SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934
May 12, 1999
Date of Report (Date of earliest event reported)
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
incorporation of organization) Identification 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
ALZA CORPORATION FORM 8-K
Item 5. Other Events
On March 16, 1999, ALZA Corporation ("ALZA") completed
its merger with SEQUUS Pharmaceuticals, Inc. ("SEQUUS").
The merger was accounted for as a pooling-of-interests
and, accordingly, all historical financial information
has been restated to reflect the combined operations,
financial position and cashflows of both companies.
ALZA is filing this current report on Form 8-K in order
to file, as Exhibit 99.1 hereto, selected consolidated
financial data, management's discussion and analysis of
financial condition and results of operations, and
audited consolidated financial statements as of and for
the periods listed therein, as restated to reflect the
combined results of ALZA and SEQUUS.
Item 7. Financial Statements and Exhibits
(a) Financial statements of businesses acquired
None required
(b) Pro forma financial information
None required
(c) Exhibits
Exhibit 23 Consent of Ernst & Young, LLP
Exhibit 27.1 Restated Financial Data Schedule for
the year ended December 31, 1998
Exhibit 27.2 Restated Financial Data Schedule for
the year ended December 31, 1997
Exhibit 27.3 Restated Financial Data Schedule for
the year ended December 31, 1996
Exhibit 27.4 Restated Financial Data Schedule for
the nine months ended September 30, 1998
Exhibit 27.5 Restated Financial Data Schedule for
the six months ended June 30, 1998
Exhibit 27.6 Restated Financial Data Schedule for
the three months ended March 31, 1998
Exhibit 27.7 Restated Financial Data Schedule for
the nine months ended September 30, 1997
Exhibit 27.8 Restated Financial Data Schedule for
the six months ended June 30, 1997
Exhibit 27.9 Restated Financial Data Schedule for
the three months ended March 31, 1997
Exhibit 99.1 Selected consolidated financial data
Management's discussion and analysis of
financial condition and results of operations
Consolidated statement of operations for the years
ended December 31, 1998, 1997, and 1996
Consolidated balance sheet at December 31, 1998 and
1997
Consolidated statement of stockholders' equity for
the years ended December 31, 1998, 1997 and 1996
Consolidated statement of cash flows for the years ended
December 31, 1998, 1997, 1996
Notes to the consolidated financial statements
Report of Ernst & Young LLP, Independent Auditors
SCHEDULE II --Consolidated valuation and qualifying
accounts for the years ended December 31, 1998, 1997
and 1996
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
Date: May 12, 1999 By: /s/ Dr. Ernest Mario
Dr. Ernest Mario
Chairman and
Chief Executive Officer
Date: May 12, 1999 By: /s/ Bruce C. Cozadd
Bruce C. Cozadd
Senior Vice President and
Chief Financial Officer
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 paragraph 2 of Note 1 and Note 12 as
to which date is March 16, 1999, with respect to the consolidated
financial statements of ALZA Corporation for the year ended
December 31, 1998 included herein.
Our audits also included the consolidated financial statement
schedule (Schedule II-Consolidated valuation and qualifying
accounts for the years ended December 31, 1998, 1997 and 1996) of
ALZA Corporation included in Exhibit 99.1 herein. 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
May 12. 1999
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THIS SCHEDULE CONTAINS SUMMARY INFORMATION EXTRACTED FROM THE FINANCIAL
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COMBINED RESULTS OF ALZA CORPORATION AND SEQUUS PHARMACEUTICALS, INC.
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THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
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THE COMBINED RESULTS OF ALZA CORPORATION AND SEQUUS PHARMACEUTICALS, INC.
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<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 1996, RESTATED TO REFLECT
THE COMBINED RESULTS OF ALZA CORPORATION AND SEQUUS PHARMACEUTICALS, INC.
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<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS FOR THE NINE MONTHS ENDED sEPTEMBER 30, 1998, RESTATED TO
REFLECT THE COMBINED RESULTS OF ALZA CORPORATION AND SEQUUS PHARMACEUTICALS,
INC.
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<LEGEND>
THIS SCHEDULES CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS FOR THE SIX MONTHS ENDED JUNE 30, 1998, RESTATED TO REFLECT
THE COMBINED RESULTS OF ALZA CORPORATION AND SEQUUS PHARMACEUTICALS, INC.
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0
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<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS FOR THE THREE MONTHS ENDED MARCH 31, 1998, RESTATED TO
REFLECT THE COMBINED RESULTS OF ALZA CORPORATION AND SEQUUS PHARMACEUTICALS,
INC.
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0
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<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997, RESTATED TO
REFLECT THE COMBINED RESULTS OF ALZA CORPORATION AND SEQUUS PHARMACEUTICALS,
INC.
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<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS FOR THE SIX MONTHS ENDED JUNE 30, 1997, RESTATED TO REFLECT
THE COMBINED RESULTS OF ALZA CORPORATION AND SEQUUS PHARMACEUTICALS, INC.
</LEGEND>
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0
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<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
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REFLECT THE COMBINED RESULTS OF ALZA CORPORATION AND SEQUUS PHARMACEUTICALS,
INC.
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EXHIBIT 99.1
ALZA CORPORATION FORM 8-K
Restated Financial Information
Table of Contents
PAGE
Selected consolidated financial data 2
Management's discussion and analysis of financial condition
and results of operations 3-29
Consolidated statement of operations for the years ended
December 31, 1998, 1997, and 1996 30
Consolidated balance sheet at December 31, 1998 and 1997 31
Consolidated statement of stockholders' equity for the years
ended December 31, 1998, 1997 and 1996 32
Consolidated statement of cash flows for the years ended
December 31, 1998, 1997, 1996 33
Notes to the consolidated financial statements 34-61
Report of Ernst & Young LLP, Independent Auditors 62
SCHEDULE II --Consolidated valuation and qualifying
accounts for the years ended December 31, 1998, 1997 and 199663
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
(In millions, except per share amounts)
1998 1997 1996 1995 1994
____________________________________________________________________
Total revenues $ 646.9 $ 504.4 $ 446.1 $326.6 $265.0
Net income (loss) 108.3 (275.2)(1) 82.1 52.2 38.5
Earnings (loss)
per share,
Basic 1.09 (2.83) 0.86 0.57 0.43
Diluted 1.07 (2.83) 0.84 0.56 0.43
Cash and investments514.1 561.1 1,032.8 469.4 356.7
Total assets 1,666.6 1,450.7 1,698.6 1,018.0 834.1
Total long-term
liabilities 1,006.1 968.0 949.8 414.7 385.8
Total stockholders'
equity 531.9 366.3 670.9 527.2 385.0
____________________________________________________________________
1 Reflects a total of $368.7 million (or $3.77 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 Pharmaceuticals Corporation, $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>
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 $646.9 $504.4 $446.1
Operating Income (Loss) 196.5 (228.8) 120.2
Net Income (Loss) 108.3 (275.2) 82.1
Earnings (Loss) per Share (diluted) 1.07 (2.83) 0.84
______________________________________________________________
ALZA's net income for 1998 was $108.3 million, compared with a
net loss of $275.2 million in 1997 and net income of $82.1 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."
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. ALZA issued 13.2 million shares to acquire the
outstanding shares of SEQUUS on the closing date. ALZA has
accounted for the transaction as a pooling of interests, and
accordingly, the consolidated financial statements and all
financial information presented herein have been restated to
reflect the combined operations, financial position and cash flows
of both companies.
1998 Compared to 1997
On a comparable basis, ALZA's 1998 net income increased 16% to
$108.3 million, or $1.07 per diluted share, compared with 1997 net
income of $93.4 million, or $0.94 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 60% to $289.4 million in 1998 from $181.1
million in 1997. Sales of products by ALZA Pharmaceuticals
doubled in 1998 compared with 1997, increasing to $175.8 million
in 1998 from $87.9 million in 1997.
-Gross margin as a percentage of net sales increased to 57% in
1998 from 45% in 1997.
-Royalties, fees and other revenues increased 24% to $233.1
million in 1998, compared with $188.3 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 $141.9
million in 1998 from $85.3 million in 1997, excluding $0.4
million in costs related to workforce reductions in 1997. This
increase reflects the substantial increase in the size of the
sales organization, increased marketing 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 54% 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 17% in 1997
to $93.4 million, or $0.94 per diluted share, compared with 1996
net income of $79.8 million, or $0.82 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 increased 80% in 1997 compared with 1996,
increasing to $87.9 million in 1997 from $48.7 million in 1996.
-Gross margin as a percentage of sales increased to 45% in 1997
from 33% in 1996. Gross margin for 1996 was 35% excluding
certain charges described below.
-Royalties, fees and other revenues increased 4% to $188.3
million in 1997 compared with $180.8 million in 1996.
Royalties, fees and other revenues for 1996 were $170.3 million,
excluding certain credits described below.
-ALZA's effective income tax rate declined to 34% 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 $180.6
million in 1997 compared to $162.2 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 15% to
$85.7 million in 1997 compared with $74.5 million in 1996,
resulting from an 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-trademark-
fentanyl 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 and research and
development 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;
-$5.9 million of charges 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; and
-Income tax expense of $1.4 million related to the above items.
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.
SEQUUS' net sales, costs of products shipped, research and
development expenses for products marketed by, and potential
products to be marketed by, ALZA Pharmaceuticals, and sales and
marketing expenses are all included in the ALZA Pharmaceuticals
segment; SEQUUS' royalty and fee revenues and research and
development revenues and related expenses (largely for activities
undertaken on behalf of ALZA Pharmaceuticals) are included in the
ALZA Technologies segment; and SEQUUS' general and administrative
expenses are included in the Other segment.
OPERATING SEGMENT SUMMARY
(In millions, except per share amounts) 1998 1997 1996
______________________________________________________________
Revenues
ALZA PHARMACEUTICALS $294.1 $191.3 $ 156.2
ALZA TECHNOLOGIES 480.6 434.7 409.5
OTHER 2.4 0.8 3.2
______________________________________________________________
Total segment revenues 777.1 626.8 568.9
Intersegment eliminations (130.2) (122.4) (122.8)
______________________________________________________________
Total revenues $ 646.9 $ 504.4 $ 446.1
Operating Income (Loss)
ALZA PHARMACEUTICALS $ 23.2 $(332.5) $(13.7)
ALZA TECHNOLOGIES 193.6 133.4 159.5
OTHER (20.3) (29.7) (25.6)
______________________________________________________________
Total operating income (loss) $196.5 $(228.8) $120.2
______________________________________________________________
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 $1.5 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 $167.8
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
(including milestone payments) 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 products marketed by,
and potential products for marketing by, ALZA Pharmaceuticals under
development by Crescendo. Crescendo is expected to expend its
funds within the next two years, at which time ALZA Pharmaceuticals
will 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
$23.2 million from $1.5 million in 1997, excluding certain charges
described above. This improvement was due to a 100% increase in
net sales of ALZA-marketed products and an increase in gross margin
as a percentage of net sales on these products to 77% in 1998
compared with 76% 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 $1.5 million, excluding certain charges
described above, compared with an operating loss of $13.7 million
in 1996. This increase resulted primarily from an 80% increase in
net sales of ALZA-marketed products and an increase in the gross
margin to 76% in 1997 from 70% 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.
ALZA TECHNOLOGIES
ALZA Technologies derives its revenues from net sales of
products manufactured for client companies and for ALZA
Pharmaceuticals, royalty revenues, fee revenues (including
milestone payments) under 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 $193.6 million compared
with $167.8 million in 1997, excluding certain charges described
above. This increase was primarily due to a 17% 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 $167.8 million, excluding certain charges, from $159.5 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 $20.3
million, compared with $29.3 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 $29.3 million in 1997, excluding certain charges,
compared with $25.6 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.
NET SALES
NET SALES
(Dollars in millions) 1998 1997 1996
______________________________________________________________
ALZA PHARMACEUTICALS
Doxil-registered trademark-
/Caelyx-registered trademark- $ 48.4 $ 29.5 $ 22.7
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
Other 35.9 15.9 9.9
_______________________________________________________________
Total 175.8 87.9 48.7
_______________________________________________________________
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 $ 289.4 $ 181.1 $ 134.1
_______________________________________________________________
Total net sales as a percentage
of total revenues 45% 36% 30%
_______________________________________________________________
ALZA Pharmaceuticals as a percentage
of total net sales 61% 49% 36%
_______________________________________________________________
ALZA PHARMACEUTICALS
Included in net sales of ALZA Pharmaceuticals 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
(and to a limited extent, direct sales by ALZA of Amphocil-
registered trademark- (lipid-based amphotericin B) in the United
Kingdom). ALZA Pharmaceuticals net sales increased 100% in 1998
compared to 1997, resulting from a 64% increase in sales of Doxil-
registered trademark- (doxorubicin HCl liposome injection), which
is marketed by Schering-Plough Ltd. ("Schering-Plough") in Europe
under the tradename Caelyx-registered trademark-, and 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 80%
compared with 1996, primarily as a result of sales of Mycelex
Troche and Elmiron, rights to each of which were acquired in 1997,
together with a 30% increase in Doxil sales. Sales of Ethyol,
which was launched in April 1996, also contributed to the increase in ALZA
Pharmaceuticals' net sales in 1997.
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. In addition, Doxil,
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 Elmiron for ALZA.
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.
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 an increase in ALZA shipments of Nicoderm-registered
trademark- and NicoDerm-registered trademark- CQ-trademark-
(nicotine) and 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) 77% 76% 70%
ALZA TECHNOLOGIES (1) 24% 15% 12%
_______________________________________________________________
Gross margin as a percentage of
total net sales (2) 57% 45% 33%
_______________________________________________________________
(1) Includes intersegment revenues or expenses
(2) After intersegment eliminations
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
generally approximate the prices charged to third parties.
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.
ROYALTIES, FEES AND OTHER REVENUES
(Dollars in millions) 1998 1997 1996
_______________________________________________________________
ALZA PHARMACEUTICALS $ 25.3 $ 11.9 $ 10.9
ALZA TECHNOLOGIES 205.4 175.6 166.7
OTHER 2.4 0.8 3.2
_______________________________________________________________
Total royalties, fees and
other revenues $ 233.1 $ 188.3 $ 180.8
_______________________________________________________________
Percentage of total revenues 36% 37% 41%
_______________________________________________________________
ALZA PHARMACEUTICALS
In 1998, fee revenue for ALZA Pharmaceuticals included
technology fees of $10.7 million from Crescendo and fees from
Synthelabo for the rights to commercialize OROS-registered
trademark- oxybutynin (Ditropan XL in the United States) in Europe,
fees from Schering-Plough under an agreement between Schering-
Plough and SEQUUS covering Doxil, 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, fees from Schering-Plough and co-
promotion fees. Fee revenue in 1996 consisted of fees from
Schering-Plough, and co-promotion and commercialization fees.
ALZA has a distribution agreement with Schering-Plough, entered
into by SEQUUS and Schering-Plough in 1996. Under the agreement,
which expires in 2010, Schering-Plough has obtained exclusive
rights to distribute, market and sell Caelyx worldwide, except for
the United States, Japan and certain other countries. Under the
terms of the agreement, SEQUUS received an upfront payment of $5.3
million and ALZA receives payments based upon product sold to
Schering-Plough, with the price determined based on sales of the
product. Each party undertakes clinical trials in specific
indications.
ALZA TECHNOLOGIES
Royalties, fees and other revenues for ALZA Technologies
increased 17% 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.
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, from Pfizer for the rights to commercialize
the OROS-registered trademark- pseudoephedrine product in certain
countries outside the U.S., and from Schering-Plough under the
Caelyx agreement.
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 7% of total revenues
in 1998, compared with 11% in 1997 and 16% in 1996. Several
companies have filed
Abbreviated New Drug Applications ("ANDAs") 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.
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 123.6 116.5 116.0
_______________________________________________________________
Total ALZA Technologies 155.0 160.0 150.6
_______________________________________________________________
Intersegment elimination (123.6) (116.5) (116.0)
Total research and development revenues$124.4 $135.0 $131.2
_______________________________________________________________
Percentage of total revenues 19% 27% 29%
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 for research and
development related to products marketed by, or under development
for potential 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 and 3%
for the second and third years. Thereafter, until 15 years after
the date of the first commercial sale of the product, the
percentage owed to Crescendo 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.
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 in-
process 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
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 3% 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 5% in 1997 compared to 1996, excluding the 1996
charges, reflecting an increase in product development under ALZA's
agreements with client companies.
Research and Development Expenses
(Dollars in millions) 1998 1997 1996
_______________________________________________________________
ALZA PHARMACEUTICALS
Intersegment $ 123.6 $ 116.5 $ 116.0
_______________________________________________________________
ALZA TECHNOLOGIES 182.8 180.6 162.2
_______________________________________________________________
Intersegment eliminations (123.6) (116.5) $(116.0)
_______________________________________________________________
Total research and development
expenses $ 182.8 $ 180.6 $ 162.2
_______________________________________________________________
As a percentage of total revenues 28% 36% 36%
_______________________________________________________________
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 increased 6%
in 1998 compared to 1997 due to increased research and development
related to Crescendo products, Doxil, and other research and
development projects. Expenses were relatively constant in 1997
compared to 1996, reflecting expenses relating to Crescendo
products and, to a small extent, other research and development
projects.
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 and 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,
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."
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
(Dollars in millions) 1998 1997 1996
_______________________________________________________________
ALZA PHARMACEUTICALS
Sales and marketing expenses $ 95.2 $ 45.8 $ 37.1
_______________________________________________________________
Total 95.2 45.8 37.1
_______________________________________________________________
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 31.0 35.9 35.2
_______________________________________________________________
Total selling, general and
administrative expenses $141.9 $85.7 $ 74.5
_______________________________________________________________
Total selling, general and adminis-
trative expenses a percentage of
total revenues 22% 17% 17%
_______________________________________________________________
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 by approximately 260 sales professionals.
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,
Elmiron and Doxil.
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 13% in 1998
compared to 1997, excluding $0.4 million in costs related to
workforce reductions in 1997. This decline is due primarily 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 increased slightly in 1997 compared to
1996, excluding the workforce reduction costs described above. The
increase in corporate administrative costs in 1997 compared with
1996 was partially offset by an increase in the cash surrender
value of life insurance policies.
INTEREST INCOME AND EXPENSE
NET INTEREST
(Dollars in millions) 1998 1997 1996
_______________________________________________________________
Interest and other income $ (26.4) $ (57.1) $ (54.7)
Distribution to debenture holders - 8.0 -
Interest expense 56.7 55.2 43.0
_______________________________________________________________
Net interest and other
expense (income) $ 30.3 $ 6.1 $ (11.7)
_______________________________________________________________
Interest and other income decreased 54% 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 4% 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 3% 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 $40.3 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 34% 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.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY AND CAPITAL RESOURCES
(In millions) 1998 1997 1996
_______________________________________________________________
Working capital $ 297.1 $ 276.9 $ 533.4
Cash and investments 514.1 561.1 1,032.8
Total assets 1,666.6 1,450.7 1,698.6
Long-term debt 966.1 932.2 893.2
Net cash provided by (used in)
operating activities 136.8 (200.3) 98.3
Capital expenditures 65.1 41.8 52.2
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 a real 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 $158.3
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 $135.4 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.
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 is being 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 $65.1 million for
additions to property, plant and equipment to support its expanding
research, development and manufacturing activities, compared to
capital spending of $41.8 million in 1997 and $52.2 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.
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 ALZA's Form 10-K Annual Report for the
year ended December 31, 1998, 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 increases in sales of other
products. 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 1999 contract manufacturing revenues for
ALZA Technologies to increase slightly from 1998 levels due to
expected increases in orders from customers. 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-to-
quarter fluctuations will continue to occur. Higher gross margins
may be achieved through continuing the proportionate increase in
direct sales by ALZA Pharmaceuticals (as compared with sales from
contract manufacturing), and, to a lesser extent, increased
utilization of capacity and greater operating efficiencies by ALZA
Technologies.
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 one-
time 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.
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 product development revenue from 1998
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 1998 level of internal
research in order to continue strengthening ALZA's leadership in
the drug delivery field. In 1999, certain product development
activities funded by ALZA Pharmaceuticals in prior years are
expected to be funded by Crescendo, reducing ALZA Pharmaceuticals'
internal product development expenses for 1999.
Selling, General and Administrative Expenses
Sales and marketing expenses are expected to increase in 1999
due to the launch of Ditropan XL, which occurred in February 1999,
and as ALZA increases its activities for Doxil. Sales and
marketing expenses for ALZA Pharmaceuticals are also expected to
continue to increase in 1999, primarily due to the expansion of
marketing efforts for recently-acquired products and the increase
in the size of ALZA's sales organization in 1998. 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 those products. Certain ongoing cost savings resulting from the
combination of ALZA's and SEQUUS' operations may offset a portion
of these increases.
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.
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 32%, assuming it has
the ability to utilize SEQUUS' net operating losses in 1999. 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.
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.
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:
(In millions) There- Fair
1999 2000 2001 2002 2003 after Total Value
________________________________________________________________
Cash and cash equivalents
Fixed Rate
Securities$112.8 - - - - - $112.8 $112.8
Average Interest
Rate 5.32% - - - - - 5.32%
________________________________________________________________
Short-term Investments
Fixed Rate
Securities$ 86.1 - - - - - $ 86.1 $86.1
Average Interest
Rate 5.67% - - - - - 5.67%
________________________________________________________________
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 $198.9 $94.1 $67.0 $54.2 $42.9 $457.1 $459.9
Average Interest
Rate 5.47% 6.17% 6.48% 6.60% 6.23% - 5.97%
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 with 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 a decrease of
approximately $11.0 million 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 countries. 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>
ALZA Corporation
CONSOLIDATED STATEMENT OF OPERATIONS
Years ended December 31,
(In millions, except per share amounts) 1998 1997 1996
_______________________________________________________________
REVENUES
Net sales $ 289.4 $ 181.1 $ 134.1
Royalties, fees and other 233.1 188.3 180.8
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 646.9 504.4 446.1
COSTS AND EXPENSES
Costs of products shipped 125.7 99.9 89.2
Research and development 182.8 180.6 162.2
Selling, general and administrative 141.9 85.7 74.5
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 450.4 733.2 325.9
Operating income (loss) 196.5 (228.8) 120.2
Interest expense 56.7 55.2 43.0
Distribution to debenture holders - 8.0 -
Interest and other income (26.4) (57.1) (54.7)
_______________________________________________________________
Net interest and other
expense (income) 30.3 6.1 (11.7)
_______________________________________________________________
Income (loss) before income taxes 166.2 (234.9) 131.9
Provision for income taxes 57.9 40.3 49.8
_______________________________________________________________
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
Shares
Basic 99.0 97.3 95.8
Diluted 101.5 97.3 97.4
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 $ 110.1 $ 71.7
Short-term investments 86.1 127.8
Receivables, net of allowance for doubtful
accounts(1998-$2.7; 1997-$2.3) 131.1 109.0
Receivable from Crescendo, a related party 17.5 15.0
Inventories 54.6 41.9
Prepaid expenses and other current assets 26.3 27.9
_______________________________________________________________
Total current assets 425.7 393.3
PROPERTY, PLANT AND EQUIPMENT
Buildings and leasehold improvements 229.6 214.7
Equipment 184.1 157.9
Construction in progress 56.6 23.4
Land and prepaid land leases 34.4 24.3
504.7 420.3
_______________________________________________________________
Less accumulated depreciation and
amortization (132.3) (103.3)
_______________________________________________________________
Net property, plant and equipment 372.4 317.0
Investments in long-term securities 317.9 361.6
Deferred product acquisition payments 279.1 147.2
Other assets 271.5 231.6
_______________________________________________________________
TOTAL ASSETS $1,666.6 $1,450.7
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 59.7 $ 60.7
Accrued liabilities 61.5 52.8
Current portion of long-term debt 7.4 2.9
_______________________________________________________________
Total current liabilities 128.6 116.4
5% convertible subordinated debentures 500.0 500.0
5 1/4% zero coupon convertible subordinated
debentures 422.6 402.6
Other long-term liabilities 83.5 65.4
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value, 0.1 shares authorized - -
Common stock, $.01 par value, 300.0 shares authorized;
100.3 and 97.7 shares issued and outstanding in
1998 and 1997, respectively 1.0 1.0
Additional paid-in capital 644.5 581.4
Accumulated other comprehensive income (loss) (10.6) (4.8)
Retained earnings (deficit) (103.0) (211.3)
_______________________________________________________________
Total stockholders' equity 531.9 366.3
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $ 1,666.6 $ 1,450.7
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 $0.9 $493.4 $ 1.9 $30.9 $ 527.1
Common stock issued 0.1 63.6 - - 63.7
Comprehensive income (loss)
Net income - - - 82.1 82.1
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) 80.1
_______________________________________________________________________
Balance, December 31, 1996 1.0 557.0 (0.1) 113.0 670.9
Common stock issued - 24.4 - - 24.4
Distribution of
Crescendo Shares - - - (49.1) (49.1)
Comprehensive income (loss)
Net loss - - - (275.2) (275.2)
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) (279.9)
_______________________________________________________________________
Balance, December 31, 1997 1.0 581.4 (4.8) (211.3) 366.3
Common stock issued - 63.1 - - 63.1
Comprehensive income (loss)
Net income - - - 108.3 108.3
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 102.5
______________________________________________________________________
Balance, December 31, 1998 $1.0 $644.5 $(10.6) $(103.0) $ 531.9
______________________________________________________________________
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) $108.3 $(275.2) $82.1
Non-cash adjustments to reconcile net
income (loss) to net cash provided by
(used in) operating activities:
Depreciation and amortization 34.4 31.3 21.6
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
Issuance of common stock to 401(k) plan 0.3 0.3 0.2
Issuance of common stock in exchange for
research and development technology
license - - 0.4
Decrease (increase) in assets:
Receivables (24.6) 1.5 (15.9)
Inventories (12.8) 3.1 (9.3)
Prepaid expenses and other current
assets 5.8 (4.1) (1.9)
Increase (decrease) in liabilities:
Accounts payable 0.4 27.4 10.4
Accrued liabilities (15.5) 0.1 2.3
Deferred revenue (0.7) 0.3 (17.9)
Other long-term liabilities 4.1 (20.8) 4.8
Asset write-down - 11.5 -
Total adjustments 28.5 74.9 16.2
__________________________________________________________________
Net cash provided by (used in)
operating activities 136.8 (200.3) 98.3
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (65.1) (41.8) (52.2)
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 (323.3) (435.4) (1,215.4)
Sales of available-for-sale securities 317.0 707.5 587.7
Maturities of available-for-sale
securities 82.1 65.7 163.7
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 (used in) provided by investing
activities (155.4) 96.3 (546.1)
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 61.4 24.1 63.0
Principal payments on long-term debt (4.4) 3.0 (1.1)
Net cash provided by (used in)
financing activities 57.0 (22.0) 550.7
__________________________________________________________________
Net increase (decrease) in cash and
cash equivalents 38.4 (126.0) 102.9
Cash and cash equivalents at the
beginning of year 71.7 197.7 94.8
Cash and cash equivalents at
the end of year $ 110.1 $71.7 $ 197.7
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.
ALZA acquired all of SEQUUS' outstanding stock in a tax-free,
stock-for-stock transaction on March 16, 1999. SEQUUS was engaged
in the development, manufacturing, marketing and sales of
proprietary liposome and lipid-based products used primarily to
treat cancer and certain fungal infections. ALZA has accounted for
the transaction as a pooling of interests, and accordingly, the
consolidated financial statements and all financial information
have been restated to reflect the combined operations, financial
position and cash flows of both companies.
Nature of Operations
Net sales includes sales of products marketed directly by ALZA
and sales of those products to distributors, as well as 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, milestones 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 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, and
after the close of the merger, SEQUUS Pharmaceuticals, Inc. 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.
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 $ 18.2 $19.2
Work in process 10.6 8.5
Finished goods 25.8 14.2
__________________________________________________________________
Total inventories $ 54.6 $41.9
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 $27.2 million, $26.7 million and $19.6 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 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 $ 25.3 $20.0
Accrued income taxes 23.7 11.4
Other accrued liabilities 12.5 21.4
__________________________________________________________________
Total accrued liabilities $ 61.5 $52.8
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 $16.3 million, $8.5 million and $5.0 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 29.8 36.8 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:
Before-Tax Tax(Expense) Net-of-Tax
(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.
Reclassifications
Certain prior year amounts have been reclassified to conform
to the current presentation.
Note 2. INVESTMENTS
ALZA has classified its entire investment portfolio, including
cash equivalents of $112.8 million and $70.8 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.
The following is a summary of ALZA's investment portfolio (in
millions):
December 31, 1998
Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
______________________________________________________________
U.S. Treasury
securities
and obligations
of U.S. government
agencies $66.3 $ 0.6 $(0.1) $66.8
Collateralized mortgage
obligations and asset
backed securities 58.4 0.4 - 58.8
Corporate debt
securities 332.4 2.0 (0.1) 334.3
_____________________________________________________________
Total debt
securities 457.1 3.0 (0.2) 459.9
Equity securities 77.6 - (20.7) 56.9
______________________________________________________________
Total available
for sale 534.7 3.0 (20.9) 516.8
Less cash
equivalents (112.8) - _ (112.8)
______________________________________________________________
Total investments $421.9 $3.0 $ (20.9) $404.0
December 31, 1997
_________________
Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
______________________________________________________________
U.S. Treasury
securities
and obligations
of U.S. government
agencies $149.8 $ 0.4 $ (0.3) $ 149.9
Collateralized mortgage
obligations and asset
backed securities 70.9 0.3 (0.2) 71.0
Corporate debt
securities 270.6 0.9 (0.4) 271.1
______________________________________________________________
Total debt
securities 491.3 1.6 (0.9) 492.0
Equity securities 77.1 1.1 (10.0) 68.2
______________________________________________________________
Total available
for sale 568.4 2.7 (10.9) 560.2
Less cash
equivalents (70.8) - - (70.8)
______________________________________________________________
Total investments $ 497.6 $ 2.7 $(10.9) $489.4
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 $199.0 $198.9 $ 198.8 $ 198.7
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 $457.1 $459.9 $491.3 $492.0
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 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.
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:
Net income (loss) $108.3 $(275.2) $ 82.1
______________________________________________________________
DENOMINATOR:
Basic
Weighted average shares 99.0 97.3 95.8
______________________________________________________________
Diluted
Weighted average shares 99.2 97.3 95.8
Effect of dilutive securities:
Employee stock options
and warrants 2.3 - 1.6
______________________________________________________________
Weighted average shares 101.5 97.3 97.4
Basic earnings (loss) per share $ 1.09 $(2.83) $ .86
Diluted earnings (loss) per share $ 1.07 $(2.83) $ .84
Outstanding options and warrants to purchase 0.3 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
and 5 1/4% 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
options and warrants would have been anti-dilutive and were
therefore excluded from the diluted calculation.
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 Elmiron for ALZA.
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.
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.
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. At December 31, 1998 the outstanding
5 1/4% Debentures had a total 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.
Other Long-term Liabilities
ALZA's other long-term liabilities are as follows (in millions):
1998 1997
______________________________________________________________
Long-term debt $ 43.5 $29.6
Deferred compensation 40.0 35.8
______________________________________________________________
Total other long-term liabilities $83.5 $65.4
At December 31, 1998 and 1997, long-term debt primarily
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 $7.5 million in 1999, $8.3 million in 2000, $8.1 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.
At December 31, 1998, SEQUUS had outstanding 0.3 million
warrants, each to purchase 0.5 shares of SEQUUS common stock at an
exercise price per share of $7.4328. Warrants outstanding at March
16, 1999 totaling 0.2 million were assumed by ALZA. Each warrant
is exercisable for 0.2 shares of ALZA common stock at an exercise
price per share of $18.58, and all warrants expire, to the extent
not exercised, in May 1999.
ALZA is authorized to issue 100,000 shares of preferred stock,
$0.01 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 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
and/or have been licensed 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 of the
license, ALZA must pay Crescendo 2.5% of net sales of the licensed
product for the first year and 3% for the second and third years.
Thereafter, until 15 years after the date of the first commercial
sale of the product, the percentage owed to Crescendo 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; 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.
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
acquisition 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. SEQUUS' bonus expenses for 1998, 1997, 1996 were
$1.7 million, $1.6 million and $1.8 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. A supplemental plan
for executives provides for contributions in excess of those made
to the above plan. ALZA recognized expense of $0.3 million related
to this plan in 1998, the first year in which contributions were
accrued.
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.
SEQUUS has a 401(k) Plan under which it may make employer
contributions, in the form of common stock, at the discretion of
the Board of Directors. SEQUUS reserved 55,200 shares (ALZA
equivalent shares) for issuance under the plan. In 1998, 1997 and
1996, SEQUUS' contribution of common stock to the plan was valued
at approximately $0.3 million, $0.3 million and $0.2 million,
respectively.
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 shares 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.
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 ExerciseOptions Exercise Options Exercise
(in millions)Price(in millions)Price(in millions)Price
Outstanding-begin-
ning 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 ALZA's stock plan were 0.4 million and 2.7 million,
respectively.
SEQUUS' stock plans include the SEQUUS 1987 Employee Stock
Option Plan, the SEQUUS 1987 Consultant Stock Option Plan, the
SEQUUS 1990 Director Stock Option Plan and the SEQUUS Equity
Incentive Plan. Most of the outstanding options accelerated so as
to become exerciseable immediately prior to the closing date of the
merger. Upon closing of the merger, ALZA assumed all remaining
options under these plans, which were converted into outstanding
options to purchase ALZA common stock. The following table shows
activity under the SEQUUS plans, adjusted to ALZA equivalent
shares:
1998 1997 1996
______________________________________________________________
Weighted Weighted Weighted
Average Average Average
Options ExerciseOptions Exercise Options Exercise
(in millions)Price(in millions)Price(in millions)Price
______________________________________________________________
Outstanding-begin-
ning of year 1.6 $23 1.6 $ 25 1.6 $ 20
Granted 0.4 25 0.5 18 0.4 40
Exercised (0.3) 20 (0.1) 15 (0.3) 15
Forfeited - - (0.4) 28 (0.1) 28
______________________________________________________________
Outstanding-end
of year 1.7 23 1.6 23 1.6 25
Exercisable-end
of year 0.9 23 0.9 20 0.8 18
Weighted-average fair
value of options
granted $15.62 $10.92 $23.23
The following is a summary of ALZA and SEQUUS (on an
equivalent basis) combined options outstanding and options
exercisable:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
______________________________________________________________
Number Weighted-Average Number
Range of Outstanding Remaining Weighted-Average Exercisable Weighted-
Exercise at Contrac- Exercise at Average
Prices 12/31/98 tual life Price 12/31/98 Exercise
(in millions)(in years) (in millions) Price
______________________________________________________________
$ 2.80-15.59 0.3 6.9 $ 13.25 0.2 $13.25
15.60-24.50 2.7 5.8 20.50 2.2 20.70
24.75-29.00 1.7 7.0 25.37 1.0 25.21
29.06-45.75 2.4 8.1 32.70 0.6 35.09
46.69-51.62 1.6 9.3 47.01 - -
______________________________________________________________
8.7 4.0
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"). ALZA has
elected to continue to follow
APB 25 in accounting for its employee stock options and employee
stock purchase plan.
Had compensation expense for ALZA's and SEQUUS' stock options
and shares issued under the stock purchase plans 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:
(in millions, except per share amounts) 1998 1997 1996
Net income (loss)
As reported $ 108.3 $(275.2) $ 82.1
Pro forma 88.4 (287.1) 70.6
Earnings (loss) per share (basic)
As reported $ 1.09 $ (2.83) $ 0.86
Pro forma 0.89 (2.95) 0.74
Earnings (loss) per share (diluted)
As reported $ 1.07 $ (2.83) $ 0.84
Pro forma 0.87 (2.95) 0.72
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% to 6.2% 6.2% to 6.4% 6.0% to 6.2%
Expected dividend yield 0% 0% 0%
Expected volatility (1) 30% 30% 30%
Expected life (in years) 2.25-3.8 2.25-4.0 2.25-3.6
(1) SEQUUS' volatility rates for 1998, 1997 and 1996 were 83%, 79%
and 74%, respectively.
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 plans.
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 Black-
Scholes 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 weighted-
average 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.
SEQUUS had a stock purchase plan for its employees, which,
upon closing of the merger was assumed by ALZA. Under this plan,
SEQUUS employees could purchase stock at 85% of the fair market
value at certain specified dates. Employees enrolled in the plan
may purchase equivalent shares of ALZA stock through July 1999,
when the plan terminates. In 1998, 1997 and 1996 total shares
(ALZA equivalent) of SEQUUS common stock purchased by the
participants under the terms of this plan were not significant.
Since the plan's inception, 0.1 million equivalent shares have been
issued and 0.2 million equivalent shares are available for
issuance.
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 (0.7) (20.2) (7.8)
_______________________________________________________________
49.0 26.7 40.1
State
Current 11.1 16.5 11.2
Deferred (2.3) (2.9) (1.5)
_______________________________________________________________
8.8 13.6 9.7
_______________________________________________________________
Provision for income taxes $ 57.8 $40.3 $49.8
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.
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% $ 58.2 $(81.2) $ 46.2
State income taxes, net of
federal benefit 5.7 8.8 6.3
Investment and research
tax credits (7.5) (5.2) (2.3)
Purchased in-process research and
development - 113.4 -
Other 1.4 4.5 (0.4)
_______________________________________________________________
Provision for income taxes $ 57.8 $ 40.3 $49.8
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 $ 53.7 $ 47.9
Net operating loss and credit
carry forwards 46.0 40.2
Compensation 19.2 16.1
Unrealized losses on
available-for-sale securities 7.3 3.4
Inventories 7.2 5.6
Investments 4.2 5.7
Bad debt 4.0 3.0
State income taxes 1.0 7.4
Deferred revenue - 0.1
Other 5.9 5.2
_______________________________________________________________
Total deferred tax assets 148.5 134.6
Less valuation allowance (23.2) (23.2)
_______________________________________________________________
125.3 111.4
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 $ 75.7 $64.4
The valuation allowance at December 31, 1998 relates to net
operating losses and tax credit carryforwards which ALZA believes
may not be realizable because of delayed availability due to tax
"change of ownership" limitations. The remainder of such
carryforwards are realizable within the next three years. Of the
valuation allowance, $4.1 million is attributable to stock option
deductions, the benefit of which will be allocated to contributed
capital when realized. The valuation allowance did not change in
1998 or 1997.
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 $5.3
million, $6.5 million and $5.5 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 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 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.
Aggregate minimum lease commitments under all non-cancelable
operating lease arrangements as of December 31, 1998 were (in
millions):
1999 $ 11.2
2000 12.3
2001 12.0
2002 12.1
2003 11.3
Later years 156.6
______________________
Total $215.5
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.
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 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 is making 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. ALZA issued
13.2 million shares to acquire the outstanding SEQUUS shares on the
closing date. ALZA has accounted for the transaction as a
pooling of interests, and accordingly the consolidated financial
statements and all financial information have been restated to
reflect the combined operations, financial position and cash flows
of both companies.
The following table summarizes the separate and combined
results of operations of ALZA and SEQUUS:
Year ended December 31, 1998
(in millions, except per share amounts)
POOLING
ALZA SEQUUS ADJUSTMENT COMBINED
_______________________________________________________________
Revenues $ 584.5 $ 62.4 $ 646.9
Net income (loss) 112.3 (6.7) $ 2.7 108.3
Earnings (loss) per share
Basic 1.30 (0.21) 1.09
Diluted 1.26 (0.21) 1.07
Year ended December 31, 1997
(in millions, except per share amounts)
POOLING
ALZA SEQUUS ADJUSTMENT COMBINED(1)
_____________________________________________________________________
Revenues $ 464.4 $40.0 $ 504.4
Net income (loss) (261.1) (23.6) $ 9.4 (275.2)
Earnings (loss) per share
Basic (3.07) (0.78) (2.83)
Diluted (3.07) (0.78) (2.83)
Year ended December 31, 1996
(in millions, except per share amounts) POOLING
ALZA SEQUUS ADJUSTMENT COMBINED
_____________________________________________________________________
Revenues $ 413.1 $33.0 $446.1
Net income (loss) 92.4 (17.2) $6.9 82.1
Earnings (loss) per share
Basic 1.10 (0.59) 0.86
Diluted 1.08 (0.59) 0.84
(1) Net loss 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 products marketed by, and
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.
SEQUUS' net sales, costs of products shipped, research and
development expenses for products marketed by, and potential
products to be marketed by, ALZA Pharmaceuticals, and sales and
marketing expenses are included in the ALZA Pharmaceuticals
segment; SEQUUS' royalty and fee revenues and research and
development revenues and related expenses (largely for activities
undertaken on behalf of ALZA Pharmaceuticals) are included in the
ALZA Technologies segment; and SEQUUS' general and administrative
expenses are included in the Other segment.
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 $ 175.8 $ 113.6 $- $289.4
Royalties, fees and other 25.3 205.4 2.4 233.1
Research and development 93.0 31.4 - 124.4
___________________________________________________________________
Total 294.1 350.4 2.4 646.9
Intersegment revenues
Net sales - 6.6 - 6.6
Research & development - 123.6 - 123.6
___________________________________________________________________
Total - 130.2 - 130.2
Depreciation and amortization
expense (1) 12.0 23.0 10.2 45.2
___________________________________________________________________
Segment operating income
(loss) 23.2 193.6 (20.3) 196.5
___________________________________________________________________
Year ended December 31, 1997
ALZA ALZA
(in millions) Pharmaceuticals Technologies Other Total
___________________________________________________________________
Revenues from external
customers
Net sales $ 87.9 $ 93.2 $ - $181.1
Royalties, fees and other 11.9 175.6 0.8 188.3
Research and development 91.5 43.5 - 135.0
___________________________________________________________________
Total 191.3 312.3 0.8 504.4
Intersegment revenues
Net sales - 6.0 - 6.0
Research and development - 116.5 - 116.5
___________________________________________________________________
Total - 122.5 - 122.5
Depreciation and amortization
expense (1) 4.7 16.9 10.3 31.9
Segment operating income
(loss) (322.6)(2) 133.5(3)(29.7) (228.8)
Year ended December 31, 1996
ALZA ALZA
(in millions) Pharmaceuticals Technologies Other Total
___________________________________________________________________
Revenues from external
customers
Net sales $ 48.7 $ 85.4 $ - $134.1
Royalties, fees and other 10.9 166.7 3.2 180.8
Research and development 96.6 34.6 - 131.2
___________________________________________________________________
Total 156.2 286.7 3.2 446.1
Intersegment revenues
Net sales - 6.8 - 6.8
Research and development - 116.0 - 116.0
___________________________________________________________________
Total - 122.8 - 122.8
Depreciation and amortization
expense (1) 2.8 14.6 6.6 24.0
Segment operating income
(loss) (13.7) 159.5 (25.6) 120.2(1)
(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.
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 $644.5 $503.6 $442.9
Intersegment revenues
for reportable segments 123.6 116.5 116.0
Other revenues 2.4 0.8 3.2
Elimination of intersegment revenues (123.6) (116.5) (116.0)
___________________________________________________________________
Total consolidated revenues $646.9 $504.4 $446.1
Income (loss) before taxes
Total operating income (loss) for
reportable segments $220.7 $(195.7) $149.1
Other loss (24.2) (33.1) (28.9)
Unallocated amounts:
Interest income 26.4 57.1 54.7
Interest expense (56.7) (63.2) (43.0)
___________________________________________________________________
Income (loss) before income taxes $166.2 $(234.9) $131.9
Company-wide Information:
Geographic Revenues
(in millions) 1998 1997 1996
___________________________________________________________________
United States $538.7 $415.5 $372.9
Canada 7.9 6.1 3.0
Europe 94.9 79.3 67.4
Other foreign countries 5.4 3.5 2.8
Consolidated total $646.9 $504.4 $446.1
Long-lived assets outside the United States were not
significant. Export sales, principally net sales to distributors
and client companies in Europe, were $42.6 million, $36.2 million
and $25.8 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) 18% 14% 13%
Crescendo (1,2) 16 * -
Pfizer (2) 12 16 20
TDC (1,2) - 14 22
(1) Included in the ALZA Pharmaceuticals segment
(2) Included in the ALZA Technologies segment
* Less than 10%
NOTE 14: QUARTERLY FINANCIAL DATA (UNAUDITED)
(In millions, except per share amounts)
1998 1997
First Second Third Fourth First Second Third(1) Fourth(2)
___________________________________________________________________
Total revenues $143.5 $158.3 $172.8 $172.3 $113.8 $126.7 $125.0 $138.9
Gross margin
on net sales 35.4 37.2 42.1 48.9 13.0 19.4 21.9 26.9
Operating income
(loss) 47.6 53.1 50.5 45.3 31.4 35.2( 311.2) 15.8
Net income
(loss) 26.5 29.4 27.7 24.7 21.8 22.0(329.6) 10.6
Earnings (loss) per share
Basic $0.27 $0.30 $0.28 $0.25 $0.23 $0.23 $(3.38)$0.11
Diluted 0.27 0.29 0.27 0.24 0.22 0.22 (3.38) 0.10
(1) In the third quarter of 1997, ALZA recorded charges totaling
$353.5 million, or $3.63 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 $0.16 per share,
diluted.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
THE BOARD OF DIRECTORS AND STOCKHOLDERS
ALZA CORPORATION
We have audited the accompanying consolidated balance sheets 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 paragraph 2 of Note 1 and Note 12 as to which date is
March 16, 1999
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 $ 2.3 $ 1.7 $ 1.3 $ 2.7
1997 $ 1.1 $ 1.4 $ 0.2 $ 2.3
1996 $ 0.4 $ 1.0 $ 0.3 $ 1.1
