XNYS:MRX Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

 

[x]

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

OR

 

[  ]

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                  to                 

Commission file number: 001-14471

 

 

MEDICIS PHARMACEUTICAL CORPORATION

 

(Exact name of Registrant as specified in its charter)

 

                    Delaware                 

                          52-1574808                       
(State or other jurisdiction of     (I.R.S. Employer Identification No.)
incorporation or organization)    

7720 North Dobson Road

Scottsdale, Arizona 85256-2740

(Address of principal executive offices)

(602) 808-8800

(Registrant’s telephone number,

including area code)

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 [  ]

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 [   ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer [X]

  Accelerated filer [  ]

Non-accelerated filer [  ] (do not check if a smaller reporting  company)

  Smaller reporting company [  ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes [  ]  No [X]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class

           Outstanding atAugust 6, 2012            

Class A Common Stock $.014 Par Value

   59,756,432 (a)   
   (a) includes 1,992,476 shares of unvested restricted stock awards   


Table of Contents

MEDICIS PHARMACEUTICAL CORPORATION

Table of Contents

 

          Page  

PART I.

   FINANCIAL INFORMATION   
   Item 1    Financial Statements   
      Condensed Consolidated Balance Sheets as of June 30, 2012 and December 31, 2011      1   
     

Condensed Consolidated Statements of Income for the Three and Six Months Ended June 30, 2012 and 2011

     3   
     

Condensed Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2012 and 2011

     4   
     

Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2012 and 2011

     5   
      Notes to the Condensed Consolidated Financial Statements      6   
   Item 2    Management’s Discussion and Analysis of Financial Condition and Results of Operations      35   
   Item 3    Quantitative and Qualitative Disclosures About Market Risk      61   
   Item 4    Controls and Procedures      61   

PART II.

   OTHER INFORMATION   
   Item 1    Legal Proceedings      62   
   Item 1A    Risk Factors      65   
   Item 2    Unregistered Sales of Equity Securities and Use of Proceeds      65   
   Item 6    Exhibits      66   

SIGNATURES

        67   


Table of Contents

Part I.  Financial Information

Item 1.  Financial Statements

MEDICIS PHARMACEUTICAL CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

 

 

 
     June 30, 2012     December 31, 2011  

 

 

Assets

     (unaudited  

Current assets:

    

Cash and cash equivalents

       $ 256,094     $ 42,823      

Short-term investments

     573,525       245,497      

Accounts receivable, net

     104,269       193,009      

Inventories, net

     40,427       34,519      

Deferred tax assets, net

     69,214       12,720      

Prepaid income taxes

     28,126       1,314      

Other current assets

     25,544       21,272      
  

 

 

 

Total current assets

     1,097,199       551,154      
  

 

 

 

Property and equipment, net

     31,443       25,081      

Intangible assets, net

     471,046       502,492      

Goodwill

     202,703       202,627      

Deferred tax assets, net

     61,429       114,555      

Long-term investments

     22,559       40,270      

Other assets

     37,111       15,780      
  

 

 

 
     $         1,923,490     $         1,451,959      
  

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

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Table of Contents

MEDICIS PHARMACEUTICAL CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS, Continued

(in thousands, except share amounts)

 

 

 
     June 30, 2012      December 31, 2011      

 

 

Liabilities

     (unaudited)      

Current liabilities:

     

Accounts payable

       $ 76,876           $ 54,094       

Current portion of long-term debt

     181             169,145       

Reserve for sales returns

     63,920             60,024       

Accrued consumer rebates and loyalty programs

     81,240             139,948       

Managed care and Medicaid reserves

     96,252             72,801       

Other current liabilities

     81,380             78,785       
  

 

 

 

Total current liabilities

     399,849             574,797       
  

 

 

 

Long-term liabilities:

     

Long-term debt

     591,162             181       

Other liabilities

     51,055             44,998       

Stockholders’ Equity

     

Preferred stock, $0.01 par value; shares authorized: 5,000,000; issued and outstanding: none

     -              -        

Class A common stock, $0.014 par value; shares authorized: 150,000,000; issued and outstanding: 75,952,663 and 74,740,324 at June 30, 2012 and December 31, 2011, respectively

     1,037             1,028       

Class B common stock, $0.014 par value; shares authorized: 1,000,000; issued and outstanding: none

     -              -        

Additional paid-in capital

     852,661             796,979       

Accumulated other comprehensive loss

     (19,914)             (21,315)       

Accumulated earnings

     575,987             567,581       

Less: Treasury stock, 18,192,010 and 17,745,039 shares at cost at June 30, 2012 and December 31, 2011, respectively

     (528,347)             (512,290)       
  

 

 

 

Total stockholders’ equity

     881,424             831,983       
  

 

 

 
       $         1,923,490           $ 1,451,959       
  

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

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Table of Contents

MEDICIS PHARMACEUTICAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

(in thousands, except per share data)

 

     Three Months Ended      Six Months Ended  
     June 30, 2012      June 30, 2011      June 30, 2012      June 30, 2011  

 

 

Net product revenues

   $ 195,092      $ 189,819      $ 395,138      $ 353,715       

Net contract revenues

     1,462        1,008        3,159        2,025       
  

 

 

 

Net revenues

     196,554        190,827        398,297        355,740       
  

 

 

 

Cost of product revenues (1)

     21,770        18,237        42,703        32,568       
  

 

 

 

Gross profit

     174,784        172,590        355,594        323,172       

Operating expenses:

           

Selling, general and administrative (2)

     101,933        90,393        205,371        175,023       

Research and development (3)

     23,312        15,195        75,143        29,468       

Depreciation and amortization

     18,077        7,110        36,157        14,434       
  

 

 

 

Operating income

     31,462        59,892        38,923        104,247       

Interest and investment income

     (560)         (1,238)         (1,173)         (2,512)      

Interest expense

     4,024        1,141        5,082        2,199       

Other expense (income), net

     2,900        -         (100)         -      
  

 

 

 

Income from continuing operations before income tax expense

     25,098        59,989        35,114        104,560       

Income tax expense

     10,172        25,477        14,839        43,363       
  

 

 

 

Net income from continuing operations

     14,926        34,512        20,275        61,197       

Loss from discontinued operations, net of income tax benefit

     -         5,729        -         13,054       
  

 

 

 

Net income

       $ 14,926      $ 28,783      $ 20,275      $ 48,143       
  

 

 

 

Basic net income per share - continuing operations

       $ 0.25      $ 0.55      $ 0.34      $ 0.99       
  

 

 

 

Basic net loss per share - discontinued operations

       $ -       $ (0.09)       $ -       $ (0.22)       
  

 

 

 

Basic net income per share

       $ 0.25      $ 0.46      $ 0.34      $ 0.78       
  

 

 

 

Diluted net income per share - continuing operations

       $ 0.24      $ 0.51      $ 0.33      $ 0.91       
  

 

 

 

Diluted net loss per share - discontinued operations

       $ -       $ (0.09)       $ -       $ (0.22)       
  

 

 

 

Diluted net income per share

       $ 0.24      $ 0.43      $ 0.33      $ 0.72       
  

 

 

 

Cash dividend declared per common share

       $ 0.10      $ 0.08      $ 0.20      $ 0.16       
  

 

 

 

Common shares used in calculating:

           

Basic net income per share

     57,560        60,308        57,549        59,719       
  

 

 

 

Diluted net income per share

     63,980        67,140        63,983        66,347       
  

 

 

 

(1) amounts exclude amortization of intangible assets related to acquired products

       $                 15,676      $                 5,266      $                 31,352      $                 10,718       

(2) amounts include share-based compensation expense

       $ 3,158      $ 8,705      $ 11,558      $ 14,989       

(3) amounts include share-based compensation expense

       $ (64)       $ 615      $ 633      $ 1,020       

See accompanying notes to condensed consolidated financial statements.

 

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MEDICIS PHARMACEUTICAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited)

(in thousands)

 

     Three Months Ended      Six Months Ended  
  

 

 

    

 

 

 
    

June 30,

2012

    

June 30,

2011

    

June 30,

2012

    

June 30,

2011

 

 

 

Net income

   $ 14,926            $ 28,783            $ 20,275            $ 48,143        

Other comprehensive income, net of income taxes:

           

Amortization of prior service costs related to supplemental executive retirement plan

     775              256              1,550              256        

Establishment of prior service costs for new participants under supplemental executive retirement plan

     -              (21,647)             (531)             (21,647)       

Net unrealized (loss) gain on available-for-sale securities

     (73)             123              331              175        

Foreign currency translation adjustment

     (135)             (81)             51              67        
  

 

 

 

Total other comprehensive income, net of income taxes

     567              (21,349)             1,401              (21,149)       
  

 

 

 

Comprehensive income

       $             15,493            $             7,434      $             21,676      $             26,994        
  

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

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MEDICIS PHARMACEUTICAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)

 

     Six Months Ended  

 

 
           June 30, 2012                June 30, 2011       

Operating Activities:

     

Net income

       $ 20,275               $ 48,143       

Loss from discontinued operations, net of income tax benefit

     -              13,054       
  

 

 

    

 

 

 

Net income from continuing operations

     20,275             61,197       
  

 

 

    

 

 

 

Adjustments to reconcile net income from continuing operations to net cash provided by operating activities from continuing operations:

     

Depreciation and amortization

     36,157             14,434       

Amortization of prior service costs, supplemental executive retirement plan

     2,419             400       

Amortization of discount on long-term debt

     1,750             -       

Amortization of debt issuance costs

     296             -       

Gain on sale of product rights

     (3,000)             -       

Charge reducing value of investment in a third party entity

     2,900             -       

Net gain on sale of available-for-sale investments and supplemental executive retirement plan investments, net

     (111)             (27)       

Share-based compensation expense

     12,191             16,009       

Deferred income tax (benefit)

     (3,137)             (877)       

Tax benefit from exercise of stock options and vesting of restricted stock awards

     1,153             1,864       

Excess tax benefits from share-based payment arrangements

     (4,647)             (2,872)       

(Decrease) increase in provision for sales discounts and chargebacks

     (1,865)             1,163       

Net amortization (accretion) of premium (discount) on investments

     1,071             2,604       

Changes in operating assets and liabilities:

     

Accounts receivable

     90,605             (36,940)       

Inventories

     (5,908)             4,453       

Prepaid income taxes

     (26,812)             (395)       

Other current assets

     (4,271)             (3,600)       

Accounts payable

     20,683             4,378       

Reserve for sales returns

     3,896             17,528       

Accrued consumer rebates and loyalty programs

     (58,708)             23,244       

Managed care and Medicaid reserves

     23,451             1,863       

Income taxes payable

     -             (4,628)       

Other current liabilities

     (6,473)             (12,607)       

Other liabilities

     5,228             128       
  

 

 

    

 

 

 

Net cash provided by operating activities from continuing operations

     107,143             87,319       
  

 

 

    

 

 

 

Net cash used in operating activities from discontinued operations

     -             (9,978)       
  

 

 

    

 

 

 

Net cash provided by operating activities

     107,143             77,341       

Investing Activities:

     

Purchase of property and equipment

     (8,942)             (2,834)       

Payments for purchase of product rights

     (109)             (12,824)       

Proceeds from sale of product rights

     6,000             -       

Purchase of investments for supplemental executive retirement plan

     (12,512)             -       

Purchase of available-for-sale investments

     (418,191)             (474,810)       

Sale of available-for-sale investments

     58,371             112,379       

Maturity of available-for-sale investments

     49,019             188,865       
  

 

 

    

 

 

 

Net cash used in investing activities

     (326,364)             (189,224)       

Financing Activities:

     

Payment of dividends

     (10,606)             (8,535)       

Proceeds from issuance of long-term debt

     500,000             -       

Purchase of hedge related to long-term debt

     (80,000)             -       

Proceeds from sale of warrants related to long-term debt

     35,150             -       

Payment of debt issuance costs

     (14,239)             -       

Payment of principal of long-term debt

     (3)             -       

Withholding of common shares for tax obligations on vested restricted stock awards

     (16,057)             (4,731)       

Excess tax benefits from share-based payment arrangements

     4,647             2,872       

Proceeds from the exercise of stock options

     13,549             54,049       
  

 

 

    

 

 

 

Net cash provided by financing activities

     432,441             43,655       

Effect of exchange rate on cash and cash equivalents

     51             67       
  

 

 

    

 

 

 

Net increase (decrease) in cash and cash equivalents

     213,271             (68,161)       

Cash and cash equivalents at beginning of period

     42,823             218,362       
  

 

 

    

 

 

 

Cash and cash equivalents at end of period

       $ 256,094               $ 150,201       
  

 

 

    

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

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Table of Contents

MEDICIS PHARMACEUTICAL CORPORATION

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2012

(unaudited)

 

1.

NATURE OF BUSINESS

Medicis Pharmaceutical Corporation (“Medicis” or the “Company”) is a leading specialty pharmaceutical company focusing primarily on helping patients attain a healthy and youthful appearance and self-image through the development and marketing in the United States (“U.S.”) and Canada of products for the treatment of dermatological and aesthetic conditions.

The Company offers a broad range of products addressing various conditions or aesthetic improvements including facial wrinkles, glabellar lines, acne, fungal infections, hyperpigmentation, photoaging, psoriasis, actinic keratosis, bronchospasms, external genital and perianal warts/condyloma acuminate, seborrheic dermatitis and cosmesis (improvement in the texture and appearance of skin). Medicis currently offers 29 branded products. Its primary brands are DYSPORT®, PERLANE®, RESTYLANE®, SOLODYN®, VANOS®, ZIANA® and ZYCLARA®.

The condensed consolidated financial statements include the accounts of Medicis and its wholly owned subsidiaries. The Company does not have any subsidiaries in which it does not own 100% of the outstanding stock. All of the Company’s subsidiaries are included in the condensed consolidated financial statements. All significant intercompany accounts and transactions have been eliminated in consolidation.

The accompanying interim condensed consolidated financial statements of Medicis have been prepared in conformity with U.S. generally accepted accounting principles, consistent in all material respects with those applied in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. The financial information is unaudited, but reflects all adjustments, consisting only of normal recurring adjustments and accruals, which are, in the opinion of the Company’s management, necessary to a fair statement of the results for the interim periods presented. Interim results are not necessarily indicative of results for a full year. The information included in this Form 10-Q should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

 

2.

DISCONTINUED OPERATIONS

On February 25, 2011, the Company announced that as a result of the Company’s strategic planning process and the existing regulatory and commercial capital equipment environment, the Company would explore strategic alternatives for its LipoSonix business including, but not limited to, the sale of the stand-alone business. As a result of this decision, the Company classified the LipoSonix business as a discontinued operation for consolidated financial statement reporting purposes. On November 1, 2011, the Company sold LipoSonix to Solta Medical, Inc.

 

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The following is a summary of loss from discontinued operations, net of income tax benefit, for the three and six months ended June 30, 2011 (in thousands):

 

      Three Months Ended      Six Months Ended  
     

June 30,

2011

    

June 30,

2011

 

Net revenues

       $ 200               $ 356       

Cost of revenues

     82             2,456       
  

 

 

    

 

 

 

Gross profit

     118             (2,100)      

Operating expenses:

     

Selling, general and administrative

     5,731             11,594       

Research and development

     3,302             6,648       
  

 

 

    

 

 

 

Loss from discontinued operations before income tax benefit

     (8,915)            (20,342)      

Income tax benefit

     (3,186)            (7,288)      
  

 

 

    

 

 

 

Loss from discontinued operations, net of income tax benefit

       $ (5,729)              $ (13,054)      
  

 

 

    

 

 

 

The Company included only revenues and costs directly attributable to the discontinued operations, and not those attributable to the ongoing entity. Accordingly, no interest expense or general corporate overhead costs were allocated to the LipoSonix discontinued operations. Included in cost of revenues for the six months ended June 30, 2011 was a $1.9 million charge related to an increase in the valuation reserve for LipoSonix inventory that was not expected to be sold.

The following is a summary of net cash used in operating activities from discontinued operations for the six months ended June 30, 2011 (in thousands):

 

        Six Months Ended    
    

June 30,

2011

 

 

 

Loss from discontinued operations, net of income tax benefit

       $ (13,054)       

Share-based compensation expense

     1,795       

Decrease in assets held for sale from discontinued operations

     2,879       

Decrease in liabilities held for sale from discontinued operations

     (1,598)       
  

 

 

 

Net cash used in operating activities from discontinued operations

       $ (9,978)       
  

 

 

 

 

3.

SHARE-BASED COMPENSATION

At June 30, 2012, the Company had seven active share-based employee compensation plans. Of these seven share-based compensation plans, only the 2006 Incentive Award Plan is eligible for the granting of future awards.

Stock Option Awards

Stock option awards are granted at the fair market value on the date of grant. The option awards vest over a period determined at the time the options are granted, ranging from one to five years, and generally have a maximum term of ten years. Certain options provide for accelerated vesting if there is a change in control (as defined in the plans). When options are exercised, new shares of the Company’s Class A common stock are issued.

 

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The total value of the stock option awards is expensed ratably over the service period of the employees receiving the awards. As of June 30, 2012, total unrecognized compensation cost related to stock option awards, to be recognized as expense subsequent to June 30, 2012, was approximately $1.5 million and the related weighted average period over which it is expected to be recognized is approximately 2.5 years.

A summary of stock option activity within the Company’s stock-based compensation plans and changes for the six months ended June 30, 2012, is as follows:

 

     

Number

    of Shares    

     Weighted
Average
Exercise
Price
    

Weighted

Average
Remaining
Contractual
Term

     Aggregate
Intrinsic
    Value    
 

Balance at December 31, 2011

         4,101,505            $       31.31             

Granted

     88,818            $       36.72             

Exercised

     (619,185)            $       22.47             

Terminated/expired

     (58,348)            $       38.28             
  

 

 

          

Balance at June 30, 2012

     3,512,790            $       32.88             2.3       $       11,322,820       
  

 

 

          

The intrinsic value of options exercised during the six months ended June 30, 2012 was approximately $8.7 million. Options exercisable under the Company’s share-based compensation plans at June 30, 2012 were 3,340,931 with a weighted average exercise price of $33.06, a weighted average remaining contractual term of 2.1 years, and an aggregate intrinsic value of approximately $10.3 million.

A summary of outstanding and exercisable stock options that are fully vested and are expected to vest, based on historical forfeiture rates, as of June 30, 2012, is as follows:

 

     

Number

    of Shares    

     Weighted
Average
Exercise
Price
    

Weighted

Average
Remaining
Contractual
Term

     Aggregate
Intrinsic
    Value    
 

Outstanding, net of expected forfeitures

     3,339,865       $       32.95         2.3       $       10,518,196   

Exercisable, net of expected forfeitures

     3,210,396       $       33.02         2.1       $       9,924,196   

The fair value of each stock option award is estimated on the date of the grant using the Black-Scholes option pricing model with the following assumptions:

 

      Six Months Ended
          June 30, 2012           June 30, 2011    

Expected dividend yield

   1.06% to 1.14%   0.77% to 0.88%

Expected stock price volatility

   0.31 to 0.32   0.33

Risk-free interest rate

   1.13% to 1.19%   2.47% to 2.81%

Expected life of options

   6.0 to 7.0 Years   7.0 Years

The expected dividend yield is based on expected annual dividends to be paid by the Company as a percentage of the market value of the Company’s stock as of the date of grant. The Company determined that a blend of implied volatility and historical volatility is more reflective of market conditions and a better indicator of expected volatility than

 

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using purely historical volatility. The risk-free interest rate is based on the U.S. treasury security rate in effect as of the date of grant whose term is consistent with the expected life of the related grant. The expected lives of the options are based on the Company’s historical exercise data.

The weighted average fair value of stock options granted during the six months ended June 30, 2012 and 2011, was $10.77 and $12.25, respectively.

Restricted Stock Awards

The Company also grants restricted stock awards to certain employees. Restricted stock awards are valued at the closing market value of the Company’s Class A common stock on the date of grant, and the total value of the award is expensed ratably over the service period of the employees receiving the grants. As of June 30, 2012, the total amount of unrecognized compensation cost related to nonvested restricted stock awards, to be recognized as expense subsequent to June 30, 2012, was approximately $47.4 million, and the related weighted average period over which it is expected to be recognized is approximately 3.5 years.

A summary of restricted stock activity within the Company’s share-based compensation plans and changes for the six months ended June 30, 2012, is as follows:

 

Nonvested Shares    Shares     

Weighted

Average
Grant-Date

    Fair Value    

 

Nonvested at December 31, 2011

             1,919,462           $ 22.61      

Granted

     705,807           $ 35.01      

Vested

     (585,722)           $ 20.54      

Forfeited

     (31,349)           $ 30.81      
  

 

 

    

Nonvested at June 30, 2012

     2,008,198           $ 27.44      
  

 

 

    

The total fair value of restricted shares vested during the six months ended June 30, 2012 and 2011 was approximately $12.0 million and $8.5 million, respectively.

Stock Appreciation Rights

During 2009, the Company began granting cash-settled stock appreciation rights (“SARs”) to many of its employees. SARs generally vest over a graduated five-year period and expire seven years from the date of grant, unless such expiration occurs sooner due to the employee’s termination of employment, as provided in the applicable SAR award agreement. SARs allow the holder to receive cash (less applicable tax withholding) upon the holder’s exercise, equal to the excess, if any, of the market price of the Company’s Class A common stock on the exercise date over the exercise price, multiplied by the number of shares relating to the SAR with respect to which the SAR is exercised. The exercise price of the SAR is the fair market value of a share of the Company’s Class A common stock relating to the SAR on the date of grant. The total value of the SAR is expensed over the service period of the employee receiving the grant, and a liability is recognized in the Company’s condensed consolidated balance sheets until settled. The fair value of SARs is required to be remeasured at the end of each reporting period until the award is settled, and changes in fair value must be recognized as compensation expense to the extent of vesting during each reporting period based on the new fair value. As of June 30, 2012, the total measured amount of unrecognized compensation cost related to outstanding SARs, to be recognized as expense subsequent to June 30, 2012, based on the remeasurement at June 30, 2012, was approximately $17.8 million, and the related weighted average period over which it is expected to be recognized is approximately 2.3 years.

 

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The fair value of each SAR was estimated on the date of the grant, and was remeasured at quarter-end, using the Black-Scholes option pricing model with the following assumptions:

 

     

Remeasurement
as of

June 30, 2012

  SARs Granted During the
Six Months Ended
June 30, 2011

Expected dividend yield

   1.17%   0.87%

Expected stock price volatility

   0.31   0.32

Risk-free interest rate

   0.41% to 0.72%   3.12%

Expected life of SARs

   2.7 to 4.6 Years   7.0 Years

No SARs were granted during the six months ended June 30, 2012. The weighted average fair value of SARs granted during the six months ended June 30, 2011, as of the grant date, was $9.90. The weighted average fair value of all SARs outstanding as of the remeasurement date of June 30, 2012 was $16.77.

A summary of SARs activity for the six months ended June 30, 2012 is as follows:

 

      Number
    of SARs    
     Weighted
Average
Exercise
Price
    

Weighted

Average
Remaining
Contractual
Term

     Aggregate
Intrinsic
    Value    
 

Balance at December 31, 2011

             2,323,060            $ 17.52        

Granted

     -             $ -         

Exercised

     (295,877)             $ 14.65        

Terminated/expired

     (82,983)             $ 17.55        
  

 

 

          

Balance at June 30, 2012

     1,944,200            $ 17.96        4.3      $ 31,484,679      
  

 

 

          

The intrinsic value of SARs exercised during the six months ended June 30, 2012 was approximately $6.3 million.

As of June 30, 2012, 175,195 SARs were exercisable, with a weighted average exercise price of $16.75, a weighted average remaining contractual term of 4.2 years, and an aggregate intrinsic value of approximately $3.0 million.

Total share-based compensation expense related to continuing operations recognized during the three and six months ended June 30, 2012 and 2011 was as follows (in thousands):

 

      Three Months Ended      Six Months Ended  
          June 30, 2012              June 30, 2011              June 30, 2012              June 30, 2011      

Stock options

       $ 209              $ 234              $ 404              $ 484      

Restricted stock awards

     3,364            3,197            6,983            5,799      

Stock appreciation rights

     (479)             5,889            4,804            9,726      
  

 

 

    

 

 

    

 

 

    

 

 

 

Total share-based compensation expense

       $ 3,094              $ 9,320              $ 12,191              $ 16,009      
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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4.

SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN

On June 24, 2011, the Company’s Compensation Committee adopted the Medicis Pharmaceutical Corporation Supplemental Executive Retirement Plan, as amended on October 3, 2011 (the “SERP”), a non-qualified, noncontributory, defined benefit pension plan that provides supplemental retirement income for a select group of officers, including the Company’s named executive officers. The SERP became effective as of June 1, 2011. Retirement benefits are calculated based on a percentage of a SERP participant’s average earnings, which ranges from 1.25% to 10% of the participant’s base salary plus cash bonus or incentive payments during any three calendar years of service, regardless of whether the years are consecutive, beginning with the 2009 calendar year. The percentage of average earnings is multiplied by the participant’s years of service up to a specified cap on service ranging from five to twenty years. In no event will an executive officer’s retirement benefit exceed 50% of his or her average earnings, and for those participants who are not executive officers, their retirement benefits will not exceed 25% of average earnings. The SERP retirement benefit is intended to be paid to participants who reach the “normal retirement date,” which is age 65, or age 59  1/2 with twenty years of service, subject to certain exceptions.

A SERP participant vests in 1/6th of his or her retirement benefit per plan year, (which runs from June 1 to May 31), effective as of the first day of the plan year, and becomes fully vested in his or her accrued retirement benefit upon (1) the participant’s normal retirement date, provided that the participant has at least fifteen years of service with the Company and is employed by the Company on such date, (2) the participant’s separation from service due to a discharge without “cause” or resignation for “good reason” (as such terms are defined in the participant’s employment agreement, or in the absence of such employment agreement or definitions, in the Company’s Executive Retention Plan), or (3) a “change in control” of the Company.

Participants in the SERP received credit for prior service with the Company. The prior service accrued benefit of approximately $33.8 million was recorded during the three months ended June 30, 2011 as other comprehensive income within stockholders’ equity, and is amortized as compensation expense over the remaining service years of each participant. The Company also established a deferred tax asset of approximately $12.0 million, the benefit of which was also recorded in other comprehensive income. During the three months ended March 31, 2012, an additional participant was added to the plan, and a prior service accrued benefit of approximately $0.8 million was recorded as other comprehensive income within stockholders’ equity, and is being amortized over the remaining service years of the participant. Total amortization of prior service costs recognized as compensation expense during the three and six months ended June 30, 2012, was approximately $1.2 million and $2.4 million, respectively. Amortization of prior service costs recognized as compensation expense during the three months ended June 30, 2011, was approximately $0.4 million, representing one month of amortization.

Compensation expense recognized during the three and six months ended June 30, 2012 related to current service costs was approximately $0.3 million and $0.5 million, respectively. Interest cost accrued related to prior and current service costs during the three and six months ended June 30, 2012 was approximately $0.4 million and $0.8 million, respectively. The total present value of accrued benefits for the SERP as of June 30, 2012 was approximately $37.1 million, which is included in other long-term liabilities in the Company’s condensed consolidated balance sheets as of June 30, 2012.

The Company maintains a rabbi trust to fund the SERP benefit. During the three months ended September 30, 2011 and three months ended June 30, 2012, the Company purchased life insurance policy investments of approximately $9.8 million and $12.1 million, respectively, to fund the SERP. The life insurance policies cover the SERP participants. The Company intends to make similar annual purchases during each of the next three years. During the three months ended March 31, 2012, the Company made an additional life insurance policy investment purchase of approximately $0.4 million related to the new participant added to the SERP during such time. No material net gains on the investments were recognized during the three or six months ended June 30, 2012. The Company’s expected return on the plan assets is 4%. The total investment related to the SERP of $22.4 million is included in other assets in the Company’s condensed consolidated balance sheets as of June 30, 2012, and is the cash surrender value of the life insurance policies, representing the fair value of the plan assets.

 

5.

SHORT-TERM AND LONG-TERM INVESTMENTS

The Company’s policy for its short-term and long-term investments is to establish a high-quality portfolio that preserves principal, meets liquidity needs, avoids inappropriate concentrations and delivers an appropriate yield in relationship to the Company’s investment guidelines and market conditions. Short-term and long-term investments

 

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consist of corporate and various government agency and municipal debt securities. The Company’s investments in auction rate floating securities consist of investments in student loans. Management classifies the Company’s short-term and long-term investments as available-for-sale. Available-for-sale securities are carried at fair value with unrealized gains and losses reported in stockholders’ equity. Realized gains and losses and declines in value judged to be other than temporary, if any, are included in other expense in the condensed consolidated statement of operations. A decline in the market value of any available-for-sale security below cost that is deemed to be other than temporary, results in impairment of the fair value of the investment. Except for impairments related to the illiquidity of the Company’s auction rate floating securities, other-than-temporary impairments are charged to earnings and a new cost basis for the security is established. Premiums and discounts are amortized or accreted over the life of the related available-for-sale security. Dividends and interest income are recognized when earned. The cost of securities sold is calculated using the specific identification method. At June 30, 2012, the Company has recorded the estimated fair value of available-for-sale securities in short-term and long-term investments of approximately $573.5 million and $22.6 million, respectively.

Available-for-sale securities consist of the following at June 30, 2012 (in thousands):

 

 

 
     June 30, 2012  
  

 

 

 
         Cost          Gross
Unrealized
    Gains    
     Gross
Unrealized
Losses
     Other-Than-
Temporary
Impairment
    Losses    
    

Fair

    Value    

 

 

 

Corporate notes and bonds

         $    299,940                $    338                $    (212)                 $    -                 $    300,066      

Federal agency notes and bonds

     236,684            220            (59)             -             236,845      

Auction rate floating securities

     17,350            -             (4,584)             -             12,766      

Asset-backed securities

     46,400            21            (14)             -             46,407      
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total securities

         $    600,374                $    579                $    (4,869)                 $    -                 $    596,084      
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

 
     December 31, 2011  
  

 

 

 
         Cost          Gross
Unrealized
    Gains    
     Gross
Unrealized
Losses
     Other-Than-
Temporary
Impairment
    Losses    
    

Fair

    Value    

 

 

 

Corporate notes and bonds

         $    138,554                $    161                $    (549)               $     -                 $    138,166      

Federal agency notes and bonds

     125,092            221            (24)             -             125,289      

Auction rate floating securities

     17,400            -             (4,607)             -             12,793      

Asset-backed securities

     9,527            -             (8)             -             9,519      
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total securities

         $    290,573                $    382                $    (5,188)               $ -                 $    285,767      
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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During the six months ended June 30, 2012, gross realized gains on sales of available-for-sale securities totaled approximately $0.1 million. During the three and six months ended June 30, 2012, there were no significant gross realized losses on sales of available-for-sale securities. During the three and six months ended June 30, 2011, there were no significant gross realized gains or losses on sales of available-for-sale securities. Gross unrealized gains and losses are determined based on the specific identification method. The net adjustment to unrealized losses during the six months ended June 30, 2012, on available-for-sale securities included in stockholders’ equity totaled approximately $0.3 million. The amortized cost and estimated fair value of the available-for-sale securities at June 30, 2012, by maturity, are shown below (in thousands):

 

 

 
     June 30, 2012  
  

 

 

 
     Cost          Estimated    
    Fair Value    
 

 

 

Available-for-sale

     

Due in one year or less

     $      261,275            $      261,399      

Due after one year through five years

     321,749            321,919      

Due after 10 years

     17,350            12,766      
  

 

 

    

 

 

 
       $      600,374            $      596,084      
  

 

 

    

 

 

 

Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties, and the Company views its available-for-sale securities as available for current operations. At June 30, 2012, approximately $22.6 million in estimated fair value expected to mature greater than one year has been classified as long-term investments since these investments are in an unrealized loss position, and management has both the ability and intent to hold these investments until recovery of fair value, which may be maturity.

As of June 30, 2012, the Company’s investments included auction rate floating securities with a fair value of $12.8 million. The Company’s auction rate floating securities are debt instruments with a long-term maturity and with an interest rate that is reset in short intervals through auctions. The negative conditions in the credit markets from 2008 through the first six months of 2012 have prevented some investors from liquidating their holdings, including their holdings of auction rate floating securities. During the three months ended March 31, 2008, the Company was informed that there was insufficient demand at auction for the auction rate floating securities. As a result, these affected auction rate floating securities are now considered illiquid, and the Company could be required to hold them until they are redeemed by the holder at maturity. The Company may not be able to liquidate the securities until a future auction on these investments is successful.

The following table shows the gross unrealized losses and the fair value of the Company’s investments, with unrealized losses that are not deemed to be other-than-temporarily impaired aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2012 (in thousands):

 

 

 
     Less Than 12 Months      Greater Than 12 Months  
  

 

 

 
    

Fair

Value

     Gross
Unrealized
Loss
    

Fair

Value

     Gross
Unrealized
Loss
 

 

 

Corporate notes and bonds

       $     144,330                $    (170)               $     1,958                $    (42)       

Federal agency notes and bonds

     136,641            (59)             -             -       

Auction rate floating securities

     -             -             12,766            (4,584)       

Asset-backed securities

     16,267            (14)             -             -       
  

 

 

    

 

 

    

 

 

    

 

 

 

Total securities

       $     297,238                $    (243)               $     14,724                $    (4,626)       
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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As of June 30, 2012, the Company has concluded that the unrealized losses on its investment securities are temporary in nature and are caused by changes in credit spreads and liquidity issues in the marketplace. Available-for-sale securities are reviewed quarterly for possible other-than-temporary impairment. This review includes an analysis of the facts and circumstances of each individual investment such as the severity of loss, the expectation for that security’s performance and the creditworthiness of the issuer. Additionally, the Company does not intend to sell and it is not more-likely-than-not that the Company will be required to sell any of the securities before the recovery of their amortized cost basis.

 

6.

FAIR VALUE MEASUREMENTS

As of June 30, 2012, the Company held certain assets that are required to be measured at fair value on a recurring basis. These included the Company’s short-term and long-term investments, including investments in auction rate floating securities.

The Company has invested in auction rate floating securities, which are classified as available-for-sale securities and reflected at fair value. Due to events in credit markets, the auction events for some of these instruments held by the Company failed during the three months ended March 31, 2008 (See Note 5). Therefore, the fair values of these auction rate floating securities, which are primarily rated AAA, are estimated utilizing a discounted cash flow analysis as of June 30, 2012. These analyses consider, among other items, the collateralization underlying the security investments, the creditworthiness of the counterparty, the timing of expected future cash flows, and the expectation of the next time the security is expected to have a successful auction. These investments were also compared, when possible, to other observable market data with similar characteristics to the securities held by the Company. Changes to these assumptions in future periods could result in additional declines in fair value of the auction rate floating securities.

 

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Table of Contents

The Company’s assets measured at fair value on a recurring basis subject to the disclosure requirements of ASC 820, Fair Value Measurements and Disclosures, at June 30, 2012 and December 31, 2011, were as follows (in thousands):

 

 

 
            Fair Value Measurement at Reporting Date Using  
     

 

 

 
         June 30, 2012         

Quoted

Prices in
Active
Markets
    (Level 1)    

    

Significant

Other

Observable

Inputs

    (Level 2)    

    

Significant
Unobservable
Inputs

    (Level 3)    

 

 

 

Corporate notes and bonds

       $     300,066               $ -               $     300,066               $ -       

Federal agency notes and bonds

     236,845             -             236,845             -       

Auction rate floating securities

     12,766             -             -             12,766       

Asset-backed securities

     46,407             -             46,407             -       
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets measured at fair value

       $     596,084               $ -               $     583,318               $     12,766       
  

 

 

    

 

 

    

 

 

    

 

 

 

 

 

 
            Fair Value Measurement at Reporting Date Using  
     

 

 

 
         Dec. 31, 2011         

Quoted

Prices in

Active
Markets
    (Level 1)    

    

Significant
Other
Observable
Inputs     

(Level 2)    

    

Significant
Unobservable
Inputs

    (Level 3)    

 

 

 

Corporate notes and bonds

       $     138,166               $ -               $     138,166               $ -       

Federal agency notes and bonds

     125,289             -             125,289             -       

Auction rate floating securities

     12,793             -             -             12,793       

Asset-backed securities

     9,519             -             9,519             -       
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets measured at fair value

       $     285,767               $ -               $     272,974               $     12,793       
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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The following tables present the Company’s assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and six months ended June 30, 2012 (in thousands):

 

 

    
     Fair Value
Measurements Using
Significant
Unobservable Inputs
(Level 3)
    
  

 

 

    
    

Auction Rate

Floating

Securities

    

 

    
     

Balance at March 31, 2012

       $     12,754          

Transfers to (from) Level 3

     -           

Total gains (losses) included in other (income) expense, net

     -           

Total gains included in other comprehensive income

     12          

Purchases

     -           

Settlements

     -           
  

 

 

    

Balance at June 30, 2012

       $     12,766          
  

 

 

    

 

    
     Fair Value
Measurements Using
Significant
Unobservable Inputs
(Level 3)
    
  

 

 

    
    

Auction Rate

Floating

Securities

    

 

    
     

Balance at December 31, 2011

       $     12,793          

Transfers to (from) Level 3

     -           

Total gains (losses) included in other (income) expense, net

     -           

Total gains included in other comprehensive income

     23          

Purchases

     -           

Settlements

     (50)          
  

 

 

    

Balance at June 30, 2012

       $     12,766          
  

 

 

    

The following is a description of the valuation techniques used for the assets measured at fair value classified within Level 2 or Level 3 of the fair value hierarchy:

Available-for-sale securities classified within Level 2 of the fair value hierarchy are valued utilizing reports from third-party asset managers that hold the Company’s investments, showing closing prices on the last business day of the period presented. These asset managers utilize an independent pricing source to obtain quotes for most fixed income securities, and utilize internal procedures to validate the prices obtained. In addition, the Company uses an independent third-party to perform price testing, comparing a sample of quoted prices listed in the asset managers’ reports to quotes listed through a public quotation service.

 

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Table of Contents

Available-for-sale securities classified within Level 3 of the fair value hierarchy (auction rate floating securities) are valued utilizing a discounted cash flow model. Key variables that are included in the Company’s calculation of the fair value of its auction rate floating securities utilizing a discounted cash flow model are weighted average cost of capital (“WACC”), liquidity horizon and estimated coupon rate. The liquidity horizon is an estimation of how long the liquidity issue of the auction rate floating securities will continue to exist. As part of its calculation of the fair value of its auction rate floating securities as of June 30, 2012, the Company used a WACC of 5.0%, a liquidity horizon of nine years, and an estimated coupon rate of a 12-month historical average for the indexes. The 12-month historical averages for 1-Month LIBOR and 90-Day T-Bills were 0.24% and 0.04%, respectively. As part of its assessment of these variables used in calculating the fair value of its auction rate floating securities, the Company performs a sensitivity analysis to understand the potential impact of using different amounts for these variables. As of June 30, 2012, the sensitivity analysis did not produce calculated fair values that were significantly different from those calculated using the variables described above.

 

7.

RESEARCH AND DEVELOPMENT

All research and development costs, including payments related to products under development and research consulting agreements, are expensed as incurred. The Company may continue to make non-refundable payments to third parties for new technologies and for research and development work that has been completed. These payments may be expensed at the time of payment depending on the nature of the payment made and the related stage of the research and development project.

The Company’s policy on accounting for costs of strategic collaborations determines the timing of the recognition of certain development costs. In addition, this policy determines whether the cost is classified as development expense or capitalized as an asset. Management is required to form judgments with respect to the commercial status of such products in determining whether development costs meet the criteria for immediate expense or capitalization. For example, when the Company acquires certain products for which there is already an Abbreviated New Drug Application (“ANDA”) or a New Drug Application (“NDA”) approval related directly to the product, and there is net realizable value based on projected sales for these products, the Company capitalizes the amount paid as an intangible asset.

Research and development expense for the three and six months ended June 30, 2012 and 2011 are as follows (in thousands):

 

 

 
      Three Months Ended      Six Months Ended  
         June 30,    
    2012    
        June 30,    
    2011    
         June 30,    
    2012    
         June 30,    
    2011    
 

 

 
          

Ongoing research and development costs

       $     15,376     $     7,080          $     27,504      $     13,948      

Payments related to strategic collaborations

     8,000       7,500            47,006        14,500      

Share-based compensation expense

     (64     615            633        1,020      
  

 

 

    

 

 

 

Total research and development

       $ 23,312     $ 15,195          $ 75,143      $ 29,468      
  

 

 

    

 

 

 

 

8.

STRATEGIC COLLABORATIONS

Development and License Agreement with a specialty pharmaceutical company

On March 30, 2012, the Company entered into a Development and License Agreement with a specialty pharmaceutical company pursuant to which the Company obtained exclusive worldwide rights for the development and commercialization of an investigational drug targeted at certain topical skin applications. Under the terms of the agreement, the Company agreed to pay an up-front payment of $25.0 million in connection with the execution of the agreement, and will pay up to an additional $80.0 million upon the achievement of certain research, development and regulatory milestones and up to an additional $120.0 million upon the achievement of certain commercial milestones, as well as royalties on future sales. The initial $25.0 million up-front payment, which was paid in April 2012, was recognized as research and development expense during the three months ended March 31, 2012.

 

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License Agreement with 3M

On February 24, 2012, the Company entered into a License Agreement with 3M Company and 3M Innovative Properties Company (collectively, “3M”) for worldwide rights to a number of leading molecules in 3M’s platform of immune response modifiers, for all topical dermatology indications and options for all human uses associated with the licensed molecules, excluding vaccine adjuvant. Under the terms of the agreement, the Company made an up-front payment of $7.5 million to 3M in connection with the execution of the agreement, and will pay up to an additional $25.6 million of contingent license and option fees. The Company may also pay up to an additional $25.0 million upon the achievement of certain research, development and regulatory milestones, as well as royalties on future sales. The initial $7.5 million payment was recognized as research and development expense during the three months ended March 31, 2012.

Joint Development Agreement with Lupin

On July 21, 2011, the Company entered into a Joint Development Agreement (the “Original Agreement”) with Lupin Limited, on behalf of itself and its affiliates (hereinafter collectively referred to as “Lupin”), whereby the Company and Lupin will collaborate to develop multiple novel proprietary therapeutic products. Pursuant to the Original Agreement, subject to the terms and conditions contained therein, the Company made an up-front $20.0 million payment to Lupin and was to make additional payments to Lupin upon the achievement of certain research, development, regulatory and other milestones, as well as royalty payments on sales of the products covered under the Original Agreement. In addition, the Company was to receive an exclusive, worldwide (excluding India) license on the sale of the products covered under the Original Agreement.

On March 30, 2012, the Company entered into an Amended and Restated Joint Development Agreement, with Lupin (the “Amended and Restated Joint Development Agreement”), which modified the list of products being developed. The Company made a $2.5 million payment to Lupin in April 2012 in connection with the execution of the Amended and Restated Joint Development Agreement, and will make additional payments to Lupin of up to $35.5 million upon the achievement of certain research, development, regulatory and other milestones, as well as royalty payments on sales of the products covered under the Amended and Restated Joint Development Agreement, which supersedes the additional payments the Company would have made under the Original Agreement. In addition, the Company will receive an exclusive, worldwide (excluding India) license on the sale of the products covered under the Amended and Restated Joint Development Agreement.

The $20.0 million up-front payment related to the Original Agreement was recognized as research and development expense during the three months ended September 30, 2011. The $2.5 million payment related to the Amended and Restated Joint Development Agreement was recognized as research and development expense during the three months ended March 31, 2012.

Amended and Restated Collaboration Agreement and Asset Purchase Agreement with Hyperion

On March 22, 2012, Ucyclyd Pharma, Inc. (“Ucyclyd”), a wholly-owned subsidiary of the Company, and Hyperion Therapeutics, Inc. (“Hyperion”) entered into an Amended and Restated Collaboration Agreement (the “Amended Collaboration Agreement”), which amended and restated their existing Collaboration Agreement, dated August 23, 2007, as previously amended on or about November 24, 2008, June 29, 2009 and October 12, 2009 (the “Prior Collaboration Agreement”).

Pursuant to the terms of the Prior Collaboration Agreement, Ucyclyd granted rights to Hyperion, exercisable in the future, to purchase certain worldwide rights to Ucyclyd’s existing on-market products AMMONUL® and BUPHENYL® under certain conditions, as well as to develop and commercialize Ravicti™, a compound referred to as HPN-100 (and also previously referred to as GT4P in the Prior Collaboration Agreement), for the treatment of urea cycle disorder, hepatic encephalopathies and other indications. The parties agreed to supersede the Prior Collaboration Agreement with the Amended Collaboration Agreement, under which Hyperion will continue to have the right, exercisable no earlier than January 1, 2013, to purchase certain worldwide rights to AMMONUL® and BUPHENYL®, subject to Ucyclyd’s right to elect to retain such rights to AMMONUL®, and an Asset Purchase Agreement of even date (the “APA”), under which Hyperion agreed to purchase Ucyclyd’s rights to Ravicti™ on the terms set forth therein. The parties completed the sale of Ravicti™ under the APA on March 22, 2012, for which Hyperion paid Ucyclyd $6.0 million. If Ravicti™ is not approved by the FDA by January 1, 2013, Ucyclyd will pay Hyperion $0.5 million per month until June 30, 2013, or until Ravicti™ is approved, whichever

 

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comes first, subject to a maximum of $3.0 million in aggregate payments. Pursuant to the APA, Hyperion will pay Ucyclyd certain royalties and regulatory and sales milestones relating to Ravicti™ and, pursuant to the terms of the Amended Collaboration Agreement, following exercise of its purchase rights, Hyperion will pay Ucyclyd certain royalties and regulatory and sales milestones relating to AMMONUL® (but only if Ucyclyd does not elect to retain rights to AMMUNOL®) and BUPHENYL®. Ucyclyd will continue to be entitled to all revenue from the sales of AMMONUL® and BUPHENYL® until the exercise of the purchase rights by Hyperion. If Hyperion elects to purchase AMMONUL® and BUPHENYL®, but Ucyclyd elects to retain AMMONUL®, then AMMONUL® will remain an asset of Ucyclyd and Ucyclyd will continue to be entitled to all revenue from the sales of AMMONUL®. A net gain of $3.0 million on the sale of Ravicti™ to Hyperion was recognized in other income during the three months ended March 31, 2012. This consisted of the $6.0 million payment Ucyclyd received from Hyperion, partially offset by the $3.0 million in total potential contingent payments that Ucyclyd could pay to Hyperion during the first six months of 2013, based upon the timing of the approval of Ravicti™ by the FDA. The $3.0 million contingent liability is included in other current liabilities in the Company’s condensed consolidated balance sheets as of June 30, 2012.

Collaboration with a privately-held U.S. biotechnology company

On September 10, 2010, the Company and a privately-held U.S. biotechnology company entered into a sublicense and development agreement to develop an agent for specific dermatological conditions in the Americas and Europe and a purchase option to acquire the privately-held U.S. biotechnology company.

Under the terms of the agreements, the Company paid the privately-held U.S. biotechnology company $5.0 million in connection with the execution of the agreement, and will pay additional potential milestone payments totaling approximately $100.5 million upon successful completion of certain clinical, regulatory and commercial milestones.

During the three months ended December 31, 2010 and June 30, 2011, development milestones were achieved, and the Company made a $10.0 million and a $5.5 million payment, respectively, pursuant to the agreements. The initial $5.0 million payment and the $10.0 million milestone payment were recognized as research and development expense during 2010, and the $5.5 million milestone payment was recognized as research and development expense during the three months ended June 30, 2011. As of June 30, 2012, $75.0 million of potential milestone payments upon successful completion of certain clinical, regulatory and commercial milestones remain.

Research and Development Agreement with Anacor

On February 9, 2011, the Company entered into a research and development agreement with Anacor Pharmaceuticals, Inc. (“Anacor”) for the discovery and development of boron-based small molecule compounds directed against a target for the potential treatment of acne. Under the terms of the agreement, the Company paid Anacor $7.0 million in connection with the execution of the agreement, and will pay up to $153.0 million upon the achievement of certain research, development, regulatory and commercial milestones, as well as royalties on sales by the Company. Anacor will be responsible for discovering and conducting the early development of product candidates which utilize Anacor’s proprietary boron chemistry platform, while the Company will have an option to obtain an exclusive license for products covered by the agreement. The initial $7.0 million payment was recognized as research and development expense during the three months ended March 31, 2011.

 

9.

SEGMENT AND PRODUCT INFORMATION

The Company operates in one business segment: pharmaceuticals. The Company’s current pharmaceutical franchises are divided between the dermatological and non-dermatological fields. The dermatological field represents products for the treatment of acne and acne-related dermatological conditions and non-acne dermatological conditions. The non-dermatological field represents products for the treatment of urea cycle disorder, contract revenue, and beginning on December 2, 2011, upon the Company’s acquisition of the assets of Graceway Pharmaceuticals, LLC (“Graceway”), products in the respiratory and women’s health specialties. The acne and acne-related dermatological product lines include SOLODYN® and ZIANA®. During early 2011, the Company discontinued its TRIAZ® branded products and decided to no longer promote its PLEXION® branded products. The non-acne dermatological product lines include DYSPORT®, LOPROX®, PERLANE®, RESTYLANE®, VANOS® and ZYCLARA®. ZYCLARA® was acquired by the Company as part of the acquisition of the assets of Graceway on December 2, 2011. The non-dermatological product lines include AMMONUL®, BUPHENYL® and the MAXAIR® AUTOHALER®. The MAXAIR® AUTOHALER® was acquired by the Company as part of the acquisition of the assets of Graceway on December 2, 2011.  The non-dermatological field also includes contract revenues associated with licensing agreements and authorized generic agreements.

 

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The Company’s pharmaceutical products, with the exception of AMMONUL® and BUPHENYL®, are promoted to dermatologists and plastic surgeons. Such products are often prescribed by physicians outside these two specialties, including family practitioners, general practitioners, primary-care physicians and OB/GYNs, as well as hospitals, government agencies and others. ZIANA® and SOLODYN® are also promoted to pediatricians whose prescribing habits closely resemble those of dermatologists. Currently, the Company’s products are sold primarily to wholesalers and retail chain drug stores.

Net revenues and the percentage of net revenues for each of the product categories are as follows (amounts in thousands):

 

 

 
     Three Months Ended     Six Months Ended  
  

 

 

   

 

 

 
         June 30,    
2012
        June 30,    
2011
        June 30,    
2012
        June 30,    
2011
 

 

 

Acne and acne-related dermatological products

       $     93,131              $         123,130         $     201,632              $         226,592      

Non-acne dermatological products

     81,113           57,719       155,112           109,940      

Non-dermatological products

     22,310           9,978       41,553           19,208      
  

 

 

 

Total net revenues

       $     196,554              $         190,827         $     398,297              $         355,740      
  

 

 

 
        

 

 
     Three Months Ended     Six Months Ended  
  

 

 

   

 

 

 
    

    June 30,    

2012

   

    June 30,    

2011

   

    June 30,    

2012

   

    June 30,    

2011

 

 

 

Acne and acne-related dermatological products

     48         65         51         64    

Non-acne dermatological products

     41           30           39           31      

Non-dermatological products

     11           5           10           5      
  

 

 

 

Total net revenues

     100         100         100         100    
  

 

 

 

During the three and six months ended June 30, 2012, approximately 5.3% and 5.1% of the Company’s net revenues were generated in Canada. No country or region outside of the U.S. and Canada generated more than 5%, individually or in the aggregate, of the Company’s net revenues during the three or six months ended June 30, 2012. During the three and six months ended June 30, 2011, less than 5% of the Company’s net revenues were generated outside of the U.S.

 

10.

INVENTORIES

The Company utilizes third parties to manufacture and package inventories held for sale, takes title to certain inventories once manufactured, and warehouses such goods until packaged for final distribution and sale. Inventories consist of salable products held at the Company’s warehouses, as well as raw materials and components at the manufacturers’ facilities, and are valued at the lower of cost or market using the first-in, first-out method. The Company provides valuation reserves for estimated obsolescence or unmarketable inventory in an amount equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions.

Inventory costs associated with products that have not yet received regulatory approval are capitalized if, in the view of the Company’s management, there is probable future commercial use and future economic benefit. If future commercial use and future economic benefit are not considered probable, then costs associated with pre-launch inventory that has not yet received regulatory approval are expensed as research and development expense during the period the costs are incurred. As of June 30, 2012 and December 31, 2011, there were no costs capitalized into inventory for products that had not yet received regulatory approval.

 

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Inventories as of June 30, 2012 and December 31, 2011 is comprised of the following (in thousands):

 

      June 30, 2012     December 31, 2011  

Raw materials

   $ 11,752     $ 9,100  

Work-in-process

     1,148       5,495  

Finished goods

     31,572       29,250  

Valuation reserve

     (4,045     (9,326
  

 

 

   

 

 

 

Total inventories

   $ 40,427     $ 34,519  
  

 

 

   

 

 

 

11. OTHER CURRENT LIABILITIES

Other current liabilities as of June 30, 2012 and December 31, 2011 is comprised of the following (in thousands):

 

      June 30, 2012      December 31, 2011  

Accrued incentives, including SARs liability

   $ 33,331      $ 41,516  

Deferred revenue

     17,129        13,703  

Other accrued expenses

     30,920        23,566  
  

 

 

    

 

 

 
   $ 81,380      $ 78,785  
  

 

 

    

 

 

 

Deferred revenue as of June 30, 2012 and December 31, 2011 is comprised of the following (in thousands):

 

      June 30, 2012      December 31, 2011  

Deferred revenue - aesthetics products, net of cost of revenue

   $ 8,917      $ 13,349  

Deferred revenue - sales into distribution channel in excess of eight weeks of projected demand

     8,070        212  

Other deferred revenue

     142        142  
  

 

 

    

 

 

 
   $ 17,129      $ 13,703  
  

 

 

    

 

 

 

The Company defers revenue, and the related cost of revenue, of its aesthetics products, including DYSPORT®, PERLANE® and RESTYLANE®, until its exclusive U.S. distributor ships the product to physicians. The Company also defers the recognition of revenue for certain sales of inventory into the distribution channel that are in excess of eight (8) weeks of projected demand. The increase in deferred revenue for units in the distribution channel in excess of eight weeks of projected demand during the six months ended June 30, 2012 was primarily associated with units of SOLODYN® and ZYCLARA®.

 

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12. LONG-TERM DEBT

Long-term debt as of June 30, 2012 and December 31, 2011 is comprised of the following (in thousands):

 

      June 30, 2012     December 31, 2011  

1.375% Convertible Senior Notes

   $ 500,000     $ -   

Discount on 1.375% Convertible Senior Notes

     (77,764     -   
  

 

 

   

 

 

 

1.375% Convertible Senior Notes, net of discount

     422,236       -   

2.5% Contingent Convertible Senior Notes

     168,926       169,145  

1.5% Contingent Convertible Senior Notes

     181       181  
  

 

 

   

 

 

 
     591,343       169,326  

Less current portion

     (181     (169,145
  

 

 

   

 

 

 

Total long-term debt

   $ 591,162     $ 181  
  

 

 

   

 

 

 

1.375% Convertible Senior Notes Due 2017

On May 16, 2012, the Company issued and sold $500.0 million of its 1.375% Convertible Senior Notes due 2017 (the “1.375% Notes”) in a public offering. The 1.375% Notes will mature on June 1, 2017 and pay 1.375% annual cash interest, payable semi-annually in arrears on June 1 and December 1 of each year, beginning on December 1, 2012.

On or after March 1, 2017, until the close of business on the second scheduled trading day immediately preceding the stated maturity date, or prior to then but only under certain circumstances, the 1.375% Notes will be convertible into cash up to the principal amount, with the remaining amount, if any, to be satisfied, at the Company’s option, in shares of the Company’s Class A common stock, cash or a combination thereof. The 1.375% Notes will be convertible at an initial conversion rate of 21.2427 shares of the Company’s Class A common stock per $1,000 principal amount of the 1.375% Notes, subject to adjustment upon certain events, which is equivalent to an initial conversion price of approximately $47.07 per share of the Company’s Class A common stock.

The 1.375% Notes are convertible, at the holders’ option, prior to the close of business on the business day immediately preceding March 1, 2017, into shares of the Company’s Class A common stock in the following circumstances:

 

   

during any calendar quarter commencing after the calendar quarter ending on September 30, 2012, if the closing price of the Company’s Class A common stock over a specified number of trading days during the previous quarter, including the last trading day of such quarter, is more than 130% of the conversion price of the 1.375% Notes in effect on each applicable trading day;

 

   

during the five consecutive trading day period immediately following any ten consecutive trading day period in which the trading price of the 1.375% Notes per $1,000 principal amount for each such trading day was less than 98% of the product of the closing sale price of the Company’s Class A common stock on such days and the then-current conversion rate of $1,000 principal amount of the 1.375% Notes; or

 

   

upon the occurrence of specified corporate transactions.

The 1.375% Notes are senior unsecured obligations of the Company and are not guaranteed by any of the Company’s subsidiaries. The 1.375% Notes rank senior in right of payment to the Company’s existing and future indebtedness that is expressly subordinated in right of payment to the 1.375% Notes; equal in right of payment to the Company’s existing and future unsecured indebtedness that is not so subordinated; effectively junior in right of payment to any of the Company’s secured indebtedness to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future indebtedness (including trade payables) incurred by the Company’s subsidiaries.

The 1.375% Notes do not contain any restrictions on the payment of dividends, the incurrence of additional indebtedness or the repurchase of the Company’s securities and do not contain any financial covenants. The 1.375% Notes require an anti-dilution adjustment to the conversion rate upon certain specified corporate dividend or common stock events or transactions, and if such event or transaction would result in at least a one percent (1%) change in the conversion rate. If the one percent (1%) threshold is not met on a particular qualifying event or

 

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transaction, the adjustment is carried forward and taken into account when a subsequent qualifying event or transaction is assessed for potential conversion rate adjustment. The Company may not redeem the 1.375% Notes prior to maturity and no sinking fund will be provided for the 1.375% Notes. If the Company undergoes a fundamental change, subject to certain conditions, holders of the 1.375% Notes may require the Company to purchase 1.375% Notes in whole or in part for cash at a fundamental change purchase price equal to 100% of the principal amount of the 1.375% Notes to be purchased, plus accrued and unpaid interest, if any, to, but excluding the fundamental change purchase date. In certain events of default, as defined in the 1.375% Notes indenture, the trustee by notice to the Company, or the holders of at least 25% in principal amount of the then outstanding 1.375% Notes by notice to the Company and trustee, may declare 100% of the principal of, and accrued and unpaid interest, if any, on, all outstanding 1.375% Notes to be due and payable. Upon such a declaration, such principal and accrued and unpaid interest, if any, will be due and payable immediately.

As of June 30, 2012, the 1.375% Notes were not convertible.

The conversion feature embedded within the 1.375% Notes is considered a derivative; however, it has not been bifurcated and accounted for separately because it is considered to be indexed to the Company’s Class A common stock and meets the criteria for equity classification. Because the 1.375% Notes are considered to be cash convertible debt, the Company has separately accounted for the liability and equity components of the 1.375% Notes by allocating the $500.0 million in proceeds from the issuance between the liability component and the embedded conversion option, or the equity component. The allocation was conducted by estimating an interest rate at the time of issuance of the 1.375% Notes for similar debt instruments that do not include the embedded conversion feature. A straight-debt interest rate of 5.0% was used to compute the initial fair value of the liability component of $420.5 million. For purposes of the fair value measurement, the Company determined that the valuation of the 1.375% Notes falls under Level 2 of the fair value hierarchy. The excess of the $500.0 million of proceeds from the issuance of the 1.375% Notes over the $420.5 million initial amount allocated to the liability component, or $79.5 million, was allocated to the embedded conversion option, or equity component. This excess was treated as a debt discount and is being amortized through interest expense, using the effective interest method, over the five-year term of the 1.375% Notes, which runs through June 1, 2017.

In connection with the offering of the 1.375% Notes, on May 10, 2012 and May 11, 2012, the Company entered into privately negotiated convertible note hedge transactions (the “Convertible Note Hedge Transactions”) with affiliates of the underwriters of the 1.375% Notes (the “Option Counterparties”). The Convertible Note Hedge Transactions cover, collectively, the number of shares of the Company’s Class A common stock underlying the 1.375% Notes, subject to anti-dilution adjustments substantially similar to those applicable to the 1.375% Notes. The Company purchased these hedges for $80.0 million, in aggregate, which was recorded as a reduction in additional paid-in capital during the three months ended June 30, 2012. The Company also entered into separate, privately-negotiated warrant transactions with the Option Counterparties on May 10, 2012 and into additional warrant transactions with the Option Counterparties on May 11, 2012 (collectively, the “Warrant Transactions” and together with the Convertible Note Hedge Transactions, the “Convertible Note Hedge and Warrant Transactions”), initially covering a number of shares of the Company’s Class A common stock underlying the 1.375% Notes, subject to customary anti-dilution adjustments. Subject to certain conditions, the Company may settle the warrants in cash or on a net-share basis. The warrants were issued and sold for proceeds of approximately $35.2 million, which was recorded as an increase in additional paid-in capital during the three months ended June 30, 2012.

The Convertible Note Hedge Transactions are expected to reduce the potential economic dilution with respect to the Company’s Class A common stock and/or reduce the Company’s exposure to potential cash payments that may be required upon conversion of the 1.375% Notes. The strike price of the Warrant Transactions will initially be approximately $60.26 per share, which represents a premium of approximately 60% over the last reported sale price of $37.66 per share of the Company’s Class A common stock on The New York Stock Exchange on May 10, 2012.

The Convertible Note Hedge and Warrant Transactions are considered derivative instruments; however, they have been classified within stockholders’ equity because both financial instruments are considered to be indexed to the Company’s Class A common stock and meet the criteria for equity classification.

The Convertible Note Hedge and Warrant Transactions have been accounted for as separate financial instruments, in each case, entered into by the Company with the Option Counterparties, and are not part of the terms of the 1.375% Notes and will not affect any holder’s rights under the 1.375% Notes. Holders of the 1.375% Notes will not have any rights with respect to the Convertible Note Hedge and Warrant Transactions.

 

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The Company incurred $14.2 million of fees and other origination costs related to the issuance of the 1.375% Notes. These fees and other origination costs have been allocated to the liability and equity components of the 1.375% Notes in proportion to their allocated values. Approximately $2.3 million of these fees and other origination costs were recorded as a reduction in additional paid-in capital. The remaining $11.9 million of fees and other origination costs are included in other assets in the Company’s condensed consolidated balance sheets and are being amortized through interest expense over the five-year term of the 1.375% Notes, which runs through June 1, 2017.

 

2.5%

Contingent Convertible Senior Notes Due 2032

In June 2002, the Company sold $400.0 million aggregate principal amount of its 2.5% Contingent Convertible Senior Notes Due 2032 (the “2.5% Notes”) in private transactions. As discussed below, approximately $230.8 million in principal amount of the 2.5% Notes was exchanged for 1.5% Notes on August 14, 2003. The 2.5% Notes bear interest at a rate of 2.5% per annum, which is payable on June 4 and December 4 of each year, beginning on December 4, 2002. The Company also agreed to pay contingent interest at a rate equal to 0.5% per annum during any six-month period, with the initial six-month period commencing June 4, 2007, if the average trading price of the 2.5% Notes reaches certain thresholds. Contingent interest of approximately $0.1 million related to the 2.5% Notes was payable at June 30, 2012. No contingent interest related to the 2.5% Notes was payable at December 31, 2011. The 2.5% Notes will mature on June 4, 2032.

The Company may redeem some or all of the 2.5% Notes at any time on or after June 11, 2007, at a redemption price, payable in cash, of 100% of the principal amount of the 2.5% Notes, plus accrued and unpaid interest, including contingent interest, if any. Holders of the 2.5% Notes may require the Company to repurchase all or a portion of their 2.5% Notes on June 4, 2017, or upon a change in control, as defined in the indenture governing the 2.5% Notes, at 100% of the principal amount of the 2.5% Notes, plus accrued and unpaid interest to the date of the repurchase, payable in cash. Holders of the 2.5% Notes also had this option on June 4, 2012. Under GAAP, if an obligation is due on demand or will be due on demand within one year from the balance sheet date, even though liquidation may not be expected within that period, it should be classified as a current liability. Accordingly, the outstanding balance of 2.5% Notes along with the deferred tax liability associated with accelerated interest deductions on the 2.5% Notes are classified as a current liability during the respective twelve month periods prior to June 4, 2012 and June 4, 2017. As of December 31, 2011, $169.1 million of the 2.5% Notes and $62.5 million of deferred tax liabilities were classified as current liabilities in the Company’s condensed consolidated balance sheets. The $62.5 million of deferred tax liabilities were included within current deferred tax assets, net.

On May 3, 2012, the Company filed with the Securities and Exchange Commission (the “SEC”) a Tender Offer Statement on Schedule TO and a notice (the “Company Notice”) to the holders of the 2.5% Notes related to the option of the holders to require the Company to repurchase all or a portion of their 2.5% Notes on June 4, 2012. In addition, such Company Notice was made available through The Depository Trust Company and Deutsche Bank Trust Company Americas, the paying agent.

The Company Notice specified the terms, conditions and procedures for surrendering and withdrawing the 2.5% Notes for purchase. Specifically, the Company Notice provided that the opportunity to surrender the 2.5% Notes for purchase would commence on May 3, 2012, and would terminate at 5:00 p.m., Eastern Time, on Friday, June 1, 2012, and also that the holders of the 2.5% Notes could withdraw any 2.5% Notes previously surrendered for purchase at any time prior to 5:00 p.m., Eastern Time, on June 1, 2012.

The Company Notice also stated that holders that did not surrender their 2.5% Notes for purchase would maintain the right to convert their 2.5% Notes into shares of the Company’s Class A common stock, as further described below.

Holders of $3,000 in principal amount of the 2.5% Notes requested to have their 2.5% Notes repurchased by the Company.

The 2.5% Notes are convertible, at the holders’ option, prior to the maturity date into shares of the Company’s Class A common stock in the following circumstances:

 

   

during any quarter commencing after June 30, 2002, if the closing price of the Company’s Class A common stock over a specified number of trading days during the previous quarter, including the last trading day of such quarter, is more than 110% of the conversion price of the 2.5% Notes, or $31.96. The 2.5% Notes are initially convertible at a conversion price of $29.05 per share, which is equal to a conversion rate of approximately 34.4234 shares per $1,000 principal amount of 2.5% Notes, subject to adjustment;

 

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if the Company has called the 2.5% Notes for redemption;

 

   

during the five trading day period immediately following any nine consecutive day trading period in which the trading price of the 2.5% Notes per $1,000 principal amount for each day of such period was less than 95% of the product of the closing sale price of the Company’s Class A common stock on such days multiplied by the number of shares of the Company’s Class A common stock issuable upon conversion of $1,000 principal amount of the 2.5% Notes; or

 

   

upon the occurrence of specified corporate transactions.

The 2.5% Notes, which are unsecured, do not contain any restrictions on the payment of dividends, the incurrence of additional indebtedness or the repurchase of the Company’s securities and do not contain any financial covenants.

The Company incurred $12.6 million of fees and other origination costs related to the issuance of the 2.5% Notes. The Company amortized these costs over the first five-year Put period, which ran through June 4, 2007.

During the quarters ended December 31, 2011, March 31, 2012 and June 30, 2012, the 2.5% Notes met the criteria for the right of conversion into shares of the Company’s Class A common stock. This right of conversion of the holders of 2.5% Notes was triggered by the stock closing above $31.96 on 20 of the last 30 trading days and the last trading day of the quarters ended December 31, 2011, March 31, 2012 and June 30, 2012. During the quarter ended June 30, 2012, outstanding principal amounts of $216,000 of 2.5% Notes were converted into shares of the Company’s Class A common stock. The holders of the remaining $168.9 million of 2.5% Notes have this conversion right only until September 30, 2012. At the end of each future quarter, the conversion rights will be reassessed in accordance with the bond indenture agreement to determine if the conversion trigger rights have been achieved.

 

1.5%

Contingent Convertible Senior Notes Due 2033

On August 14, 2003, the Company exchanged approximately $230.8 million in principal amount of its 2.5% Notes for approximately $283.9 million in principal amount of its 1.5% Contingent Convertible Senior Notes Due 2033 (the “1.5% Notes”). Holders of 2.5% Notes that accepted the Company’s exchange offer received $1,230 in principal amount of 1.5% Notes for each $1,000 in principal amount of 2.5% Notes. The terms of the 1.5% Notes are similar to the terms of the 2.5% Notes, but have a different interest rate, conversion rate and maturity date. Holders of 2.5% Notes that chose not to exchange continue to be subject to the terms of the 2.5% Notes.

The 1.5% Notes bear interest at a rate of 1.5% per annum, which is payable on June 4 and December 4 of each year, beginning December 4, 2003. The Company will also pay contingent interest at a rate of 0.5% per annum during any six-month period, with the initial six-month period commencing June 4, 2008, if the average trading price of the 1.5% Notes reaches certain thresholds. No contingent interest related to the 1.5% Notes was payable at June 30, 2012 or December 31, 2011. The 1.5% Notes will mature on June 4, 2033.

As a result of the exchange, the outstanding principal amounts of the 2.5% Notes and the 1.5% Notes were $169.2 million and $283.9 million, respectively. The Company incurred approximately $5.1 million of fees and other origination costs related to the issuance of the 1.5% Notes. The Company amortized these costs over the first five-year Put period, which ran through June 4, 2008.

Holders of the 1.5% Notes were able to require the Company to repurchase all or a portion of their 1.5% Notes on June 4, 2008, at 100% of the principal amount of the 1.5% Notes, plus accrued and unpaid interest, including contingent interest, if any, to the date of the repurchase, payable in cash. Holders of approximately $283.7 million of 1.5% Notes elected to require the Company to repurchase their 1.5% Notes on June 4, 2008. The Company paid $283.7 million, plus accrued and unpaid interest of approximately $2.2 million, to the holders of 1.5% Notes that elected to require the Company to repurchase their 1.5% Notes. The Company was also required to

 

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pay an accumulated deferred tax liability of approximately $34.9 million related to the repurchased 1.5% Notes. This $34.9 million deferred tax liability was paid during the second half of 2008. Following the repurchase of these 1.5% Notes, $181,000 of principal amount of 1.5% Notes remained outstanding as of June 30, 2012 and December 31, 2011.

Remaining holders of the 1.5% Notes may require the Company to repurchase all or a portion of their 1.5% Notes on June 4, 2013 and June 4, 2018, or upon a change in control, as defined in the indenture governing the 1.5% Notes, at 100% of the principal amount of the 1.5% Notes, plus accrued and unpaid interest to the date of the repurchase, payable in cash. Under GAAP, if an obligation is due on demand or will be due on demand within one year from the balance sheet date, even though liquidation may not be expected within that period, it should be classified as a current liability. Accordingly, the outstanding balance of 1.5% Notes along with the deferred tax liability associated with accelerated interest deductions on the 1.5% Notes will be classified as a current liability during the respective twelve month periods prior to June 4, 2013 and June 4, 2018. As of June 30, 2012, $181,000 of the 1.5% Notes and $55,000 of deferred tax liabilities were classified as current liabilities in the Company’s condensed consolidated balance sheets. The $55,000 of deferred tax liabilities were included within current deferred tax assets, net.

The remaining 1.5% Notes are convertible, at the holders’ option, prior to the maturity date into shares of the Company’s Class A common stock in the following circumstances:

 

   

during any quarter commencing after September 30, 2003, if the closing price of the Company’s Class A common stock over a specified number of trading days during the previous quarter, including the last trading day of such quarter, is more than 120% of the conversion price of the 1.5% Notes, or $46.51. The 1.5% Notes are initially convertible at a conversion price of $38.76 per share, which is equal to a conversion rate of approximately 25.7998 shares per $1,000 principal amount of 1.5% Notes, subject to adjustment;

 

   

if the Company has called the 1.5% Notes for redemption;

 

   

during the five trading day period immediately following any nine consecutive day trading period in which the trading price of the 1.5% Notes per $1,000 principal amount for each day of such period was less than 95% of the product of the closing sale price of the Company’s Class A common stock on such days multiplied by the number of shares of the Company’s Class A common stock issuable upon conversion of $1,000 principal amount of the 1.5% Notes; or

 

   

upon the occurrence of specified corporate transactions.

The remaining 1.5% Notes, which are unsecured, do not contain any restrictions on the incurrence of additional indebtedness or the repurchase of the Company’s securities and do not contain any financial covenants. The 1.5% Notes require an adjustment to the conversion price if the cumulative aggregate of all current and prior dividend increases, through June 11, 2008, above $0.025 per share would result in at least a one percent (1%) increase in the conversion price. This threshold was not reached and no adjustment to the conversion price has been made.

During the quarter ended June 30, 2012, the 1.5% Notes did not meet the criteria for the right of conversion.

 

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Interest expense

Interest expense recognized related to the Company’s long-term debt during the three and six months ended June 30, 2012 and 2011 was as follows (in thousands):

 

  

   Three Months Ended      Six Months Ended  
      June 30,
2012
     June 30,
2011
    

June 30,

2012

     June 30,
2011
 

1.375% Notes:

           

Coupon rate interest

   $ 850      $ -       $ 850      $ -   

Amortization of discount

     1,750        -         1,750        -   

Amortization of issuance costs

     296        -         296        -   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total 1.375% Notes

     2,896        -         2,896        -   
  

 

 

    

 

 

    

 

 

    

 

 

 

2.5% Notes:

           

Coupon rate interest

     1,057        1,057        2,114        2,114  

Contingent interest

     70        70        70        70  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total 2.5% Notes

     1,127        1,127        2,184        2,184  
  

 

 

    

 

 

    

 

 

    

 

 

 

1.5% Notes:

           

Coupon rate interest

     1        1        2        2  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total 1.5% Notes

     1        1        2        2  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest expense related to long-term debt

   $ 4,024      $ 1,128      $ 5,082      $ 2,186  
  

 

 

    

 

 

    

 

 

    

 

 

 

Fair value of long-term debt

The fair value of the Company’s long-term debt, based on market quotations, was approximately $707.6 million and $202.5 million at June 30, 2012 and December 31, 2011, respectively. The fair value of the long-term debt held as of June 30, 2012 and December 31, 2011 were valued using Level 2 pricing inputs based on quoted prices for similar instruments in markets that are not active, and through model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

13.

INCOME TAXES

Income taxes are determined using an annual effective tax rate, which generally differs from the U.S. Federal statutory rate, primarily because of state and local income taxes, enhanced charitable contribution deductions for inventory, tax credits available in the U.S., the treatment of certain share-based payments that are not designed to normally result in tax deductions, various expenses that are not deductible for tax purposes, changes in the reserve for uncertain tax positions, changes in valuation allowances against deferred tax assets and differences in tax rates in certain non-U.S. jurisdictions. The Company’s effective tax rate may be subject to fluctuations during the year as new information is obtained which may affect the assumptions it uses to estimate its annual effective tax rate, including factors such as its mix of pre-tax earnings in the various tax jurisdictions in which it operates, changes in valuation allowances against deferred tax assets, reserves for tax audit issues and settlements, utilization of tax credits and changes in tax laws in jurisdictions where the Company conducts operations. The Company recognizes tax benefits only if the tax position is more likely than not of being sustained. The Company recognizes deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of its assets and liabilities, along with net operating losses and credit carryforwards. The Company records valuation allowances against its deferred tax assets to reduce the net carrying value to amounts that management believes is more likely than not to be realized.

On November 1, 2011, the Company closed its sale of all issued and outstanding shares of common stock of LipoSonix to Solta. The transaction resulted in a $30.5 million capital loss for income tax purposes, of which $26.2 million can be carried back and used to offset capital gains generated in prior tax years. Accordingly, an

 

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income tax benefit of $9.4 million was recognized and is included in the gain from discontinued operations for the year ended December 31, 2011. A deferred tax asset was recorded on the portion of the capital loss ($4.3 million) that could not be carried back to prior years. As a capital loss can only be utilized to offset capital gains, the Company recorded at December 31, 2011 a valuation allowance of $1.5 million against the deferred tax asset in order to reduce the carrying value of the deferred tax asset to $0, which was the amount that management believed was more likely than not to be realized. During the six months ended June 30, 2012, the Company recognized a $6.0 million capital gain (see Note 8), and accordingly, the reversal of this $1.5 million valuation allowance has been reflected in the Company’s estimate of its annual effective tax rate for 2012.

The sales price used to calculate the above capital loss consisted of $15.5 million of cash received at closing, $20.0 million of cash received on November 18, 2011 and $29.3 million of value from future additional contingent cash and milestone payments. A deferred tax asset was recorded on the $29.3 million as it was not recognized as additional selling price for financial reporting purposes. The Company has recorded a valuation allowance of $10.5 million against this deferred tax asset in order to reduce the carrying value of this deferred tax asset to $0, which is the amount that management believes is more likely than not to be realized.

At June 30, 2012, the Company has an unrealized tax loss of $21.0 million related to the Company’s option to acquire Revance or license Revance’s topical product that is under development. The Company will not be able to determine the character of the loss until the Company exercises or fails to exercise its option. A realized loss characterized as a capital loss can only be utilized to offset capital gains. At June 30, 2012, the Company has recorded a valuation allowance of $7.6 million against the deferred tax asset associated with this unrealized tax loss in order to reduce the carrying value of the deferred tax asset to $0, which is the amount that management believes is more likely than not to be realized.

At June 30, 2012, the Company has an unrealized tax loss of $21.9 million related to the Company’s option to acquire a privately-held U.S. biotechnology company. If the Company fails to exercise its option, a capital loss will be recognized. A loss characterized as a capital loss can only be used to offset capital gains. At June 30, 2012, the Company has recorded a valuation allowance of $7.9 million against the deferred tax asset associated with this unrealized tax loss in order to reduce the carrying value of the deferred tax asset to $0, which is the amount that management believes is more likely than not to be realized.

During the three months ended June 30, 2012 and June 30, 2011, the Company made net tax payments of $31.1 million and $32.0 million, respectively. During the six months ended June 30, 2012 and June 30, 2011, the Company made net tax payments of $42.4 million and $38.0 million, respectively.

The Company operates in multiple tax jurisdictions and is periodically subject to audit in these jurisdictions. These audits can involve complex issues that may require an extended period of time to resolve and may cover multiple years. The Company and its domestic subsidiaries file a consolidated U.S. federal income tax return. Such returns have either been audited or settled through statute expiration through 2007. The state of California is currently conducting an examination of the Company’s tax returns for the periods ending December 31, 2008 and December 31, 2009.

The Company owns two subsidiaries that file corporate tax returns in Sweden. The Swedish tax authorities examined the tax return of one of the subsidiaries for fiscal 2004. The examiners issued a no change letter, and the examination is complete. The Company’s other subsidiary in Sweden has not been examined by the Swedish tax authorities. The Swedish statute of limitations may be open for up to five years from the date the tax return was filed. Thus, all returns filed for periods ending December 31, 2006 forward are open under the statute of limitations.

At June 30, 2012 and December 31, 2011, the Company had unrecognized tax benefits of $10.1 million and $8.6 million, respectively. The amount of unrecognized tax benefits which, if ultimately recognized, could favorably affect the Company’s effective tax rate in a future period is $6.7 million and $5.6 million as of June 30, 2012 and December 31, 2011, respectively. The Company estimates that it is reasonably possible that the amount of unrecognized tax benefits will decrease by $0.3 million in the next twelve months due to audit settlements.

The Company recognizes accrued interest and penalties, if applicable, related to unrecognized tax benefits in income tax expense. The Company had approximately $0.4 million and $0.3 million for the payment of interest and penalties accrued (net of tax benefit) at June 30, 2012 and December 31, 2011, respectively.

 

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14.

DIVIDENDS DECLARED ON COMMON STOCK

On June 14, 2012, the Company announced that its Board of Directors had declared a cash dividend of $0.10 per issued and outstanding share of the Company’s Class A common stock, which was paid on July 31, 2012, to stockholders of record at the close of business on July 2, 2012. The $6.0 million dividend was recorded as a reduction of accumulated earnings and is included in other current liabilities in the accompanying condensed consolidated balance sheets as of June 30, 2012. The Company has not adopted a dividend policy.

 

15.

STOCK REPURCHASE

On August 8, 2011, the Company announced that its Board of Directors approved a Stock Repurchase Plan to purchase up to $200 million in aggregate value of shares of Medicis Class A common stock (“common stock”). The plan was set to expire on August 7, 2012; however, on August 7, 2012, the Company’s Board of Directors approved a six-month extension of the plan to February 7, 2013. The plan may also terminate at the time at which the purchase limit is reached, and may be suspended or terminated at any time at the Company’s discretion without prior notice.

Any repurchases will be made in compliance with the SEC’s Rule 10b-18 if applicable, and may be made in the open market or in privately negotiated transactions, including the entry into derivatives transactions.

The number of shares to be repurchased and the timing of repurchases will depend on a variety of factors, including, but not limited to, stock price, economic and market conditions and corporate and regulatory requirements. It is intended that any repurchases will be funded by existing general corporate funds. The plan does not obligate the Company to repurchase any common stock.

As part of its stock repurchase program, the Company may from time to time enter into structured share repurchase agreements with financial institutions. These agreements generally require the Company to make one or more cash payments in exchange for the right to receive shares of its common stock and/or cash at the expiration of the agreement and/or at various times during the term of the agreement, generally based on the market price of the Company’s common stock during the relevant valuation period or periods, but the Company may enter into structured share repurchase agreements with different features.

No shares were repurchased during the six months ended June 30, 2012. Total shares repurchased from the inception of the plan through June 30, 2012 in the open market and through structured share repurchase arrangements was 4,438,233 shares at a weighted average cost of $33.82 per share.

As of June 30, 2012, the remaining authorized amount under the plan is approximately $49.9 million.

 

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Table of Contents
16.

NET INCOME PER COMMON SHARE

The following table sets forth the computation of basic and diluted net income per common share (in thousands, except per share amounts):

 

        Three Months Ended  
        June 30, 2012        June 30, 2011  
        Continuing
Operations
       Discontinued
Operations
       Net
Income
       Continuing
Operations
       Discontinued
Operations
       Net
Income
 

BASIC

                             

Net income (loss)

     $ 14,926        $ -         $ 14,926        $ 34,512        $ (5,729)         $ 28,783  

Less: income (loss) allocated to participating securities

       453          -           453          1,113          -           916  
    

 

 

      

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Net income (loss) available to common stockholders

       14,473          -           14,473          33,399          (5,729)           27,867  

Weighted average number of common shares outstanding

       57,560          -           57,560          60,308          60,308          60,308  
    

 

 

      

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Basic net income (loss) per common share

     $ 0.25        $ -         $ 0.25        $ 0.55        $ (0.09)         $ 0.46  
    

 

 

      

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

DILUTED

                             

Net income (loss)

     $ 14,926        $ -         $ 14,926        $ 34,512        $ (5,729)         $ 28,783  

Less: income (loss) allocated to participating securities

       453          -           453          1,113          -           916  
    

 

 

      

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Net income (loss) available to common stockholders

       14,473          -           14,473          33,399          (5,729)           27,867  

Less:

                             

Undistributed earnings allocated to unvested stockholders

       (307)           -           (307)           (987)           -           (796)   

Add:

                             

Undistributed earnings re-allocated to unvested stockholders

       304          -           304          971          -           783  

Add:

                             

Tax-effected interest expense related to 2.5% Notes

       711          -           711          711          -           711  
    

 

 

      

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Net income (loss) assuming dilution

     $ 15,181        $ -         $ 15,181        $ 34,094        $ (5,729)         $ 28,565  

Weighted average number of common shares outstanding

       57,560          -           57,560          60,308          60,308          60,308  

Effect of dilutive securities:

                             

2.5% Notes

       5,822          -           5,822          5,823          -           5,823  

1.5% Notes

       4          -           4          4          -           4  

Stock options

       594          -           594          1,005          -           1,005  
    

 

 

      

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Weighted average number of common shares assuming dilution

       63,980          -           63,980          67,140          60,308          67,140  
    

 

 

      

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Diluted net income (loss) per common share

     $ 0.24        $ -         $ 0.24        $ 0.51        $ (0.09)         $ 0.43  
    

 

 

      

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

 

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        Six Months Ended  
        June 30, 2012        June 30, 2011  
        Continuing
Operations
       Discontinued
Operations
       Net
Income
       Continuing
Operations
       Discontinued
Operations
       Net
Income
 

BASIC

                             

Net income (loss)

     $ 20,275        $ -         $ 20,275        $ 61,197        $ (13,054)         $ 48,143  

Less: income (loss) allocated to participating securities

       569          -           569          1,905          -           1,469  
    

 

 

      

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Net income (loss) available to common stockholders

       19,706          -           19,706          59,292          (13,054)           46,674  

Weighted average number of common shares outstanding

       57,549          -           57,549          59,719          59,719          59,719  
    

 

 

      

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Basic net income (loss) per common share

     $ 0.34        $ -         $ 0.34        $ 0.99        $ (0.22)         $ 0.78  
    

 

 

      

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

DILUTED

                             

Net income (loss)

     $ 20,275        $ -         $ 20,275        $ 61,197        $ (13,054)         $ 48,143  

Less: income (loss) allocated to participating securities

       569          -           569          1,905          -           1,469  
    

 

 

      

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Net income (loss) available to common stockholders

       19,706          -           19,706          59,292          (13,054)           46,674  

Less:

                             

Undistributed earnings allocated to unvested stockholders

       (285)           -           (285)           (1,668)           -           (1,245)   

Add:

                             

Undistributed earnings re-allocated to unvested stockholders

       282          -           282          1,647          -           1,229  

Add:

                             

Tax-effected interest expense related to 2.5% Notes

       1,376          -           1,376          1,376          -           1,376  

Tax-effected interest expense related to 1.5% Notes

       1          -           1          1          -           1  
    

 

 

      

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Net income (loss) assuming dilution

     $ 21,080        $ -         $ 21,080        $ 60,648        $ (13,054)         $ 48,035  

Weighted average number of common shares outstanding

       57,549          -           57,549          59,719          59,719          59,719  

Effect of dilutive securities:

                             

2.5% Notes

       5,822          -           5,822          5,823          -           5,823  

1.5% Notes

       4          -           4          4          -           4  

Stock options

       608          -           608          801          -           801  
    

 

 

      

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Weighted average number of common shares assuming dilution

       63,983          -           63,983          66,347          59,719          66,347  
    

 

 

      

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Diluted net income (loss) per common share

     $ 0.33        $ -         $ 0.33        $ 0.91        $ (0.22)         $ 0.72  
    

 

 

      

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Diluted net income per common share must be calculated using the “if-converted” method. Diluted net income per share using the “if-converted” method is calculated by adjusting net income for tax-effected net interest on the 2.5% Notes and 1.5% Notes, divided by the weighted average number of common shares outstanding assuming conversion.

 

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Unvested share-based payment awards that contain rights to receive nonforfeitable dividends or dividend equivalents (whether paid or unpaid) are participating securities, and thus, are included in the two-class method of computing earnings per share. The two-class method is an earnings allocation formula that treats a participating security as having rights to earnings that would otherwise have been available to common stockholders. Restricted stock granted to certain employees by the Company (see Note 3) participate in dividends on the same basis as common shares, and these dividends are not forfeitable by the holders of the restricted stock. As a result, the restricted stock grants meet the definition of a participating security.

The diluted net income per common share computation for the three months ended June 30, 2012 and 2011 excludes 1,732,550 and 1,797,876 shares of stock, respectively, that represented outstanding stock options whose impact would be anti-dilutive. The diluted net income per common share computation for the six months ended June 30, 2012 and 2011 excludes 2,482,193 and 3,291,806 shares of stock, respectively, that represented outstanding stock options whose impact would be anti-dilutive.

Due to the net loss from discontinued operations during the three and six months ended June 30, 2011, diluted earnings per share and basic earnings per share from discontinued operations are the same, as the effect of potentially dilutive securities would be anti-dilutive.

 

17.

COMMITMENTS AND CONTINGENCIES

Legal Matters

The Company is currently party to various legal proceedings, including those noted in this section. Unless specifically noted below, any possible range of loss associated with the legal proceedings described below is not reasonably estimable at this time. The Company is engaged in numerous other legal actions not described below arising in the ordinary course of its business and, while there can be no assurance, the Company believes that the ultimate outcome of these actions will not have a material adverse effect on its operating results, liquidity or financial position.

From time to time the Company may conclude it is in the best interests of its stockholders, employees and customers to settle one or more litigation matters, and any such settlement could include substantial payments; however, other than as noted below, the Company has not reached this conclusion with respect to any particular matter at this time. There are a variety of factors that influence the Company’s decisions to settle and the amount the Company may choose to pay, including the strength of its case, developments in the litigation, the behavior of other interested parties, the demand on management time and the possible distraction of the Company’s employees associated with the case and/or the possibility that the Company may be subject to an injunction or other equitable remedy. It is difficult to predict whether a settlement is possible, the amount of an appropriate settlement or when is the opportune time to settle a matter in light of the numerous factors that go into the settlement decision. Unless otherwise specified below, any settlement payment made pursuant to any of the completed settlement agreements described below is immaterial to the Company for financial reporting purposes.

Revance Litigation

On May 18, 2012, the Company received notice that Revance Therapeutics, Inc. (“Revance”) filed a lawsuit against the Company in the Court of Chancery of the State of Delaware. As previously disclosed, the Company is a minority owner of Revance and has an option to acquire Revance or license Revance’s topical product that is under development. Revance alleges that the option period has commenced and is seeking specific performance and an injunction against the Company. The Company believes that the option period has not commenced, and intends to vigorously defend the lawsuit. Revance amended its complaint on June 8, 2012. The Company filed an answer to Revance’s amended complaint on June 25, 2012 and, on the same day, filed counterclaims against Revance seeking declaratory relief, injunctive relief and specific performance from Revance. Revance filed its answer to the Company’s counterclaims on July 16, 2012. The Company filed a motion for judgment on certain of Revance’s claims on July 2, 2012. A hearing on the motion was held on August 3, 2012 and the motion was denied. Trial is currently scheduled for September 12, 2012.

 

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In addition to the matters discussed above, in the ordinary course of business, the Company is involved in a number of legal actions, both as plaintiff and defendant, and could incur uninsured liability in any one or more of them. Although the outcome of these actions is not presently determinable, it is the opinion of the Company’s management, based upon the information available at this time, that the expected outcome of these matters, individually or in the aggregate, will not have a material adverse effect on the results of operations, financial condition or cash flows of the Company.

 

18.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In May 2011, the FASB issued Accounting Standards Update (“ASU”) No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (Topic 820) – Fair Value Measurement, to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between U.S. GAAP and International Financial Reporting Standards. ASU No. 2011-04 changes certain fair value measurement principles and enhances the disclosure requirements, particularly for level 3 fair value measurements. ASU No. 2011-04 is effective for interim and annual reporting periods beginning after December 15, 2011 and must be applied prospectively. The Company adopted ASU No. 2011-04 as of January 1, 2012 and the revised guidance, which relates to disclosure, did not impact its results of operations and financial condition.

In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. The updated guidance amends the FASB Accounting Standards Codification (“Codification”) to allow an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both alternatives, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU No. 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amendments to the Codification in the ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. ASU No. 2011-05 will be applied retrospectively. ASU No. 2011-05 is effective for annual reporting periods beginning after December 15, 2011, with early adoption permitted, and will be applied retrospectively. The Company adopted ASU No. 2011-05 as of January 1, 2012, and the adoption of this amendment only impacted the presentation of comprehensive income within the Company’s condensed consolidated financial statements. Comprehensive income is now presented in the condensed consolidated statements of comprehensive income that are now included as part of the Company’s condensed consolidated financial statements.

In September 2011, the FASB issued ASU 2011-08, Intangibles – Goodwill and Other (Topic 350): Testing Goodwill for Impairment. The updated guidance permits an entity to make a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying value before applying the two-step goodwill impairment model that is currently in place. If it is determined through the qualitative assessment that a reporting unit’s fair value is more likely than not greater than its carrying value, the remaining impairment steps would be unnecessary. The qualitative assessment is optional, allowing companies to go directly to the quantitative assessment. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed in annual reporting periods beginning after December 15, 2011, with early adoption permitted. The Company adopted ASU 2011-08 as of January 1, 2012, and the revised guidance did not impact its results of operations and financial condition.

In July 2012, the FASB issued ASU 2012-02, Intangibles – Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment. The updated guidance allows an entity to first assess qualitative factors to determine whether it is necessary to perform a quantitative impairment test. Under the updated guidance, an entity would not be required to calculate the fair value of an indefinite-lived intangible asset unless the entity determines, based on qualitative assessment, that it is not more likely than not, the indefinite-lived intangible asset is impaired. The updated guidance also includes a number of events and circumstances for an entity to consider in conducting the qualitative assessment. ASU 2012-02 is effective for annual and interim indefinite-lived intangible asset impairment tests performed in annual reporting periods beginning after September 15, 2012, with early adoption permitted. The Company is currently assessing what impact, if any, the revised guidance will have on its results of operations and financial condition.

 

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19.

SUBSEQUENT EVENTS

The Company has evaluated subsequent events through the date of issuance of its condensed consolidated financial statements.

On August 7, 2012, the Company’s Board of Directors approved a six-month extension of the expiration date of the Company’s Stock Repurchase Plan to February 7, 2013. The plan was previously set to expire on August 7, 2012 (see Note 15).

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Executive Summary

We are a leading independent specialty pharmaceutical company focused primarily on helping patients attain a healthy and youthful appearance and self-image through the development and marketing in the U.S. and Canada of products for the treatment of dermatological and aesthetic conditions. We offer a broad range of products addressing various conditions or aesthetics improvements, including facial wrinkles, glabellar lines, acne, fungal infections, hyperpigmentation, photoaging, psoriasis, actinic keratosis, bronchospasms, external genital and perianal warts/condyloma acuminate, seborrheic dermatitis and cosmesis (improvement in the texture and appearance of skin).

During the fourth quarter of 2011, we acquired substantially all of the assets of Graceway Pharmaceuticals, LLC (“Graceway”) for approximately $455.9 million in cash, after our successful bid at a bankruptcy auction. Graceway’s commercial pharmaceutical product portfolio includes on-market prescription products and important development projects primarily in dermatology and women’s health specialties.

Our current product lines are divided between the dermatological and non-dermatological fields. The dermatological field represents products for the treatment of acne and acne-related dermatological conditions and non-acne dermatological conditions. The non-dermatological field represents products in the respiratory and women’s health specialties and products for the treatment of urea cycle disorder. Our non-dermatological field also includes contract revenues associated with licensing agreements and authorized generic agreements. Our acne and acne-related dermatological product lines include SOLODYN® and ZIANA®. Our non-acne dermatological product lines include DYSPORT®, LOPROX®, PERLANE®, RESTYLANE®, VANOS® and ZYCLARA®. Our non-dermatological product lines include AMMONUL®, BUPHENYL® and the MAXAIR® AUTOHALER®.

Financial Information About Segments

We operate in one business segment: pharmaceuticals. Our current pharmaceutical franchises are divided between the dermatological and non-dermatological fields. Information on revenues, operating income, identifiable assets and supplemental revenue of our business franchises appears in the condensed consolidated financial statements included in Item 1 hereof.

Key Aspects of Our Business

We derive a majority of our revenue from our primary products: DYSPORT®, PERLANE®, RESTYLANE®, SOLODYN®, VANOS®, ZIANA® and ZYCLARA®. We believe that sales of our primary products will constitute a significant portion of our revenue for 2012.

We have built our business by executing a four-part growth strategy: promoting existing brands, developing new products and important product line extensions, entering into and utilizing strategic collaborations and acquiring complementary products, technologies and businesses. Our core philosophy is to cultivate high integrity relationships of trust and confidence with the foremost physicians in the U.S. and Canada. We rely on third parties to manufacture our products.

We estimate customer demand for our prescription products primarily through use of third party syndicated data sources which track prescriptions written by health care providers and dispensed by licensed pharmacies. The data represents extrapolations from information provided only by certain pharmacies and are estimates of historical demand levels. We estimate customer demand for our non-prescription products primarily through internal data that we compile. We observe trends from these data and, coupled with certain proprietary information, prepare demand forecasts that are the basis for purchase orders for finished and component inventory from our third party manufacturers and suppliers. Our forecasts may fail to accurately anticipate ultimate customer demand for our products. Overestimates of demand and sudden changes in market conditions may result in excessive inventory production and underestimates may result in inadequate supply of our products in channels of distribution.

We schedule our inventory purchases to meet anticipated customer demand. As a result, miscalculation of customer demand or relatively small delays in our receipt of manufactured products could result in revenues being deferred or lost. Our operating expenses are based upon anticipated sales levels, and a high percentage of our operating expenses are relatively fixed in the short term.

 

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We sell our products primarily to major wholesalers and retail pharmacy chains. Approximately 70%-80% of our gross revenues are typically derived from two major drug wholesale concerns. Depending on the customer, we recognize revenue at the time of shipment to the customer, or at the time of receipt by the customer, net of estimated provisions. We recognize revenue on our aesthetics products DYSPORT®, PERLANE® and RESTYLANE® upon shipment from McKesson, our exclusive U.S. distributor of these products, to physicians. Consequently, variations in the timing of revenue recognition could cause significant fluctuations in operating results from period to period and may result in unanticipated periodic earnings shortfalls or losses. We have distribution services agreements with our two largest wholesale customers. We review the supply levels of our significant products sold to major wholesalers by reviewing periodic inventory reports that are supplied to us by our major wholesalers in accordance with the distribution services agreements. We rely wholly upon our wholesale and retail chain drugstore customers to effect the distribution allocation of substantially all of our prescription products. We believe our estimates of trade inventory levels of our products, based on our review of the periodic inventory reports supplied by our major wholesalers and the estimated demand for our products based on prescription and other data, are reasonable. We further believe that inventories of our products among wholesale customers, taken as a whole, are similar to those of other specialty pharmaceutical companies, and that our trade practices, which periodically involve volume discounts and early payment discounts, are typical of the industry.

We periodically offer promotions to wholesale and retail chain drugstore customers to encourage dispensing of our prescription products, consistent with prescriptions written by licensed health care providers. Because many of our prescription products compete in multi-source markets, it is important that licensed health care providers’ dispensing instructions are fulfilled with our branded products and are not improperly substituted with a generic product or another therapeutic alternative product which may be contrary to the licensed health care providers’ recommended and prescribed Medicis brand. We believe that a critical component of our brand protection program is maintenance of full product availability at wholesale and retail chain drugstore customers. We believe such availability reduces the probability of local and regional product substitutions, shortages and backorders, which could result in lost sales. We expect to continue providing favorable terms to wholesale and retail chain drugstore customers as may be necessary to ensure the fullest possible distribution of our branded products within the pharmaceutical chain of commerce. From time to time we may enter into business arrangements (e.g., loans or investments) involving our customers and those arrangements may be reviewed by federal and state regulators.

Purchases by any given customer, during any given period, may be above or below actual prescription volumes of any of our products during the same period, resulting in fluctuations of product inventory in the distribution channel. In addition, we consistently assess our product mix and portfolio to promote a high level of profitability and revenues and to ensure that our products are responsive to consumer tastes and changes to regulatory classifications. During early 2011, we discontinued our TRIAZ® branded products and decided to no longer promote our PLEXION® branded products. During the fourth quarter of 2011, we acquired substantially all of the assets of Graceway for approximately $455.9 million in cash, after our successful bid at a bankruptcy auction. Graceway’s commercial pharmaceutical product portfolio includes on-market prescription products and development projects primarily in dermatology and women’s health specialties. Also during the fourth quarter of 2011, we closed the sale of our LipoSonix business to Solta Medical, Inc. for aggregate cash consideration of approximately $35.5 million and continuing milestone payments based upon the commercial success of the LipoSonix products.

In March 2012, we launched our alternate fulfillment initiatives. Currently, our SOLODYN® and ZIANA® branded products are participating in the initiatives. The alternate fulfillment initiatives are designed to transfer unprofitable prescriptions from the traditional wholesale and retail chain drugstore channel and improve the profitability of the brands. During the second quarter of 2012, as a result of our alternate fulfillment initiatives and the accompanying decrease in the number of prescriptions flowing through the traditional wholesale and retail chain drugstore channel, wholesale customers reduced their inventory purchases to better correspond to the reduced demand through their channels. We expect this trend to continue during the third quarter of 2012 as our wholesale and retail chain drugstore customers continue to adjust their inventory levels to better correspond to reduced demand.

 

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Recent Developments

As described in more detail below, the following significant events and transactions occurred during the six months ended June 30, 2012 (in chronological order) and affected our results of operations, our cash flows and our financial condition:

 

-

License agreement with 3M;

-

Increase of our quarterly dividend from $0.08 per share to $0.10 per share;

-

Amended and restated collaboration agreement and asset purchase agreement with Hyperion;

-

Development and license agreement with a specialty pharmaceutical company;

-

Amended and restated joint development agreement with Lupin; and

-

Issuance of 1.375% Convertible Senior Notes due 2017.

License agreement with 3M

On February 24, 2012, we entered into a License Agreement with 3M Company and 3M Innovative Properties Company (collectively, “3M”) for worldwide rights to a number of leading molecules in 3M’s platform of immune response modifiers, for all topical dermatology indications and options for all human uses associated with the licensed molecules, excluding vaccine adjuvant. Under the terms of the agreement, we made an up-front payment of $7.5 million to 3M in connection with the execution of the agreement, and will pay up to an additional $25.6 million of contingent license and option fees. We may also pay up to an additional $25.0 million upon the achievement of certain research, development and regulatory milestones, as well as royalties on future sales. The initial $7.5 million payment was recognized as research and development expense during the three months ended March 31, 2012.

Increase of our quarterly dividend from $0.08 per share to $0.10 per share

On February 27, 2012, we announced that our Board of Directors had declared a cash dividend of $0.10 per issued and outstanding share of our Class A common stock, which was paid on April 30, 2012, to stockholders of record at the close of business on April 2, 2012. This represented a 25% increase compared to our previous $0.08 dividend. A subsequent cash dividend announced in June 2012 was also at the rate of $0.10 per issued and outstanding share of our Class A common stock. The dividend was paid on July 31, 2012 to stockholders of record at the close of business on July 2, 2012.

Amended and restated collaboration agreement and asset purchase agreement with Hyperion

On March 22, 2012, Ucyclyd Pharma, Inc. (“Ucyclyd”), our wholly-owned subsidiary, and Hyperion Therapeutics, Inc. (“Hyperion”) entered into an Amended and Restated Collaboration Agreement (the “Amended Collaboration Agreement”), which amended and restated our existing Collaboration Agreement, dated August 23, 2007, as previously amended on or about November 24, 2008, June 29, 2009 and October 12, 2009 (the “Prior Collaboration Agreement”).

Pursuant to the terms of the Prior Collaboration Agreement, Ucyclyd granted rights to Hyperion, exercisable in the future, to purchase certain worldwide rights to Ucyclyd’s existing on-market products AMMONUL® and BUPHENYL® under certain conditions, as well as to develop and commercialize Ravicti™, a compound referred to as HPN-100 (and also previously referred to as GT4P in the Prior Collaboration Agreement), for the treatment of urea cycle disorder, hepatic encephalopathies and other indications. The parties agreed to supersede the Prior Collaboration Agreement with the Amended Collaboration Agreement, under which Hyperion will continue to have the right, exercisable no earlier than January 1, 2013, to purchase certain worldwide rights to AMMONUL® and BUPHENYL®, subject to Ucyclyd’s right to elect to retain such rights to AMMONUL®, and an Asset Purchase Agreement of even date with the Amended Collaboration Agreement (the “APA”), under which Hyperion agreed to purchase Ucyclyd’s rights to Ravicti™ on the terms set forth therein. The parties completed the sale of Ravicti™ under the APA on March 22, 2012, for which Hyperion paid Ucyclyd $6.0 million. If Ravicti™ is not approved by the FDA by January 1, 2013, Ucyclyd will pay Hyperion $0.5 million per month until June 30, 2013, or until Ravicti™ is approved, whichever comes first, subject to a maximum of $3.0 million in aggregate payments. Pursuant to the APA, Hyperion will pay Ucyclyd certain royalties and regulatory and sales milestones relating to Ravicti™ and, pursuant to the terms of the Amended Collaboration Agreement, following exercise of its purchase rights, Hyperion will pay Ucyclyd certain royalties and regulatory and sales milestones relating to

 

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AMMONUL® and BUPHENYL®. Ucyclyd will continue to be entitled to all revenue from the sales of AMMONUL® and BUPHENYL® until the exercise of the purchase rights by Hyperion. If Hyperion elects to purchase AMMONUL® and BUPHENYL®, but Ucyclyd elects to retain AMMONUL®, then AMMONUL® will remain an asset of Ucyclyd and Ucyclyd will continue to be entitled to all revenue from the sales of AMMONUL®. A net gain of $3.0 million on the sale of Ravicti™ to Hyperion was recognized in other income during the three months ended March 31, 2012. This consisted of the $6.0 million payment Ucyclyd received from Hyperion, partially offset by the $3.0 million in potential contingent payments that Ucyclyd could pay to Hyperion during the first six months of 2013, based upon the timing of the approval of Ravicti™ by the FDA.

Development and license agreement with a specialty pharmaceutical company

On March 30, 2012, we entered into a Development and License Agreement with a specialty pharmaceutical company pursuant to which we obtained exclusive worldwide rights for the development and commercialization of an investigational drug targeted at certain topical skin applications. Under the terms of the agreement, we agreed to pay an up-front payment of $25.0 million in connection with the execution of the agreement, and will pay up to an additional $80.0 million upon the achievement of certain research, development and regulatory milestones and up to an additional $120.0 million upon the achievement of certain commercial milestones, as well as royalties on future sales. The initial $25.0 million up-front payment, paid in April 2012, was recognized as research and development expense during the three months ended March 31, 2012.

Amended and restated joint development agreement with Lupin

On July 21, 2011, we entered into a Joint Development Agreement (the “Original Agreement”) with Lupin Limited, on behalf of itself and its affiliates (hereinafter collectively referred to as “Lupin”), whereby we and Lupin will collaborate to develop multiple novel proprietary therapeutic products. Pursuant to the Original Agreement, subject to the terms and conditions contained therein, we made an up-front $20.0 million payment to Lupin and were to make additional payments to Lupin upon the achievement of certain research, development, regulatory and other milestones, as well as royalty payments on sales of the products covered under the Original Agreement. In addition, we were to receive an exclusive, worldwide (excluding India) license on the sale of the products covered under the Original Agreement.

On March 30, 2012, we entered into an Amended and Restated Joint Development Agreement with Lupin (the “Amended and Restated Joint Development Agreement”), which modified the list of products being developed. We made a $2.5 million payment to Lupin in April 2012 in connection with the execution of the Amended and Restated Joint Development Agreement, and will make additional payments to Lupin of up to $35.5 million upon the achievement of certain research, development, regulatory and other milestones, as well as royalty payments on sales of the products covered under the Amended and Restated Joint Development Agreement, which supersedes the additional payments we would have made under the Original Agreement. In addition, we will receive an exclusive, worldwide (excluding India) license on the sale of the products covered under the Amended and Restated Joint Development Agreement.

The $20.0 million up-front payment related to the Original Agreement was recognized as research and development expense during the three months ended September 30, 2011. The $2.5 million payment related to the Amended and Restated Joint Development Agreement was recognized as research and development expense during the three months ended March 31, 2012.

Issuance of 1.375% Convertible Senior Notes Due 2017

On May 16, 2012, we issued and sold $500.0 million of our 1.375% Convertible Senior Notes due 2017 (the “1.375% Notes”) in a public offering. The 1.375% Notes will mature on June 1, 2017 and pay 1.375% annual cash interest, payable semi-annually in arrears on June 1 and December 1 of each year, beginning on December 1, 2012.

On or after March 1, 2017, until the close of business on the second scheduled trading day immediately preceding the stated maturity date, or prior to then but only under certain circumstances, the 1.375% Notes will be convertible into cash up to the principal amount, with the remaining amount, if any, to be satisfied, at our option, in shares of our Class A common stock, cash or a combination thereof. The 1.375% Notes will be convertible at an initial conversion rate of 21.2427 shares of our Class A common stock per $1,000 principal amount of the 1.375% Notes, subject to adjustment upon certain events, which is equivalent to an initial conversion price of approximately $47.07 per share of our Class A common stock.

 

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The 1.375% Notes are convertible, at the holders’ option, prior to the close of business on the business day immediately preceding March 1, 2017, into shares of our Class A common stock in the following circumstances:

 

   

during any calendar quarter commencing after the calendar quarter ending on September 30, 2012, if the closing price of our Class A common stock over a specified number of trading days during the previous quarter, including the last trading day of such quarter, is more than 130% of the conversion price of the 1.375% Notes in effect on each applicable trading day.

 

   

during the five consecutive trading day period immediately following any ten consecutive trading day period in which the trading price of the 1.375% Notes per $1,000 principal amount for each such trading day was less than 98% of the product of the closing sale price of our Class A common stock on such days and the then-current conversion rate of $1,000 principal amount of the 1.375% Notes; or

 

   

upon the occurrence of specified corporate transactions.

The 1.375% Notes are our senior unsecured obligations and are not guaranteed by any of our subsidiaries. The 1.375% Notes rank senior in right of payment to our existing and future indebtedness that is expressly subordinated in right of payment to the 1.375% Notes; equal in right of payment to our existing and future unsecured indebtedness that is not so subordinated; effectively junior in right of payment to any of our secured indebtedness to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future indebtedness (including trade payables) incurred by our subsidiaries.

The 1.375% Notes do not contain any restrictions on the payment of dividends, the incurrence of additional indebtedness or the repurchase of our securities and do not contain any financial covenants. The 1.375% Notes require an anti-dilution adjustment to the conversion rate upon certain specified corporate dividend or common stock events or transactions, and if such event or transaction would result in at least a one percent (1%) change in the conversion rate. If the one percent (1%) threshold is not met on a particular qualifying event or transaction, the adjustment is carried forward and taken into account when a subsequent qualifying event or transaction is assessed for potential conversion rate adjustment. We may not redeem the 1.375% Notes prior to maturity and no sinking fund will be provided for the 1.375% Notes. If we undergo a fundamental change, subject to certain conditions, holders of the 1.375% Notes may require us to purchase 1.375% Notes in whole or in part for cash at a fundamental change purchase price equal to 100% of the principal amount of the 1.375% Notes to be purchased, plus accrued and unpaid interest, if any, to, but excluding the fundamental change purchase date. In certain events of default, as defined in the 1.375% Notes indenture, the trustee by notice to us, or the holders of at least 25% in principal amount of the then outstanding 1.375% Notes by notice to us and trustee, may declare 100% of the principal of, and accrued and unpaid interest, if any, on, all outstanding 1.375% Notes to be due and payable. Upon such a declaration, such principal and accrued and unpaid interest, if any, will be due and payable immediately.

As of June 30, 2012, the 1.375% Notes were not convertible.

The conversion feature embedded within the 1.375% Notes is considered a derivative; however, it has not been bifurcated and accounted for separately because it is considered to be indexed to our Class A common stock and meets the criteria for equity classification. Because the 1.375% Notes are considered to be cash convertible debt, we have separately accounted for the liability and equity components of the 1.375% Notes by allocating the $500.0 million in proceeds from the issuance between the liability component and the embedded conversion option, or the equity component. The allocation was conducted by estimating an interest rate at the time of issuance of the 1.375% Notes for similar debt instruments that do not include the embedded conversion feature. A straight-debt interest rate of 5.0% was used to compute the initial fair value of the liability component of $420.5 million. For purposes of the fair value measurement, we determined that the valuation of the 1.375% Notes falls under Level 2 of the fair value hierarchy. The excess of the $500.0 million of proceeds from the issuance of the 1.375% Notes over the $420.5 million initial amount allocated to the liability component, or $79.5 million, was allocated to the embedded conversion option, or equity component. This excess was treated as a debt discount and is being amortized through interest expense, using the effective interest method, over the five-year term of the 1.375% Notes, which runs through June 1, 2017.

In connection with the offering of the 1.375% Notes, on May 10, 2012 and May 11, 2012, we entered into privately negotiated convertible note hedge transactions (the “Convertible Note Hedge Transactions”) with affiliates of the underwriters of the 1.375% Notes (the “Option Counterparties”). The Convertible Note Hedge Transactions

 

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cover, collectively, the number of shares of our Class A common stock underlying the 1.375% Notes, subject to anti-dilution adjustments substantially similar to those applicable to the 1.375% Notes. We purchased these hedges for $80.0 million, in aggregate, which was recorded as a reduction in additional paid-in capital during the three months ended June 30, 2012. We also entered into separate, privately-negotiated warrant transactions with the Option Counterparties on May 10, 2012 and into additional warrant transactions with the Option Counterparties on May 11, 2012 (collectively, the “Warrant Transactions” and together with the Convertible Note Hedge Transactions, the “Convertible Note Hedge and Warrant Transactions”), initially covering a number of shares of our Class A common stock underlying the 1.375% Notes, subject to customary anti-dilution adjustments. Subject to certain conditions, we may settle the warrants in cash or on a net-share basis. The warrants were issued and sold for proceeds of approximately $35.2 million, which was recorded as an increase in additional paid-in capital during the three months ended June 30, 2012.

The Convertible Note Hedge Transactions are expected to reduce the potential dilution with respect to our Class A common stock and/or reduce our exposure to potential cash payments that may be required upon conversion of the 1.375% Notes. The strike price of the Warrant Transactions will initially be approximately $60.26 per share, which represents a premium of approximately 60% over the last reported sale price of $37.66 per share of our Class A common stock on The New York Stock Exchange on May 10, 2012.

The Convertible Note Hedge and Warrant Transactions are considered derivative instruments; however, they have been classified within stockholders’ equity because both financial instruments are considered to be indexed to the Company’s Class A common stock and meet the criteria for equity classification.

The Convertible Note Hedge and Warrant Transactions have been accounted for as separate financial instruments, in each case, we entered into with the Option Counterparties, and are not part of the terms of the 1.375% Notes and will not affect any holder’s rights under the 1.375% Notes. Holders of the 1.375% Notes will not have any rights with respect to the Convertible Note Hedge and Warrant Transactions.

We incurred $14.2 million of fees and other origination costs related to the issuance of the 1.375% Notes. These fees and other origination costs have been allocated to the liability and equity components of the 1.375% Notes in proportion to their allocated values. Approximately $2.3 million of these fees and other origination costs were recorded as a reduction in additional paid-in capital. The remaining $11.9 million of fees and other origination costs are included in other assets in our condensed consolidated balance sheets and are being amortized through interest expense over the five-year term of the 1.375% Notes, which runs through June 1, 2017.

Interest expense recognized during the three months ended June 30, 2012 related to the 1.375% Notes was approximately $2.9 million, including $1.8 million from the amortization of the discount and $0.3 million from the amortization of debt issuance costs.

Subsequent Events

Stock Repurchase Plan

On August 8, 2011, we announced that our Board of Directors approved a Stock Repurchase Plan to purchase up to $200 million in aggregate value of shares of Medicis Class A common stock. The plan was set to expire on the first anniversary of the plan, August 7, 2012; however, on August 7, 2012, our Board of Directors approved a six-month extension of the expiration date of the plan to February 7, 2013. The plan may also terminate at the time at which the purchase limit is reached, and may be suspended or terminated at any time at our discretion without prior notice.

Any repurchases will be made in compliance with the SEC’s Rule 10b-18, if applicable, and may be made in the open market or in privately negotiated transactions, including the entry into derivatives transactions. The number of shares to be repurchased and the timing of repurchases will depend on a variety of factors, including, but not limited to, stock price, economic and market conditions and corporate and regulatory requirements. It is intended that any repurchases will be funded by existing general corporate funds. The plan does not obligate us to repurchase any common stock.

As part of our stock repurchase program, we may from time to time enter into structured share repurchase agreements with financial institutions. These agreements generally require us to make one or more cash payments

 

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in exchange for the right to receive shares of its common stock and/or cash at the expiration of the agreement and/or at various times during the term of the agreement, generally based on the market price of our common stock during the relevant valuation period or periods, but we may enter into structured share repurchase agreements with different features.

During the six months ended June 30, 2012, no shares were repurchased under the plan. As of June 30, 2012, 4,438,233 shares at an average cost of $33.82 per share, or approximately $150 million in the aggregate, have been purchased as part of this plan, and therefore, approximately $49.9 million of shares remained to be repurchased under the plan.

Results of Operations

The following table sets forth certain data as a percentage of net revenues for the periods indicated.

 

     Three Months Ended     Six Months Ended  
      June 30,
2012
    June 30,
2011
    June 30,
2012
    June 30,
2011
 
     (a)     (b)     (c)     (d)  

Net revenues

     100.0     100.0     100.0     100.0

Gross profit (e)

     88.9        90.4        89.3        90.8   

Operating expenses

     72.9        59.1        79.5        61.5   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     16.0        31.3        9.8        29.3   

Other (expense) income, net

     (1.5)                        

Interest and investment (expense) income, net

     (1.8)        0.1        (1.0)        0.1   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income tax expense

     12.7        31.4        8.8        29.4   

Income tax expense

     (5.2)        (13.4)        (3.7)        (12.2)   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income from continuing operations

     7.5        18.0        5.1        17.2   

Loss from discontinued operations, net of income tax benefit

            (3.0)               (3.7)   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     7.5     15.0     5.1     13.5
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(a)

Included in operating expenses is $8.0 million (4.1% of net revenues) of charges related to product development agreements with Medicis partners, and $3.1 million (1.6% of net revenues) of compensation expense related to stock options, restricted stock and stock appreciation rights.

(b)

Included in operating expenses is 5.5 million (2.9% of net revenues) paid related to a product development agreement with a privately-held U.S. biotechnology company, $2.0 million (1.0% of net revenues) paid to a Medicis partner related to a product development agreement and $9.3 million (4.9% of net revenues) of compensation expense related to stock options, restricted stock and stock appreciation rights.

(c)

Included in operating expenses is $25.0 million (6.3% of net revenues) related to a development and license agreement with a specialty pharmaceutical company, $7.5 million (1.9% of net revenues) paid to 3M related to a license agreement, $12.0 million (3.0% of net revenues) of charges related to product development agreements with Medicis partners, $2.5 million (0.6% of net revenues) related to a product development agreement with Lupin and $12.2 million (3.1% of net revenues) of compensation expense related to stock options, restricted stock and stock appreciation rights.

(d)

Included in operating expenses is $7.0 million (2.0% of net revenues) paid to Anacor related to a product development agreement, $5.5 million (1.5% of net revenues) paid related to a product development agreement with a privately-held U.S. biotechnology company, $2.0 million (0.6% of net revenues) paid to a Medicis partner related to a product development agreement and $16.0 million (4.5% of net revenues) of compensation expense related to stock options, restricted stock and stock appreciation rights.

(e)

Gross profit does not include amortization of the related intangibles as such expense is included in operating expenses.

 

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Three Months Ended June 30, 2012 Compared to the Three Months Ended June 30, 2011

Net Revenues

The following tables set forth our net revenues for the three months ended June 30, 2012 (the “second quarter of 2012”) and June 30, 2011 (the “second quarter of 2011”), along with the percentage of net revenues and percentage point change for each of our product categories (dollar amounts in millions):

 

      Second Quarter
2012
    Second Quarter
2011
    $ Change     % Change  

Net product revenues

   $ 195.1     $ 189.8     $ 5.3       2.8 

Net contract revenues

     1.5       1.0       0.5       50.0 
  

 

 

 

Total net revenues

   $ 196.6     $ 190.8     $ 5.8       3.0 
  

 

 

 
        
      Second Quarter
2012
    Second Quarter
2011
    $ Change     % Change  

Acne and acne-related dermatological products

   $ 93.2     $ 123.1     $ (29.9)        (24.3)

Non-acne dermatological products

     81.1       57.7       23.4       40.6 

Non-dermatological products (including contract revenues)

     22.3       10.0       12.3       123.0 
  

 

 

 

Total net revenues

   $ 196.6     $ 190.8     $ 5.8       3.0 
  

 

 

 
        
      Second Quarter
2012
    Second Quarter
2011
    Change        

Acne and acne-related dermatological products

     47.4      64.5      (17.1)  

Non-acne dermatological products

     41.3      30.3      11.0   

Non-dermatological products (including contract revenues)

     11.3      5.2      6.1   
  

 

 

   

Total net revenues

     100.0      100.0      —       
  

 

 

   

Net revenues associated with our acne and acne-related dermatological products decreased by $29.9 million, or 24.3%, during the second quarter of 2012 as compared to the second quarter of 2011, primarily due to a reduction in SOLODYN® and ZIANA® inventory purchases by our wholesale and retail customers to better correspond to the reduced demand through their channels due to the impact of our alternate fulfillment program. Net revenues of SOLODYN® during the second quarter of 2012 as compared to the second quarter of 2011 were also impacted by a reduction in consumer rebates due to the launch of our alternate fulfillment initiatives during the first quarter of 2012, and an increase in managed care rebates as a result of new managed care contracts that were entered into during December 2011. See “Critical Accounting Policies and Estimates – Items Deducted from Gross Revenue” for a discussion of our managed care rebates. Included in the net revenues of ZIANA® during the second quarter of 2011 was a $3.9 million reversal of reserve originally recorded during the first quarter of 2011 related to a targeted recall of product from one lot, as a result of a notice we received during April 2011 from our contract manufacturer regarding one lot of ZIANA® that went out of specifications, as the amount of product subject to recall was less than previously estimated.

Net revenues associated with our non-acne dermatological products increased by $23.4 million, or 40.6%, during the second quarter of 2012 as compared to the second quarter of 2011 primarily due to sales of ZYCLARA®

 

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and ALDARA®. ZYCLARA® and ALDARA® were acquired during December 2011 as part of our acquisition of the assets of Graceway. Our net revenues of our non-acne dermatological products also increased because of increases in net revenues of RESTYLANE®, PERLANE® and VANOS®.

Net revenues associated with our non-dermatological products increased by $12.3 million, or 123.0%, during the second quarter of 2012 as compared to the second quarter of 2011 primarily due to sales of various products that were acquired as part of the acquisition of the assets of Graceway during December 2011.

Gross Profit

Gross profit represents our net revenues less our cost of product revenue. Our cost of product revenue includes our acquisition cost for the products we purchase from our third party manufacturers and royalty payments made to third parties. Amortization of intangible assets related to products sold is not included in gross profit. Amortization expense related to these intangibles for the second quarter of 2012 and 2011 was approximately $15.7 million and $5.3 million, respectively. Product mix plays a significant role in our quarterly and annual gross profit as a percentage of net revenues. Different products generate different gross profit margins, and the relative sales mix of higher gross profit products and lower gross profit products can affect our total gross profit.

The following table sets forth our gross profit for the second quarter of 2012 and 2011, along with the percentage of net revenues represented by such gross profit (dollar amounts in millions):

 

      Second Quarter
2012
    Second Quarter
2011
    $ Change      % Change  

Gross profit

   $ 174.8     $ 172.6     $ 2.2        1.3 

% of net revenues

     88.9      90.4      

The increase in gross profit during the second quarter of 2012 as compared to the second quarter of 2011 is primarily due to the $5.8 million increase in net revenues.

Selling, General and Administrative Expenses

The following table sets forth our selling, general and administrative expenses for the second quarter of 2012 and 2011, along with the percentage of net revenues represented by selling, general and administrative expenses (dollar amounts in millions):

 

      Second Quarter
2012
    Second Quarter
2011
    $ Change     % Change  

Selling, general and administrative

   $ 101.9      $ 90.4      $ 11.5        12.7

% of net revenues

     51.9     47.4    

Share-based compensation expense included in selling, general and administrative

   $ 3.2      $ 8.7      $ (5.5     (63.2 )% 

Selling, general and administrative expenses increased $11.5 million, or 12.7%, during the second quarter of 2012 as compared to the second quarter of 2011, and increased as a percentage of net revenues from 47.4% during the second quarter of 2011 to 51.9% during the second quarter of 2012. Included in this increase was a $9.2 million increase in professional fees and costs, a $1.7 million decrease in personnel costs, a $2.5 million increase in promotion costs and an increase of $1.5 million of other selling, general and administrative costs. Included in the decrease in personnel costs was a $5.5 million decrease in stock compensation expense, primarily related to the revaluation of stock appreciation rights (“SARs”) awards based on changes in the market price of our common stock at the end of each of the comparable periods, partially offset by the impact of an increase in headcount (excluding research and development personnel) from 586 as of June 30, 2011 to 771 as of June 30, 2012.

 

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Table of Contents

Research and Development Expenses

The following table sets forth our research and development expenses for the second quarter of 2012 and 2011 (dollar amounts in millions):

 

      Second Quarter
2012
     Second Quarter
2011
     $ Change      % Change  

Research and development

   $ 23.3      $ 15.2      $ 8.1        53.3  

Charges included in research and development

   $ 8.0      $ 7.5      $ 0.5        6.7  

Share-based compensation expense included in research and development

   $ (0.1)       $ 0.6      $ (0.7)         (116.7)  

Included in research and development expenses for the second quarter of 2012 was $8.0 million in aggregate charges related to development and license agreements with certain Medicis partners. Included in research and development expense for the second quarter of 2011 was a $5.5 million payment related to a product development agreement with a privately-held U.S. biotechnology company and $2.0 million paid to a Medicis partner related to a product development agreement. We expect research and development expenses to continue to fluctuate from quarter to quarter based on the timing of the achievement of development milestones under license and development agreements, as well as the timing of other development projects and the funds available to support these projects.

Depreciation and Amortization Expenses

Depreciation and amortization expenses during the second quarter of 2012 increased $11.0 million, or 154.9%, to $18.1 million during the second quarter of 2012, as compared to $7.1 million during the second quarter of 2011, primarily as a result of $335.8 million of intangible assets acquired during December 2011 as part of the acquisition of the assets of Graceway. Amortization expense is expected to be significantly higher during 2012, and in subsequent years, as compared to 2011, as 2011 only included one month of amortization expense related to these acquired intangible assets.

Interest and Investment Income

Interest and investment income during the second quarter of 2012 decreased $0.6 million, or 50.0%, to $0.6 million from $1.2 million during the second quarter of 2011, due to a decrease in the amount of funds available for investment during the second quarter of 2012. The decrease in the amount of funds available for investment was primarily impacted by the $455.9 million used to acquire the assets of Graceway during the fourth quarter of 2011 and the $150.1 million used to repurchase shares of our common stock during the second half of 2011. The net proceeds from the issuance of our 1.375% Notes during May 2012 was only available for investment for a portion of the second quarter of 2012 and therefore did not generate significant incremental interest and investment income during the period.

Interest Expense

Interest expense during the second quarter of 2012 increased $2.9 million from $1.1 million during the second quarter of 2011 to $4.0 million during the second quarter of 2012. The increase was due to $2.9 million of interest expense incurred during the second quarter of 2012 related to our 1.375% Notes that were issued during May 2012. Included in the $2.9 million of interest expense related to the 1.375% Notes was $1.8 million from the amortization of the debt discount and $0.3 million from the amortization of debt issuance costs.

Other Expense, net

Other expense during the second quarter of 2012 included a $2.9 million other-than-temporary impairment recorded against an investment in a third party entity.

 

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Income Tax Expense

Our effective tax rate for continuing operations for the second quarter of 2012 was 40.5%, as compared to 42.5% for the second quarter of 2011. The effective tax rate for the second quarter of 2012 reflects a benefit of approximately $1.2 million primarily related to additional research and development tax credits identified during the quarter.

Loss from Discontinued Operations, Net of Income Tax Benefit

Loss from discontinued operations, net of income tax benefit, was $5.7 million during the second quarter of 2011. See Note 2 in our accompanying condensed consolidated financial statements for further discussion.

 

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Six Months Ended June 30, 2012 Compared to the Six Months Ended June 30, 2011

Net Revenues

The following table sets forth our net revenues for the six months ended June 30, 2012 (the “2012 six months”) and June 30, 2011 (the “2011 six months”), along with the percentage of net revenues and percentage point change for each of our product categories (dollar amounts in millions):

 

      2012 Six
Months
    2011 Six
Months
    $ Change     % Change  

Net product revenues

   $ 395.1     $ 353.7     $ 41.4        11.7  

Net contract revenues

     3.2       2.0       1.2        60.0  
  

 

 

 

Total net revenues

   $ 398.3     $ 355.7     $ 42.6        12.0  
  

 

 

 
        
      2012 Six
Months
    2011 Six
Months
    $ Change     % Change  

Acne and acne-related dermatological products

   $ 201.6     $ 226.6     $ (25.0)        (11.0)  

Non-acne dermatological products

     155.1       109.9       45.2        41.1  

Non-dermatological products
(including contract revenues)

     41.6       19.2       22.4        116.7  
  

 

 

 

Total net revenues

   $ 398.3     $ 355.7     $ 42.6        12.0  
  

 

 

 
        
      2012 Six
Months
    2011 Six
Months
    Change        

Acne and acne-related dermatological products

     50.6      63.7      (13.1)    

Non-acne dermatological products

     39.0      30.9      8.1    

Non-dermatological products
(including contract revenues)

     10.4      5.4      5.0    
  

 

 

   

Total net revenues

     100.0      100.0       
  

 

 

   

Net revenues associated with our acne and acne-related dermatological products decreased by $25.0 million, or 11.0%, during the 2012 six months as compared to the 2011 six months, primarily due to a reduction in SOLODYN® and ZIANA® inventory purchases by our wholesale and retail customers during the second quarter of 2012 to better correspond to the reduced demand through their channels due to the impact of our alternate fulfillment program. Net revenues of SOLODYN® during the 2012 six months as compared to the 2011 six months were also impacted by a reduction in consumer rebates due to the launch of our alternate fulfillment initiatives during the first quarter of 2012, and an increase in managed care rebates as a result of new managed care contracts that were entered into during December 2011.

Net revenues associated with our non-acne dermatological products increased by $45.2 million, or 41.1%, during the 2012 six months as compared to the 2011 six months primarily due to sales of ZYCLARA® and ALDARA®. ZYCLARA® and ALDARA® were acquired during December 2011 as part of our acquisition of the assets of Graceway. Our net revenues of our non-acne dermatological products also increased because of increases in net revenues of RESTYLANE®, PERLANE® and VANOS®.

 

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Table of Contents

Net revenues associated with our non-dermatological products increased by $22.4 million, or 116.7%, during the 2012 six months as compared to the 2011 six months primarily due to sales of various products that were acquired as part of the acquisition of the assets of Graceway during December 2011.

Gross Profit

Gross profit represents our net revenues less our cost of product revenue. Our cost of product revenue includes our acquisition cost for the products we purchase from our third party manufacturers and royalty payments made to third parties. Amortization of intangible assets related to products sold is not included in gross profit. Amortization expense related to these intangibles for the 2012 six months and 2011 six months was approximately $31.4 million and $10.7 million, respectively. Product mix plays a significant role in our quarterly and annual gross profit as a percentage of net revenues. Different products generate different gross profit margins, and the relative sales mix of higher gross profit products and lower gross profit products can affect our total gross profit.

The following table sets forth our gross profit for the 2012 six months and 2011 six months, along with the percentage of net revenues represented by such gross profit (dollar amounts in millions):

 

 

 
    

2012 Six

Months

   

2011 Six

Months

    $ Change     % Change  

 

 

Gross profit

  $ 355.6      $ 323.2      $ 32.4       10.0

% of net revenues

    89.3      90.8     

The increase in gross profit during the 2012 six months as compared to the 2011 six months is primarily due to the $42.6 million increase in net revenues.

Selling, General and Administrative Expenses

The following table sets forth our selling, general and administrative expenses for the 2012 six months and 2011 six months, along with the percentage of net revenues represented by selling, general and administrative expenses (dollar amounts in millions):

 

     

2012 Six

Months

   

2011 Six

Months

    $ Change     % Change  

Selling, general and administrative

   $ 205.4      $ 175.0      $ 30.4       17.4

% of net revenues

     51.6      49.2     

Share-based compensation expense included in selling, general and administrative expense

   $ 11.6      $ 15.0      $ (3.4     (22.7 )% 

Selling, general and administrative expenses increased $30.4 million, or 17.4%, during the 2012 six months as compared to the 2011 six months, and increased as a percentage of net revenues from 49.2% during the 2011 six months to 51.6% during the 2012 six months. Included in this increase was an $18.0 million increase in professional fees and costs, a $6.3 million increase in personnel costs, a $3.9 million increase in promotion costs and an increase of $2.2 million of other selling, general and administrative costs. The increase in professional fees and costs was primarily due to increased legal fees related to intellectual property and other disputes. The increase in personnel costs was primarily due to an increase in headcount (excluding research and development personnel) from 586 as of June 30, 2011 to 771 as of June 30, 2012. The increase in personnel costs was partially offset by a $3.4 million decrease in stock compensation expense, primarily related to the revaluation of SARs awards based on changes in the market price of our common stock at the end of each of the comparable periods.

 

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Table of Contents

Research and Development Expenses

The following table sets forth our research and development expenses for the 2012 six months and 2011 six months (dollar amounts in millions):

 

 

 
      2012 Six
Months
     2011 Six
Months
     $
Change
     %
Change
 

 

 

Research and development

   $ 75.1       $ 29.5       $ 45.6         154.6 

Charges included in research and development

   $ 47.0       $ 14.5       $ 32.5         224.1 

Share-based compensation expense included in research and development

   $ 0.6       $ 1.0       $ (0.4)         (40.0) 

Included in research and development expenses for the 2012 six months was a $25.0 million payment to a specialty pharmaceutical company related to a development and license agreement, a $7.5 million payment to 3M related to a license agreement, $4.0 million paid to a Medicis partner related to a product development agreement, $2.5 million paid to Lupin related to a product development agreement and $8.0 million in aggregate charges related to development and license agreements with certain Medicis partners. Included in research and development expense for the 2011 six months was $7.0 million paid to Anacor related to a product development agreement, a $5.5 million payment related to a product development agreement with a privately-held U.S. biotechnology company and $2.0 million paid to a Medicis partner related to a product development agreement. We expect research and development expenses to continue to fluctuate from quarter to quarter based on the timing of the achievement of development milestones under license and development agreements, as well as the timing of other development projects and the funds available to support these projects.

Depreciation and Amortization Expenses

Depreciation and amortization expenses during the 2012 six months increased $21.8 million, or 151.4%, to $36.2 million during the 2012 six months, as compared to $14.4 million during the 2011 six months, primarily as a result of $335.8 million of intangible assets acquired during December 2011 as part of the acquisition of the assets of Graceway. Amortization expense is expected to be significantly higher during 2012, and in subsequent years, as compared to 2011, as 2011 only included one month of amortization expense related to these acquired intangible assets.

Interest and Investment Income

Interest and investment income during the 2012 six months decreased $1.3 million, or 52.0%, to $1.2 million from $2.5 million during the 2011 six months, due to a decrease in the amount of funds available for investment during the 2012 six months. The decrease in the amount of funds available for investment was primarily impacted by the $455.9 million used to acquire the assets of Graceway during the fourth quarter of 2011 and the $150.1 million used to repurchase shares of our common stock during the second half of 2011. The net proceeds from the issuance of our 1.375% Notes during May 2012 was only available for investment for a portion of the 2012 six months and therefore did not generate significant incremental interest and investment income during the period.

Interest Expense

Interest expense during the 2012 six months increased $2.9 million from $2.2 million during the 2011 six months to $5.1 million during the 2012 six months. The increase was due to $2.9 million of interest expense incurred during the 2012 six months related to our 1.375% Notes that were issued in May 2012. Included in the $2.9 million of interest expense related to the 1.375% Notes was $1.8 million from the amortization of the debt discount and $0.3 million from the amortization of debt issuance costs.

 

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Table of Contents

Other Income, net

Other income, net, during the 2012 six months included a $3.0 million gain on the sale of the product rights for RavictiTM to Hyperion, partially offset by a $2.9 million other-than-temporary impairment recorded against an investment in a third party entity.

Income Tax Expense

Our effective tax rate for the 2012 six months was 42.3%, as compared to 41.5% for the 2011 six months.

Loss from Discontinued Operations, Net of Income Tax Benefit

Loss from discontinued operations, net of income tax benefit, was $13.1 million during the 2011 six months. See Note 2 in our accompanying condensed consolidated financial statements for further discussion.

 

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Table of Contents

Liquidity and Capital Resources

Overview

The following table highlights selected cash flow components for the 2012 six months and 2011 six months, and selected balance sheet components as of June 30, 2012 and December 31, 2011 (dollar amounts in millions):

 

     

2012

Six
Months

    

2011

Six
Months

     $ Change      % Change  

Cash provided by (used in):

           

Operating activities

   $ 107.1      $ 77.3      $ 29.8        38.6 

Investing activities

     (326.4)         (189.2)         (137.2)         (72.5) 

Financing activities

     432.4        43.7        388.7        889.5 

 

      June 30, 2012      Dec. 31, 2011      $ Change      % Change  

Cash, cash equivalents, and short-term investments

   $ 829.6      $ 288.3      $ 541.3        187.8 

Working capital

     697.4        (23.6)         721.0        3,055.1 

Long-term investments

     22.6        40.3        (17.7)         (43.9) 

1.375% convertible senior notes due 2017, net of discount

     422.2        -         422.2        100.0 

2.5% contingent convertible senior notes due 2032

     168.9        169.1        (0.2)         (0.1) 

1.5% contingent convertible senior notes due 2033

     0.2        0.2        -        

 

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Working Capital

Working capital as of June 30, 2012 and December 31, 2011 consisted of the following (dollar amounts in millions):

 

      June 30, 2012      Dec. 31, 2011      $ Change      % Change  

Cash, cash equivalents, and short-term investments

   $ 829.6       $ 288.3       $ 541.3         187.8

Accounts receivable, net

     104.3         193.0         (88.7)         (46.0)

Inventories, net

     40.4         34.5         5.9         17.1

Deferred tax assets, net

     69.2         12.7         56.5         444.9

Prepaid income taxes

     28.1         1.3         26.8         2,061.5

Other current assets

     25.6         21.3         4.3         20.2
  

 

 

 

Total current assets

     1,097.2         551.1         546.1         99.1
  

 

 

 

Accounts payable

     76.9         54.1         22.8         42.1

Current portion of long-term debt

     0.2         169.1         (168.9)         (99.9)

Reserve for sales returns

     63.9         60.0         3.9         6.5

Accrued consumer rebate and loyalty programs

     81.2         139.9         (58.7)         (42.0)

Managed care and Medicaid reserves

     96.3         72.8         23.5         32.3

Other current liabilities

     81.3         78.8         2.5         3.2
  

 

 

 

Total current liabilities

     399.8         574.7         (174.9)         (30.4)
  

 

 

 

Working capital

   $ 697.4       $ (23.6)       $ 721.0         3,055.1
  

 

 

    

We had cash, cash equivalents and short-term investments of $829.6 million and working capital of $697.4 million at June 30, 2012, as compared to $288.3 million and negative working capital of $23.6 million, respectively, at December 31, 2011. The increase in cash, cash equivalents and short-term investments was primarily due to the proceeds received from the issuance of our 1.375% Notes in May 2012, net of a purchase of a related hedge and the proceeds from the issue of related warrants, of approximately $455 million and the generation of $107.1 million of operating cash flow during the six months of 2012. In addition to the impact of these events, the increase in working capital was also impacted by the reclassification of our 2.5% Notes to long-term liabilities subsequent to the June 4, 2012 option the holders of the 2.5% Notes had to require us to offer to repurchase their 2.5% Notes for cash. Only holders of $3,000 in principal amount requested their 2.5% Notes be repurchased. During the twelve month period prior to June 4, 2012, the 2.5% Notes were classified as a current liability.

Accounts receivable, net, was $104.3 million and $193.0 million at June 30, 2012 and December 31, 2011, respectively. The decrease was primarily due to an $80.1 million decrease in gross sales during the month of June 2012 as compared to the month of December 2011. As our standard payment terms are 30 days, orders that occur during the last month of a quarter are typically not due for payment until after the end of the quarter. Gross sales during the month of June 2012 were $121.7 million, or 34.0% of the total gross sales for the second quarter of 2012, as compared to gross sales during the month of December 2011 of $201.8 million, or 54.8% of total gross sales for the fourth quarter of 2011. Days’ sales outstanding, calculated as accounts receivable, net, as of the end of the reporting period, divided by total gross sales for the quarter, multiplied by the number of days in the quarter, was 27 days as of June 30, 2012 as compared to 48 days as of December 31, 2011. The calculated days’ sales outstanding is impacted by the amount and timing of orders placed within their inventory management agreement terms by customers during the second quarter of 2012 and the fourth quarter of 2011. Total purchases by customers, excluding the impact of the sales of Graceway products, decreased during the second quarter of 2012 as compared to prior quarters primarily due to a reduction in SOLODYN® and ZIANA® inventory purchases by our wholesale and retail customers to better correspond to the reduced demand through their channels due to the impact of our alternate fulfillment program. Gross sales during the first half of 2012 and during the month of December 2011 included sales of Graceway products, which were acquired as part of our acquisition of the assets of Graceway in December

 

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2011. We sell our products primarily to major wholesalers and retail chain drugstores. We have distribution services agreements with our two largest wholesale customers. We review the supply levels of our significant products sold to major wholesalers by reviewing periodic inventory reports that are supplied to us by our major wholesalers in accordance with the distribution services agreements. Other than our alternate fulfillment program for SOLODYN® and ZIANA®, which began in 2012, we rely wholly upon our wholesale and retail chain drugstore customers to effect the distribution allocation of substantially all of our prescription products. We also defer the recognition of revenue for certain sales of inventory into the distribution channel that are in excess of eight (8) weeks of projected demand, and we defer the recognition of revenue of our aesthetics products DYSPORT®, PERLANE® and RESTYLANE®, until our exclusive U.S. distributor, McKesson, ships these products to physicians.

Management believes existing cash and short-term investments, together with funds generated from operations, should be sufficient to meet operating requirements for the foreseeable future. Our cash and short-term investments are available for dividends, milestone payments related to our product development collaborations, strategic investments, acquisitions of companies or products complementary to our business, the repayment of outstanding indebtedness, repurchases of our outstanding securities and other potential large-scale needs. In addition, we may consider incurring additional indebtedness and issuing additional debt or equity securities in the future to fund potential acquisitions or investments, to refinance existing debt or for general corporate purposes. If a material acquisition or investment is completed, our operating results and financial condition could change materially in future periods. However, no assurance can be given that additional funds will be available on satisfactory terms, or at all, to fund such activities.

As of June 30, 2012, our short-term investments included $12.8 million of auction rate floating securities. Our auction rate floating securities are debt instruments with a long-term maturity and with an interest rate that is reset in short intervals through auctions. During the three months ended March 31, 2008, we were informed that there was insufficient demand at auction for the auction rate floating securities, and since that time we have been unable to liquidate our holdings in such securities. As a result, these affected auction rate floating securities are now considered illiquid, and we could be required to hold them until they are redeemed by the holder at maturity or until a future auction on these investments is successful. During the 2012 six months, we liquidated approximately $0.1 million of our auction rate floating securities at par.

 

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Operating Activities

Net cash provided by operating activities during the 2012 six months was approximately $107.1 million, compared to cash provided by operating activities of approximately $77.3 million during the 2011 six months. The following is a summary of the primary components of cash provided by operating activities during the 2012 six months and 2011 six months (in millions):

 

      2012 Six
Months
    2011 Six
Months
 

Income taxes paid

   $ (42.4   $ (38.0

Payment made to a specialty pharmaceutical company related to a development agreement

     (25.0     -   

Payment made to 3M related to a license agreement

     (7.5     -   

Payment made to Lupin partner related to a development agreement

     (2.5     -   

Payment made to Anacor related to development agreement

     -        (7.0

Payment made to a privately-held U.S. biotechnology company related to a development agreement

     -        (5.5

Payments made to other Medicis partners related to development agreements

     (7.0     (2.0

Decrease (increase) in accounts receivable