Research Partnerships G_~y~,~:lrish' Drug Maker Rqsy~ipancial\ Glow!' "'" s~ ~f)\.JtJ(, ~ .. Elan Set;Up Joint Ventures,.'J..' ..Sold Them Li'cens~,Got .;Qui~k Dose of Revenue Perfectly Legitimate, It Says '.." ,c. , .~~~'i-.'._C ." -, " :"."':'1! By JESSE EISINGER Staff Reporter of THE WALL STREET JOURNAL DUBJ:JN -Some pharmaceutical compa-nies ar.e known for their research excel- lence, others for their marketing prowess.Ireland'&Elan Corp., the world's 20th-larg- est drug company,with a market value of about $12 billion, stands out for its account- ing. " :fii;"onecase," ii]olntventiire with a small North Carolina biotech firm de- signed 'to- find a treatment.for ulcerative ~olitis, Elan booked revenue even though , no cash appears to have changed han~s when -theventUre was set up. In another joint venture, with a Canadian biotech"firnl"tl1e... pai1Iiers hadn 'tdecided what researchthe venture would pursue before , it paid all of its ..funds to "Elan for a license. ;.."~;~ . ,. 'j AmongElan ventures'other quirks: Af- ter bu~g a license from Elan, the ven- tmes .t~icallY have no moneyleft to pur- sue research on new drugs. Elan some-' " . ..tiniesmakes.them a loan. Then they con- tract out the researchwork, often partly to ., yC "' Elan itself; again producing revenue for~~~an. c~!:i~~;":;,,,,'::;'i.',(:-~:c:: ":1::;"", ,):~,;~atelY1:~e ~ comp~yhasbeen sell- mg off ~~aller product .lines,. It ba<1ks ,the ;; 'proceeds as "product revenue," although some accountants say they shoUldbe de- scribed as one-time gains,undergenerally accepted ac~\ffitfug principles.~J.",i,: , ..,-, ","-' Short-Sellers ":, ' , '" c C C c' j~;;Questions about Elan's accounting , have dogged the company for years~ Short- sellers, who benefit when a stock goes down,bave often criticized it. Mr. Turner, now head of the Center for Quality Finan- cial Reporting at Colorado State Univer- ,sity, SaysElan is "too fast for the regula- tors and too fast for their own gOOd. They appear to have gotten around the account- ing rule~,and,around the system." The SEC wrote toEIan in 1999 ~xpressing con- cerns about -8pme accounting maneuvers the companxwas using at that time. Elan restate~'orie'year~searnings a few months ...after, J"oceiving the 1999 letter. and it now .., ~lj.ysthea:ccounting issue has beenlaid to rest..",,:,:~[:: ..' : ..Somemvestmeni professionaJs seem to agree;'The matter "is clearly histori- cal,.. and doesn'tplaya significant part in the 'buSiness currently," says John Mur'" Phy, aqpldmanSachs pharmaceutical an- alyst:GoIdman has the stock on its rec- ommended list, its highest rating. Ana- lysts at Merrill Lynch & Co. and 10 other brokerage firms also recommend the stock, according to Thomson Finan- -cialjFirst,Call. ~ Elan's American depositary shares'- trade on the New York Stock Exchange, requiring it to showits results under U.S. . accounting rules. Annual revenue..jumped i to $1.5 billion,in 2000 from $323 million in I 1996. What Elan calls ea~ngs per share before other charges rose to $1.46 in 2000 .1 from 48c~nts in 1996. Analyst~ estimate ! the 2001 figure at $1.92 and peg Elan's 2001 revenue at $1.9 billion. Elan expects its! revenue, most of which comes from sales' , in the U.S., to doubleagaih in the next four years.. ' , j ,Consider its more than 50 research and development joint ventures. They simulta- neously ...shlft R&P research costs off Elan's books and allow Elan to book reve-nue long 'before the ventures have devel- oped any products to sell~; In their most typical form, Elan invests $20 million in a partner and the joint ven- 'ture, and the venture ~mmediately pays Elan '$15:i:nillion for a medical-technology'license.'Elan books that as revenue. But the money that Elan invested doesn't cut intoitS;,,~arnings because that's an..invest~ ment, and appears only on the balance sheet, where it's an asset,lneffect, Elan conveqs $15 million of money it already had into new revenue. "What's the real substance?" asks Lynn,; TurDer, a former 'chief accountant for tlleV.S, Securities and Exchange Com- inission:'"I'm taking money out oton'e pocket and putting it into another. That is 11: charade; Elan firmly rejects that no- tion. J:There is nothing inappropriate abom'o\iraccQunting," says its executive vice chairman, Thomas Lynch, a former partner at KPMG LLP. ,1:.', Uncommon Setup In the wake of the scandal over Enron Corp.'s misleading accounting, the ways tJiat faSt~growing companies reach their: stellarnumb~rs are drawing a closer look. In the <:ase of Elan, whose revenue and earnings;havesoared in the past decade, such scrunny'reveals some unusually structured deals that contribute to finan- cial results, but thalare difficult for inves- .W!:.s to 'eval~ate. ,Elancurrently sells dozensof drug and dia~os~ic,prOducts. It ISdevelopingdrugs for mUltIple sclerosisand Alzheimer's dis- ease,although the Alzheimer's prOduct re- cen.tly hit a snag and trials were tempo- ranly-suspended. Besides Ireland, Elan has labs in San Diego and SouthSan Fran- cisco, Calif. -. :~~~~.~ays 'it currently 'has about 55 c. research joint ventures, but stopped cre- i ating new ones in mid-2001to focus on developing their products. The ventures have more than two dozen potential drugs in human testing, it says. The sys- tem is "very productive," says the compa- ny's chief scientific and medical officer, Ivan Lieberburg. Because of this re- search setup, he adds, "we don't have to do the Merck model of bringing every- thing inside. The advantage of that is complete control. The disadvantage is it costs a lot of money." In each of these joint ventures, Elan holds a 19.9% interest and its partner the rest. The ventures, several based in Ber- muda, have few or no employees. This system contrasts with a more common' way pharmaceutical companies link up with small biotech firms" which is to ac- quire equity in the small firm in gradual steps as the research advances,and re- ceive co-marketingrights to any drug pro- I duced. Cross Receipt Though Elan doesn't announce the joint ventures' financial resUlts,some de- tails can be gleaned from SEC filings by the company or its partners, such as In- cara Pharmaceuticals Corp. of Research Triangle Park, N.C. According to a securi- ties-purchase agreement filed by Incara with the SEC last January, Elan invested $2.985 million in this joint venture and $16.015 million in Incara stock and a war- rant. Incara, the majority partner, then put $12.015 million into the joint venture, bringing the venture's funding to $15 mil- lion. The SEC filing said Elan woUld pay Incara the $16.015 million by wire trans- fer. But in Incara's subsequent quarterly .filings with the SEC, its statements of cash flow don't show a receipt of this cash in financing activities, nor do they show any payment from Incara to the joint venture in investing activities. Yet SEC filings say the joint venture bought a $15 million technology license from Elan. Asked why the quarterly filings showed no payments of cash, Elan says in a writ- ten response that "cash was transferred by way of a crossreceipt," which it calls a "legal mechanism under which amounts owing under different contracts are amal- gamated with the resUlting amount being settled by wire transfer." Elan says it is "not aware of how Incara disclosed the movement in cash." Incara declines to comment on its accounting for the transac- tion.