for the period plus the dilutive effect of stock
options, warrants and convertible securities.
The following table sets forth the computation of ALZA's
basic and diluted earnings per share (in millions, except per
share amounts):
Quarter Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
_________________________________________________________________
NUMERATOR:
Basic
Net income (loss) $ 27.9 $(326.5) $86.9 $(273.8)
Diluted
Net income (loss) $ 27.9 $(326.5) $86.9 $(273.8)
Adjustments, net of tax:
Interest on 5 1/4%
Debentures 3.5 - 10.3 -
Interest on 5% Debentures - - 12.2 -
Amortization expense 0.1 - 0.8 -
_________________________________________________________________
Adjusted net income
(loss) $ 31.5 $(326.5) $110.2 $(273.8)
=================================================================
DENOMINATOR:
Basic
Weighted average shares 86.8 85.2 86.3 85.0
=================================================================
Diluted
Weighted average shares 86.8 85.2 86.3 85.0
Effect of dilutive
securities:
Employee stock options 1.4 - 1.6 -
5 1/4% Debentures 12.3 - 12.3 -
5% Debentures - - 13.1 -
___________________________________________________________________
Weighted average shares
and assumed conversions 100.5 85.2 113.3 85.0
===================================================================
Basic earnings (loss)
per share $ 0.32 $(3.83) $1.01 $(3.22)
===================================================================
Diluted earnings (loss)
per share $ 0.31 $(3.83) $0.97 $(3.22)
===================================================================
ALZA CORPORATION
Notes to Condensed Consolidated Financial Statements (unaudited)
Options to purchase approximately 1.7 million shares of
common stock were excluded from the diluted earnings per share
calculation for the quarter and nine months ended September 30,
1998 because the exercise price of the options was greater than
the average market price of the common shares during the periods,
and therefore the effect of including those options would have
been anti-dilutive. ALZA's outstanding 5% convertible
subordinated debentures due 2006 were not included in the diluted
earnings per share calculation for the quarter and nine months
ended September 30, 1998, as their inclusion for those periods
would have been anti-dilutive. For the quarter and nine months
ended September 30, 1997, the effects of stock options and
assumed conversions of the 5 1/4% Debentures and the 5%
Debentures were excluded from the calculations for both periods
as their inclusion would have been anti-dilutive.
5. CRESCENDO PHARMACEUTICALS CORPORATION
Under the Development Agreement between ALZA and Crescendo
Pharmaceuticals Corporation ("Crescendo"), ALZA recorded product
development revenues of $25.2 million and $70.1 million for the
quarter and nine months ended September 30, 1998, respectively,
compared to $8.1 million for the quarter and nine months ended
September 30, 1997, Crescendo's initial period of operations.
Disclosed products currently in active development with Crescendo
are Ditropan-registered trademark- XL (oxybutynin), DUROS-
trademark- leuprolide, OROS-registered trademark- methylphenidate
and E-TRANS-trademark- fentanyl (chronic pain). In the third
quarter of 1998, based upon ALZA's recommendation, Crescendo
determined not to continue its funding of two products previously
in early development: E-TRANS-trademark- LHRH and E-TRANS-
trademark- Macroflux-trademark- insulin. ALZA intends to
continue its research on the technologies utilized in these
product development programs.
Under the Technology License Agreement between ALZA and
Crescendo, ALZA recorded technology fee revenue from Crescendo of
$2.7 million and $8.7 million for the quarter and nine months
ended September 30, 1998, respectively, compared to $1.0 million
for the quarter and nine months ended September 30, 1997.
ALZA has an option to acquire an exclusive, royalty-bearing
license to each product developed by Crescendo under the
Development Agreement. The option is exercisable on a product-by-
product, country-by-country, basis. Under Crescendo's Restated
Certificate of Incorporation, ALZA has the right to purchase all
(but not less than all) of the Class A Common Stock of Crescendo
at a price based upon a pre-established formula.
ALZA CORPORATION
Notes to Condensed Consolidated Financial Statements (unaudited)
6. SUBSEQUENT EVENT
On November 3, 1998, ALZA announced that it had acquired
exclusive marketing and distribution rights to Urispas-registered
trademark- (flavoxate hydrochloride) in the United States from
SmithKline Beecham Corporation ("SB"). Under the terms of the
agreement, ALZA made an upfront payment of $25 million to SB, and
may make additional milestone payments. SB will manufacture the
product for ALZA.
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Notice Concerning Forward-Looking Statements
Some of the statements made in this Form 10-Q, and
particularly in Management's Discussion and Analysis of Financial
Condition and Results of Operations, are forward-looking in
nature, including, without limitation, plans concerning the
commercialization of products, statements concerning potential
product sales, future costs of products shipped (and gross
margins), associated sales and marketing expenses, plans
concerning the development of products and technologies and other
statements that are not historical facts. The occurrence of the
events described, and the achievement of the intended results,
are subject to various risk factors that could cause ALZA's
actual results to be materially different than those presented,
some or all of which are not predictable or within ALZA's
control. The significant risks related to ALZA's business are
described in ALZA's Annual Report on Form 10-K for the year ended
December 31, 1997. In addition, as a result of the acquisition
of SEQUUS, described below, ALZA's business will be subject to
additional risks related to SEQUUS' business. These risks will
be described in ALZA's filings after completion of the merger.
Non-recurring charges totaling $353.5 million, or $4.14 per
diluted share, occurred in the third quarter of 1997, and are
described under "Non-recurring Items". Unless otherwise noted,
the discussion and tables below cover the results of operations
excluding non-recurring items.
RESULTS OF OPERATIONS
SUMMARY
Quarter Ended Nine Months Ended
(In millions, September 30, September 30,
except per share amounts) 1998 1997 1998 1997
_________________________________________________________________
Revenues $ 154.8 $ 114.5 $ 427.8 $338.2
_________________________________________________________________
Operating Income (loss)
As reported 51.1 (305.9) 157.4 (223.8)
Excluding non-recurring
items 51.1 39.6 157.4 121.7
_________________________________________________________________
Net Income (loss)
As reported 27.9 (326.5) 86.9 (273.8)
Excluding non-recurring
items 27.9 27.0 86.9 79.8
_________________________________________________________________
Earnings (loss) per share
(diluted)
As reported 0.31 (3.83) 0.97 (3.22)
Excluding non-recurring
items 0.31 0.31 0.97 0.91
_________________________________________________________________
For the quarter ended September 30, 1998, ALZA's net income
and operating income increased 3% and 29%, respectively, compared
to the same quarter of 1997. For the nine months ended September
30, 1998, ALZA's net income and operating income increased 9% and
29%, respectively, compared to the nine months ended September 30,
1997. These increases were due primarily to a significant increase
in the sales of ALZA-marketed products, reflecting sales of Elmiron-
registered trademark- (pentosan polysulfate sodium), which ALZA
began marketing in the fourth quarter of 1997, and Mycelex-
registered trademark- (clotrimazole) Troche, which ALZA began
marketing in the third quarter of 1997, increased sales of Ethyol-
registered trademark- (amifostine), and an increase in contract
manufacturing revenues related to Duragesic and Covera-HSTM
(verapamil). Also contributing to higher income for the quarter
and nine months ended September 30, 1998, as compared to the same
periods of 1997, was an increase in royalties, fees and other
revenues, primarily reflecting an increase in Duragesic royalties,
licensing fees from third parties, and the technology fees from
Crescendo. These increases were partially offset by declines in
research and development revenues, increases in selling, general
and administrative expenses and substantially lower interest
income.
NET SALES AND COSTS OF PRODUCTS SHIPPED
Net Sales
Quarter Ended Nine Months Ended
September 30, September 30,
(Dollars in millions) 1998 1997 1998 1997
_________________________________________________________________
ALZA-marketed products
Ethyol-registered trademark-$ 9.5 $ 5.7 $ 23.4 $ 14.3
Mycelex-registered trademark-
Troche 5.9 5.2 21.6 5.2
Elmiron-registered trademark-5.5 - 16.1 -
Testoderm-registered
trademark- line 2.1 1.5 6.4 4.4
Other 5.2 1.7 18.2 5.5
__________________________________________________________________
Total ALZA-marketed products 28.2 14.1 85.7 29.4
Contract manufacturing 30.8 22.4 86.3 71.0
__________________________________________________________________
Total net sales $ 59.0 $ 36.5 $172.0 $100.4
==================================================================
Percentage of total revenues 38% 32% 40% 30%
ALZA-marketed products as a
percentage of net sales 48% 39% 50% 29%
Net sales of ALZA-marketed products for the quarter and nine
months ended September 30, 1998 increased substantially compared
to the same periods of 1997. These increases are attributable in
part to sales of Elmiron (as well as BiCitra-registered trademark-
, PolyCitra-registered trademark- and Neutra-Phos-registered
trademark-). The United States and Canadian rights to Elmiron
and the United States right to the other products were acquired
in October 1997. Higher sales of Ethyol also contributed to the
increases in net sales for the 1998 periods. Net sales for the
nine months ended September 30, 1998 included sales of Mycelex
Troche, the United States rights to which were acquired by ALZA
in July 1997, and initial sales of Testoderm-registered trademark-
TTS, which was launched in March 1998. Sales of ALZA-marketed
products can be expected to fluctuate from quarter to quarter
with variations in the timing and quantities of orders from
wholesalers for ALZA-marketed products, which vary due to factors
such as demand for the products, ordering patterns of
wholesalers, and the introduction and sales of competing
products.
Net sales from contract manufacturing increased 37% and 21%
for the quarter and nine months ended September 30, 1998,
respectively, compared to the same periods of 1997. The third
quarter increases were primarily due to higher shipments of
Duragesic to Janssen, Covera-HS to G.D. Searle & Co. and Nicoderm-
registered trademark- and NicoDerm-registered trademark- CQ-
trademark- (nicotine) to Hoeschst Marion Roussel, Inc. and
SmithKline Beecham p.l.c. ("SKB"). The increase in net sales
from contract manufacturing for the nine months ended September
30, 1998, compared to the nine months ended September 30, 1997,
was primarily due to higher shipments of Duragesic and Covera-HS.
The timing and quantities of orders for products marketed by
client companies are not within ALZA's control. Net sales to
client companies can be expected to fluctuate from period to
period, sometimes significantly, depending on the volume, mix and
timing of orders of products shipped to client companies, and in
some quarters, due to the shipment of launch quantities of
products to the clients.
Costs of products shipped increased to $30.1 million for the
quarter ended September 30, 1998, compared to $22.0 million for
the corresponding quarter of 1997. Costs of products shipped
increased to $92.5 million for the nine months ended September
30, 1998, compared to $64.9 million for the same period of 1997.
These fluctuations reflect the significant increase in net sales
for the 1998 periods.
Quarter Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
_________________________________________________________________
Gross margin as a percentage
of net sales (1) 49% 40% 46% 35%
_________________________________________________________________
(1) Gross margin is net sales less costs of products shipped.
The increase in ALZA's gross margin in the third quarter and
nine months ended September 30, 1998, compared to the same
periods of 1997, was primarily due to the substantial increase in
sales of ALZA-marketed products. ALZA expects its gross margin,
as a percentage of net sales, to increase over the longer term,
although quarter-to-quarter fluctuations will continue to occur.
Higher gross margins may be achieved through continuing the
proportionate increase in the sales of ALZA-marketed products (as
compared to sales from contract manufacturing) and, to a lesser
extent, increased utilization of capacity and greater operating
efficiencies.
On November 3, 1998, ALZA announced that it had acquired
exclusive marketing and distribution rights to Urispas in the
United States from SB. Under the terms of the agreement, ALZA
made an upfront payment of $25 million to SB, and may make
additional milestone payments. SB will manufacture the product
for ALZA.
ROYALTIES, FEES AND OTHER REVENUES
Quarter Ended Nine Months Ended
September 30, September 30,
(Dollars in millions) 1998 1997 1998 1997
_________________________________________________________________
Royalties, fees and
other revenues $ 63.0 $ 41.9 $164.1 $131.8
Percentage of total
revenues 41% 37% 38% 39%
_________________________________________________________________
Royalties, fees and other revenues increased 51% and 25% for
the quarter and nine months ended September 30, 1998, compared to
the corresponding periods of 1997. The third quarter increase in
royalties was primarily due to increased royalties from sales of
Duragesic. On June 20, 1998, ADC elected to exercise its option
to purchase all of the outstanding limited partnership interests
in the Partnership, discussed in Note 3 to the Condensed
Consolidated Financial Statements, which resulted in ALZA
retaining all royalties paid by Janssen on sales of Duragesic.
During the quarter, ALZA and Janssen entered into an agreement
under which Janssen will make a series of quarterly payments to
ALZA over two years to help defray ALZA's substantial purchase
price paid for the limited partnership interests in the
Partnership. In exchange, the royalty rate payable by Janssen to
ALZA with respect to Duragesic will be reduced by a portion of
the rate that ALZA previously paid to the Partnership.
Royalties on sales of NicoDerm CQ and Glucotrol XL-registered
trademark- (glipizide) also increased in the third quarter of
1998 compared with the third quarter of 1997. Partially
offsetting these increases in royalties were lower royalties on
sales of Procardia XL-registered trademark- (nifedipine) by
Pfizer, Inc. ("Pfizer"). Fee revenue increased in the third
quarter of 1998 compared to the third quarter of 1997, resulting
from a milestone payment from Knoll Pharmaceutical Company, an
upfront payment from Janssen related to the initiation of a new
transdermal fentanyl product development program, and technology
fees of $2.7 million from Crescendo. For the nine months ended
September 30, 1998, royalties, fees and other revenues increased
due to higher royalties on sales of Duragesic by Janssen
(including $5.9 million in royalties resulting from timing
differences between product sales, payments of royalties to ALZA
by Janssen and payments by ALZA to the Partnership), higher
royalties on sales of Glucotrol XL by Pfizer and higher fee
revenue, including the technology fees of $8.7 million from
Crescendo.
Sales of Procardia XL, as reported by Pfizer, decreased 14%
for the third quarter of 1998, compared to the same period in
1997. Several companies have filed Abbreviated New Drug
Applications with the U.S. Food and Drug Administration ("FDA")
requesting clearance to market generic sustained-release
nifedipine products. Pfizer is involved in litigation concerning
patent infringement and regulatory requirements, in which Pfizer
is seeking to enjoin the introduction of such generic nifedipine
products. While it is not possible to predict the timing and
amount of the negative impact on sales of Procardia XL that could
result from competition from these or other potential sustained-
release nifedipine products, such competition could have a
substantial adverse impact on sales of Procardia XL and ALZA's
royalties from those sales.
During the next several years, ALZA intends to continue to
reduce its dependence on royalties and fees by further expanding
ALZA's sales and marketing activities and by directly marketing
and selling more products. However, there can be no assurance
that ALZA will be successful in this expansion, or that any
expanded sales and marketing activities will be successful, due
to factors such as the risks associated with developing,
clinically testing and obtaining regulatory clearance of products
for marketing by ALZA, the difficulties and costs associated with
acquiring products from third parties for ALZA to market, the
length of the regulatory approval process, the uncertainties
surrounding the acceptance of new products by the intended
markets, the marketing of competitive products, the risks
relating to patents and proprietary rights and the current health
care cost containment environment in the United States. ALZA
expects that, in the near term, royalties on sales by clients of
currently marketed products will continue to be a substantial
contributor to net income.
RESEARCH AND DEVELOPMENT
Research and Development Revenues
Quarter Ended Nine Months Ended
September 30, September 30,
(Dollars in millions) 1998 1997 1998 1997
_________________________________________________________________
Crescendo Pharmaceuticals
Corporation $ 25.2 $ 8.1 $70.1 $ 8.1
Therapeutic Discovery
Corporation (1) - 18.5 - 67.8
Other clients 7.6 9.5 21.6 30.1
_________________________________________________________________
Total research and
development revenues $ 32.8 $ 36.1 $91.7 $106.0
=================================================================
Percentage of total
revenues 21% 32% 21% 31%
_________________________________________________________________
(1) Purchased by ALZA in the third quarter of 1997.
Research and development revenues decreased 9% and 13% in
the quarter and nine months ended September 30, 1998,
respectively, compared to the same periods in 1997, reflecting a
decline in product development activities under agreements with
client companies.
Research and Development Expenses
Quarter Ended Nine Months Ended
September 30, September 30,
(Dollars in millions) 1998 1997 1998 1997
_________________________________________________________________
Research and development
expenses $ 42.4 $ 41.9 $111.6 $116.5
As a percentage of total
revenues 27% 37% 26% 34%
_________________________________________________________________
Research and development expenses increased 1% and decreased
4% for the quarter and nine months ended September 30, 1998,
respectively, compared to the same periods in 1997. For the
third quarter of 1998, an increase in internal research and
development expenses was partially offset by a decrease in client
development expenses. For the nine months ended September 30,
1998, client development expenses declined, but the decline was
partially offset by an increase in internal research and
development costs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Quarter Ended Nine Months Ended
September 30, September 30,
(Dollars in millions) 1998 1997 1998 1997
_________________________________________________________________
Sales and marketing expenses $22.1 $ 6.3 $ 46.6 $ 19.1
General and administrative
expenses 4.0 3.6 9.3 14.3
Amortization of product
and license acquisition
payments 5.1 1.1 10.4 1.7
_________________________________________________________________
Total selling, general and
administrative expenses $ 31.2 $ 11.0 $66.3 $ 35.1
==================================================================
As a percentage of total
revenues 20% 10% 16% 10%
_________________________________________________________________
Selling, general and administrative expenses rose
dramatically for the quarter and nine months ended September 30,
1998, compared to the same periods of 1997. These increases were
the result of ALZA's expanded sales and marketing activities, an
increase in the size of the sales force and the added
amortization of payments for product rights acquired in 1997 and
1998. During the third quarter of 1998, ALZA expanded its sales
organization from approximately 100 to approximately 360 sales
representatives, under arrangements with VIVUS, Inc. and Innovex,
Inc.
In addition, during the quarter ALZA entered into an
agreement under which UCB Pharma, Inc. will co-promote Ditropan
XL, beginning at the time of launch, currently expected in early
1999. As a result of the sales force expansion, the UCB Pharma
co-promotion arrangement and additional amortization of product
acquisition payments, sales and marketing expenses are expected
to increase in future quarters.
NET INTEREST
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1998 1997 1998 1997
________________________________________________________________
Interest expense $ 14.1 $ 13.8 $ 42.3 $ 41.3
Interest and other income (5.9) (17.8) (18.6) (48.3)
_________________________________________________________________
Net interest
expense (income) $ 8.2 $ (4.0) $ 23.7 $ (7.0)
=================================================================
Interest expense increased 2% for both the third quarter and
nine months ended September 30, 1998, compared to the same
periods of 1997, primarily due to accreted interest on ALZA's
outstanding 5 1/4% zero coupon convertible subordinated
debentures due 2014. Interest and other income declined 67% and
61% in the third quarter and the nine months ended September 30,
1998, respectively, compared to the same periods in 1997, due to
lower cash balances as a result of the purchase of Therapeutic
Discovery Corporation ("TDC"), the formation of Crescendo and
several product acquisitions, all of which occurred in the second
half of 1997, and payment of $91.2 million for the limited
partnership interests in the Partnership, which occurred in the
third quarter of 1998.
Effective Tax Rate
For the third quarter and the nine months ended September
30, 1998, ALZA's effective combined federal and state income tax
rate was 35%, compared to 38% on income excluding non-recurring
items for the nine months ended September 30, 1997. ALZA's
annual effective tax rate for 1998 is expected to be 35%, the
same as the rate for 1997.
NON-RECURRING ITEMS
The table below summarizes non-recurring charges:
Quarter Ended Nine Months Ended
September 30, September 30,
(In millions) 1998 1997 1998 1997
________________________________________________________________
Acquisition of in-process
research and development $ - $ (87.0) $ - $ (87.0)
Contribution to Crescendo - (247.0) - (247.0)
Asset write-down - (11.5) - (11.5)
Distribution to debenture
holders - (8.0) - (8.0)
________________________________________________________________
Total non-recurring items $ - $(353.5) $ - $(353.5)
=================================================================
Non-recurring items for the third quarter of 1997 included
the following charges: in-process research and development
charges of $77.0 million relating to the purchase of TDC and
$10.0 million for a payment to Alkermes, Inc. under an agreement
relating to the Cereport-registered trademark- product under
development by Alkermes; a $247.0 million charge and $8.0 million
interest expense relating to ALZA's distribution of shares of
Crescendo; and a write-down of $11.5 million of excess
manufacturing equipment and excess and idle assets.
LIQUIDITY AND CAPITAL RESOURCES
September 30, December 31,
(In millions) 1998 1997
________________________________________________________________
Working capital $ 295.6 $ 253.4
Cash and investments 478.0 535.8
Total assets 1,479.7 1,369.2
Long-term debt 917.3 902.6
________________________________________________________________
Nine Months Ended September 30,
(In millions) 1998 1997
________________________________________________________________
Net cash provided by
operating activities (1) $ 110.6 $ 156.5
Capital expenditures 39.8 23.6
________________________________________________________________
(1) Excludes non-recurring items.
ALZA's capital spending for the nine months ended September
30, 1998 was $39.8 million for additions to facilities and
equipment to support its research, development and manufacturing
activities, compared to capital spending of $23.6 million in the
same period of 1997. While ALZA believes its current facilities
and equipment are sufficient to meet its current operating
requirements, ALZA is expanding its facilities and equipment to
support its future requirements. ALZA is in the process of
constructing buildings under a joint venture agreement entered
into in 1997. In addition to a $36.2 million contribution to the
joint venture made in 1997, which is being applied to the
construction of the buildings, ALZA expects to spend in excess of
$100.0 million on building improvements. The joint venture will
lease the buildings to ALZA upon completion of construction,
which is currently scheduled for late 1999. Capital expenditures
during the fourth quarter of 1998 are expected to be higher than
those in the fourth quarter of 1997.
ALZA believes that its existing cash and investment balances
are adequate to fund its cash needs for 1998 and beyond. In
addition, should the need arise, ALZA believes it would be able
to borrow additional funds or otherwise raise additional capital.
ALZA may consider using its capital to make strategic investments
or acquisitions, or to acquire or license technology or products.
AGREEMENT TO ACQUIRE SEQUUS PHARMACEUTICALS, INC.
On October 5, 1998, ALZA and SEQUUS announced that the
companies have entered into a definitive merger agreement. Under
the terms of the agreement, ALZA will acquire all of SEQUUS'
outstanding stock in a tax-free, stock-for-stock transaction.
SEQUUS stockholders will receive 0.4 shares of ALZA Common Stock
for each share of SEQUUS Common Stock. Based upon SEQUUS'
currently outstanding shares, options and warrants, ALZA expects
to issue approximately 12.7 million shares as a result of the
acquisition. ALZA expects to issue up to approximately 2.4
million additional shares based upon outstanding SEQUUS stock options,
warrants and stock purchase rights. ALZA intends to account for the
transaction as a pooling of interests. SEQUUS' commercialized
products are Doxil-registered trademark- (doxorubicin HCl
liposome injection), an anticancer product, and Amphotec-
registered trademark- (amphotericin B cholesteryl sulfate complex
for injection), an antifungal product. The transaction, which is
subject to regulatory and SEQUUS stockholder approvals, is
expected to close in late 1998 or early 1999.
YEAR 2000 READINESS DISCLOSURE
ALZA is reliant upon its computer systems and applications,
including scientific and manufacturing equipment containing
computer-related components, to conduct its business. Key
internal systems and applications include manufacturing
production management, raw materials supply, inventory control,
research and development activities and project management,
documentation, marketing and financial systems. The majority of
ALZA's significant operating and accounting systems are currently
Year 2000 compliant. The financial and accounting systems that
are not currently Year 2000 compliant have been identified and
are in the process of being upgraded or replaced. Other internal
systems have been, or are in the process of being, inventoried
and evaluated for Year 2000 compliance. Depending on the outcome
of such evaluation, internal systems will be upgraded or replaced
or contingency plans will be developed, as necessary. Financial
systems are expected to be fully Year 2000 compliant by December
1998, and Year 2000 issues are expected to be resolved with
respect to all systems critical to ALZA's business by the end of
1999.
In addition to its internal systems, ALZA is also reliant
upon the capabilities of the computer systems of its
distributors, customers, vendors, banks, and government agencies.
ALZA has initiated communications with third parties with whom it
has material direct business relationships in order to determine
their level of Year 2000 compliance.
Total costs to modify ALZA's systems for Year 2000
compliance are expected to be less than $5.0 million. Such costs
do not include normal systems upgrades and replacements and the
actual financial impact could exceed this estimate. Year 2000
costs incurred to date have not been material.
If ALZA is unable to bring its systems into compliance in
the expected timeframe, any noncompliance could have a material
impact on ALZA's operations, and could result in delays or
failures in manufacturing, research and development and similar
activities. The extent of such impact cannot presently be
determined. ALZA may also experience delays or failures in
manufacturing, distribution, order entry, order processing,
product shipping and distribution, invoicing, payment, or similar
normal business activities, if certain third party distributors,
customers, vendors and banks are not Year 2000 compliant. In
addition, ALZA may experience some delay in obtaining approvals
to market ALZA products from government agencies if government
computer systems are not Year 2000 compliant. There can be no
assurances that third parties' failure to ensure Year 2000
compliance would not have an adverse impact on ALZA's financial
condition or results of operations. ALZA is currently
identifying and developing specific contingency plans intended to
mitigate the effects of any potential Year 2000 disruption. ALZA
expects to have contingency plans in place by the middle of 1999.
Item 3. Quantitative and Qualitative Disclosures about Market
Risk
Not applicable to ALZA for this reporting period.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Product liability suits have been filed against Janssen and
ALZA from time to time relating to the Duragesic product.
Janssen is managing the defense of these suits in consultation
with ALZA under an agreement between the parties.
Historically, the cost of resolution of liability claims
against ALZA (including product liability claims) has not been
significant, and ALZA is not aware of any asserted or unasserted claims
pending against it, including the suits mentioned above, the
resolution of which would have a material adverse impact on the
operations or financial position of ALZA.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
10.1 Amendment No. 1 to Services Agreement between ALZA
Corporation and Crescendo Pharmaceuticals Corporation
27 Financial Data Schedule
(b) No reports on Form 8-K were filed during the quarter
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act
of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned thereunto duly authorized.
ALZA CORPORATION
Date: November 13, 1998 By: /s/ E. Mario
Dr. Ernest Mario
Chairman and Chief
Executive Officer
Date: November 13, 1998 By: /s/ Bruce C. Cozadd
Bruce C. Cozadd
Senior Vice President and
Chief Financial Officer
EXHIBIT INDEX
Exhibit
10.1 Amendment No.1 to Services
Agreement between ALZA Corporation and Crescendo
Pharmaceuticals Corporation
27 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
financial statements included in Part I, Item 1 of Form 10-Q dated September 30,
1998 and is qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 77
<SECURITIES> 87
<RECEIVABLES> 145
<ALLOWANCES> 1
<INVENTORY> 39
<CURRENT-ASSETS> 376
<PP&E> 459
<DEPRECIATION> 112
<TOTAL-ASSETS> 1,480
<CURRENT-LIABILITIES> 80
<BONDS> 917
0
0
<COMMON> 1
<OTHER-SE> 421
<TOTAL-LIABILITY-AND-EQUITY> 1,480
<SALES> 172
<TOTAL-REVENUES> 428
<CGS> 93
<TOTAL-COSTS> 204
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 42
<INCOME-PRETAX> 134
<INCOME-TAX> 47
<INCOME-CONTINUING> 87
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 87
<EPS-PRIMARY> 1.01
<EPS-DILUTED> 0.97
</TABLE>
EXHIBIT 10.1
AMENDMENT NO. 1
TO SERVICES AGREEMENT
This AMENDMENT NO. 1 (the "Amendment") to Services Agreement is
entered into this 24th day of August, 1998, effective as of
September 5, 1997, between ALZA Corporation ("ALZA") and
Crescendo Pharmaceuticals Corporation ("Crescendo").
RECITALS
A. ALZA and Crescendo are parties to a Services Agreement
(the "Agreement") dated as of September 5, 1997.
B. Pursuant to the Agreement, ALZA provides various
administrative services to Crescendo.
C. The parties wish to amend the Agreement as set forth
herein.
NOW, THEREFORE, the parties agree as follows:
1. Section 4 of the Agreement is eliminated in its
entirety and the following is substituted therefor:
"4. Indemnification. Crescendo hereby agrees to
indemnify, protect and hold ALZA harmless from any and all
liabilities, costs or expenses incurred by ALZA as a result
of the services rendered by it under this Agreement,
including, without limitation, lawsuits of and claims by
third parties, except for liabilities, costs or expenses
resulting from ALZA's gross negligence or willful
misconduct. ALZA hereby agrees to indemnify, protect and
hold Crescendo harmless from any and all liabilities, costs
or expenses incurred by Crescendo resulting from the gross
negligence or willful misconduct of ALZA or any of its
employees or agents in the performance of services rendered
by ALZA under this Agreement. The party claiming the right
to indemnification under this Section 4 shall give the
indemnifying party prompt written notice, in the manner set
forth in Section 6.7 below, of any claim or demand made
against the party seeking indemnity for which such party may
be entitled to indemnification under this Section 4."
2. Except as set forth in this Amendment No. 1, the
Agreement remains in full force and effect as originally
executed.
IN WITNESS WHEREOF, the parties have executed this Agreement
as of the date first set forth above.
Crescendo Pharmaceuticals Corporation
By: /s/ Gary L. Neil
Its: President and Chief Executive
Officer
ALZA Corporation
By: /s/ Bruce Cozadd
Its: Senior Vice President and
Chief Financial Officer
