IMCLONE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Expected Volatility:   Volatility is a measure of the amount by which a financial variable, such as share price, has fluctuated (historical volatility) or is expected to fluctuate (expected volatility). The expected volatility of stock option awards at the date of grant is estimated based on the implied volatility of greater than one-year publicly traded options. The decision to use implied volatility was based upon the availability of actively traded options on the Company’s common stock and the assessment that implied volatility is more representative of future stock price trends than historical volatility. Prior to the adoption of SFAS 123R, the Company calculated expected volatility using only historical stock price volatility.

Risk-Free Interest Rate:   The risk-free interest rate used in the Black-Scholes option pricing model is based on the implied yield available on U.S. Treasury zero-coupon issues with a remaining term equal to the expected term used. The risk free rate used in the Monte-Carlo valuation model is based on the implied yield in effect at the time of grant from the constant maturity treasury yield curve over the contractual terms of the award.

Dividends:   Cash dividends have never been declared on the Company’s common stock and the Company has no present intention to declare cash dividends in the foreseeable future. Consequently, an expected dividend yield of zero was used in both the Black-Scholes and Monte-Carlo valuation models.

Forfeitures:   The Company uses historical data to estimate pre-vesting option forfeitures. Share-based compensation expense is recorded only for those awards that are expected to vest.

The following assumptions were used to estimate the fair value of options granted under the Company’s Stock Option Plans:

		Year Ended December 31,
		2006		2005		2004
Expected term (years)		3.95-5.72		4.49		4.47
Risk-free interest rate		4.31-5.21	%	3.62	%	2.63	%
Expected volatility		27.45-42.70	%	82.92	%	85.42	%
Expected dividend rate		0	%	0	%	0	%

 

The assumptions used in the Monte-Carlo simulation modeling to estimate the fair value of awards under the Retention Plan for the year ended December 31, 2006 were: expected volatility of 42.23 %, risk-free interest rate ranging from 4.87% to 5.03% and expected dividend yield of 0%. The fair value of the Company’s ESPP awards during the year ended December 31, 2006 were calculated using the intrinsic value of the common stock purchased on the end of each quarter based on the fact that the Company’s offering period is three months and the ESPP does not contain a look-back provision.

F-33

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IMCLONE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Stock Option Activity and Share-Based Compensation Expense

Stock option activity for the year ended December 31, 2006 is summarized as follows:

		Number of Shares		Weighted Average Exercise Price Per Share					Weighted Average Remaining Contractual Term				Aggregate Intrinsic Value
									(Years)				(in thousands)
Outstanding at December 31, 2005		12,619,193			$	37.38
Granted		1,763,905			34.32
Exercised		(1,701,447	)		17.04
Forfeitures		(2,171,921	)		45.14
Expired		(436	)		6.01
Outstanding at December 31, 2006		10,509,294			$	38.55				6.12				$	19,331
Vested and expected to vest		10,327,285			$	38.64				6.01				$	19,325
Exercisable at December 31, 2006		9,089,017			$	39.42				5.65				$	18,587

 

The weighted average fair value of options granted during the years ended December 31, 2006, 2005 and 2004 was $14.64,  $25.34 and $33.21, respectively. The aggregate intrinsic value of options outstanding at December 31, 2006 is calculated as the difference between the exercise price of the underlying options and the market price of the Company’s common stock for the 1,486,837 shares that had exercise prices that were lower than the $26.76 market price of our common stock at December 31, 2006. The total intrinsic value of options exercised during the years ended December 31, 2006, 2005 and 2004 was approximately $27.3 million, $22.5 million and $150.8 million, respectively, determined as of the date of exercise.

The Company recognized for the year ended December 31, 2006 approximately $7.4 million in share-based compensation expense, net of amounts capitalized, for stock options granted under the Company’s Stock Option Plans. As of December 31, 2006, there was approximately $14.9 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Company’s Stock Option Plans. This amount assumes the Company’s expected forfeiture rate. That cost is expected to be recognized over a weighted average period of approximately 2.6 years. The Company utilizes newly issued shares to satisfy the exercise of stock options.

Upon issuance of the awards, the grant date fair value for the Retention Plan was approximately $3.7 million. The fair value (based on the December 31, 2006 valuation) of the Retention Plan awards outstanding at December 31, 2006 was approximately $1.8 million. The combined fair value of the Retention Plan awards that were cancelled during the year ended December 31, 2006 was approximately $591,000 (based on the December 31, 2006 valuation). The aggregate intrinsic value of the awards outstanding at December 31, 2006, all of which are not vested, is $0 because the 30-day average closing stock price preceding December 31, 2006 did not exceed the trigger price of $32.99. The aggregate intrinsic value of the awards expected to vest at December 31, 2006 is $0. The weighted average remaining contractual term for both the awards outstanding and the awards that are vested and expected to vest at December 31, 2006 is approximately 1.5 years.

 

F-34

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IMCLONE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The Company recognized for the year ended December 31, 2006 approximately $557,000 in share-based compensation expense, net of amounts capitalized, for the Retention Plan. As of December 31, 2006, there was approximately $910,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Retention Plan. This amount assumes the Company’s expected forfeiture rate. The costs associated with the awards are expected to be recognized over the Performance Periods.

During the year ended December 31, 2006, the Company granted  29,749 shares for the ESPP for a total of 213,144 shares that have been issued under the plan and recognized approximately $122,000 in share-based compensation expense, net of amounts capitalized. The Company utilizes newly issued shares to satisfy the issuance of shares under the ESPP.

Comparable Disclosures

The following table illustrates the effect on net income and net income per share for the years ended December 31, 2005 and 2004, if the compensation cost for the Company’s stock option grants had been determined based on the fair value at the grant dates for awards consistent with the fair value method of Statement of Financial Accounting Standards No. 123 “Accounting for Stock-Based Compensation (“SFAS 123”). The stock-based employee compensation expense determined under the fair value based method was calculated using the graded vesting attribution approach.

		Year Ended December 31,
		2005			2004
		(in thousands, except per share amounts)
Net income, as reported		$	86,496		$	113,653
Add: Stock-based employee compensation expense included in net income, tax effected		—			1,759
Deduct: Total stock-based employee compensation expense determined under fair value based method, tax effected		(89,365		)	(46,283		)
Pro forma net (loss) income		$	(2,869	)	$	69,129
Net (loss) income per common share:
Basic, as reported		$	1.03		$	1.43
Basic, pro forma		$	(0.03	)	$	0.87
Diluted, as reported		$	1.01		$	1.33
Diluted, pro forma		$	(0.03	)	$	0.85

 

For the years ended 2005 and 2004 there were 19,552,000, and 3,487,000, respectively, of potential common shares excluded from the pro forma diluted income per share computation because their inclusion would have had an anti-dilutive effect. The potential common shares excluded from the computation consist of anti-dilutive stock options for all periods and shares related to the 13¤8% convertible notes and 51¤2% convertible notes for the year ended December 31, 2005. The pro forma effect on the net income (loss) for the years ended December 31, 2005 and 2004 is not necessarily indicative of the effect on future years’ operating results. Pro-forma stock-based compensation expense in 2005 includes expenses associated with the accelerated vesting of options in the fourth quarter of 2005.

F-35

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IMCLONE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(12) Income Taxes

The (benefit) provision for income taxes includes the following: (in thousands)

		Year Ended December 31,
		2006			2005			2004
Current:
Federal		$	78,993		$	861		$	5,947
State and local		24,401			717			11,414
Total provision for income taxes		103,394			1,578			17,361
Deferred:
Federal		(130,846		)	—			—
State and local		(22,902		)	—			—
Total benefit for income taxes		(153,748		)	—			—
(Benefit) provision for income taxes		$	(50,354	)	$	1,578		$	17,361

 

The Company recorded as increases to additional paid-in capital approximately $93.9 million, $1.7 million and $10.0 million of tax benefit from the exercise of stock options for the years ended December 31, 2006, 2005 and 2004, respectively. As a result of legislation in New Jersey passed in 2002 an Alternative Minimum Assessment (AMA) tax is computed and may be applicable. This AMA tax impacted the Company’s tax provision for the year ended December 31, 2005.

Reconciliations between the total tax provision and the tax provision based on the federal statutory rate are presented below: (in thousands)

		Year Ended December 31,
		2006			2005			2004
Pre-tax income		$	320,320		$	88,074		$	131,014
Tax provision at federal statutory rate of 35%		112,112			30,826			45,855
State and local income taxes (net of federal benefit)		5,159			338			8,005
Change in valuation allowance		(161,095		)	(28,418		)	(33,023		)
Research and development credits		(5,989		)	(4,331		)	(3,585		)
Non-deductible expenses		(541		)	3,163			109
(Benefit) provision for income taxes		$	(50,354	)	$	1,578		$	17,361

 

F-36

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IMCLONE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The tax effects of temporary differences that give rise to significant portions of the gross deferred tax assets and gross deferred tax liabilities are presented below: (in thousands)

		December 31,
		2006			2005
Gross deferred tax assets:
Research and development credit carryforwards and other credits		$	73,619		$	77,012
Compensation relating to the issuance of stock options and warrants		3,413			894
Net operating loss carryforwards		49,614			173,096
Deferred revenue		156,118			142,135
Withholding tax liability		—			9,422
Capital loss carryforward		3,909			3,761
Other		12,218			10,470
Total gross deferred tax assets		298,891			416,790
Less valuation allowance		(133,589		)	(415,510		)
Net deferred tax assets		165,302			1,280
Gross deferred tax liabilities:
Other		3,538			1,280
State taxes		8,016			—
Net deferred tax asset		$	153,748		$	—

 

In 2006, the Company released a portion of its valuation allowance against our total deferred tax assets. This partial release was based on revised expectations of projected book and taxable income, which caused the Company to conclude that it is more likely than not that a portion of the benefit of these deferred tax assets would be realized. This release resulted in a net tax benefit of approximately $111.3 million. The financial projections supporting our conclusion to release a portion of our valuation allowance contain significant assumptions based on current facts about our market share and our competitive landscape. If such assumptions were to differ significantly, it may have a material impact on our ability to realize our deferred tax assets. The Company will continue to monitor its current performance and future financial projections, including market share and competitive landscape, in order to determine the effect on the valuation allowance.

The net change in the total valuation allowance for the years ended December 31, 2006, 2005 and 2004 were decreases of approximately $281.9 million, $14.6 million and $2.7 million, respectively. Approximately $120.7 million of the total valuation allowance pertains to tax deductions relating to stock option exercises for which any subsequently recognized tax benefit will be recorded as an increase to additional paid-in capital.

At December 31, 2006, the Company had net operating loss carryforwards for federal and certain state income tax purposes of approximately $124.0 million, which expire at various dates from 2010 through 2025. At December 31, 2006, the Company had research credit carryforwards for federal and New Jersey state purposes of $49.6 million and $14.5 million, respectively, and federal alternative minimum tax credits of $9.4 million. The federal and state research credits expire at various dates from 2007 through 2026. The American Jobs Creation Act of 2004 provides for a tax deduction up to 9% (when fully phased in) of qualified production activities income. This deduction does not yet provide any material benefit to the Company.

 

F-37

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IMCLONE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(13) Discontinuation of Small Molecule Program

On May 11, 2005, the Company announced a plan to discontinue its small molecule research program. This decision was made after evaluating the Company’s investment in such program against the time horizon before commercial benefits would be realized. As a result of this decision, the Company reflected $6.2 million of costs associated with the discontinuation of this program in the Consolidated Statements of Operations for the year ended December 31, 2005. Such costs included approximately $2.2 million of costs related to severance for 45 employees that were terminated, approximately $3.7 million of costs related to the write-off of fixed assets used in such program (shown net of $227,000 from the subsequent sale of equipment that was previously written off as part of this discontinuance), approximately $60,000 of contract termination costs related to the cancellation of the lease at the Brooklyn facility where the employees were conducting such research and approximately $282,000 of other shutdown expenses. The Company had no additional other shutdown expenses and paid the remaining  amount of $12,000 that was accrued at December 31, 2005 during the year ended December 31, 2006 to complete the disposition of this program.

(14) Contingencies

In January 2002, a number of complaints asserting claims under the federal securities laws against the Company and certain of the Company’s directors and officers were filed in the U.S. District Court for the Southern District of New York. Those actions were consolidated under the caption Irvine v. ImClone Systems Incorporated, et al., No. 02 Civ. 0109 (RO). In the corrected consolidated amended complaint, plaintiffs asserted claims against the Company, its former President and Chief Executive Officer, Dr. Samuel D. Waksal, its former Chief Scientific Officer and then-President and Chief Executive Officer, Dr. Harlan W. Waksal, and several of the Company’s other present or former officers and directors, for securities fraud under sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5, on behalf of a purported class of persons who purchased the Company’s publicly traded securities between March 27, 2001 and January 25, 2002. The complaint also asserted claims against Dr. Samuel D. Waksal under section 20A of the Exchange Act on behalf of a separate purported sub-class of purchasers of the Company’s securities between December 27, 2001 and December 28, 2001. The complaint sought to proceed on behalf of the alleged classes described above, sought monetary damages in an unspecified amount and sought recovery of plaintiffs’ costs and attorneys’ fees. On January 24, 2005, the Company announced that it had reached an agreement in principle to settle the consolidated class action for a cash payment of $75.0 million, a portion of which would be paid by the Company’s insurers. Therefore, the Company recorded in its Consolidated Balance Sheet as of December 31, 2004, as Litigation settlement, a liability of  approximately $75.9 million and a receivable from our insurers of approximately $20.5 million, included in Other assets. Net expense of approximately $55.4 million was recorded in the fourth quarter of 2004 and reflected in the Consolidated Statement of Operations as Litigation settlement. The parties signed a definitive stipulation of settlement and as provided for under the stipulation of settlement, on March 11, 2005, the Company paid $50.0 million into an escrow account, subject to Court approval of the proposed settlement. On July 29, 2005 the Court approved the proposed settlement and on August 5, 2005, the Company paid the remaining $25.0 million into the escrow account, with such funds to be held in and distributed pursuant to the terms of the settlement. The Company has collected from its insurers all of the outstanding receivable amounting to $20.5 million. The amount received from the insurers includes $8.75 million, less attorneys fees of $875,000, that was paid to the Company under the derivative settlement discussed below.

 

F-38

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IMCLONE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

On January 13, 2002, and continuing thereafter, nine separate purported shareholder derivative actions were filed against members of the Company’s board of directors, certain of the Company’s present and former officers, and the Company, as nominal defendant, advancing claims based on allegations similar to the allegations in the federal securities class action complaints. Four of these derivative cases were filed in the Delaware Court of Chancery and have been consolidated in that court under the caption In re ImClone Systems Incorporated Derivative Litigation, Cons. C.A. No. 19341-NC. Three of these derivative actions were filed in New York State Supreme Court in Manhattan. All of these state court actions have been stayed in deference to the proceedings in the U.S. District Court for the Southern District of New York, which have been consolidated under the caption In re ImClone Systems, Inc. Shareholder Derivative Litigation, Master File No. 02 CV 163 (RO). A supplemental verified consolidated amended derivative complaint in these consolidated federal actions was filed on August 8, 2003. It asserted, purportedly on behalf of the Company, claims including breach of fiduciary duty by certain current and former members of the Company’s board of directors, among others, based on allegations  including that they failed to ensure that the Company’s disclosures relating to the regulatory and marketing prospects for ERBITUX were not misleading and that they failed to maintain adequate controls and to exercise due care with regard to the Company’s ERBITUX application to the FDA. On January 24, 2005, the Company announced that it had reached an agreement in principle to settle the consolidated derivative action. The parties entered into a definitive stipulation of settlement on March 14, 2005, which was approved by the Court on July 29, 2005. In August 2005, the Company received $8.75 million from its insurers, which was contributed toward the settlement of the Irvine securities class action described above, after deducting $875,000 for Court awarded plaintiffs’ attorney’s fees and expenses. Following Court approval of the settlement of the consolidated derivative action, all of the state court derivative actions that had been pending in Delaware and New York were dismissed with prejudice, with no further payment required by the Company.

On August 14, 2002, after the federal grand jury indictment of Dr. Samuel D. Waksal had been issued but before Dr. Samuel D. Waksal’s guilty plea to certain counts of that indictment, the Company filed an action in New York State Supreme Court seeking recovery of certain compensation, including advancement of certain defense costs, that the Company had paid to or on behalf of Dr. Samuel D. Waksal and cancellation of certain stock options. That action was styled ImClone Systems Incorporated v. Samuel D. Waksal, Index No. 02/602996. On July 25, 2003, Dr. Samuel D. Waksal filed a Motion to Compel Arbitration seeking to have all claims in connection with the Company’s action against him resolved in arbitration. By order dated September 19, 2003, the Court granted Dr. Samuel D. Waksal’s motion and the action was stayed pending arbitration. On September 25, 2003, Dr. Samuel D. Waksal submitted a Demand for Arbitration with the American Arbitration Association (the “AAA”), by which Dr. Samuel D. Waksal asserted claims to enforce the terms of his separation agreement, including provisions relating to advancement of legal fees, expenses, interest and indemnification, for which Dr. Samuel D. Waksal claimed unspecified damages of at least $10.0 million. On March 10, 2004, the Company commenced a second action against Dr. Samuel D. Waksal in the New York State Supreme Court. That action was styled ImClone Systems Incorporated v. Samuel D. Waksal, Index No. 04/600643. Specifically, by this action, the Company sought to recover: (a) $4.5 million that the Company paid to the State of New York in respect of exercises of non-qualified stock options and certain warrants in 2000; (b) at least $16.6 million that the Company paid to Samuel D. Waksal in the form of ImClone common stock, in lieu of withholding federal income taxes from exercises of non-qualified stock options and certain warrants in 2000; and (c)  approximately $1.1 million that the Company paid in the form of ImClone common stock to Samuel D. Waksal and his beneficiaries, in lieu of withholding federal, state and local

 

F-39

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IMCLONE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

income taxes from certain warrant exercises in 1999-2001. The complaint asserted claims for unjust enrichment, common law indemnification, moneys had and received and constructive trust. On June 18, 2004, Dr. Samuel D. Waksal filed an Answer to the Company’s Complaint.

On December 21, 2005, the Company and Dr. Samuel D. Waksal entered into a settlement agreement with respect to the foregoing actions, providing for, among other things, judgments in both actions in the Company’s favor. The settlement agreement included the payment of director and officer legal fee expense indemnification by the Company, for which the Company paid approximately $2.0 million in the fourth quarter of 2005. The settlement agreement also provided for the return to the Company of 416,667 of stock options that were previously issued to Dr. Samuel D. Waksal. Such options were returned to the Company and were cancelled as of December 31, 2005.

On October 28, 2003, a complaint was filed by Yeda Research and Development Company Ltd. (“Yeda”) against ImClone Systems and Aventis Pharmaceuticals, Inc. in the U.S. District Court for the Southern District of New York (03 CV 8484). This action did not seek damages, but rather alleged that three individuals associated with Yeda should also be named as co-inventors on U.S. Patent No. 6,217,866, which relates to the therapeutic use of EGFR antibodies (such as ERBITUX, the Company’s EGFR antibody product) in combination with chemotherapy. The Company has exclusively licensed this patent from Rhone-Poulenc Rorer Pharmaceuticals, now known as Sanofi-Aventis. On June 7, 2005, Yeda amended its U.S. complaint to seek sole inventorship of the subject patent. On November 4, 2005, the Court denied the Company’s motion for summary judgment with respect to this matter, as filed with the Court on June 24, 2005. At the same time, the Court granted summary judgment to Yeda dismissing two of ImClone’s affirmative defenses. A bench trial on the merits of Yeda’s complaint was held between June 5, 2006 and July 19, 2006. On September 18, 2006, the Court ruled in favor of Yeda by awarding it sole inventorship rights to the patent. ImClone Systems then appealed the Court’s decision to the Court of Appeals for the Federal Circuit. The appeal was docketed on October 5, 2006 (as No. 2007-1012), and is in its early stages. The Company, having had the advice of its patent counsel, believes the positions raised on appeal are sound, and it plans to vigorously pursue this appeal.

On September 20, 2006, subsequent to the Court’s inventorship decision, the Company also filed an action (06 CV 7190) against Yeda in the U.S. District Court for the Southern District of New York seeking a declaratory judgment that the patent is invalid due to the removal of the originally named inventors. On October 31, 2006, Yeda filed an answer and counterclaim to the Company’s declaratory judgment complaint in which Yeda alleges the Company is liable to Yeda for willful patent infringement, unjust enrichment and conversion, and seeks damages from the Company and an order requiring the Company to license the patent and pay Yeda royalties until the patent expires. The declaratory judgment action is in its early stages. The Company,  having had the advice of its patent counsel, believes that the claims asserted in the declaratory judgment action are sound, and that Yeda’s counterclaims are not sound, and it plans to vigorously pursue this action. The Company is unable to predict the outcome of these actions at this time. If the Company’s appeal is unsuccessful and Yeda’s sole inventorship rights to the patent are upheld and the Company is unsuccessful with respect to its declaratory judgment action, the Company may become obligated to pay Yeda a royalty and may be liable to Yeda for other damages.

 

F-40

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IMCLONE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

On March 25, 2004, an action was filed in the United Kingdom Patent Office entitled Referrer’s Statement requesting transfer of co-ownership and amendment of patent EP (UK) 0 667 165 to add three Yeda employees as inventors. Also on March 25, 2004, a German action entitled Legal Action was filed in the Munich District Court I, Patent Litigation Division, in which Yeda sought a 75% ownership interest in patent EP (DE) 0 667 165 based on its allegation that the inventorship on that patent was incorrect. The Company was not named as a party in these actions which relate to the European equivalent of U.S. Patent No. 6,217,866 discussed above. Accordingly, the Company has intervened in the U.K. and German actions. Yeda sought to amend its pleadings in the United Kingdom and Germany to seek sole inventorship and sole ownership. Following hearings, both the U.K. and German courts held that Yeda was not entitled to amend its pleadings. In the U.K., Yeda sought leave from the House of Lords to appeal the High Court’s decision, and such leave was granted in November 2006. In Germany, Yeda has appealed the lower court’s decision to the Higher Regional Court of Munich. Additionally, on or about March 25, 2005 and March 29, 2005, respectively, Yeda filed legal actions in Austria and France against both Aventis and ImClone Systems seeking full inventorship of EP (AU) 0 667 165 and EP (FR) 0 667 165, as well as payment of legal costs and fees. The Company, having had the advice of its patent counsel, believes there are sound defenses to these actions, and it presently plans to vigorously defend against the claims asserted. The Company is unable to predict the outcome of these actions at this time. In addition, in December 2002, Opposition Proceedings seeking to revoke the European patent discussed above were brought by the Scripps Research Institute, Amgen Inc., Abgenix, Inc., and YM Biosciences Inc. An Opposition Proceeding is an administrative process, the outcome of which may be that the European patent will be revoked. The Company has vigorously defended its position in this matter, which is suspended pending a final determination of the Yeda matter discussed above.

On May 4, 2004, a complaint was filed against the Company by Massachusetts Institute of Technology (“MIT”) and Repligen Corporation (“Repligen”) in the U.S. District Court for the District of Massachusetts (04-10884 RGS). This action alleges that ERBITUX infringes U.S. Patent No. 4,663,281, which is owned by MIT and exclusively licensed to Repligen and that the Company should therefore pay damages. On July 28, 2006, the Court denied the Company’s motion for summary judgment seeking to dismiss all claims on the basis that the patent rights at issue were exhausted as a matter of law and granted MIT and Repligen’s cross motion that their patent rights were not exhausted. On September 26, 2006, a hearing was held in response to a Motion for Sanctions filed by Repligen, which alleged that the Company’s counsel, Kenyon & Kenyon, and the Company acted improperly during and after the deposition of one of Repligen’s potential witnesses. Repligen seeks evidentiary sanctions which may limit the Company’s proofs on non-infringement issues, and the Court has raised the possibility that Kenyon & Kenyon may be disqualified from further representation of the Company in the case. The Company and Kenyon & Kenyon deny any improper conduct. The Court has not ruled on the motion, and it is not possible to predict what impact, if any, this collateral matter may have in the case. Upon a ruling by the Court, the case will proceed to trial on the merits of the Company’s other defenses. The Company, having had the advice of its patent counsel, believes that its defenses are sound, and it presently plans to vigorously defend against the claims asserted.

On February 5, 2007, a complaint was filed against the Company by Abbott Laboratories (“Abbott”) in the U.S. District Court for the District of Massachusetts (07-cv-10216). This action alleges that the manufacture and sale of ERBITUX infringes U.S. Patent No, 5,665,578, which is owned by Abbott and that the Company should therefore pay damages. As of this time, the Company has not yet filed an answer to this complaint. The Company plans to vigorously defend against any claims asserted in this action. The Company is unable to predict the outcome of this action at the present time.

 

F-41

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IMCLONE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

No reserve has been established in the financial statements for any of the intellectual property-related legal proceedings described above because the Company does not believe that such a reserve is required to be established at this time under Statement of Financial Accounting Standards No. 5. However, if in a future period, events in any such legal proceedings render it probable that a loss will be incurred and if such loss is reasonably estimable at that time, the Company will establish such a reserve. Thus, it is possible that legal proceedings and settlements arising therefrom, if any, may have a material adverse impact on operating results for that period, on our balance sheet or both.

The Company is developing a fully-human monoclonal antibody, referred to as IMC-11F8. The Company believes it has the right to do so under its existing development and license agreement with Merck KGaA. However, Merck KGaA had advised the Company that it believed that IMC-11F8 was covered under the development and license agreement with Merck KGaA and that it could therefore have the exclusive rights to market IMC-11F8 outside the United States and Canada and co-exclusive development rights in Japan, for which it would pay the same royalty as it pays for ERBITUX  (see Note 10- Corporate Collaborations—Collaborations with Merck KGaA). In agreement with Merck KGaA, the Company submitted this dispute to binding arbitration through an expedited process outside of the provisions of the development and license agreement. Merck KGaA subsequently took the position that the expedited arbitration provision was no longer valid and the Company sued Merck KGaA in federal court in the Southern District of New York to either enforce the arbitration provision previously agreed to or to have the court decide the question of whether IMC-11F8 is or is not covered under the development and license agreement with Merck KGaA. On November 29, 2005, the Court granted the Company’s motion to enforce the expedited arbitration provision previously agreed to, and subsequently appointed a new arbitrator to hear and decide this dispute. On March 31, 2006, the arbitrator decided the matter in favor of the Company, finding that Merck KGaA had no rights to IMC-11F8. That decision is binding and unappealable pursuant to the parties’ arbitration agreement and the parties have subsequently confirmed the arbitration award.

(15) Commitments

Leases

The Company leases office, operating and laboratory space under various operating lease agreements. The effects of scheduled and specified rent increases or any “rent holidays” are recognized on a straight-line basis over the lease term. Rent expense was approximately $5.7 million, $5.6 million and $4.0 million for the years ended December 31, 2006, 2005 and 2004, respectively.

In October 2001, the Company entered into a sublease (the “Sublease”) for a four-story building at 325 Spring Street, New York, New York, which includes approximately 100,000 square feet of usable space. The Sublease has a term of 22 years, followed by two five-year renewal option periods. In order to induce the sublandlord to enter into the Sublease, the Company made a loan to the sublandlord in the principal amount of a $10.0 million note receivable, of which approximately $8.4 million is outstanding as of December 31, 2006. The loan is secured by a leasehold mortgage on the prime lease as well as a collateral assignment of rents by the sublandlord. The loan is payable by the sublandlord over 20 years and bears interest at 51¤2 % in years one through five, 61¤2% in years six through ten, 71¤2 % in years eleven through fifteen and 81¤2 % in years sixteen through twenty. In addition, the Company paid the owner a consent fee in the amount of $500,000. Effective March 1, 2005, the Company amended the Sublease to add an additional 6,500 square feet of space upon all the same terms and conditions set forth in the Sublease. In connection with this amendment, the Company paid an up-front fee of approximately $1.7

 

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IMCLONE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

million which is being amortized, as a reduction in lease expense, over the respective term of the Sublease. The future minimum lease payments remaining at December 31, 2006, are approximately $46.5 million.

The Company leases its research and corporate headquarters in New York City. In August 2004, the Company modified its existing operating lease for its corporate headquarters in New York City. The modification extends the term of the lease, which was to expire at December 31, 2004, for an additional ten years for a portion of the premises and by an additional three years with renewal rights for the space that houses its research department. The future minimum lease payments remaining at December 31, 2006, are approximately $8.4 million.

In June 2004, the Company entered into an operating lease for a building located at 59-61 ImClone Drive in Branchburg, New Jersey. The building contains 54,247 square feet of floor area. The lease expires on December 31, 2022 with no option to renew or extend beyond such date. The future minimum lease payments at December 31, 2006, are approximately $9.8 million.

In August 2005, the Company entered into an operating lease for a portion of a building located at 41A ImClone Drive in Branchburg, New Jersey. The Company is leasing 10,704 square feet of floor area. The lease expires on August 31, 2010, with two options to renew for five additional years each. The future minimum lease payments at December 31, 2006, are $412,000.

Future minimum lease payments under all of the Company’s operating leases are as follows: (in thousands)

Year ending December 31,
2007				$	5,411
2008				4,253
2009				4,281
2010				4,174
2011				4,050
2012 and thereafter				43,964
				$	66,133

 

Employment Agreements

On March 19, 2004, the Company entered into an employment agreement with Daniel S. Lynch in regards to his employment as Chief Executive Officer. In connection with Mr. Lynch’s resignation effective November 10, 2005 by mutual agreement with the Company’s Board of Directors, such resignation was treated as a termination by the Company without cause under Mr. Lynch’s employment agreement. As a result, the Company has recorded severance benefit expense due Mr. Lynch of approximately $2.9 million in Marketing, general and administrative expenses in the fourth quarter of 2005. Payment of this severance was made in 2006.

Supported Research

The Company has entered into various research and license agreements with certain academic institutions and others to supplement the Company’s research activities and to obtain rights to certain technologies. The agreements generally require the Company to fund the research, to pay milestones upon the achievement of defined events, such as the submission or approval of regulatory filings and to pay royalties based upon percentages of revenues, if any, on sales of products developed from technology arising under these agreements.

 

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IMCLONE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Contract Services

On March 17, 2005, the Company entered into a five year multi-product supply agreement with Lonza Biologics PLC (“Lonza”) for the manufacture of biological material at the 5,000 liter scale. The Company has discretion over which products to manufacture, which may include later-stage clinical production of the Company’s antibodies currently in Phase I clinical testing and those nearing Phase I testing. The value of producing all batches under the Agreement is $68.0 million, unless terminated earlier. The Agreement provides that the Company can cancel any batches at any time; however, depending on how much notice the Company provides Lonza, the Company could incur a cancellation fee that varies based on timing of the cancellation. This cancellation fee is only applicable if Lonza does not resell the slots reserved for the cancelled batches.

License Agreements

The Company has an exclusive license from the University of California to an issued United States patent for the murine form of ERBITUX, the Company’s EGFR antibody product. The Company has exclusively licensed from Rhone-Poulenc Rorer Pharmaceuticals, now known as Aventis, patent applications seeking to cover the therapeutic use of antibodies to the EGFR in conjunction with anti-neoplastic agents. The agreements with the University of California and Aventis require the Company to pay royalties on sales of ERBITUX that are covered by these licenses. The Company has license agreements with Genentech, Inc. (“Genentech”) for rights to patents covering certain use of epidermal growth factor receptor antibodies and with both Genentech and Centocor, Inc. (“Centocor”) for rights to patents covering various aspects of antibody technology. These agreements with both Genentech and Centocor require us to pay royalties on the sale of ERBITUX that are covered by these licenses. The Company is obligated to pay royalties of approximately 9.25% of North American net sales and a single-digit royalty on sales outside of North America, which will increase if sales outside of North America consist of ERBITUX produced in the United States. In 2006, the Company received reimbursements from its corporate partners of 4.5% on North American net sales and a single-digit percentage on net sales  outside of North America. Effective January 1, 2007, the reimbursement from our corporate partners will decrease to 2.5% on North American net sales.

(16) Employee Benefit Plans

Defined Contribution Plan

All employees of the Company who meet certain minimum age and period of service requirements are eligible to participate in a 401(k) defined contribution plan. The 401(k) plan allows eligible employees to defer up to 25 percent of their annual compensation, subject to certain limitations imposed by federal law. The amounts contributed by employees are immediately vested and non-forfeitable. Under the 401(k) plan, the Company, at management’s discretion, may match employee contributions and/or make discretionary contributions. Neither the employee contributions nor voluntary matching contributions are invested in the Company’s securities. Total expense incurred by the Company was approximately $2.2 million, $1.9 million and $580,000 for the years ended December 31, 2006, 2005 and 2004, respectively.

Change in Control Plan

During 2004, the Board of Directors of the Company adopted a Change in Control Plan to maintain the focus of certain key employees of the Company on the business, mitigate the distractions that could be caused if the Company were to become the target of an acquisition strategy, and provide certain benefits to the covered employees if a change in control of the Company (as such term is defined in the plan) occurs

 

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IMCLONE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

and/or the employee’s employment is terminated in connection with such change in control. Participants in the Change in Control Plan are determined by the Compensation Committee.

In the event of a change in control, all equity-based compensation awards held by the plan participants will vest in full (unless the Compensation Committee determines that the participants’ awards will be substituted for equity awards in the surviving entity of equivalent economic value) and any deferred compensation of participants will become nonforfeitable. In addition, if a participant in the Change in Control Plan is terminated in connection with a change in control by the Company without cause or by the participant for good reason (as such terms are defined in the plan), the Company will pay to the participant a cash payment equal to the participant’s earned but unpaid base salary and bonus, unreimbursed expenses, any other accrued obligations, a pro rata bonus based on target bonus for the year of termination, and a multiple of base salary and bonus (with the multiplier ranging from 0.5 to three based on the tier assigned to the participant under the plan).

In connection with a termination described in the preceding sentence, if the participant signs a waiver and release of claims against the Company, each participant will vest in full in all long-term incentive arrangements he or she has with the Company and be entitled to continued health coverage for six to 18 months (based on the participant’s plan tier) and outplacement services for six months. These benefits are reduced by any other severance amounts for which the participants are eligible under any other arrangement of the Company or its subsidiary. As a condition to receipt of these benefits, each participant agrees to be bound by noncompetition, nonsolicitation, confidentiality, return of Company property, and cooperation covenants contained in the plan. If a plan participant becomes subject to the change-in-control golden parachute excise tax under Section 4999 of the Internal Revenue Code and the aggregate parachute payment exceeds the safe harbor amount by ten percent or more, the plan provides that the Company shall pay to the participant a tax gross-up payment such that after payment by the participant of all federal, state and local excise, income, employment, Medicare and other taxes resulting from the payment of the parachute payments and the tax gross-up payments, the participant retains an after-tax amount equal to the amount that he or she would have retained in the absence of the parachute excise tax.

Severance Plans

The Compensation Committee of the Board of Directors approved on February 10, 2005, a Senior Executive Severance Plan (the “Plan”) to enhance the predictability of treatment for executives at the level of Vice President, Senior Vice President and Executive Vice President whose employment with the Company is terminated by the Company without cause (as such concept is explained in the Plan).

As a condition to receipt of benefits under the Plan, a participating employee must sign an agreement and general release in a form acceptable to the Plan administrator under which the participant agrees to certain confidentiality and non-solicitation provisions for a period of one year following his or her employment termination date, agrees to certain non-competition provisions for the duration of the employee’s receipt of severance pay, and releases and discharges the Company and related entities (as well as any third party for whom the employee provides services on the Company’s behalf) from any and all claims and liabilities relating to the employee’s employment with the Company or the termination of the employee’s employment. Receipt of benefits under the Plan is also contingent upon the employee’s continued employment through the employment termination date designated by the Company. The severance amounts payable to an employee under the Plan will be reduced, dollar-for-dollar, by the amount of any other termination payments paid or payable to the employee under any other plan, program or law (excluding any right to exercise stock options, any unemployment benefits payable in accordance with state law and payment for accrued but unused vacation).

 

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IMCLONE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The Senior Vice Presidents and Executive Vice Presidents who participate in the Plan and sign the above-described agreement and release upon their termination without cause are entitled to receive an amount equal to one year’s base salary as severance and, if the employee would otherwise be eligible to elect employee-paid continued coverage under COBRA, Company-provided health insurance coverage for one year following a termination without Cause, subject to cessation upon the employee’s becoming eligible for similar coverage offered by another employer. Senior Vice Presidents and Executive Vice Presidents would also be entitled continue their non-voluntary life insurance coverage provided by the Company with the premiums paid by the Company for 12 months after a termination without cause, subject to cessation when the employee becomes eligible for coverage under a life insurance plan or policy of another employer. Vice Presidents who meet the above criteria are entitled to the greater of six months base salary or two weeks base salary for each year of service with the Company, as well as six months Company-paid health and life insurance coverage, subject to the conditions described above.

On February 16, 2006, the Compensation Committee of the Board of Directors adopted a transition severance plan for certain employees of the Company whereby each such employee is eligible to receive a severance payment from the Company (varying between six and twelve months of the employee’s base salary) upon any involuntary termination of his or her employment by the Company without cause and, following any change in control of the Company, upon his or her voluntary termination of employment for good reason. The severance plan’s duration is 18 months.

Annual Incentive Plan

In September 2003, the shareholders approved and the Company adopted the Annual Incentive Plan. The plan permits the Compensation Committee to grant performance awards based upon pre-established performance goals to executives of the Company and its subsidiaries selected by the Compensation Committee, whether or not such executives, at the time of grant, are subject to the limit on deductible compensation under Section 162(m) of the Internal Revenue Code. The Annual Incentive Plan became effective as of January 1, 2003.

(17) Supplemental Cash Flow Information and Non-cash Investing and Financing Activities:

(in thousands)

		Year Ended December 31,
		2006			2005			2004
Cash paid for:
Interest, net of amounts capitalized of $2,640, $5,394 and $6,087 for the years ended December 31, 2006, 2005 and 2004, respectively		$	5,610		$	2,856		$	8,729
Income taxes		5,358			1,400			6,167
Non-cash investing and financing activities:
Change in net unrealized gain (loss) in securities available-for-sale		4,078			(8,345		)	(987		)
Options exercised and exchanged for mature shares of common stock		—			—			200
Common stock issued from conversion of 51¤2% subordinated convertible notes		—			—			239,997
Reclassification of unamortized deferred financing costs on the 51¤2% subordinated convertible notes to stockholders’ equity		—			—			1,193

 

 

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IMCLONE SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(18) Fair Value of Financial Instruments

The carrying amounts of cash and cash equivalents, receivables from corporate partners, accounts payable, and other current liabilities at December 31, 2006 and 2005 approximate fair value because maturities are less than one year in duration. The fair value of the 13¤8% convertible senior notes of $600.0 million was approximately $545.6 million and $502.5 million at December 31, 2006 and 2005, respectively, based on their quoted market price. See Note 3 for the fair value disclosures of securities available for sale.

(19) Quarterly Financial Data (Unaudited)

The tables below summarize the Company’s unaudited quarterly operating results for 2006 and 2005 (in thousands, except per share data):  

		Three months ended
		March 31, 2006			June 30, 2006			September 30, 2006					December 31, 2006
Revenues		$	245,131		$	149,856			$	150,697				$	132,163
Net income		$	229,591		$	37,209			$	57,316				$	46,558
Basic net income per share allocable to common stockholders		$	2.75		$	0.44			$	0.68				$	0.55
Diluted net income per share allocable to common stockholders		$	2.51		$	0.42			$	0.65				$	0.53

 

		Three months ended
		March 31, 2005					June 30, 2005			September 30, 2005					December 31, 2005
Revenues			$	85,771			$	92,385			$	106,525				$	98,992
Net income			$	28,820			$	26,031			$	30,951				$	694
Basic net income per share allocable to common stockholders			$	0.35			$	0.31			$	0.37				$	0.01
Diluted net income per share allocable to common stockholders			$	0.33			$	0.30			$	0.35				$	0.01

 

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