-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, WccaYLb/Vh14NF5VkFT7jlnMcn2eXs8vGguxFIrZDQaXiQ1t45VAGIeIseRPxfI2 xduIv+uUkvSYcdRsSVAVNQ== 0000004310-99-000019.txt : 19990816 0000004310-99-000019.hdr.sgml : 19990816 ACCESSION NUMBER: 0000004310-99-000019 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 19990813 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ALZA CORP CENTRAL INDEX KEY: 0000004310 STANDARD INDUSTRIAL CLASSIFICATION: PHARMACEUTICAL PREPARATIONS [2834] IRS NUMBER: 770142070 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-06247 FILM NUMBER: 99689539 BUSINESS ADDRESS: STREET 1: 950 PAGE MILL RD STREET 2: PO BOX 10950 CITY: PALO ALTO STATE: CA ZIP: 94303-0802 BUSINESS PHONE: 6504945000 MAIL ADDRESS: STREET 1: 950 PAGE MILL RD STREET 2: PO BOX 10950 CITY: PALO ALTO STATE: CA ZIP: 94303 10-Q 1 10Q TEXT UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (X) Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended June 30, 1999 or ( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from __________ to __________ Commission File Number 1-6247 ALZA CORPORATION (Exact name of registrant as specified in its charter) Delaware 77-0142070 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 950 Page Mill Road P.O. Box 10950 Palo Alto, California 94303-0802 (Address of principal executive offices) Registrant's telephone number, including area code (650) 494-5000 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes (X) No ( ) Number of shares outstanding of each of the registrant's classes of common stock as of July 30, 1999: Common Stock, $.01 par value - 101,596,932 shares ALZA CORPORATION FORM 10-Q for the Quarter Ended June 30, 1999 INDEX Part I. Financial Information Item 1. Financial Statements Condensed Consolidated Statement of Income 3 Condensed Consolidated Balance Sheet 4 Condensed Consolidated Statement of Cash Flows 5 Notes to Condensed Consolidated Financial Statements 6-12 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13-27 Item 3. Quantitative and Qualitative Disclosures about Market Risk 28 Part II. Other Information Item 1. Legal Proceedings 28 Item 4. Submission of matters to vote of security holders 29 Item 6. Exhibits and Reports on Form 8-K 30 Signatures 31 Exhibits PART I. FINANCIAL INFORMATION Item 1. Financial Statements ALZA CORPORATION Condensed Consolidated Statement of Operations (unaudited) (In millions, except per share amounts) Quarter Ended Six Months Ended June 30, June 30, 1999 1998 1999 1998 ---------------------------------------- Revenues: Net sales $103.2 $ 72.3 $199.4 $139.1 Royalties, fees and other 54.8 53.4 113.7 103.8 Research and development 37.2 32.6 67.6 58.9 ---------------------------------------- Total revenues 195.2 158.3 380.7 301.8 Costs and expenses: Costs of products shipped 40.3 35.2 74.6 66.5 Research and development 47.8 42.7 91.9 82.9 Selling, general and administrative 60.4 27.3 115.6 51.7 SEQUUS merger-related costs - - 32.6 - ---------------------------------------- Total costs and expenses 148.5 105.2 314.7 201.1 Operating income 46.7 53.1 66.0 100.7 Interest expense 14.8 14.3 29.7 28.5 Interest and other income (18.4) (6.5) (23.4) (13.4) ---------------------------------------- Net interest and other (income) expense (3.6) 7.8 6.3 15.1 ---------------------------------------- Income before income taxes 50.3 45.3 59.7 85.6 Provision for income taxes 16.1 15.9 21.8 29.7 ---------------------------------------- Net income $ 34.2 $ 29.4 $ 37.9 $ 55.9 ====================================== Earnings per share Basic $ 0.34 $ 0.30 $ 0.38 $ 0.57 ====================================== Diluted $ 0.33 $ 0.29 $ 0.37 $ 0.56 ====================================== Shares used in per share computation Basic 100.7 99.0 100.5 98.6 Diluted 114.9 113.8 102.9 100.7 See accompanying notes. ALZA Corporation Condensed Consolidated Balance Sheet (unaudited) (In millions) June 30, December 31, 1999 1998 ________________________________________________________________ ASSETS Current assets: Cash and cash equivalents $ 92.2 $ 110.1 Short-term investments 58.1 86.1 Receivables, net 166.7 148.6 Inventories, at cost: Raw materials 19.9 18.2 Work in process 10.4 10.6 Finished goods 29.0 25.8 ________________________________________________________________ Total inventories 59.3 54.6 Prepaid expenses and other current assets 69.5 26.3 ________________________________________________________________ Total current assets 445.8 425.7 Property, plant and equipment 511.2 504.7 Less accumulated depreciation and amortization (131.0) (132.3) ________________________________________________________________ Net property, plant and equipment 380.2 372.4 Investments in long-term securities 336.6 317.9 Deferred product acquisition payments 281.9 279.1 Other assets 285.4 271.5 ________________________________________________________________ TOTAL ASSETS $ 1,729.9 $ 1,666.6 ================================================================ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 53.0 $ 59.7 Accrued liabilities 57.3 61.5 Other current liabilities 7.5 7.4 ________________________________________________________________ Total current liabilities 117.8 128.6 5% convertible subordinated debentures 499.9 500.0 5 1/4% zero coupon convertible subordinated debentures 433.7 422.6 Other long-term liabilities 81.4 83.5 Stockholders' equity: Common stock and additional paid-in capital 671.7 645.5 Accumulated other comprehensive loss (9.5) (10.6) Accumulated deficit (65.1) (103.0) ________________________________________________________________ Total stockholders' equity 597.1 531.9 ________________________________________________________________ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,729.9 $ 1,666.6 ================================================================ See accompanying notes. ALZA CORPORATION Condensed Consolidated Statement of Cash Flows (unaudited) (In millions) Six Months Ended June 30, 1999 1998 __________________________________________________________________ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 37.9 $ 55.9 Non-cash adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 20.0 18.7 Amortization of product acquisition payments 12.2 5.3 Interest on 5 1/4% zero coupon convertible subordinated debentures 11.2 10.5 Changes in current assets: Receivables (18.1) (9.3) Inventories (4.6) 6.7 Prepaid expenses and other current assets (43.8) 0.4 Changes in liabilities: Accounts payable (1.8) (34.8) Accrued liabilities 0.4 (15.3) Other long-term liabilities 1.9 1.2 Gain on sale of real estate and other assets, net (12.5) - Asset write-down 10.7 - ___________________ Total adjustments (24.4) (16.6) ___________________ Net cash provided by operating activities 13.5 39.3 CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (40.8) (25.1) Proceeds from sale of real estate assets 20.3 - Product acquisition payments (20.0) (6.2) Purchases of available-for-sale securities (102.5) (176.4) Sales and maturities of available-for-sale securities 113.2 167.0 Other investing activities (18.0) (14.0) ______________________________________________________________________ Net cash used in investing activities (47.8) (54.7) CASH FLOWS FROM FINANCING ACTIVITIES: Issuances of common stock 20.0 38.1 Principal repayments of long-term debt, net (3.6) (4.2) ______________________________________________________________________ Net cash provided by financing activities 16.4 33.9 ______________________________________________________________________ Net (decrease) increase in cash and cash equivalents (17.9) 18.5 Cash and cash equivalents at beginning of period 110.1 71.7 _____________________________________________________________________ Cash and cash equivalents at end of period $ 92.2 $ 90.2 ======================= See accompanying notes. ALZA CORPORATION Notes to Condensed Consolidated Financial Statements (unaudited) NOTE 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information. The information at June 30, 1999 and for the three and six months ended June 30, 1999 and 1998 includes all adjustments (consisting only of normal recurring adjustments) that the management of ALZA Corporation ("ALZA") believes necessary for fair presentation of the results for the periods presented. Results for any interim period are not necessarily indicative of results for any future interim period or for the entire year. The accompanying financial statements should be read in conjunction with the financial statements and notes thereto included in ALZA's Annual Report on Form 10-K for the year ended December 31, 1998 and on ALZA's Report on Form 8-K filed May 13, 1999, which restates financial information for prior periods to reflect the combined results of ALZA and SEQUUS Pharmaceuticals, Inc. ("SEQUUS"). In March 1999, all of the outstanding shares of SEQUUS were acquired by ALZA in a business combination accounted for as a pooling of interests. Accordingly, the financial data for prior periods has been restated to represent the combined financial results of ALZA and SEQUUS (Note 5). Comprehensive Income Total comprehensive income includes net income plus other comprehensive income, which, for ALZA, primarily comprises net unrealized gains or losses on available-for-sale securities. Other comprehensive income (loss) was $(6.8) million and $(9.8) million for the quarters ended June 30, 1999 and 1998, respectively, and $1.1 million and $(9.9) million for the six months ended June 30, 1999 and 1998. Total comprehensive income was $27.4 million and $19.6 million for the quarters ended June 30, 1999 and 1998, respectively, and $39.0 million and $46.0 million for the six months ended June 30, 1999 and 1998, respectively. Supplemental Disclosures of Cash Flow Information Noncash Investing and Financing Activities (In millions) Six months ended June 30, 1999 1998 _________________________________________________________________ Investment in low-income housing in exchange for long-term debt $ - $ 10.1 Acquisition of building in lieu of repayment of note receivable - 17.5 Accrued purchase option exercise price for limited partners' interests in ALZA TTS Research Partners, Ltd. - 91.2 Conversion of 5% and 5 1/4% Debentures into ALZA common stock 0.2 1.2 Reclassification Certain amounts in the prior year's financial statements have been reclassified to conform to the 1999 presentation. NOTE 2. MERGER AGREEMENT WITH ABBOTT LABORATORIES On June 21, 1999, ALZA entered into an Agreement and Plan of Merger ("Merger Agreement") with Abbott Laboratories ("Abbott"), an Illinois corporation. Under the terms of the Merger Agreement, Abbott would acquire all of ALZA's outstanding stock in a tax free, stock-for-stock transaction. ALZA's stockholders would receive 1.2 shares of Abbott common stock for each share of ALZA common stock held on the record date. The transaction is expected to be completed by the end of 1999, subject to approval by ALZA's stockholders, clearance by regulatory agencies and customary closing conditions. NOTE 3. EARNINGS PER SHARE INFORMATION Basic earnings per share is calculated by dividing net income by the weighted average common shares outstanding for the period. Diluted earnings per share is calculated by dividing net income, as adjusted, by the weighted average common shares outstanding for the period plus the dilutive effect of stock options, warrants and convertible securities. The following table sets forth the computation of ALZA's basic and diluted earnings per share: Quarter Ended Six Months Ended (In millions except June 30, June 30, per share amounts) 1999 1998 1999 1998 _________________________________________________________________ NUMERATOR: Basic Net income $ 34.2 $ 29.4 $37.9 $ 55.9 _________________________________________________________________ Diluted Net income $ 34.2 $ 29.4 $37.9 $ 55.9 Adjustments, net of tax: Interest on 5 1/4% Debentures 33.8 3.5 - - ___________________________________________________________________ Adjusted net income $ 38.0 $ 32.9 $37.9 $ 55.9 ================================================================= DENOMINATOR: Basic Weighted average shares 100.7 99.0 100.5 98.6 ================================================================= Diluted Weighted average shares 101.0 99.1 100.8 98.6 Effect of dilutive securities: Employee stock options 1.6 2.3 2.1 2.0 Warrants - 0.1 - 0.1 5 1/4% Debentures 12.3 12.3 - - ___________________________________________________________________ Weighted average shares and assumed conversions 114.9 113.8 102.9 100.7 ================================================================= Basic earnings per share $ 0.34 $ 0.30 $0.38 $ 0.57 =================================================================== Diluted earnings per share $ 0.33 $ 0.29 $0.37 $ 0.56 ================================================================= Stock options and warrants to purchase 3.5 million and 3.0 million shares of common stock were excluded from the diluted earnings per share calculation for the quarter and six months ended June 30, 1999, respectively, compared to 2.5 million shares for the same periods in 1998 because the exercise price of the options and warrants was greater than the average market price of the common shares during the quarter, and therefore the effect of including those options and warrants would have been anti-dilutive. Assumed conversions of ALZA's outstanding 5% convertible subordinated debentures due 2006 ("5% Debentures") were not included in the diluted earnings per share calculation for the periods presented as their inclusion would have been anti-dilutive. The 5 1/4% zero coupon convertible subordinated debentures due 2014 ("5 1/4% Debentures") were not included in the diluted earnings per share calculation for the six months ended June 30, 1999 and 1998 as their inclusion would have been anti-dilutive. NOTE 4. CRESCENDO PHARMACEUTICALS CORPORATION (RELATED PARTY) Under the Development Agreement between ALZA and Crescendo Pharmaceuticals Corporation ("Crescendo"), ALZA recorded product development revenues of $28.5 million for the quarter ended June 30, 1999 and $51.8 million for the six months ended June 30, 1999 compared with $24.9 million for the quarter ended June 30, 1998 and $44.9 million for the six months ended June 30, 1998. ALZA expects that Crescendo will have expended all of its available funds during 2000. Under the Technology License Agreement between ALZA and Crescendo, ALZA recorded technology fee revenue from Crescendo of $2.0 million for the quarter ended June 30, 1999 and $4.0 million for the six months ended June 30, 1999, compared with $3.0 million for the quarter ended June 30, 1998 and $6.0 million for the six months ended June 30, 1998, all in accordance with the terms of the agreement. 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 OROSr- registered trademark- oxybutynin (marketed by ALZA in the United States as Ditropanr-registered trademark- XL). Under the license agreement for this product, ALZA must pay Crescendo 2.5% of net sales of the licensed product in the first year of sales, and 3% in 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%. NOTE 5. ACQUISITION OF SEQUUS PHARMACEUTICALS, INC. On March 16, 1999, ALZA completed a merger with SEQUUS by acquiring all of SEQUUS' outstanding stock in a tax-free, stock- for-stock transaction. SEQUUS stockholders received 0.4 shares of ALZA common stock for each share of SEQUUS common stock. ALZA issued 13.2 million shares in the merger. ALZA accounted for the transaction as a pooling of interests. Accordingly, ALZA's consolidated financial statements have been retroactively restated for prior periods to include the combined financial results of ALZA and SEQUUS. For the quarter and six months ended June 30, 1999, the consolidated results of operations of the combined companies have been presented and no adjustments were necessary to conform the accounting practices of the two companies. The table below presents the separate results of operations for ALZA and SEQUUS for the periods prior to the merger and combined results after the merger: Merger- related (In millions) ALZA SEQUUS adjustments Total _________________________________________________________________ Six months ended June 30, 1999 Revenues (a)$ 368.3 $ 12.4 $ - $ 380.7 Net income (a) 76.2 (5.7) (b)(32.6) 37.9 ___________________________________________________________ Six months ended June 30, 1998 Revenues $ 273.0 $ 28.8 $ - $ 301.8 Net income (loss) 59.0 (5.2) (c) 2.1 55.9 ________________________________________________________________ (a) SEQUUS' results are included in ALZA's combined results subsequent to March 16, 1999. (b) Represents expenses incurred by ALZA related to the merger. (c) Represents a 40% tax benefit derived from SEQUUS' net loss. As a result of the SEQUUS acquisition, ALZA incurred merger- related costs that consisted of merger transaction costs, exit costs and employee severance costs. Merger transaction costs consisted primarily of fees for investment bankers, attorneys and accountants, filing fees, financial printing costs and other related charges. Exit costs include costs such as cancellation of lease agreements and the write-down of SEQUUS assets that will not be used in continuing operations. The following table shows the details of the accrual for merger-related costs for the six months ended June 30, 1999: Merger- Balance related at June 30, (In millions) costs Utilized 1999 ____________________________________________________________________ Merger transaction costs $ 13.2 $ 13.2 $ - Exit costs 14.3 10.3 4.0 Employee severance 5.1 5.1 - _______________________________ Total $ 32.6 $ 28.6 $ 4.0 =============================== NOTE 6. SEGMENT REPORTING ALZA has two operating segments: ALZA Pharmaceuticals and ALZA Technologies. The ALZA Pharmaceuticals segment includes sales of products directly to the pharmaceutical marketplace, research and development of potential products to be marketed by ALZA (including revenues and expenses relating to products under development with Crescendo) and co-promotion revenues for products co-promoted by ALZA. The ALZA Technologies segment includes research, development and manufacturing for client companies and ALZA Pharmaceuticals, and royalties and fees (including milestone payments) from ALZA's client companies under joint product 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 for potential products to be marketed by ALZA and sales and marketing expenses are included in ALZA Pharmaceuticals; SEQUUS royalties and fee revenues and research and development expenses are included in ALZA Technologies; and SEQUUS general and administrative expenses are included in Other. 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 in ALZA's Annual Report on Form 10-K for the year ended December 31, 1998. ALZA accounts for intersegment revenues based on prices negotiated between the segments, which generally approximate the prices charged to third parties. ALZA's reported segments are strategic operating 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 ALZA Technologies' arrangements with client companies. The following tables contain information about segment operating income (loss) for the quarter ended June 30, 1999 and 1998, and six months ended June 30, 1999 and 1998. Quarter ended Six months ended June 30, June 30, (In millions) 1999 1998 1999 1998 ________________________________________________________________ Revenues from external customers Net sales ALZA Pharmaceuticals $ 68.8 $ 41.8 $ 136.7 $ 83.7 ALZA Technologies 34.4 30.5 62.7 55.4 Royalties, fees and other ALZA Pharmaceuticals 3.2 6.3 6.3 10.1 ALZA Technologies 51.2 46.2 106.6 92.5 Other 0.4 0.9 0.8 1.2 Research and development ALZA Pharmaceuticals 28.5 24.3 51.8 43.8 ALZA Technologies 8.7 8.3 15.8 15.1 __________________________________________ Total $ 195.2 $ 158.3 $ 380.7 $301.8 ========================================= Intersegment revenues Net sales ALZA Pharmaceuticals $ - $ - $ - $ - ALZA Technologies 3.8 2.0 8.0 3.6 Research and development ALZA Pharmaceuticals - - - - ALZA Technologies 28.6 24.3 51.9 43.9 __________________________________________ Total $ 32.4 $ 26.3 $ 59.9 $ 47.5 ========================================= Segment operating income (loss) ALZA Pharmaceuticals $ 2.5 $ 10.7 $ 6.3 $ 21.8 ALZA Technologies 52.3 47.7 106.5 90.2 Other (8.1) (5.3) (46.8) (11.3) __________________________________________ Total $ 46.7 $ 53.1 $ 66.0 $100.7 ========================================= The following table contains a reconciliation of ALZA's income before taxes to that reported by segment in the tables above: Quarter ended Six months ended June 30, June 30, (In millions) 1999 1998 1999 1998 ________________________________________________________________ Income (loss) before taxes Total operating income for reportable segments $ 54.8 $ 58.4 $ 112.8 $112.0 Other loss (8.1) (5.3) (46.8) (11.3) Unallocated amounts: Interest and other income 18.4 6.5 23.4 13.4 Interest expense (14.8) (14.3) (29.7) (28.5) ___________________________________________ Income before income taxes $ 50.3 $ 45.3 $ 59.7 $ 85.6 ========================================= NOTE 7. SALE OF REAL ESTATE ASSETS During the second quarter of 1999, ALZA sold five buildings located in Palo Alto, California, resulting in a total pretax gain of $12.6 million. ALZA will lease back these buildings through December 31, 1999, when it expects to complete occupancy of new buildings in Mountain View. In the near term, ALZA expects to lease out certain other Palo Alto, Menlo Park and Mountain View properties, currently occupied by ALZA, which could result in additional rental income in 2000 and beyond. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Notice Concerning Forward-Looking Statements Some of the statements made in this Form 10-Q are forward- looking in nature, including, without limitation, plans concerning the commercialization of products, statements concerning potential product sales, future costs of products shipped (and gross margins), associated sales and marketing expenses, plans concerning 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 than those presented, some or all of which risks 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 ALZA's Annual Report on Form 10-K for the year ended December 31, 1998. RESULTS OF OPERATIONS SUMMARY Quarter Ended Six Months Ended (In millions June 30, June 30, except per share amounts) 1999 1998 1999 1998 _________________________________________________________________ Revenues $ 195.2 $ 158.3 $ 380.7 $ 301.8 _________________________________________________________________ Operating income 46.7 53.1 66.0 100.7 _________________________________________________________________ Net income 34.2 29.4 37.9 55.9 _________________________________________________________________ Diluted earnings per share 0.33 0.29 0.37 0.56 _________________________________________________________________ ALZA's net income for the quarter ended June 30, 1999 was $34.2 million or $0.33 per diluted share compared with a net income of $29.4 million or $0.29 per diluted share for the quarter ended June 30, 1998. ALZA's net income for the six months ended June 30, 1999 was $37.9 million or $0.37 per diluted share compared with a net income of $55.9 million or $0.56 per diluted share for the six months ended June 30, 1998. Net income for the six months ended June 30, 1999 included merger-related charges of $24.8 million (net of tax effect of $7.8 million), or $0.24 per diluted share, which should be excluded in order to analyze comparable operating results for the six month periods of 1999 and 1998. Net income increased 16% for the quarter ended June 30, 1999, compared with the quarter ended June 30, 1998. On a comparable basis for the six months ended June 30, 1999, ALZA's net income increased 12% to $62.7 million, or $0.61 per diluted share, excluding the merger related charges discussed above, compared with $55.9 million or $0.56 per share for the six months ended June 30, 1998. The increase in net income for the quarter and six months ended June 30, 1999 compared to the same periods in 1998 resulted primarily from the following: -Net sales increased 43% to $103.2 million and $199.4 million for the quarter and six months ended June 30, 1999, respectively, from $72.3 million and $139.1 million for the quarter and six months ended June 30, 1998, respectively. The increase in net sales resulted primarily from a 64% increase in sales of products by ALZA Pharmaceuticals to $68.8 million and $136.7 million for the quarter and six months ended June 30, 1999, respectively, from $41.8 million and $83.7 million for the same three and six month periods in 1998. This increase in ALZA Pharmaceuticals' sales can be primarily attributed to $14.4 million and $36.4 million sales of Ditropan-registered trademark- XL (oxybutynin chloride), which was launched on February 1, 1999, for the quarter and six months ended June 30, 1999, respectively, as well as an increase of 19% and 26% in sales of Doxil-registered trademark-/Caelyx-registered trademark- (doxorubicin HCl liposome injection) for the quarter and six months ended June 30, 1999, respectively, all as compared to the same periods in 1998. In addition, revenues from contract manufacturing increased 13% to $34.4 million and $62.7 million for the quarter and six months ended June 30, 1999, respectively, from $30.5 million and $55.4 million for the same periods in 1998, due to higher shipments of Glucotrol XL-registered trademark- (glipizide) to Pfizer Inc. ("Pfizer"), Duragesic-registered trademark- (fentanyl) shipments to Janssen Pharmaceutica, Inc.(together with its affiliates, ("Janssen"), and NicoDerm-registered trademark- and Nicoderm- registered trademark- CQ-trademark- (nicotine) to Hoechst Marion Roussel, Inc. and SmithKline Beecham p.l.c.("SB"), respectively. - Gross margin increased to 61% for the quarter ended June 30, 1999 from 51% for the quarter ended June 30, 1998, and increased to 63% for the six months ended June 30, 1999 from 52% for the six months ended June 30, 1998. The increase in gross margin was largely due to the increase in sales of ALZA-marketed products as a percentage of total net sales and, to a lesser extent, an improvement in margins on certain contract manufactured products. - Royalties, fees and other revenues increased 3% to $54.8 million for the quarter ended June 30, 1999 from $53.4 million for the quarter ended June 30, 1998, and increased 10% to $113.7 million for the six months ended June 30, 1999 from $103.8 million for the six months ended June 30, 1998. The increase in royalties is primarily due to an increase in royalties on sales of Catapres-TTS-registered trademark-(clonidine) by Boehringer Ingelheim Pharmaceuticals Inc. ("Boehringer"), NicoDerm CQ by SB and Glucotrol XL by Pfizer, partially offset by a decrease in royalties from sales of Procardia XL-registered trademark- (nifedipine) by Pfizer. Fee revenue decreased to $5.0 million for the quarter ended June 30, 1999 from $7.6 million for the quarter ended June 30, 1998, and to $10.0 million for the six months ended June 30, 1999 from $15.8 million for the six months ended June 30, 1998. Fee revenues consists 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. - Research and development revenues increased 14% to $37.2 million for the quarter ended June 30, 1999 from $32.6 million for the quarter ended June 30, 1998, and increased 15% to $67.6 million for the six months ended June 30, 1999 from $58.9 million for the six months ended June 30, 1998. The increase is primarily due to an increase in research and development revenue from Crescendo to $28.5 million and $51.8 million for the quarter and six months ended June 30, 1999, respectively, compared with $24.9 million and $44.9 million for the same periods in 1998. - Interest and other income increased substantially to $18.4 million for the quarter ended June 30, 1999 from $6.5 million for the quarter ended June 30, 1998, and increased to $23.4 million for the six months ended June 30, 1999 compared with $13.4 million for the six months ended June 30, 1998. This increase was primarily due to a pretax gain of $12.6 million on sales of real estate assets that were completed during the quarter ended June 30, 1999. - ALZA's effective tax rate declined to 32% for the quarter and six months ended June 30, 1999, excluding the tax effect of $7.8 million on merger-related costs of $32.6 million, compared to 35% for the quarter and six months ended June 30, 1998. Substantially offsetting these contributions to net income in 1999 were the following: - Research and development expenses increased 12% to $47.8 million for the quarter ended June 30, 1999 from $42.7 million for the quarter ended in June 30, 1998, and increased 11% to $91.9 million for the six months ended June 30, 1999 from $82.9 million for the six months ended June 30, 1998. - Selling, general and administrative expenses increased to $60.4 million for the quarter ended June 30, 1999 from $27.3 million for the quarter ended June 30, 1998, and increased to $115.6 million for the six months ended June 30, 1999 from $51.7 million for the six months ended June 30, 1998. This increase was due to the expansion of the sales organization in the second half of 1998, the increase in marketing expenditures related to the launch of Ditropan XL in the first half of 1999 and increased marketing expenses for ALZA's expanded product portfolio. OPERATING SEGMENT SUMMARY 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 conducts product development, 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 other 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 for potential products to be marketed by ALZA and sales and marketing expenses are included in ALZA Pharmaceuticals; SEQUUS royalties and fee revenues and research and development expenses are included in ALZA Technologies; and SEQUUS general and administrative expenses are included in Other. OPERATING SEGEMENT SUMMARY Quarter ended Six months ended June 30, June 30, (In millions) 1999 1998 1999 1998 _________________________________________________________________ Revenues ALZA PHARMACEUTICALS $ 100.5 $ 72.4 $ 194.8 $137.6 ALZA TECHNOLOGIES 126.7 111.3 245.0 210.5 OTHER 0.4 0.9 0.8 1.2 _________________________________________________________________ Total segment revenues 227.6 184.6 440.6 349.3 Intersegment elimination (32.4) (26.3) (59.9) (47.5) _________________________________________________________________ Total revenues $ 195.2 $ 158.3 $ 380.7 $301.8 Operating income (loss) ALZA PHARMACEUTICALS $ 2.5 $ 10.7 $ 6.3 $ 21.8 ALZA TECHNOLOGIES 52.3 47.7 106.5 90.2 OTHER (8.1) (5.3) (46.8) (11.3) _________________________________________________________________ Total operating income $ 46.7 $ 53.1 $ 66.0 $100.7 _________________________________________________________________ ALZA PHARMACEUTICALS ALZA Pharmaceuticals' revenues increased 39% and 42% for the quarter and six months ended June 30, 1999 compared to the same periods in 1998 due to a 64% increase in net sales of ALZA- marketed products for both the quarter and six months ended June 30, 1999 compared to the same periods in 1998. The decrease in ALZA Pharmaceuticals' operating income for the quarter and six months ended June 30, 1999 compared to the quarter and six months ended June 30, 1998, was due to substantial increases in sales and marketing, reflecting the substantial expansion of ALZA's sales organization and increased marketing expenses related to the launch of Ditropan-registered trademark-XL and ALZA's expanded product portfolio. ALZA TECHNOLOGIES Operating income for ALZA Technologies increased 10% for the quarter ended June 30, 1999 and 18% for the six months ended June 30, 1999 compared to the same periods in 1998. This increase was primarily due to an 11% and 15% increase in royalties, fees and other revenues for the quarter and six months ended June 30, 1999, respectively, and a 13% increase in contract manufacturing sales for the quarter and six months ended June 30, 1999. OTHER Operating loss for the "Other" segment increased to $8.1 million and $46.8 million for the quarter and six months ended June 30, 1999, respectively, from $5.3 million and $11.3 million for the quarter and six months ended June 30, 1998, respectively. The increase in the operating loss for the six months ended June 30, 1999 was due primarily to $32.6 million of merger-related charges recorded in the quarter ended March 31, 1999 related to the SEQUUS acquisition. NET SALES Net Sales Quarter Ended Six Months Ended June 30, June 30, (Dollars in millions) 1999 1998 1999 1998 _________________________________________________________________ ALZA PHARMACEUTICALS Ditropan-registered trademark- XL $ 14.4 $ - $36.4 $ - Doxil-registered trademark-/ Caelyx-registered trademark-14.0 11.8 28.3 22.5 Ethyol-registered trademark- 8.5 5.8 17.1 13.9 Mycelex-registered trademark- Troche 7.7 9.8 12.7 15.7 Elmiron-registered trademark- 7.7 3.7 12.6 10.7 Testoderm-registered trademark- TTS line 5.2 2.2 9.7 4.3 Other 11.3 8.5 19.9 16.6 ___________________________________________________________________ Total 68.8 41.8 136.7 83.7 ___________________________________________________________________ ALZA TECHNOLOGIES Contract manufacturing 34.4 30.5 62.7 55.4 Intersegment 3.8 2.0 8.0 3.6 ___________________________________________________________________ Total 38.2 32.5 70.7 59.0 ___________________________________________________________________ Intersegment eliminations (3.8) (2.0) (8.0) (3.6) ___________________________________________________________________ Total net sales $103.2 $ 72.3 $199.4 $139.1 ___________________________________________________________________ Total net sales as a percentage of total revenues 53% 46% 52% 46% ___________________________________________________________________ ALZA PHARMACEUTICALS Included in net sales of ALZA-marketed products are sales of the products marketed directly by ALZA in the United States and Canada, and sales of those products in other countries through distributors. Net sales of ALZA-marketed products increased 64% for both the quarter and six months ended June 30, 1999 compared to the same periods for 1998. The increase resulted primarily from sales of Ditropan XL, which was launched in February 1999. Sales of Doxil/Caelyx increased 19% and 26% for the quarter and six months ended June 30, 1999, respectively, compared to the same periods in 1998. Sales of Ethyol-registered trademark- (amifostine) increased 48% and 23% for the quarter and six months ended June 30, 1999, respectively, compared to the same periods for 1998. Partially offsetting these increases was a 22% and 19% decline in sales of Mycelex-registered trademark-(clotrimazole) Troche for the quarter and six months ended June 30, 1999, respectively, compared to the same periods in 1998. 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. Ditropan XL was launched in the first quarter of 1999, and Doxil, Ethyol, Elmiron-registered trademark- (pentosan polysulfate sodium) and Testoderm-registered trademark- TTS (Testosterone Transdermal System) were cleared for marketing during the past few years. Additionally in June, 1999 the United States Food and Drug Administration ("FDA") approved new indications for Ethyol and Doxil. All of these products 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. ALZA TECHNOLOGIES Net sales from contract manufacturing include sales generated from contract manufacturing activities for ALZA's client companies and for ALZA Pharmaceuticals. Net sales from contract manufacturing increased 13% for both the quarter and six months ended June 30, 1999, compared to the same periods in 1998, primarily due to an increase in ALZA shipments of Glucotrol XL to Pfizer, Duragesic to Janssen and NicoDerm CQ to SB. These increases were partially offset by a decline in ALZA shipments of Covera-HST-trademark-(verapamil) to Searle. 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 clients. GROSS MARGIN Gross Margin Quarter Ended Six Months Ended June 30, June 30, 1999 1998 1999 1998 _________________________________________________________________ ALZA PHARMACEUTICALS(1) 80% 76% 81% 76% ALZA TECHNOLOGIES(1) 21% 16% 20% 15% _________________________________________________________________ Gross margin(2) 61% 51% 63% 52% ___________________________________________________________________ (1) Includes intersegment revenues or expenses. (2) After intersegment eliminations. The increase in total gross margin for the quarter and six months ended June 30, 1999 compared to the same periods for 1998 was due to increased sales of higher-margin products by ALZA Pharmaceuticals and, to a lesser extent, an increase in 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 direct sales by ALZA Pharmaceuticals in relation to sales from contract manufacturing 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 the quarter and six months ended June 30, 1999 compared to the same periods for 1998 due to a shift in product mix towards sales of higher-margin products, including Ditropan XL, which was launched in February 1, 1999. ALZA TECHNOLOGIES The gross margin on net sales of products manufactured by ALZA Technologies for sale by client companies and ALZA Pharmaceuticals increased marginally in the quarter and six months ended June 30, 1999 compared with the same periods in 1998 as a result of an increase in shipments of higher-margin products to client companies. ALZA Technologies' gross margin on its 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 Quarter Ended Six Months Ended June 30, June 30, (Dollars in millions) 1999 1998 1999 1998 ________________________________________________________________ ALZA PHARMACEUTICALS $ 3.2 $ 6.3 $ 6.3 $ 10.1 ALZA TECHNOLOGIES 51.2 46.2 106.6 92.5 OTHER 0.4 0.9 0.8 1.2 _________________________________________________________________ Total royalties, fees and other revenues $ 54.8 $ 53.4 $113.7 $103.8 _________________________________________________________________ Percentage of total revenues 28% 34% 30% 34% _________________________________________________________________ ALZA PHARMACEUTICALS For the quarter and six months ended June 30, 1999, fee revenue for AlZA Pharmaceuticals included technology fees from Crescendo of $2.0 million and $4.0 million, respectively, compared to $3.0 million and $6.0 million for the same periods in 1998, as provided in the agreements between ALZA and Crescendo. ALZA TECHNOLOGIES Royalties, fees and other revenues increased 11% and 15% for the quarter and six months ended June 30, 1999, respectively, compared to the same periods in 1998. The increase in royalties, fees and other revenues was largely due to an increase in royalties for the three and six months ended June 30, 1999, resulting primarily from higher royalties on product sales of NicoDerm CQ, Catapres-TTS and Glucotrol XL, partially offset by a decrease in royalties from sales of Procardia XL. Sales of Procardia XL, as reported by Pfizer, decreased 28% and 27% for the quarter and six months ended June 30, 1999, respectively, compared to the same periods in 1998. Several companies have filed Abbreviated New Drug Applications ("ANDAs") with the 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 applicant'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 Research and Development Revenue Quarter Ended Six Months Ended June 30, June 30, (Dollars in millions) 1999 1998 1999 1998 _________________________________________________________________ ALZA PHARMACEUTICALS Crescendo $ 28.5 $ 24.3 $51.8 $ 43.8 _________________________________________________________________ ALZA TECHNOLOGIES Other clients 8.7 8.3 15.8 15.1 Intersegment 28.6 24.3 51.9 43.9 _________________________________________________________________ Total 37.3 32.6 67.7 59.0 Intersegment elimination (28.6) (24.3) (51.9) (43.9) _________________________________________________________________ Total research and development revenues $ 37.2 $ 32.6 $67.6 $ 58.9 _________________________________________________________________ Percentage of total revenues 19% 21% 18% 20% _________________________________________________________________ ALZA PHARMACEUTICALS ALZA Pharmaceuticals derives research and development revenues from Crescendo. Revenues from Crescendo are offset by intersegment charges from ALZA Technologies for research and development expenses incurred on behalf of ALZA Pharmaceuticals related to products under development for marketing by ALZA Pharmaceuticals. ALZA expects that Crescendo will have expended all its available funds during 2000. 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 license agreement, ALZA must pay Crescendo 2.5% of net sales of the licensed product for the first year of sales 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%. ALZA TECHNOLOGIES Research and development revenues increased 14% and 15% for the quarter and six months ended June 30, 1999, respectively, compared to the same periods in 1998, primarily due to an 18% increase in intersegment research and development revenues from ALZA Pharmaceuticals related to Crescendo projects. Research and development revenues from client companies increased 5% for the quarter and six months ended June 30, 1999. Research and Development Expenses Quarter Ended Six Months Ended June 30, June 30, (Dollars in millions) 1999 1998 1999 1998 _________________________________________________________________ ALZA PHARMACEUTICALS Intersegment $ 28.6 $ 24.3 $51.9 $ 43.9 Product development expense 5.9 6.5 14.1 12.9 ___________________________________________________________________ Total 34.5 30.8 66.0 56.8 _________________________________________________________________ ALZA TECHNOLOGIES 41.9 36.2 77.8 70.0 _________________________________________________________________ Intersegment elimination (28.6) (24.3) (51.9) (43.9) _________________________________________________________________ Total research and development expenses $ 47.8 $ 42.7 $91.9 $ 82.9 _________________________________________________________________ Percentage of total revenues 25% 27% 24% 27% _________________________________________________________________ ALZA PHARMACEUTICALS ALZA Pharmaceuticals engages ALZA Technologies to provide research and development services, which are charged under the same formula ALZA charges client companies. Intersegment expenses related to these services increased for the quarter and six months ended June 30, 1999 as compared to the same periods in 1998 due to additional expenses incurred in the preparation of New Drug Application ("NDA") submissions for DUROS-registered trademark- leuprolide (leuprolide acetate implant) which ALZA has named ViadurT-trademark-, and OROS-registered trademark- methylphenidate, which were submitted in May 1999 and July 1999, respectively. Product development expense remained relatively constant for the quarter ended June 30, 1999 compared to the quarter ended June 30, 1998. For the six months ended June 30, 1999 compared to the six months ended June 30, 1998, product development expense increased by 9% primarily due to an increase in development costs related to products marketed by ALZA Pharmaceuticals. ALZA TECHNOLOGIES Research and development expenses increased 16% and 11% for the quarter and six months ended June 30, 1999, respectively, compared to the same periods for 1998, reflecting an increase in product development activities for ALZA Pharmaceuticals and under agreements with client companies. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, General and Administrative Expenses Quarter Ended Six Months Ended June 30, June 30, (Dollars in millions) 1999 1998 1999 1998 _________________________________________________________________ ALZA PHARMACEUTICALS Sales and marketing expenses $ 45.9 $ 18.4 $88.4 $ 33.9 ___________________________________________________________________ ALZA PHARMACEUTICALS Amortization of product acquisition payments 3.7 2.7 7.6 5.3 ALZA TECHNOLOGIES Amortization of product acquisition payments 2.3 - 4.6 - ___________________________________________________________________ Total 6.0 2.7 12.2 5.3 _________________________________________________________________ OTHER General and administrative expenses 8.5 6.2 15.0 12.5 _________________________________________________________________ Total selling, general administrative expenses $ 60.4 $ 27.3 $115.6 $ 51.7 =================================================================== Total selling, general and administrative expenses as a percentage of total revenues 31% 17% 30% 17% _________________________________________________________________ ALZA PHARMACEUTICALS Sales and marketing expense increased substantially for the quarter and six months ended June 30, 1999 compared to the same periods in 1998 as a result of the significant increase in the size of ALZA's sales organization, the increased sales and marketing activities due to the launch of Ditropan XL and the increased marketing expenses for ALZA's expanded product portfolio. During the second half of 1998, ALZA expanded its sales organization by approximately 260 sales professionals. In 1998, ALZA entered into an agreement with UCB Pharma, Inc.("UCB Pharma") under which approximately 350 sales professionals of UCB Pharma are co-promoting Ditropan XL in the United States with ALZA. UCB Pharma receives payments based on sales of Ditropan XL above certain levels, as well as payments for sales calls made. The term of the co-promotion arrangement continues through March 2002. In July 1999 ALZA expanded the agreement with UCB Pharma to increase the number of calls to primary care physicians during a three-month period. In July 1999 ALZA entered into an agreement with Abbott to co-promote Ditropan XL in the United States, adding 300 more sales professionals to the sales force currently promoting Ditropan XL. Amortization of product acquisition payments for the ALZA Pharmaceuticals segment increased 38% and 45% for the quarter and six months ended June 30, 1999 compared to the same periods in 1998 due to the amortization of payments for products that were acquired in the second half of 1998 and the amortization of additional payments made since the second quarter of 1998 related to previous product acquisitions. ALZA TECHNOLOGIES Amortization of product acquisition payments for ALZA Technologies relates to three and six months amortization of the $91.2 million exercise price paid in August 1998 to acquire all of the outstanding limited partnership interests in the TTS Partnership. NET INTEREST Quarter Ended Six Months Ended Net Interest June 30, June 30, (In millions) 1999 1998 1999 1998 _________________________________________________________________ Interest and other income $(18.4) $ (6.5) $(23.4) $ (13.4) Interest expense 14.8 14.3 29.7 28.5 ________________________________________________________________ Net interest and other (income) expense (3.6) 7.8 6.3 15.1 ________________________________________________________________ Interest and other income increased to $18.4 million for the quarter ended June 30, 1999 from $6.5 million for the quarter ended June 30, 1998, and increased to $23.4 million for the six months ended June 30, 1999 compared with $13.4 million for the six months ended June 30, 1998. This increase was primarily due to a pretax gain of $12.6 million on sales of real estate assets that were completed during the quarter ended June 30, 1999. Interest expense was slightly higher for the quarter and six months ended June 30, 1999 compared to the same periods for 1998, primarily due to accreted interest on ALZA's outstanding 5 1/4% Debentures. Effective Tax Rate For the quarter and six months ended June 30, 1999, ALZA's effective income tax rate was 32%, excluding the tax effect of $7.8 million on merger-related costs of $32.6 million, compared to 35% for the quarter and six months ended June 30, 1998. ALZA's annual effective combined federal and state income tax rate for 1999 is estimated to be 31% to 32%, assuming utilization of SEQUUS' net operating losses. The actual effective income tax rate will depend upon the actual level of earnings, potential changes in the tax laws, the amount of investment and research credits available and ALZA's ability to utilize such credits. LIQUIDITY AND CAPITAL RESOURCES Liquidity and Capital Resources June 30, December 31, (In millions) 1999 1998 _________________________________________________________________ Working capital $ 328.0 $ 297.1 Cash and investments 486.9 514.1 Total assets 1,729.9 1,666.6 Long-term debt 973.4 966.1 _________________________________________________________________ Six months ended June 30, (In millions) 1999 1998 _________________________________________________________________ Net cash provided by operating activities $ 13.5 $ 39.3 Capital expenditures 40.8 25.1 Product acquisition payments 20.0 6.2 _________________________________________________________________ Cash flow generated by operating activities for the six months ended June 30, 1999 was $13.5 million (or $32.6 million excluding payments for merger-related expenses) compared to $39.3 million for the six months ended June 30, 1998. The decrease in cash flow provided by operating activities was a result of lower net income of $37.9 million, due to merger-related charges, an increase in prepaid and other current assets of $43.8 million and an increase in accounts receivable of $18.1 million. ALZA's capital spending for the six months ended June 30, 1999 was $40.8 million for additions to facilities and equipment to support its research, development and manufacturing activities, compared to capital spending of $25.1 million in the same period in 1998. While ALZA believes its current facilities and equipment (including the facilities currently under construction) 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 during the remainder of 1999 are expected to continue to increase over 1998 levels as a result of the spending on the new Mountain View facilities being built, which ALZA plans to begin occupying during the third quarter of 1999. As a result of ALZA's investment in a real estate joint venture and construction of buildings in Mountain View, California, which are scheduled to be completed in late 1999, ALZA has been evaluating its real estate holdings and future facilities needs. During the second quarter of 1999, ALZA sold five buildings located in Palo Alto, California for a total of $20.3 million. ALZA will lease back these buildings through December 31, 1999, when it expects to complete occupancy of its new buildings in Mountain View. In the near term ALZA expects to lease out certain other Palo Alto, Menlo Park and Mountain View properties currently occupied by ALZA, which could result in lease income in 2000 and beyond. 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. Merger Agreement with Abbott Laboratories On June 21, 1999, Abbott Laboratories and ALZA announced that the companies have entered into a merger agreement. Under the terms of the agreement, Abbott would acquire all of ALZA's outstanding stock in a tax free, stock-for-stock transaction. ALZA's stockholders would receive 1.2 shares of Abbott common stock for each share of ALZA common stock. The transaction is expected to be completed by the end of 1999 subject to approval by ALZA's stockholders, clearance by regulatory agencies and customary closing conditions. 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 continues to develop specific contingency plans intended to mitigate the effects of any potential Year 2000 disruption, including the effects of operational problems and costs that may result from a failure of ALZA and certain third parties to complete efforts necessary to achieve Year 2000 compliance on a timely basis or from abnormal buying patterns in anticipation of Year 2000. ALZA expects to have contingency plans in place by the end of the third quarter of 1999. Item 3. Quantitative and Qualitative Disclosures about Market Risk Financial market risks related to changes in interest rates and foreign currency exchange rates are described in Part II, Item 7A, Quantitative and Qualitative Disclosure About Market Risk, in ALZA's Annual Report on Form 10-K for the year ended December 31, 1998 and the Form 8-K filed May 13, 1999, which restates financial information for prior periods to reflect the combined results of ALZA and SEQUUS. 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 an approximate $10 million decrease in ALZA'S available-for- sale securities, based upon a sensitivity analysis performed on ALZA's financial position at June 30, 1999. However, actual results may differ materially. PART II. OTHER INFORMATION Item 1. Legal Proceedings Product liability suits have been filed against Janssen and ALZA from time to time relating to the Duragesic product. Janssen is managing the defense of these suits in consultation with ALZA under an agreement between the parties. Historically, the cost of resolution of liability claims against ALZA (including product liability claims) has not been significant, and ALZA is not aware of any asserted or unasserted claims pending against it, including the suits mentioned above, the resolution of which would have a material adverse impact on the operations or financial position of ALZA. Pursuant to a Remedial Action Order No. HSA 88/89-016 issued by the California Department of Toxic Substances Control ("DTSC"), ALZA has been named as one of a number of potentially responsible parties in connection with the cleanup and environmental remediation of the Hillview-Porter Regional Site Project near ALZA's Palo Alto facilities. The purpose of the DTSC action is, in part, to apportion responsibility for cleanup costs among the parties involved. Cleanup costs for the entire region have been estimated at approximately $16 million. ALZA believes that it did not discharge any of the chemicals of concern at the site in question. ALZA does not believe that its liability in this matter, if any, will be material. On June 22, 1999, a purported class action lawsuit was filed in the Superior Court of the State of California, County of Santa Clara, against ALZA and all of the current members of its Board of Directors. The action is captioned Lisa Fruchter v. ALZA Corporation, et al., No. CV 782725 (Santa Clara County, California, Superior Court). The complaint alleges that ALZA and its directors breached fiduciary duties owed to ALZA's stockholders when they permitted ALZA to enter into the Merger Agreement with Abbott. In general, the complaint alleges that the exchange ratio under the Merger Agreement is inadequate and further alleges that ALZA's board of directors had an obligation to place ALZA up for auction when it entered into the Merger Agreement. The allegations purport to be based on California law. The action seeks both an injunction to prevent the merger and damages in event that the merger is completed. ALZA believes the complaint to be without merit and intends to defend the action vigorously. Item 4. Submission of Matters to a Vote of Security Holders: (a) The annual meeting of the stockholders of ALZA was held on May 6, 1999. (b) A total of 77,455,501 shares were represented at the annual meeting. Stockholders approved the following proposals: (i) Election of Class III Directors: Votes For Votes Withheld Dr. I. Craig Henderson 76,153,248 1,302,253 Dr. Ernest Mario 75,338,033 2,117,468 Isaac Stein 76,684,550 770,951 (ii) To increase by 5,000,000 shares the number of shares of ALZA common stock reserved for issuance under ALZA's Amended and Restated Stock Plan. There were 51,888,737 votes in favor, 25,143,667 votes against and 423,097 abstentions. (iii)The ratification of the appointment of Ernst & Young LLP as ALZA's independent auditors for the fiscal year ended December 31, 1999. There were 77,077,043 votes in favor, 85,269 votes against and 293,189 abstentions. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits: 10.1 Amended and Restated Stock Plan 10.2 Form of Amendment to Executive Agreement between ALZA Corporation and Certain Executive Officers dated as of June 11, 1999. 10.3 Executive Agreement between ALZA Corporation and Dr. Ernest Mario, dated as of June 21, 1999. 27 Financial Data Schedule (b) On May 13, 1999, ALZA filed a current report on Form 8-K to file as Exhibit 99.1 the 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. On June 25, 1999 ALZA filed a current report on Form 8-K to report the signing of the merger agreement between ALZA and Abbott on June 21, 1999. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ALZA CORPORATION Date: August 13, 1999 By: /s/ E. Mario Dr. Ernest Mario Chairman and Chief Executive Officer Date: August 13, 1999 By: /s/ Bruce C. Cozadd Bruce C. Cozadd Senior Vice President and Chief Financial Officer EXHIBIT INDEX Exhibit 10.1 Amended and Restated Stock Plan 10.2 Form of Amendment to Executive Agreement between ALZA Corporation and Certain Executive Officers dated as of June 11, 1999. 10.3 Executive Agreement between ALZA Corporation and Dr. Ernest Mario, dated as of June 21, 1999. 27 Financial Data Schedule EX-10.1 2 EXHIBIT 10.1 Exhibit 10.1 ALZA CORPORATION Amended and Restated Stock Plan (as amended through May 6, 1999) 1. PURPOSE. The purpose of this ALZA Corporation Amended and Restated Stock Plan (the "Plan") is to attract, retain and motivate key employees (including employees who are also directors), directors and consultants of ALZA Corporation (the "Company") and its subsidiaries by giving them the opportunity to acquire stock ownership in the Company. Grants under this Plan may consist of incentive stock options, intended to satisfy the requirements of Section 422 of the Internal Revenue Code of 1986, as it may be amended from time to time (the "Code"), or non- statutory stock options (in either case, where unspecified, "options"). This Plan also provides for the award of restricted stock. 2. EFFECTIVE DATE AND TERM OF PLAN. The effective date of this Plan is May 4, 1992, the date of the approval of the 1992 Stock Option Plan by the Company's stockholders. This Plan shall terminate automatically ten (10) years after its effective date unless terminated earlier by the Board of Directors (the "Board") under Section 13 hereof. No grant of options or restricted stock shall be made after termination of this Plan, but all grants made prior to termination shall remain in effect in accordance with their terms. 3. SHARES SUBJECT TO THE PLAN. (a) NUMBER AND SOURCE OF SHARES. Subject to the provisions of Section 9, the total number of shares of stock reserved for grants under this Plan is 14,000,000 shares of Common Stock, $. 01 par value, of the Company (the "Stock"). If any option terminates or expires without being exercised in full, or if any shares of Stock issued as restricted stock are forfeited prior to conferring on their holder benefits of ownership other than voting rights or accumulated dividends that are not realized, the shares issuable under such option or so forfeited shall become available again for grant under this Plan. The shares to be issued hereunder may consist of authorized and unissued shares or treasury shares. (b) INDIVIDUAL LIMITATION. The Company may not grant options covering in the aggregate more than 200,000 shares of Stock (subject to adjustments and substitutions as required under Section 9 below) to any one participant in any one-year period, except that, at the time of an offer of employment, the Company may grant options covering in the aggregate up to 750,000 shares of Stock (subject to adjustments and substitutions as required under Section 9 below). 4. ADMINISTRATION OF THE PLAN. This Plan shall be administered by the Board or by a committee that meets the requirements of Rule 16b-3 under the Securities Exchange Act of 1934 (the "Exchange Act") as in effect from time to time (in either case, the "Administrator"). The Administrator (i) may authorize any one or more of its members or any officer of the Company to execute and deliver documents on behalf of the Administrator and (ii) so long as not otherwise required for the Plan to comply with Rule 16b-3, may delegate to one or more officers or directors of the Company authority to grant options to persons who are not subject to Section 16 of the Exchange Act with respect to Stock. The Administrator may delegate non- discretionary administrative duties to such employees of the Company or a subsidiary as it deems proper. The Administrator may also make rules and regulations which it deems useful to administer this Plan. Any decision or action of the Administrator in connection with this Plan or any options or restricted stock granted or shares of Stock purchased under this Plan shall be final and binding. No member of the Board shall be liable for any decision, action or omission respecting this Plan, or any options or restricted stock granted or shares of Stock issued under this Plan. 5. ELIGIBILITY. (a) Incentive stock options may be granted under this Plan only to employees of the Company or a subsidiary, including employees who may also be officers or directors of the Company or any subsidiary of the Company. Non-statutory options and restricted stock may be granted to employees (including employees who are also directors), directors, consultants and potential employees (in contemplation of and subject to employment) of the Company or any subsidiary of the Company; provided, however, that grants to directors who are not also employees of the Company may be made only in accordance with Section 5(b) below. Participants in this Plan shall be recommended for grants hereunder by the Chief Executive Officer or Chief Operating Officer of the Company and approved by the Administrator. Determination by the Administrator as to eligibility shall be conclusive. (b) Notwithstanding any other provision of this Plan, directors who are not also employees of the Company may receive grants under this Plan only in accordance with this Section 5(b). Automatically and in connection with the offer of directorship to a person who is not an employee of the Company, and subject to that person becoming a director of the Company within the time period set forth in the offer, the person shall be granted a non- statutory option to purchase 20,000 shares of Stock at the fair market value of the Stock on the date of the offer. Such option shall vest in five equal annual increments of 4,000 shares for each increment, beginning on the first anniversary of the date on which the person first attends a meeting of the Board following his or her election as a director (the "Service Date"), and shall be exercisable until the date that is ten (10) years after the date of grant. Assuming that the director is a non employee director on the fifth anniversary of his or her Service Date, such director automatically shall be granted on such fifth anniversary of his or her Service Date a further non-statutory option to purchase 10,000 shares of Stock at the fair market value of the Stock on the date of the grant. Such additional option shall vest in five equal annual increments of 2,000 shares each, beginning one year after the date of grant and shall be exercisable until the date that is ten (10) years after the date of grant. Thereafter, on each subsequent fifth anniversary of his or her Service Date, assuming the director is then a non employee director, a further option to purchase an additional 10,000 shares of Stock automatically shall be granted to such director on the same basis as set forth in the preceding sentence. The Service Date for a director who is also an employee of the Company but who terminates employment with the Company while remaining a director shall, for purposes of this Section 5(b), be deemed to be the date on which such director first attends a meeting of the Board following the termination of his or her employment with the Company. If such director has not been granted options to purchase Stock within five years prior to his or her Service Date, he or she automatically shall be granted a non-statutory option to purchase 20,000 shares of Stock on the same basis as set forth above for a grant to a person becoming a director of the Company; and, thereafter, on each subsequent fifth anniversary of his or her Service Date, assuming the director is then a non-employee director, a further option to purchase an additional 10,000 shares of Stock automatically shall be granted to such director on the same basis as set forth above for further options. However, if such director has been granted options to purchase Stock within five years prior to his or her Service Date, he or she shall automatically be granted a non- statutory option to purchase 10,000 shares of Stock on the same basis as set forth above for further options on the fifth anniversary of the date of the last grant of options by the Company to such person prior to the termination of his or her employment with the Company (the "Initial Grant Date"); and, thereafter, on each subsequent fifth anniversary of his or her Initial Grant Date, assuming the director is then a non-employee director, a further option to purchase an additional 10,000 shares of Stock automatically shall be granted to such director on the same basis as set forth above for further options. 6. OPTIONS. (a) GRANT. The Administrator may, in its discretion, grant options under this Plan at any time and from time to time before the expiration of this Plan. The Administrator shall specify the date of grant or, if it fails to, the date of grant shall be the date of the action taken by the Administrator to grant the option (in either case, the "Grant Date"). If an incentive stock option is approved in anticipation of employment, the Grant Date shall in any event not be prior to the date the intended optionee is first treated as an employee of the Company or any subsidiary for payroll purposes. (b) OPTION AGREEMENTS. As soon as practicable after the Grant Date, the Company will provide the optionee a written stock option agreement (the "Option Agreement"), which designates the option as an incentive stock option or non-statutory option and which identifies the Grant Date, the number of shares of Stock covered by the option, the option price and the terms and conditions for exercise of the option. (c) TERMS AND CONDITIONS OF OPTIONS. Options granted under this Plan shall be subject to the following additional terms and conditions and such other terms and conditions not inconsistent with this Plan as the Administrator may impose: (i) EXERCISE OF OPTION. In order to exercise all or any portion of an incentive stock option granted under this Plan (or any other option which, by its terms, so requires), an optionee must remain in the employ of the Company or a subsidiary of the Company until the date on which the option (or portion thereof) becomes exercisable (the "Vesting Date"). An option shall be partially exercisable on or after each Vesting Date with respect to the percentage of total shares of Stock covered by the option set out in the Option Agreement. If an option (or portion thereof) is not exercised on the earliest Vesting Date on which it becomes exercisable, it may be exercised thereafter at any time prior to its expiration date; provided, however, that in no event may an incentive stock option granted under this Plan be exercised more than ten (10) years from the Grant Date. If the Company grants an incentive stock option to an optionee who owns, on the Grant Date, directly or by attribution, stock possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the company or any subsidiary, the option shall not be exercisable more than five (5) years after the Grant Date. Notwithstanding any other provision of this Plan, to the extent required by Section 422(d) of the Code, the aggregate value of all shares first becoming exercisable by an optionee during any year, under all incentive stock options granted to such optionee covering stock of the Company (or any company which, at the time of grant, was a parent or subsidiary of the Company), shall not exceed $100,000 or such other amount as may be in effect from time to time. If by their terms such incentive stock options, when taken together, would first become exercisable at a faster rate then, except as otherwise specifically provided by the Administrator in its discretion, the portion thereof which exceeds such amount shall be non-statutory options. For this purpose, value shall be the fair market value of the option stock when the options were granted and options shall be taken into account in the order in which they were granted. In no event may the operation of this Section 6(c)(i) cause an option to vest before its terms or, having vested, cease to be vested. Options granted to employees under this Plan shall be exercisable until ten (10) years after the Grant Date, unless the Administrator shall determine otherwise. (ii) OPTION PRICE. The option price of incentive stock options shall be at least one-hundred percent (100%) of the fair market value of the shares covered by the option on the Grant Date, as determined in good faith by the Administrator and, in the case of non-statutory options, shall be at least one hundred percent (100%) of the fair market value of the shares covered by the option on the Grant Date unless the Administrator specifically determines otherwise, in which event the option price of such non-statutory options shall not be less than eighty- five percent (85%) of the fair market value of the shares covered thereby on the Grant Date, determined in the same manner. If the Company grants an incentive stock option to an optionee owning on the Grant Date, directly or by attribution, shares possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the Company or any subsidiary, the option price shall be at least one-hundred ten percent (110%) of the fair market value of the shares covered by the option on the Grant Date determined in the same manner. (iii) METHOD OF EXERCISE. To the extent the right to purchase shares has accrued, an option (or portion thereof) may be exercised from time to time in accordance with its terms by written notice from the optionee to the Company stating the number of shares with respect to which the option is being exercised and accompanied by payment in full of the exercise price of the shares. Payment may be made in cash, by check, or by delivery of shares of Stock (duly endorsed in favor of the Company or accompanied by a duly endorsed stock power), by a combination of the above, or any other form of consideration approved by the Administrator (including payment in accordance with a cash-less exercise program as permitted under Regulation T promulgated by the Federal Reserve Board, as amended from time to time). Any shares delivered to the Company as payment upon exercise of an option shall be valued at their fair market value as of the date of exercise of the option determined in good faith by the Administrator. Options may not be exercised by any optionee by the delivery of shares of stock more frequently than once every six months. (iv) RESTRICTIONS ON OPTION SHARES. At the time it grants options under this Plan, the Company may retain for itself (or others) rights to purchase the shares acquired under the option or impose other restrictions on the shares. The terms and conditions of any such rights or other restrictions shall be set forth in the Option Agreement evidencing the option. (v) NON-ASSIGNABILITY OF OPTION RIGHTS. Except as otherwise determined by the Administrator, no option shall be transferable other than by will or by the laws of descent and distribution or a qualified domestic relations order and, otherwise during the lifetime of an optionee, only the optionee may exercise an option. (vi) EXERCISE AFTER TERMINATION OF SERVICE OR DEATH. If for any reason other than permanent and total disability or death, an optionee ceases to be employed by, or a consultant or director to (if such relationship forms the sole basis for the grant), the Company or a subsidiary, options held at the date of such termination (to the extent then exercisable) may be exercised at any time within three months after the date of such termination (but in no event after the expiration date of the option as set forth in the Option Agreement). If an optionee becomes permanently and totally disabled (within the meaning of Section 22(e)(3) of the Code) or dies while employed by, or a consultant or director to, the Company or a subsidiary, (or, if the optionee dies within the period that the option remains exercisable after termination of employment, consultancy or directorship), options then held (to the extent then exercisable) may be exercised by the optionee, the optionee's personal representative, or by the person to whom the option is transferred by will or the laws of descent and distribution, at any time within one year after the disability or death or any lesser period specified in the Option Agreement (but in no event after the expiration date of the option as set forth in the Option Agreement). 7. RESTRICTED STOCK. (a) GRANT. The Administrator may grant restricted stock under this Plan at any time and from time to time before the expiration of this Plan. (b) RESTRICTED STOCK AGREEMENT. As soon as practicable after the grant of restricted stock, which in no event shall be later than thirty (30) days after the grant date of the restricted stock, the Company will provide the participant with a written restricted stock agreement setting forth the terms and conditions of the grant (the "Restricted Stock Agreement"). (c) PRICE. Participants awarded restricted stock, within fifteen (15) days of receipt of the Restricted Stock Agreement, shall pay to the Company the purchase price of the restricted stock set forth in the Restricted Stock Agreement, which shall not be less than the par value of the Stock subject to the grant. If such payment is not made and received by the Company by such date, the grant of restricted stock shall lapse. (d) RESTRICTIONS. Subject to the provisions of the Plan and the Restricted Stock Agreement, during a period set by the Administrator, commencing with, and not exceeding ten (10) years from, the grant date of the restricted stock (the "Restriction Period"), the participant shall not be permitted to sell, assign, transfer, pledge or otherwise encumber shares of restricted stock. Within these limits, the Administrator may provide for the lapse of such restrictions in installments and may accelerate or waive such restrictions, in whole or in part, based on service, performance or such other factors or criteria as the Administrator may determine. (e) DIVIDENDS. Unless otherwise determined by the Administrator, cash dividends with respect to shares of restricted stock shall be automatically reinvested in additional restricted stock, and dividends payable in Stock shall be paid in the form of restricted stock. (f) TERMINATION. Except to the extent otherwise provided in the Restricted Stock Agreement and pursuant to Section 7(d), upon termination of a participant's employment for any reason during the Restriction Period, all shares still subject to restriction shall be forfeited by the participant. 8. PAYMENT OF TAXES. (a) The exercise of an option (regardless of the form of payment for exercise of the option) or the transfer or other disposition of restricted stock shall be conditioned upon payment in cash, or provision satisfactory to the Administrator for payment to the Company, of any federal and state withholding taxes which, in the Administrator's judgment, are payable in connection therewith. (b) If and to the extent consented to by the Administrator in its sole discretion, a person who exercises an option may (i) tender to the Company previously-owned shares of Stock, or (iii) have shares of Stock to be obtained upon exercise of the option withheld by the Company on behalf of the optionee, in either case to pay the amount of tax that the Administrator, in its discretion, determines to be required to be withheld by the Company. 9. ADJUSTMENT FOR CHANGES IN CAPITALIZATION. The existence of outstanding options shall not affect the Company's right to effect adjustments, re-capitalization, reorganizations, or other changes in its or any other corporation's capital structure or business, any merger or consolidation, any issuance of bonds, debentures, preferred or prior preference stock ahead of or affecting the Stock, the dissolution or liquidation of the Company's, or any other corporation's, assets or business, or any other corporate act whether similar to the events described above or otherwise. Subject to Section 10, if the number of outstanding shares of Stock is increased or decreased in number or changed into or exchanged for a different number or kind of securities of the Company or any other corporation by reason of a re-capitalization, reclassification, stock split, combination of shares, stock dividend or other event, the number and kind of securities with respect to which options or restricted stock may be granted under this Plan, the individual limitations under Section 3(b) above, the number and kind of securities as to which outstanding options may be exercised, the option price at which outstanding options may be exercised hereunder shall be proportionately adjusted. 10. DISSOLUTION, LIQUIDATION, MERGER. In the event of a dissolution or liquidation of the Company, a merger or consolidation in which the Company is not the surviving corporation, a reverse merger in which the Company is the surviving corporation but in which more than fifty percent (50%) of the shares of its Stock outstanding before the merger are held, after the merger, by holders different from those immediately prior to the merger, or a sale of more than eighty percent (80%) of the assets of the Company, (a) except as otherwise provided in the Option Agreement, the time at which each outstanding option may be exercised (subject, in the case of incentive stock options, to the limitations on exercisability set forth in Section 6(c)(i) of this Plan) shall be accelerated at a time such that the optionee (upon exercise of the option) would be eligible to receive the consideration payable to holders of Stock in connection with such liquidation, dissolution, merger, consolidation, reverse merger or sale, and (b) except as otherwise provided in the Restricted Stock Agreement, the restrictions applicable to any restricted stock shall lapse. 11. RIGHTS AS STOCKHOLDER. Unless the Plan or the Administrator expressly specify otherwise, a participant shall have no rights as a stockholder with respect to any shares of Stock covered by a grant hereunder until the date of issuance (as evidenced by the appropriate entry on the books of the Company or a duly authorized transfer agent) of a certificate representing the shares of Stock. Subject to Sections 9 and 10, no adjustment shall be made for dividends or other rights for which the record date is prior to the date the certificate is issued. 12. DISQUALIFYING DISPOSITIONS. If shares of Stock acquired upon exercise of an incentive stock option are disposed of in a "disqualifying disposition" (within the meaning of Section 422 of the Code), the holder of the shares shall notify the Company in writing, within five days after the disposition, of the date and the terms of such disposition. In the event of any such disposition, the holder will comply with any other requirements imposed by the Company in order to enable the Company to secure the related income tax deduction to which it is entitled. 13. TERMINATION OR AMENDMENT. (a) The Board may amend, alter or discontinue this Plan, but no amendment, alteration or discontinuance shall be made which would impair the rights of a participant under an outstanding grant without the participant's consent. In addition, the Board may not amend or alter the Plan without the approval of stockholders of the Company entitled to vote at a duly held stockholders' meeting or by an action by written consent and, if at a meeting, a quorum of the voting power of the Company is represented in person or by proxy, where such amendment or alteration would, except as expressly provided in the Plan, increase the total number of shares reserved for issuance pursuant to grants under the Plan or in such other circumstances as the Board deems appropriate to comply with Rule 16b-3 or with Section 422 of the Code or otherwise. 14. PARENT AND SUBSIDIARY. As used in this Plan, "parent" and "subsidiary" mean any corporation in an unbroken chain of corporations which includes the Company if, at the relevant time, each of the corporations other than the last corporation in the chain owns stock possessing more than fifty percent (50%) of the total combined voting power of all classes of stock of one of the other corporations in the chain. 15. EMPLOYMENT OR CONSULTING RELATIONSHIP. Nothing in this Plan or any option granted hereunder shall interfere with or limit in any way the right of the Company or of any its subsidiaries to terminate any optionee's employment or consulting at any time, nor confer upon any optionee any right to continue in the employ of, or consult with, the Company or any its subsidiaries. 16. GOVERNING LAW. This Plan and the rights of all persons under this Plan shall be construed in accordance with and under applicable provisions of the Code and the laws of the State of California. * * * * * * * * * The Board adopted the ALZA Corporation 1992 Stock Option Plan on January 30, 1992 and the stockholders approved it on May 4, 1992. The Board amended the ALZA Corporation 1992 Stock Option Plan on February 16, 1995, renaming it the ALZA Corporation Amended and Restated Stock Plan (the "Amended and Restated Plan") and the stockholders approved the amendments on May 11, 1995. The Board amended the Amended and Restated Plan on February 12, 1997 to increase the number of shares from 6,000,000 to 9,000,000 and to provide for the transferability of option rights. The stockholders approved the amendment to increase the number of shares on May 8, 1997. The Board further amended the Amended and Restated Plan on August 13, 1997. These amendments did not require stockholder approval. The Board further amended the Amended and Restated Plan on February 9, 1999 to increase the number of shares from 9,000,000 to 14,000,000, subject to stockholder approval. The stockholders approved this amendment on May 6, 1999. The Compensation and Benefits Committee of the Board made certain non-material amendments to Section 8 of the Amended and Restated Plan on May 6, 1999. EX-10.2 3 EXHIBIT 10.2 EXHIBIT 10.2 FORM OF AMENDMENT TO EXECUTIVE AGREEMENT AMENDMENT (the "Amendment") to Executive Agreement (the "Executive Agreement"), between _______________ (the "Executive") and ALZA Corporation, a Delaware corporation (the "Company"). WHEREAS, Compensation and Benefits Committee (the "Committee") of the Board of Directors (the "Board") of the Company previously authorized the Company to enter into agreements with certain executive officers of the Company (the "Executive Agreements") providing for the payment of severance and other benefits upon termination of such executives following a change in control of the Company; WHEREAS, the Committee has determined that it is in the best interests of the Company and its stockholders to modify such benefits in the manner set forth below. NOW, THEREFORE, in consideration of the mutual agreements hereinafter set forth, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Executive and the Company have agreed and do hereby agree to amend the Executive Agreement as follows, effective as of the 11th day of June, 1999: 1. Section 6 of the Executive Agreement is hereby renamed "Severance Payments." 2. Section 6.1(A) of the Executive Agreement is hereby amended in its entirety to read as follows: "In lieu of any further salary and bonus payments to the Executive for periods subsequent to the Date of Termination and in lieu of any severance benefit otherwise payable to the Executive, the Company shall pay to the Executive a lump sum severance payment, in cash, equal to the product of (x) the sum of (i) the Executive's annual base salary in effect immediately prior to the occurrence of the event or circumstance upon which the Notice of Termination is based or in effect immediately prior to the Change in Control, if higher, and (ii) the amount paid to or accrued by the Executive pursuant to the Company's regular bonus, incentive cash compensation or income deferral arrangements (and not including any special one-time awards not made as part of a regular program) in the one-year period immediately preceding that in which the Date of Termination occurs or, if higher, the amount paid or accrued in the one-year period immediately preceding that in which the Change in Control occurs and (y) 2.5." 3. Section 6.1(C) of the Executive Agreement is hereby amended in its entirety to read as follows: "All outstanding Options, to the extent not then vested on the Date of Termination shall be exercisable in accordance with the terms and conditions of the Amended and Restated Stock Plan and 1985 Stock Option Plan, as applicable, and Executive's option agreement(s)." 4. Section 6.2 of the Executive Agreement is hereby amended in its entirety to read as follows: "(A) In the event that the Executive becomes entitled to the Severance Payments, if any of the payments or benefits received or to be received by the Executive in connection with a Change in Control or the Executive's termination of employment (whether pursuant to the terms of this Agreement or any other plan, arrangement or agreement with the Company, any Person whose actions result in a Change in Control or any Person affiliated with the Company or such Person) (all such payments and benefits, excluding the Gross-Up Payment, being hereinafter referred to as the "Total Payments") will be subject to the Excise Tax, the Company shall pay to the Executive an additional amount (the "Gross-Up Payment") such that the net amount retained by the Executive, after deduction of any Excise Tax on the Total Payments and any Federal, state and local income and employment taxes and Excise Tax upon the Gross-Up Payment, shall be equal to the Total Payments. (B) For purposes of determining whether any of the Total Payments will be subject to the Excise Tax and the amount of such Excise Tax, (i) all of the Total Payments shall be treated as "parachute payments" (within the meaning of section 280G(b)(2) of the Code) unless, in the opinion of tax counsel ("Tax Counsel")reasonably acceptable to the Executive and selected by the accounting firm which was, immediately prior to the Change in Control, the Company's independent auditor (the "Auditor"), such payments or benefits (in whole or in part) do not constitute parachute payments, including by reason of section 280G(b)(4)(A)of the Code, (ii) all "excess parachute payments" within the meaning of section 280G(b)(l) of the Code shall be treated as subject to the Excise Tax unless, in the opinion of Tax Counsel, such excess parachute payments (in whole or in part)represent reasonable compensation for services actually rendered (within the meaning of section 280G(b)(4)(B) of the Code) in excess of the Base Amount allocable to such reasonable compensation, or are otherwise not subject to the Excise Tax, and (iii) the value of any noncash benefits or any deferred payment or benefit shall be determined by the Auditor in accordance with the principles of sections 280G(d)(3) and (4) of the Code. For purposes of determining the amount of the Gross-Up Payment, the Executive shall be deemed to pay federal income tax at the highest marginal rate of federal income taxation in the calendar year in which the Gross-Up Payment is to be made and state and local income taxes at the highest marginal rate of taxation in the state and locality of the Executive's residence on the Date of Termination (or if there is no Date of Termination, then the date on which the Gross-Up Payment is calculated for purposes of this Section 6.2), net of the maximum reduction in federal income taxes which could be obtained from deduction of such state and local taxes. (C) In the event that the Excise Tax is finally determined to be less than the amount taken into account hereunder in calculating the Gross-Up Payment, the Executive shall repay to the Company, within five (5) business days following the time that the amount of such reduction in the Excise Tax is finally determined, the portion of the Gross-Up Payment attributable to such reduction (plus that portion of the Gross-Up Payment attributable to the Excise Tax and federal, state and local income and employment taxes imposed on the Gross-Up Payment being repaid by the Executive, to the extent that such repayment results in a reduction in the Excise Tax and a dollar-for-dollar reduction in the Executive's taxable income and wages for purposes of federal, state and local income and employment taxes, plus interest on the amount of such repayment at 120% of the rate provided in Section 1274(b)(2)(B) of the Code. In the event that the Excise Tax is determined to exceed the amount taken into account hereunder in calculating the Gross-Up Payment (including by reason of any payment the existence or amount of which cannot be determined at the time of the Gross-Up Payment), the Company shall make an additional Gross-Up Payment in respect of such excess (plus any interest, penalties or additions payable by the Executive with respect to such excess) within five (5) business days following the time that the amount of such excess is finally determined. The Executive and the Company shall each reasonably cooperate with the other in connection with any administrative or judicial proceedings concerning the existence or amount of liability for Excise Tax with respect to the Total Payments." 5. Except as otherwise provided herein, the remaining terms of the Executive Agreement shall remain in full force and effect. IN WITNESS WHEREOF, the Company has caused the Amendment to be executed by its duly authorized officer, and the Executive has hereunto signed the Amendment, as of the date first above written. ALZA Corporation By: _____________________________ Its: ______________________________ SCHEDULE OF SIGNATORIES TO FORM OF AMENDMENT TO EXECUTIVE AGREEMENT James Butler Bruce Cozadd Harold Fethe Ron Haak Robert M. Myers Samuel R. Saks Peter Staple Jane Wissel James Young EX-10.3 4 EXHIBIT 10.3 EXHIBIT 10.3 EXECUTIVE AGREEMENT THIS AGREEMENT dated June 21, 1999, is made by and between ALZA Corporation, a Delaware corporation (the "Company"), and Dr. Ernest Mario, Ph.D. (the "Executive"). WHEREAS, the Company considers it essential to the best interests of its shareholders to foster the continuous employment of key management personnel; and WHEREAS, the Board of Directors of the Company (the "Board") recognizes that, as is the case with many publicly held corporations, the possibility of a Change in Control (as defined in the last Section hereof) exists and that such possibility, and the uncertainty and questions which it may raise among management, may result in the departure or distraction of management personnel to the detriment of the Company and its shareholders; and WHEREAS, the Board has determined that appropriate steps should be taken to reinforce and encourage the continued attention and dedication of members of the Company's management, including the Executive, to their assigned duties without distraction in the face of potentially disturbing circumstances arising from the possibility of a Change in Control. NOW, THEREFORE, in consideration of the premises and the mutual covenants herein contained, the Company and the Executive hereby agree as follows: 1. DEFINED TERMS. The definition of capitalized terms used in this Agreement is provided in the last Section hereof. 2. TERM OF AGREEMENT. This Agreement shall commence on the date hereof and shall continue in effect through December 31, 2000; provided that, commencing on January 1, 2001 and each January 1 thereafter, the term of this Agreement shall automatically be extended for one additional year unless, not later than October 30 of the preceding year, the Company or the Executive shall have given notice not to extend this Agreement or a Change in Control shall have occurred prior to such January 1; provided, however, that if a Change in Control shall have occurred during the term of this Agreement, this Agreement shall continue in effect for a period of not less than twenty-four (24) months from the date on which such Change in Control occurred. 3. COMPANY'S COVENANTS SUMMARIZED. In order to induce the Executive to remain in the employ of the Company and in consideration of the Executive's covenants set forth in Section 4 hereof, the Company agrees, under the conditions described herein, to pay the Executive the "Severance Payments" described in Section 6.1 hereof and the other payments and benefits described herein in the event the Executive's employment with the Company is terminated following a Change in Control and during the term of this Agreement. No amount or benefit shall be payable under this Agreement unless there shall have been (or, under the terms hereof, there shall be deemed to have been) a termination of the Executive's employment with the Company following a Change in Control. This Agreement shall not be construed as creating an express or implied contract of employment and, except as otherwise agreed in writing between the Executive and the Company, the Executive shall not have any right to be retained in the employ of the Company. 4. THE EXECUTIVE'S COVENANTS. The Executive agrees that, subject to the terms and conditions of this Agreement, in the event of a Potential Change in Control during the term of this Agreement, the Executive will remain in the employ of the Company until the earliest of (A) a date which is twelve (12) months after the date of such Potential Change of Control, (B) the date of a Change in Control, (C) the date of termination by the Executive of the Executive's employment for Good Reason (determined by creating the Potential Change in Control as a Change in Control in applying the definition of Good Reason), or by reason of the Executive's death, Disability or Retirement, or (D) the termination by the Company of the Executive's employment for any reason. 5. COMPENSATION OTHER THAN SEVERANCE PAYMENTS. 5.1 Following a Change in Control and during the term of this Agreement, during any period that the Executive fails to perform the Executive's full-time duties with the Company as a result of incapacity due to physical or mental illness, the Company shall pay the Executive's full salary to the Executive at the rate in effect at the commencement of any such period, together with all compensation and benefits payable to the Executive under the terms of any compensation or benefit plan, program or arrangement maintained by the Company during such period, until the Executive's employment is terminated by the Company for Disability. 5.2 If the Executive's employment shall be terminated for any reason following a Change in Control and during the term of this Agreement, the Company shall pay the Executive's full salary to the Executive through the Date of Termination at the rate in effect at the time the Notice of Termination is given, together with all compensation and benefits payable to the Executive through the Date of Termination under the terms of any compensation or benefit plan, program or arrangement maintained by the Company during such period. 5.3 If the Executive's employment shall be terminated for any reason following a Change in Control and during the term of this Agreement, the Company shall pay the Executive's normal post-termination compensation and benefits under the circumstances (other than any regular severance benefits) to the Executive as such payments become due. Such post-termination compensation and benefits shall be determined under, and paid in accordance with, the Company's retirement, insurance and other compensation or benefit plans, programs and arrangements. 6. SEVERANCE PAYMENTS/CONSULTING AGREEMENT. 6.1 Subject to Section 6.2 hereof, the Company shall pay the Executive the payments described in this Section 6.1 (the "Severance Payments") upon the termination of the Executive's employment following a Change in Control and during the term of this Agreement, in addition to the payments and benefits described in Section 5 hereof, unless such termination is (a) by the Company for Cause, (b) by reason of death, Disability or Retirement, or (c) by the Executive without Good Reason. The Executive's employment shall be deemed to have been terminated following a Change in Control by the Company without Cause or by the Executive with Good Reason if the Executive's employment is terminated prior to a Change in Control without Cause at the direction of a Person who has entered into an agreement with the Company the consummation of which will constitute a Change in Control or if the Executive terminates his employment with Good Reason prior to a Change in Control (determined by treating a Potential Change in Control as a Change in Control in applying the definition of Good Reason) if the circumstance or event which constitutes Good Reason occurs at the direction of such Person. (A) In lieu of any further salary and bonus payments to the Executive for periods subsequent to the Date of Termination and in lieu of any severance benefit otherwise payable to the Executive, the Company shall pay to the Executive a lump sum severance payment, in cash, equal to the product of (x) the sum of (i) the Executive's annual base salary in effect immediately prior to the occurrence of the event or circumstance upon which the Notice of Termination is based or in effect immediately prior to the Change in Control, if higher, and (ii) the amount paid to or accrued by the Executive pursuant to the Company's regular bonus, incentive cash compensation or income deferral arrangements (including any special one-time awards not made as part of a regular program) in the one-year period immediately preceding that in which the Date of Termination occurs or, if higher, the amount paid or accrued in the one-year period immediately preceding that in which the Change in Control occurs and (y) three (3); provided, however, that in no event shall such amount be less than $4.5 million. (B) Notwithstanding any provision of the Company's bonus, incentive cash compensation or income deferral arrangements, the Company shall pay to the Executive a lump sum amount, in cash, equal to the sum of (i) any bonus, incentive or deferred cash compensation that has been allocated or awarded to the Executive for a completed year or other measuring period preceding the Date of Termination but has not yet been paid (pursuant to Section 5.2 hereof or otherwise), and (ii) a pro rata portion of the aggregate value of all contingent bonus, incentive or deferred cash compensation awards to the Executive for all uncompleted periods (based on the number of days from the commencement of the applicable period through the Date of Termination) calculated as to each such award by a good faith proration of performance toward applicable objectives prior to the Date of Termination; provided, however, that in the event a Change in Control occurs prior to December 31, 1999, the Executive shall be entitled to participate in the Company's annual performance bonus plan applicable to the Company's senior executive officers pursuant to which the Company shall pay to the Executive, no later than February 28, 2000, the full amount of the performance bonus the Executive is entitled to receive thereunder for fiscal year 1999, which amount shall not be less than $750,000. (C) All outstanding Options, to the extent not then vested on the Date of Termination shall be exercisable in accordance with the terms and conditions of the Amended and Restated Stock Plan and 1985 Stock Option Plan, as applicable, and Executive's option agreements. (D) The Company shall pay the Executive a lump sum amount, in cash, equal to the excess of (x) the benefits under any retirement, pension or deferred compensation arrangements that the Executive would have accrued under the terms of such plan without regard to any amendments made subsequent to a Change in Control and on or prior to the Date of Termination, which amendment adversely affects in any manner the computation of the benefits thereunder, determined as if the Executive were fully vested thereunder, over (y) the benefits that the Executive is otherwise entitled to receive under such plan. (E) For a twenty-four (24) month period after the Date of Termination, provided that such period shall be reduced by one month for each full month that the Date of Termination is later than the first anniversary of the Change in Control, the Company shall arrange to provide the Executive with life, disability, accident and health insurance benefits substantially similar to those which the Executive is receiving immediately prior to the Notice of Termination (without giving effect to any reduction in such benefits subsequent to a Change in Control which reduction constitutes Good Reason). Benefits otherwise receivable by the Executive pursuant to this Section 6.1(E) shall be reduced to the extent comparable benefits are actually received by or made available to the Executive without cost during the above-referenced period following the Executive's termination of employment (and any such benefits actually received by the Executive shall be reported to the Company by the Executive). 6.2 (A) In the event the Executive becomes entitled to the Severance Payments, if any of the payments or benefits received or to be received by the Executive in connection with a Change in Control or the Executive's termination of employment (whether pursuant to the terms of this Agreement or any other plan, arrangement or agreement with the Company, any Person whose actions result in a Change in Control or any Person affiliated with the Company or such Person) (all such payments and benefits, excluding the Gross-Up Payment (as defined below), being hereinafter referred to as the "Total Payments") will be subject to the Excise Tax, the Excise Tax shall be allocated pro rata to the portion of the Total Payments that are not attributable to the acceleration of equity-based awards to the Executive (the "Non-Equity Payments") and the portion of the Total Payments that are attributable to the acceleration of equity-based awards to the Executive (the "Equity Payments") and the Company shall pay to the Executive an additional amount (the "Gross-Up Payment") such that the net amount retained by the Executive, after deduction of any Excise Tax allocated to the Non-Equity Payments and any Federal, state and local income and employment taxes and Excise Tax upon the Gross-Up Payment, shall be equal to the Non-Equity Payments. By way of example, if the Excise Tax equals $100,000 and each of the Non-Equity Payments and the Equity Payments are $200,000, the Gross-Up would be based on 50% of the Excise Tax. (B) For purposes of determining whether any of the Total Payments will be subject to the Excise Tax and the amount of such Excise Tax, (i) all of the sum of the Total Payments shall be treated as "parachute payments" (within the meaning of section 280G(b)(2) of the Code) unless, in the opinion of tax counsel ("Tax Counsel") reasonably acceptable to the Executive and selected by the accounting firm which was, immediately prior to the Change in Control, the Company's independent auditor (the "Auditor"), such payments or benefits (in whole or in part) do not constitute parachute payments, including by reason of section 280G(b)(4)(A) of the Code, (ii) all "excess parachute payments" within the meaning of section 280G(b)(l) of the Code shall be treated as subject to the Excise Tax unless, in the opinion of Tax Counsel, such excess parachute payments (in whole or in part) represent reasonable compensation for services actually rendered (within the meaning of section 280G(b)(4)(B) of the Code) in excess of the Base Amount allocable to such reasonable compensation, or are otherwise not subject to the Excise Tax, and (iii) the value of any noncash benefits or any deferred payment or benefit shall be determined by the Auditor in accordance with the principles of sections 280G(d)(3) and (4) of the Code. For purposes of determining the amount of the Gross-Up Payment, the Executive shall be deemed to pay federal income tax at the highest marginal rate of federal income taxation in the calendar year in which the Gross-Up Payment is to be made and state and local income taxes at the highest marginal rate of taxation in the state and locality of the Executive's residence on the date of termination (or if there is no date of termination, then the date on which the Gross-Up Payment is calculated for purposes of this section), net of the maximum reduction in federal income taxes which could be obtained from deduction of such state and local taxes. (C) In the event that the Excise Tax is finally determined to be less than the amount taken into account hereunder in calculating the Gross-Up Payment, the Executive shall repay to the Company, within five (5) business days following the time that the amount of such reduction in the Excise Tax is finally determined, the portion of the Gross-Up Payment attributable to such reduction (plus that portion of the Gross-Up Payment attributable to the Excise Tax and federal, state and local income and employment taxes imposed on the Gross-Up Payment being repaid by the Executive, to the extent that such repayment results in a reduction in the Excise Tax and a dollar-for-dollar reduction in the Executive's taxable income and wages for purposes of federal, state and local income and employment taxes, plus interest on the amount of such repayment at 120% of the rate provided in section 1274(b)(2)(B) of the Code. In the event that the Excise Tax is determined to exceed the amount taken into account hereunder in calculating the Gross-Up Payment (including by reason of any payment the existence or amount of which cannot be determined at the time of the Gross-Up Payment), the Company shall make an additional Gross- Up Payment in respect of such excess (plus any interest, penalties or additions payable by the Executive with respect to such excess) within five (5) business days following the time that the amount of such excess is finally determined. The Executive and the Company shall each reasonably cooperate with the other in connection with any administrative or judicial proceedings concerning the existence or amount of liability for Excise Tax with respect to the Total Payments." (D) The Executive and the Company shall enter into an agreement, which shall (i) have a term of four (4) years, (ii) contain appropriate provisions restricting competition by the Executive from working in a Listed Drug Delivery Company during the term, and (iii) provide the Executive with a quarterly fee in an amount equal to $31,250, which amount shall be paid on the first business day of each calendar quarter occurring during the term. 6.3 The payments provided for in Section 6.1 (other than Section 6.1(E)) shall be made not later than the fifteenth (15th) day following the Date of Termination; provided that, if the amounts of such payments cannot be finally determined on or before such day, the Company shall pay to the Executive on such day an estimate, as determined in good faith by the Company, of the minimum amount of such payments to which the Executive is clearly entitled and shall pay the remainder of such payments (together with interest at the rate provided in section 1274(b)(2)(B) of the Code) as soon as the amount thereof can be determined but in no event later than the thirtieth (30th) day after the Date of Termination. In the event that the amount of the estimated payments exceeds the amount subsequently determined to have been due, such excess shall constitute a loan by the Company to the Executive, payable on the fifth (5th) business day after demand by the Company (together with interest at the rate provided in section 1274(b)(2)(B) of the Code). At the time that payments are made under this Section, the Company shall provide the Executive with a written statement setting forth the manner in which such payments were calculated and the basis for such calculations including, without limitation, any opinions or other advice the Company has received from outside counsel, auditors or consultants (and any such opinions or advice which are in writing shall be attached to the statement). 7. TERMINATION PROCEDURES. 7.1 NOTICE OF TERMINATION. After a Change in Control and during the term of this Agreement, any purported termination of the Executive's employment (other than by reason of death) shall be communicated by written Notice of Termination from one party hereto to the other party hereto in accordance with Section 10 hereof. For purposes of this Agreement, a "Notice of Termination" shall mean a notice which shall indicate the specific termination provision in this Agreement relied upon and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive's employment under the provision so indicated. 7.2 DATE OF TERMINATION. "Date of Termination," with respect to any purported termination of the Executive's employment after a Change in Control and during the term of this Agreement, shall mean (i) if the Executive's employment is terminated for Disability, thirty (30) days after Notice of Termination is given (provided that the Executive shall not have returned to the full-time performance of the Executive's duties during such thirty (30) day period), and (ii) if the Executive's employment is terminated for any other reason, the date specified in the Notice of Termination (which, in the case of a termination by the Company, shall not be less than thirty (30) days (except in the case of a termination for Cause) and, in the case of a termination by the Executive, shall not be less than fifteen (15) days nor more than sixty (60) days, respectively, from the date such Notice of Termination is given). 8. NO MITIGATION. The Company agrees that, if the Executive's employment by the Company is terminated during the term of this Agreement, the Executive is not required to seek other employment or to attempt in any way to reduce any amounts payable to the Executive by the Company pursuant to Section 6. Further, the amount of any payment or benefit provided for in Section 6 (other than Section 6.1(E)) shall not be reduced by any compensation earned by the Executive as the result of employment by another employer, by retirement benefits, by offset against any amount claimed to be owed by the Executive to the Company, or otherwise. 9. SUCCESSORS; BINDING AGREEMENT. 9.1 In addition to any obligations imposed by law upon any successor to the Company, the Company will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company to expressly assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken place. Failure of the Company to obtain such assumption and agreement prior to the effectiveness of any such succession shall be a breach of this Agreement and shall entitle the Executive to compensation from the Company in the same amount and on the same terms as the Executive would be entitled to hereunder if the Executive were to terminate the Executive's employment for Good Reason after a Change in Control, except that, for purposes of implementing the foregoing, the date on which any such succession becomes effective shall be deemed the Date of Termination. 9.2 This Agreement shall inure to the benefit of and be enforceable by the Executive's personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If the Executive shall die while any amount would still be payable to the Executive hereunder (other than amounts which, by their terms, terminate upon the death of the Executive) if the Executive had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the executors, personal representatives or administrators of the Executive's estate. 10. NOTICES. For the purpose of this Agreement, notices and all other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by United States registered mail, return receipt requested, postage prepaid, addressed to the respective addresses set forth below, or to such other address as either party may have furnished to the other in writing in accordance herewith, except that notice of change of address shall be effective only upon actual receipt: To the Company: ALZA Corporation 950 Page Mill Road P.O. Box 10950 Palo Alto, CA 94303 Attention: General Counsel To the Executive: Dr. Ernest Mario Squire House 900 University Avenue Palo Alto, California 94301 11. MISCELLANEOUS. No provision of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing and signed by the Executive and on behalf of the Company by a duly authorized officer. No waiver by either party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not expressly set forth in this Agreement. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of California. All references to sections of the Exchange Act or the Code shall be deemed also to refer to any successor provisions to such sections. Any payments provided for hereunder shall be paid net of any applicable withholding required under federal, state or local law and any additional withholding to which the Executive has agreed. The obligations of the Company and the Executive under Sections 5, 6 and 7 shall survive the expiration of the term of this Agreement. 12. VALIDITY. The invalidity or unenforceability or any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect. 13. COUNTERPARTS. This Agreement may be executed in several counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument. 14. SETTLEMENT OF DISPUTES; ARBITRATION. All claims by the Executive for benefits under this Agreement shall be directed to and determined by the Board or a designated committee of the Board and shall be in writing. Any denial by the Board of a claim for benefits under this Agreement shall be delivered to the Executive in writing and shall set forth the specific reasons for the denial and the specific provisions of this Agreement relied upon. Any further dispute or controversy arising under or in connection with this Agreement shall be settled exclusively by arbitration in Palo Alto, California in accordance with the rules of the American Arbitration Association then in effect. Judgment may be entered on the arbitrator's award in any court having jurisdiction; provided, however, that the Executive shall be entitled to be paid until the Date of Termination during the pendency of any dispute or controversy arising under or in connection with this Agreement. 15. DEFINITIONS. For purposes of this Agreement, the following terms shall have the meanings indicated below: (A) "Base Amount" shall have the meaning defined in section 280G(b)(3) of the Code. (B) "Beneficial Owner" shall have the meaning defined in Rule 13d-3 under the Exchange Act. (C) "Board" shall mean the Board of Directors of the Company. (D) "Cause" for termination by the Company of the Executive's employment, after any Change in Control, shall mean (i) the willful and continued failure by the Executive to substantially perform the Executive's duties with the Company (other than any such failure resulting from the Executive's incapacity due to physical or mental illness or any such actual or anticipated failure after the issuance of a Notice of Termination for Good Reason by the Executive pursuant to Section 7.1) after a written demand for substantial performance is delivered to the Executive by the Company, which demand specifically identifies the manner in which the Company believes that the Executive has not substantially performed the Executive's duties, (ii) the willful engaging by the Executive in conduct which is demonstrably and materially injurious to the Company or its subsidiaries, monetarily or otherwise, (iii) the conviction of the Executive of a felony involving moral turpitude or (iv) the Executive becoming eligible for Retirement. (E) A "Change in Control" shall be deemed to have occurred if the conditions set forth in any one of the following paragraphs shall have been satisfied: (i) any Person is or becomes the Beneficial Owner, directly or indirectly, of securities of the Company representing 50% or more of the combined voting power of the Company's then outstanding securities; or (ii) during any period of two consecutive years (not including any period prior to the execution of this Agreement), a majority of the Board ceases to be comprised of (a) individuals who at the beginning of such period constitute the Board and (b) any new directors (other than a director designated by a Person who has entered into an agreement with the Company to effect a transaction described in clause (i), (iii) or (iv) of this paragraph) whose election by the Board or nomination for election by the Company's stockholders was approved by a vote of at least two- thirds (2/3) of the directors then still in office who either were directors at the beginning of the period or whose election or nomination for election was previously so approved; or (iii) the shareholders of the Company approve a merger or consolidation of the Company with any other corporation, other than (a) a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity), in combination with the ownership of any trustee or other fiduciary holding securities under an employee benefit plan of the Company, more than 50% of the combined voting power of the voting securities of the Company or such surviving entity outstanding immediately after such merger or consolidation, or (b) a merger or consolidation effected to implement a recapitalization of the Company (or similar transaction) in which no Person acquires more than 50% of the combined voting power of the Company's then outstanding securities; or (iv) the shareholders of the Company approve a plan of complete liquidation of the Company or an agreement for the sale or disposition by the Company of all or substantially all the Company's assets. Notwithstanding the foregoing, a Change in Control shall not include any event, circumstance or transaction occurring during the six-month period following a Potential Change in Control which results from the action of any entity or group which includes, is affiliated with or is wholly or partly controlled by one or more executive officers of the Company (a "Management Group"); provided that, such action shall not be taken into account for this purpose if it occurs within a six-month period following a Potential Change in Control resulting from the action of any Person which is not a Management Group. (F) "Code" shall mean the Internal Revenue Code of 1986, as amended from time to time. (G) "Company" shall mean ALZA Corporation and any successor to its business and/or assets (except in determining, under Section 15(E) hereof, whether or not any Change in Control of the Company has occurred in connection with such succession). (H) "Company Shares" shall mean shares of common stock of the Company or any equity securities into which such shares have been converted. (I) "Date of Termination" shall have the meaning stated in Section 7.2 hereof. (J) "Disability" shall be deemed the reason for the termination by the Company of the Executive's employment, if, as a result of the Executive's incapacity due to physical or mental illness, the Executive shall have been absent from the full-time performance of the Executive's duties with the Company for a period of six (6) consecutive months, or for any period of eight (8) months in any twelve-month period, the Company shall have given the Executive a Notice of Termination for Disability, and, within thirty (30) days after such Notice of Termination is given, the Executive shall not have returned to the full-time performance of the Executive's duties. (K) "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended from time to time. (L) "Excise Tax" shall mean any excise tax imposed under section 4999 of the Code. (M) "Executive" shall mean the individual named in the first paragraph of this Agreement. (N) "Good Reason" for termination by the Executive of the Executive's employment shall mean the occurrence (without the Executive's express written consent) of any one of the following acts by the Company, or failures by the Company to act, unless, in the case of any act or failure to act described in paragraph (i), (v) or (vi) below, such act or failure to act is corrected prior to the Date of Termination specified in the Notice of Termination given in respect thereof: (i) the assignment to the Executive of any duties materially inconsistent with the Executive's status as an executive officer of the Company or a substantial adverse alteration in the nature or status of the Executive's responsibilities from those in effect immediately prior to the Change in Control; provided, however, that the Executive shall be deemed to have Good Reason to terminate employment if, after the Change in Control (and without otherwise terminating the Executive's employment) the Executive ceases to be the chief executive officer of a company whose securities are publicly traded on a national securities exchange or quotation system, but any termination for Good Reason that is solely pursuant to this proviso shall not be effective until the expiration of 180 days after the Change in Control; (ii) a reduction by the Company in the Executive's annual base salary as in effect on the date hereof or as the same may be increased from time to time; (iii) the relocation of the Executive's principal place of employment by the Company to a location outside the Palo Alto/San Jose metropolitan area (or, if different, the metropolitan area in which the Executive's employment was located immediately prior to the Change in Control) or the Company's requiring the Executive to travel on the Company's business to an extent substantially inconsistent with the Executive's business travel obligations as of the date of the Change in Control; (iv) the failure by the Company, without the Executive's consent, to pay to the Executive any portion of the Executive's current compensation, or to pay to the Executive any portion of an installment of deferred compensation under any deferred compensation program of the Company, within seven (7) days of the date such compensation is due; (v) the failure by the Company to continue in effect any compensation plan in which the Executive participates immediately prior to the Change in Control which is material to the Executive's total compensation, including but not limited to the Company's stock option, incentive compensation, bonus and other plans or any substitute plans adopted prior to the Change in Control, unless an equitable arrangement (embodied in an ongoing substitute or alternative plan) has been made with respect to such plan, or the failure by the Company to continue the Executive's participation therein (or in such substitute or alternative plan) on a basis that is not less favorable than that which existed at the time of the Change in Control; provided that, in each case under this clause (v), such failure causes a material adverse change in the annual compensation of the Executive, taken as a whole and including amounts or awards that are reasonably expected to be made, compared to the compensation package that existed at the time of the Change in Control; and provided, further, that any such determination which is based on participation in a stock option plan shall take into account, among other factors, the overall practices and policies of a parent company with respect to its option plans; or (vi) the failure by the Company to continue to provide the Executive with benefits substantially similar to those enjoyed by The Executive under any of the Company's pension, life insurance, medical, health and accident, or disability plans in which the Executive was participating at the time of the Change in Control, the taking of any action by the Company which would directly or indirectly materially reduce any of such benefits or deprive the Executive of any material fringe benefit enjoyed by the Executive at the time of the Change in Control, or the failure by the Company to provide the Executive with the number of paid vacation days to which the Executive is entitled on the basis of years of service with the Company in accordance with the Company's normal vacation policy in effect at the time of the Change in Control unless any such failure is the result of a change in policy applicable generally to senior employees of the Company and of any corporation of which the Company is a subsidiary. The Executive's right to terminate the Executive's employment for Good Reason shall not be affected by the Executive's incapacity due to physical or mental illness. The Executive's continued employment shall not constitute consent to, or a waiver of rights with respect to, any act or failure to act constituting Good Reason hereunder. (O) "ISOs" shall mean options qualifying as incentive stock options under section 422 of the Code. (P) "Listed Drug Delivery Company" shall mean any one of the following companies, or a business entity controlled by any one of such companies: Advanced Polymer Systems, Biovail Corp. International, Cygnus Therapeutic Systems, Elan Corporation Plc., Ethical Holdings Plc., Gensia Corp., Genta Inc., KV Pharmaceutical Co., Noven Pharmaceuticals Inc., R.P. Scherer Corp. or TheraTech Inc. (Q) "Notice of Termination" shall have the meaning stated in Section 7.1 hereof. (R) "Options" shall mean options for Company Shares granted to the Executive under the Company's Amended and Restated Stock Plan and 1985 Stock Option Plan. (S) "Pension Plan" shall mean the ALZA Retirement Plan. (T) "Person" shall have the meaning given in Section 3(a)(9) of the Exchange Act, as modified and used in Sections 13(d) and 14(d) thereof; however, a Person shall not include (i) the Company or any of its subsidiaries, (ii) a trustee or other fiduciary holding securities under an employee benefit plan of the Company or any of its subsidiaries, (iii) an underwriter temporarily holding securities pursuant to an offering of such securities, or (iv) a corporation owned, directly or indirectly, by the stockholders of the Company in substantially the same proportions as their ownership of stock of the Company. (U) "Potential Change in Control" shall be deemed to have occurred if the conditions set forth in any one of the following paragraphs shall have been satisfied: (i) the Company enters into an agreement, the consummation of which would result in the occurrence of a Change in Control; (ii) the Company or any Person publicly announces an intention to take actions which, if consummated, would constitute a Change in Control; (iii) any Person who is or becomes the Beneficial Owner, directly or indirectly, of securities of the Company representing 20% or more of the combined voting power of the Company's then outstanding securities, increases such Person's beneficial ownership of such securities to 30% or more of such combined voting power; or (iv) the Board adopts a resolution to the effect that, for purposes of this Agreement, a Potential Change in Control has occurred. (V) "Retirement" shall be deemed the reason for the termination by the Company or the Executive of the Executive's employment ifsuch employment is terminated in accordance with the Company's retirement policy, not including retirement before the age of 65 (or such later age as may be established in such policy), generally applicable to its salaried employees, as in effect immediately prior to the Change in Control, or in accordance with any retirement arrangement established with the Executive's written consent with respect to the Executive. (W) "Severance Payments" shall mean those payments described in Section 6.1 hereof. (X) "Shares" shall mean shares of the common stock, $.01 par value, of the Company. (Y) "Total Payments" shall mean those payments described in Section 6.2 hereof. ALZA Corporation By: _______________________________ Name: Title: __________________________________ Dr. Ernest Mario, Ph.D. EX-27 5 FINANCIAL DATA SCHEDULE
5 This schedule contains summary financial information extracted from the financial statements included in Part I, Item 1 of Form 10-Q dated June 30, 1999 and is qualified in its entirety by reference to such financial statements. 1,000,000 6-MOS DEC-31-1999 JUN-30-1999 92 58 171 4 59 446 511 131 1,730 118 934 0 0 1 596 1,730 199 381 75 167 0 0 30 60 22 38 0 0 0 38 .38 .37
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