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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the quarterly period ended June 30, 2012
For the transition period from to
Commission file number 0-26301
United Therapeutics Corporation
(Exact Name of Registrant as Specified in Its Charter)
(Registrants Telephone Number, Including Area Code)
(Former Name, Former Address and Former Fiscal Year, If Changed Since Last Report)
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 o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or smaller reporting company. See definition of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act:
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
The number of shares outstanding of the issuers common stock, par value $.01 per share, as of July 20, 2012 was 51,718,810.
UNITED THERAPEUTICS CORPORATION
(In thousands, except share data)
See accompanying notes to consolidated financial statements.
UNITED THERAPEUTICS CORPORATION
(In thousands, except per share data)
See accompanying notes to consolidated financial statements.
UNITED THERAPEUTICS CORPORATION
See accompanying notes to consolidated financial statements.
UNITED THERAPEUTICS CORPORATION
See accompanying notes to consolidated financial statements.
UNITED THERAPEUTICS CORPORATION
June 30, 2012
1. Organization and Business Description
United Therapeutics Corporation is a biotechnology company focused on the development and commercialization of unique products to address the unmet medical needs of patients with chronic and life-threatening conditions. As used in these notes to the consolidated financial statements, unless the context otherwise requires, the terms we, us, our, and similar terms refer to United Therapeutics Corporation and its consolidated subsidiaries.
Our lead product, Remodulin® (treprostinil) Injection (Remodulin), was first approved in 2002 by the United States Food and Drug Administration (FDA) and has also been approved for use in countries outside of the United States. We sell Remodulin in the United States and in various other countries around the world. In 2009, we received FDA approval for Tyvaso® (treprostinil) Inhalation Solution (Tyvaso) and Adcirca® (tadalafil) tablets (Adcirca), both of which we market in the United States.
2. Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with the rules and regulations of the United States Securities and Exchange Commission (SEC) for interim financial information. Accordingly, they do not include all of the information required by United States generally accepted accounting principles (GAAP) for complete financial statements. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the accompanying notes to the consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the SEC on February 28, 2012.
In our managements opinion, the accompanying consolidated financial statements contain all adjustments, including normal, recurring adjustments, necessary to fairly present our financial position as of June 30, 2012, results of operations and comprehensive income for the three- and six-month periods ended June 30, 2012 and 2011, and cash flows for the six months ended June 30, 2012 and 2011. Interim results are not necessarily indicative of results for an entire year. On March 31, 2011, we sold our wholly-owned telemedicine subsidiary, Medicomp, Inc. Accordingly, the operating results of Medicomp, Inc., for the six-month period ended June 30, 2011 have been recast and presented within discontinued operations on our consolidated statements of operations. This change in presentation had no impact on net income as previously reported. We did not recast our consolidated statement of cash flows for the six months ended June 30, 2011 to reflect the classification of Medicomp, Inc. as a discontinued operation as the impact was not significant to that statement. For details regarding the sale of Medicomp, Inc. refer to Note 18Sale of Medicomp, Inc. to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2011.
Inventories are stated at the lower of cost (first-in, first-out method) or market (current replacement cost) and consist of the following, net of reserves (in thousands):
4. Fair Value Measurements
Assets and liabilities subject to fair value measurements are required to be disclosed within a fair value hierarchy. The fair value hierarchy ranks the quality and reliability of inputs used to determine fair value. Accordingly, assets and liabilities carried at, or permitted to be carried at, fair value are classified within the fair value hierarchy in one of the following categories based on the lowest level input that is significant to a fair value measurement:
Level 1Fair value is determined by using unadjusted quoted prices that are available in active markets for identical assets and liabilities.
Level 2Fair value is determined by using inputs other than Level 1 quoted prices that are directly or indirectly observable. Inputs can include quoted prices for similar assets and liabilities in active markets or quoted prices for identical assets and liabilities in inactive markets. Related inputs can also include those used in valuation or other pricing models such as interest rates and yield curves that can be corroborated by observable market data.
Level 3Fair value is determined by using inputs that are unobservable and not corroborated by market data. Use of these inputs involves significant and subjective judgment.
Assets and liabilities subject to fair value measurements are as follows (in thousands):
(1) Included in cash and cash equivalents and marketable investments and cashrestricted on the accompanying consolidated balance sheets.
(2) Included in current and non-current marketable investments on the accompanying consolidated balance sheets. The fair value of these securities is principally measured or corroborated by trade data for identical issues or that of comparable securities in which related trading activity is not sufficiently frequent to be considered a Level 1 input. See also Note 5Marketable InvestmentsHeld-to-Maturity Investments to these consolidated financial statements.
(3) Included in convertible notes on the accompanying consolidated balance sheets. Refer to Note 9DebtConvertible Notes Due 2016 for details. The fair value of our 1.0% Convertible Senior Notes due September 15, 2016 (2016 Convertible Notes) has been estimated using other observable inputs including the price of our common stock, implied volatility, interest rates and credit spreads among others. Over time, we expect a market for the 2016 Convertible Notes to develop. At that time, we intend to use trade data as the principal basis for measuring fair value.
(4) Included in non-current liabilities on the accompanying consolidated balance sheets. The fair value of contingent consideration has been estimated using probability weighted discounted cash flow models (DCF). The DCF
incorporates Level 3 inputs including estimated discount rates that we believe market participants would consider relevant in pricing and the projected timing and amount of cash flows, which are estimated and developed, in part, based on the requirements specific to each acquisition agreement. We analyze and evaluate these fair value measurements quarterly to determine whether valuation inputs continue to be relevant and appropriate or whether current period developments warrant adjustments to valuation inputs and related measurements. Any increases or decreases in discount rates would have an inverse impact on the value of related fair value measurements, while increases or decreases in expected cash flows would result in corresponding increases or decreases in fair value. As of both June 30, 2012 and December 31, 2011, the cost of debt and weighted average cost of capital used to discount projected cash flows relating to contingent consideration ranged from 8.6 percent to 17.9 percent.
A reconciliation of the beginning and ending balance of Level 3 liabilities for the three- and six-month periods ended June 30, 2012, is presented below (in thousands):
Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses approximate fair value because of their short maturities. The fair values of our marketable investments and our 2016 Convertible Notes are reported above within the fair value hierarchy. The recorded value of our $70.0 million mortgage loan approximates its fair value as it bears a variable rate of interest that we believe approximates the market rate of interest for debt with similar credit risk profiles, terms and maturities. Refer to Note 9DebtMortgage Financing for details.
5. Marketable Investments
Marketable investments classified as held-to-maturity consist of the following (in thousands):
The following table summarizes gross unrealized losses and the length of time marketable investments have been in a continuous unrealized loss position (in thousands):
We attribute the unrealized losses on held-to-maturity securities as of June 30, 2012, to the variability in related market interest rates. We do not intend to sell these securities, nor is it more likely than not that we will be required to sell them prior to the end of their contractual term. Furthermore, we believe these securities do not expose us to undue market risk or counterparty credit risk. As such, we do not consider these securities to be other than temporarily impaired.
The following table summarizes the contractual maturities of held-to-maturity marketable investments at June 30, 2012 (in thousands):
We own less than 1 percent of the common stock of a public company. Our investment is classified as available-for-sale and reported at fair value based on the quoted market price under the caption Noncurrent marketable investments.
As of June 30, 2012, we maintain investments in equity totaling approximately $8.0 million in privately-held corporations. We account for these investments at cost since we do not have the ability to exercise significant influence over these companies and their fair values are not readily determinable. The fair value of these investments has not been estimated at June 30, 2012, as there have been no events or developments indicating their carrying amounts may be impaired. We include these investments within non-current other assets on our consolidated balance sheets.
6. Goodwill and Other Intangible Assets
Goodwill and other intangible assets comprise the following (in thousands):
(1) Includes foreign currency translation adjustments.
(2) During the quarter ended June 30, 2012, we wrote off the net book value of a contract-based intangible asset we had recorded in connection with our acquisition of Revivicor, Inc. during July 2011, relating to a licensing arrangement to which Revivicor was a party. On April 24, 2012, we received notice from the counterparty to the licensing arrangement of its election to terminate the contract in its entirety. The original counterparty was acquired in late 2011 and subsequent to its acquisition, decided not to pursue development of products utilizing Revivicors technology. Accordingly, we recognized a corresponding impairment charge of $6.8 million which has been included under the caption selling, general and administrative expenses on our consolidated statements of operations for the three- and six-month periods ended June 30, 2012.
Total amortization relating to other intangible assets for the five succeeding years and thereafter is presented below (in thousands):
7. Supplemental Executive Retirement Plan
We maintain the United Therapeutics Corporation Supplemental Executive Retirement Plan (SERP) to provide retirement benefits to certain senior members of our management team. To help fund our expected obligations under the SERP, we maintain the United Therapeutics Corporation Supplemental Executive Retirement Plan Rabbi Trust Document (Rabbi Trust). The balance in the Rabbi Trust was approximately $5.1 million as of June 30, 2012 and December 31, 2011. The Rabbi Trust is irrevocable and SERP participants have no preferred claim on, nor any beneficial ownership interest in, any assets of the Rabbi Trust. The investments in the Rabbi Trust are classified as restricted marketable investments and cash on our consolidated balance sheets.
Net periodic pension cost consists of the following (in thousands):
8. Share Tracking Award Plans
We maintain the United Therapeutics Corporation Share Tracking Awards Plan, originally adopted in June 2008 (2008 STAP) and the United Therapeutics Corporation 2011 Share Tracking Awards Plan, adopted in March 2011 (2011 STAP). In February 2012, our Board of Directors amended the 2011 STAP to increase the total number of awards available for grant under the 2011 STAP by 2.0 million and concurrently amended the 2008 STAP to cancel the approximately 400,000 remaining awards available for future grants. We refer to the 2008 STAP and the 2011 STAP collectively as the STAP, and awards granted and/or outstanding under either of these plans as STAP awards.
Under the STAP, we grant long-term, equity-based compensation to eligible participants. STAP awards convey the right to receive in cash an amount equal to the appreciation of our common stock, which is calculated as the positive difference between the closing price of our common stock on the date of exercise and the date of grant. STAP awards generally vest in equal increments on each anniversary of the date of grant over a four-year period and expire on the tenth anniversary of the date of grant.
We account for outstanding STAP awards as a liability because they are required to be settled in cash. Accordingly, we estimate the fair value of outstanding STAP awards at each financial reporting date using the Black-Scholes-Merton valuation model until settlement occurs or awards are otherwise no longer outstanding. Changes in the fair value of outstanding STAP awards are recognized as an adjustment to compensation expense on our consolidated statements of operations. The STAP liability balance was $77.9 million and $79.9 million at June 30, 2012 and December 31, 2011, respectively, and has been included within other current liabilities on our consolidated balance sheets.
In estimating the fair value of STAP awards, we are required to use inputs that materially impact the determination of fair value and the amount of compensation expense (benefit) to be recognized. These inputs include the expected volatility of the price of our common stock, the risk-free interest rate, the expected term of STAP awards, the expected forfeiture rate and the expected dividend yield.
The table below presents the assumptions used to measure the fair value of STAP awards at June 30, 2012 and 2011:
A summary of the activity and status of STAP awards for the six-month period ended June 30, 2012 is presented below:
The weighted average fair value of awards granted during the six-month periods ended June 30, 2012 and 2011 was $21.07 and $28.06, respectively.
Share-based compensation expense (benefit) recognized in connection with the STAP is as follows (in thousands):
(1) Share-based compensation benefit for the three months ended June 30, 2011 resulted from the decrease in the fair value of STAP awards as a result of the decline in the price of our common stock at June 30, 2011.
Cash paid to settle STAP awards exercised during the six-month periods ended June 30, 2012 and 2011, was $8.9 million and $24.3 million, respectively.
Convertible Notes Due 2016
In October 2011, we issued $250.0 million in aggregate principal value 2016 Convertible Notes. The 2016 Convertible Notes are unsecured, unsubordinated debt obligations that rank equally with all of our other unsecured and unsubordinated indebtedness. We pay interest semi-annually on March 15th and September 15th of each year. The initial conversion price is $47.69 per share and the number of underlying shares used to determine the aggregate consideration upon conversion is approximately 5.2 million shares.
Conversion can occur: (1) any time after June 15, 2016; (2) during any calendar quarter that follows a calendar quarter in which the price of our common stock exceeds 130 percent of the conversion price for at least 20 days during the 30 consecutive trading-day period ending on the last trading day of the quarter; (3) during the ten consecutive trading-day period following any five consecutive trading-day period in which the trading price of the 2016 Convertible Notes is less than 95 percent of the closing price of our common stock multiplied by the then current number of shares underlying the 2016 Convertible Notes; (4) upon specified distributions to our shareholders; (5) in connection with certain corporate transactions; or (6) in the event that our common stock ceases to be listed on the NASDAQ Global Select Market, the NASDAQ Global Market, or the New York Stock Exchange, or any of their respective successors. As of June 30, 2012, none of the contingent conversion thresholds described above were met in order for the 2016 Convertible Notes to be convertible at the option of the note holders. As a
result, the 2016 Convertible Notes have been classified as a non-current liability on our consolidated balance sheet at June 30, 2012. In future financial reporting periods, the classification of the 2016 Convertible Notes may change depending on whether any of the above contingent criteria have been subsequently satisfied.
At June 30, 2012, the aggregate conversion value of the 2016 Convertible Notes exceeded their par value by $8.9 million using a conversion price of $49.38, the closing price of our common stock on June 30, 2012.
Upon conversion, holders of our 2016 Convertible Notes are entitled to receive: (1) cash equal to the lesser of the par value of the notes or the conversion value (the number of shares underlying the 2016 Convertible Notes multiplied by the then current conversion price per share); and (2) to the extent the conversion value exceeds the par value of the notes, shares of our common stock. In the event of a change in control, as defined in the indenture under which the 2016 Convertible Notes have been issued, holders can require us to purchase all or a portion of their 2016 Convertible Notes for 100 percent of the notes par value plus any accrued and unpaid interest.
Because the terms of the 2016 Convertible Notes provide for settlement wholly or partially in cash, we are required to account for their liability and equity components separately so that the subsequent recognition of interest expense reflects our non-convertible borrowing rate. Accordingly, we estimated the fair value of the 2016 Convertible Notes without consideration of the conversion option as of the date of issuance (Liability Component). The excess of the proceeds received over the estimated fair value of the Liability Component totaling $57.9 million has been recorded as the conversion option (Equity Component) and a corresponding offset has been recognized as a discount to the 2016 Convertible Notes to reduce their net carrying value. We are amortizing the discount over the five-year period ending September 15, 2016 (the expected life of the Liability Component) using the interest method and an effective rate of interest of 6.7 percent, which corresponded to our estimated non-convertible borrowing rate at the date of issuance.
Interest expense incurred in connection with our convertible notes consisted of the following (in thousands):
(1) Interest expense recognized in connection with our convertible notes for the three- and six-month periods ended June 30, 2011 consisted solely of the effective interest relating to a prior issue of convertible notes that matured in October 2011 (2011 Convertible Notes). We accounted for the 2011 Convertible Notes in a manner similar to that of the 2016 Convertible Notes using an effective interest rate of 7.5 percent.
Amounts comprising the carrying value of the 2016 Convertible Notes include the following (in thousands):
Convertible Note Hedge and Warrant Transactions
In connection with the issuance of our 2016 Convertible Notes, we entered into separate convertible note hedge and warrant transactions with Deutsche Bank AG London (DB London) to reduce the potential dilutive impact upon the conversion of our convertible notes. Pursuant to the convertible note hedge, we purchased call options to acquire up to approximately 5.2 million shares of our common stock with a strike price of $47.69. The call options become exercisable upon conversion of the 2016 Convertible Notes, and will terminate upon the maturity of the 2016 Convertible Notes or the first day the 2016 Convertible Notes are no longer outstanding, whichever occurs first. We also sold DB London warrants to acquire up to approximately 5.2 million shares of our common stock with a strike price of $67.56. The warrants will expire incrementally on a series of expiration dates subsequent to the maturity date of our 2016 Convertible Notes. Both the convertible note hedge and warrant transactions will be settled on a net-share basis. If the conversion price of our 2016 Convertible Notes remains between
the strike prices of the call options and warrants, our shareholders will not experience any dilution in connection with the conversion of our 2016 Convertible Notes; however, to the extent that the price of our common stock exceeds the strike price of the warrants on any or all of the series of related incremental expiration dates, we will be required to issue shares of our common stock to DB London.
The warrants we sold to DB London in connection with the issuance of our 2011 Convertible Notes expired in March 2012. Since the price of our common stock over the series of expiration dates did not exceed the strike price of the warrants, we were not required to issue any shares of our common stock to DB London upon expiration of the warrants.
In December 2010, we entered into a Credit Agreement with Wells Fargo Bank, National Association (Wells Fargo) and Bank of America, N.A., pursuant to which we obtained $70.0 million in debt financing. The Credit Agreement has a forty-eight month term maturing in December 2014 and is secured by certain of our facilities in Research Triangle Park, North Carolina and Silver Spring, Maryland. Annual principal payments are based on a twenty-five year amortization schedule using a fixed rate of interest of 7.0 percent and the outstanding debt bears a floating rate of interest per annum based on the one-month London Interbank Offer Rate (LIBOR), plus a credit spread of 3.75 percent, or approximately 4.0 percent as of June 30, 2012. Alternatively, we have the option to change the rate of interest charged on the loan to 2.75 percent plus the greater of: (1) Wells Fargos prime rate, or (2) the federal funds effective rate plus 0.05 percent, or (3) LIBOR plus 1.0 percent. The Credit Agreement permitted prepayment of the outstanding loan balance in its entirety, subject to a prepayment premium until June 30, 2012. We did not elect to prepay the loan balance during the prepayment term. The Credit Agreement subjects us to various financial and negative covenants. As of June 30, 2012, we were in compliance with these covenants.
Details of interest expense are presented below (in thousands):
10. Stockholders Equity
Earnings per common share
Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period, adjusted for the potential dilutive effect of other securities if such securities were converted or exercised.
The components of basic and diluted earnings per common share comprise the following (in thousands, except per share amounts):
(1) Calculated using the treasury stock method.
(2) Certain stock options and warrants were excluded from the computation of diluted earnings per share because their impact would be anti-dilutive.
Stock Option Plan
We may grant stock option awards under our equity incentive plan. The fair value of stock options is estimated using the Black-Scholes-Merton valuation model. Option pricing models, including Black-Scholes-Merton, require the input of assumptions that can materially impact the estimation of fair value and related compensation expense. These assumptions include the expected volatility of our common stock, the risk-free interest rate, the expected term of stock option awards, the expected forfeiture rate and the expected dividend yield. We did not grant any stock options during the three- and six-month periods ended June 30, 2012 and 2011.
A summary of the activity and status of employee stock options during the six-month period ended June 30, 2012 is presented below:
Total share-based compensation expense (benefit) related to employee stock options for the three- and six-month periods ended June 30, 2012 and 2011, is as follows (in thousands):
Employee and non-employee stock option exercise data is summarized below (dollars in thousands):
Employee Stock Purchase Plan
In June 2012, our shareholders approved the United Therapeutics Corporation Employee Stock Purchase Plan (ESPP) which has been structured to comply with Section 423 of the Internal Revenue Code (Section 423). The ESPP provides eligible employees the right to purchase shares of our common stock at a discount through elective accumulated payroll deductions at the end of each offering period. Beginning on September 5, 2012, offering periods will commence in consecutive six-month periods. Eligible employees may contribute up to 15 percent of their base salary, subject to certain limitations under Section 423 and certain ownership limitations, to purchase shares of our common stock in each calendar year. The purchase price of the shares will be equal to 85 percent of the closing price of our common stock on either the first or last trading day of a given offering period, whichever is lower. In addition, the ESPP provides that no eligible employee may purchase more than 4,000 shares of our common stock during any offering period. The ESPP has a 20 year term and limits the aggregate number of shares that can be issued to 3.0 million.
In October 2011, our Board of Directors approved a share repurchase program authorizing up to $300 million in aggregate repurchases of our common stock, at our discretion, over a two-year period ending in October 2013 (Repurchase Program). In connection with the Repurchase Program, we paid $212.0 million for an accelerated share repurchase agreement (ASR) entered
into with DB London in October 2011, under which we repurchased approximately 4.7 million shares of our common stock in October 2011. In May 2012, we completed the Repurchase Program by acquiring approximately 2.0 million shares of our common stock at an aggregate cost of $88.0 million.
In June 2012, our Board of Directors authorized the repurchase of up to an additional $100 million of our common stock. This repurchase program will become effective July 31, 2012 and will remain open for up to one year.
11. Income Taxes
Income tax expense for the three- and six-month periods ended June 30, 2012 and 2011 is based on the estimated effective tax rate for the entire year. The estimated annual effective tax rate can be subject to adjustment in subsequent quarterly periods if components used in its estimation are revised. The estimated annual effective tax rates as of June 30, 2012 and 2011 were 32 percent and 34 percent, respectively.
As of June 30, 2012, we had available for federal income tax purposes approximately $29.7 million in business tax credit carryforwards that will expire at various dates through 2032.
We are subject to federal and state taxation in the United States and various foreign jurisdictions. Currently, our 2010 tax year is subject to examination by the Internal Revenue Service and our tax years from 2008 to 2010 are subject to examination by state taxing authorities.
We are unaware of any positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within the next 12 months.
12. Segment Information
Following the sale of our telemedicine subsidiary, Medicomp, Inc. and the discontinuation of further telemedicine-related business in 2011, we currently operate as one operating segment. However, we use and regularly review revenues, cost of revenues and gross profit data as a primary measure of performance for each of our three commercial products.
Revenues, cost of revenues and gross profit for each of our commercial products for the three- and six-month periods ended June 30, 2012 and 2011 were as follows (in thousands):
For the three-month periods ended June 30, 2012 and 2011, net revenues from our three U.S.-based distributors represented 78 percent and 82 percent, respectively, of our total net operating revenues. For the six-month periods ended June 30, 2012 and 2011, net revenues from our three U.S.-based distributors represented 80 percent and 83 percent, respectively, of our total net operating revenues.
In February 2012, we announced receipt of a Paragraph IV Certification Notice Letter (Notice Letter) from Sandoz Inc. (Sandoz) advising that Sandoz has submitted an abbreviated new drug application (ANDA) to the FDA requesting approval to market a generic version of the 10 mg/mL strength of Remodulin.
In the Notice Letter, Sandoz stated that it intends to market a generic version of Remodulin before the expiration of the following patents relating to Remodulin: U.S. Patent No. 5,153,222, which expires in October 2014; U.S. Patent No. 6,765,117, which expires in October 2017; and U.S. Patent No. 7,999,007, which expires in March 2029. Sandozs Notice Letter stated that the ANDA contains a Paragraph IV Certification alleging that these patents are not valid, not enforceable and/or will not be infringed by the commercial manufacture, use or sale of the proposed product described in Sandozs ANDA submission.
In response to the Notice Letter, we filed a lawsuit for patent infringement on March 14, 2012 against Sandoz in the U.S. District Court for the District of New Jersey. We filed our patent-infringement lawsuit within forty-five days from the receipt of the Notice Letter. Therefore, under the Hatch-Waxman Act, the FDA is automatically precluded from approving Sandozs ANDA for up to 30 months or until the issuance of a district court decision that is adverse to us, whichever occurs first.
On May 4, 2012, Sandoz filed its answer to our complaint, and also filed counterclaims alleging that the patents at issue in the litigation are invalid or will not be infringed by the commercial manufacture, use or sale of the proposed product described in Sandozs ANDA submission. On May 25, 2012, we filed our answer to Sandozs counterclaims.
We intend to vigorously enforce our intellectual property rights relating to Remodulin, including the three patents mentioned in the Notice Letter which are listed in the FDAs Approved Drug Products List (the Orange Book).
Lexington Insurance Company
During the third quarter of 2011, we reported a claim to our insurance provider regarding damage to certain Remodulin inventory that occurred as the result of a warehouse accident. The estimated net commercial value of the damaged inventory was approximately $65.0 million. Because we did not reach a satisfactory agreement on the amount to settle the claim, we filed a lawsuit against Lexington Insurance Company in April 2012 in the North Carolina Business Court, a specialized division of North Carolinas Superior Court, seeking to recover the full net commercial value of the damaged inventory. Although we believe we are entitled to recover the full net commercial value of the damaged inventory, any litigation is inherently uncertain and we cannot predict the timing or outcome of the litigation, including the ultimate level of recovery (if any).
The following discussion should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2011, and the consolidated financial statements and accompanying notes included in Part I, Item I of this Quarterly Report on Form 10-Q. The following discussion contains forward-looking statements made pursuant to the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995, including the statements listed in the section below entitled Part II, Item 1ARisk Factors. These statements are based on our beliefs and expectations about future outcomes, and are subject to risks and uncertainties that could cause our actual results to differ materially from anticipated results. Factors that could cause or contribute to such differences include those described in Part II, Item 1ARisk Factors of this Quarterly Report on Form 10-Q; factors described in our Annual Report on Form 10-K for the year ended December 31, 2011, under the section entitled Part I, Item 1ARisk FactorsForward-Looking Statements; and factors described in other cautionary statements, cautionary language and risk factors set forth in other filings with the Securities and Exchange Commission (SEC). We undertake no obligation to publicly update these forward-looking statements, whether as a result of new information, future events or otherwise.
Our key therapeutic products and product candidates include:
· Prostacyclin analogues (Remodulin®, Tyvaso®, oral treprostinil and L-314d QID (a reformulation of beraprost-MR)): stable synthetic forms of prostacyclin, an important molecule produced by the body that has powerful effects on blood vessel health and function;
· Phosphodiesterase type 5 (PDE-5) inhibitor (Adcirca®): a molecule that acts to inhibit the degradation of cyclic guanosine monophosphate (cGMP) in cells. cGMP is activated by nitric oxide, a naturally occurring substance in the body that mediates the relaxation of vascular smooth muscle;
· Monoclonal antibodies for oncologic applications (Ch14.18 MAb and 8H9 MAb): antibodies that treat cancer by activating the immune system;
· Glycobiology antiviral agents: a novel class of small, sugar-like molecules that have shown antiviral activity in a range of pre-clinical settings; and
· Cell-based therapy: a cell-based product known as PLacental eXpanded (PLX) cells being studied for the treatment of pulmonary hypertension.
We concentrate substantially all of our research and development efforts on these key therapeutic programs. Our lead product is Remodulin (treprostinil) Injection (Remodulin) for the treatment of pulmonary arterial hypertension (PAH). The United States Food and Drug Administration (FDA) initially approved Remodulin in 2002 for subcutaneous (under the skin) administration. The FDA subsequently broadened its approval of Remodulin in 2004 for intravenous (in the vein) use and for the treatment of patients requiring transition from Flolan® (epoprostenol sodium) for Injection, the first drug approved by the FDA for the treatment of PAH. Remodulin has also been approved in various countries outside of the United States, but approval in most countries was initially limited to subcutaneous use. In December 2011, we received regulatory approval by the French regulatory agency, LAgence Nationale de Sécurité du Médicament et des Produits de Santé (ANSM), for the intravenous use of Remodulin to treat PAH. The ANSM approval followed a review period during which 22 European Economic Area member nations, each of which had previously approved subcutaneous Remodulin through the mutual recognition process, reviewed and endorsed the final variation assessment report issued by ANSM, which will allow the marketing of intravenous Remodulin in those nations. Our other commercial products include Adcirca (tadalafil) tablets (Adcirca) and Tyvaso (treprostinil) Inhalation Solution (Tyvaso). In May 2009, the FDA approved Adcirca, an orally administered therapy for the treatment of PAH to which we acquired certain exclusive commercialization rights from Eli Lilly and Company (Lilly). In July 2009, we received FDA approval of Tyvaso, an inhaled therapy for the treatment of PAH. We launched both of these products for commercial sale during the third quarter of 2009. As compared with Remodulin, these two products enable us to offer treatments to a broader range of patients who suffer from PAH. In addition, in December 2011 we filed a new drug application (NDA) with the FDA seeking marketing approval of an oral formulation of treprostinil for the treatment of PAH. We are also continuing to develop an oral formulation of another prostacyclin analogue, L-314d QID, for the treatment of PAH.
On March 31, 2011, we sold our former telemedicine subsidiary, Medicomp, Inc., and have no intentions to pursue future development and/or commercialization of telemedicine-based products and services. Accordingly, the results of Medicomp, Inc. have been included within discontinued operations for the six months ended June 30, 2011 on our consolidated statements of operations.
Sales of Remodulin comprise the largest share of our revenues. In addition, sales of both Tyvaso and Adcirca continue to become increasingly prominent sources of our revenues since their commercial introduction in 2009. We sell Remodulin and Tyvaso in the United States to our specialty pharmaceutical distributors: Accredo Health Group, Inc., CuraScript, Inc. and CVS Caremark. Adcirca is sold to pharmaceutical wholesalers that are part of Lillys pharmaceutical wholesaler network. Effective April 2012, we increased the price at which we sell Tyvaso to our specialty pharmaceutical distributors by 4.9 percent. In addition, since receiving FDA approval of Adcirca, Lilly has generally increased the net wholesale price of Adcirca twice annually. Most recently, Lilly increased the price of Adcirca by 8.9 percent effective in each of January 2012 and July 2012. Under our agreement with Lilly, Lilly has the right to determine the price at which we sell Adcirca.
We also sell Remodulin to distributors outside of the United States. In April 2011, Express Scripts, Inc., the parent company of CuraScript, closed on its acquisition of Medco Health Solutions, Inc., the parent company of Accredo. Presently, we do not expect the merger to materially affect our business.
We require our distributors to maintain reasonable levels of inventory reserves at all times as the interruption of Remodulin or Tyvaso therapy can be life threatening. Consequently, sales of these therapies in any given quarter may not precisely reflect patient demand. Our distributors typically place monthly orders based on estimates of future demand and considerations of contractual minimum inventory requirements. As a result, sales volumes of Remodulin and Tyvaso can vary, depending on the timing and magnitude of these orders.
The Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act (collectively, the Acts), contains broad provisions that will be implemented over the next several years. We continue to evaluate the impact of the Acts on our business; however, our evaluation is dependent upon the issuance of final regulations and the impact this legislation will have on insurance companies and their relationships with drug manufacturers.
In January 2011, certain provisions of the Acts that address the coverage gap in the Medicare Part D prescription drug program (commonly known as the donut hole) became effective. Under these provisions, drug manufacturers are required to provide a 50 percent discount on branded prescription drugs to patients receiving reimbursement under Medicare Part D while they remain in this coverage gap. These provisions of the Acts apply to Adcirca, which is our only commercial pharmaceutical product covered by Medicare Part D. Approximately 35 percent of our Adcirca patients are covered under Medicare Part D. The vast majority of our Remodulin and Tyvaso Medicare patients are covered under Medicare Part B, which does not contain a similar coverage gap.
Since the enactment of this legislation, we have not been materially impacted and have not yet identified any provisions of the Acts that could materially impact our business in the future. However, the potential long-term impact of the Acts on our business is inherently difficult to predict, as many details regarding the implementation of this legislation have not yet been determined.
Total revenues are reported net of: (1) estimated rebates; (2) prompt pay discounts; (3) allowances for sales returns; and (4) distributor fees. We estimate our liability for rebates based on an analysis of historical levels of rebates by product to both state Medicaid agencies and commercial third-party payers relative to sales of each product. In addition, we determine our obligation for prescription drug discounts required for Medicare Part D patients within the coverage gap based on estimations of the number of Medicare Part D patients and the period such patients will remain within the coverage gap. We provide prompt pay discounts to customers that pay amounts due within a specific time period and base our estimates for prompt pay discounts on observed historical customer payment behavior. We derive estimates relating to the allowance for returns of Adcirca from published industry data specific to specialty pharmaceuticals and will continue to do so until we have sufficient historical data on which to base our allowance. In addition, we compare patient prescription data for Adcirca to sales of Adcirca on a quarterly basis to ensure a reasonable relationship between prescription and sales trends. To date, we have not identified any unusual patterns in the volume of prescriptions relative to sales that would warrant reconsideration of, or adjustment to, the methodology we currently employ to estimate our allowance for returns. The allowance for exchanges for Remodulin is based on the historical rate of product exchanges, which has been immaterial. In addition, because Tyvaso is distributed under similar contractual terms as Remodulin, the level of product exchanges for Tyvaso has been comparable to that of Remodulin. As such, we do not record reserves for exchanges of either Remodulin or Tyvaso. Furthermore, we
anticipate minimal exchange activity in the future for both products. Lastly, we estimate distributor fees based on contractual rates for specific services applied to the estimated units of service provided for the period.
Cost of Product Sales
Cost of product sales is comprised of (1) costs to produce and acquire products sold to customers; (2) royalty payments under license agreements granting us rights to sell related products; and (3) direct and indirect distribution costs incurred in the sale of products. We acquired the rights to sell our commercial products through license and assignment agreements with the original developers of these products. These agreements obligate us to pay royalties based on our net revenues from related products. While the royalties vary by agreement, we pay royalties on each of our current commercial products ranging from 5 percent to 10 percent of net revenues.
We synthesize treprostinil using advanced intermediate compounds purchased in bulk from several third-party vendors that have the capacity to produce greater quantities of these compounds more cost effectively than we do. Our synthesis process has been designed to give us the flexibility to produce the forms of treprostinil used in Remodulin, Tyvaso, and our oral tablet, based on forecasted demand for each of these products. We maintain inventories of Remodulin and Tyvaso equivalent to at least two years of expected demand to ensure sufficient availability of these products at all times. We have reduced our target inventory levels from three years to two years in light of the approval of additional production sites for Remodulin and Tyvaso, including our own facilities which we expect will become our primary sources of supply, as these developments have helped mitigate the risk of shortages.
In 2009, we amended our contract with our Remodulin producer, Baxter Pharmaceutical Solutions, LLC (Baxter), to extend the contract term through 2013. As part of that contract amendment, we agreed that Baxter will formulate Remodulin in greater quantities using larger capacity equipment. This new process and related equipment will require FDA and international regulatory approval. We are currently conducting validation testing for the new equipment and process. Until FDA approval of the new process and equipment, Baxter will continue to formulate Remodulin using previously approved processes and equipment. In January 2011, we received FDA approval of Jubilant Hollister-Stier Contract Manufacturing and Services as an additional producer for Remodulin in the larger quantities discussed above. In addition, in July 2011, we received FDA approval to use our Silver Spring, Maryland facility for the formulation of Remodulin. We received a Good Manufacturing Practice certificate from the U.K. Medicines and Health Products Regulatory Agency to produce Remodulin and Tyvaso in our Silver Spring facility in June 2012. Catalent Pharma Solutions, Inc. formulates Tyvaso for us and in March 2011 we received FDA approval to also formulate Tyvaso in our Silver Spring, Maryland facility. We intend to use our own facilities to produce our primary supply of Remodulin, Tyvaso and oral treprostinil tablets, and we will contract with third parties to supplement our production capacity.
We acquired the rights to the Tyvaso Inhalation System from NEBU-TEC International Med Products Eike Kern GmbH (NEBU-TEC) in September 2009. We currently manufacture the Tyvaso Inhalation System in Germany using labor supplied by NEBU-TEC. In addition, we received FDA approval in December 2010 for Minnetronix, Inc. to manufacture the Tyvaso Inhalation System and for Quality Tech Services, Inc. to package daily supplies.
Under the terms of our manufacturing and supply agreement with Lilly, Lilly manufactures and distributes Adcirca on our behalf via its pharmaceutical wholesaler network, in the same manner that it distributes its own pharmaceutical products. We take title to Adcirca upon its manufacture by Lilly and bear any losses related to the distribution and sale of Adcirca.
Since our inception, we have devoted substantial resources to our various research and development initiatives. Accordingly, we incur considerable costs related to our clinical trials and other research and development efforts, which are conducted both internally and through third parties, on a variety of projects to develop pharmaceutical products. From time-to-time, we also license or acquire additional technologies and compounds to be incorporated into our development pipeline.
Our operating expenses can be materially impacted by the recognition of share-based compensation expense (benefit) in connection with our share tracking award plans (STAP), and stock option grants containing a performance requirement. STAP awards are required to be measured at fair value at the end of each reporting period until the awards are no longer outstanding. The fair value of equity-based awards is measured using inputs and assumptions that can materially impact the amount of compensation expense for a given period. Additionally, some or all of the following factors, among others, can cause substantial volatility in the amount of share-based compensation recognized in connection with the STAP from period to period: (1) changes in the price of our common stock; (2) changes in the number of outstanding awards; and (3) changes in both the number of vested awards and the period awards have accrued toward vesting. In the case of stock options granted to our Chief Executive Officer, which vest immediately upon issuance in accordance with her employment contract, we recognize
all associated compensation expense immediately at the grant date. Furthermore, we accrue for estimated compensation expense associated with STAP awards and stock option grants containing performance-based conditions affecting vesting when we determine that it is probable that performance criteria will be met.
Major Research and Development Projects
Our major research and development projects focus on the use of prostacyclin analogues and other therapies to treat cardiopulmonary diseases, monoclonal antibodies to treat a variety of cancers, and glycobiology antiviral agents to treat infectious diseases.
Cardiopulmonary Disease Projects
A majority of the patients who die of PAH in the United States each year have not initiated treatment with an infused prostacyclin analogue, which is a complex and burdensome form of medical therapy. In 2009, we entered into an agreement with Medtronic, Inc. to develop its Synchromed® II implantable pump to deliver Remodulin that, if successful, could eliminate many of the patient burdens associated with infused prostacyclins. Medtronic is currently enrolling a clinical study to support ultimate FDA approval for the use of the implantable pump with Remodulin. In certain countries in Europe, an implantable pump distributed by OMT GmbH & Co. KG is used to deliver intravenous Remodulin to certain patients.
The FDA approved Tyvaso for the treatment of PAH in July 2009, and we launched the product for commercial sale in September 2009. In connection with the Tyvaso approval, we agreed to a post-marketing requirement (PMR) and certain post-marketing commitments (PMCs). PMRs and PMCs often obligate sponsors to conduct studies after FDA approval to gather additional information about a products safety, efficacy, or optimal use. PMRs are required studies, whereas PMCs are voluntary commitments. In September 2011, the FDA notified us that we had fulfilled the requirements of the PMCs. We are required to provide the FDA with annual updates on our PMR. Failure to complete or adhere to the timelines set forth by the FDA for the PMR could result in penalties, including fines or withdrawal of Tyvaso from the market, unless we are able to demonstrate good cause for the failure or delay.
In accordance with our PMR, we are enrolling patients in a long-term observational study in the U.S. that will include 1,000 patient years of follow-up in patients treated with Tyvaso, and 1,000 patient years of follow up in control patients receiving other PAH treatments. This study will allow us to continue assessing the safety of Tyvaso. We are currently required to submit the results of the study by December 15, 2014.
We decided not to conduct a new clinical trial aimed at securing European Medicines Agency (EMA) approval of Tyvaso for the treatment of PAH. We made this decision after reviewing the cost of the trial, the length of time required to conduct the trial and obtain marketing authorization and pricing approval, and the current, as well as the expected, commercial environment in Europe. We expect to make Tyvaso available in certain European and Latin American countries on an unmarketed, named-patient basis through country-specific arrangements with our distributors, to the extent physicians prescribe Tyvaso in those countries. We recently decided to evaluate additional inhalation devices for Tyvaso that could be easier for patients to use. We are analyzing the functional and operational parameters of such devices as compared to the current Tyvaso Inhalation System. If ultimately approved by the FDA, these new devices could enhance patient convenience and potentially increase the number of patients using Tyvaso.
In December 2006, we commenced two phase III multi-national, placebo-controlled clinical trials of oral treprostinil in patients with PAH to study both safety and efficacy. The FREEDOM-C trial was a 16-week study of patients on approved background therapy using a PDE-5 inhibitor, such as Revatio®, or an endothelin receptor antagonist (ETRA), such as Tracleer®, or a combination of both. The FREEDOM-M trial was a 12-week study of patients who were not on any background therapy.
We commenced both trials using a 1.0 mg tablet, but during the open-label extension trial (and an associated pharmacokinetic substudy) we discovered that treprostinil concentrations were higher in PAH patients than in healthy individuals due to the difference in overall absorption, metabolism and excretion of the drug between these two populations. These differences led to a number of discontinuations by patients randomized to receive the drug due to tolerability-related side effects. As a result, we introduced a 0.5 mg tablet in July 2007 and a 0.25 mg tablet in April 2008 to enable more gradual dose titration in order to increase dosing to a tolerable level.
In November 2008, we announced that the FREEDOM-C trial did not meet statistical significance (p=0.072) for its primary endpoint. Analysis suggested that the inability to dose titrate was a limiting factor that suppressed the overall treatment effect. Of the 174 patients who received the active drug, 25 patients discontinued due to an adverse event and 33 patients who completed the trial were unable to titrate their doses above 1.0 mg twice-daily.
In June 2009, we began enrollment of our FREEDOM-C2 trial, which was a 16-week study of PAH patients on an approved background therapy. In this trial, patients were provided access to a 0.25 mg tablet and doses were titrated in 0.25 mg to 0.5 mg increments. In March 2011, we completed enrollment of FREEDOM-C2 with 313 patients, compared to a target enrollment of 300 patients. In August 2011, we announced the completion of FREEDOM-C2 and that the trial did not achieve statistical significance for the primary endpoint of improvement in six-minute walk distance at week 16.
Enrollment in FREEDOM-M was initially closed in October 2008, with 171 patients enrolled in the trial. In March 2009, the FDA approved a protocol amendment to add patients to the ongoing FREEDOM-M trial. These additional patients were provided access to a 0.25 mg tablet when beginning the trial. We completed enrollment of FREEDOM-M in January 2011 with 349 patients, with the population for the primary analysis consisting of the 228 patients who had access to the 0.25 mg tablet at randomization. In June 2011, we announced the completion of the FREEDOM-M trial and that the trial met its primary endpoint of improvement in six-minute walk distance at week 12. Analysis of the FREEDOM-M results demonstrated that patients receiving oral treprostinil improved their median six-minute walk distance by approximately 23 meters (p=0.0125, Hodges-Lehmann estimate and non-parametric analysis of covariance in accordance with the trials pre-specified statistical analysis plan) as compared to patients receiving placebo. The median change from baseline at week 12 was 25 meters for patients receiving oral treprostinil and -5 meters for patients receiving placebo. This clinical treatment effect is supported by other secondary efficacy endpoints including the change in six-minute walk distance observed at week 8 (Hodges-Lehmann estimate of +17 meters; p=0.0307) and combined six-minute walk distance and Borg Dyspnea Score rating (shortness of breath test) at week 12 (p=0.0497).
Based on the positive results achieved in the FREEDOM-M trial, we submitted to the FDA an NDA in December 2011. The FDA has accepted the NDA for review and has indicated the filing will be subjected to the standard 10-month review period commencing from the submission date. We have also applied to the FDA for orphan drug designation for oral treprostinil.
Although we believe oral treprostinil is approvable on the basis of the FREEDOM-M study, there can be no guarantee that our NDA will be approved. Furthermore, if our NDA is approved, the results of the FREEDOM-C and FREEDOM-C2 studies may nonetheless limit our ability to market oral treprostinil in combination with other therapies, and reduce its commercial potential. Therefore, in an effort to provide clinical support for the efficacy of oral treprostinil in combination with other PAH therapies and improve the labeling for oral treprostinil, if it is approved, we are designing additional studies. Because we believe that patients in both the FREEDOM-C and FREEDOM-C2 trials were not provided sufficient amounts of oral treprostinil over an adequate period of time, we have finalized the p