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UNITED STATES Washington, D.C. 20549
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2012
OR
Commission file number: 0-21379
CUBIST PHARMACEUTICALS, INC. (Exact Name of Registrant as Specified in its Charter)
65 Hayden Avenue, Lexington, MA 02421 (Address of Principal Executive Offices and Zip Code)
(781) 860-8660 (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 o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
Number of shares of the registrant’s Common Stock, $0.001 par value, outstanding on July 23, 2012: 63,837,982.
Cubist Pharmaceuticals, Inc.
Item 1. Condensed Consolidated Financial Statements
CUBIST PHARMACEUTICALS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS UNAUDITED (in thousands, except share data)
The accompanying notes are an integral part of the condensed consolidated financial statements.
CUBIST PHARMACEUTICALS, INC. CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME UNAUDITED (in thousands, except share and per share data)
The accompanying notes are an integral part of the condensed consolidated financial statements.
CUBIST PHARMACEUTICALS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS UNAUDITED (in thousands)
The accompanying notes are an integral part of the condensed consolidated financial statements.
CUBIST PHARMACEUTICALS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS UNAUDITED
A. BASIS OF PRESENTATION AND ACCOUNTING POLICIES
Basis of Presentation and Consolidation
The accompanying condensed consolidated financial statements are unaudited and have been prepared by Cubist Pharmaceuticals, Inc. (“Cubist” or the “Company”) in accordance with accounting principles generally accepted in the United States of America, or GAAP, and pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X. Certain information and footnote disclosures normally included in the Company’s annual consolidated financial statements have been condensed or omitted. The condensed consolidated financial statements, in the opinion of management, reflect all normal and recurring adjustments necessary for a fair statement of the Company’s financial position and results of operations. Certain reclassifications have been made to prior year amounts to conform to the current year presentation.
The year-end condensed consolidated financial statements were derived from audited financial statements, but do not include all disclosures required by GAAP. The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for any future period or the entire fiscal year. These interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2011, which are contained in Cubist’s Annual Report on Form 10-K filed with the Securities and Exchange Commission, or SEC, on February 27, 2012.
The accompanying condensed consolidated financial statements include the accounts of Cubist and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. The Company’s results of operations for the three and six months ended June 30, 2012, include the results of Adolor Corporation, or Adolor, which Cubist acquired in December 2011.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires the extensive use of estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. The most significant assumptions are employed in estimates used in determining values of: inventories; investments; acquisition-date fair value and subsequent impairment of long-lived assets, including goodwill, in-process research and development, or IPR&D, and other intangible assets; accrued clinical research costs; contingent consideration; income taxes; accounting for stock-based compensation; product rebate, chargeback and return accruals; restructuring charges; as well as in estimates used in accounting for contingencies, debt and revenue recognition. Actual results could differ from these estimates.
Fair Value Measurements
On January 1, 2012, the Company adopted amended guidance for fair value measurement and disclosure, which requires Cubist to disclose quantitative information about unobservable inputs used in the fair value measurement within Level 3 of the fair value hierarchy. See Note D., “Fair Value Measurements,” for additional information.
The accounting standard for fair value measurements defines fair value, establishes a framework for measuring fair value in accordance with GAAP, and requires detailed disclosures about fair value measurements. Under this standard, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The valuation techniques are based on observable and unobservable inputs. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect certain market assumptions. This standard classifies these inputs into the following hierarchy:
Level 1 Inputs—Quoted prices for identical instruments in active markets.
Level 2 Inputs—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
Level 3 Inputs—Instruments with primarily unobservable value drivers.
The fair value hierarchy level is determined by asset class based on the lowest level of significant input. In periods of market inactivity, the observability of prices and inputs may be reduced for certain instruments. This condition could cause an instrument to be reclassified between Level 1 and Level 2 or between Level 2 and Level 3. During the six months ended June 30, 2012, there were no transfers between Level 1, Level 2 or Level 3.
The carrying amounts of Cubist’s cash and cash equivalents, accounts receivable, net, accounts payable and accrued expenses approximate their fair value due to the short-term nature of these amounts. Short-term and long-term investments primarily consist of available-for-sale securities as of June 30, 2012 and December 31, 2011, and are carried at fair value.
Concentration of Risk
Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of cash and cash equivalents, investments and accounts receivable. The Company’s cash and cash equivalents are held primarily with five financial institutions in the United States, or U.S. Investments are restricted, in accordance with the Company’s investment policy, to a concentration limit per institution.
Cubist’s accounts receivable at June 30, 2012 and December 31, 2011, primarily represent amounts due to the Company from wholesalers, including AmerisourceBergen Drug Corporation, Cardinal Health, Inc. and McKesson Corporation. Cubist performs ongoing credit evaluations of its key wholesalers, distributors and other customers and generally does not require collateral. For the three and six months ended June 30, 2012 and 2011, Cubist did not have any significant write-offs of accounts receivable, and its days sales outstanding has not significantly changed since December 31, 2011.
IPR&D
IPR&D acquired in a business combination is capitalized on the Company’s condensed consolidated balance sheets at its acquisition-date fair value. Until the underlying project is completed, these assets are accounted for as indefinite-lived intangible assets, subject to impairment testing. Once the project is completed, the carrying value of the IPR&D is amortized over the estimated useful life of the asset. Post-acquisition research and development expenses related to the acquired IPR&D are expensed as incurred.
IPR&D is tested for impairment on an annual basis, in the fourth quarter, or more frequently if impairment indicators are present, using projected discounted cash flow models. If IPR&D becomes impaired or is abandoned, the carrying value of the IPR&D is written down to its revised fair value with the related impairment charge recognized in the period in which the impairment occurs. If the fair value of the asset becomes impaired as the result of unfavorable data from any ongoing or future clinical trial, changes in assumptions that negatively impact projected cash flows, or because of any other information regarding the prospects of successfully developing or commercializing the Company’s programs, Cubist could incur significant charges in the period in which the impairment occurs. The valuation techniques utilized in performing impairment tests incorporate significant assumptions and judgments to estimate the fair value. The use of different valuation techniques or different assumptions could result in materially different fair value estimates.
Revenue Recognition
Principal sources of revenue are: (i) sales of CUBICIN® (daptomycin for injection) and ENTEREG® (alvimopan) in the U.S.; (ii) revenues derived from sales of CUBICIN by Cubist’s international distribution partners; and (iii) service revenues derived from Cubist’s agreement with Optimer Pharmaceuticals, Inc., or Optimer, for the promotion and support of DIFICID® (fidaxomicin) in the U.S. In all instances, revenue is recognized only when the price is fixed or determinable, persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered and collectibility of the resulting receivable is reasonably assured.
U.S. Product Revenues, net
Cubist maintains a drop-ship program under which orders are processed through wholesalers, but shipments are sent directly to the end users, who are generally hospitals and acute care settings. The Company generally does not allow wholesalers to stock CUBICIN or ENTEREG. All revenues from product sales are recorded net of applicable provisions for returns, chargebacks, Medicaid rebates, Medicare coverage gap discount program rebates, wholesaler management fees and pricing discounts in the same period the related sales are recorded.
Gross U.S. product revenues are offset by provisions for the three and six months ended June 30, 2012 and 2011, as follows:
Certain product sales qualify for rebates or discounts from standard list pricing due to government-sponsored programs or other contractual agreements. Contractual adjustments in the table above include pricing and early payment discounts extended to the Company’s external customers, as well as provisions for returns and wholesaler distribution fees. Governmental rebates in the table above represent estimated amounts for Medicaid rebates, Medicare coverage gap discount program rebates and chargebacks related to 340B/Public Health Service and Federal Supply Schedule drug pricing programs. Estimates and assumptions for reserves are analyzed quarterly.
Service Revenues
Service revenues for the three and six months ended June 30, 2012, represent (i) the ratable recognition of the quarterly service fee earned in accordance with the co-promotion agreement with Optimer, which was entered into in April 2011 to promote and provide medical affairs support for DIFICID in the U.S.; and (ii) an additional $5.0 million recognized in June 2012 upon achieving an annual sales target under the terms of the co-promotion agreement with Optimer. Cubist is also eligible to receive, under the terms of the co-promotion agreement, a portion of Optimer’s gross profits on net sales of DIFICID above the annual sales targets, if any, in 2012 and 2013, as well as an additional $12.5 million in 2013 if a specified sales target is achieved. The initial two-year term of the co-promotion agreement ends in July 2013.
Basic and Diluted Net Income (Loss) Per Share
Basic net income (loss) per common share has been computed by dividing net income (loss) by the weighted average number of shares outstanding during the period. Diluted net income (loss) per share has been computed by dividing diluted net income (loss) by the diluted number of shares outstanding during the period. Except where the result would be antidilutive to income from continuing operations, diluted net income (loss) per share has been computed assuming the conversion of convertible obligations and the elimination of the interest expense related to the Company’s 2.25% convertible subordinated notes, or 2.25% Notes, and 2.50% convertible senior notes, or 2.50% Notes, the elimination of the loss on the partial repurchase of the Company’s 2.25% Notes, discussed below, the exercise of stock options and the vesting of restricted stock units, or RSUs, as well as their related income tax effects.
In June 2012, Cubist repurchased $74.7 million of its 2.25% Notes, in privately-negotiated transactions, which reduced Cubist’s fully-diluted shares of common stock outstanding by 2,427,738 shares. See Note G., “Debt,” for additional information.
The following table sets forth the computation of basic and diluted net income (loss) per common share:
Potential common shares excluded from the calculation of diluted net income (loss) per share, as their inclusion would have been antidilutive, were:
Subsequent Events
Cubist considers events or transactions that have occurred after the balance sheet date of June 30, 2012, but prior to the filing of the financial statements with the SEC on this Quarterly Report on Form 10-Q to provide additional evidence relative to certain estimates or to identify matters that require additional recognition or disclosure. Subsequent events have been evaluated through the date of the filing with the SEC of this Quarterly Report on Form 10-Q. There were no subsequent events that occurred after June 30, 2012.
Recent Accounting Pronouncements
In July 2012, the Financial Accounting Standards Board issued amended accounting guidance for testing indefinite-lived intangible assets for impairment. The amendments permit a company to first assess the qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. If, after assessing the totality of events or circumstances, a company concludes it is more likely than not that the fair value of the indefinite-lived intangible asset exceeds its carrying value, then the company is not required to take further action. A company also has the option to bypass the qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to performing the quantitative impairment test. A company will be able to resume performing the qualitative assessment in any subsequent
period. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted, including for annual and interim impairment tests performed as of a date before July 27, 2012, if a public company’s financial statements for the most recent annual or interim period have not yet been issued. The Company does not expect the adoption to have any impact on its consolidated financial statements.
B. INVESTMENTS
The following table summarizes the amortized cost and estimated fair values of the Company’s available-for-sale investments:
The following table contains information regarding the range of contractual maturities of the Company’s short-term and long-term investments:
Certain short-term debt securities with original maturities of less than 90 days are included in cash and cash equivalents on the condensed consolidated balance sheets and are not included in the tables above. In addition, a $60.0 million certificate of deposit included within short-term investments was not deemed an available-for-sale security and is not included in the tables above.
C. BUSINESS COMBINATIONS AND ACQUISITIONS
Acquisition of Adolor
On December 12, 2011, Cubist acquired 100% of the outstanding shares of common stock of Adolor for $4.25 in cash for each share owned by Adolor’s former stockholders, plus, contingent payment rights, or CPRs, as described below, upon which Adolor became a wholly-owned subsidiary of Cubist. The Company’s acquisition of Adolor provided an existing commercialized product, ENTEREG, as well as rights to an additional late-stage product candidate, CB-5945, among other assets. CB-5945 is an oral, peripherally-acting mu-opioid receptor antagonist currently in development for the treatment of chronic opioid-induced constipation.
The following table summarizes the fair value of total consideration at December 12, 2011:
The contingent consideration relates to the achievement of certain regulatory milestones, sales milestones or a combination of both, with respect to CB-5945, and in which Cubist granted non-transferable CPRs to the former stockholders of Adolor. The CPRs represent the right to receive additional payments above the upfront purchase price, up to a maximum of $4.50 for each share owned by Adolor’s former stockholders upon achievement of such milestones. The CPRs may not be sold, assigned, transferred, pledged, encumbered or disposed of, subject to limited exceptions. See Note D., “Fair Value Measurements,” for additional information.
The acquisition was accounted for as a business combination under the acquisition method of accounting. Accordingly, the tangible assets and identifiable intangible assets acquired and liabilities assumed were recorded at fair value, with the remaining purchase price recorded as goodwill.
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition:
The allocation of the purchase price to acquired assets and liabilities has been prepared on a preliminary basis and is subject to change as additional information becomes available, including the finalization of the fair value of acquired assets and certain tax matters. Any adjustments to the purchase price allocation will be made as soon as practicable but no later than one year from December 12, 2011, the acquisition date.
The difference between the purchase price and the fair value of the assets acquired and liabilities assumed of $60.7 million was allocated to goodwill. None of this goodwill is expected to be deductible for income tax purposes.
The Company recorded $40.8 million of ENTEREG inventory that was acquired from Adolor. See Note I., “Inventory,” for additional information.
Restructuring Activities
In connection with the acquisition of Adolor, Cubist committed to a restructuring program in the fourth quarter of 2011, which included severance benefits to former Adolor employees and execution of a lease termination agreement with respect to Adolor’s operating lease for its facility in Exton, Pennsylvania, which was vacated in June 2012. The lease termination payment was made in June 2012, and the remaining severance payments will be made through the first half of 2013.
The following table summarizes the activity within the restructuring liability:
D. FAIR VALUE MEASUREMENTS
The following tables set forth the Company’s assets and liabilities that are measured at fair value on a recurring basis as of June 30, 2012 and December 31, 2011:
(1) Excludes $105.4 million and $178.3 million of cash at June 30, 2012 and December 31, 2011, respectively. (2) Excludes a $60.0 million certificate of deposit not deemed a security at June 30, 2012 and December 31, 2011.
Marketable Securities
The Company classifies its bank deposits and corporate and municipal notes as Level 2 under the fair value hierarchy based on the lowest level of significant input. These assets have been valued using information obtained through a third-party pricing service at each balance sheet date, using observable market inputs that may include trade information, broker or dealer quotes, bids, offers, or a combination of these data sources.
Debt
The Company estimates the fair value of its 2.50% Notes and 2.25% Notes by using quoted market rates in an inactive market, which are classified as Level 2 inputs. See Note G., “Debt,” for additional information.
Payable to Glaxo
In connection with the acquisition of Adolor in December 2011, Cubist assumed the obligation to pay Glaxo Group Limited, or Glaxo, annual payments aggregating to $22.5 million as a result of Adolor’s termination of its collaboration agreement with Glaxo in September 2011, which was recorded at its estimated fair value of $18.9 million. At June 30, 2012, the carrying value of the remaining six annual payments to Glaxo of $19.4 million approximates its fair value. The fair value estimate utilizes a discount rate, which is classified as a Level 3 input.
Contingent Consideration
Contingent consideration is measured at fair value and is based on significant inputs not observable in the market, which represents a Level 3 measurement within the fair value hierarchy. The valuation of contingent consideration uses assumptions the Company believes would be made by a market participant. The Company assesses these estimates on an on-going basis as additional data impacting the assumptions is obtained. Changes in the fair value of contingent consideration related to updated assumptions and estimates are recognized within the condensed consolidated statements of comprehensive income.
Contingent consideration expense may change significantly as development progresses and additional data is obtained, impacting the Company’s assumptions regarding probabilities of successful achievement of related milestones used to estimate the fair value of the liability. In evaluating the fair value information, considerable judgment is required to interpret the market data used to develop the estimates. The estimates of fair value may not be indicative of the amounts that could be realized in a current market exchange. Accordingly, the use of different market assumptions and/or different valuation techniques could result in materially different fair value estimates.
Level 3 Disclosures
The following table provides quantitative information associated with the fair value measurement of the Company’s Level 3 inputs:
The significant unobservable inputs used in the fair value measurement of Cubist’s contingent consideration are the probabilities of successful achievement of development, regulatory and sales milestones, the period in which these milestones are expected to be achieved and a discount rate. Significant increases or decreases in any of the probabilities of success would result in a significantly higher or lower fair value measurement, respectively. Significant increases or decreases in the discount rate and/or the period in which milestones will be achieved would result in a significantly lower or higher fair value measurement, respectively.
The table below provides a rollforward of fair value balances that used Level 3 inputs:
Adolor
The fair value of contingent consideration relating to amounts payable by the Company to the former stockholders of Adolor upon the achievement of certain regulatory milestones, sales milestones or a combination of both, with respect to CB-5945, was estimated to be $113.4 million and $110.5 million as of June 30, 2012 and December 31, 2011, respectively. The change in fair value for the three and six months ended June 30, 2012, is due to the time value of money. The aggregate, undiscounted amount of contingent consideration that Cubist could pay under the merger agreement ranges from zero to approximately $233.8 million.
Calixa
The fair value of contingent consideration relating to amounts payable by the Company to the former stockholders of Calixa Therapeutics Inc., or Calixa, upon the achievement of certain development, regulatory and sales milestones with respect to ceftolozane/tazobactam, or CXA-201, was estimated to be $110.4 million and $137.7 million as of June 30, 2012 and December 31, 2011, respectively. The change in fair value for the three months ended June 30, 2012, is due to the time value of money. The change in fair value for the six months ended June 30, 2012, is primarily due to a $30.0 million milestone payment that Cubist made to the former stockholders of Calixa in January 2012, which was triggered by first patient enrollment in a Phase 3 clinical trial for complicated intra-abdominal infections, or cIAI, which occurred in December 2011. This was partially offset by contingent consideration expense related to the time value of money. Cubist
may be required to make up to an additional $220.0 million of undiscounted payments to the former stockholders of Calixa under the merger agreement. CXA-201 is being developed as a potential treatment for hospital-acquired bacterial pneumonia, or HABP, ventilator-associated bacterial pneumonia, or VABP, complicated urinary tract infections, or cUTI, and cIAI.
E. PROPERTY AND EQUIPMENT, NET
Property and equipment, net consisted of the following at:
Depreciation expense was $3.1 million and $2.3 million for the three months ended June 30, 2012 and 2011, respectively, and $6.1 million and $4.8 million for the six months ended June 30, 2012 and 2011, respectively.
F. GOODWILL AND OTHER INTANGIBLE ASSETS, NET
Indefinite-Lived Assets
The Company’s goodwill balance as of June 30, 2012, remained unchanged from the goodwill balance as of December 31, 2011. As of June 30, 2012, there were no accumulated impairment losses. Goodwill has been assigned to the Company’s single reporting unit, which is the single operating segment by which the chief decision maker manages the Company. See Note K., “Segment Information,” for additional information.
As of June 30, 2012, the Company’s IPR&D consisted of $117.4 million related to CB-5945, which was acquired through the Company’s acquisition of Adolor in December 2011, and $194.0 million related to CXA-201, which was acquired through the Company’s acquisition of Calixa in December 2009. The IPR&D value of CXA-201 as a potential treatment for HABP and VABP had an estimated fair value of $174.0 million, and the IPR&D value of CXA-201 as a potential treatment for cUTI and cIAI had an estimated fair value of $20.0 million as of the acquisition date. Cubist has not recorded any impairment charges related to the IPR&D since the acquisition of the assets.
Other Intangible Assets
Other intangible assets, net consisted of the following at:
Amortization expense was $5.2 million and $0.6 million for the three months ended June 30, 2012 and 2011, respectively, and $10.4 million and $1.3 million for the six months ended June 30, 2012 and 2011, respectively. The increase in amortization expense during the three and six months ended June 30, 2012, as compared to the three and six months ended June 30, 2011, was primarily due to the ENTEREG technology rights acquired in connection with the acquisition of Adolor in December 2011.
The estimated aggregate amortization of intangible assets as of June 30, 2012, for each of the five succeeding years and thereafter is as follows:
G. DEBT
Debt is comprised of the following amounts at:
2.25% Notes
As of June 30, 2012, the Company had $34.5 million aggregate principal outstanding of 2.25% Notes, which are due June 2013 and are recorded as short-term debt in the condensed consolidated balance sheet. The Company repurchased $74.7 million of the original principal amount of the 2.25% Notes, in privately-negotiated transactions, in June 2012, as further discussed below. The 2.25% Notes are convertible at any time prior to maturity into common stock at an initial conversion rate of 32.4981 shares of common stock per $1,000 of the 2.25% Notes principal, subject to adjustment upon certain events, which is equivalent to an initial conversion price of approximately $30.77 per share of common stock. Cubist may deliver cash or a combination of cash and common stock in lieu of shares of common stock, at Cubist’s option. Cubist retains the right to redeem all or a portion of the 2.25% Notes at 100% of the principal amount plus accrued and unpaid interest if the closing price of Cubist’s common stock is greater than 150% of the conversion price for at least 20 trading days (whether or not consecutive) out of 30 consecutive trading days. The shares attributable to the 2.25% Notes, if converted, could potentially dilute the Company’s shares of common stock outstanding. Interest is payable on June 15th and December 15th of each year. As of June 30, 2012, the “if-converted value” exceeded the principal amount of the 2.25% Notes by $8.0 million. The fair value of the outstanding 2.25% Notes was estimated to be $45.5 million as of June 30, 2012.
In June 2012, the Company repurchased, in privately-negotiated transactions, $74.7 million of the principal amount of its 2.25% Notes, reducing the outstanding amount from $109.2 million to $34.5 million. Cubist repurchased the 2.25% Notes at an average price of approximately $136.07 per $100 par value of debt plus accrued interest and transaction fees, resulting in a cash outflow of $102.6 million. The repurchase resulted in a net loss of $3.7 million, primarily comprised of a $3.3 million difference between the net carrying value and the fair value of the $74.7 million principal at the time of repurchase, which was recorded to other income (expense). The net carrying value of the equity portion of the 2.25% Notes was $15.7 million as of June 30, 2012, which includes a reduction of approximately $26.8 million to additional-paid-in-capital, net of deferred taxes of $1.2 million.
2.50% Notes
As of June 30, 2012, the Company had $450.0 million aggregate principal outstanding of 2.50% Notes, which are due November 2017. These 2.50% Notes are convertible into common stock at an initial conversion rate of 34.2759 shares of common stock per $1,000 of principal, subject to adjustment upon certain events, which is equivalent to an initial conversion price of approximately $29.18 per share of common stock. Holders of the 2.50% Notes may convert them at any time prior to the close of business on the business day immediately preceding May 1, 2017, if one of the following criteria is met: (i) during the calendar quarter immediately following any calendar quarter in which the last reported sale price of the common stock is greater than or equal to 130% of the conversion price on each applicable trading day for at least 20 trading days (whether or not consecutive) out of 30 consecutive trading days; (ii) during the five business day period immediately following any five consecutive trading days in which the trading price per $1,000 of the 2.50% Notes’ principal for each trading day was less than 98% of the last reported sale price of Cubist’s common stock multiplied by the conversion rate on each such trading day; or (iii) upon the occurrence of certain specified corporate events. Upon conversion by a note holder, Cubist may deliver cash, common stock or a combination of cash and common stock, at Cubist’s option. The shares attributable to the 2.50% Notes, if converted, may potentially dilute the Company’s shares of common stock outstanding. Interest is payable to the note holders on May 1st and November 1st of each year. As of June 30, 2012, the “if-converted value” exceeded the principal amount of the 2.50% Notes by $134.7 million. The fair value of the outstanding 2.50% Notes was estimated to be $648.3 million as of June 30, 2012.
In accordance with accounting guidance for debt with conversion and other options, Cubist separately accounted for the liability and equity components of each of the 2.50% Notes and 2.25% Notes in a manner that reflected its non-convertible debt borrowing rate of similar debt. The equity component of each of the 2.50% Notes and 2.25% Notes was recognized as a debt discount and represents the difference between the proceeds from the issuance of the convertible notes and the fair value of the liability of each note at the date of issuance. The debt discount is amortized to interest expense using the effective interest method over the expected life of a similar liability without an equity component. The Company determined this expected life to be equal to the original seven-year term of each of the 2.50% Notes and 2.25% Notes, resulting in an amortization period ending November 1, 2017, and June 15, 2013, respectively. Subsequent to the partial repurchase of the 2.25% Notes in June 2012, the Company determined the effective interest rate to be 8.2% for these notes.
Payable to Glaxo
The acquisition-date fair value of the payable to Glaxo assumed in connection with the acquisition of Adolor in December 2011 was allocated between current and non-current liabilities within the condensed consolidated balance sheets based on the contractual payment dates, and imputed interest on the payable to Glaxo is recorded as interest expense within the condensed consolidated statements of comprehensive income. See Note D., “Fair Value Measurements,” for additional information.
The table below summarizes the interest expense the Company incurred on its 2.50% Notes, 2.25% Notes and the payable to Glaxo for the periods presented:
Credit Facility
In December 2008, Cubist entered into a $90.0 million revolving credit facility with RBS Citizens National Association, or RBS Citizens, for general corporate purposes. Cubist terminated the revolving credit facility with RBS Citizens in June 2012. There were no outstanding borrowings under the credit facility as of December 31, 2011.
H. ACCRUED LIABILITIES
Accrued liabilities consisted of the following at:
Accrued clinical trials increased as of June 30, 2012, as compared to December 31, 2011, as a result of clinical trial activity primarily related to CXA-201 and CB-315. Accrued bonus decreased at June 30, 2012, as compared to December 31, 2011, due to payment of annual performance-based bonuses during the six months ended June 30, 2012.
I. INVENTORY
Inventories consisted of the following at:
Inventory included in other assets within the condensed consolidated balance sheets as of June 30, 2012, and December 31, 2011, represents the amount of ENTEREG inventory held that is in excess of the amount expected to be sold within one year. In connection with the acquisition of Adolor in December 2011, Cubist recorded the acquired ENTEREG inventory at its fair value, which required a step-up adjustment to recognize the inventory at its expected net realizable value. The inventory step-up is recorded to cost of product revenues within the condensed consolidated statements of comprehensive income as the related inventory is sold, which is expected to be over a period of approximately eight years.
J. EMPLOYEE STOCK BENEFIT PLANS
Summary of Stock-Based Compensation Plans
In June 2012, the Company’s stockholders approved, and the Company adopted the 2012 Equity Incentive Plan, or 2012 EIP, which replaced the Company’s 2010 Equity Incentive Plan, or 2010 EIP, and the Company’s Amended and Restated 2002 Directors’ Equity Incentive Plan, or Directors’ EIP, and is the only existing equity compensation plan from which the Company may make equity-based awards to employees, directors and consultants. Under the 2012 EIP, the Company has reserved 5,000,000 shares of common stock for grant to employees, officers, directors and consultants in the form of stock options, restricted stock, RSUs, performance units, stock grants and stock appreciation rights, plus the number of shares of common stock subject to stock options and RSUs granted and outstanding under the 2010 EIP, the Directors’ EIP and the Amended and Restated 2000 Equity Incentive Plan as of June 7, 2012, which become available for grant upon the
forfeiture, cancellation, expiration or termination of those awards after June 7, 2012. Vesting conditions of the Company’s equity awards did not change as a result of the adoption of the 2012 EIP. At June 30, 2012, there were 4,984,006 shares remaining available for grant under the 2012 EIP.
Summary of Stock-Based Compensation Expense
Stock-based compensation expense recorded in the condensed consolidated statements of comprehensive income for the three and six months ended June 30, 2012 and 2011, is as follows:
General Option Information
A summary of option activity for the six months ended June 30, 2012, is as follows:
RSU Information
A summary of RSU activity for the six months ended June 30, 2012, is as follows:
K. SEGMENT INFORMATION
Cubist has one operating segment, the research, development and commercialization of pharmaceutical products that address unmet medical needs in the acute care environment. The Company’s entire business is managed by a single
management team, which reports to the Chief Executive Officer. For both of the three months ended June 30, 2012 and 2011, the Company generated approximately 95% of revenues within the U.S., and for the six months ended June 30, 2012 and 2011, the Company generated approximately 94% and 95% of revenues, respectively, within the U.S.
L. INCOME TAXES
Cubist’s federal statutory rate for the three and six months ended June 30, 2012 and 2011, was 35.0%. The effective rate differs from the statutory rate as follows:
The decrease in the effective tax rate for the three months ended June 30, 2012, as compared to the three months ended June 30, 2011, is primarily due to the reversal of $16.9 million of gross uncertain tax positions, or $11.0 million net of federal tax benefit, during the three months ended June 30, 2012. In 2011, the Company established a reserve for uncertain tax positions upon making a decision to file amended state income tax returns for the years ended December 31, 2008 and 2009, and to file its 2010 and 2011 state income tax returns using the same filing positions as the amended 2008 and 2009 returns. During the three and six months ended June 30, 2012, the Company reached agreement with the Massachusetts tax authorities related to its state income tax filing positions and reversed its uncertain tax positions, resulting in an increase of $12.8 million in available state tax credit carryforwards and a reduction of its liability for uncertain tax positions.
As of December 31, 2011, the Company had federal, foreign and state net operating loss, or NOL, carryforwards of $157.1 million, $2.3 million and $32.9 million, respectively. Included in the NOLs and credit carryforwards are state NOLs and credit carryforwards of $2.2 million attributable to excess tax benefits from the exercise of non-qualified stock options. The tax benefits attributable to these NOLs and credit carryforwards are credited directly to additional paid-in capital when realized. These NOLs and credit carryforwards expire between 2012 and 2030. Of the total federal NOLs, approximately $149.0 million relate to NOLs that were acquired in connection with the acquisition of Adolor. These NOLs are subject to limitation under the Internal Revenue Code, Section 382. The Company expects to utilize approximately $33.1 million of Adolor’s federal NOLs by the end of 2012.
As of June 30, 2012, the Company had $13.1 million of uncertain tax positions, a decrease of $14.6 million from December 31, 2011, which was primarily the result of the agreement reached related to the filing of the amended state tax returns, as discussed above. Of the total uncertain tax positions as of June 30, 2012, $11.4 million was included in other long-term liabilities within the condensed consolidated balance sheet.
M. LEGAL PROCEEDINGS
In February 2012, the Company received a Paragraph IV Certification Notice Letter from Hospira, Inc., or Hospira, notifying Cubist that it had submitted an Abbreviated New Drug Application, or ANDA, to the U.S. Food and Drug Administration, or FDA, seeking approval to market a generic version of CUBICIN. Hospira’s notice letter advised that it is seeking FDA approval to market daptomycin for injection prior to the expiration of U.S. Patent Nos. 6,468,967 and 6,852,689, which expire on September 24, 2019, U.S. Patent No. RE39,071, which expires on June 15, 2016, U.S. Patent No. 8,058,238, which expires on November 28, 2020, and U.S. Patent No. 8,003,673, which expires on September 4, 2028. In May 2012, the Company received a second Paragraph IV Certification Notice Letter from Hospira notifying Cubist that it had submitted to the FDA an amendment to its ANDA. Hospira’s second notice letter advised that it is seeking FDA approval to market daptomycin for injection prior to the expiration of U.S. Patent No. 8,129,342, which expires on November 28,
2020. Each of these patents is listed in the FDA’s list of “Approved Drug Products with Therapeutic Equivalence Evaluations” (commonly referred to as the “Orange Book”). Both notice letters further stated that Hospira is asserting that each claim in the referenced patents is invalid, and/or unenforceable and/or will not be infringed by the commercial manufacture, use or sale of the drug product described by Hospira’s ANDA, as amended. On March 21, 2012, Cubist filed a patent infringement lawsuit against Hospira in response to its initial ANDA filing. On July 9, 2012, Cubist filed a new complaint against Hospira to allege infringement of U.S. Patent No. 8,129,342 in response to Hospira’s amendment to its ANDA. The complaints, which were both filed in the U.S. District Court for the District of Delaware, respectively allege infringement of U.S. Patent Nos. 6,468,967; 6,852,689; RE39,071; 8,058,238; and 8,129,342. The complaints seek (i) an order preventing the effective date of the FDA’s approval of Hospira’s ANDA until the expiration of the patents in the respective lawsuits; (ii) an order preventing Hospira from making, using, selling, offering for sale, marketing, distributing or importing Hospira’s generic version of CUBICIN until the expiration of the patents in the respective lawsuits and; (iii) an award of attorney’s fees. By statute, the FDA is automatically prohibited from approving Hospira’s ANDA for 30 months from Cubist’s receipt of Hospira’s first Paragraph IV notification letter unless the court enters a judgment finding the patents invalid, unenforceable or not infringed before expiration of the 30-month period or otherwise shortens the 30-month period. The Company cannot predict the outcome of this matter. Any final, unappealable adverse result in the litigation would likely have a material adverse effect on the Company’s results of operations and financial condition.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This document contains and incorporates by reference “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, or the Exchange Act. In some cases, these statements can be identified by the use of forward-looking terminology such as “may,” “will,” “could,” “should,” “would,” “expect,” “anticipate,” “continue” or other similar words. These statements discuss future expectations, contain projections of results of operations or of financial condition, or state trends and known uncertainties or other forward-looking information. You are cautioned that forward-looking statements are based on current expectations and are inherently uncertain. Actual performance and results of operations may differ materially from those projected or suggested in the forward-looking statements due to certain risks and uncertainties, including the risks and uncertainties described or discussed in Item 1A under the heading “Risk Factors” in Part II of this report. The forward-looking statements contained and incorporated herein represent our judgment as of the date of this Quarterly Report on Form 10-Q, and we caution readers not to place undue reliance on such statements. The information contained in this Quarterly Report on Form 10-Q is provided by us as of the date of this Quarterly Report on Form 10-Q, and, except as required by law, we do not undertake any obligation to update any forward-looking statements contained in this document as a result of new information, future events or otherwise.
Forward-looking statements in this Quarterly Report on Form 10-Q include, without limitation, statements regarding our expectations with respect to:
(i) our financial performance, including revenues, expenses, capital expenditures, gross margin and income taxes and our expected available cash and use of cash, including for the repayment of the outstanding amount of our 2.25% convertible subordinated notes, or 2.25% Notes, in June 2013;
(ii) the commercialization and manufacturing of CUBICIN® (daptomycin for injection) and ENTEREG® (alvimopan) and the commercial success of DIFICID® (fidaxomicin);
(iii) the strength of our intellectual property portfolio protecting CUBICIN and our ability to enforce this intellectual property portfolio; and
(iv) our expectations regarding our drug candidates, including the anticipated timing and results of our clinical trials, timing of our meetings with, and submissions to, regulatory authorities, including the timing of our submission of a supplemental New Drug Application, or sNDA, seeking label expansion for the use of ENTEREG, and the development, regulatory filing and review and commercial potential of our drug candidates and the costs and expenses related thereto.
This Management’s Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, is provided in addition to the condensed consolidated financial statements and accompanying notes to assist readers in understanding our results of operations, financial condition and cash flows. We have organized the MD&A as follows:
· Overview: This section provides a summary of our financial highlights, business developments and product and product pipeline updates for the three and six months ended June 30, 2012.
· Results of Operations: This section provides a review of our results of operations for the three and six months ended June 30, 2012 and 2011.
· Liquidity and Capital Resources: This section provides a summary of our financial condition, including our sources and uses of cash, capital resources, commitments and liquidity.
· Commitments and Contingencies: This section provides a summary of our material legal proceedings and commitments and contingencies that are outside our normal course of business, as well as our commitment to make potential future milestone payments to third parties as part of our various business agreements.
· Critical Accounting Policies and Estimates: This section describes our critical accounting policies and the significant judgments and estimates that we have made in preparing our condensed consolidated financial statements.
· Recent Accounting Pronouncements: This section provides a summary of recently issued accounting pronouncements.
Overview
We are a biopharmaceutical company headquartered in Lexington, Massachusetts, focused on the research, development and commercialization of pharmaceutical products that address unmet medical needs in the acute care environment. Such products and product candidates are used, or are being developed to be used in hospitals and other acute care settings, including home infusion and hospital outpatient clinics. Cubist has two marketed products, CUBICIN and ENTEREG. We acquired ENTEREG in connection with the acquisition of Adolor Corporation, or Adolor, in December 2011. We also co-promote DIFICID in the United States, or U.S., under our co-promotion agreement with Optimer Pharmaceuticals, Inc., or Optimer. In addition, Cubist has three late-stage drug candidates and several pre-clinical programs, each being developed to address areas of significant medical needs.
CUBICIN is a once-daily, bactericidal, intravenous antibiotic with proven activity against methicillin-resistant Staphylococcus aureus (S. aureus), or MRSA. CUBICIN is approved in the U.S., the European Union, or EU, Japan and many other countries for the treatment of certain infections caused by Gram-positive bacteria, including treatment for certain bloodstream infections. ENTEREG is approved in the U.S. to accelerate upper and lower gastrointestinal, or GI, recovery following partial large or small bowel resection surgery with primary anastomosis. ENTEREG is not approved for marketing outside of the U.S. DIFICID is approved in the U.S. for the treatment of Clostridium difficile-associated diarrhea, or CDAD.
Financial Highlights
The following table is a summary of our financial results for the periods presented:
Business Developments
The following is a summary of significant business developments that occurred during the six months ended June 30, 2012, or that impacted the period thereof. For additional 2011 developments or for a more comprehensive discussion of certain developments discussed below, see our Annual Report on Form 10-K for the year ended December 31, 2011, filed with the Securities and Exchange Commission, or SEC, on February 27, 2012, or 2011 Form 10-K.
ANDA Notification/Patent Litigation in U.S.
In February 2012, we received a Paragraph IV Certification Notice Letter from Hospira, Inc., or Hospira, notifying us that it had submitted an Abbreviated New Drug Application, or ANDA, to the U.S. Food and Drug Administration, or FDA, seeking approval to market a generic version of CUBICIN. Hospira’s notice letter advised that it is seeking FDA approval to market daptomycin for injection prior to the expiration of U.S. Patent Nos. 6,468,967 and 6,852,689, which expire on September 24, 2019, U.S. Patent No. RE39,071, which expires on June 15, 2016, U.S. Patent No. 8,058,238, which expires on November 28, 2020, and U.S. Patent No. 8,003,673, which expires on September 4, 2028. In May 2012, we received a second Paragraph IV Certification Notice Letter from Hospira notifying us that it had submitted to the FDA an amendment to its ANDA. Hospira’s second notice letter advised that it is seeking FDA approval to market daptomycin for injection prior to the expiration of U.S. Patent No. 8,129,342, which expires on November 28, 2020. Each of these patents is listed in the FDA’s list of “Approved Drug Products with Therapeutic Equivalence Evaluations,” or the Orange Book. Both notice letters further stated that Hospira is asserting that each claim in the referenced patents is invalid, and/or unenforceable and/or will not be infringed by the commercial manufacture, use or sale of the drug product described by Hospira’s ANDA,
as amended. On March 21, 2012, Cubist filed a patent infringement lawsuit against Hospira in response to its initial ANDA filing. On July 9, 2012, Cubist filed a new complaint against Hospira to allege infringement of U.S. Patent No. 8,129,342 in response to Hospira’s amendment to its ANDA. The complaints, which were both filed in the U.S. District Court for the District of Delaware, respectively allege infringement of U.S. Patent Nos. 6,468,967; 6,852,689; RE39,071; 8,058,238; and 8,129,342. The complaints seek (i) an order preventing the effective date of the FDA’s approval of Hospira’s ANDA until the expiration of the patents in the respective lawsuits; (ii) an order preventing Hospira from making, using, selling, offering for sale, marketing, distributing or importing Hospira’s generic version of CUBICIN until the expiration of the patents in the respective lawsuits; and (iii) an award of attorney’s fees. By statute, the FDA is automatically prohibited from approving Hospira’s ANDA for 30 months from Cubist’s receipt of Hospira’s first Paragraph IV notification letter unless the court enters a judgment finding the patents invalid, unenforceable or not infringed before expiration of the 30-month period or otherwise shortens the 30-month period. Any final, unappealable adverse result in the litigation would likely have a material adverse effect on our results of operations and financial condition. We are confident in our intellectual property portfolio protecting CUBICIN, including the patents listed in the Orange Book.
Acquisition of Adolor
In December 2011, we completed our acquisition of Adolor. Under the terms of the agreement and plan of merger, we paid Adolor’s former stockholders $4.25 in cash for each share of Adolor common stock, or approximately $220.8 million, in aggregate, which we funded from our existing cash balances. Adolor’s former stockholders also received one non-transferable contingent payment right, or CPR, which represents the right to receive up to an additional $4.50 in cash for each share of Adolor common stock owned, or up to approximately $233.8 million in aggregate, which Cubist will pay upon achievement of certain regulatory milestones, sales milestones or a combination of both, related to CB-5945. The fair value of the purchase price was estimated to be $331.0 million and was allocated to the tangible assets and identifiable intangible assets acquired and liabilities assumed on the basis of their fair values at the date of acquisition. See Note C., “Business Combinations and Acquisitions,” in the accompanying notes to condensed consolidated financial statements for additional information.
Repurchase of Convertible Subordinated Notes
In June 2012, we repurchased $74.7 million aggregate principal amount of our outstanding 2.25% Notes, in privately-negotiated transactions, which we funded from our existing cash balances. Cubist repurchased the 2.25% Notes at an average price of approximately $136.07 per $100 par value of debt plus accrued interest and transaction fees, resulting in a cash outflow of $102.6 million. The repurchase resulted in a net loss of $3.7 million for the three and six months ended June 30, 2012. See Note G., “Debt,” in the accompanying notes to condensed consolidated financial statements for additional information.
Product and Product Pipeline Updates
In July 2012, we announced first patient enrollment in a Phase 3 clinical trial of CB-315, which we are developing for the treatment of CDAD. We are also developing CB-5945 for the treatment of chronic opioid-induced constipation, or OIC, and we expect to initiate a Phase 3 clinical trial by the end of 2012.
In April 2012, we announced that a Phase 4 clinical study of ENTEREG in patients undergoing radical cystectomy met its primary endpoint of time to achieve recovery of both upper and lower GI function. We expect to submit an sNDA seeking label expansion for the use of ENTEREG to accelerate the time to upper and lower GI recovery in patients undergoing this procedure by the end of 2012.
We are developing ceftolozane/tazobactam, or CXA-201, as a potential therapy for the treatment of certain serious Gram-negative bacterial infections in the hospital, including those caused by multi-drug-resistant Pseudomonas aeruginosa. First patient enrollment in a Phase 3 clinical trial of CXA-201 for the treatment of complicated intra-abdominal infections, or cIAI, occurred in December 2011, which triggered a $30.0 million milestone payment that we made to the former stockholders of Calixa Therapeutics Inc., or Calixa, in January 2012. We also have an ongoing Phase 3 clinical trial of CXA-201 for the treatment of complicated urinary tract infections, or cUTI. We plan to file a New Drug Application, or NDA, for cUTI and cIAI indications by the end of 2013 and a subsequent filing of a marketing authorization application outside the U.S., assuming positive Phase 3 clinical trial results in both cUTI and cIAI. We also are planning to pursue the development of CXA-201 as a potential treatment for hospital-acquired bacterial pneumonia, or HABP, and ventilator-associated bacterial pneumonia, or VABP, and expect to begin Phase 3 clinical trials of CXA-201 for VABP in the second half of 2012.
In addition, we continue to seek opportunities to build our pipeline of acute care therapies through our business development efforts and to progress compounds into clinical development that we have developed internally.
Results of Operations for the Three Months Ended June 30, 2012 and 2011
Revenues
The following table sets forth net revenues for the periods presented:
Product Revenues, net
Cubist’s net U.S. product revenues included $200.2 million of sales of CUBICIN and $9.7 million of sales of ENTEREG for the three months ended June 30, 2012, as compared to $168.6 million of net U.S. product revenues from sales of CUBICIN for the three months ended June 30, 2011. We did not have any ENTEREG revenues for the three months ended June 30, 2011, because we had not yet acquired Adolor. Gross U.S. product revenues totaled $241.9 million and $192.9 million for the three months ended June 30, 2012 and 2011, respectively. The $49.0 million increase in gross U.S. product revenues was due to: (i) price increases of 5.5% for CUBICIN in both July 2011 and January 2012, which resulted in $23.5 million of additional gross U.S. product revenues; (ii) an increase of approximately 8.0% in vial sales of CUBICIN in the U.S., which resulted in higher gross U.S. product revenues of $15.3 million; and (iii) revenues related to the addition of ENTEREG to our product portfolio in December 2011.
Gross U.S. product revenues are offset by provisions for the three months ended June 30, 2012 and 2011, as follows:
Contractual adjustments include pricing and early payment discounts extended to our external customers, as well as provisions for sales returns and wholesaler distribution fees. Governmental rebates represent estimated amounts for Medicaid rebates, Medicare coverage gap discount program rebates and chargebacks related to 340B/Public Health Service, or 340B/PHS, and Federal Supply Schedule, or FSS, drug pricing programs. The increase in provisions against gross product revenue was primarily driven by increases in chargebacks, Medicaid rebates, including the amount of rebates and the number of individuals eligible to participate in the Medicaid program, and pricing discounts due to increased U.S. sales of CUBICIN and the price increases described above.
International product revenues increased $3.6 million for the three months ended June 30, 2012, as compared to the three months ended June 30, 2011, primarily related to an increase in product sold to Novartis AG, or Novartis, and MSD Japan, a wholly-owned subsidiary of Merck & Co., Inc., or Merck, for Novartis’ and MSD Japan’s distribution of CUBICIN in their respective territories.
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