SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED
DECEMBER 31, 1998
Commission File Number 1-6247
ALZA CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 77-0142070
(State or other jurisdiction of (I.R.S.Employer Identification
incorporation of organization) No.)
950 Page Mill Road, P.O. Box 10950, Palo Alto, CA 94303-0802
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (650) 494-5000
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
Common Stock New York Stock Exchange
5 1/4% Liquid Yield Option-trademark- New York Stock Exchange
Notes due 2014 (Zero Coupon-Subordinated)
5% Convertible Subordinated Debentures
due 2006 New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
Warrants (to purchase Common Stock at $65 per share)
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days: Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not contained herein,
and will not be contained, to the best of registrant's knowledge,
in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this
Form 10-K.[X]
State the aggregate market value of the voting stock held by
non-affiliates of the registrant, as of March 19, 1999:$4,992,560,924.
Indicate the number of shares outstanding of each of the
registrant's classes of common stock, as of March 19, 1999:
Title of Class Number of Shares
Common Stock 100,701,006
DOCUMENTS INCORPORATED BY REFERENCE
Part III, Items 10, 11, 12 and 13 are incorporated by
reference to the definitive proxy statement for the registrant's
Annual Meeting of Stockholders to be held on May 6, 1999.
<PAGE>
ALZA CORPORATION FORM 10-K ANNUAL REPORT
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
TABLE OF CONTENTS
Page
Part I.
Item 1. BUSINESS 3
Item 2. PROPERTIES 32
Item 3. LEGAL PROCEEDINGS 33
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 34
EXECUTIVE OFFICERS OF THE REGISTRANT 34
Part II.
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS 36
Item 6. SELECTED CONSOLIDATED FINANCIAL DATA 37
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 38
Item 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK 63
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 65
Item 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE 97
Part III.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE
REGISTRANT 97
Item 11. EXECUTIVE COMPENSATION 97
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT 97
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 97
Part IV.
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES,
AND REPORTS ON FORM 8-K 98
SIGNATURES 101
EXHIBIT INDEX 103
<PAGE>
PART I
Item 1. BUSINESS
Introduction
ALZA Corporation ("ALZA") is a research-based pharmaceutical
company with leading drug delivery technologies. ALZA applies
its technologies to develop pharmaceutical products with enhanced
therapeutic value for its own portfolio and for many of the
world's leading pharmaceutical companies. ALZA is currently
focusing its sales and marketing efforts in urology and oncology.
ALZA was incorporated under the laws of the State of California
on June 11, 1968, and changed its legal domicile from California
to Delaware in 1987. ALZA's mailing address is 950 Page Mill
Road, P.O. Box 10950, Palo Alto, California, 94303-0802.
Before the 1990s, ALZA's business consisted almost
exclusively of product development activities undertaken pursuant
to joint development and commercialization agreements with large
pharmaceutical companies. Among the ALZA-developed products
commercialized to date by client companies under these
arrangements are Procardia XL-registered trademark-/Adalat CR-
registered trademark- (nifedipine) for the treatment of angina
and hypertension, Transderm-Nitro-registered trademark-
(nitroglycerin transdermal system) for the prevention and
treatment of angina, NicoDerm-registered trademark- CQ-trademark-
(nicotine transdermal system) for use as an aid in smoking
cessation, and Glucotrol XL-registered trademark- (glipizide) for
the treatment of Type II diabetes.
Beginning in the early 1990s, ALZA embarked on a new
strategy to become a fully-integrated commercial pharmaceutical
company. While ALZA has continued its traditional product
development arrangements with client companies, and currently has
products in development with a number of major pharmaceutical
companies, ALZA has expanded its commerciali-zation capabilities
and activities, with significant expansion in 1997 and 1998. ALZA
Pharmaceuticals now markets and promotes 15 urology and oncology
products. At December 31, 1998, ALZA Pharmaceuticals had a
specialty United States oncology sales organization of
approximately 75 sales professionals, and a sales organization of
over 300 United States sales professionals (plus 12 in Canada)
promoting its urology products to urologists and other
specialists, as well as primary care physicians. In addition,
ALZA's Ditropan-registered trademarkXL (oxybutynin chloride)
product, launched in the United States on February 1, 1999, is co-
promoted to general practitioners by a group of approximately 350
sales professionals from UCB Pharma, Inc. ("UCB Pharma").
ALZA's business falls into two operating segments:
ALZA Pharmaceuticals: In this segment ALZA
develops and commercializes products intended for
marketing in North America by ALZA Pharmaceuticals'
direct sales forces, and commercializes these products
elsewhere, at the present time, through distributors; and
<PAGE>
ALZA Technologies: In this segment, ALZA develops
and manufactures products incorporating ALZA's drug
delivery technologies for marketing by client companies,
as well as by ALZA Pharmaceuticals.
In March 1999, ALZA acquired SEQUUS Pharmaceuticals, Inc.
("SEQUUS") in a merger that will be accounted for by ALZA as a
pooling of interests. The results and other information included
in this Form 10-K Annual Report do not include any SEQUUS
results, as the merger was not consummated until March 16, 1999.
Notice Concerning Forward-Looking Statements
Some of the statements made in this Form 10-K Annual Report
are forward-looking in nature, including but not limited to
ALZA's sales and marketing plans and expansion, product
development activities and plans, statements about the effects of
the merger with SEQUUS and other statements that are not
historical facts. Forward-looking statements include, but are not
limited to, statements that are not historical facts, and
statements including forms of the words "intend", "believe",
"will", "may", "could", "expect", "anticipate", "possible", and
similar terms. The occurrence of the events described, and the
achievement of the intended results, are subject to the future
occurrence of many events, some or all of which are not
predictable or within ALZA's control; therefore, actual results
may differ materially from those anticipated in any forward-
looking statements. Many risks and uncertainties are inherent in
the pharmaceutical industry; others are more specific to ALZA's
business. Many of the significant risks related to ALZA's
business are described in this Form 10-K Annual Report, including
risks associated with introducing and commercializing new
pharmaceutical products, the risks inherent in technology and
product development, risks relating to clinical development,
regulatory clearance to market products and medical acceptance of
products, changes in the health care marketplace, competition,
patent and intellectual property matters, regulatory risks and
manufacturing issues.
ALZA Pharmaceuticals
In 1994, ALZA formed its ALZA Pharmaceuticals sales and
marketing division, which had grown to a sales force of almost
400 professionals by the end of 1998. At the end of 1998, ALZA
Pharmaceuticals was marketing 11 pharmaceutical products and was
copromoting four additional products marketed by third parties.
The United States sales organization now includes two specialty
sales forces: an oncology sales force and a urology products
sales force. At the end of 1998, the urology sales and marketing
organization was marketing and promoting the Testoderm-registered
trademark- TTS (Testosterone Transdermal System) CIII line of
products, Elmiron-registered trademark- (pentosan polysulfate
sodium), immediate release Ditropan-registered trademark
(oxybutynin chloride), PolyCitra-registered trademark- (potassium
citrate monohydrate), BiCitra-registered trademark- (sodium
citrate dihydrate and citric acid monohydrate), Neutra-Phos-
registered trademark- (potassium and sodium phosphates) and
Urispas-registered trademark- (flavoxate HCl), and was preparing
for the launch of Ditropan XL. The oncology sales organization
was marketing and promoting Ethyol-registered trademark-
(amifostine) and Mycelex-registered trademark- (clotrimzaole)
<PAGE>
Troche, and was co-promoting Duragesic-registered trademark-
(fentanyl transdermal system) CII, Hexalen-registered trademark-
(altretamine) and NeuTrexin-registered trademark- (trimetrexate
glucuronate), and was preparing to market and promote Doxil-
registered trademark- (doxorubicin HCl liposome injection) and
Amphotec-registered trademark(amphotericin B cholesteryl sulfate
complex for injection) upon completion of ALZA's acquisition of
SEQUUS. (See "Acquisition of SEQUUS Pharmaceuticals, Inc."
below.)
In 1997, ALZA expanded its sales and marketing activities
into Canada when ALZA acquired the United States and Canadian
rights to Elmiron, PolyCitra, BiCitra and Neutra-Phos. ALZA
International, Inc. ("ALZA International") has approximately 20
employees located in Canada, marketing Elmiron, PolyCitra,
Ditropan, MacroBIDregistered trademark- (nitrofurantoin
monohydrate-nitrofurantoin macrocrystals) and Macrodantin-
registered trademark(nitrofurantoin macrocrystals). ALZA
International is doing business in Canada as ALZA Canada.
Urology Products Marketed by ALZA Pharmaceuticals
At the end of 1998, ALZA was marketing 11 urology products.
ALZA's sales organization of over 300 professionals calls on
urologists and other specialists. In July 1998, ALZA hired
approximately 75 sales representatives who had been employed by
VIVUS, Inc. Under an agreement with Innovex, Inc. ("Innovex"),
approximately 150 additional sales professionals are promoting
Ditropan XL, the Testoderm TTS line of products and Mycelex
Troche to primary care physicians. Under an agreement with UCB
Pharma, approximately 350 UCB Pharma sales professionals are
promoting ALZA's recently launched Ditropan XL product to primary
care physicians.
Ditropan XL - On February 1, 1999, ALZA Pharmaceuticals
launched Ditropan XL, a once-daily treatment for overactive
bladder with symptoms of urge urinary incontinence, urgency and
frequency developed by ALZA with Crescendo Pharmaceuticals
Corporation ("Crescendo"). Ditropan XL is the first and only once-daily
treatment foroveractive bladder approved in the United States. In
October 1997, ALZA acquired the exclusive United States rights to the
immediate release oral Ditropan product from Hoechst Marion
Roussel, Inc. ("HMRI"). In 1998, ALZA acquired the rights to the
product in Canada from HMRI and Procter & Gamble Pharmaceuticals,
Inc ("P&G"). This product is indicated for the treatment of urge
urinary incontinence. As part of these transactions, ALZA also
acquired the right to use the Ditropan-registered trademark-
trademark in the United States and Canada with other products,
including Ditropan XL. In late 1998, ALZA entered into an
agreement with Synthelabo under which Synthelabo will market the
Ditropan XL product in Europe, after regulatory approval.
Elmiron - In October 1997, ALZA acquired the exclusive
rights in the United States and Canada to this product, indicated
for the treatment of the pain and discomfort of interstitial
cystitis, from IVAX Corporation and its subsidiary, Baker Norton
Pharmaceuticals, Inc. (together, "IVAX"). In connection with
that transaction, ALZA hired as ALZA employees most of the IVAX
personnel involved in promoting the product in the United States
and Canada.
<PAGE>
Testoderm TTS Line of Products - ALZA has developed
three once-daily transdermal systems for testosterone replacement
therapy in males for conditions associated with a deficiency or
absence of endogenous testosterone, referred to as the Testoderm
TTS line of products. Testoderm was introduced in the United
States in 1994; and Testoderm with Adhesive was launched in the
United States in 1996. Both products are worn on the scrotum. In
March 1998, ALZA launched Testoderm TTS, which can be worn on the
arm, back or upper buttocks.
PolyCitra, BiCitra and Neutra-Phos - The exclusive
rights to these products in the United States and Canada were
acquired from IVAX in the same transaction in which the rights to
Elmiron were acquired. PolyCitra and BiCitra are used in the
treatment of kidney stones, and Neutra-Phos, sold over-the-
counter, is a nutritional supplement used to treat phosphorous
deficiency. All three products are marketed in the United
States; PolyCitra is also marketed in Canada.
Urispas - In November 1998, ALZA acquired the United
States rights to Urispas from SmithKline Beecham Pharmaceuticals
("SB"). Urispas is a smooth muscle relaxant that counteracts
muscle spasms of the urinary tract. The product is used to
relieve symptoms associated with urinary incontinence and painful
urination.
MacroBID and Macrodantin - In October 1998, ALZA
licensed the marketing rights to the MacroBID and Macrodantin
products in Canada from P&G. The products are antibacterial
agents indicated for the treatment of acute uncomplicated urinary
tract infections.
The Ditropan XL product and the Testoderm TTS line of
products are manufactured by ALZA Technologies for ALZA
Pharmaceuticals. The other products described above are manufactured
by the third parties from which the rights were acquired or by other
third party manufacturers. (See "ALZA Technologies - Manufacturing"
below.)
Oncology Products Marketed by ALZA Pharmaceuticals
At the end of 1998, ALZA Pharmaceuticals was marketing
Ethyol and Mycelex Troche, and was co-promoting Duragesic,
Hexalen and NeuTrexin. For its co-promotion activities, ALZA
generally receives co-promotion fees, either pursuant to a
specified formula or as a percentage of sales (or incremental
sales) of the product. At December 31, 1998, ALZA
Pharmaceuticals' oncology sales organization consisted of
approximately 75 professionals.
Ethyol - In April 1996, ALZA Pharmaceuticals began
marketing Ethyol in the United States. Ethyol is a unique
cytoprotective agent developed by U.S. Bioscience, Inc. ("USB"),
indicated for the reduction of cumulative renal toxicity
associated with repeated administration of the chemotherapeutic
drug cisplatin in patients with advanced ovarian or non-small
cell lung cancer.In late 1998, USB submitted a supplemental New
Drug Application ("sNDA") to the United States Food and Drug
<PAGE>
Administration ("FDA"), requesting approval to market the product
for use to reduce the incidence and severity of radiation-induced
xerostomia. USB copromotes the product with ALZA. ALZA has the
right to market the product until mid-2001, with an option to
extend its rights for an additional year, and will receive
residual payments from USB for a specified period after the end
of ALZA's marketing term.
Mycelex Troche - ALZA acquired the exclusive United
States rights to this product from Bayer Corporation ("Bayer") in
July 1997. Mycelex Troche is an antifungal agent for the
localized treatment of oral thrush. Prior to ALZA's acquiring
the rights to the product, ALZA Pharmaceuticals promoted the
product for Bayer.
At December 31, 1998, ALZA Pharmaceuticals was co-promoting
the following oncology products:
Duragesic - a 72-hour system for management of chronic
pain in patients who require continuous opioid analgesia for pain
that cannot be controlled by lesser means, marketed by Janssen
Pharmaceutica, Inc. (together with its affiliates, "Janssen").
ALZA Pharmaceuticals has co-promoted the product in the United
States since 1994.
NeuTrexin - a product developed and marketed by USB as
an alternate treatment for moderate to severe pneumocystis
carinii pneumonia. ALZA Pharmaceuticals has co-promoted the
product in the United States since 1996, and will continue co-
promoting the product until mid-1999.
Hexalen - a product developed and marketed by USB for
the palliative treatment of patients with persistent or recurrent
ovarian cancer following first-line therapy with a cisplatin
and/or alkylating agent-based combination. ALZA Pharmaceuticals
has co-promoted the product in the United States since 1996, and
will continue co-promoting the product until mid-1999.
With the acquisition of SEQUUS in March 1999, ALZA added
approximately 30 professionals to its oncology sales force, and
began marketing the following SEQUUS products:
Doxil - a liposome formulation of doxorubicin, marketed
by SEQUUS (and now ALZA) in the United States since December 1995
for the treatment of AIDS-related Kaposi's sarcoma in patients
with disease that has progressed on prior combination
chemotherapy or in patients who are intolerant to such therapy.
Affiliates of Schering-Plough Corporation distribute the product
outside the United States under the trade name Caelyx-trademark-.
Caelyx is available in 18 countries, including the United
Kingdom, Germany, Sweden, Austria, Denmark, Finland and the
Netherlands.
Amphotec - a lipid-based formulation of amphotericin B,
marketed by SEQUUS (and now ALZA) in the United States since
December 1996 for the treatment of invasive aspergillosis in
patients where renal impairment or unacceptable toxicity
precludes the use of amphotericin B
<PAGE>
deoxycholate in effective doses, and in patients with invasive
aspergillosis where prior amphotericin B deoxycholate therapy has
failed. The product is marketed as Amphocil-trademark- in
approximately 20 countries outside the United States by several
marketing partners.
Duragesic is manufactured by ALZA Technologies. The other
products described above are manufactured by the third parties
from which the marketing rights were acquired or, in some cases,
other third parties. (See "ALZA Technologies - Manufacturing
below.)
Other Products
In addition to the products described above, ALZA
Pharmaceuticals markets ALZET-registered trademark- osmotic pumps
for laboratory research and the Progestasert-registered trademark
(progesterone) intrauterine contraceptive system developed by
ALZA, and co-promotes the ENACT AirWatch-trademark- system.
ALZET miniosmotic pumps are implantable, capsule-shaped units
that can deliver solutions containing a wide range of agents in
laboratory animals at controlled rates for up to four weeks.
Progestasert provides contraception for one year by releasing the
natural hormone progesterone. The ENACT AirWatch system is a
product developed by ENACT Health Management Systems for daily
monitoring of asthma. During 1998, ALZA sold the marketing
rights to its Ocusert (pilocarpine) systems for the treatment of
glaucoma.
Product Marketing Risks
Many of the products described above have been introduced by
ALZA Pharmaceuticals during the last few years. Several, such as
Ethyol and Elmiron, are relatively new therapies that had no
established market at the time of their introduction. Others,
such as the Testoderm TTS product line, are used for the
treatment of conditions that may be underdiagnosed. Ditropan XL
and Doxil incorporate drug delivery technology with proven drug
compounds in products that ALZA believes provide improvements in
therapy, but market acceptance will be critical to the commercial
success of these products as compared with the original
formulations. There can be no assurance that ALZA
Pharmaceuticals will be successful in its marketing and sales
efforts for these and other products. There are numerous risks
associated with the marketing and sales of pharmaceutical products,
including the following:
Commercial Potential - In order to provide added value
and gain medical and commercial acceptance, a product generally
must show some performance improvement or other benefit over
products incorporating the same or similar drug compounds or
other products indicated for the same illness or condition. In
some cases, these benefits may be difficult to establish.
Competition from Other Products - Many companies have a
commercial presence in urology and/or oncology, areas in which
ALZA Pharmaceuticals is currently focusing its sales and
marketing efforts, including companies that focus exclusively on
oncology. Many competitors have far larger sales forces, and
significantly greater resources and experience in marketing
pharmaceutical products, than ALZA
<PAGE>
Pharmaceuticals. In addition,other companies are marketing
products that compete directly with the products marketed
by ALZA Pharmaceuticals, and may introduce
products that offer competitive advantages when compared to
products marketed by ALZA Pharmaceuticals.
Availability of Products for In-Licensing and/or
Acquisition - While ALZA has successfully acquired and in-
licensed several products during the past few years, there can be
no assurance of continued success in such activities. Other
companies are attempting to acquire and in-license products,
particularly in the oncology field, and ALZA may not be able to
acquire or inlicense additional products on favorable terms.
Pricing and Reimbursement - As pressures for cost
containment increase, particularly in the United States and
Canada, there can be no assurance that the prices ALZA
Pharmaceuticals can charge for the products it markets will be as
favorable as historical pharmaceutical product prices.
Reimbursement by payers such as government and managed care
organizations has become increasingly important, as has the
listing of new products on large formularies, such as those of
managed care organizations, pharmaceutical benefit providers and
group buying organizations. There can be no assurance that
innovative new products such as Ethyol and Elmiron, or drug
delivery products such as Testoderm TTS and Ditropan XL, will
achieve reimbursement and formulary acceptance that will result
in an appropriate return on ALZA's research and development
efforts or investment in the acquisition of products. Failure of
one or more products to be included on formulary lists, or to be
reimbursed by managed care organizations, could have a negative
impact on the profitability of ALZA Pharmaceuticals. In
addition, in 1999 there has been publicity concerning potential
legislative proposals that could mandate large discounts on the
prices that pharmaceutical companies can charge for
pharmaceutical products for Medicare participants. It is
impossible to predict whether any of these early proposals will
become laws or regulations, and what impact their adoption would
have on sales by ALZA Pharmaceuticals.
Physician and Patient Acceptance of Products
Significant efforts will be required to educate physicians and
other health care practitioners, as well as patients, concerning
some of ALZA Pharmaceuticals' current products, in order that the
full potential of the products can be realized. For example,
Ethyol is the first chemoprotective therapy to be cleared for
marketing in the United States. Elmiron, the only oral therapy
approved by the FDA for the pain and discomfort associated with
interstitial cystitis, is used in the treatment of a disease that
is often undiagnosed or misdiagnosed. The Testoderm TTS line of
products is used to treat testosterone deficiency in men, a
condition that is believed to be largely undiagnosed.
Dependence on Third Party Manufacturers - The products
inlicensed and acquired by ALZA to date from third parties are
manufactured by third parties or others. ALZA Pharmaceuticals is
therefore dependent upon the manufacturing capabilities and
capacity of the third parties for supply of those products to
sell in the marketplace. A significant
<PAGE>
interruption in supply ofany of these products could
impair ALZA's ability to market the product successfully.
Dependence on Third Parties to Assist in Promoting the
Products - ALZA Pharmaceuticals' sales force is relatively small
compared to the sales forces of many of its competitors. ALZA
Pharmaceuticals is increasing its urology sales presence through
the use of a contract sales organization from Innovex, and
through a co-promotion arrangement with UCB Pharma for Ditropan
XL. The sales representatives from these two companies are not
entirely under ALZA Pharmaceuticals' control, and the UCB Pharma
representatives also promote other products in addition to
Ditropan XL.
High Costs of Promotional Activities - With the launch
of Ditropan XL, ALZA Pharmaceuticals is substantially increasing
its marketing and promotional activities and therefore the
related costs including, in particular, the costs of direct-to-
consumer advertising, which ALZA Pharmaceuticals has not used in
the past. There can be no assurance that the increased activities
and costs will result in significantly increased sales of
products by ALZA Pharmaceuticals.
Need for Expansion into International Markets - ALZA
Pharmaceuticals' direct sales and marketing efforts are currently
limited to the United States and Canada, which together comprise
approximately one-third of the total world market for
pharmaceutical products. For products that ALZA Pharmaceuticals
has rights to outside the United States and Canada, ALZA
Pharmaceuticals will need to expand its direct marketing and
promotion activities or enter into arrangements with distributors
or marketing partners. There can be no assurance that ALZA
Pharmaceuticals will be able to expand successfully or that
acceptable distribution or marketing partners can be obtained, or
that ALZA Pharmaceuticals' return from its international
marketing activities will contribute significantly to ALZA's
profits. In 1998, ALZA entered into an agreement with Synthelabo
to commercialize Ditropan XL in Europe. Before the product can
be commercialized by Synthelabo, appropriate regulatory and
pricing approvals must be obtained. Such approvals will also be
required for other products to be commercialized by ALZA
Pharmaceuticals outside the United States.
Disclosed Products in Development for Marketing by ALZA
Pharmaceuticals
ALZA has several products in development with Crescendo.
(See "Crescendo Pharmaceuticals Corporation" below.) ALZA has an
option to license all such products, on a product-by-product
basis. ALZA also has arrangements with other third parties with
respect to other products in development that ALZA
Pharmaceuticals may market or co-promote in the future. Because
of the potential marketing by ALZA Pharmaceuticals, these
products are treated as part of the ALZA Pharmaceuticals segment,
and the research and development expenses related to Crescendo
products, and corresponding research and development revenues
from Crescendo, are included in the ALZA Pharmaceuticals segment.
Disclosed products in development for potential marketing by ALZA
Pharmaceuticals include:
<PAGE>
DUROS-trademark- leuprolide - The DUROS leuprolide
product, under development with Crescendo, is a small osmotically
driven implantable system designed to deliver leuprolide
continuously for up to 12 months to provide palliative treatment
of advanced prostate cancer. Phase III clinical trials of the
product have been completed, and a New Drug Application ("NDA")
is expected to be submitted to the FDA by mid-1999.
OROS-registered trademark- methylphenidate - The OROS
methylphenidate product is designed as a once-daily treatment for
attention deficit disorder/ attention deficit hyperactivity
disorder. The product is in development with Crescendo, and
pivotal Phase III clinical trials are ongoing. An NDA submission
is planned for 1999.
E-TRANS-registered trademark- (electrotransport)
fentanyl system (chronic and breakthrough pain) - ALZA and
Crescendo are developing an E-TRANS fentanyl product for the
treatment of chronic pain and incidences of breakthrough pain.
Under an agreement between ALZA and Janssen, Janssen will have an
option, until a specified time, to take over funding the
continued development of the product and to commercialize the
product worldwide. If Janssen exercises its option, ALZA will
receive a share of the United States operating profits from the
product and royalties from sales of the product outside the
United States; ALZA Pharmaceuticals will have the right to co-
promote the product in the United States. If Janssen does not
exercise its option, ALZA may continue the development of the
product with Crescendo, on its own or with another third party.
The product is in early development. ALZA Pharmaceuticals also
will have the right to co-promote the E-TRANS fentanyl product
for acute pain under development by ALZA Technologies with
Janssen (see "ALZA Technologies" below).
RMP-7/Cereport-trademark- (bradykinin-based receptor
mediated permeabilizer) - In September 1997, ALZA entered into a
clinical development and option agreement with Alkermes, Inc.
("Alkermes") relating to Cereport (previously called RMP-7), a
compound intended to facilitate the delivery of chemotherapeutic
agents to the brain. Under the agreement, Alkermes is conducting
additional clinical activities related to Cereport, and ALZA has
the option to acquire exclusive worldwide commercialization rights
to the product.
ALZA Technologies
The ALZA Technologies segment of ALZA's business encompasses
research and product development, clinical testing and regulatory
activities for products incorporating ALZA's proprietary drug
delivery technologies and/or technologies licensed from third
parties. The ALZA Technologies segment also includes the
manufacturing by ALZA of products incorporating those
technologies that are marketed by ALZA Pharmaceuticals and other
clients.
ALZA was the pioneer, and is a recognized leader, in the
development of innovative drug delivery technologies. ALZA's
therapeutic systems are designed to provide controlled,
predetermined rates of drug
<PAGE>
administration. By administering drugs in preset patterns and by
alternative routes, ALZA's advanced dosage forms, called therapeutic
systems, can add to the medical and economic value of drug therapies
by minimizing their unpleasant or harmful side effects, optimizing
their beneficial actions, simplifying drug therapy, increasing patient
compliance, and in some cases improving the patient's quality of life,
by decreasing the frequency with which medication must be
administered. ALZA's OROS and D-TRANS-registered trademark- drug
delivery systems have been incorporated into more than two dozen
products currently marketed in many countries of the world. ALZA
Technologies develops products (such as Procardia XL and
Duragesic) incorporating ALZA's proprietary technologies for
marketing by client companies, and products (such as Ditropan XL
and the Testoderm TTS line of products) for marketing by ALZA
Pharmaceuticals.
Technologies Developed by ALZA Technologies
OROS (Oral Tablet) Systems. ALZA Technologies has
developed several therapeutic systems for oral administration.
ALZA's OROS systems include the push-pull, push-stick and
elementary osmotic pump systems. OROS products resemble
conventional tablets or capsules in appearance, but use an
osmotic mechanism to provide pre-programmed, controlled drug
delivery to the gastrointestinal tract. An OROS product
comprises a polymer membrane with one or more laser-drilled holes
surrounding a core containing the drug or drugs, with or without
osmotic or other agents. Water from the gastrointestinal tract
diffuses through the membrane at a controlled rate into the drug
core, causing the drug to be released in solution or suspension
at a predetermined controlled rate out of the laser-drilled
hole(s). OROS systems are well suited for delivering drug
compounds throughout the gastrointestinal tract in programmed
delivery for local treatment or systemic absorption.
ALZA is also developing a liquid OROS system designed for the
delivery of highly insoluble drugs or polypeptides. A delivery
orifice in the outer layers of a coated capsule allows controlled
release of drug, while an internal osmotic layer pushes against
the drug compartment, forcing the liquid drug formulation from
the system.
D-TRANS (Passive Transdermal) Systems. ALZA's D-TRANS
transdermal therapeutic systems provide for the controlled
delivery of drugs directly into the bloodstream through intact
skin. Transdermal systems are well suited for the delivery of
potent drugs that are poorly absorbed and/or extensively
metabolized when administered orally. ALZA's D-TRANS products
are thin, multilayer systems, in the form of small adhesive
patches, that combine a drug reservoir with a polymer membrane or
other mechanism to control drug release to the surface of intact
skin, and then through the skin into the bloodstream.
E-TRANS (Electrotransport) Systems. ALZA's
electrotransport (E-TRANS) systems are designed to deliver drugs
across intact skin through the use of an electrical potential
gradient. E-TRANS systems are small, easy-to-apply devices
consisting of an adhesive, a drug reservoir, electrodes and a power
source/controller. The systems are designed to deliver potent
therapeutic agents through the skin.
<PAGE>
Macroflux-trademark- Systems. ALZA is conducting
research on a skin interface technology designed to increase drug
transport across the skin and enable delivery of larger molecular
weight compounds, including proteins and peptides. This new
technology, which uses an array of micro-projections to
painlessly open channels for drug transport in the outermost
layer of the skin, may be used to enhance ALZA's existing
D-TRANS and E-TRANS technologies.
DUROS Systems. ALZA's DUROS human implant technology
is designed to enable the delivery of therapeutic agents,
including potent small molecules, peptides or proteins, for
periods of one month or longer. DUROS systems use an osmotic
engine approach, similar to that used in OROS systems. Products
incorporating DUROS implant technology have the potential to
deliver drugs to subcutaneous sites for systemic therapy or to
specific tissues. A single miniature implant may provide therapy
for up to one year.
Depot Injection Systems. ALZA's depot injection
technology, in preclinical development, is designed as a platform
to deliver therapeutic agents over an extended period of up to
one month. The bioerodible depot gel has been demonstrated, when
injected into the subcutaneous tissue of animals, to deliver
therapeutic agents with little or no drug burst upon injection.
ALZA manages the ALZA Technologies portfolio of technologies
in a variety of ways. ALZA enters into joint product development
agreements with client companies to develop specific products for
marketing by the client; ALZA Technologies develops products for
marketing by ALZA Pharmaceuticals; ALZA in-licenses and acquires
technologies for product development; and on occasion, ALZA
licenses technologies to third parties for further development or
for the development of particular products. As of March, 1998
ALZA licensed two of its oral technologies, the RingCap-trademark-
and dose sipping technologies, to Alkermes. ALZA received
upfront fees and will receive payments from Alkermes based on
sales of products incorporating these technologies. In the
second quarter of 1998, ALZA licensed the use of its DUROS
technology to Durect Therapeutics Corporation ("Durect") for the
development of DUROS products using ALZA's DUROS technology in
five specified therapeutic applications. Durect has an agreement
with ALZA under which ALZA Technologies performs research and
development of such products for Durect.
Technology Development Risks
Technical Issues - The development of ALZA's drug
delivery systems requires many years of research and development
activity. ALZA's therapeutic systems can be quite complex, with
many different components. There can be no assurance that any
particular system will perform in the same manner when used with
different therapeutic agents.
Special Materials - Often special materials must be
fabricated for the first time for use in ALZA drug delivery
systems, or materials may be used in the systems in a manner
different from their customary
<PAGE>
commercial uses. The quality of materials can be critical to the
performance of a drug delivery system, so a reliable source of a
consistent supply of materials can be critical. Materials needed by
ALZA Technologies may be difficult to obtain on commercially
reasonable terms, particularly when relatively small quantities are
required, or if the materials traditionally have not been used in
pharmaceutical products. In addition, companies supplying materials
for thechemical, computer and semiconductor industries, for example,
may be unwilling to supply materials to ALZA for use in
pharmaceutical products due to product liability concerns, even
in light of the recent enactment of laws limiting or precluding
the liability of the suppliers for injury resulting from ALZA's
Product.
Manufacturing Processes - For each drug delivery
system, manufacturing processes must be developed. Often novel
manufacturing processes are required for both ALZA and its
vendors. There is substantial risk and cost related to the
development of these processes.
Costs of Technology Development - The development of
ALZA's drug delivery systems can cost tens of millions of
dollars. Significant amounts must be invested in technology
development before the development of a specific product
commences. Many years will be required to take a technology from
the earliest stages of development to its incorporation in a
product that is sold commercially.
Competition - While ALZA was the first company to have
products incorporating its drug delivery technology
commercialized, other companies have developed their own drug
delivery technologies. Some of the competitors are small
companies specializing in drug delivery. Many large
pharmaceutical companies also have programs to develop drug
delivery products.
Client-Marketed Products Incorporating ALZA Technologies
ALZA Technologies develops products under joint development
arrangements with a number of leading pharmaceutical companies.
The products combine one of ALZA's drug delivery systems with a
client's proprietary compound or, in some cases, a compound that
is no longer patented. Under a typical arrangement with a client
company, the client pays ALZA Technologies' costs incurred in the
development of the product, and the client markets the product,
making payments to ALZA based on sales of the product. The
client approves the work plans for product development and
clinical testing (which may be conducted by ALZA Technologies,
the client or both), and makes the decisions concerning product
commercialization. As a result, decisions affecting the timing
of product development, the clinical plan, regulatory strategy,
and the level of marketing support are not within ALZA's control.
Under its arrangements with client companies, ALZA
Technologies typically undertakes the initial product
development, in which ALZA Technologies performs the system
design and formulation work, research and testing necessary to
incorporate the drug selected by the client into an ALZA drug
delivery system. ALZA Technologies typically manufactures
<PAGE>
product for animal and human clinical studies; in many cases,
ALZA Technologies performs the required human clinical studies;
in other cases, the client takes this responsibility. ALZA
Technologies develops manufacturing processes, typically from
small laboratory scale, then to pilot scale, and finally to
commercial manufacturing scale. Regulatory submissions to conduct
clinical studies and to obtain regulatory approval may be prepared
by ALZA Technologies or by the client, as negotiated. In any case,
ALZA Technologies' activities are generally reimbursed by the
client on a cost-reimbursement basis.
Under its arrangements with client companies, ALZA retains
the rights to, and owns any improvements to, ALZA's technologies.
The client obtains the right to commercialize the specific
product developed under the arrangement for an agreed upon time
period, and makes payments to ALZA with respect to sales of the
product. The client generally does not obtain the right to use
ALZA technology except in the specific product covered by the
arrangement.
The products developed by ALZA under these joint development
arrangements and currently marketed by client companies
incorporate ALZA's D-TRANS (transdermal) and OROS (oral tablet)
technologies. The D-TRANS products developed by ALZA and currently
marketed by client companies include:
Catapres-TTS-registered trademark- (clonidine
transdermal therapeutic system) - A product applied once-weekly
for the treatment of hypertension, marketed by Boehringer
Ingelheim Pharmaceuticals, Inc.
Duragesic - A 72-hour transdermal system for management
of chronic pain in patients who require continuous opioid
analgesia for pain that cannot be controlled by lesser means,
marketed by Janssen and co-promoted in the United States by ALZA
Pharmaceuticals.
Estraderm-registered trademark- TTS (estradiol
transdermal therapeutic system) - A product applied twice weekly
for treating certain post-menopausal symptoms and preventing
osteoporosis, marketed by Novartis Pharmaceuticals Corporation
("Novartis").
NicoDerm CQ/Nicoderm-registered trademark- (transdermal
system) - A product applied once-daily to the skin to aid in
smoking cessation. NicoDerm CQ is marketed for over-the-counter
use in the United States by SB as part of a joint venture with
HMRI, and Nicoderm is marketed as a prescription product by HMRI
and/or SB in some countries outside the United States. SB has
rights to market Nicoderm CQ in most other countries of the
world, and applications for regulatory approval have been filed
in several countries.
Transderm-Nitro (nitrogylcerin transdermal system) - A
product applied once-daily for the prevention and treatment of
angina pectoris, marketed by Novartis.
<PAGE>
Transderm Scop-registered trademark- (scopolamine
transdermal system) - A product applied once every three days for
prevention of nausea and vomiting associated with motion
sickness, marketed by Novartis in the United States and several
European countries, and by Recordati Industria Chimica e
Farmaceutica SPA in Italy.
The OROS products developed by ALZA and currently marketed
by client companies include:
Cardura XL (doxazosin mesylate) - A once-daily product
for the treatment of hypertension and benign prostatic
hyperplasia, introduced by Pfizer, Inc. ("Pfizer") in Germany in
1998. Pfizer has worldwide marketing rights to the product.
ColorMark-trademark- Tablets - A tablet designed to
deliver Blue Dye #1 to a variety of enteral nutritional fluids,
marketed by the Ross Products division of Abbott Laboratories.
Covera-HS-registered trademark- (verapamil
hydrochloride)- A once-daily controlled-onset-extended release
(COER-24-trademark) tablet for the treatment of hypertension and
angina pectoris, marketed by G.D. Searle.
DynaCirc CR-registered trademark- (isradipine) - A once
daily extended release tablet for the treatment of hypertension,
marketed by Novartis.
Glucotrol XL (glipizide) - A once-daily treatment for
Type II diabetes, marketed by Pfizer.
Minipress XL-registered trademark-/Alpress-registered
trademark- LP (prazosin) - A once-daily formulation for the
treatment of hypertension, marketed by Pfizer.
Procardia XL/Adalat CR (nifedipine) - A once-daily
formulation for the treatment of both angina and hypertension,
marketed by Pfizer in the United States and by Bayer outside the
United States.
Sudafed-registered trademark- 24 Hour (pseudoephedrine)
A once-daily dosage form for the treatment of cold and allergy
symptoms, marketed by Warner-Lambert Consumer Healthcare ("Warner
Lambert"). The product has been marketed by Warner-Lambert in
the United States since early 1998 pursuant to semi-exclusive
marketing rights.
Volmax-registered trademark- (albuterol) - A twice-
daily dosage form for the treatment of asthma, marketed by Muro
Pharmaceutical, Inc. (an ASTA Medica Company) and Forest
Laboratories, Inc. in the United States and by Glaxo Holdings
p.l.c. outside the United States.
In addition, Hogil Pharmaceuticals Corporation has semi-
exclusive marketing rights in the United States to Efidac 24
registered trademark- (chlorpheniramine maleate), a once-daily
dosage form for the treatment of allergy symptoms, and also has
semi-exclusive marketing rights in the United States to the OROS
pseudoephedrine product described above, which it markets under
the
<PAGE>
trade name Efidac 24 (pseudoephedrine) and a once-daily cold
allergy product, OROS pseudoephedrine/brompheniramine.
Other products developed by ALZA and marketed by third
parties include the Actisite-registered trademark- (tetracycline
hydrochloride) periodontal fiber, designed to treat adult
periodontal disease by providing rate-controlled delivery of
tetracycline for ten days after placement in the periodontal
pocket by a dental practitioner; the Baxter-registered trademark-
Infusor, a lightweight, disposable device for intravenous
therapy; and IVOMEC SR-registered trademark- Bolus (ivermectin),
a product combining the antiparasitic agent ivermectin with
ALZA's ruminal bolus technology which controls internal and
external parasites in cattle for an entire grazing season
following a single administration. Finally, as a result of
patents issued to ALZA, ALZA receives royalties on sales of the
following products not developed or marketed by ALZA: Habitrol-
registered trademark(nicotine transdermal system), Tiazac-
registered trademark(diltiazem hydrochloride) extended release
capsules and Teczemregistered trademark- (enalapril
maleate/diltiazem maleate) extended release tablets.
Disclosed Products in Development by ALZA Technologies with
Client Companies
ALZA Technologies has other products in development with
client companies. For competitive reasons, ALZA does not
disclose all of the products in development at any particular
time. Disclosed products in development include:
Transfenta-trademark- E-TRANS fentanyl (acute pain)
ALZA and Janssen have an agreement pursuant to which the
companies are jointly developing an E-TRANS fentanyl product for
the treatment of acute pain. Under this agreement, ALZA paid
Janssen $21.5 million in early 1998, and ALZA will receive a
share of the United States operating profits from the product and
royalties from sales of the product outside the United States.
ALZA Pharmaceuticals has the right to co-promote the product in
the United States. The product is currently in Phase III
development.
OROS hydromorphone - The OROS hydromorphone product is
designed as a once-daily dosage form of the opioid analgesic
hydromorphone. The product is in Phase III clinical trials under
an agreement with Knoll Pharmaceuticals and its parent Knoll AG.
Additional Transdermal Fentanyl Products - Under an
agreement with Janssen, ALZA Technologies is developing a 12.5
microgram/hour Duragesic product (the Duragesic product is
currently sold in 25, 50, 75 and 100 microgram/hour doses). Also
under an agreement with Janssen, ALZA is developing a new
transdermal fentanyl system, which incorporates new technology
and is expected to provide additional benefits over the currently
available Duragesic product.
DUROS Sufentanil - Under the arrangements with Durect,
ALZA Technologies is developing a DUROS sufentanil product for
chronic pain for Durect. The product is in early development.
<PAGE>
In addition to the products described above, ALZA
Technologies develops products for marketing by ALZA
Pharmaceuticals. These products include DUROS leuprolide, OROS
methylphenidate and E-TRANS fentanyl (chronic and breakthrough
pain). (See "ALZA Pharmaceuticals - Disclosed Products in
Development for Marketing by ALZA Pharmaceuticals.")
Product Development Risks
All pharmaceutical products require extensive technical and
clinical activities before an application can be submitted for
regulatory clearance to market the product. There are many risks
inherent in this process, and it should be expected that many of
the products for which development is initiated ultimately will
not become commercial products. Substantial technical, financial
and human resources are required to successfully complete the
development of a product.
Product Circumscription - For each new product, the
proper performance characteristics must be defined, and the
product must be designed and developed to meet those
characteristics. Every product faces significant technological
hurdles as it progresses through development, and often one or
more of these cannot be overcome. ALZA's DUROS, E-TRANS and
Macroflux technologies, as well as some of ALZA's oral
technologies, are relatively new, and have not yet been incorporated
in a commercial product.
Small Scale Manufacturing - Once a product is
developed, it must be manufactured, on a pilot scale, for
clinical testing. Small-scale manufacturing can be costly and
time-consuming, and must comply with the FDA's regulations
concerning current Good Manufacturing Practices. ALZA's drug
delivery technologies generally require a series of complex
manufacturing steps. For example, DUROS products require aseptic
manufacturing, which ALZA Technologies has undertaken in order to
manufacture clinical, and later commercial, supplies of the DUROS
leuprolide product.
Clinical Studies - Once a product has been successfully
manufactured on a small scale, studies to show clinical safety
and efficacy must be undertaken and completed. Clinical studies
are costly, and can take many years to complete. There can be no
assurance that the desired outcomes will be shown in the clinical
studies.
Commercial Scale Manufacturing - Once a product has
been developed, manufactured on a small scale and clinically
tested, there are further risks in converting a small scale
manufacturing process to commercial scale. Due to the complexity
of drug delivery technologies, this conversion can be
significantly more costly than for other pharmaceutical products.
Sometimes manufacturing processes must be modified in order to
achieve successful commercial manufacturing and to obtain a
reproducible, robust process. For products incorporating newer
ALZA technologies, this commercial manufacturing scale-up can
take several years and cost millions of dollars.
<PAGE>
Regulatory Risks - Obtaining regulatory clearance to
market a product can take many years, and the process varies from
country to country. Pricing and reimbursement approvals are also
required in some countries, particularly in Europe. Any delay in
the regulatory process could adversely affect the commercial
potential of a product. In addition, it is possible to fulfill
all NDA submission requirements, but subsequently to fail an FDA
preapproval inspection of the manufacturing facility, which can
result in significant delay in obtaining FDA approval to market a
product. Some products, such as Ethyol, are approved by the FDA
on an accelerated basis, and the approval is conditioned upon
further clinical testing. The approval can be withdrawn if the
testing is not completed in the required time period, or if the
clinical results are not acceptable to the FDA.
Manufacturing
ALZA Technologies generally manufactures products marketed
by ALZA's client companies, and certain products developed by
ALZA Technologies for, and marketed by, ALZA Pharmaceuticals, in
ALZA's Vacaville, California commercial manufacturing facility.
The Vacaville facility is the sole manufacturing site for several
products, although some lower-volume and/or recently introduced
products are manufactured in ALZA's Mountain View and Palo Alto,
California research and development facilities. These latter
facilities were not designed for high volume commercial
manufacturing.
ALZA Technologies generally manufactures its drug delivery
products for ALZA's client companies on a cost reimbursement
basis, with a small margin over ALZA's costs. As a result, ALZA
Technologies' margins on these product are low. ALZA receives
royalties from the clients on their sales of the products. (The
royalties are not reported as product sales.) ALZA Technologies
manufactures products for ALZA Pharmaceuticals for prices
negotiated between the two segments, which generally approximate
the prices charged by ALZA to third party clients for products
using similar technologies.
The products acquired and in-licensed for marketing by ALZA
Pharmaceuticals are manufactured by the third parties from whom
ALZA acquired or in-licensed the products, or by other third
parties. Generally these products are also manufactured at only
one site. A shut-down in one of these facilities, or in ALZA's
Vacaville facility, resulting in an interruption in supply of one
or more of the products, could have an adverse impact on ALZA's
financial results.
Some of the critical materials and components used in ALZA-
developed products are sourced from one single supplier. An
interruption in supply from a vendor of a key material could
significantly delay the manufacturing of one or more ALZA
manufactured products. Because the vendors of key components and
materials must be named in the NDA for the relevant product,
significant delays can occur if the qualification of a new vendor
is required. Significant delays or an interruption in product
supply could occur if a supplement to the NDA must be filed and
approved
<PAGE>
before materials obtained from the new vendor can be
used to manufacture a product.
The manufacturing process for pharmaceutical products is
highly regulated. Periodic inspections are conducted by the FDA
and regulatory agencies from other countries. The FDA's current
Good Manufacturing Practices are extensive regulations governing
the manufacturing process, stability testing, record-keeping and
quality standards. Similar, but not identical, regulations are
in effect in other countries. The cost of complying with these
regulations is substantial.
Environmental regulations may also affect the manufacturing
process. As a pharmaceutical company, ALZA uses chemicals and
materials which may be classified as hazardous or toxic, and
which require special handling and disposal. ALZA undertakes to
comply with all applicable requirements to minimize releases to
the environment and exposure of its employees and the public to
such materials. The costs of these activities have increased
substantially in recent years, and it is possible that such costs
may continue to increase significantly in the future.
Crescendo Pharmaceuticals Corporation
In 1993, ALZA determined to pursue the business of
commercialization of products by ALZA, in addition to its
business of developing products for commercialization by client
companies resulting in payments to ALZA based on sales of the
resulting products. To that end, ALZA formed ALZA
Pharmaceuticals' sales and marketing division to commercialize
products. In addition, around that time ALZA formed Therapeutic
Discovery Corporation ("TDC") to develop products for
commercialization by ALZA Pharmaceuticals.
ALZA Pharmaceuticals' growing product commercialization
business offers the potential rewards inherent in the direct
commercialization of pharmaceutical products; however, the
development of products for commercialization by ALZA
Pharmaceuticals requires the investment of substantial resources
in product selection and development, including clinical
evaluation and regulatory activities. When ALZA Technologies
develops products for commercialization by ALZA Pharmaceuticals,
ALZA must bear most or all of the risk and expenses of product
development and has the opportunity to retain all or most of any
gross margin resulting from sales of the product. Therefore, the
risk/reward profile is significantly different from that of ALZA
Technologies' traditional client-sponsored/royalty-based
business, in which ALZA Technologies' clients bear most of the
expenses and risks associated with product development and
commercialization activities, and make payments to ALZA based on
their sales of the products developed jointly with ALZA
Technologies. Such payments to ALZA generally represent a
relatively small portion of the total gross margin.
As part of its strategy to expand its commercialization
activities, and in order to decrease ALZA's dependence on client
companies, in 1993 ALZA formed TDC to develop, with ALZA, a
pipeline of products for
<PAGE>
commercialization by ALZA Pharmaceuticals. TDC and ALZA
undertook the development of Testoderm TTS and Ditropan XL,
as well as other products. In the third quarter of 1997,
ALZA purchased all of the outstanding shares of TDC.
In September 1997, ALZA contributed $300 million to
Crescendo and distributed the shares of Class A Common Stock of
Crescendo (the "Crescendo Shares") to ALZA's stockholders and
debenture holders. Crescendo was formed by ALZA for the purpose
of selecting and developing human pharmaceutical products and
commercializing such products, most likely through licensing to
ALZA. The products may, but are not required to, incorporate
ALZA drug delivery technologies.
ALZA and Crescendo have a Technology License Agreement
pursuant to which ALZA has granted to Crescendo a worldwide
license to use ALZA technology solely to select and develop
Crescendo products, to conduct related activities, and to
commercialize such products. In exchange for the license to use
existing ALZA technology relating to the Initial Products
(discussed below), Crescendo pays ALZA a Technology Fee, payable
monthly over a period of three years, in the amount of $1 million
per month for the first 12 months following the distribution of
Crescendo Shares, $667,000 per month for the following 12 months
and $333,000 per month for the next 12 months. The Technology Fee
will no longer be payable at such time as fewer than two of the
Initial Products are being developed by Crescendo and/or have been
licensed by ALZA pursuant to the license option described below.
In 1998, Crescendo paid ALZA a total of $10.7 million of Technology
Fees.
ALZA and Crescendo have a Development Agreement pursuant to
which ALZA Technologies conducts product development and related
activities on behalf of Crescendo under work plans and cost
estimates which have been proposed by ALZA Technologies and
approved by Crescendo. Development Costs are billed to Crescendo
on a product-by-product basis under terms consistent with
arrangements with other client companies. Crescendo is required
to spend all of the funds contributed to Crescendo, plus interest
earned thereon, less Crescendo's reasonable administrative costs,
the Technology Fee paid to ALZA, and reserves of up to $2 million
(the "Available Funds"), to conduct activities under the
Development Agreement. Under the Development Agreement,
Crescendo agreed to fund the development of seven products (the
"Initial Products"), the development of which was commenced by
ALZA and TDC, from August 25, 1997, the date on which TDC ceased
funding such products, through October 31, 1997. Continuation of
development of the Initial Products after October 31, 1997 was
subject to ALZA proposing, and Crescendo's Board of Directors
accepting, work plans and cost estimates for the products. As of
December 31, 1998, three of the Initial Products, OROS oxybutynin
(Ditropan XL), DUROS leuprolide and OROS methylphenidate, were in
active development, and ALZA had licensed OROS oxybutynin from
Crescendo for worldwide marketing.
Four of the initial products are not currently in active
development. Crescendo makes the determination, independent of
ALZA, as to whether or not Crescendo will continue the funding of
any particular
<PAGE>
product. ALZA Technologies may make recommendations to Crescendo
as to the continuation (or discontinuation) of the development of
a particular product, but Crescendo has no obligation to follow
ALZA's recommendations.
In the License Option Agreement entered into by ALZA and
Crescendo, Crescendo has granted ALZA an option to acquire a
license to each product developed under the Development
Agreement, including the Initial Products. The license option
for any such Crescendo product is exercisable on a country-by-
country basis at any time until (i) with respect to the United
States, 30 days after clearance by the FDA to market such
Crescendo product in the United States and (ii) with respect to
any other country, 90 days after the earlier of (a) clearance by
the appropriate regulatory agency to market the Crescendo product
in such country and (b) clearance by the FDA to market the
Crescendo product in the United States. The license option will
expire, to the extent not previously exercised, 30 days after the
expiration of ALZA's option to purchase all of the outstanding
Crescendo Shares, described below. If and to the extent the
license option is exercised as to any Crescendo product, ALZA
will acquire a perpetual, exclusive license (with the right to
sublicense) to develop, make, have made and use the licensed
product, and to sell and have sold the licensed product in the
country or countries as to which the license option is exercised.
Under the License Agreement for each licensed product, a
form of which is attached to the License Option Agreement, ALZA
will make payments to Crescendo with respect to the licensed
product equal to 1% of net sales of the licensed product by ALZA
and its sublicensees, distributors and marketing partners, plus
an additional 0.1% of such net sales for each full $1 million of
development costs of the licensed product that have been paid by
Crescendo; provided, however, that such total payments will not
exceed 2.5% of net sales in the first four quarters a licensed
product is sold in a major market country, and will not exceed 3%
for the following two years. In late 1998, ALZA exercised its
option to obtain a worldwide license to OROS oxybutynin, and ALZA
and Crescendo executed a License Agreement for the product, which
was launched by ALZA in the United States on February 1, 1999
under the trade name Ditropan XL. Under the license agreement
for this product, Crescendo will receive payments of 2.5%, 3.0%
and 3.0% of net sales for the next three years, respectively;
thereafter, based on Crescendo's funding of product development
to date, the payment rate is expected to be between 5% and 6% of
net sales.
ALZA has the right to buy out Crescendo's right to receive
payments for licensed products on a country-by-country or global
basis. A country-by-country buy-out option may be exercised for
any Crescendo product in any country at any time after the end of
the twelfth calendar quarter during which the product was
commercially sold in such country. The buy-out price will be 15
times the payments made by or due from ALZA to Crescendo with
respect to sales of such product in such country for the four
calendar quarters immediately preceding the quarter in which the
buy-out option is exercised (plus 15 times such additional
product payments as would have been made by ALZA to Crescendo for
such period but
<PAGE>
for the 2.5% and 3% limits described above.) The
global buy-out option may be exercised for any Crescendo product,
at any time after the end of the twelfth calendar quarter during
which the product was commercially sold in either the United
States or two other major market countries. The global buy-out
price will be (i) 20 times (a) the payments made by or due from
ALZA to Crescendo for the relevant product, plus (b) such
payments as would have been made by or due from ALZA to Crescendo
if ALZA had not exercised any country-specific buy-out option
with respect to such product, plus (c) such additional product
payments as would have been made by ALZA to Crescendo but for the
2.5% and 3% limits described above, in each case for the four
calendar quarters immediately preceding the quarter in which the
global buy-out option is exercised, less (ii) any amounts
previously paid to exercise any country-specific buy-out option
with respect to such product.
Pursuant to Crescendo's Restated Certificate of
Incorporation, ALZA has the right to purchase all (but not less
than all) of the Crescendo Shares (the "Purchase Option"). The
Purchase Option will be exercisable by written notice to
Crescendo at any time until January 31, 2002, provided that such
date will be extended for successive six month periods if, as of
any July 31 or January 31 beginning with July 31, 2001, Crescendo
has not paid (or accrued expenses for) at least 95% of Available
Funds pursuant to the Development Agreement. In any event, the
Purchase Option will terminate on the 60th day after Crescendo
provides ALZA with a statement that, as of the end of any
calendar month, there are less than $2.5 million of Available
Funds remaining, accompanied by a report of Crescendo's
independent auditors. As of December 31, 1998, Crescendo had
approximately $175.4 million of Available Funds remaining.
If the Purchase Option is exercised, the exercise price will
be the greatest of:
(a)(i) 25 times the actual payments made by or due from ALZA
to Crescendo under the Development Agreement and the License
Agreement with respect to any product (and, in addition, such
payments as would have been made by or due from ALZA to Crescendo
if ALZA had not previously exercised its payment buy-out option
with respect to any such payments) for the four calendar quarters
immediately preceding the quarter in which the Purchase Option is
exercised (provided, however, that for any product which has not
been commercially sold during each of such four calendar quarters,
the portion of the exercise price for such product will be 100 times
the average of the quarterly payments made by or due from ALZA to
Crescendo for each of such calendar quarters during which such
product was commercially sold) less (ii) any amounts previously
paid to exercise any payment buy-out option;
(b) the fair market value of one million shares of ALZA Common
Stock;
(c) $325 million less all amounts paid by or due from
Crescendo under the Development Agreement to the date the
Purchase Option is exercised; and
(d) $100 million.
<PAGE>
In each case, the amount payable as the Purchase Option
exercise price will be reduced to the extent, if any, that
Crescendo's liabilities at the time of exercise (other than
liabilities under the Development Agreement, the Technology
License Agreement and the Services Agreement, described below)
exceed Crescendo's cash and cash equivalents and short-term and
long-term investments (excluding the amount of Available Funds
remaining at such time). ALZA may pay the exercise price in cash,
in ALZA Common Stock or in any combination of cash and ALZA
Common Stock.
ALZA and Crescendo have entered into a Services Agreement
pursuant to which ALZA has agreed to provide Crescendo with
administrative services, including accounting and legal services,
on a fully-burdened cost reimbursement basis. The Services
Agreement has a one year term and will be renewed automatically
for successive one year terms during the term of the Development
Agreement unless terminated by Crescendo at any time upon 60
days' written notice.
Crescendo has a six person Board of Directors, none of whom
is affiliated with ALZA, with many years of experience in
different aspects of the pharmaceutical industry. Crescendo has
a Chief Executive Officer (who is also a director of Crescendo)
with more than 30 years of pharmaceutical industry experience,
who is the sole employee of Crescendo. The Crescendo Board of
Directors meets frequently, and reviews in detail all of the
activities conducted by ALZA under the Development Agreement.
The Chief Executive Officer of Crescendo holds regular meetings
with the leaders of the ALZA development teams working on
Crescendo products and provides advice to them on an ongoing
basis, as well as providing regular reports to the Crescendo
Board of Directors. Crescendo approves or disapproves all work
plans and cost estimates proposed by ALZA for activities with
respect to Crescendo products. Crescendo makes the determination
as to whether a product will initially be accepted as a product,
and the amount of Crescendo funding to be allocated for the
development of the product. Work plans are generally approved by
Crescendo on a milestone basis - once a milestone is achieved,
Crescendo reviews the program and the proposed work plan and cost
estimate for the next stage of development to determine whether
to continue funding the product.
ALZA may not continue the development of a product with
Crescendo funding unless the work plan is approved by the
Crescendo Board of Directors. If Crescendo determines to stop
funding the development of a product, which decision is in
Crescendo's sole discretion, the product remains a Crescendo
product and development cannot continue, unless ALZA exercises
its license option for the product. Crescendo funding and product
decisions are made by the Crescendo Board of Directors without any
ALZA participation.
ALZA performs, or engages subcontractors such as contract
manufacturers, clinical investigators, contract research
organizations (for clinical studies) and analytical laboratories
to perform the activities under work plans approved by Crescendo.
ALZA charges Crescendo for these activities pursuant to a formula
set forth in the
<PAGE>
Development Agreement, which formula is intended
to reimburse ALZA for its fully-burdened costs of performing the
activities. Amounts paid to third parties are billed to
Crescendo at cost, with no mark-up by ALZA. The formula under
which ALZA charges Crescendo for activities under the Development
Agreement is the same formula used by ALZA Technologies in
charging its pharmaceutical company clients under ALZA's product
development arrangements with them, and in charging ALZA
Pharmaceuticals for product development activities.
As discussed above, the formation of Crescendo (and
previously, TDC) has enabled ALZA to pursue the development of
products for commercialization by ALZA more quickly than
otherwise would have been possible. Had ALZA not formed
Crescendo (or TDC), any research and development activities that
ALZA might nonetheless have decided to undertake would have been
research and development expenses of ALZA, without corresponding
research revenues. Under those circumstances, ALZA might have
determined not to proceed as rapidly with the development of
products for commercialization by ALZA Pharmaceuticals, or could
have reduced the number of such products, because of the
potentially negative impact on ALZA's operating profits.
ALZA TTS Research Partners, Ltd.
ALZA developed the Duragesic product and the original
Testoderm product on behalf of ALZA TTS Research Partners, Ltd.
(the "TTS Partnership"), a limited partnership funded in 1983
from which ALZA licensed those products. The TTS Partnership
received payments from ALZA equal to 4% of Janssen's sales of
Duragesic and 4% of ALZA's sales of Testoderm and Testoderm with
Adhesive.
In August 1998, ALZA Development Corporation, a wholly-owned
subsidiary of ALZA, purchased all of the limited partners'
interests in the TTS Partnership for the predetermined formula
price of $91.2 million cash, under an option granted in 1983. As
a result of the purchase, ALZA has no further payment obligations
to the TTS Partnership or to its former limited partners.
Research and Development Revenues and Expenditures
ALZA had research and development revenue of $124.4 million
during 1998, $135.0 million during 1997 and $131.2 million during
1996, from clients with which ALZA has joint product development
agreements. These amounts included $95.0 million from Crescendo
in 1998, $67.8 million from TDC and $29.7 million from Crescendo
in 1997, and $100.7 million from TDC in 1996. The payments by
TDC and Crescendo were made from funds contributed by ALZA to TDC
and Crescendo at the time of their respective formation.
Research and development revenue generally represents clients'
reimbursement of costs, including a portion of general and
administrative expenses. Therefore, product development
activities do not contribute significantly to operating results.
For research and development revenues by segment, see Note 13 of
the Notes to ALZA's Financial Statements included in Item 8 of
this Form 10-K Annual Report.
<PAGE>
ALZA spent $121.2 million on customer-sponsored product
development activities during 1998 ($126.3 million and $114.8
million in 1997 and 1996, respectively); such amounts exclude
reimbursable general and administrative costs. ALZA spent $35.5
million on internal research and development activities during
1998 ($30.6 million and $26.8 million in 1997 and 1996,
respectively), also excluding allocable general and
administrative costs. Research and development costs are
expensed as incurred.
International Activities
Outside the United States and Canada, ALZA has arrangements
to market several of its products through distribution
arrangements with companies in specific countries and/or
territories. Ferring NV has distribution rights to market
Testoderm, Testoderm with Adhesive and Testoderm TTS in 12
European countries and has submitted applications for regulatory
approval to market the product in those countries. ALZA
Pharmaceuticals also has distribution agreements with various
distributors for 17 Asian countries (excluding Japan) for
Testoderm and Testoderm with Adhesive. ALZA has an agreement
with SB for the commercialization by SB of the Nicoderm
(nicotine) transdermal product developed by ALZA in all countries
of the world except the United States, Canada and Korea, where
HMRI has rights. (The product is marketed in the United States
through a joint venture between SB and HMRI.) Actisite, for the
treatment of periodontal disease, is distributed on behalf of
ALZA in several European countries by distributors, and
distribution agreements for certain Asian countries have been
signed, with introduction subject to regulatory approval.
In 1997, ALZA Pharmaceuticals expanded its sales and
marketing activities into Canada when ALZA acquired the United
States and Canadian rights to Elmiron, PolyCitra, BiCitra and
Neutra-Phos. In 1998, ALZA acquired the Canadian rights to
Ditropan, MacroBID and Macrodantin. ALZA International now has
approximately 12 employees located in Canada, marketing Elmiron,
PolyCitra, Ditropan, MacroBID and Macrodantin. ALZA
International is doing business in Canada as ALZA Canada.
In order to continue the expansion of its international
activities, in 1997 ALZA opened an office in London for ALZA
International. This presence in Europe is intended to help ALZA
identify distributors for ALZA products, to help identify new
opportunities for product development programs combining ALZA
technologies with compounds developed or under development by
companies in Europe, and to identify products under development
or marketed in Europe for potential acquisition or in-licensing
by ALZA for commercialization by ALZA Pharmaceuticals.
Governmental Regulation
Under the United States Food, Drug and Cosmetic Act, "new
drugs" must obtain clearance from the FDA before they lawfully
can be marketed in the United States. Applications for marketing
clearance must be based on extensive clinical and other testing,
the cost of which is very substantial. Approvals (sometimes
including pricing approvals) are
<PAGE>
required from health regulatory authorities in foreign countries
before marketing of pharmaceutical products may commence in those
countries. Requirements for approval may differ from country to
country, and can involve additional testing. There can be
substantial delays in obtaining required clearances from both the
FDA and foreign regulatory authorities after applications are filed.
Even after clearances are obtained, further delays may be encountered
before the products become commercially available in countries requiring
pricing approvals.
Product development generally involves all of the following
steps which are required by the regulatory process:
-preclinical development, during which initial
laboratory development and in vitro and in vivo testing takes
place;
-submission to the FDA of an investigational new drug
application (IND), which must become effective before human
clinical studies may begin;
-adequate and well-controlled human clinical trials
(Phase I, II and III studies) to establish the safety and
efficacy of the product;
-submission of an NDA to the FDA (and comparable filings
to regulatory agencies outside the United States) requesting
clearance to market the product; and
-clearance from the FDA (and foreign regulatory
agencies) must be obtained before the product can be marketed.
All of these steps can take several years and cost tens of
millions of dollars.
The products sold by ALZA Pharmaceuticals and by ALZA
Technologies' client companies in the United States, and/or
exported to other countries, are subject to extensive regulation
by the FDA and comparable agencies in other countries where the
products are distributed. Regulations govern a range of
activities including manufacturing, quality assurance,
advertising and recordkeeping. The continuing trend of stringent
FDA oversight in product clearance and enforcement has caused
more uncertainty, greater risks and higher costs of obtaining
clearance to market a product, and sometimes longer clearance
cycles. Failure to obtain, or delays in obtaining, regulatory
clearance to market new products, as well as other regulatory
actions and recalls, could adversely affect ALZA's financial
results.
The packaging, labeling and advertising of pharmaceutical
products are also subject to government regulation. The FDA
recommends preclearing advertising materials prior to the launch
of a product, and the launch materials for products receiving an
accelerated FDA clearance must be precleared by the FDA. With an
accelerated FDA clearance (such as was obtained by USB for
Ethyol), all labeling and advertising must be submitted to the
FDA 30 days prior to use, unless the FDA determines otherwise.
In addition, the FDA may require that additional clinical
<PAGE>
studies -Phase IV studies- be completed after clearance to market
a product has been granted. If these studies are not completed, or
if the expected outcomes are not achieved, a product could be
withdrawn from the market.
Patents and Patent Applications
As of December 31, 1998, ALZA held approximately 570 United
States patents and had approximately 225 pending United States
patent applications, and held approximately 1,650 foreign patents
and approximately 800 pending foreign patent applications,
relating to its various technologies and products. Patents have
been issued, or are expected to be issued, covering both current
technologies and products as well as those under development.
Patent protection generally has been important in the
pharmaceutical industry. ALZA believes that its current patents,
and patents that may be obtained in the future, are important to
current and future operations. ALZA technologies and products
are generally covered by multiple patents. However, there can be
no assurance that ALZA's existing patents will cover future
products, that additional patents will be issued, or that any
patents now or hereafter issued will be of commercial benefit.
In the United States, patents are granted for specified
periods of time. Some of ALZA's earlier patents covering various
aspects of certain OROS and D-TRANS dosage forms have expired, or
will expire, over the next several years.
In 2003, certain significant ALZA patents are due to expire
that relate to ALZA's OROS systems and the Procardia XL product
developed by ALZA and marketed by Pfizer (which uses the OROS
delivery system). Other forms of sustained release nifedipine
using different delivery systems are reported to be in various
stages of development by other companies, and several companies
have filed Abbreviated New Drug Applications ("ANDAs") with the
FDA requesting clearance to market "generic equivalents" of
Procardia XL. In March 1999 one of these companies received a
tentative approval of its ANDA. In general, a tentative approval
means that the ANDA may not be finally approved until a specified
period of time has elapsed, or until certain results have been
reached in patent litigation involving the product. Pfizer
has filed suit against these companies for infringement of patent
rights relating to the nifedipine active drug substance in
Procardia XL, and is also involved in litigation with the FDA and
one of the ANDA applicants concerning the regulatory status of that
company's product. It is not possible to predict the timing and
amount of the negative impact on sales of Procardia XL that will
result from competition from these or other potential generic
sustained release nifedipine products.
ALZA Pharmaceuticals commercializes several products it has
acquired or in-licensed from third parties. The extent to which
such products are protected by patent rights varies significantly
from product to product. Ditropan, Mycelex Troche and Urispas
have been sold for many
<PAGE>
years and are not covered by patents. The chemical compounds
constituting the active ingredients of Ethyol and Elmiron are
not covered by patents. However, patentshave issued or
are pending relating to significant developments in uses
and the formulation of Ethyol, and for certain uses of
Elmiron. ALZA anticipates that additional patents may issue
relating to these products; however, there can be no assurance
that any such patent coverage will be obtained, or if obtained
will provide significant proprietary protection for the products.
For Ditropan XL and Doxil, while the products themselves are
patented, the active ingredient is not covered by patents; as a
result, other companies are commercializing products
incorporating the same active ingredient in a generic form, and
competitors either are commercializing, or may in the future
commercialize, the active ingredient in another drug delivery
product.
Although a patent has a statutory presumption of validity in
the United States, the issuance of a patent is not conclusive as
to such validity or as to the enforceable scope of the claims of
the patent. There can be no assurance that patents of ALZA will
not be successfully challenged in the future. In some cases,
third parties have initiated reexamination by the Patent and
Trademark Office of patents issued to ALZA, and have opposed ALZA
patents in other jurisdictions. The validity or enforceability
of ALZA patents after their issuance have also been challenged in
litigation. If the outcome of such litigation is adverse to
ALZA, third parties may then be able to use the invention covered
by the patent, in some cases without payment. There can be no
assurance that ALZA patents will not be infringed or successfully
avoided through design innovation.
It is also possible that third parties may obtain patent or
other proprietary rights that may be necessary or useful to ALZA.
With numerous other companies engaged in developing new chemical
entities and competitive drug delivery technologies, it can be
expected that other parties may in some circumstances file patent
applications or obtain patents that compete in priority with
ALZA's patent applications. Such competition may result in
adversarial proceedings such as patent interferences and
oppositions, which can increase the uncertainty of patent
coverage. In cases where third parties are first to invent a
particular product or technology, it is possible that those
parties will obtain patents that will be sufficiently broad so as
to prevent ALZA from using certain technology or from further
developing or commercializing certain products. As ALZA
Pharmaceuticals expands its direct marketing of products, ALZA
may attempt to in-license additional products, or compounds or
technologies for use in products. In each of these cases, if
licenses from third parties are necessary but cannot be obtained,
commercialization of the products would be delayed or prevented.
In addition, ALZA Technologies utilizes significant
unpatented proprietary technology, and there can be no assurance
that others will not develop similar technology.
<PAGE>
Competition
It can be expected that all or most of the products
developed or commercialized by ALZA will face competition at the
time of introduction, or later in their life cycles, from
different chemical or other agents intended for treatment of the
same indications. All of ALZA Technologies' current and future
drug delivery products are likely to face competition both from
traditional forms of drug delivery and from advanced delivery
systems being developed by others. The competition potentially
includes all of the pharmaceutical companies in the world,
including current ALZA Technologies clients. Many of these
pharmaceutical companies have greater financial resources,
technical staff and manufacturing and marketing capabilities than
ALZA. A large number of companies are developing drug delivery
technologies. To the extent that ALZA develops or markets
products incorporating drugs that are off-patent, or are being
developed by multiple companies, ALZA will face competition from
other companies developing and marketing similar products.
As the pharmaceutical industry continues to consolidate, and
as pressures increase for cost-effective research and
development, some pharmaceutical companies have reduced, and may
continue to reduce, their funding of research and development.
Competition for limited client dollars may therefore increase,
and this competition could include the clients' internal research
and development programs, other drug delivery programs and other
technologies and products of third parties. Similarly, as
pharmaceutical companies search to fill gaps in their product
pipelines with in-licensed or acquired products, ALZA
Pharmaceuticals will be competing for product in-licensing and
acquisition opportunities with companies with far greater
financial and other resources than ALZA.
Competition among pharmaceutical products is generally based
on performance characteristics and price. Acceptance by
hospitals, physicians and patients is crucial to the success of a
product. Health care reimbursement policies of managed care
organizations, insurers and government agencies will continue to
exert pressure on pricing, and various federal and state agencies
have enacted regulations requiring rebates of a portion of the
purchase price of many pharmaceutical products. Cost-
effectiveness, although often difficult to measure, is becoming
increasingly critical to the commercial success of a new product.
A major challenge faced by ALZA and other pharmaceutical
companies is competition from generic pharmaceutical
manufacturers. Generic competitors generally are able to obtain
regulatory approval for off-patent drugs without investing in
costly and timeconsuming clinical trials, and need only
demonstrate bioequivalence to the drug they wish to copy.
Because of their substantially reduced development costs, generic
companies are often able to charge much lower prices for their
products than the originator of a new product. A number of
products developed by ALZA Technologies incorporate chemical
entities that are not covered by patents. These products
therefore may be subject to potential generic
<PAGE>
competition to the extent that competitors can demonstrate
bioequivalence without infringing ALZA patents relating to its
drug delivery technologies. Several companies have filed ANDAs
with the FDA requesting clearance to market generic versions of
Procardia XL, and one of the ANDAs has received tentative approval
by the FDA (see "Patents and Patent Applications" above).
The health care industry has continued to change rapidly as
the public, government, medical practitioners and the
pharmaceutical industry focus on ways to expand medical coverage
while controlling the growth in health care costs. The growth of
managed care organizations and the resulting pressures for cost-
containment in the United States health care system are expected
to continue to put pressures on the prices charged for
pharmaceutical products. Prescription drug reimbursement
practices and the growth of managed care organizations,
pharmaceutical benefit management groups and group buying
organizations, as well as generic and therapeutic substitution
(substitution of a different product for the same indication),
will significantly affect ALZA's business. While ALZA believes
the changing health care environment may increase the value of
ALZA's drug delivery products over the long term, it is
impossible to predict accurately the impact these changes may
have on ALZA.
It is expected that, during 1999, the United States Congress
will consider various proposals that could have the effect of
requiring large discounts on the prices that pharmaceutical
companies can charge for pharmaceutical products for Medicare
participants. A number of states are also considering this type
of legislation, or other measures that could secure large
discounts for senior citizens. It is not clear whether, or when,
any of these proposals may be enacted.
Revenues
For a description of ALZA's revenues, see the Financial
Statements included in Item 8 of the Form 10-K Annual Report; for
revenues by segment, see Note 13 to the Financial Statements.
ALZA's dependence on certain important customers is discussed in
Note 13 to the Financial Statements.
Product Returns; Payment Terms
For products marketed by ALZA Pharmaceuticals, payment terms
are generally net 30 days. From time to time, ALZA has extended
its customary payment terms, for example in the case of new
product introduction or in anticipation of a holiday shutdown.
ALZA Pharmaceuticals generally accepts returns of unopened
product for full credit. Payments from client companies for
products manufactured by ALZA Technologies and shipped to the
clients generally are due 30 to 60 days after shipment by ALZA.
Such products generally may be returned only if they do not meet
the applicable product specifications.
<PAGE>
Exports
ALZA's export sales were $33.7 million in 1998, $31.5
million in 1997 and $23.0 million in 1996, principally to
distributors and client companies in Europe. For additional
information concerning export sales, see Note 16 to ALZA's
Financial Statements included in Item 8 of this Form 10-K Annual
Report.
Employees
On December 31, 1998, ALZA had 1,845 employees, of whom
approximately 725 were engaged in research and development
activities, approximately 550 were engaged in manufacturing
activities, approximately 300 were engaged in sales and marketing
activities and the remainder were working in general and
administrative areas. ALZA does not have any union contracts,
and believes that its relations with its employees are generally
good.
Acquisition of SEQUUS Pharmaceuticals, Inc.
On October 5, 1998, ALZA and SEQUUS announced they had
entered into a definitive merger agreement for ALZA to acquire
SEQUUS, subject to the approval of SEQUUS' stockholders and
certain other conditions. On March 16, 1999, the SEQUUS
stockholders approved the merger, which became effective on that
date. As a result of the merger, SEQUUS stockholders received
0.4 ALZA shares for each share of SEQUUS common stock. ALZA is
accounting for the transaction as a pooling of interests.
Item 2. PROPERTIES
ALZA's corporate offices are located in Palo Alto,
California, and its two primary research and development campuses
are in Palo Alto and Mountain View, California. Most of the
facilities in Palo Alto are held under prepaid ground leases from
Stanford University that expire in approximately 16 to 59 years.
One Palo Alto facility is subleased to ALZA; there are two years
remaining on the sublease and ALZA has an option for an
additional three years.ALZA owns all of its significant Mountain
View facilities, except as described below. ALZA also occupies
a research facility in Spring Lake Park, Minnesota which is
leased from a third party until the year 2000. ALZA also owns
an undeveloped parcel in Minnesota. ALZA's large-scale commercial
manufacturing facility, which is owned by ALZA, is located in
Vacaville, California. Some smaller scale manufacturing also
takes place in Palo Alto and Mountain View facilities.
While ALZA believes that its facilities and equipment are
sufficient to meet its current operating requirements, ALZA is
expanding its facilities and equipment to support its long-term
requirements, in particular in Mountain View, California.
In late 1997, ALZA acquired a 50% interest in a real estate
joint venture, formed as a limited liability company, for the
development of a
<PAGE>
13-acre parcel of land in Mountain View, California.
ALZA invested $36.2 million in the joint venture, which will
be applied to the construction of three buildings on
the parcel. ALZA is also obligated to make improvements to the
buildings. The total cost of the buildings and improvements is
estimated to be in excess of $100.0 million; approximately $39.2
million had been spent as of December 31, 1998. The joint
venture will lease the buildings to ALZA upon completion of
construction. The lease payments due on the 13-acre Mountain View
parcel, which begin in May 1999, are based upon the final square
footage of the buildings (which is estimated to be approximately
120,000 square feet per building). Those lease payments are
currently estimated to be approximately $225,000 per month per
building for the first year and escalate $0.05 per square foot
per year for the remainder of the initial term of the lease.
ALZA currently plans to occupy two of the buildings and a portion
of the third building upon completion, and to sublease a portion
of the third building for several years. The leases provide for
an initial term of 15 years, with options to extend for
approximately 20 additional years, and with scheduled annual rent
increases during the extended term based upon the Consumer Price Index.
ALZA receives 50% of the joint venture's income (rent less management
fees).
ALZA has also entered into a ground lease agreement for an
adjacent seven-acre parcel of land on which it may construct a
pilot plant, laboratories and other technical facilities. The
remaining term of the ground lease is approximately 32 years and
includes options for ALZA to purchase, or to be required to
purchase, the property. Ground lease payments are approximately
$140,000 per month. Under the ground lease for the seven-acre
parcel, ALZA's option to acquire the property may be exercised at
any time after August 31, 2000 and prior to expiration of the
lease, and the landlord may exercise its option to sell the
property to ALZA at any time before August 31, 2000. For a
purchase on or before September 30, 2002, the purchase price is
approximately $17 million; thereafter the purchase price is
adjusted for inflation. If neither ALZA nor the landlord
exercises its option, then any improvements constructed by ALZA
on the parcel would be the property of the landlord on
termination of the lease.
ALZA's properties are not allocated to, or divided between,
its operating segments, except that ALZA's Vacaville, California
and Minnesota facilities are used almost exclusively for
activities in the ALZA Technologies segment. Other properties
house ALZA personnel from both operating segments, as well as
administrative personnel.
Item 3. 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
<PAGE>
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.
Pursuant to a Remedial Action Order No. HSA 88/89-016 issued
by the California Department of Toxic Substances Control
("DTSC"), ALZA has been named as one of a number of potentially
responsible parties in connection with the cleanup and
environmental remediation of the Hillview-Porter Regional Site
Project near ALZA's Palo Alto facilities. The purpose of the
DTSC action is, in part, to apportion responsibility for cleanup
costs among the parties involved. Cleanup costs for the entire
region have been estimated at approximately $16 million. ALZA
believes that it did not discharge any of the chemicals of
concern at the site in question. ALZA does not believe that its
liability in this matter, if any, will be material.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
EXECUTIVE OFFICERS
Principal Occupations for
Name Age Past Five Years
Dr. Ernest Mario 60 Chairman of the Board and
Chief Executive
Officer of ALZA (since 1993);
Chief Executive of Glaxo
Holdings, p.l.c., a
pharmaceutical company (1989-
1993).
James R. Butler 58 Senior Vice
President, Sales and Marketing
of ALZA (since 1997); Vice
President, Sales and Marketing
(19931996); Vice President and
General Manager of the
corporate division of Glaxo,
Inc., a pharmaceutical company
(1987-1993).
Bruce C. Cozadd 35 Senior Vice
President and Chief Financial
Officer of ALZA (since 1997);
Vice President and Chief
Financial Officer (1994-1996).
Harold Fethe 54 Senior Vice
President, Human Resources of
ALZA (since 1998); Vice
President, Human Resources
(1991 to 1998).
Dr. Samuel R. Saks 44 Senior Vice
President, Medical Affairs of
ALZA (since 1994); Vice
President, Medical Affairs
(1992-1994); Vice President,
Clinical Research, Oncology,
ScheringPlough Corporation, a
pharmaceutical company (1991-
1992).
Peter D. Staple 47 Senior Vice President
and General Counsel
of ALZA (since 1997); Vice
President and General Counsel
(19941996); Vice President and
Associate General Counsel of
Chiron Corporation, a
biotechnology company (1992-
1994).
Janne Wissel 43 Senior President, Operations
of ALZA (since 1998);
Vice President
Regulatory and Quality
Management(1995 to 1997); Vice
President, Quality Management
(1994 to 1995); Senior
Director, Regulatory Affairs
(1993 to 1994).
Dr. James W. Young 54 Senior Vice
President, Research and
Development of ALZA (since
1997); Senior Vice President,
Commercial Development (1995-
1997); Vice President and
Managing Director of ALZA
Technology Institute (1995);
President, Pharmaceuticals
Division, Affymax N.V., a
biotechnology company (1992
1995).
<PAGE>
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
ALZA common stock (symbol AZA) is listed for trading on the
New York Stock Exchange and, as of March 18, 1999 there were
approximately 7,030 holders of record of the common stock. ALZA
has never paid cash dividends on its common stock and has no plan
to do so in the near term. The quarterly high and low sales
prices of ALZA common stock for 1998 and 1997, as reported on the
composite tape, are shown below:
ALZA COMMON STOCK
1998 1997
High Low High Low
First quarter $45 9/16 $30 7/8 $31 3/8 $24 7/8
Second quarter 52 7/8 40 1/2 31 3/8 25 1/2
Third quarter 45 1/2 33 3/4 32 1/2 28 1/16
Fourth quarter 54 38 9/16 31 13/16 24 7/8
NOTE
The information contained in Items 6, 7, and 8 of this Form
10K Annual Report reflects the consolidated financial
information of ALZA Corporation before its acquisition of SEQUUS
Pharmaceuticals, Inc., which became effective on March 16, 1999.
ALZA will account for the merger as a pooling of interests and,
accordingly, will restate all prior period financial information
to include the combined results of operations, financial position
and cash flows of ALZA and SEQUUS as though they had always been a
single company.
<PAGE>
Item 6. SELECTED CONSOLIDATED FINANCIAL DATA
(In millions, except per share amounts)
1998 1997 1996 1995 1994
_________________________________________________________________
Total revenues $ 584.5 $ 464.4 $ 413.1 $324.6 $261.2
Net income (loss) 112.3 (261.1)(1) 92.4 72.4 58.1
Earnings (loss)
per share,
Basic 1.30 (3.07) 1.10 0.88 0.71
Diluted 1.26 (3.07) 1.08 0.88 0.71
Cash and
investments 488.5 535.8 999.8 419.1 344.9
Total assets 1,576.3 1,369.2 1,613.7 937.2 806.3
Total long-term
liabilities 1,003.0 963.4 949.8 414.7 385.8
Total stockholders'
equity 455.2 301.2 596.7 454.6 364.5
_________________________________________________________________
(1) Reflects a total of $368.7 million (or $4.30 per share, diluted)
of charges, including a $247.0 million charge and $8.0 million of
interest expense related to ALZA's distribution of shares of
Crescendo, $108.5 million for acquired in-process research and
development, an asset write-down of $11.5 million and costs of
$1.8 million related to a workforce reduction, less a tax benefit
of $8.1 million.
<PAGE>
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
SUMMARY
SUMMARY
(In millions, except per share amounts) 1998 1997 1996
_________________________________________________________________
Revenues $584.5 $464.4 $413.1
_________________________________________________________________
Operating Income (Loss) 204.3 (204.0) 139.2
_________________________________________________________________
Net Income (Loss) 112.3 (261.1) 92.4
_________________________________________________________________
Earnings (Loss) per Share (diluted) 1.26 (3.07) 1.08
_________________________________________________________________
ALZA's net income for 1998 was $112.3 million compared with a net
loss of $261.1 million in 1997 and net income of $92.4 million
in 1996. Net income (loss) for 1997 and 1996 contained items
that ALZA believes should be excluded in order to analyze
comparable operating results for the three years. Those items
are described below under "Certain Items Affecting
Comparability of Operating Results."
1998 Compared to 1997
On a comparable basis, ALZA's 1998 net income increased 4%
to $112.3 million, or $1.26 per diluted share, compared with 1997
net income of $107.6 million, or $1.23 per diluted share,
excluding the impact of the 1997 items described below under
"Certain Items Affecting Comparability of Operating Results."
The increase in 1998 net income resulted primarily from the
following:
-Net sales increased 59% to $232.9 million in 1998 from $146.1
million in 1997. Sales of products by ALZA Pharmaceuticals
more than doubled in 1998 compared with 1997, increasing to
$119.3 million in 1998 from $52.9 million in 1997.
-Gross margin as a percentage of net sales increased to 50% in
1998 from 36% in 1997.
-Royalties, fees and other revenues increased 24% to $227.2
million in 1998 compared with $183.3 million in 1997.
Royalties, fees and other revenues for 1998 included $10.7
million in technology fees from Crescendo Pharmaceuticals
Corporation ("Crescendo").
Substantially offsetting these contributions to net income
in 1998 were the following:
-Selling, general and administrative expenses increased to
$106.6 million in 1998 from $51.8 million in 1997, reflecting
the substantial increase in the size of the sales organization
and increased marketing
<PAGE>
expenses related to ALZA's expanded product portfolio
and preparation for the launch of Ditropan-registered trademark-
XL (oxybutynin chloride) in February 1999. Increased
amortization of product acquisition costs also
contributed to the increase in selling, general and
administrative expenses in 1998, as a result of a full year of
amortization of the costs of products acquired by ALZA in 1997.
-Interest income declined 55% in 1998 compared with 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
exercise of the option to acquire all of the outstanding
limited partnership interests in ALZA TTS Research Partners,
Ltd. (the "TTS Partnership"), which occurred in the third
quarter of 1998.
1997 Compared to 1996
On a comparable basis, ALZA's net income increased 19% in
1997 to $107.6 million, or $1.23 per diluted share, compared with
1996 net income of $90.1 million, or $1.06 per diluted share,
excluding the impact of the 1997 and 1996 items described below
under "Certain Items Affecting Comparability of Operating
Results." This increase primarily resulted from the following:
-Net sales increased 35% in 1997 compared with 1996. Sales of
ALZA-marketed products more than doubled in 1997 compared with
1996, increasing to $52.9 million in 1997 from $23.2 million in
1996.
-Gross margin as a percentage of sales increased to 36% in 1997
from 21% in 1996. Gross margin for 1996 was 24% excluding
certain charges described below.
-Royalties, fees and other revenues increased 6% to $183.3
million in 1997 compared with $173.3 million in 1996.
Royalties, fees and other revenues for 1996 were $162.8 million,
excluding certain credits described below.
-ALZA's effective income tax rate declined to 35% in 1997, after
excluding certain items described below which are not generally
deductible for tax purposes, from 38% in 1996.
Partially offsetting these contributions to net income in
1997 were the following:
-Research and development expenses increased 11% to $156.8
million in 1997 compared to $141.6 million in 1996, while
research and development revenues increased 3% to $135.0
million in 1997, compared with $131.2 million in 1996.
-Selling, general and administrative expenses increased 10% to
$51.8 million in 1997 compared with $47.1 million in 1996,
resulting from an
<PAGE>
increase in sales and marketing expenses and amortization
of the acquisition costs of products acquired in 1997.
-Interest expense increased 28% in 1997 compared with 1996 as a
result of ALZA's 5% convertible subordinated debentures due
2006 ("5% Debentures"), issued in April 1996, being outstanding
for all of 1997.
Certain Items Affecting Comparability of Operating Results
The following charges were incurred in 1997 and significantly
affected ALZA's operating results:
-Acquisitions of in-process research and development, which
consisted of $77.0 million related to the purchase of the Class
A Common Stock of TDC, a $10.0 million charge in connection
with a development and option agreement for Cereport-registered
trademark- (bradykinin-based receptor-mediated permeabilizer)
between ALZA and Alkermes, Inc. ("Alkermes") and a $21.5
million expenditure related to a development and commercialization
agreement between ALZA and Janssen Pharmaceutica, Inc.
(together with its affiliates "Janssen") for an E-TRANS-
trademarkfentanyl product ("Transfenta-trademark-") for the
treatment of acute pain;
-A charge of $247.0 million and interest expense of $8.0 million
related to ALZA's contribution to Crescendo and distribution of
shares to ALZA stockholders and debenture holders,
respectively;
-A write-down of excess manufacturing equipment of $11.5 million;
-A workforce reduction with a total cost of $1.8 million ($1.4
million included in research and development expense and $0.4
million included in selling, general and administrative
expenses); and
-An income tax benefit of $8.1 million related to certain of the
above charges.
Net income for 1996 included the following charges and benefits:
-A $7.1 million benefit from the reversal of a reserve related to
Procardia XL-registered trademark- (nifedipine) royalties;
-A $6.4 million benefit from the settlement of litigation related
to patent disputes concerning transdermal nicotine patches;
-A $4.0 million charge for the unamortized portion of a
partnership acquisition prepayment for the OROS-registered
trademark- Products Limited Partnership;
-A $1.9 million charge related to a limited recall of two lots
of Duragesic-registered trademark- (fentanyl transdermal
system) CII by Janssen, and other joint venture, partnership
and product reserves.
<PAGE>
OPERATING SEGMENTS
In 1998, ALZA adopted Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise
and Related Information" ("SFAS 131"), which establishes revised
standards for public companies in reporting financial information
on operating segments. Accordingly, ALZA has organized the
following discussion of its results of operations by its
operating segments.
ALZA has two operating segments: ALZA Pharmaceuticals and
ALZA Technologies.
ALZA Pharmaceuticals markets and sells products developed by
ALZA Technologies or others, directly to the pharmaceutical
marketplace in the United States and Canada and to distributors
who sell such products outside the United States and Canada.
ALZA Pharmaceuticals also co-promotes products with third
parties, and engages ALZA Technologies and others to conduct
product development and manufacture products for ALZA
Pharmaceuticals.
ALZA Technologies conducts research and development of
ALZA's drug delivery technologies and products for ALZA
Pharmaceuticals (and Crescendo) and pharmaceutical company
clients, and manufactures products for sale by ALZA
Pharmaceuticals and client companies.
The "Other" category primarily comprises corporate general
and administrative activities and the associated costs related to
finance, legal, human resources, commercial development,
executive and other functions not directly attributable (or
allocated) to the activities of the operating segments, as well
as rental and service fee revenues.
OPERATING SEGMENT SUMMARY
(In millions, except per share amounts) 1998 1997 1996
_________________________________________________________________
Revenues
ALZA PHARMACEUTICALS $233.6 $152.0 $ 123.4
ALZA TECHNOLOGIES 455.3 413.0 393.1
OTHER 2.4 0.8 3.2
_________________________________________________________________
Total Segment Revenues 691.3 565.8 519.7
Intersegment Elimination (106.8) (101.4) (106.6)
_________________________________________________________________
Total Revenues $ 584.5 $ 464.4 $ 413.1
_________________________________________________________________
Operating Income (Loss)
ALZA PHARMACEUTICALS $ 13.2 $(326.7) $(13.4)
ALZA TECHNOLOGIES 208.1 147.6 174.0
OTHER (17.0) (24.9) (21.4)
_________________________________________________________________
Total Operating Income (Loss) $ 204.3 $(204.0) $139.2
_________________________________________________________________
<PAGE>
In 1997, the operating loss for ALZA Pharmaceuticals
includes charges totaling $334.0 million for the purchase of TDC,
the contribution to Crescendo, and a payment in connection with a
development and option agreement for Cereport between ALZA and
Alkermes. Excluding these charges, operating income for ALZA
Pharmaceuticals would have been $7.3 million in 1997. Operating
income for ALZA Technologies in 1997 included charges totaling
$34.4 million related to a development and commercialization
agreement between ALZA and Janssen for Transfenta, a write-down
of manufacturing and research and development assets, and costs
related to a workforce reduction. Excluding these charges,
operating income for ALZA Technologies would have been $182.0
million in 1997.
ALZA PHARMACEUTICALS
ALZA Pharmaceuticals derives its revenues from sales of ALZA
marketed products to the pharmaceuticals marketplace in the
United States and Canada and to distributors who market the
products elsewhere; research and development revenues from
Crescendo (and prior to 1998, TDC); co-promotion fees from third
parties, and fees received with respect to rights to market
outside the United States or Canada products marketed or intended
to be marketed by ALZA Pharmaceuticals in the United States and
Canada. Revenues from Crescendo (and previously, TDC) are offset
by intersegment charges from ALZA Technologies for research and
development expenses related to potential products for marketing
by ALZA under development by Crescendo. Crescendo is expected to
expend its funds within the next two years, at which time ALZA
Pharmaceuticals would no longer have offsetting revenues for
these research and development expenses. ALZA Pharmaceuticals'
costs and expenses include costs of products shipped for ALZA-
marketed products, including costs of products manufactured by
ALZA Technologies and third party manufacturers, research and
development expenses billed by ALZA Technologies and others,
sales and marketing expenses and amortization of product
acquisition payments.
In 1998, ALZA Pharmaceuticals' operating income increased to
$13.2 million from $7.3 million in 1997, excluding certain
charges described above. This improvement was due to a 125% increase in
net sales of ALZA-marketed products and an increase in gross
margin as a percentage of net sales on these products to 74% in
1998 compared with 73% in 1997. These increases were offset by
increased sales and marketing expenses and amortization of
product acquisition payments. In 1997, ALZA Pharmaceuticals'
operating income increased to $7.3 million, excluding certain
charges described above, compared with an operating loss of $13.4
million in 1996. This increase resulted primarily from a 128%
increase in net sales of ALZA-marketed products and an increase
in the gross margin to 73% in 1997 from 55% in 1996, partially
offset by an increase in sales and marketing expenses and an
increase in amortization of product acquisition costs in 1997
compared to 1996.
<PAGE>
ALZA TECHNOLOGIES
ALZA Technologies derives its revenues from net sales of
products manufactured for client companies and for ALZA
Pharmaceuticals, royalty revenues, fee revenues resulting from
agreements with client companies, and revenues for research and
development activities undertaken for client companies and ALZA
Pharmaceuticals. In 1998, operating income for ALZA Technologies
increased to $208.1 million compared with $182.0 million in 1997,
excluding certain charges described above. This increase was
primarily due to a 16% increase in royalties, fees and other
revenues, a 21% increase in contract manufacturing sales and an
improvement in gross margin to 24% in 1998 compared with 15% in
1997. Operating income in 1997 increased to $182.0 million,
excluding certain charges, from $174.0 million in 1996 due to a
5% increase in royalties and fees, an 8% increase in contract
manufacturing sales and an improvement in gross margin to 15% in
1997 from 12% in 1996.
OTHER
In 1998, the operating loss for the "Other" segment was
$17.0 million, compared with $24.5 million in 1997, excluding a
$0.4 million charge related to a workforce reduction. The
decrease in the operating loss was due primarily to lower
allocated internal expenses, a reduction in certain corporate
expenses and higher cash surrender value of company-owned life
insurance policies in 1998 compared with 1997. The operating
loss for the Other segment increased to $24.5 million in 1997,
excluding certain charges, compared with $21.4 million in 1996,
due primarily to lower rent and service revenues in 1997 compared
with 1996, partially offset by higher cash surrender value of
company-owned life insurance policies in 1997.
<PAGE>
NET SALES
NET SALES
(Dollars in millions) 1998 1997 1996
_________________________________________________________________
ALZA PHARMACEUTICALS
Ethyol-registered trademark- $ 32.6 $ 20.6 $ 9.4
Mycelex-registered trademark-
Troche 25.9 10.8 -
Elmiron-registered trademark- 23.0 4.8 -
Testoderm-registered trademark-
TTS line 10.0 6.3 6.7
Ditropan-registered trademark- 8.7 1.0 -
Other 19.1 9.4 7.1
_________________________________________________________________
Total 119.3 52.9 23.2
_________________________________________________________________
ALZA TECHNOLOGIES
Contract manufacturing 113.6 93.2 85.4
Intersegment 6.6 6.0 6.8
_________________________________________________________________
Total 120.2 99.2 92.2
_________________________________________________________________
Intersegment eliminations (6.6) (6.0) (6.8)
_________________________________________________________________
Total net sales $ 232.9 $ 146.1 $ 108.6
_________________________________________________________________
Total net sales as a percentage
of total revenues 40% 31% 26%
_________________________________________________________________
ALZA Pharmaceuticals as a percentage
of total net sales 51% 36% 21%
_________________________________________________________________
ALZA PHARMACEUTICALS
Included in net sales of ALZA-marketed products are sales of
the products marketed directly by ALZA in the United States and
Canada, and sales of those products in other countries through
distributors. Net sales of ALZA-marketed products increased 125%
in 1998 compared to 1997, resulting from a 58% increase in sales
of Ethyol-registered trademark- (amifostine), together with sales
of Mycelex-registered trademark- (clotrimazole) Troche, Elmiron
registered trademark- (pentosan polysulfate sodium), BiCitra
registered trademark- (sodium citrate and citric acid), PolyCitra
registered trademark- (potassium citrate), and Ditropan-
registered trademark- (oxybutynin chloride), the rights to all of
which were acquired by ALZA in the second half of 1997, and sales of
Testoderm-registered trademark- TTS (Testosterone Transdermal
System), which was launched in March 1998.
In 1997, net sales of ALZA-marketed products increased 128%
compared with 1996, primarily as a result of sales of Mycelex
Troche and Elmiron, rights to each of which were acquired in
1997. Sales of Ethyol, which was launched in April 1996, also
contributed to the increase in sales of ALZA-marketed products in
1997.
<PAGE>
Net sales of ALZA-marketed products can be expected to vary
from quarter to quarter, particularly in the first years after
launch of a new product. Rights to several of the ALZA-marketed
products were acquired by ALZA during 1997. Ethyol, Elmiron and
Testoderm TTS were cleared for marketing during the past few
years and have not yet achieved their steady-state sales levels.
Wholesaler stocking patterns, managed care and formulary
acceptance, the introduction of competitive products, and
acceptance by patients and physicians will affect future sales of
these products.
Product Acquisitions
In July 1997, ALZA acquired exclusive rights to Mycelex
Troche in the United States from Bayer Corporation ("Bayer").
Under the terms of the agreement, ALZA made a $50.0 million
upfront payment to Bayer, which was capitalized, and will make an
additional payment, which will be capitalized, if net sales of
the product during a certain period are above a specified level.
Bayer manufactures Mycelex Troche for ALZA.
In October 1997, ALZA acquired the exclusive rights in the
United States and Canada to Elmiron and three additional urology
products, BiCitra, PolyCitra and Neutra-Phos-registered trademark
(potassium and sodium phosphate), from Baker Norton
Pharmaceuticals, Inc. and its parent, IVAX Corporation,
(together, "IVAX"). Under the terms of the agreement, ALZA paid
a $75.0 million upfront fee to IVAX, which was capitalized, and
must pay additional fees if specified Elmiron sales levels are
achieved during the five years ending October 2002. ALZA incurred an
additional fee of $8.5 million in 1998 based upon Elmiron sales,
which was capitalized. IVAX manufactures the products for ALZA
and receives payments from ALZA based on sales of the products.
In October 1997, ALZA acquired the rights in the United
States to the immediate-release Ditropan product and trademark
from Hoechst Marion Roussel, Inc. ("HMRI"). ALZA also acquired
the rights to the product in Canada in April 1998 from HMRI and
Proctor & Gamble Pharmaceuticals, Inc. ("P&G"). Under the terms
of the agreements, ALZA made upfront payments to HMRI and P&G,
which were capitalized, and incurred additional fees of $12.5
million in 1998 to HMRI based upon Ditropan sales levels in the
United States, which were capitalized. HMRI manufactures the
product for ALZA. ALZA has the right to market other products in
the United States and Canada under the Ditropan trademark, and
HMRI will receive royalty payments from ALZA if the trademark is
used by ALZA with other products, such as Ditropan XL.
In November 1998, ALZA acquired the exclusive marketing and
distribution rights in the United States to Urispas-registered
trademark- (flavoxate hydrochloride) from SmithKline Beecham
("SB"). Under the terms of the agreement, ALZA paid a $25.0
million upfront fee to SB, which was capitalized, and may be
required to make additional milestone payments. SB manufactures
the product for ALZA.
<PAGE>
Acquisition of SEQUUS Pharmaceuticals, Inc.
In October 1998, ALZA and SEQUUS announced that the
companies had entered into a definitive merger agreement under
which ALZA would acquire SEQUUS, subject to the approval of
SEQUUS stockholders. The merger was consummated on March 16,
1999. As a result, SEQUUS' commercialized products, Doxil
- -registered trademark- (doxorubicin HCl liposome injection),
an anticancer product, and Amphotec-registered trademark-
(amphotericin B cholesteryl sulfate complex for injection),
an antifungal product, became ALZA-marketed products.
Launch of Ditropan XL
On February 1, 1999 ALZA launched Ditropan XL in the United
States. This product is expected to contribute significantly to
sales of ALZA-marketed products in 1999 and beyond.
ALZA TECHNOLOGIES
Net sales from contract manufacturing include sales
generated from contract manufacturing activities for ALZA's
client companies and ALZA Pharmaceuticals. Net sales from
contract manufacturing increased 22% in 1998 compared with 1997,
primarily due to a 34% increase in ALZA shipments of Duragesic.
Net sales from contract manufacturing increased 9% in 1997
compared with 1996, primarily due to a 27% increase in ALZA
shipments of Nicoderm-registered trademark- and NicoDerm-
registered trademark- CQ-trademark(nicotine) and a 14% increase
in ALZA shipments of Duragesic.
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.
GROSS MARGIN
Gross margin as a percentage of net sales
1998 1997 1996
_________________________________________________________________
ALZA PHARMACEUTICALS (1) 74% 73% 55%
ALZA TECHNOLOGIES (1) 24% 15% 12%
_________________________________________________________________
Gross margin as a percentage of
total net sales (2) 50% 36% 21%
_________________________________________________________________
(1) Includes intersegment revenues or expenses
(2) After intersegment eliminations
<PAGE>
The increase in total gross margin in 1998 compared to 1997
and 1996 was due to increased sales of higher-margin products by
ALZA Pharmaceuticals and increased margins on products shipped by
ALZA Technologies to client companies. ALZA expects its gross
margin on net sales to increase from historical rates over the
longer term, although quarter-to-quarter fluctuations, even
significant ones, can be expected to continue to occur. A trend
of higher gross margins may be achieved through a proportionate
increase in the sales by ALZA Pharmaceuticals in relation to
sales by ALZA Technologies and, to a lesser extent, increased
utilization of capacity and greater operating efficiencies by
ALZA Technologies.
ALZA PHARMACEUTICALS
The gross margin on net sales of ALZA-marketed products
increased in 1998 compared to 1997 and 1996 due to an increase in
net sales of higher margin products, in large part reflecting a
full year of sales in 1998 of products acquired in 1997. The
increase in gross margin in 1997 compared with 1996 reflected the
addition of higher margin products to the ALZA Pharmaceuticals
portfolio in 1997.
ALZA TECHNOLOGIES
The gross margin on net sales of products manufactured by
ALZA Technologies for sale by client companies and ALZA
Pharmaceuticals increased in 1998 compared with 1997 and 1996 as
a result of an increase in shipments of higher-margin products to
client companies. ALZA Technologies' gross margin on contract
manufacturing sales is usually considerably lower than ALZA
Pharmaceuticals' gross margin on its sales of ALZA-marketed
products. ALZA's client-funded product development agreements
generally provide for a supply price that is intended to cover
ALZA's costs to manufacture the product plus a small margin.
ALZA also receives royalties on the clients' sales of the
products, which are included in royalties, fees and other
revenues. Sales to ALZA Pharmaceuticals are based upon
negotiated prices, which approximate the prices charged to third
parties.
<PAGE>
ROYALTIES, FEES AND OTHER REVENUES
Royalties, fees and other revenues consist largely of
royalties paid by client companies on products developed under
joint development and commercialization agreements with ALZA and
other client companies and marketed by the companies. Fee
revenues consist of upfront milestone and other one-time,
special, or infrequent payments made under joint development
agreements or by distributors who acquire rights to market ALZA
products outside the United States and Canada, or co-promotion
fees.
<PAGE>
ROYALTIES, FEES AND OTHER REVENUES
(Dollars in millions) 1998 1997 1996
_________________________________________________________________
ALZA PHARMACEUTICALS $ 21.3 $ 7.6 $ 3.6
ALZA TECHNOLOGIES 203.5 174.9 166.5
OTHER 2.4 0.8 3.2
_________________________________________________________________
Total royalties, fees and
other revenues $ 227.2 $ 183.3 $ 173.3
_________________________________________________________________
Percentage of total revenues 39% 39% 42%
_________________________________________________________________
ALZA PHARMACEUTICALS
In 1998, fee revenue for ALZA Pharmaceuticals included
technology fees of $10.7 million from Crescendo and a fee from
Synthelabo for the rights to commercialize OROS oxybutynin
(Ditropan XL in the United States) in Europe, and co-promotion
fees with respect to products co-promoted by ALZA Pharmaceuticals.
In 1997, ALZA Pharmaceuticals' fee revenue consisted of $4.0 million
in technology fees from Crescendo, and copromotion fees. Fee
revenue in 1996 consisted of co-promotion and commercialization fees.
ALZA TECHNOLOGIES
Royalties, fees and other revenues for ALZA Technologies
increased 16% in 1998 compared to 1997, primarily as a result of
increased royalties due to a higher effective royalty rate on and
increased sales of Duragesic by Janssen, and a higher royalty rate
on and increased sales of Glucotrol XL-registered trademark
(glipizide) by Pfizer, Inc. ("Pfizer"). Partially offsetting
these increases in royalties were lower royalties on sales of
Procardia XL by Pfizer and NicoDerm CQ by SB. Commercialization
and licensing fees also contributed to the increase in royalties,
fees and other revenues in 1998 compared with 1997. Fee revenues
for 1998 included an upfront payment from Janssen related to the
initiation of a new transdermal fentanyl product development
program.
On June 29, 1998, ALZA Development Corporation, a wholly-
owned subsidiary of ALZA, elected to exercise its option to
acquire all of the outstanding limited partnership interests in
the TTS 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 (determined under a formula set
in 1983) was paid in cash to the limited partners on August 14,
1998. ALZA had been paying the TTS Partnership four percent of
net sales of Duragesic and Testoderm-registered trademark-
(testosterone) two products developed by ALZA on behalf of the
TTS 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 acquisition cost.
<PAGE>
As of September 1998, ALZA and Janssen entered into an
agreement under which Janssen is making a series of eight
quarterly payments to ALZA over two years to help defray ALZA's
substantial purchase price paid for the limited partnership
interests in the TTS Partnership. In exchange, the royalty rate
payable by Janssen to ALZA with respect to Duragesic has been
reduced by a portion of the rate that ALZA had previously paid to
the TTS Partnership.
As of March 1998, ALZA and Alkermes entered into an
exclusive license agreement for two of ALZA's oral drug delivery
technologies: RingCap-trademark- and dose sipping technology.
Under this arrangement, ALZA granted Alkermes worldwide rights to
the two technologies and Alkermes will be responsible for
continuing research and development of products incorporating
them. ALZA received upfront payments from Alkermes and will
receive a portion of Alkermes' revenues from the development and
commercialization of products incorporating the technologies.
The growth in royalties, fees and other revenues in 1997
compared with 1996 was due to increased sales of Glucotrol XL,
Duragesic, NicoDerm CQ, and Catapres-TTS-registered trademark
(clonidine). These increases were partially offset by decreased
royalties on sales of Procardia XL. Commercialization and
licensing fees also contributed to the increase in royalties,
fees and other revenues in 1997 compared with 1996. Fees for
1997 included upfront payments from Knoll Pharmaceutical Company
in connection with an agreement for continued development and
worldwide commercialization of the OROS-registered trademark
hydromorphone product, from SB in connection with an agreement
for the commercialization of the Nicoderm product in numerous
international markets, and from Pfizer for the rights to
commercialize the OROS-registered trademark- pseudoephedrine
product in certain countries outside the U.S.
Sales of Procardia XL, as reported by Pfizer, decreased 13%
in 1998 from 1997, and decreased 18% in 1997 from 1996.
Royalties from Procardia XL accounted for approximately 8% of
total revenues in 1998, compared with 12% in 1997 and 18% in
1996. Several companies have filed Abbreviated New Drug
Applications ("ANDA") with the United States Food and Drug
Administration ("FDA") requesting clearance to market generic
equivalents to Procardia XL, and one company has received
tentative FDA approval of its ANDA. Pfizer has filed suit against
these companies for infringement of patent rights relating to the
nifedipine active drug substance in Procardia XL, and is also
involved in litigation with the FDA and one of the ANDA
applicants concerning the regulatory status of the company's
product. It is not possible to predict the timing and amount of
the negative impact on sales of Procardia XL that will result
from competition from these or other potential generic sustained
release nifedipine products.
<PAGE>
RESEARCH AND DEVELOPMENT
ALZA's research and development revenues generally represent
reimbursement of costs, including a portion of general and
administrative expenses, by clients, including Crescendo (and
previously, TDC) for development of products. Therefore, product
development activities do not contribute significantly to
operating results.
Research and Development Revenues
(Dollars in millions) 1998 1997 1996
_________________________________________________________________
ALZA PHARMACEUTICALS
Crescendo $ 93.0 $ 28.2 $ -
TDC - 63.3 96.6
_________________________________________________________________
Total ALZA Pharmaceuticals 93.0 91.5 96.6
_________________________________________________________________
ALZA TECHNOLOGIES
Crescendo 2.0 1.5 -
TDC - 4.5 4.1
Other clients 29.4 37.5 30.5
Intersegment 100.2 95.4 99.8
_________________________________________________________________
Total ALZA Technologies 131.6 138.9 134.4
Intersegment elimination (100.2) (95.4) (99.8)
Total research and development
revenues $ 124.4 $135.0 $ 131.2
_________________________________________________________________
Percentage of total revenues 21% 29% 32%
_________________________________________________________________
ALZA PHARMACEUTICALS
ALZA Pharmaceuticals derives research and development
revenues from Crescendo and, prior to 1998, TDC. Revenues from
Crescendo (and TDC) are offset by intersegment charges from ALZA
Technologies for research and development expenses incurred on
behalf of ALZA Pharmaceuticals for research and development
related to products under development for marketing by ALZA
Pharmaceuticals.
Crescendo Pharmaceuticals Corporation
In September 1997, ALZA contributed $300.0 million in cash to
Crescendo for Crescendo's Class A Common Stock (the "Crescendo
Shares"). Also in September 1997, the Crescendo Shares were
distributed to the holders of ALZA common stock and ALZA's
outstanding convertible subordinated debentures. ALZA recorded a
charge of $247.0 million (including expenses of $4.0 million) and
interest expense of $8.0 million related to ALZA's contribution
to Crescendo and the distribution to stockholders and debenture
holders, respectively. ALZA also recorded a dividend of $49.1
million to ALZA stockholders in connection with the distribution
of the Crescendo Shares.
Under a Development Agreement between ALZA and Crescendo,
Crescendo is funding the development of human pharmaceutical
products proposed by ALZA and accepted by Crescendo. The
development of certain specified products was funded by Crescendo
beginning August 25, 1997, the date on which TDC ceased funding
the development of such products.
Under a Technology License Agreement between ALZA and
Crescendo, ALZA has granted to Crescendo a worldwide license to
use ALZA technology solely to select and develop Crescendo
products, to conduct related activities, and to commercialize
Crescendo products. In exchange for the license to use existing
ALZA technology relating to the products initially under
development by ALZA and Crescendo, Crescendo pays a technology
fee to ALZA, payable monthly over a period of three years, in the
amount of $1.0 million per month for the 12 months following the
distribution of the Crescendo Shares, $667,000 per month for the
following 12 months and $333,000 per month for the following 12
months. The technology fee will no longer be payable at such
time as fewer than two of the seven initial products under
development by ALZA and Crescendo are being developed by
Crescendo and/or have been licensed by ALZA pursuant to the
option, granted to it by Crescendo, to license any or all
Crescendo products. ALZA recorded technology fee revenue from
Crescendo of $10.7 million and $4.0 million for 1998 and 1997,
respectively. Three of the seven initial products were in
development and/or had been licensed at December 31, 1998.
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. In December 1998, ALZA
exercised its option to obtain a worldwide license to OROS
oxybutynin (Ditropan XL). Under the terms of the license
agreement, ALZA will make payments to Crescendo based upon
worldwide sales of the product, which was developed by ALZA on
behalf of Crescendo. In consideration of the grant of the license,
ALZA must pay Crescendo 2.5% of net sales of the licensed product for
the first year, 3% for the second and third years. Thereafter, until
15 years after the date of the first commercial sale of the product,
the percentage would be based upon development costs of the
product paid by Crescendo; based upon current information, this
rate is expected to be between 5% and 6%.
In addition, under Crescendo's Restated Certificate of
Incorporation, ALZA has the right to purchase all (but not less
than all) of the Crescendo Shares at a price based upon a pre
established formula, discussed in Note 7 to the consolidated
financial statements.
<PAGE>
Therapeutic Discovery Corporation
In September 1997, ALZA purchased all of the outstanding
shares of TDC Class A Common Stock for $100.0 million in cash.
The purchase resulted in a charge of $77.0 million to acquisition of
inprocess research and development. Approximately $23.0 million
of the purchase price was allocated to a deferred tax asset
arising from TDC's net operating loss carryforwards and capitalized
<PAGE>
research and development expense. TDC was formed by ALZA in 1993
to develop and commercialize products incorporating ALZA's drug
delivery technologies. At the time of its purchase by ALZA, TDC
had a broad range of products in development, although none of
these products had yet received regulatory approval for
marketing. A significant portion of the purchase price was
charged to the acquisition of in-process research and development
because the TDC products were under development and had not yet
been approved by the FDA. In addition, because TDC had rights
only to specific products, and not technology, the products
acquired had no alternative future uses.
ALZA TECHNOLOGIES
Research and development revenues decreased 5% in 1998
compared to 1997, reflecting a decline in product development
activities under agreements with client companies. The increase
in research and development revenues in 1997 compared to 1996 was
due to product development activities undertaken on behalf of
client companies and ALZA Pharmaceuticals. The 1996 research and
development revenues were reduced by charges related to a credit
from ALZA to TDC and a write-off of potentially uncollectible
receivables totaling $2.1 million. Research and development
revenues increased 2% in 1997 compared to 1996, excluding the
1996 charges, reflecting an increase in product development under
ALZA's agreements with client companies, partially offset by a
decline in revenues from ALZA Pharmaceuticals.
Research and Development Expenses
(Dollars in millions) 1998 1997 1996
_________________________________________________________________
ALZA PHARMACEUTICALS
Intersegment $ 100.2 $ 95.4 $ 99.8
_________________________________________________________________
ALZA TECHNOLOGIES 150.8 151.5 137.7
_________________________________________________________________
OTHER 6.0 5.3 3.9
_________________________________________________________________
Intersegment elimination (100.2) (95.4) (99.8)
Total research and development
expenses $ 156.8 $ 156.8 $ 141.6
_________________________________________________________________
As a percentage of total revenues 27% 34% 34%
_________________________________________________________________
<PAGE>
ALZA PHARMACEUTICALS
ALZA Pharmaceuticals engages ALZA Technologies to perform
research and development services, the cost of which is
determined based upon amounts that would be charged to third
parties for similar services. Expenses related to these services
were relatively constant in 1998, 1997 and 1996, reflecting
expenses relating to Crescendo products and, to a small extent,
other research and development projects.
<PAGE>
Development and Option Agreements
In September 1997, ALZA entered into a clinical development
and option agreement with Alkermes relating to Cereport, a
compound intended to facilitate the delivery of chemotherapeutic
agents to the brain. Under the terms of the agreement, ALZA paid
Alkermes $10.0 million, which was charged to acquisition of in-
process research and development. Under the agreement, Alkermes
is conducting additional clinical activities related to Cereport,
and ALZA has the option to acquire exclusive worldwide
commercialization rights to the product.
ALZA entered into two agreements with Janssen, effective
December 31, 1997, modifying the previous arrangements between
the parties relating to two E-TRANS fentanyl products. Under one
agreement, ALZA Pharmaceuticals is continuing the development,
with Crescendo, of an E-TRANS fentanyl product for the treatment
of chronic and breakthough pain. Janssen will have an option,
exercisable until 90 days after ALZA has spent $30.0 million on
product development, to take over funding the continued
development of the product and to commercialize the product
worldwide. If Janssen exercises its option, ALZA will receive a
share of the United States operating profits from the product and
royalties from sales of the product outside the United States,
and ALZA Pharmaceuticals will have the right to co-promote the
product. If Janssen does not exercise its option, ALZA may
continue the development of the product, which ALZA did not have
the right to develop independent of Janssen prior to the
modification of the arrangements with Janssen. The second
agreement is discussed below under "ALZA Technologies."
ALZA TECHNOLOGIES
Research and development expenses in 1998 compared to 1997
were relatively constant after excluding $1.4 million in costs
related to workforce reductions in 1997. The increase in
research and development expenses in 1997 compared to 1996
reflects the increased activity for client companies, including
ALZA Pharmaceuticals.
Development Agreement
ALZA entered into two agreements with Janssen, effective
December 31, 1997, modifying the previous arrangements between
the parties relating to two E-TRANS fentanyl products. Under a
development and commercialization agreement, ALZA and Janssen
modified the agreement pursuant to which the companies were
jointly developing Transfenta, for the treatment of acute pain.
In connection with this modified agreement,
<PAGE>
ALZA made a one-time payment of $21.5 million to Janssen.
As the product was not yet approved by the FDA and has no
alternative future use, the payment was charged to
acquisition of in-process research and development.
ALZA will receive a share of the United States operating
profits from the product and royalties from sales of
the product outside the United States, and ALZA Pharmaceuticals
will have the right to co-promote the product. The product is in
Phase III clinical development. Prior to the modifications
described above, the agreement with Janssen for Transfenta was a
typical client arrangement for ALZA under which Janssen paid
all development costs, and ALZA would receive a royalty based on
sales of the product, if it was successfully developed. The second
agreement is discussed above under ALZA Pharmaceuticals.
OTHER
Other research and development expenses primarily comprise
ALZA's commercial development costs that are of a general
corporate nature and are not allocated to ALZA Pharmaceuticals or
ALZA Technologies. These costs have increased in 1998 and 1997
over prior years as ALZA increases its efforts in connection with
various product acquisition, licensing and distribution
arrangements with other companies.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
(Dollars in millions) 1998 1997 1996
_________________________________________________________________
ALZA PHARMACEUTICALS
Sales and marketing expenses $ 77.0 $ 28.8 $ 24.2
_________________________________________________________________
Total 77.0 28.8 24.2
_________________________________________________________________
ALZA PHARMACEUTICALS
Amortization of product acquisition
payments 11.1 4.0 2.2
ALZA TECHNOLOGIES
Amortization of product acquisition
payments 4.6 - -
_________________________________________________________________
Total 15.7 4.0 2.2
_________________________________________________________________
OTHER
General and administrative expenses 13.9 19.0 20.7
_________________________________________________________________
Total selling, general and
administrative expenses $106.6 $51.8 $ 47.1
_________________________________________________________________
Total selling, general and
administrative expenses a
percentage of total revenues 18% 11% 11%
_________________________________________________________________
<PAGE>
ALZA PHARMACEUTICALS
Sales and marketing expenses increased substantially in 1998
as compared to 1997 as a result of a significant increase in the
size of ALZA's sales organization, and its expanded sales and
marketing activities. In July 1998, ALZA entered into
arrangements with VIVUS, Inc. and Innovex, Inc. whereby ALZA
expanded its sales organization from approximately 100 to
approximately 360 sales professionals.
<PAGE>
Higher sales and marketing expenses in 1997 compared with
1996 resulted from the expansion of ALZA's sales organization and
increased marketing costs in support of Ethyol, Mycelex Troche
and Elmiron.
Amortization of product acquisition payments for the ALZA
Pharmaceuticals segment increased significantly in 1998 compared
to 1997 due to a full year of amortization of the acquisition
costs of products acquired in 1997 and, to a lesser extent,
products acquired in 1998. The 1997 increase in amortization
expense compared with 1996 was due to the amortization of
acquisition costs of products acquired in 1997.
ALZA TECHNOLOGIES
Amortization of product acquisition payments for ALZA
Technologies increased significantly in 1998 compared to 1997 due
to six months amortization of the $91.2 million exercise price to
acquire all of the outstanding limited partnership interests in
the TTS Partnership discussed above. For reporting purposes,
these costs are treated as product acquisition costs because they
relate to acquiring the rights to Duragesic and retaining all
royalties paid by Janssen on sales of that product.
OTHER
General and administrative expenses declined 25% in 1998
compared to 1997, excluding $0.4 million in costs related to
workforce reductions in 1997. This decline is due to lower
allocated depreciation and facilities costs, a reduction in
certain corporate costs and an increase in the cash surrender
value of company-owned life insurance policies. General and
administrative expenses declined 10% in 1997 compared to 1996
excluding the costs described above. While corporate
administrative costs increased 5% in 1997 compared with 1996,
this increase was offset by an increase in the cash surrender
value of life insurance policies.
<PAGE>
INTEREST INCOME AND EXPENSE
NET INTEREST
(Dollars in millions) 1998 1997 1996
_________________________________________________________________
Interest and other income $ (24.8) $ (55.6) $ (52.9)
Distribution to debenture holders - 8.0
Interest expense 56.3 55.0 43.0
_________________________________________________________________
Net interest and other
expense (income) $ 31.5 $ 7.4 $ (9.9)
_________________________________________________________________
Interest and other income decreased 55% in 1998 compared to
1997 primarily due to significantly lower average invested cash
balances during 1998. ALZA's lower cash balances in 1998 are
attributable to the purchase of 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
exercise of the option to acquire all of the outstanding limited
partnership interests in the TTS Partnership, which occurred in
the third quarter of 1998.
Interest and other income increased 5% in 1997 compared to
1996, primarily due to higher average invested cash balances
during 1997 following ALZA's issuance of $500.0 million of the 5%
Debentures in April 1996, offset by lower realized gains on the
sales of investments in 1997 compared with 1996.
Interest expense increased 2% in 1998 compared to 1997, as a
result of higher interest on the 5 1/4% zero coupon convertible
subordinated debentures due 2014 (the "5 1/4% Debentures") issued
in 1994.
Interest expense increased 28% in 1997 compared to 1996, as
the 5% Debentures were outstanding for all of 1997. Also
contributing to the increase were lower amounts of capitalized
interest on construction projects and higher interest on the 5
1/4% Debentures.
The 1997 distribution to debenture holders is related to the
Crescendo transaction as discussed under "Crescendo
Pharmaceuticals Corporation" above.
INCOME TAXES
In 1998, ALZA's effective income tax rate was 35%. In 1997,
ALZA recorded income tax expense of $49.7 million despite ALZA's
pretax loss, as certain charges recognized in 1997 are generally
not deductible for income tax purposes. ALZA's 1997 effective
income tax rate was 35% excluding such items, compared to 38% in
1996. The rate decline in 1998 and 1997 from 1996 was primarily
due to increased investment and research tax credits.
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY AND CAPITAL RESOURCES
(In millions) 1998 1997 1996
_________________________________________________________________
Working capital $ 270.9 $ 253.4 $ 494.8
Cash and investments 488.6 535.8 999.8
Total assets 1,576.3 1,369.2 1,613.7
Long-term debt 922.6 902.6 882.3
Net cash provided by (used in)
operating activities 144.2 (185.9) 123.3
Capital expenditures 58.0 38.8 48.6
Product acquisition payments 127.6 140.1 -
_________________________________________________________________
During 1998, ALZA paid $91.2 million in cash for the
purchase of all of the outstanding limited partnership interests
of the TTS Partnership. Also in 1998, ALZA made an upfront fee
payment of $25.0 million to SB for the United States rights to
Urispas, and made additional fee payments of $6.2 million to HMRI
for the immediate release Ditropan product, and $5.0 million to
U.S. Bioscience ("USB") related to Ethyol. Cash for these
transactions was provided from the sales and maturities of short-
and long-term investments, as well as from cash and cash
equivalents.
During 1997, ALZA paid $100.0 million in cash for the
purchase of all of the shares of TDC, and contributed $300.0
million in cash to Crescendo. Also in 1997, ALZA paid Bayer a
$50.0 million upfront fee for the United States rights to Mycelex
Troche, made a $10.0 million payment to USB related to Ethyol and
made an upfront payment of $75.0 million to IVAX for the United
States and Canadian rights to Elmiron and three additional
urology products. ALZA also paid $10.0 million to Alkermes under
the agreement related to Cereport. Also during 1997, ALZA made a
$36.2 million investment in areal estate joint venture, described
below. Cash for these transactions was provided from the sales and
maturities of short and long-term investments, as well as from cash
and cash equivalents.
Cash flow provided by operating activities in 1998 was
$165.7 million, excluding a $21.5 million payment to Janssen in
January 1998 discussed above under "Certain Items Affecting
Comparability of Operating Results". Cash flow provided by
operating activities in 1997 was $149.8 million excluding a
$247.0 million charge and $8.0 million interest expense relating
to ALZA's distribution of shares of Crescendo; a $77 million
charge relating to the purchase of TDC; a $10.0 million payment
to Alkermes under an agreement relating to Cereport; and $1.8
million in severance payments; and an $8.1 million income tax
benefit. These items are discussed above under "Certain Items
Affecting Comparability of Operating Results." Cash flow from
operating activities in 1996 was $123.3 million.
<PAGE>
In late 1997, ALZA acquired a 50% interest in a real estate
joint venture for the development of a 13-acre parcel of land in
Mountain View, California. ALZA invested $36.2 million in the
joint venture, which will be applied to the construction of
buildings on the parcel. ALZA is also obligated to make
improvements to the buildings, the total cost of which is
estimated to be in excess of $100.0 million; approximately $39.2
million had been spent as of December 31, 1998. The improvements
are currently expected to be completed during the fourth quarter
of 1999. The joint venture will lease the buildings to ALZA upon
completion of construction. The leases provide for an initial
term of 15 years with scheduled annual rent increases, followed
by two 10-year extension periods with rent increases based upon
the Consumer Price Index. ALZA receives 50% of the joint
venture's income.
ALZA has also entered into a ground lease agreement for an
adjacent seven-acre parcel of land on which it may construct a
pilot plant, laboratories and other technical facilities. The
term of the ground lease is approximately 33 years and includes
options for ALZA to purchase, or to be required to purchase, the
property.
ALZA's capital spending for 1998 was $58.0 million for
additions to property, plant and equipment to support its
expanding research, development and manufacturing activities,
compared to capital spending of $38.8 million in 1997 and $48.6
million in 1996. 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 medium-term and long-term requirements. Capital
expenditures in 1999 are expected to increase over 1998 levels.
ALZA believes that its existing cash and investment balances
are adequate to fund its cash needs for 1999 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 to acquire or license technology or products. ALZA may also
enter into strategic alliances with third parties that could
provide access to additional capital.
Acquisition of SEQUUS Pharmaceuticals, Inc.
On October 5, 1998, ALZA and SEQUUS announced that the
companies entered into a definitive merger agreement under which
ALZA would acquire SEQUUS, subject to SEQUUS' stockholder
approval and certain other conditions. Under the terms of the
agreement, ALZA acquired all of SEQUUS' outstanding stock in a
tax-free, stockfor-stock transaction on March 16, 1999. SEQUUS
stockholders received 0.4 shares of ALZA common stock for each
share of SEQUUS common stock. Based upon SEQUUS' outstanding
shares, ALZA issued 13.2 million shares as a result of the
acquisition. ALZA may issue up to 1.7 million additional shares
upon the exercise of outstanding SEQUUS options, warrants and
purchase rights. ALZA will account for the transaction as a pooling
of interests.
<PAGE>
OUTLOOK
Notice Concerning Forward-Looking Statements
The following is intended to provide an outlook for 1999 and
beyond. To the extent any statements made in this section or
elsewhere in this management's discussion and analysis or in the
financial statements deal with information that is not
historical, these statements are forward-looking. Such
statements include, 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
development of products 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 from those
presented in this outlook, some or all of which are not
predictable or within ALZA's control. Many risks and
uncertainties are inherent in the pharmaceutical industry; others
are more specific to ALZA's business. Many of the significant
risks related to ALZA's business are described in Item 1 of this
Form 10-K Annual Report, and some are also discussed briefly
below.
Net Sales
Net sales of products marketed by ALZA Pharmaceuticals
are expected to increase significantly in 1999 due to the
launch of Ditropan XL and the marketing by ALZA of Doxil.
Wholesaler stocking patterns, managed care and formulary
acceptance, the introduction of competitive products, and
acceptance by patients, physicians and formularies will affect
future sales of ALZA's products.
ALZA expects that 1999 contract manufacturing revenues for
ALZA Technologies are expected to increase slightly from 1998
levels. Because many factors affecting contract manufacturing
activities are not within ALZA's control, revenues will fluctuate
from period to period depending on the volume, mix and timing of
orders received from client companies and ALZA Pharmaceuticals.
Gross Margins on Net Sales
ALZA expects that gross margins, as a percentage of net
sales, will continue to increase over the longer term, although
quarter-toquarter fluctuations will continue to occur. Higher
gross margins may be achieved through continuing the
proportionate increase in the sales by ALZA Pharmaceuticals
(as compared with sales from contract manufacturing), and
increased utilization of capacity and greater operating
efficiencies by ALZA Technologies.
<PAGE>
Royalties, Fees and Other Revenues
Fees for ALZA Pharmaceuticals in 1999 are expected to
include $6.7 million in technology fees from Crescendo. Fees for
1999 may also include upfront fees from third parties in
connection with arrangements for the commercialization of
Crescendo products.
ALZA expects royalties, fees and other revenues for ALZA
Technologies to continue to increase in 1999 as a result of
growth in sales of products currently marketed by client
companies. Sales of Procardia XL, and therefore ALZA's royalties
from this product, are expected to continue to decline in 1999.
ALZA expects fee revenue to continue to contribute to its
operating results. Fees for 1999 are expected to include the
quarterly fee from Janssen discussed above under "Royalties, Fees
and Other Revenues."
Royalties, fees and other revenues, which are derived
largely from sales by client companies of products developed by
ALZA Technologies, vary from quarter to quarter as a result of
changing levels of product sales by client companies and,
occasionally, the receipt by ALZA of fees. Because ALZA's
clients generally take responsibility for obtaining necessary
regulatory approvals and make all marketing and commercialization
decisions regarding these products, most of the variables that
affect ALZA's royalties, fees and other revenues are not directly
within ALZA's control. Sales of products from which ALZA derives
royalties and fees are affected by the clients' marketing efforts
and the introduction and marketing of competing products, among other
factors. Fees are onetime in nature and will vary from year to year
and quarter to quarter.
During the next several years, ALZA intends to continue
reducing its dependence on royalties and fees by further
expanding ALZA's sales and marketing activities and by directly
marketing and selling more products through ALZA Pharmaceuticals,
including products developed with Crescendo. However, there can
be no assurance that ALZA will be successful in undertaking 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 ALZA marketing by ALZA Pharmaceuticals, the
difficulties and costs associated with acquiring from third
parties products for ALZA Pharmaceuticals 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, risks relating to patents and
proprietary rights and the current health care cost containment
environment. 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.
<PAGE>
Research and Development
ALZA expects that Crescendo will expend its available funds
within the next two years. The rate of expenditure by Crescendo
will depend upon the continued development of products currently
under development by ALZA and Crescendo, and new products
proposed by ALZA and accepted by Crescendo for development.
After Crescendo expends its available funds, ALZA Pharmaceuticals
will incur significant expenses for research and development
services provided by ALZA Technologies that will no longer be
reimbursed by Crescendo.
To maintain or increase 1998 product development revenue
levels, ALZA will need to enter into new arrangements with client
companies to replace revenues lost when programs terminate or
products are submitted for regulatory clearance or cleared for
marketing. Development agreements with client companies are
generally terminable by the clients on short notice and may be
terminated for many reasons, including technical issues,
marketing concerns, reallocation of client resources, and changes
in client priorities. In addition, product development revenues
from any particular client program could decrease dramatically
once the New Drug Application for the product has been filed, and
could decrease earlier if the client, rather than ALZA, were to
undertake the clinical development of a product. In 1999, ALZA
expects to continue its current level of internal research and
development in order to continue strengthening ALZA's leadership
in the drug delivery field.
Selling, General and Administrative Expenses
Sales and marketing expenses for ALZA Pharmaceuticals are
expected to continue to increase in 1999, primarily due to growth
in marketing efforts resulting from the acquisition of new
products and the introduction of products developed by ALZA. The
increase in the size of ALZA's sales organization in late 1998
will increase sales and marketing expenses in 1999 compared to
1998. Sales and marketing expenses are also expected to increase
due to the launch of Ditropan XL, which occurred in February
1999, and as ALZA increases its activities for Doxil.
Amortization of product acquisition costs for 1999 will include
ongoing amortization of costs of products acquired in prior years,
as well as additional payments under the arrangements for the
acquisition of the products.
In August 1998, ALZA entered into an agreement under which
UCB Pharma, Inc. ("UCB Pharma") is co-promoting Ditropan XL in
the United States. UCB Pharma's approximately 350 sales
professionals will bring the total number of sales professionals
dedicated to the product's introduction to more than 700. UCB
Pharma will receive a payment based on sales of Ditropan XL above
certain levels. The term of the co-promotion arrangement
continues through March 2002. This arrangement will result in
increased sales and marketing expenses beginning in 1999.
<PAGE>
For ALZA Technologies, selling, general and administrative
expenses in 1999 will include a full year of amortization of
costs relating to the 1998 acquisition of limited partnership
interests from the TTS Partnership.
Interest and Other Income
Interest and other income is expected to be somewhat lower
in 1999 as a result of the reduction of cash and investment
balances in 1998.
As a result of ALZA's investment in a real estate joint
venture and construction of buildings in Mountain View, which are
scheduled to be completed in late 1999, ALZA has been evaluating
its real estate holdings and future facilities needs. ALZA
expects to sell or lease certain Palo Alto and/or Mountain View
properties in the near term, which could result in substantial
gains in 1999 and lease income in 2000 and beyond.
Income Tax Rate
ALZA currently expects its combined federal and state 1999
effective income tax rate to be approximately 35%. The actual
effective income tax rate will depend upon the actual level of
earnings, changes in the tax laws, and the amount of investment
and research credits available and ALZA's ability to utilize such
credits. Additionally, the ability to utilize SEQUUS' net
operating losses will likely reduce ALZA's combined effective
tax rate in 1999.
Year 2000
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 inventoried and evaluated for Year 2000
compliance. Internal systems will be upgraded or replaced or
contingency plans will be developed, as necessary. 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.
<PAGE>
Year 2000 costs incurred to date have not been material.
Total costs to modify ALZA's systems for Year 2000 compliance are
expected to be less than $2.0 million. Such costs do not include
normal system upgrades and replacements and the actual financial
impact could exceed this estimate.
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 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
ALZA's exposure to market risk for changes in interest rates
relates primarily to ALZA's investment portfolio and long-term
debt obligations. ALZA does not use derivative financial
instruments in its investment portfolio. ALZA's investment
policy requires investments with high credit quality issuers and
limits the amount of credit exposure to any one issuer.
The table below presents principal amounts and related
weighted-average interest rates by year of maturity for ALZA's
investment portfolio:
<PAGE>
(In millions) There- Fair
1999 2000 2001 2002 2003 after Total Value
____________________________________________________________________
Cash and cash equivalents
Fixed Rate
Securities $105.3 - - - - - $105.3 $105.3
Average Interest
Rate 5.44% - - - - - 5.44%
____________________________________________________________________
Short-term Investments
Fixed Rate
Securities$ 67.0 - - - - - $ 67.0 $67.0
Average Interest
Rate 5.65% - - - - - 5.65%
____________________________________________________________________
Long-term Investments
Fixed Rate
Securities - $94.1 $67.0 $54.2 $42.9 - $258.2 $261.0
Average Interest
Rate - 6.17% 6.48% 6.60% 6.23% - 6.35%
____________________________________________________________________
Total Investments
Securities $172.3 $94.1 $67.0 $54.2 $42.9 - $430.5 $433.3
Average Interest
Rate 5.52% 6.17% 6.48% 6.60% 6.23% - 6.02%
____________________________________________________________________
ALZA is exposed to equity price risks on the marketable
portion of equity securities included in its portfolio of
investments entered into to further its business and strategic
objectives. These investments are generally in small
capitalization stocks in the pharmaceutical and biotechnology
industry sector, in companies which ALZA has research and
development or product agreements. ALZA typically does not
attempt to reduce or eliminate its market exposure on these
securities. A 20% adverse change in equity prices would result
in an approximate $11.0 million decrease in ALZA's available-for-
sale securities, based upon a sensitivity analysis performed on
ALZA's financial position at December 31, 1998. However, actual
results may differ materially.
ALZA derives royalty revenues from client companies with
significant sales to customers in foreign counties. ALZA
believes its exposure to foreign currency exchange rate risks is
generally limited to such royalty revenues. ALZA does not use
derivative financial instruments to mitigate this exposure.
<PAGE>
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ALZA Corporation
CONSOLIDATED STATEMENT OF OPERATIONS
Years ended December 31,
(In millions, except per share amounts)
1998 1997 1996
_________________________________________________________________
REVENUES
Net sales $ 232.9 $ 146.1 $ 108.6
Royalties, fees and other 227.2 183.3 173.3
Research and development, including
amounts from Crescendo, a related party
(1998-$95.0, 1997-$29.7) and TDC, a
related party
(1997-$67.8, 1996-$100.7) 124.4 135.0 131.2
_____________________________
Total revenues 584.5 464.4 413.1
COSTS AND EXPENSES
Costs of products shipped 116.8 92.8 85.2
Research and development 156.8 156.8 141.6
Selling, general and administrative 106.6 51.8 47.1
Acquisitions of in-process
research and development - 108.5 -
Contribution to Crescendo, a related
party - 247.0 -
Asset write-down - 11.5 -
____________________________
Total costs and expenses 380.2 668.4 273.9
____________________________
Operating income (loss) 204.3 (204.0) 139.2
Interest expense 56.3 55.0 43.0
Distribution to debenture holders - 8.0 -
Interest and other income (24.8) (55.6) (52.9)
____________________________
Net interest and other expense
income) 31.5 7.4 (9.9)
____________________________
Income (loss) before income taxes 172.8 (211.4) 149.1
Provision for income taxes 60.5 49.7 56.7
____________________________
Net income (loss) $ 112.3 $(261.1) $ 92.4
============================
Earnings (loss) per share
Basic $ 1.30 $ (3.07) $ 1.10
Diluted $ 1.26 $ (3.07) $ 1.08
Shares
Basic 86.4 85.1 84.2
Diluted 100.5 85.1 97.2
See accompanying notes.
<PAGE>
ALZA Corporation
CONSOLIDATED BALANCE SHEET
December 31,
(In millions, except per share amounts) 1998 1997
_________________________________________________________________
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 103.7 $ 65.0
Short-term investments 67.0 109.2
Receivables, net of allowance for doubtful
accounts(1998-$1.8; 1997-$0.8) 124.2 104.2
Receivable from Crescendo, a related party 17.5 15.0
Inventories 50.7 37.8
Prepaid expenses and other current assets 25.9 26.8
___________________
Total current assets 389.0 358.0
PROPERTY, PLANT AND EQUIPMENT
Buildings and leasehold improvements 224.2 209.6
Equipment 170.3 145.0
Construction in progress 50.6 22.9
Land and prepaid land leases 34.4 24.3
____________________
479.5 401.8
Less accumulated depreciation and
amortization (118.5) (91.4)
___________________
Net property, plant and equipment 361.0 310.4
___________________
Investments in long-term securities 317.9 361.6
Deferred product acquisition payments 279.1 147.2
Other assets 229.3 192.0
___________________
TOTAL ASSETS $1,576.3 $1,369.2
===================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 55.7 $ 56.9
Accrued liabilities 56.3 45.9
Current portion of long-term debt 6.1 1.8
___________________
Total current liabilities 118.1 104.6
5% convertible subordinated debentures 500.0 500.0
5 1/4% zero coupon convertible subordinated
debentures 422.6 402.6
Other long-term liabilities 80.4 60.8
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value, 0.1 shares
authorized - -
Common stock, $.01 par value, 300.0 shares
authorized; 87.3 and 85.5 shares issued
and outstanding in
1998 and 1997, respectively 0.9 0.9
Additional paid-in capital 429.0 381.5
Accumulated other comprehensive income (loss) (10.6) (4.8)
Retained earnings (deficit) 35.9 (76.4)
_____________________
Total stockholders' equity 455.2 301.2
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $1,576.3 $1,369.2
=====================
See accompanying notes.
<PAGE>
ALZA Corporation
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Years ended December 31, 1998, 1997 and 1996
(In millions)
ACCUMULATED TOTAL
ADDITIONAL OTHER RETAINED STOCK-
COMMON PAID-IN COMPREHENSIVE EARNINGS HOLDERS'
STOCK CAPITAL INCOME(LOSS) (DEFICIT) EQUITY
Balance, December 31,
1995 $0.8 $ 310.5 $ 1.9 $141.4 $ 454.6
Common stock issued - 51.7 - - 51.7
Comprehensive income (loss)
Net income - - - 92.4 92.4
Unrealized gains on
securities of $3.2, net of
reclassification adjustment
for gains included in net
income of $5.2 - - (2.0) - (2.0)
________________________________________________________________________
Total comprehensive income
(loss) 90.4
________________________________________________________________________
Balance, December 31, 1996 0.8 362.2 (0.1) 233.8 596.7
________________________________________________________________________
Common stock issued 0.1 19.3 - - 19.4
Distribution of Crescendo
Shares - - - (49.1) (49.1)
Comprehensive income (loss)
Net loss - - - (261.1) (261.1)
Unrealized losses on
securities of $1.0, net of
reclassification adjustment
for gains included in net
income of $3.7 - - (4.7) - (4.7)
________________________________________________________________________
Total comprehensive income
(loss) (265.8)
________________________________________________________________________
Balance, December 31, 1997 0.9 381.5 (4.8) (76.4) 301.2
________________________________________________________________________
Common stock issued - 47.5 - - 47.5
Comprehensive income (loss)
Net income - - - 112.3 112.3
Unrealized losses on
securities of $4.8, net of
reclassification adjustment
for gains included in net
income of $1.0 - - (5.8) - (5.8)
________________________________________________________________________
Total comprehensive income
(loss) 106.5
________________________________________________________________________
Balance, December 31, 1998 $0.9 $429.0 (10.6) $35.9 $ 455.2
========================================================================
See accompanying notes.
<PAGE>
ALZA Corporation
CONSOLIDATED STATEMENT OF CASH FLOWS
(In millions)
Years ended December 31, 1998 1997 1996
________________________________________________________________________
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $112.3 $(261.1) $92.4
Non-cash adjustments to reconcile net
income (loss)
to net cash provided by (used in)
operating activities:
Depreciation and amortization 32.2 29.3 19.8
Amortization of product acquisition
payments 15.7 4.0 2.2
Interest on 5 1/4% zero coupon
convertible subordinated debentures 21.4 20.3 19.3
Decrease (increase) in assets:
Receivables (22.6) (2.6) (8.6)
Inventories (13.0) 1.5 (4.7)
Prepaid expenses and other
current assets 4.9 (4.4) (1.2)
Increase (decrease) in liabilities:
Accounts payable 0.3 28.1 8.7
Accrued liabilities (11.1) 8.7 7.8
Deferred revenue - (0.4) (17.2)
Other long-term liabilities 4.1 (20.8) 4.8
Asset write-down - 11.5 -
_______________________________
Total adjustments 31.9 75.2 30.9
_______________________________
Net cash provided by (used in)
operating activities 144.2 (185.9) 123.3
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (58.0) (38.8) (48.6)
Product acquisition payments (36.4) (140.1) -
Purchase of limited partners'
interests in ALZA TTS Research
Partners, Ltd. (91.2) - -
Investment in real estate joint
venture - (36.2) -
Purchase of TDC deferred tax asset - (23.0) -
Purchases of available-for-sale
securities (261.2) (370.8) (1,125.2)
Sales of available-for-sale
securities 287.3 680.9 542.6
Maturities of available-for-sale
securities 50.2 23.3 98.1
Increase in cash surrender value-life
insurance and prepaid premiums (21.8) (12.8) (20.3)
Decrease (increase) in other assets (16.7) 12.4 (9.6)
______________________________
Net cash provided by (used in)
investing activities (147.8) 94.9 (563.0)
CASH FLOWS FROM FINANCING ACTIVITIES:
Distribution of Crescendo
Pharmaceuticals Corporation
shares to ALZA stockholders _ (49.1) -
Net proceeds from 5% convertible
subordinated debentures - - 488.8
Issuances of common stock 46.1 19.4 51.7
Principal payments on long-term debt (3.8) (2.0) (1.1)
_______________________________
Net cash provided by (used in)
financing activities 42.3 (31.7) 539.4
_______________________________
Net increase (decrease) in cash and
cash equivalents 38.7 (122.7) 99.7
Cash and cash equivalents at the
beginning of year 65.0 187.7 88.0
_______________________________
Cash and cash equivalents at the
end of year $ 103.7 $ 65.0 $ 187.7
===============================
See accompanying notes.
<PAGE>
ALZA Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
ALZA Corporation is a research-based pharmaceutical company
with leading drug delivery technologies. ALZA applies its
delivery technologies to develop pharmaceutical products with
enhanced therapeutic value for its own portfolio and for many of
the world's leading pharmaceutical companies. ALZA is currently
focusing its sales and marketing efforts in urology and oncology.
Nature of Operations
Net sales includes sales of products marketed directly by
ALZA and through distributors, and sales generated from contract
manufacturing activities for ALZA's client companies. ALZA
recognizes sales revenues at the time of product shipment, net of
discounts, rebates and allowances.
ALZA's contract manufacturing activities are undertaken with
respect to products developed as a result of ALZA's client-funded
product development arrangements. Under the third party
arrangements, ALZA is reimbursed for its costs of developing the
products; ALZA often manufactures the product for the client,
generally for a supply price intended to cover ALZA's costs to
manufacture the product plus a small margin; and ALZA receives
royalties based on the client's sales of the products.
Royalties, fees and other revenues include royalty revenue
and other payments based on sales by ALZA's client companies of
products developed under joint development and commercialization
agreements, and certain one-time or infrequent fees or similar
payments under such agreements. Included in royalties, fees and
other revenues are revenues from ALZA's promotion and co-
promotion of certain products, some of which are contingent on
sales. Royalties, fees and other revenues are recognized as
earned. ALZA recognizes upfront fee revenues on or after the
effective date of the licensing, copromotion or other agreement,
when there are no contingencies or conditions to ALZA's receipt
of the payments. ALZA recognizes milestone fee revenues when all
of the conditions to payment have been met and there are no further
contingencies or conditions to ALZA's receipt of payment.
Such fees, when recognized, are not refundable, and do not require
any future performance by ALZA in order to retain them.
Revenues from research and development activities with
client companies, including Crescendo, are reported as research
and development revenues, and are recognized as earned. ALZA's
research and development revenues represent clients'
reimbursement to ALZA of costs incurred in product development
and clinical evaluation, including a portion of general and
administrative expenses, and therefore do not contribute
significantly to operating income. Research and development
revenues are recognized when billable in accordance with the
terms prescribed in each respective client development agreement
(billed based upon labor and
<PAGE>
other costs incurred during the period). Such revenues are
not refundable. ALZA's policy is to expense all costs of
research and product development related both
to costs incurred on its own behalf and on behalf of its clients.
Credit and Investment Risks
Royalties, fees and other revenues and research and
development revenues are generally derived from agreements with
major pharmaceutical company clients and Crescendo, all of which
have significant cash resources. Therefore, ALZA considers its
credit risk related to these transactions to be minimal. ALZA's
net sales result from sales of ALZA-marketed products primarily
to major pharmaceutical distributors, and sales from contract
manufacturing for ALZA's client companies. If the financial
condition or operations of any of the pharmaceutical distributors
were to deteriorate substantially, ALZA's operating results could
be adversely affected.
ALZA generally invests excess cash in securities of banks
and companies from a variety of industries with strong credit
ratings, and in U.S. government obligations. These securities
typically bear minimal risk and ALZA has not experienced any
losses on its investments due to institutional failure or
bankruptcy. ALZA's investment policy is designed to limit
exposure with any one institution.
Principles of Consolidation
The consolidated financial statements include the accounts
of ALZA and its wholly-owned subsidiaries, ALZA Development
Corporation, ALZA International, Inc., ALZA Land Management,
Inc., ALZA Limited and, since its acquisition in September 1997,
TDC. All significant intercompany accounts and transactions have been
eliminated.
Use of Estimates
The preparation of financial statements in accordance with
generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported
in the financial statements and accompanying notes. Actual
results could differ from those estimates.
Cash, Cash Equivalents and Short-term Investments
Cash and cash equivalents include cash balances and
investments with maturities of three months or less at the time
of purchase. Short-term investments include commercial paper and
other highly liquid investments with maturities less than one
year. The carrying amount reported on the balance sheet for cash,
cash equivalents and short-term investments approximates their
fair value.
<PAGE>
Stock-Based Compensation
ALZA accounts for stock option grants in accordance with APB
Opinion No. 25, Accounting for Stock Issued to Employees. ALZA
currently grants stock options for a fixed number of shares to
employees and directors with an exercise price equal to the fair
value of the shares at the date of grant, and therefore records
no compensation expense.
Inventories
Raw materials, work in process and finished goods
inventories are stated at the lower of standard cost (which
approximates actual costs on a first-in, first-out cost method)
or market value.
Inventories consist of the following (in millions):
1998 1997
__________________________
Raw materials $ 15.7 $16.5
Work in process 10.6 8.5
Finished goods 24.4 12.8
__________________________
Total inventories $ 50.7 $37.8
==========================
Property, Plant and Equipment
Property, plant and equipment are stated at cost, including
capitalized interest of $1.5 million in 1998, $0.7 million in
1997 and $2.2 million in 1996. Maintenance and repairs are
expensed as incurred. Depreciation and amortization are
generally computed on the straight-line method, over estimated
useful lives, as follows:
Classification Estimated Useful Life
Buildings 30 to 40 years
Leasehold improvements Terms of the leases (1 to 5 years)
Equipment 3 to 9 years
Prepaid land leases Remaining terms of the leases (16
to 59 years)
Depreciation and amortization expense for property, plant
and equipment was $25.0 million, $24.7 million and $17.8 million
for 1998, 1997 and 1996, respectively. Prepaid land leases
represent ALZA's total cost, paid in advance, of leasehold rights
to land upon which certain of ALZA's buildings in Palo Alto,
California are situated. Included in construction in progress at
December 31, 1998 are payments made in connection with facilities
being constructed or modified, and the installation of related
equipment in Palo Alto and Mountain View, California (primarily
research and development) and Vacaville, California (primarily
commercial manufacturing).
Deferred Product Acquisition Costs and Acquisition of In-process
Research and Development
Initial payments and distribution fees for the acquisition
of products that, at the time of acquisition by ALZA, are already
marketed or are approved by the FDA for marketing (or for which
such approval is imminent) are capitalized and amortized over the
estimated life cycle of the products, which range from 10 to 20
years. At the time of acquisition, the product life cycle is
estimated by ALZA based upon the
<PAGE>
term of the agreement, the patent life of the product and,
for products that are no longer covered by patents, the product's
historical profitability trend since it has been off-patent and
management's assessment of future sales and profitability of the
product. This estimate is assessed regularly during the
amortization period and the asset value or useful life is reduced
when appropriate. Accumulated amortization of these costs was
$21.9 million, $6.2 million and $2.2 million at December 31,
1998, 1997 and 1996, respectively.
Payments for rights to products acquired by ALZA when they
are in development and not yet approved by the FDA (and which
have no alternative future use) are recognized as charges to
acquisition of in-process research and development. Charges to
in-process research and development were $108.5 million in 1997.
Long-Lived Assets
ALZA routinely evaluates the carrying value of its long-
lived assets. ALZA records impairment losses on long-lived
assets used in operations when events and circumstances indicate
that assets may be impaired and the undiscounted cash flows
estimated to be generated by the assets are less than the
carrying amount of those assets.
In 1997, ALZA wrote down approximately $11.5 million of
fixed assets, $3.7 million of which related to excess
manufacturing equipment. Lower than expected production
requirements under a supply agreement with G.D. Searle & Co. for
Covera-HS-trademark(verapamil) contributed to the excess capacity
of manufacturing equipment. Such equipment was written down to
its fair market value, which was determined based upon estimates of
current market prices. The remaining $7.8 million of the write-down
is related primarily to custom-designed manufacturing and research
and development equipment that was determined to have limited or
no future use based upon changes in production volumes or product
formulations. ALZA has returned certain custom designed
manufacturing equipment to the vendor, and is using other
manufacturing equipment to a limited extent. ALZA continues to
pursue alternative uses for the remaining equipment and will
dispose of equipment with no alternative future use.
Accrued Liabilities
Accrued liabilities are as follows (in millions):
1998 1997
_________________________
Accrued compensation $ 23.0 $17.7
Accrued income taxes 22.5 9.7
Other accrued liabilities 10.8 18.5
_________________________
Total accrued liabilities $ 56.3 $45.9
=========================
<PAGE>
Advertising Costs
Advertising costs are accounted for as expenses in the
period in which they are incurred. Advertising expense for 1998,
1997 and 1996 was $15.3 million, $6.4 million and $4.4 million,
respectively.
Supplemental Disclosures of Cash Flow Information (in millions)
Cash paid during the year for:
1998 1997 1996
_________________________
Income taxes $ 34.2 $ 59.5 $ 42.2
Interest, net of amount
capitalized 29.3 36.6 16.3
Non cash investing and financing activities:
1998 1997 1996
_________________________
Net unrealized losses
on available-for-sale
securities, net of tax effect $ (5.8) $(4.7) $(2.0)
Acquisition of building in lieu of
repayment of note receivable 17.5 - -
Accrued product and license
acquisition costs 20.0 - -
Conversion of 5 1/4% Debentures into
ALZA common stock 1.4 - -
Deferred issuance costs for
5% Debentures - - 11.2
Investment in low-income housing
in exchange for long term debt 23.6 17.1 11.9
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. The adoption of SFAS 130 had no
impact on ALZA's results of operations or financial position.
The following table shows the tax effect allocated to each
component of comprehensive income for the years ended December
31, 1998, 1997 and 1996:
<PAGE>
Before-Tax Tax(Expense) Net-ofTax
(In millions) Amount or Benefit Amount
_________________________________
Unrealized gains on available-
for-sale securities $5.0 $(1.8) $3.2
Less: reclassification adjustment
for gains realized in net income 8.4 (3.2) 5.2
_________________________________
Net unrealized loss for the year ended
December 31, 1996 (3.4) 1.4 (2.0)
=================================
Unrealized losses on available-
for-sale securities (1.9) 0.9 (1.0)
Less: reclassification adjustment
for gains realized in net income 6.1 (2.4) 3.7
__________________________________
Net unrealized loss for the year ended
December 31, 1997 (8.0) 3.3 (4.7)
==================================
Unrealized losses on available-
for-sale securities (8.3) 3.5 (4.8)
Less: reclassification adjustment
for gains realized in net income 1.5 (0.5) 1.0
___________________________________
Net unrealized loss for the year ended
December 31, 1998 $(9.8) $4.0 $(5.8)
===================================
Segment Information
In 1998, ALZA adopted FASB Statement No. 131, "Disclosures
about Segments of an Enterprise and Related Information" ("SFAS
131"). The new rules establish revised standards for the
reporting of financial and descriptive information about
operating segments in financial statements. The adoption of SFAS
131 did not have a material effect on ALZA's financial
statements, but did affect the disclosure of segment information
contained in Note 13.
Note 2. INVESTMENTS
ALZA has classified its entire investment portfolio,
including cash equivalents of $105.3 million and $64.1 million at
December 31, 1998 and 1997, respectively, as available-for-sale.
Investments in the available-for-sale category are generally
carried at fair value with unrealized gains and losses recorded
as a separate component of stockholders' equity. At December 31,
1998, net unrealized losses on available-for-sale securities were
$10.6 million, net of $7.3 million tax effect. At December 31,
1997, net unrealized losses on available-for-sale securities were
$4.8 million, net of $3.4 million tax effect. The cost of
securities when sold is based upon specific identification.
Realized gains and losses for the year ended December 31, 1998
were $1.7 million and $0.2 million, respectively. Realized gains
and losses for the year ended December 31, 1997 were $7.6 million
and $1.5 million, respectively.
<PAGE>
The following is a summary of ALZA's investment portfolio (in
millions):
December 31, 1998 December 31, 1997
Esti- Esti-
Amor- Unreal- Unreal- mated Amor- Unreal- Unreal- mated
tized rized rized Fair tized rized rized Fair
Cost Gains Losses Value Cost Gains Losses Value
_________________________________________________________________________
U.S. Treasury
securities
and obligations of
U.S. government
agencies $63.5 $ 0.6 $(0.1) $64.0 $143.2 $ 0.4 $ (0.3) $143.3
Collateralized
mortgage obligations
and asset backed
securities 58.4 0.4 - 58.8 70.9 0.3 (0.2) 71.0
Corporate debt
securities 308.6 2.0 (0.1) 310.5 251.9 0.9 (0.4) 252.4
___________________________________________________________
Total debt
securities 430.5 3.0 (0.2) 433.3 466.0 1.6 (0.9) 466.7
Equity
securities 77.6 - (20.7) 56.9 77.1 1.1 (10.0) 68.2
___________________________________________________________
Total available
for sale 508.1 3.0 (20.9) 490.2 543.1 2.7 (10.9) 534.9
Less cash
equivalents (105.3) - - (105.3) (64.1) - - (64.1)
____________________________________________________________
Total
investments $402.8 $3.0 $ (20.9) $384.9 $ 479.0 $ 2.7 $ (10.9) $470.8
=============================================================
<PAGE>
The amortized cost and estimated fair value of debt securities
at December 31, 1998 and 1997, by contractual maturity, are shown
below. Expected maturities will differ from contractual
maturities because the issuers of the securities may have the
right to prepay certain of the obligations without prepayment
penalties.
(in millions)
December 31, 1998 1997
_____________________________________________________________________
Estimated Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value
_____________________________________________________________________
Due in one year or less $172.4 $172.3 $ 173.5 $ 173.4
Due after one year
through four years 215.3 217.5 235.0 235.5
Due after four years
through eight years 42.8 43.5 57.5 57.8
__________________________________________
Total $430.5 $433.3 $ 466.0 $ 466.7
==========================================
In early 1997, ALZA purchased approximately 1.2 million
common shares of USB (4.9% of the outstanding common shares at that
time) at a price of $18.256 per share, for an aggregate investment of
$21.5 million. Beginning in the first quarter of 1998, this stock
has been classified as available for sale and recorded at fair
market value. Prior to 1998, ALZA could not dispose of the
shares for one year from the balance sheet date and, in
accordance with SFAS 115, "Accounting for Certain Investments in
Debt and Equity Securities", the shares were considered
restricted stock and therefore recorded at cost. ALZA and USB
are parties to a marketing and distribution agreement for Ethyol,
which is described in Note 4.
In early 1997, ALZA purchased 2.0 million common shares of
Alkermes (9.7% of the outstanding common shares at that time) at
a price of $25.0 per share, for an aggregate investment of
$50.0 million. This stock is not restricted and is therefore
classified as available-for-sale. In 1997, ALZA entered into a
clinical development and option agreement with Alkermes for
Cereport, which is described in Note 4. In 1998, ALZA and
Alkermes entered into an exclusive license agreement for two of
ALZA's oral drug delivery technologies, RingCap and dose sipping
technology, which is described in Note 4.
<PAGE>
NOTE 3. PER SHARE INFORMATION
Basic earnings (loss) per share is calculated by dividing
net income (loss) by the weighted average common shares
outstanding for the period. Diluted earnings (loss) per share is
calculated by dividing net income (loss) 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 (loss) per share (in millions, except
per share amounts):
1998 1997 1996
_________________________
NUMERATOR:
Basic
Net income (loss) $112.3 $(261.1) $ 92.4
==========================
Diluted
Net income (loss) $112.3 $(261.1) $ 92.4
Interest on 5 1/4% Debentures,
net of tax 14.2 - 12.2
__________________________
Adjusted net income (loss) $126.5 $(261.1) $104.6
==========================
DENOMINATOR:
Basic
Weighted average shares 86.4 85.1 84.2
==========================
Diluted
Weighted average shares 86.6 85.1 84.2
Effect of dilutive securities:
Employee stock options 1.6 - 0.7
5 1/4% Debentures 12.3 - 12.3
__________________________
Weighted average shares and
assumed conversions 100.5 85.1 97.2
==========================
Basic earnings (loss) per share $ 1.30 $(3.07) $ 1.10
==========================
Diluted earnings (loss) per share $ 1.26 $(3.07) $ 1.08
==========================
Outstanding options to purchase 0.1 million shares of ALZA's
common stock were excluded from the 1998 earnings per share
calculation for the year ended December 31, 1998 because the
exercise price of the options was greater than the average market
price. The potentially dilutive effect of the 5% Debentures
would have been anti-dilutive in all periods presented, and were
therefore excluded from the diluted earnings per share
calculation. In 1997, the potentially dilutive effect of the 5
1/4% Debentures and employee stock options would have been anti-
dilutive and were therefore excluded from the diluted
calculation.
<PAGE>
NOTE 4: ACQUISITIONS OF PRODUCT RIGHTS AND DEVELOPMENT AND OPTION
AGREEMENTS
Product Acquisitions
In late 1995, ALZA entered into a marketing and distribution
agreement with USB for Ethyol. Under the terms of the agreement,
ALZA has exclusive rights to market the product in the United
States for five years after its launch in April 1996, and is
responsible for sales and marketing; the USB sales force co
promotes the product with ALZA. After the five-year period, which
ALZA has an option to extend for one year, marketing rights to
Ethyol will revert to USB, and ALZA will receive payments from
USB for ten years based on continued sales of the product. ALZA
paid USB an upfront payment and initial distribution fees
totaling $20.0 million in 1995 and 1996. Of this amount,
approximately $13.3 million was attributed by ALZA to the initial
FDA approved indication (ovarian cancer) and was capitalized.
Approximately $6.7 million, which was attributed by ALZA to potential
expanded product indications not yet approved by the FDA, was charged
to selling, general and administrative expenses. ALZA paid $10.0
million in distribution fees in 1997 based on USB clinical
activities relating to Ethyol, and paid an additional $5.0
million in early 1998, both of which were capitalized.
In July 1997, ALZA acquired exclusive rights to Mycelex
Troche in the United States from Bayer. Under the terms of the
agreement, ALZA made a $50.0 million upfront payment to Bayer, which
was capitalized, and will make an additional payment if net sales of
the product during a certain period are above a specified level.
Bayer manufactures Mycelex Troche for ALZA.
In October 1997, ALZA acquired the exclusive rights in the
United States and Canada to Elmiron and three additional urology
products, BiCitra, PolyCitra and Neutra-Phos, from IVAX. Under
the terms of the agreement, ALZA paid a $75.0 million upfront fee
to IVAX, which was capitalized, and must pay additional fees if
specified Elmiron sales levels are achieved during the five years
ending October 2002. ALZA incurred an additional fee of $8.5
million in 1998 based upon Elmiron sales, which was capitalized.
IVAX manufactures the products for ALZA and receives payments
from ALZA based on sales of the products.
In October 1997, ALZA acquired the rights in the United
States to the immediate-release Ditropan product and trademark
from HMRI. ALZA also acquired the rights to the product in Canada
in April 1998 from HMRI and P&G. Under the terms of the
agreements, ALZA made upfront payments, which were capitalized.
ALZA incurred additional fees of $12.5 million in 1998 based upon
Ditropan sales levels in the United States, which were
capitalized. HMRI manufactures the product for ALZA. ALZA has
the right to market other products in the United States and
Canada under the Ditropan trademark, and HMRI will receive
royalty payments from ALZA if the trademark is used by ALZA with
other products, such as Ditropan XL.
<PAGE>
In November 1998, ALZA acquired the exclusive marketing and
distribution rights in the United States to Urispas from SB.
Under the terms of the agreement, ALZA paid a $25.0 million
upfront fee to SB, which was capitalized, and may be required to
make additional milestone payments. SB manufactures the product
for ALZA.
Development and Option Agreements
In September 1997, ALZA entered into a clinical development
and option agreement with Alkermes relating to Cereport, a
compound intended to facilitate the delivery of chemotherapeutic
agents to the brain. Under the terms of the agreement, ALZA paid
Alkermes $10.0 million, which was charged to acquisition of in-
process research and development. Under the agreement, Alkermes
is conducting additional clinical activities related to Cereport,
and ALZA has the option to acquire exclusive worldwide
commercialization rights to the product.
ALZA entered into two agreements with Janssen, effective
December 31, 1997, modifying the previous arrangements between
the parties relating to two E-TRANS fentanyl products. Under a
development and commercialization agreement, ALZA and Janssen
modified the agreement pursuant to which the companies were
jointly developing Transfenta. In connection with this modified
agreement, ALZA made a one-time payment of $21.5 million to
Janssen. As the product was not yet approved by the FDA and has
no alternative future use, the payment was charged to acquisition
of in-process research and development. ALZA will receive a
share of the United States operating profits from the product and
royalties from sales of the product outside the United States.
The product is currently in Phase III clinical development. Under
the second agreement, ALZA will continue the development of an E-
TRANS fentanyl product for the treatment of chronic and
breakthrough pain. Janssen will have an option, exercisable
until 90 days after ALZA has spent $30 million on the product, to
take over funding the continued development of the product and to
commercialize the product worldwide. If Janssen exercises its
option, ALZA will receive a share of the United States operating
profits from the product and royalties from sales of the product
outside the United States. If Janssen does not exercise its option,
ALZA may continue the development of the product, which is currently
under development with Crescendo, and which ALZA did not have the
right to develop independent of Janssen prior to the modification of
the arrangements.
In April 1998, ALZA and Alkermes entered into an exclusive
license agreement for two of ALZA's oral drug delivery
technologies: RingCap and dose sipping technology. The
arrangement gives Alkermes worldwide rights to the two
technologies and Alkermes will be responsible for the continued
research and development of products incorporating them. Alkermes
will pay ALZA upfront payments and revenues from the development
and commercialization of products incorporating the technologies.
For the arrangements described above, the amounts paid by ALZA
were charged to acquisition of in-process research and
development because the products were under development and had
not yet been approved by the FDA, and the products had no
alternative future use.
<PAGE>
NOTE 5: DEBT OBLIGATIONS AND OTHER LONG-TERM LIABILITIES
In 1996, ALZA issued $500 million of 5% convertible
subordinated debentures due 2006 (the "5% Debentures"). Each 5%
Debenture is convertible, at the option of the holder, into
shares of ALZA common stock at an initial conversion price of
$38.19 per share, subject to certain anti-dilution adjustments.
At anytime on or after May 1, 2000, the 5% Debentures are
redeemable at ALZA's option at a premium to their face value.
From May 1, 1999 to May 1, 2000, the 5% Debentures are redeemable
at ALZA's option if ALZA's common stock trades above a certain
level. Interest is payable semiannually. The 5% Debentures rank
pari passu with ALZA's outstanding 5 1/4% Debentures discussed
below. Unamortized costs related to the issuance of the 5%
Debentures were $8.8 million at December 31, 1998 and were
included in other assets. At December 31, 1998 and 1997, the fair
value of the 5% Debentures was $723.6 million and $526.9 million,
respectively.
In 1994, ALZA issued 5 1/4% zero coupon convertible
subordinated debentures due 2014 (the "5 1/4% Debentures"). The
5 1/4% Debentures were issued at a price of $354.71 per $1,000
principal amount at maturity. The 5 1/4% Debentures have a principal
amount at maturity of $945.6 million, with a yield to maturity of
5 1/4% per annum, computed on a semiannual bond equivalent basis.
There are no periodic interest payments. At the option of the
holder, each 5 1/4% Debenture is convertible into 12.987 shares of
common stock. At the option of the holder, the 5 1/4% Debentures
will be purchased by ALZA on July 14, 1999, July 14, 2004 or July
14, 2009, at a purchase price equal to the issue price plus
accreted original issue discount to such purchase date. ALZA, at
its option, may elect to deliver either common stock or cash in
the event of conversion or purchase of the 5 1/4% Debentures.
ALZA, at its option, may redeem any or all of the 5 1/4%
Debentures for cash after July 14, 1999 at a redemption price
equal to the issue price plus accreted original issue discount.
Unamortized costs related to the issuance of the 5 1/4%
Debentures were $7.0 million at December 31, 1998. At December
31, 1998 and 1997, the fair value of the 5 1/4% Debentures was
$650.6 million and $441.2 million, respectively.
<PAGE>
Other Long-term Liabilities
ALZA's other long-term liabilities are as follows (in millions):
1998 1997
_______________________
Long-term debt $ 40.4 $25.0
Deferred compensation 40.0 35.8
_______________________
Total other long-term liabilities $80.4 $60.8
=======================
At December 31, 1998 and 1997, long-term debt consists of
notes representing the required future payments under investments
of $52.5 million and $32.1 million, respectively, in low income
housing partnerships (included in other assets). The aggregate
annual maturities of long-term debt at December 31, 1998 were
$6.2 million in 1999, $6.8 million in 2000, $6.5 million in 2001,
$6.3 million in 2002 and $5.7 million in 2003.
ALZA has deferred compensation arrangements under which
selected employees may defer a portion of their salaries. ALZA
has purchased life insurance policies that it intends to use to
partially finance amounts to be paid in the future to
participants, based on their deferred salary amounts plus
interest. The cash surrender value of these policies totaled
$93.0 million and $71.2 million at December 31, 1998 and 1997,
respectively, and is included in other assets.
NOTE 6: CAPITAL STOCK AND WARRANTS
In connection with the formation of TDC, ALZA issued
warrants to purchase approximately 1.0 million shares of common
stock at an exercise price of $65 per share. The warrants, to
the extent not exercised, will expire on December 31, 1999.
ALZA is authorized to issue 100,000 shares of preferred
stock, $.01 par value, none of which was outstanding at December
31, 1998 or 1997. The Board of Directors may determine the
rights, preferences and privileges of any preferred stock issued
in the future.
NOTE 7: ARRANGEMENTS WITH CRESCENDO PHARMACEUTICALS CORPORATION
AND THERAPEUTIC DISCOVERY CORPORATION (RELATED PARTIES)
Crescendo Pharmaceuticals Corporation
Crescendo was formed by ALZA for the purpose of selecting and
developing human pharmaceutical products, and commercializing
such products, most likely through licensing to ALZA. On
September 29, 1997, ALZA contributed $300.0 million in cash to
Crescendo. On September 30, 1997, all of the Crescendo Shares
were distributed to the holders of ALZA common stock and ALZA's
outstanding convertible subordinated debentures. ALZA recorded a
charge of $247.0 million (including expenses of $4.0 million) and
interest expense of $8.0 million related to the distribution to
stockholders and debenture holders, respectively. ALZA also
recorded a dividend of $49.1 million for the distribution of the
Crescendo Shares to ALZA stockholders. The interest expense and
dividend amount were
<PAGE>
determined according to the fair market
value (based on NASDAQ trading prices immediately following the
distribution) of the Crescendo shares distributed to debenture
holders and stockholders, respectively. The excess of the amount
contributed to Crescendo over the fair market value of the
shares, along with transaction expenses, was recorded as an
expense.
In connection with the contribution to Crescendo and the
distribution of the Crescendo Shares, ALZA and Crescendo entered
into a number of agreements. Crescendo and ALZA entered into a
Development Agreement for the selection and development of human
pharmaceutical products. Under the agreement, Crescendo funds
the development of products recommended by ALZA for development
and accepted by Crescendo. The development of certain specified
products was funded by Crescendo beginning August 25, 1997, the
date on which TDC ceased funding the development of such
products.
Under a Technology License Agreement between ALZA and
Crescendo, ALZA has granted to Crescendo a worldwide license to
use ALZA technology solely to select and develop Crescendo
products, and to conduct related activities, and to commercialize
such products. In exchange for the license to use existing ALZA
technology relating to seven products initially under development
by Crescendo and ALZA, Crescendo pays a technology fee to ALZA,
payable monthly over a period of three years, in the amount of
$1.0 million per month for the 12 months following the
distribution of the Crescendo Shares, $667,000 per month for the
following 12 months and $333,000 per month for the following 12
months. The technology fee will no longer be payable at such
time as fewer than two of the seven initial products are being
developed by Crescendo and/or have been licensed by ALZA pursuant
to the option, granted to it by Crescendo, to license any or all
Crescendo products. ALZA recorded technology fee revenue from
Crescendo of $10.7 million and $4.0 million for 1998 and 1997,
respectively. Three of the seven initial products were in
development or had been licensed at December 31, 1998.
ALZA recognizes the technology fee from Crescendo when
earned. Since Crescendo owes the fee at the end of each month if,
and only if, at least two of the "initial products" remain in
development at the end of each month, the fee is not earned until
the end of each month in which the test is satisfied.
Development of any or all of the Initial Products could be
terminated by Crescendo at any time, and four of these products
are no longer in active development or under license. The
monthly technology fee payments are not guaranteed, and the
conditions precedent to their payment have not been fulfilled and
cannot be fulfilled before the end of each month. At the time
ALZA accrues the Crescendo technology fee, ALZA has no future
performance obligations to Crescendo in order to earn the fee
that is being accrued.
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. In December 1998, ALZA
exercised its option to obtain a worldwide license to OROS
oxybutynin (Ditropan XL). In consideration of the grant
<PAGE>
of the license, ALZA must pay Crescendo 2.5% of net sales of the
licensed product for the first year, 3% for the second and third
years. Thereafter, until 15 years after the date of the first
commercial sale of the product, the percentage would be based
upon development costs paid by Crescendo; based upon current
information this rate is expected to be between 5% and 6%.
Under the terms of the services agreement, ALZA performed
certain administrative services for Crescendo for which ALZA was
reimbursed its direct costs plus certain overhead expenses. ALZA
recorded service revenue of $0.2 million in 1998, and service
revenue in 1997 was insignificant.
In addition, under Crescendo's Restated Certificate of
Incorporation, ALZA has the right to purchase all (but not less
than all) of the Crescendo Shares at a price based upon a pre
established formula (the "Purchase Option"). The Purchase Option
price will be determined as the greatest of the following:
(a)(i) 25 times the actual payments made by or due from ALZA
to Crescendo under the Development Agreement and the License
Agreement with respect to any product (and, in addition, such
payments as would have been made by or due from ALZA to Crescendo
if ALZA had not previously exercised its payment buy-out option
with respect to any such payments) for the four calendar quarters
immediately preceding the quarter in which the Purchase Option is
exercised (provided, however, that for any product which has not
been commercially sold during each of such four calendar
quarters, the portion of the exercise price for such product will
be 100 times the average of the quarterly payments made by or due
from ALZA to Crescendo for each of such calendar quarters during
which such product was commercially sold) less (ii) any amounts
previously paid to exercise any payment buy-out option;
(b) the fair market value of one million shares of ALZA Common
Stock;
(c) $325 million less all amounts paid by or due from
Crescendo under the Development Agreement to the date the
Purchase Option is exercised; and
(d) $100 million.
In each case, the amount payable as the Purchase Option
exercise price will be reduced to the extent, if any, that
Crescendo's liabilities at the time of exercise (other than
liabilities under the Development Agreement, the Technology
License Agreement and the Services Agreement) exceed Crescendo's
cash and cash equivalents and short-term and long-term
investments (excluding the amount of Available Funds remaining at
such time). ALZA may pay the exercise price in cash, in ALZA
Common Stock or in any combination of cash and ALZA Common Stock.
<PAGE>
Therapeutic Discovery Corporation
On September 29, 1997, ALZA purchased all of the Class A
Common Stock of TDC for $100.0 million in cash. This acquisition
was recorded as a purchase and, accordingly, the purchase price
was allocated to assets acquired based upon their fair market
value on the acquisition date. The purchase resulted in a charge
of $77.0 million to acquisitions of in-process research and
development, and the remaining $23.0 million of the purchase
price was allocated to a deferred tax asset arising from TDC's
net operating loss carryforward and capitalized research and
development.
ALZA and TDC had a development contract pursuant to which
ALZA conducted research and development activities on behalf of
TDC. Product development revenues from TDC during 1997 and 1996
under this development contract were $67.8 million and $100.7
million, respectively. ALZA performed certain administrative
services for TDC under an administrative services agreement for
which ALZA was reimbursed its direct costs, plus certain overhead
expenses. For the years ended 1997 and 1996, administrative
service revenue under this agreement was $0.4 million and $0.2
million, respectively, and is included in royalties, fees and
other revenues.
NOTE 8: EMPLOYEE COMPENSATION AND BENEFIT PROGRAMS
Bonuses and Awards
ALZA has a company-wide bonus program under which
substantially all regular employees are eligible to receive a
bonus. The annual bonus pool, if any, is determined by ALZA's
Board of Directors, at its discretion, based on ALZA's
performance during the year. Bonus expenses under this program
for 1998, 1997 and 1996 were $9.2 million, $7.9 million and $6.9
million, respectively.
Defined Contribution Plan
ALZA has a company-funded, defined contribution retirement
plan for substantially all its employees. This plan provides for
an annual basic contribution and allows for additional
discretionary contributions on a year-by-year basis. Such
contributions are allocated to participants based on the
participants' salaries and ages. For 1998, 1997 and 1996, the
total expense for such contributions to this plan was $3.9
million, $3.6 million and $2.9 million, respectively.
Employee Savings Plan
ALZA has an employee savings plan which permits participants
to make contributions by salary reductions pursuant to section
401(k) of the Internal Revenue Code. ALZA makes small
contributions and matches contributions up to a specified amount
per participant. In 1998, 1997 and 1996, ALZA's contributions to
the plan were $1.8 million, $1.1 million and $0.7 million,
respectively.
<PAGE>
Stock Plan
ALZA has a stock plan whereby incentive stock options to
purchase shares of ALZA common stock at not less than the fair
market value of the stock at the date of the grant may be granted
to employees; nonstatutory stock options to purchase shares of
ALZA common stock at not less than 85% of the fair market value
of the stock at the date of grant may be granted to employees,
directors and consultants; and restricted stock may be issued.
Options typically vest one to three years from date of grant and
generally expire ten years after the date of grant. A total of
7.4 million shares of ALZA's common stock have been reserved for
issuance under its stock plan. To date, all options granted have
had exercise prices equal to the fair market value of common
stock on the date of grant.
In 1998, a total of 260,773 shares of restricted stock were
issued to a limited number of employees at a price of $0.01 per
share, the par value of the common stock. Restrictions on these
shares lapse in 2002, or upon change of control of ALZA.
In 1997, 25,000 shares of restricted stock were issued to
one employee at a price of $0.01 per share, the par value of the
common stock. Restrictions on these share lapse with respect to
25% of the shares in 1999, 50% of the shares in 2000, and 25% of
the shares in 2001. All shares for which restrictions have not
yet lapsed are subject to forfeiture in the event of termination
of the holder's employment with ALZA.
ALZA records expense for all restricted stock grants for the
difference between the market price on the date of grant and the
par value on a straight line basis over the vesting period.
Financial Accounting Standards Board SFAS No. 123,
"Accounting for Stock-Based Compensation" ("SFAS 123") prescribes
a fair value method of accounting for employee stock options.
SFAS 123 gives companies a choice of recognizing related
compensation expense by adopting the new fair value method or
continuing to measure compensation under Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB 25"). The Company has elected to continue to follow APB 25
in accounting for its employee stock options and employee stock
purchase plan.
Had compensation expense for stock options and shares issued
under the stock purchase plan been determined using the fair
value method in accordance with SFAS 123, ALZA's pro forma net
income (loss) and earnings (loss) per share would have been as
follows:
<PAGE>
(in millions, except per share amounts)
1998 1997 1996
_________________________
Net income (loss)
As reported $ 112.3 $(261.1) $ 92.4
Pro forma 96.4 (270.4) 85.8
Earnings (loss) per share (basic)
As reported $ 1.30 $ (3.07) $1.10
Pro forma 1.12 (3.18) 1.02
Earnings (loss) per share (diluted)
As reported $ 1.26 $ (3.07) $1.08
Pro forma 0.96 (3.18) 1.01
The fair value for these options was estimated at the date
of grant using the Black-Scholes option pricing model with the
following weighted average assumptions:
1998 1997 1996
______________________
Risk-free interest rate 5.5% 6.4% 6.0%
Expected dividend yield 0% 0% 0%
Expected volatility 30% 30% 30%
Expected life (in years) 3.8 4.0 3.6
Changes in the assumptions can materially affect the fair
value estimate and therefore the existing models do not
necessarily provide a reliable single measure of the fair value
of ALZA's employee stock options or shares issued under the
employee stock purchase plan.
A summary of ALZA's stock option activity, and related
information for 1998, 1997 and 1996 follows:
1998 1997 1996
______________________________________________________________________
Weighted Weighted Weighted
Average Average Average
Options Exercise Options Exercise Options Exercise
(in millions)Price(in millions)Price(in millions)Price
_______________________________________________________________________
Outstanding-
beginning
of year 6.1 $25 5.5 $ 24 5.7 $ 23
Granted 2.3 44 1.6 29 0.9 27
Exercised (1.2) 24 (0.6) 21 (0.9) 20
Forfeited (0.2) 33 (0.4) 26 (0.2) 25
_____ ______ _____
Outstanding-end
of year 7.0 31 6.1 25 5.5 24
====== ====== =====
Exercisable-end
of year 3.1 24 2.7 24 2.2 23
Weighted-average fair
value of options
granted $13.69 $9.93 $8.13
At December 31, 1998 and 1997, shares available for grant
under the stock plan were 0.4 million and 2.7 million,
respectively.
<PAGE>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
_______________________________________________________________________
Weighted-
Average
Number Remaining Weighted- Number Weighted-
Range of Outstanding Contractual Average Exercisable Average
Exercise at 12/31/98 life Exercise at 12/31/98 exercise
Prices (in millions)(in years) Price (in millions) Price
_______________________________________________________________________
$13.00-24.50 1.8 5.10 $20.98 1.7 $21.03
24.75-29.00 1.5 6.82 25.37 1.0 25.21
29.06-45.75 2.1 8.07 32.24 0.4 34.63
46.69-51.62 1.6 9.30 47.01 - -
______ ______
7.0 3.1
Employee Stock Purchase Plan
ALZA has an employee stock purchase plan in which
essentially all ALZA employees may participate and purchase stock
at 85% of its fair market value at certain specified dates.
Employee contributions are limited to 15% of compensation. In
1998, 1997 and 1996 total shares of ALZA common stock purchased
by the participants under the terms of this plan were 0.2
million, 0.3 million and 0.2 million, respectively. Since
adoption of this plan in 1984, 1.9 million shares have been
issued under this plan and 1.1 million shares are available for
issuance. The fair value of the employees' purchase rights was
estimated using the BlackScholes option pricing model with the
following weighted average assumptions for 1998, 1997 and 1996:
risk free interest rates of 5.3%, 5.4% and 5.3%, respectively;
dividend yields of zero; an expected volatility factor of the
market price of ALZA's common stock of 30%; and an expected life
of six months. The weightedaverage fair value for shares issued
under the employee stock purchase plan for 1998, 1997 and 1996
was $8.26, $6.52 and $6.00, respectively.
NOTE 9: INCOME TAXES
The provision for income taxes is as follows:
(in millions) 1998 1997 1996
__________________________________________________________________
Federal
Current $ 49.7 $46.9 $47.9
Deferred 1.4 (12.9) (2.4)
_____________________________
51.1 34.0 45.5
State
Current 11.1 16.5 11.2
Deferred (1.7) (0.8) -
9.4 15.7 11.2
_____________________________
Provision for income taxes $ 60.5 $49.7 $56.7
=============================
Tax benefits associated with employee stock option transactions
reduced current income taxes by $9.7 million, $2.3 million and
$3.3 million for 1998, 1997 and 1996, respectively.
<PAGE>
The provision for income taxes differs from the amount computed
by applying the statutory federal income tax rate to income before
income taxes. The sources and tax effects of the differences are
as follows:
(in millions) 1998 1997 1996
Expected federal tax at 35% $ 60.5 $(73.0) $ 52.2
State income taxes, net of
federal benefit 6.1 10.2 7.3
Investment and research
tax credits (7.5) (5.2) (2.3)
Purchased in-process research and
development - 113.4 -
Other 1.4 4.3 (0.5)
_______________________________
Provision for income taxes $ 60.5 $ 49.7 $56.7
===============================
Temporary differences which give rise to a significant portion of
deferred tax assets and liabilities at December 31, 1998 and 1997
are as follows (in millions):
1998 1997
Deferred tax assets:
Capitalized intangibles $ 38.1 $35.9
Compensation 19.2 16.1
State income taxes 1.0 7.4
Investments 4.2 5.7
Inventories 7.2 5.6
Bad debt 4.0 3.0
Deferred revenue - 0.1
Other 2.3 1.6
Unrealized losses on
available-for-sale securities 7.3 3.4
____________________
Total deferred tax assets 83.3 78.8
____________________
Deferred tax liabilities:
Property, plant and equipment 43.6 43.1
Other 6.0 3.9
___________________
Total deferred tax liabilities 49.6 47.0
___________________
Net deferred tax assets $ 33.7 $31.8
===================
NOTE 10: COMMITMENTS AND CONTINGENCIES
Commitments
ALZA leases certain buildings and equipment under operating
leases, the terms of which range from one to 31 years. Rent
expense under these leases for 1998, 1997 and 1996 was $2.8
million, $4.0 million and $3.7 million, respectively.
In late 1997, ALZA acquired a 50% interest in a real estate
joint venture for the development of a 13-acre parcel of land in
Mountain View, California. ALZA invested $36.2 million in the
joint venture, which will be applied to the construction of
buildings on the parcel. ALZA is also obligated to make
improvements to the buildings, the total cost of which
<PAGE>
is expected to exceed $100.0 million; approximately $39.2 million
had been spent as of December 31, 1998. The joint venture will
lease the buildings to ALZA upon completion of construction,
currently scheduled for late 1999. The leases provide for an
initial term of 15 years with scheduled annual rent increases,
followed by two 10year extension periods with rent increases
based upon the Consumer Price Index. ALZA receives 50% of the
joint venture's income.
ALZA has also entered into a ground lease agreement for an
adjacent seven-acre parcel of land on which it may construct a
pilot plant, laboratories and other technical facilities. The
term of the ground lease is approximately 33 years and includes
options for ALZA to purchase, or to be required to purchase, the
property.
Aggregate minimum lease commitments under all non-cancelable
operating lease arrangements as of December 31, 1998 were (in
millions):
1999 $ 9.4
2000 10.5
2001 10.2
2002 10.3
2003 10.6
Later years 156.6
______
Total $207.6
In January 1998, ALZA purchased a building in Mountain View,
California, which it had leased since 1992. The total purchase
price was approximately $19.0 million, which was offset by the
repayment of an outstanding note receivable from the seller. The
note receivable was included in other assets at December 31, 1997.
Contingencies
Pharmaceutical companies are subject to product liability
claims. 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 ALZA's liability
(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
ALZA's results of operations or financial position.
<PAGE>
NOTE 11. ACQUISITION OF LIMITED PARTNERS' INTERESTS IN ALZA TTS
RESEARCH PARTNERS, LTD.
On June 29, 1998, ADC, a wholly-owned subsidiary of ALZA,
elected to exercise its option to acquire all of the outstanding
limited partnership interests in the TTS 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 TTS Partnership four percent of net sales of Duragesic-
registered trademark- and Testoderm, two products developed by
ALZA on behalf of the TTS 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.
Additionally, as of September 1998 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 TTS 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 had previously paid to
the TTS Partnership.
NOTE 12. ACQUISITION OF SEQUUS PHARMACEUTICALS, INC.
On October 5, 1998, ALZA and SEQUUS announced that the
companies entered into a definitive merger agreement under which
ALZA would acquire SEQUUS, subject to SEQUUS' stockholder
approval. Under the terms of the agreement, ALZA acquired all of
SEQUUS' outstanding stock in a tax-free, stock-for-stock
transaction on March 16, 1999. SEQUUS stockholders received 0.4
shares of ALZA common stock for each share of SEQUUS common
stock. Based upon SEQUUS' outstanding shares, ALZA issued 13.2
million shares as a result of the acquisition. ALZA may issue up
to 1.7 million additional shares upon the exercise of outstanding
SEQUUS options, warrants and purchase rights. ALZA will account
for the transaction as a pooling of interests.
<PAGE>
The following unaudited pro forma data summarizes the
combined results of operations of ALZA and SEQUUS as though the
merger had occurred at the beginning of 1996:
Year ended December 31,
1998 1997 (1) 1996
____________________________
(in millions, except per share amounts)
Revenues $ 646.9 $504.4 $446.1
Net income (loss) 108.3 (275.2) 82.1
Earnings (loss) per share
Basic 1.09 (2.83) 0.86
Diluted 1.07 (2.83) 0.84
(1) Net income for the year ended December 31, 1997 reflects a
total of $368.7 million (or pro forma $3.77 per share,
diluted) of charges, net of a tax benefit of $8.1 million,
including a $247.0 million and $8.0 million of interest
expense related to ALZA's distribution of shares of Crescendo,
$108.5 million for acquired in-process research and
development, an asset write-down of $11.5 million and costs of
$1.8 million related to workforce reductions. Pro forma
combined net income excluding these items would have been
$93.4 million (or pro forma $0.94 per share, diluted).
NOTE 13: SEGMENT REPORTING
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 using the "management
approach." This approach requires reporting information
regarding operating segments on the same basis used internally by
management to evaluate segment performance. SFAS 131 is
effective beginning with the 1998 fiscal year-end financial
statements. The adoption of the new standard has no impact on
ALZA's results of operations or financial condition.
ALZA has two operating segments: ALZA Pharmaceuticals, which
includes sales of products directly to the pharmaceutical
marketplace, research and development for potential products to
be marketed by ALZA (including revenues and expenses relating to
products under development with Crescendo) and certain co-
promotion revenues for products co-promoted by ALZA; and ALZA
Technologies, which includes research, development and
manufacturing for client companies and ALZA Pharmaceuticals, and
royalties and fees resulting from sales by ALZA's client
companies of products developed under joint development and
commercialization agreements. The "Other" category primarily
comprises corporate general and administrative expenses,
including finance, legal, human resources, commercial
development, executive, and other functions not directly
attributable (or allocated) to the activities of the operating
segments, as well as rental and service fee revenues.
<PAGE>
ALZA evaluates performance and allocates resources based on
operating income or loss from operations (before allocation of
certain general and administrative expenses, net interest
expense, investment gains and losses and income taxes). ALZA
does not assess segment performance or allocate resources based
on a segment's total assets and therefore, ALZA's assets are not
reported by segment. ALZA allocates certain long-lived assets to
operating segments for purposes of allocating depreciation and
amortization expense. The accounting policies of the reportable
segments are the same as those described in the summary of
significant accounting policies. ALZA accounts for intersegment
sales based upon negotiated prices, which approximate the prices
charged to third parties.
ALZA's reportable segments are strategic units that
distribute products to different types of customers and provide
different types of services. They are managed differently
because ALZA Pharmaceuticals' sales and marketing efforts are
extensive and disparate from the revenue generation process
resulting from arrangements with client companies in ALZA
Technologies. Additionally, ALZA Pharmaceuticals develops
products for commercialization by ALZA, while ALZA Technologies
develops products for commercialization by other companies and
ALZA Pharmaceuticals.
The following tables contain information about segment
operating income (loss) for the years ended December 31, 1998,
1997 and 1996:
Year ended December 31, 1998
ALZA ALZA
(in millions) Pharmaceuticals Technologies Other Total
___________________________________________________________________
Revenues from external customers
Net sales $ 119.3 $ 113.6 $- $232.9
Royalties, fees and other 21.3 203.5 2.4 227.2
Research and development 93.0 31.4 - 124.4
____________________________________________________________________
Total 233.6 348.5 2.4 584.5
====================================================================
Intersegment revenues
Net sales - 6.6 - 6.6
Research & development - 100.2 - 100.2
____________________________________________________________________
Total - 106.8 - 106.8
====================================================================
Depreciation and amortization
expense (1) 11.5 21.6 9.9 43.0
Segment operating income(loss) 13.2 208.1 (17.0) 204.3
<PAGE>
Year ended December 31, 1997
ALZA ALZA
(in millions) Pharmaceuticals Technologies Other Total
__________________________________________________________________
Revenues from external customers
Net sales $ 52.9 93.2 $ - $146.1
Royalties, fees and other 7.6 174.9 0.8 183.3
Research and development 91.5 43.5 - 135.0
__________________________________________________________________
Total 152.0 311.6 0.8 464.4
==================================================================
Intersegment revenues
Net sales - 6.0 - 6.0
Research and development 95.4 - 95.4
__________________________________________________________________
Total - 101.4 - 101.4
==================================================================
Depreciation and amortization
expense (1) 4.2 15.6 10.1 29.9
Segment operating income
(loss) (326.7)(2) 147.6(3)(24.9) (204.0)
Year ended December 31, 1996
ALZA ALZA
(in millions) Pharmaceuticals Technologies Other Total
___________________________________________________________________
Revenues from external customers
Net sales $ 23.2 $ 85.4 $ - $108.6
Royalties, fees and other 3.6 166.5 3.2 173.3
Research and development 96.6 34.6 - 131.2
___________________________________________________________________
Total 123.4 286.5 3.2 413.1
===================================================================
Intersegment revenues
Net sales - 6.8 - 6.8
Research and development - 99.8 - 99.8
___________________________________________________________________
Total - 106.6 - 106.6
===================================================================
Depreciation and amortization
expense (1) 2.4 13.5 6.3 22.2
Segment operating income
(loss) (13.4) 174.0 (21.4) 139.2
(1) Includes depreciation expense for property, plant and
equipment and amortization expense for deferred product
acquisition costs and capitalized software.
(2) Includes charges totaling $334.0 million: acquisition of 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 under an agreement relating to the
Cereport product under development by Alkermes and a $247.0
million contribution to Crescendo.
(3) Includes charges totaling $34.4 million: $21.5 million related
to a development and commercialization agreement between ALZA
and Janssen for Transfenta-trademark-, a $11.5 million charge
relating to the write-down of excess or under-utilized
manufacturing equipment and obsolete and idle assets and a
$1.4 million charge relating to the Company's work force
reduction.
<PAGE>
The following table contains a reconciliation of ALZA's
total revenues and income before taxes to that reported by
segment in the tables above (in millions):
1998 1997 1996
__________________________________________________________________
Revenues
Total external revenues for
reportable segments $582.1 $463.6 $409.9
Intersegment revenues for
reportable segments 106.8 101.4 106.6
Other revenues 2.4 0.8 3.2
Elimination of intersegment revenues (106.8) (101.4) (106.6)
__________________________________________________________________
Total consolidated revenues $584.5 $464.4 $413.1
Income (loss) before taxes
Total operating income (loss) for
reportable segments $221.3 $(179.1) $160.6
Other loss (17.0) (24.9) (21.4)
Unallocated amounts:
Interest income 24.8 55.6 52.9
Interest expense (56.3) (63.0) (43.0)
__________________________________________________________________
Income (loss) before income taxes $172.8 $(211.4) $149.1
Company-wide Information:
Geographic Revenues
(in millions) 1998 1997 1996
__________________________________________________________________
United States $485.2 $380.2 $342.7
Canada 7.9 6.1 3.0
Europe 86.0 74.6 64.6
Other foreign countries 5.4 3.5 2.8
__________________________________________________________________
Consolidated total $584.5 $464.4 $413.1
Long-lived assets outside the United States were not
significant. Export sales, principally net sales to distributors
and client companies in Europe, were $33.7 million, $31.5 million
and $23.0 million in 1998, 1997 and 1996, respectively.
The following table shows the revenues from ALZA's major
customers as a percentage of total consolidated revenues for the
years ended December 31, 1998, 1997 and 1996.
Percentage of ALZA's Consolidated Revenues
1998 1997 1996
___________________________________________________________________
Janssen (1,2) 20% 15% 14%
Crescendo (1,2) 18 * -
Pfizer (2) 13 17 22
HMRI (2) * 10 11
TDC (1,2) - 15 24
(1) Included in the ALZA Pharmaceuticals segment
(2) Included in the ALZA Technologies segment
* Less than 10%
<PAGE>
NOTE 14: QUARTERLY FINANCIAL DATA (UNAUDITED)
(In millions, except per share amounts)
1998 1997
First Second Third Fourth First Second Third1 Fourth2
Total
revenues $130.7 $142.3 $154.8 $156.7 $105.5 $118.2 $114.5 $126.2
Gross margin 25.0 25.6 28.9 36.6 7.8 13.3 14.5 17.7
Operating in-
come (loss) 50.9 55.4 51.1 46.9 39.2 42.9 (305.9) 19.8
Net income
(loss) 28.3 30.7 27.9 25.4 26.3 26.4 (326.5) 12.7
Earnings (loss) per share
Basic $0.33 $0.35 $0.32 $0.30 $0.31 $0.31 $(3.83) $0.15
Diluted 0.32 0.34 0.31 0.29 0.30 0.30 (3.83) 0.15
___________________________________________________________________
1 In the third quarter of 1997, ALZA recorded charges totaling
$353.5 million, or $4.13 per share, diluted. These charges
included a $247.0 million charge and $8.0 million of interest
expense related to the distribution of Crescendo Shares, $87.0
million for acquired in-process research and development and an
asset write-down of $11.5 million.
2 In the fourth quarter of 1997, ALZA recorded charges of $21.5
million for acquired in-process research and development and
$1.8 million in costs related to a workforce reduction. Net of
income taxes, these charges totaled $15.2 million, or $0.17 per
share, diluted.
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
THE BOARD OF DIRECTORS AND STOCKHOLDERS
ALZA CORPORATION
We have audited the accompanying consolidated balance sheet of
ALZA Corporation as of December 31, 1998 and 1997, and the
related consolidated statements of operations, stockholders'
equity and cash flows for each of the three years in the period
ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is
to express an opinion on these financial statements based on our
audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the consolidated
financial position of ALZA Corporation at December 31, 1998 and
1997, and the consolidated results of its operations and its cash
flows for each of the three years in the period ended December
31, 1998, in conformity with generally accepted accounting
principles.
/s/Ernst & Young LLP
Palo Alto, California
January 29, 1999, except for Note 12
as to which date is March 16, 1999
<PAGE>
SCHEDULE II
ALZA CORPORATION
CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS
Years Ended December 31, 1998, 1997 and 1996
Balance at Additions Deductions
Beginning Charged to and Balance at
of Year Income write-offs End of Year
(In millions)
Allowance for
doubtful
receivables:
1998 $ 0.8 $ 1.1 $ 0.1 $ 1.8
1997 $ 0.6 $ 0.2 $ - $ 0.8
1996 $ 0.2 $ 0.4 $ - $ 0.6
<PAGE>
Item 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
ALZA incorporates by reference the information concerning
its directors set forth under the heading "Election of Directors"
on pages 1 to 4 in ALZA's definitive Proxy Statement dated March
30, 1999, for its Annual Meeting of Stockholders to be held on
May 6, 1999 (the "Proxy Statement") and the information under the
heading "Section 16(a) Beneficial Ownership Reporting Compliance"
at page 8 in the Proxy Statement. Information concerning ALZA's
executive officers appears at the end of Part I of this report on
pages 34 to 35.
Item 11. EXECUTIVE COMPENSATION
ALZA incorporates by reference the information set forth
under the headings "Summary Compensation Table", "1998 Option
Grants", "1998 Aggregated Option Exercises and Fiscal Year End
Option Values" and "Certain Executive Agreements" set forth under
the heading "Executive Compensation" on pages 5 to 11 in the
Proxy Statement.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
ALZA incorporates by reference the information set forth
under the heading "Beneficial Stock Ownership" on pages 13 to 14
in the Proxy Statement.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
ALZA incorporates by reference the information set forth
under the heading "Certain Transactions" on page 15 in the Proxy
Statement.
<PAGE>
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K
(a) Documents filed as part of this Annual Report on Form 10-K:
1. Consolidated Financial Statements: (See accompanying
Index to Consolidated Financial Statements).
2. Consolidated Financial Statement Schedule: (see
accompanying Index to Consolidated Financial Statement Schedule).
3. Exhibits:
3.1 Restated Certificate of Incorporation
of ALZA Corporation filed with the Delaware
Secretary of State on February 14, 1994(1)
3.2 Composite Bylaws of ALZA Corporation as
restated on February 10, 1994 and amended on
August 11, 1994, February 16, 1995, February 15,
1996, August 13, 1996, February 10, 1998 and
March 17, 1999.
4.1 Indenture dated July 7, 1994 between ALZA
Corporation and the Chase Manhattan Bank, N.A. as
Trustee, relating to ALZA's 5 1/4% Liquid Yield
Option-registered trademark- Notes(2)
4.2 Specimen of LYONs-trademark- Certificate
(included in Exhibit 4.1)
4.3 Form of Warrant Agreement between ALZA
Corporation and the Chase Manhattan Bank (with
attached Warrant Certificate)(3)
4.4 Indenture dated April 23, 1996 between ALZA
Corporation and the Chase Manhattan Bank, N.A.,
as Trustee, relating to ALZA's 5% Convertible
Subordinated Debentures(4)
4.5 Specimen of 5% Convertible Subordinated
Debenture (included in Exhibit 4.4)
10.1Technology License Agreement between ALZA
Corporation and Crescendo Pharmaceuticals
Corporation(5)
See footnotes on page 100.
<PAGE>
10.2 Development Agreement between ALZA
Corporation and Crescendo Pharmaceuticals
Corporation(5)
10.3 License Option Agreement between ALZA
Corporation and Crescendo Pharmaceuticals
Corporation(5)
10.4 Restated Certificate of Incorporation of
Crescendo Pharmaceuticals Corporation(5)
10.5 Amended and Restated Executive Deferral
Plan II*
10.6 Executive Deferral Plan II for Chief
Executive Officer(6)*
10.7 Executive Deferral Plan Amendments(7)*
10.8 Amendment Number 2 to Executive Deferral
Plans II(8)*
10.9 ALZA Corporation Amended and Restated
Stock Plan(9)*
10.10 Form of Executive Agreement between
ALZA Corporation and Certain Executive
Officers(10)*
10.11 Lease Agreement between ALZA and
P/A Charleston Road LLC for Building One of
Charleston Road Development Project (a
substantially identical lease is in effect for
each of two other office buildings)(11)
10.12 Construction Agreement between ALZA
and P/A Charleston Road LLC relating to three
office building lease agreements(11)
10.13 Ground Lease between ALZA and the
Peery and Arrillaga Trusts relating to a seven
acre parcel in Mountain View(11)
10.14 License Agreement between ALZA
Corporation and Crescendo Pharmaceuticals
Corporation for OROS-registered trademark
oxybutynin
21 Subsidiaries
23 Consent of Ernst & Young LLP,
Independent Auditors
27 Financial Data Schedule for the year ended
December 31, 1998
See footnotes on page 100.
<PAGE>
Footnotes to pages 98 and 99.
(1) Incorporated by reference to ALZA's Form 10-K Annual Report
for the year ended December 31, 1993.
(2) Incorporated by reference to ALZA's Form 10-Q Quarterly
Report for the quarter ended June 30, 1994.
(3) Incorporated by reference to ALZA's Form 8-A Registration
Statement (Commission File No. 0-11234) dated March 31,
1993, as amended.
(4) Incorporated by reference to ALZA's Form S-3 Registration
Statement (Commission File No. 333-2343) dated April 8,
1996, as amended.
(5) Incorporated by reference to ALZA's Form 10-Q Quarterly
Report for the quarter ended September 30, 1997.
(6) Incorporated by reference to ALZA's Form 10-Q Quarterly
Report for the quarter ended September 30, 1993.
(7) Incorporated by reference to ALZA's Form 10-K Annual Report
for the year ended December 31, 1992.
(8) Incorporated by reference to ALZA's Form 10-K Annual Report
for the year ended December 31, 1994.
(9) Incorporated by reference to ALZA's Form 10-Q Quarterly
Report for the quarter ended June 30, 1995.
(10) Incorporated by reference to ALZA's Form 10-K Annual Report
for the year ended December 31, 1995.
(11) Incorporated by reference to ALZA's Form 10-K/A Annual
Report for the year ended December 31, 1997.
*A management contract or compensatory plan or arrangement
required to be filed as an Exhibit pursuant to Item 14(c) of
Form 10-K.
(b) On October 15, 1998, ALZA filed a Form 8-K disclosing the
execution of an Agreement and Plan of Merger by ALZA and SEQUUS
Pharmaceuticals, Inc. No financial statements were filed in
connection with such
Form 8-K.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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
By: /s/ Dr. Ernest Mario Dr.
Ernest Mario
Chief Executive Officer
Date: March 26, 1999
<PAGE>
Pursuant to the requirements of the Securities Exchange Act
of 1934, this report has been signed below by the following
persons on behalf of the registrant and in the capacities and on
the dates indicated.
/s/ Dr. Ernest Mario /s/ Dean O. Morton
Dr. Ernest Mario Dean O. Morton
Chairman of the Board of Director
Directors, Director and Chief Date: March 26, 1999
Executive Officer
Date: March 26, 1999
/s/ Dr. William R. Brody /s/ Denise M. O'Leary
Dr. William R. Brody Denise M. O'Leary
Director Director
Date: March 26, 1999 Date: March 26, 1999
/s/ William G. Davis /s/ Isaac Stein
William G. Davis Isaac Stein
Director Director
Date: March 26, 1999 Date: March 26, 1999
/s/ Dr. Robert J. Glaser /s/ Julian N. Stern
Dr. Robert J. Glaser Julian N. Stern
Director Director
Date: March 26, 1999 Date: March 26, 1999
/s/ Dr. I. Craig Henderson /s/ Bruce C. Cozadd
Dr. I. Craig Henderson Bruce C. Cozadd
Director Senior Vice President, Chief
Date: March 26, 1999 Financial Officer and
Principal Accounting Officer
Date: March 26, 1999
<PAGE>
EXHIBIT INDEX
Exhibit
10.14 License Agreement between ALZA Corporation and
Crescendo Pharmaceuticals Corporation for OROS-registered
trademark-oxybutynin
21 Subsidiaries
23 Consent of Ernst & Young LLP, Independent Auditors
27 Financial Data Schedule
11
G:\JKS\VLP\LICAGR
EXHIBIT 10.14
This License Agreement (the "Agreement") is made this 16th
day of December, 1998 by and between ALZA Corporation, a Delaware
corporation ("ALZA"), and Crescendo Pharmaceuticals Corporation
("Crescendo"), a Delaware corporation.
BACKGROUND
A. Crescendo and ALZA have entered into a License Option
Agreement and certain other agreements dated as of September 5,
1997.
B. Section 2 of the License Option Agreement provides for a
license, the terms of which are to be set forth herein.
Now, therefore, the parties agree as follows:
1. Definitions.
For purposes of this Agreement, the following terms
shall have the meanings set forth below:
1.1 "Affiliate" shall mean a corporation or any other
entity that directly, or indirectly through one or more
intermediaries, controls, is controlled by, or is under common
control with, the designated party. "Control" shall mean
ownership of at least 50% of the shares of stock entitled to vote
for the election of directors in the case of a corporation, and
at least 50% of the interests in profits in the case of a
business entity other than a corporation.
1.2 "Development Agreement" shall mean the Development
Agreement between ALZA and Crescendo dated as of September 5,
1997.
1.3 "Development Cost(s)" shall mean the cost of
activities undertaken pursuant to the Development Agreement with
respect to the Licensed Product, determined in accordance with
Exhibit A thereto.
1.4 "Infringing Product" shall mean any product sold
by a third party, other than pursuant to an agreement with ALZA,
(i) which incorporates the same therapeutic agent or agents as
incorporated in the Licensed Product and (ii) in the case of a
Licensed Product using an ALZA drug delivery system, which
incorporates a delivery system substantially similar to that
incorporated in the Licensed Product, and (iii) which infringes
or is alleged to infringe any patent or patents owned by,
licensed to or controlled by ALZA.
1.5 "License Option Agreement" shall mean the License
Option Agreement between ALZA and Crescendo dated as of September
5, 1997.
1.6 "Licensed Product" shall mean the product listed
on Attachment A hereto.
1.7 "Major Market Country" shall mean any of the
following countries: the United States, France, Germany, Italy,
Japan or the United Kingdom.
1.8 "Net Sales" shall mean the total amount invoiced in United
States dollars (or converted thereto in accordance with Section
5.2 hereof) on sales of a Licensed Product by ALZA (or its
Affiliates) or any ALZA sublicensee, distributor or marketing
partner (or its Affiliates) to unrelated third parties such as
wholesalers, hospitals and others, in bona fide arm's-length
transactions, less the following deductions, in each case related
specifically to the Licensed Product and actually allowed and
taken and not otherwise recovered by or reimbursed to ALZA (or
its Affiliates) or such sublicensee, distributor or marketing
partner (or its Affiliates): (i) trade, cash and quantity
discounts; (ii) taxes on sales (such as sales or use taxes) to
the extent added to the sales price and set forth separately as
such in the total amount invoiced; (iii) freight, insurance and
other transportation charges to the extent added to the sales
price and set forth separately as such in the total amount
invoiced; and (iv) amounts repaid or credited by reason of
rejections, defects or returns or because of retroactive price
reductions, chargebacks or rebates under government programs.
Net Sales shall also include the fair market value of all other
consideration received (a) by ALZA (or its Affiliates) with
respect to sales by them of the Licensed Product to unrelated
third parties from persons other than sublicensees, distributors
or marketing partners (or their Affiliates) or (b) by any
sublicensee, distributor or marketing partner (or its Affiliates)
with respect to their sales of the Licensed Product to unrelated
third parties, in each case whether such consideration is in
cash, payment in kind, exchange or other form.
1.9 "Territory" shall mean the country or
countries listed on Attachment B hereto, as amended from time to
time by the parties in connection with the exercise by ALZA of
its option for additional countries under the License Option
Agreement or the surrender by ALZA of its rights to commercialize
the Licensed Product in any country or countries.
2. Grant of License.
2.1 Grant. Crescendo hereby grants to ALZA an
exclusive, perpetual license, with the right to sublicense, to
develop, make, have made and use the Licensed Product and to sell
and have sold the Licensed Product in the Territory. ALZA agrees
to use diligent efforts to conduct or have conducted any
remaining activities necessary to complete the development of the
Licensed Product in the Territory through regulatory clearance to
market the Licensed Product in the Territory. Such activities
will be undertaken at no cost to Crescendo, unless Crescendo
agrees otherwise in writing. Promptly after regulatory
clearance, ALZA shall commence and continue to use diligent
efforts to commercialize the Licensed Product in each Major
Market Country of the Territory through the manufacture and sale
or the sublicensing of the Licensed Product, devoting to the
Licensed Product the same resources as other pharmaceutical
companies of similar size devote to products with similar market
potential and with similar relative importance to their product
portfolios. ALZA may use reasonable business discretion in the
allocation of its technological and monetary resources in
performing its obligations hereunder, taking into account not
only the Licensed Product but also activities for its own account
and its obligations under its other agreements with third
parties. Crescendo acknowledges that ALZA will continue to own
and have the right to use any clinical supplies, materials and
other assets purchased, manufactured or developed for use in the
development of such Licensed Product, without any additional
payment to or reimbursement of Crescendo.
2.2 No Other Commercialization. ALZA shall not
commercialize the Licensed Product in any country except pursuant
to this Agreement.
3. Product Payments.
3.1 Payments.
(a) In consideration of the grant of the license,
ALZA shall make payments to Crescendo ("Product Payments") with
respect to the Licensed Product as follows: 1% of Net Sales of
the Licensed Product in the Territory, plus an additional 0.1% of
such Net Sales for each full $1 million of Development Costs of
the Licensed Product paid by Crescendo. Notwithstanding the
foregoing, Product Payments for any quarter will not exceed 2.5%
of Net Sales, on a quarterly basis, in the Territory for the
first four calendar quarters during which the Licensed Product is
commercially sold in the first Major Market Country, and 3% of
Net Sales, on a quarterly basis, for each of the following eight
completed calendar quarters.
(b) In determining Product Payments, Development
Costs shall be determined as of the last day of each calendar
quarter, in order to determine the rates payable with respect to
Net Sales for the next calendar quarter for all countries
included in the Territory as of the first day of such next
calendar quarter, and for any country added to the Territory
during such next calendar quarter.
(c) In determining Product Payments, Net Sales by
ALZA shall be reduced by the dollar amount of any license or
similar payments made by or due from ALZA or its Affiliates to
third parties with respect to sales of such Licensed Product in
the Territory. If license or similar payments are made to third
parties with respect to sales of both the Licensed Product in the
Territory and to sales of other products, ALZA shall allocate
such payments, if necessary, in a commercially reasonable manner.
3.2 Term of Payments. The obligation to make Product
Payments hereunder shall continue until 15 years after the date
of the first commercial sale of the Licensed Product in any Major
Market Country, and shall terminate as to all countries at the
end of such 15-year period.
3.3 Buy-Out of Payments.
(a) ALZA shall have the option, in its discretion, at any time
after the end of the twelfth calendar quarter during which the
Licensed Product was commercially sold in any country, to buy out
its remaining obligations to make Product Payments with respect
to Net Sales of such Licensed Product in such country. The buy-
out price shall be an amount equal to 15 times the Product
Payments made by or due from ALZA to Crescendo with respect to
Net Sales of such Licensed Product in such country for the four
calendar quarters immediately preceding the quarter in which the
buy-out option is exercised, plus 15 times such additional
Product Payments as would have been made but for the 2.5% and 3%
limits set forth in Section 3.1 on Product Payments for such
period.
(b) ALZA shall have the option, in its discretion, at any time
after the end of the twelfth calendar quarter during which the
Licensed Product was commercially sold in either the United
States or two other Major Market Countries, to buy out its
remaining obligations to make Product Payments with respect to
Net Sales of such Licensed Product in the Territory. The buy-out
price shall be an amount equal to (i) 20 times (A) the Product
Payments made by or due from ALZA to Crescendo for such Licensed
Product in the Territory, plus (B) such payments as would have
been made by or due from ALZA to Crescendo if ALZA had not
exercised any country-specific buy-out option with respect to Net
Sales of such Licensed Product, plus (C) such additional Product
Payments as would have been made but for the 2.5% and 3% limits
set forth in Section 3.1 on Product Payments for such period, in
each case, for the four calendar quarters immediately preceding
the quarter in which the buy-out option is exercised, less (ii)
any amounts previously paid to exercise any country-specific buy-
out option with respect to Net Sales of such Licensed Product.
4 Accounting.
4.1 Reports. Within 90 days after the end of each
calendar quarter for which Product Payments are due, ALZA shall
render an accounting to Crescendo, on a country-by-country basis,
with respect to all Product Payments due for such quarter. Such
report shall indicate, for such quarter, the quantity and dollar
amount of Net Sales of the Licensed Product by ALZA and its
Affiliates, sublicensees, distributors and marketing partners
(and their Affiliates), or other consideration with respect to
Net Sales, with respect to which payments are due; provided,
however, that if ALZA shall not have received from any
sublicensee, distributor or marketing partner a report of its
(and its Affiliates') sales for such quarter, then such sales
shall be included in the next quarterly report. In case no
Product Payments are due for any calendar quarter, ALZA shall so
report.
4.2 Records; Review by Accountants. ALZA shall keep
and maintain, in accordance with generally accepted accounting
principles, proper and complete records and books of account
documenting all amounts paid or payable by ALZA to Crescendo.
Crescendo shall have the right, once in each calendar year during
regular business hours and upon reasonable notice to ALZA, at
Crescendo's expense, to examine or have examined by a certified
public accountant or similar person, such of the records of ALZA
as may be necessary to verify the accuracy of the reports and
payments made under this Agreement. Such examination shall take
place not later than two years following the year in question,
and only one examination may take place with respect to any
period as to which such books and records are examined. ALZA
shall obtain, for itself and for Crescendo, similar reasonable
rights to audit information pertaining to Net Sales from each
party appointed to commercialize any product as to which payments
are due in Crescendo hereunder.
5 Times and Currencies of Payments.
5.1 Payments. Payments shown by each calendar quarter
report to have accrued shall be due and payable on the date such
report is due and shall be paid in United States dollars. Any
and all taxes due or payable on such payments or with respect to
the remittance thereof shall be deducted from such payments and
shall be paid by ALZA to the proper taxing authorities, and proof
of payment shall be secured and sent to Crescendo as evidence of
such payment. The rate of exchange to be used in computing the
amount of the United States dollars due to Crescendo in
satisfaction of payment obligations with respect to sales in
foreign countries shall be calculated by converting the amount
due in such foreign currency into United States dollars at the
rate for the purchase of United States dollars with such currency
as published in The Wall Street Journal on the last business day
of the calendar quarter for which payment is being made.
5.2 Certain Foreign Payments. If governmental regulations
prevent remittance from any foreign country of any amounts due
under Section 3.1 in respect of that country, ALZA shall so
notify Crescendo in writing, and the obligation under this
Agreement to make payments with respect to sales in that country
shall be suspended (but the amounts due but not paid shall
continue to accrue) until such remittances are possible.
Crescendo shall have the right, upon written notice to ALZA, to
receive payment in any such country in the local currency.
5.3 Late Payments. Any payments due hereunder that
are not made when due shall bear interest at the lesser of 10%
per annum or the maximum rate as may be allowed by law, beginning
on the date when Crescendo has notified ALZA that such payments
are overdue.
6 Patent Infringement.
6.1 Notice. Each party shall promptly notify the
other party of use or sale by a third party of an Infringing
Product.
6.2 Legal Action. If a third party manufactures or
sells an Infringing Product, ALZA may, at its own expense, bring
legal action to restrain such infringement and for damages. Any
recoveries resulting from any such action shall be first applied
to reimburse ALZA for its expenses (including reasonable
attorneys' fees) incurred in bringing the action. Crescendo will
be entitled to a share of the remaining recoveries in the same
percentage as the percentage of Net Sales as to which Product
Payments are due to Crescendo during the period of the
infringement or alleged infringement. If (a) ALZA fails to take
the necessary steps to restrain such infringement or alleged
infringement by litigation or otherwise within 90 days after
either party's notice described in Section 6.1, (b) if the
infringement or alleged infringement occurs during a period for
which Crescendo is entitled to receive Product Payments
hereunder, and (c) if over a period of at least two calendar
quarters such Infringing Product achieves an annualized unit
sales volume in the country of infringement equal to 25% of the
annualized unit sales volume of the Licensed Product sold by ALZA
and its Affiliates, sublicensees, distributors and marketing
partners (and their Affiliates) in such country during such year,
then Crescendo may institute, in its own name, at its own expense
and with the right to all recoveries, such litigation or other
appropriate action as it may deem appropriate to restrain such
infringement, provided that Crescendo has first given to ALZA 60
days advance notice of its intention to take such action, and
provided further, that ALZA has not itself taken appropriate
action during such 60 day period.
6.3 Cooperation. If either party desires to bring an
action in accordance with Section 6.2, the other party agrees to
cooperate fully with the party bringing such action in the
pursuit thereof, at the expense of the party bringing such action
and to the extent reasonably requested by such party. If the
third party in any such action brought by Crescendo brings a
counteraction for invalidation or misuse of a patent covering the
Licensed Product, Crescendo promptly shall notify ALZA and ALZA
may, within six months of the notification, join and participate
in such action at its own expense.
6.4 Settlement. Each party agrees not to settle any
action it brings in a manner that would adversely affect the
other party without the other party's prior written approval.
7 Effective Date and Term.
7.1 Effective Date and Term. This Agreement will
become effective in accordance with Section 2.3 of the License
Option Agreement and, unless terminated in accordance with any of
the provisions hereof, shall remain in full force and effect
thereafter.
8 Indemnification.
8.1 Indemnity. ALZA shall indemnify, defend and hold
Crescendo (and its Affiliates) harmless from and against any and
all liabilities, claims, demands, damages, costs, expenses or
money judgments incurred by or rendered against Crescendo and its
Affiliates, which arise out of the use, design, labeling or
manufacture, processing, packaging, sale or commercialization of
the Licensed Product by ALZA, its Affiliates, subcontractors,
sublicensees, distributors and marketing partners (and their
Affiliates). Crescendo shall permit ALZA's attorneys, at ALZA's
discretion and cost, to control the defense of any claims or
suits as to which Crescendo may be entitled to indemnification
hereunder, and Crescendo agrees not to settle any such claims or
suits without the prior written consent of ALZA. Crescendo shall
have the right to participate, at its own expense, in the defense
of any such claim or demand to the extent it so desires.
8.2 Notice. Crescendo shall give ALZA prompt notice
in writing, in the manner set forth in Section 11.7 below, of any
claim or demand made against Crescendo for which Crescendo may be
entitled to indemnification under Section 8.1.
9 Disclaimers.
CRESCENDO DISCLAIMS ANY EXPRESS OR IMPLIED WARRANTY (A)
THAT THE LICENSED PRODUCT OR ANY TECHNOLOGY INCORPORATED THEREIN,
OR THE MANUFACTURE, USE OR SALE THEREOF, WILL BE FREE FROM CLAIMS
OF PATENT INFRINGEMENT, INTERFERENCE OR UNLAWFUL USE OF
PROPRIETARY INFORMATION OF ANY THIRD PARTY AND (B) OF THE
ACCURACY, RELIABILITY, TECHNOLOGICAL OR COMMERCIAL VALUE,
COMPREHENSIVENESS OR MERCHANTABILITY OF THE LICENSED PRODUCT OR
ANY TECHNOLOGY INCORPORATED THEREIN OR THEIR SUITABILITY OR
FITNESS FOR ANY PURPOSE WHATSOEVER INCLUDING, WITHOUT LIMITATION,
THE DESIGN, DEVELOPMENT, MANUFACTURE, USE OR SALE OF THE LICENSED
PRODUCT. CRESCENDO DISCLAIMS ALL OTHER WARRANTIES OF WHATEVER
NATURE, EXPRESS OR IMPLIED.
10 Termination.
10.1 Termination by Crescendo. Crescendo may, in its
discretion, terminate this Agreement in the event that ALZA:
(a) breaches any of its material obligations
hereunder and such breach continues for a period of 60 days after
written notice thereof; or
(b) enters into any proceeding, whether voluntary
or otherwise, in bankruptcy, reorganization or arrangement for
the appointment of a receiver or trustee to take possession of
ALZA's assets or any other proceeding under any law for the
relief of creditors or makes an assignment for the benefit of its
creditors.
10.2 Termination by ALZA. ALZA may terminate this
Agreement with respect to one or more countries included in the
Territory upon 30 days' prior written notice to Crescendo if ALZA
elects for any reason to discontinue commercialization of the
Licensed Product in such country.
10.3 Consequences of Termination. Termination of this
Agreement for any reason in accordance with the terms hereof
shall be without prejudice to:
(a) Crescendo's right to receive all payments
accrued under Section 3 prior to the effective date of such
termination; and
(b) any other remedies which either party may
then or thereafter have hereunder or otherwise. If this
Agreement terminates pursuant to this Section 10, ALZA shall
immediately discontinue any promotion and sales of the Licensed
Product. Notwithstanding the foregoing, in the event of any
termination under this Section 10, ALZA may sell its inventory in
stock on the date of termination for a period of up to six months
after the termination, and shall remit payments to Crescendo in
respect thereto in accordance with this Agreement.
11 Miscellaneous.
11.1 Waiver, Remedies and Amendment. Any waiver by
either party hereto of a breach of any provisions of this
Agreement shall not be implied and shall not be valid unless such
waiver is recited in writing and signed by such party. Failure
of any party to require, in one or more instances, performance by
the other party in strict accordance with the terms and
conditions of this Agreement shall not be deemed a waiver or
relinquishment of the future performance of any such terms or
conditions or of any other terms and conditions of this
Agreement. A waiver by either party of any term or condition of
this Agreement shall not be deemed or construed to be a waiver of
such term or condition for any other term. All rights, remedies,
undertakings, obligations and agreements contained in this
Agreement shall be cumulative and none of them shall be a
limitation of any other remedy, right, undertaking, obligation or
agreement of either party. This Agreement may not be amended
except in writing signed by both parties.
11.2 Assignment. Neither party may assign its rights
and obligations hereunder without the prior written consent of
the other party, which consent may not be unreasonably withheld;
provided, however, that ALZA may assign such rights and
obligations hereunder to an Affiliate of ALZA or to any person or
entity with which ALZA is merged or consolidated or which
acquires all or substantially all of the assets of ALZA.
11.3 Arbitration.
(a) All disputes which may arise under, out of or in
connection with this Agreement shall be settled by arbitration
conducted in the City of San Francisco, State of California, in
accordance with the then existing rules of the American
Arbitration Association, and judgment upon the award rendered by
the arbitrators may be entered in any court having jurisdiction
thereof. The parties hereby agree that service of any notices in
the course of such arbitration at their respective addresses as
provided for in Section 11.7 of this Agreement shall be valid and
sufficient.
(b) In any arbitration pursuant to this Section 11.3,
the award shall be rendered by a majority of the members of a
board of arbitration consisting of three members who shall be
appointed by the parties jointly, or if the parties cannot agree
as to three arbitrators within 30 days after the commencement of
the arbitration proceeding, then one arbitrator shall be
appointed by ALZA and one arbitrator shall be appointed by
Crescendo within 60 days after the commencement of the
arbitration proceeding. The third arbitrator shall be appointed
by mutual agreement of such two arbitrators. In the event of
failure of the two arbitrators to agree within 75 days after
commencement of the arbitration proceeding upon the appointment
of the third arbitrator, the third arbitrator shall be appointed
by the American Arbitration Association in accordance with its
then existing rules. Notwithstanding the foregoing, in the event
that any party shall fail to appoint an arbitrator it is required
to appoint within the specified time period, such arbitrator and
the third arbitrator shall be appointed by the American
Arbitration Association in accordance with its then existing
rules. For purposes of this Section 11.3, the "commencement of
the arbitration proceeding" shall be deemed to be the date upon
which a written demand for arbitration is received by the
American Arbitration Association from one of the parties.
11.4 Counterparts. This Agreement may be executed in
any number of counterparts, each of which when so executed shall
be deemed to be an original and all of which when taken together
shall constitute this Agreement.
11.5 Governing Law. This Agreement shall be governed
by and construed in accordance with the laws of the state of
California as applied to residents of that state entering into
contracts to be performed in that state.
11.6 Headings. The headings set forth at the beginning
of the various sections of this Agreement are for convenience and
form no part of the Agreement between the parties.
11.7 Notices. Notices required under this Agreement
shall be in writing and sent by registered or certified mail,
postage prepaid, or by facsimile and confirmed by registered or
certified mail, postage prepaid, and addressed as follows:
If to ALZA: ALZA Corporation
950 Page Mill Road
Palo Alto, CA 94304
Facsimile: (650) 496-8048
Attention: Senior Vice President and
General Counsel
If to Crescendo: Crescendo Pharmaceuticals
Corporation
1454 Page Mill Road
Palo Alto, CA 94304
Facsimile: (650) 496-8250
Attention: President and Chief
Executive Officer
All notices shall be deemed to be effective five days after the
date of mailing or upon receipt if sent by facsimile (but only if
followed by certified or registered confirmation). Either party
may change the address at which notice is to be received by
written notice pursuant to this Section 11.7.
11.8 Severability. If any provision of this Agreement
is held by a court of competent jurisdiction to be invalid or
unenforceable, it shall be modified, if possible, to the minimum
extent necessary to make it valid and enforceable or, if such
modification is not possible, it shall be stricken and the
remaining provisions shall remain in full force and effect.
11.9 Relationship of the Parties. For all purposes of
this Agreement, Crescendo and ALZA shall be deemed to be
independent contractors and anything in this Agreement to the
contrary notwithstanding, nothing herein shall be deemed to
constitute Crescendo and ALZA as partners, joint venturers, co-
owners, an association or any entity separate and apart from each
party itself, nor shall this Agreement constitute any party
hereto an employee or agent, legal or otherwise, of the other
party for any purposes whatsoever. Neither party hereto is
authorized to make any statements or representations on behalf of
the other party or in any way to obligate the other party, except
as expressly authorized in writing by the other party. Anything
in this Agreement to the contrary notwithstanding, no party
hereto shall assume nor shall be liable for any liabilities or
obligations of the other party, whether past, present or future.
11.10 Survival. The provisions of Sections 1, 4.2,
8, 9, 10.3, 11.1, 11.3, 11.5, 11.6, 11.7, 11.8, 11.9 and this
Section 11.10 shall survive the termination for any reason of
this Agreement. Any payments due under this Agreement with
respect to any period prior to its termination shall be made
notwithstanding the termination of this Agreement. Neither party
shall be liable to the other due to the termination of this
Agreement as provided herein, whether in loss of good will,
anticipated profits or otherwise.
11.11 Force Majeure. Neither party to this
Agreement shall be liable for failure or delay in the performance
of any of its obligations hereunder, if such failure or delay is
due to causes beyond its reasonable control including, without
limitation, acts of God, earthquakes, fires, strikes, acts of
war, or intervention of any governmental authority, but any such
delay or failure shall be remedied by such party as soon as
possible after the removal of the cause of such failure or delay.
IN WITNESS WHEREOF, the parties have executed this Agreement
on the date first set forth above.
ALZA CORPORATION
By:
Title:
CRESCENDO PHARMACEUTICALS
CORPORATION
By:
Title:
ATTACHMENT A
LICENSED PRODUCT
OROS-registered trademark- oxybutynin (referred to as CPC-1)
ATTACHMENT B
TERRITORY
DATE OF EXERCISE COUNTRY
December 16, 1998 worldwide
Exhibit 21
SUBSIDIARIES
ALZA Development Corporation (incorporated in California)
ALZA International, Inc. (incorporated in Delaware), doing business
in the United Kingdom, and doing business in Canada as ALZA Canada
ALZA Limited (incorporated in the United Kingdom)
Therapeutic Discovery Corporation (incorporated in Delaware)
ALZA Land Management, Inc. (incorporated in Delaware)
Argyle Acquisition Corporation (incorporated in Delaware)*
*Merged into SEQUUS Pharmaceuticals, Inc. March 16, 1999
Exhibit 23
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration
Statements (Forms S-3 No. 33-53671 and No. 333-02765 and Forms S-8
No. 2-92629, No. 2-97422, No. 33-21810, No. 33-36141, No. 33-49824,
No. 33-51890, No. 333-21877, No. 333-49483, No. 333-70799 and
No. 333-74791) and in the related Prospectuses, of our report dated
January 29, 1999, except for Note 12 as to which date is March 16,
1999, with respect to the consolidated financial statements of ALZA
Corporation included in this Annual Report (Form 10-K) for the year
ended December 31, 1998.
Our audits also included the consolidated financial statement
schedule of ALZA Corporation listed in Item 14(a). This schedule
is the responsibility of ALZA's management. Our responsibility is
to express an opinion based on our audits. In our opinion, the
consolidated financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a
whole, presents fairly in all material respects the information set
forth therein.
/s/Ernst & Young LLP
Palo Alto, California
March 26, 1998
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000,000
[LEGEND]
This schedule contains summary financial information extracted from the
financial statements included in Part II, Item 8 of Form 10-K dated December 31,
1998 and is qualified in its entirety by reference to such financial statements.
[/LEGEND]
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 104
<SECURITIES> 67
<RECEIVABLES> 144
<ALLOWANCES> 2
<INVENTORY> 51
<CURRENT-ASSETS> 389
<PP&E> 480
<DEPRECIATION> 119
<TOTAL-ASSETS> 1,576
<CURRENT-LIABILITIES> 118
<BONDS> 923
0
0
<COMMON> 1
<OTHER-SE> 454
<TOTAL-LIABILITY-AND-EQUITY> 1,576
<SALES> 233
<TOTAL-REVENUES> 585
<CGS> 117
<TOTAL-COSTS> 274
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 56
<INCOME-PRETAX> 173
<INCOME-TAX> 61
<INCOME-CONTINUING> 112
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 112
<EPS-PRIMARY> 1.30
<EPS-DILUTED> 1.26
</TABLE>
