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UNITED THERAPEUTICS CORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2013, and the consolidated financial statements and accompanying notes included in Part I, Item I of this Quarterly Report on Form 10-Q. The following discussion contains forward-looking statements made pursuant to the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995, including the statements listed in the section below entitled Part II, Item 1A-Risk Factors. These statements are based on our beliefs and expectations about future outcomes, and are subject to risks and uncertainties that could cause our actual results to differ materially from anticipated results. Factors that could cause or contribute to such differences include those described in Part II, Item 1A-Risk Factors of this Quarterly Report on Form 10-Q; factors described in our Annual Report on Form 10-K for the year ended December 31, 2013, under the section entitled Part I, Item 1A-Risk Factors-Forward-Looking Statements; and factors described in other cautionary statements, cautionary language and risk factors set forth in other filings with the Securities and Exchange Commission (SEC). We undertake no obligation to publicly update these forward-looking statements, whether as a result of new information, future events or otherwise. Overview Our key therapeutic products and product candidates include: † Prostacyclin analogues (Remodulin®, Tyvaso®, Orenitram® and 314d): stable synthetic forms of prostacyclin, an important molecule produced by the body that has powerful effects on blood vessel health and function; † Phosphodiesterase type 5 (PDE-5) inhibitor (Adcirca®): a molecule that acts to inhibit the degradation of cyclic guanosine monophosphate (cyclic GMP) in cells. Cyclic GMP is activated by nitric oxide (NO), a naturally occurring substance in the body that mediates the relaxation of vascular smooth muscle; † Monoclonal antibody for oncologic applications (ch14.18 MAb): an antibody that treats cancer by activating the immune system; 21 -------------------------------------------------------------------------------- Table of Contents † Glycobiology antiviral agents: a novel class of small, sugar-like molecules that have shown antiviral activity in a range of pre-clinical settings; † Cell-based therapy: a cell-based product known as PLacental eXpanded (PLX) cells we are developing for the treatment of pulmonary hypertension; and † Lung transplantation: engineered lungs and lung tissue, which we are developing using xenotransplantation and regenerative medicine technologies, for transplantation in patients suffering from pulmonary arterial hypertension (PAH) and other lung diseases. We are also developing technologies aimed at improving outcomes for lung transplant recipients. We concentrate substantially all of our research and development efforts on the preceding key therapeutic programs. We currently market and sell the following commercial products: † Remodulin (treprostinil) Injection (Remodulin). Remodulin, a continuously-infused formulation of the prostacyclin analogue treprostinil, is approved in the United States for subcutaneous (under the skin) and intravenous (in the vein) administration. Remodulin is indicated to diminish symptoms associated with exercise in World Health Organization (WHO) Group 1 PAH patients. Remodulin is also approved for the treatment of patients requiring transition from Flolan® (epoprostenol sodium) for Injection, the first prostacyclin analogue therapy for PAH approved by the United States Food and Drug Administration (FDA). Remodulin has also been approved in various countries outside of the United States. Most recently, in March 2014, Japan's Ministry of Health, Labor and Welfare approved Remodulin for the treatment of PAH by subcutaneous and intravenous administration. Remodulin will be sold in Japan under the brand name Treprost™ by Mochida Pharmaceutical Co., Ltd. We expect commercial sales to Mochida will commence in 2014 following government pricing approval of Treprost. † Tyvaso (treprostinil) Inhalation Solution (Tyvaso). Tyvaso, an inhaled formulation of treprostinil, is approved by the FDA to improve exercise ability in WHO Group 1 PAH patients. † Orenitram (treprostinil) Extended-Release Tablets (Orenitram). In December 2013, the FDA approved Orenitram, a tablet dosage form of treprostinil, for the treatment of PAH in WHO Group 1 PAH patients to improve exercise capacity. Orenitram's label contemplates dosing either twice per day (BID) or three times per day (TID), and we anticipate that TID dosing may lead to a more favorable pharmacokinetic profile than BID, although TID dosing was not studied in our pivotal trial. We commenced sales of Orenitram during the second quarter of 2014. † Adcirca (tadalafil) Tablets (Adcirca). We acquired exclusive commercialization rights to Adcirca, an oral PAH therapy, in the United States and Puerto Rico from Eli Lilly and Company (Lilly). Adcirca is approved by the FDA to improve exercise ability in WHO Group 1 PAH patients. Revenues Sales of Remodulin, Tyvaso and Adcirca comprise substantially all of our revenues. Despite commencing Orenitram sales during the second quarter of 2014, we remain substantially reliant on sales of Remodulin, Tyvaso and Adcirca as our principal sources of revenue. We have entered into separate, non-exclusive distribution agreements with Accredo Health Group, Inc. (Accredo) and CVS Caremark (Caremark) to distribute Remodulin, Tyvaso and Orenitram in the United States. We sell these products to Accredo and Caremark under terms and conditions that are materially similar to one another. We also sell Remodulin to various distributors internationally. We sell Adcirca through Lilly's pharmaceutical wholesaler network at a wholesale price determined by Lilly, which Lilly generally increases twice per year. Most recently, Lilly increased the wholesale price of Adcirca by 9.1 percent effective on July 2, 2014. We require our specialty pharmaceutical distributors to maintain reasonable levels of inventory reserves as the interruption of Remodulin, Tyvaso or Orenitram therapy can be life threatening. Our specialty pharmaceutical distributors typically place monthly orders based on estimates of future demand and contractual minimum inventory requirements. As a result, sales of Remodulin and Tyvaso, our most significant sources of revenue, can vary depending on the timing and magnitude of these orders and may not precisely reflect patient demand. 22 -------------------------------------------------------------------------------- Table of Contents We recognize revenues net of: (1) estimated rebates; (2) prompt pay discounts; (3) allowances for sales returns; and (4) distributor fees. We estimate our liability for rebates based on an analysis of historical levels of rebates to both Medicaid and commercial third-party payers and consider the impact of sales trends, changes in government and commercial rebate programs and any anticipated changes in our products' pricing. In addition, we determine our obligation for prescription drug discounts required for Medicare Part D patients within the coverage gap based on estimates of the number of Medicare Part D patients and the period such patients will remain within the coverage gap. We provide prompt pay discounts to customers that pay amounts due within a specific time period and base related estimates on observed historical customer payment behavior. We derive estimates relating to our allowance for returns of Adcirca from actual return data accumulated since the drug's launch in 2009. We also compare patient prescription data for Adcirca to sales on a quarterly basis to ensure a reasonable relationship between prescription and sales trends. To date, we have not identified any unusual patterns in the volume of prescriptions relative to sales that would necessitate an alternative method to estimate our reserve for returns. Tyvaso, Remodulin and Orenitram are distributed under separate contracts with substantially similar terms, which include exchange rights in the event that product is damaged during shipment or expires. The allowance for exchanges for Remodulin and Tyvaso is based on the historical rate of product exchanges, which has been immaterial. Furthermore, we anticipate minimal exchange activity in the future for Tyvaso, Remodulin and Orenitram since we typically sell these products with a remaining shelf life in excess of one year and our distributors generally carry a thirty- to sixty-day supply of our products at any given time. As a result, we do not record reserves for exchanges for Tyvaso, Remodulin and Orenitram at the time of sale. Lastly, we pay our distributors for contractual services rendered and accrue for related fees based on contractual rates applied to the estimated units of service provided by distributors for a given financial reporting period. Generic Competition We disclose in Part II, Item 1.-Legal Proceedings of this Quarterly Report on Form 10-Q that we are engaged in litigation with Sandoz Inc. (Sandoz) contesting its abbreviated new drug applications (ANDAs) seeking FDA approval to market generic versions of Remodulin before the expiration of certain U.S. patents in October 2017 and March 2029. In July 2014, we received notice that another generic company, Teva Pharmaceuticals USA, Inc. (Teva), also filed an ANDA seeking FDA approval to market a generic version of Remodulin. For further details, please see Part II, Item 5.-Other Information-Paragraph IV Notice Letter for Remodulin. We intend to vigorously enforce our intellectual property rights relating to Remodulin. However, there can be no assurance that we will prevail in defending our patent rights, or that additional challenges from other ANDA filers will not surface with respect to Remodulin or our other treprostinil-based products. Our existing patents could be invalidated, found unenforceable or found not to cover one or more generic forms of Remodulin, Tyvaso or Orenitram. If any ANDA filer were to receive approval to sell a generic version of Remodulin, Tyvaso or Orenitram and/or prevail in any patent litigation, the affected product(s) would become subject to increased competition which could reduce our sales. Certain patents for Revatio®, a PDE-5 inhibitor marketed by Pfizer, Inc. for treatment of PAH, expired in 2012, leading several manufacturers to launch generic formulations of sildenafil citrate, the active ingredient in Revatio. Generic sildenafil's lower price relative to Adcirca could lead to an erosion of Adcirca's market share and limit its potential sales. Although we believe Adcirca's once-daily dosing regimen provides a significant competitive advantage over generic sildenafil's multiple dosing regimen, we believe that government payers and private insurance companies may favor the use of less expensive generic sildenafil over Adcirca. Thus far, we have not observed any measurable impact of generic sildenafil on sales of Adcirca; however, circumstances could change over time and our revenues could be adversely impacted. The U.S. patent for Adcirca for the treatment of pulmonary hypertension will expire in November 2017. Patent expiration and generic competition for any of our commercial products could have a significant, adverse impact on the magnitude of our revenues, which is inherently difficult to predict. For additional discussion, refer to the risk factor entitled, Our intellectual property rights may not effectively deter competitors from developing competing products that, if successful, could have a material adverse effect on our revenues and profits, contained in Part II, Item 1A-Risk Factors included in this Quarterly Report on Form 10-Q. Cost of Product Sales Cost of product sales comprise: (1) costs to produce and acquire products sold to customers; (2) royalty payments under license agreements granting us rights to sell related products; and (3) direct and indirect distribution costs incurred in the sale of products. We acquired the rights to sell our commercial products through license and assignment agreements with the original developers of these products. These agreements obligate us to pay royalties based on specified percentages of our net revenues from the related products. Currently, we pay GlaxoSmithKline PLC a royalty of ten percent of net sales of our treprostinil-based products (Remodulin, Tyvaso and Orenitram). This royalty obligation will expire in October 2014. As a result, we anticipate gross margins will increase on all three of our treprostinil-based products. Going forward, we will have no royalty obligations for Remodulin or Tyvaso, and our only remaining royalty obligation on Orenitram sales will be a single-digit royalty relating to technology used in its formulation. We pay a five percent royalty to Lilly on net sales of Adcirca. 23 -------------------------------------------------------------------------------- Table of Contents We synthesize treprostinil, the active ingredient in Remodulin and Tyvaso, and treprostinil diolamine, the active ingredient in Orenitram, and produce Remodulin and Tyvaso, at our facility in Silver Spring, Maryland. We produce Orenitram in our Research Triangle Park, North Carolina facility. We currently use our own facilities to produce our primary supply of Remodulin and Tyvaso, and our entire supply of Orenitram. We plan to continue to contract with third party contract manufacturers to supplement our Remodulin and Tyvaso production capacity and mitigate the risk of shortages and supply interruptions, and we are pursuing similar arrangements for Orenitram. We began selling Orenitram during the second quarter of 2014, and typical of the initial commercial activities of a newly-launched product, Orenitram's cost of product sales as a percentage of net revenue is significantly higher than that of our other commercial products. We expect that as Orenitram's revenues increase, its cost of product sales as a percentage of net revenue will decrease to levels more comparable to our other commercial products. Lilly manufactures Adcirca. We take title to Adcirca upon its manufacture and bear any losses related to the storage, distribution and sale of Adcirca. Operating Expenses Since our inception, we have devoted substantial resources to our various clinical trials and other research and development efforts, which we have conducted both internally and through third parties. From time to time, we also license or acquire additional technologies and compounds to be incorporated into our development pipeline. Share-Based Compensation Our operating expenses and net income are often materially impacted by the recognition of share-based compensation expense (benefit) associated with awards granted under our share tracking award plans (STAP) and potential stock option grants containing a market or performance condition, as the fair value of these varies with the changes in our stock price. The fair values of STAP awards and potential stock options grants are measured using inputs and assumptions under the Black-Scholes-Merton model that can materially impact the amount of compensation expense (benefit) for a given period. We account for STAP awards as liabilities because they are settled in cash. As such, we must re-measure the fair value of outstanding STAP awards at the end of each financial reporting period until the awards are no longer outstanding. Changes in our STAP-related liability resulting from such re-measurements are recorded as adjustments to share-based compensation expense (benefit) and can create substantial volatility within our operating expenses from financial reporting period to period. The following factors, among others, have a significant impact on the amount of share-based compensation expense (benefit) recognized in connection with the STAP from period to period: (1) volatility in the price of our common stock (specifically, increases in the price of our common stock will generally result in an increase in our STAP liability and related compensation expense, while decreases in our stock price will generally result in a reduction in our STAP liability and related compensation expense); (2) changes in the number of outstanding awards; (3) changes in the number of vested and partially vested awards; and (4) the probability of meeting the relevant performance criteria. If we meet annual contractual performance requirements tied to growth in our market capitalization, our Chief Executive Officer will be granted stock options at year-end, which vest immediately upon grant. We accrue compensation expense for our Chief Executive Officer's estimated stock option grant when we determine that it is probable that the performance criteria will be met. Major Research and Development Projects Our major research and development projects focus on: (1) the use of prostacyclin analogues, lung transplantation technologies and other therapies, to treat cardiopulmonary diseases; (2) a monoclonal antibody to treat high-risk neuroblastoma; and (3) glycobiology antiviral agents to treat infectious diseases. 24 -------------------------------------------------------------------------------- Table of Contents Cardiopulmonary Disease Projects Remodulin In 2009, we entered into an agreement with exclusive rights in the United States, United Kingdom, France, Germany, Italy and Japan, with Medtronic, Inc. (Medtronic) to develop its proprietary intravascular infusion catheter to be used with Medtronic's SynchroMed® II implantable infusion pump and related infusion system components (collectively referred to as the "Medtronic System") in order to deliver Remodulin for the treatment of PAH. If the Medtronic System is successful, it could reduce many of the patient burdens and other complications associated with infused prostacyclin analogues. With our funding, Medtronic conducted the DelIVery clinical trial in order to study the safety of the Medtronic System while administering Remodulin. The primary objective of this study was to demonstrate a rate of catheter-related complications below 2.5 per 1,000 patient-days while using the Medtronic System to deliver Remodulin. In September 2013, Medtronic informed us that it met this primary objective (p<0.0001). In addition to the clinical study, Medtronic must complete other stability, compatibility and technical assessments of the Medtronic System, including modifications to its hardware and software, and address any outstanding regulatory issues. Upon completion of these activities by Medtronic, we anticipate Medtronic will make preparations to file a premarket approval application seeking FDA clearance for the catheter and labeling changes to enable the use of the Medtronic System with Remodulin. In tandem, we plan to seek FDA approval of a supplement to Remodulin's label to allow the use of Remodulin with the Medtronic System. Tyvaso In connection with Tyvaso's approval from the FDA, we agreed to a post-marketing requirement (PMR) obligating us to conduct an additional study to continue to assess the safety of Tyvaso. In accordance with this PMR, we recently completed enrollment of patients in a long-term observational study the United States that will include 1,000 patient years of follow-up in patients treated with Tyvaso and 1,000 patient years of follow-up in control patients receiving other PAH treatments. We are required to update the FDA annually on our PMR and to submit the results of the study by June 30, 2015. Orenitram In December 2013, the FDA approved Orenitram for the treatment of PAH in WHO Group 1 patients to improve exercise capacity. Orenitram's label notes that Orenitram has not been shown to improve exercise capacity in patients on background vasodilator therapy, and that Orenitram is probably most useful to replace subcutaneous, intravenous, or inhaled treprostinil, but that these uses have not been studied. We believe that in order for Orenitram to reach its full commercial potential, we need to complete further studies to support an amendment to Orenitram's label to indicate that Orenitram delays morbidity and mortality in patients who are on an approved oral background therapy. As such, we are enrolling up to 858 patients in a phase IV clinical trial called FREEDOM-EV, which began in 2012. FREEDOM-EV is a placebo-controlled study of patients who enter the study on an approved background therapy, and one of the two primary endpoints of the study is the time to clinical worsening. We expect to seek approval of Orenitram in Europe upon the successful completion of the FREEDOM-EV study. In 2005, the European Medicines Agency (EMA) announced that Orenitram had been designated an orphan medicinal product for the treatment of PAH. A request for orphan drug designation for Orenitram is pending before the FDA. 314d We have been studying various formulations of beraprost since 2000. We completed a phase I safety trial of a reformulated, single-isomer version of beraprost (314d) in July 2012, and the data suggested that dosing 314d four times a day was safe. We believe that 314d and treprostinil have differing prostacyclin receptor-binding profiles and thus could provide benefits to certain groups of patients with differing sets of safety and efficacy profiles. We also believe inhaled treprostinil and 314d have complimentary pharmacokinetic and pharmacodynamic profiles, which indicates they should provide greater efficacy in combination. As a result, in 2013 we began enrolling a phase III study called BEAT (BEraprost 314d Add-on to Tyvaso) to evaluate the clinical benefit and safety of 314d in combination with Tyvaso for patients with PAH who show signs of deterioration on inhaled treprostinil or have a less than optimal response to inhaled treprostinil treatment. We intend to enroll 240 patients in the study, which will have a primary endpoint of time to clinical worsening. Cell-Based Therapy In 2011, we entered into a license agreement with Pluristem Ltd. (Pluristem) to develop and commercialize a cell-based product for the treatment of PAH using Pluristem's proprietary cell technology known as PLacental eXpanded (PLX) cells. We commenced a phase I clinical study in Australia in 2013. 25 -------------------------------------------------------------------------------- Table of Contents Lung Transplantation The only reported cure for PAH is a lung transplant. Only a few hundred PAH patients receive a lung transplant each year due to the shortage of available lungs for transplant and the demand for transplantable lungs in patients with PAH and other end-stage pulmonary diseases, such as chronic obstructive pulmonary disease and idiopathic pulmonary fibrosis. In 2011, we acquired all of the outstanding stock of Revivicor, Inc., a company focused on developing genetic biotechnology platforms to provide alternative tissue sources for the treatment of human degenerative disease through tissue and organ xenotransplantation. We are focused on this platform with the goal of providing transplantable lungs for human patients. In May 2014, we closed on a $50.0 million preferred stock investment in Synthetic Genomics Inc. (SGI). In addition, we entered into a separate multi-year research and development collaboration agreement whereby SGI will develop engineered primary pig cells with modified genomes for use in our xenotransplantation program, which is principally focused on lungs. Under this agreement, each party will assume its own research and development costs and SGI may receive royalties and milestone payments from development and commercialization of organs. We are also engaged in preclinical development of several regenerative technologies for creating transplantable lung tissue and whole lungs for patients with end-stage lung disease, as well as other technologies intended to improve outcomes for lung transplant recipients. TransCon-Based Products In June 2014, we terminated our exclusive license agreement with Ascendis Pharma A/S (Ascendis Pharma) relating to Ascendis Pharma's proprietary TransCon technology platform. Under this agreement, we had been developing sustained-release, self-injectable forms of treprostinil and beraprost for treatment of PAH. From inception to June 30, 2014, we have spent $1.0 billion on all of our current and former cardiopulmonary disease programs. Cancer-Related Projects Ch14.18 Antibody In 2010, we entered into a Cooperative Research and Development Agreement (CRADA) with the National Cancer Institute (NCI) of the United States National Institutes for Health (NIH) to collaborate on the late-stage development and regulatory approval process for Chimeric Monoclonal Antibody 14.18 (ch14.18) for children with high-risk neuroblastoma and patients with other forms of cancer. Ch14.18 is an antibody that has shown potential in the treatment of neuroblastoma by targeting GD2, a glycolipid on the surface of tumor cells. Under the terms of the CRADA, the NCI has completed necessary studies and we have developed the ability to produce ch14.18 on a commercial scale. Collectively, related NCI-supported studies and our production data were used as the foundation for our marketing authorization application, which the EMA accepted in December 2013, and a biologics license application we submitted to the FDA in April 2014. We previously received orphan drug designation for ch14.18 from both the FDA and the EMA. We have spent $116.5 million from inception to June 30, 2014, on all of our current and former cancer programs. Infectious Disease Projects Pursuant to our research agreement with the University of Oxford (Oxford), we have the exclusive right to commercialize a platform of glycobiology antiviral drug candidates in various preclinical and clinical stages of testing for the treatment of a variety of viruses. Through our research agreement with Oxford, we are also supporting the research of new glycobiology antiviral drug candidates and technologies. We are currently testing many of these compounds in preclinical studies and Oxford continues to synthesize new agents that we may elect to test. In 2011, we were awarded a cost plus fixed fee contract with an aggregate value of up to $45.0 million under a Broad Agency Announcement from the National Institute of Allergy and Infectious Diseases (NIAID) of the NIH for studies directed toward the development of a broad spectrum antiviral drug with a primary indication for dengue and a secondary indication for influenza, based on our glycobiology antiviral platform. There are eight milestone-based options to expand the project and funding under the contract. To date, we have received contract modifications exercising four of these options, increasing total committed contract funding to $25.7 million. We recognize revenue under this contract to the extent of allowable costs incurred, plus a proportionate amount of fees earned. Related revenues are included under the caption Other Revenues on our consolidated statements of operations. 26 -------------------------------------------------------------------------------- Table of Contents Pursuant to our contract with NIAID, we began enrolling a phase I clinical trial of our lead antiviral candidate, an alpha-glucosidase inhibitor called UV-4B, for the treatment of dengue in the third quarter of 2014. We have spent $80.5 million from inception to June 30, 2014, on all of our current and former infectious disease programs. Future Prospects The extent of our future success is dependent, among other things, on how well we achieve the following objectives: (1) in the near term, continued sales growth of our current commercial products by increasing our market share and launching enhancements designed to improve patient care, such as implantable pumps for Remodulin, and growing sales of our recently-launched product, Orenitram, including through positive prescriber experience with dosing three times per day; and (2) in the medium term, augmenting our near-term product growth through: (a) the successful launch of Orenitram for use in combination with other oral therapies following positive FREEDOM-EV results, and (b) the launch of 314d following positive results of the BEAT study; and (3) in the long term, supplementing our oral, inhaled and infused PAH therapy revenues by introducing transplantable cells, tissues and organs that may prove effective in treating PAH and other end-stage lung diseases. Our ability to achieve these objectives and sustain our growth and profitability will depend on many factors, including among others: (1) the timing and outcome of clinical trials and regulatory approvals for products we develop; (2) the timing of and the degree of success related to the commercial launch of new products; (3) the demand for our products; (4) pricing and reimbursement of our products by public and private health insurance organizations; (5) the competition we face within our industry; (6) our ability to effectively manage our business in an increasingly complex legal and regulatory environment; (7) our ability to defend against generic competition, including the ongoing challenge to our Remodulin patents by a generic drug company; and (8) the risks identified in Part II, Item 1A-Risk Factors, included in this Quarterly Report on Form 10-Q. We may need to construct additional facilities to support the development and commercialization of our products. For example, the development of broad-spectrum anti-viral drugs, cell therapies and transplantable lungs and lung tissues will require the design and construction of sophisticated facilities that will need to comply with stringent regulatory requirements related to these programs, some of which have not yet been developed or adopted by the relevant government agencies. The extent to which we fully develop any of these facilities will depend on the progress of our pre-clinical and clinical development in various earlier stage programs. We operate in a highly competitive market in which a small number of pharmaceutical companies control a majority share of available PAH therapies. These pharmaceutical companies are well established in the market and possess greater financial, technical and marketing resources than we do. In addition, there are a number of investigational products in late-stage development that, if approved, may erode the market share of our existing commercial therapies and make market acceptance more difficult to achieve for any therapies we attempt to market in the future. Financial Position Cash, cash equivalents and marketable securities at June 30, 2014 and December 31, 2013 (excluding restricted amounts of $88.5 million and $5.4 million, respectively) were $760.0 million and $1,136.7 million, respectively. The decrease of $376.7 million in unrestricted cash, cash equivalents and marketable securities resulted largely from the use of $377.6 million to repurchase shares of our common stock. We financed these repurchases in part by drawing down $75.0 million under our line of credit, which remains outstanding at June 30, 2014. As a result of this outstanding balance, our line of credit is secured by $88.5 million of our marketable investments at June 30, 2014, which are classified as restricted. In addition, during the six months ended June 30, 2014, we paid out $61.7 million for the exercises of cash-settled STAP awards. Accounts receivable at June 30, 2014 were $212.9 million compared to $126.3 million at December 31, 2013. The $86.6 million increase was driven by the growth in sales and the timing of customer invoices and their related payments. Other assets increased by $45.1 million during the six months ended June 30, 2014, primarily as a result of our $50.0 million investment in SGI, offset in part by our sale at par of $5.0 million of stock we held in another private company. 27 -------------------------------------------------------------------------------- Table of Contents The STAP liability (current) decreased by $123.5 million, from $288.0 million at December 31, 2013, to $164.4 million at June 30, 2014. The decrease of the liability resulted from a 22 percent decline in the price of our common stock and $61.7 million of STAP exercises during the six months ended June 30, 2014. Line of credit and mortgages payable-current increased by $74.8 million to $141.6 million at June 30, 2014, compared to December 31, 2013, due to the $75.0 million increase in the outstanding balance of our line of credit to help fund share repurchases. Additional paid-in capital was $1,101.5 million at June 30, 2014, compared to $1,057.2 million at December 31, 2013. The $44.3 million increase in additional paid-in capital primarily consisted of the following components: (1) $36.2 million in proceeds from stock option exercises and related tax benefits; (2) $5.9 million from the reclassification of part of the equity component of our Convertible Notes (for further information, refer to Note 9-Debt-Convertible Notes Due 2016 to our consolidated financial statements included in this Quarterly Report on Form 10-Q); and (3) $1.7 million in proceeds from the issuance of approximately 27,000 shares of our common stock under our employee stock purchase plan. The $377.6 million increase in treasury stock to $891.0 million at June 30, 2014 from $513.4 million at December 31, 2013 reflects the cost to repurchase approximately 3.9 million shares of our common stock during the six months ended June 30, 2014. 28 -------------------------------------------------------------------------------- Table of Contents Three Months Ended June 30, 2014 and 2013 Revenues The following table sets forth the components of net revenues (dollars in thousands): Three Months Ended June 30, Percentage 2014 2013 Change Cardiopulmonary products: Remodulin $ 138,152 $ 124,311 11.1 % Tyvaso 121,227 109,458 10.8 % Adcirca 55,318 43,726 26.5 % Orenitram 6,632 - - % Other 1,473 3,111 (52.7 )% Total net revenues $ 322,802 $ 280,606 15.0 % The growth in product revenues for the three months ended June 30, 2014, compared to the same quarter in 2013, corresponded primarily to the continued increase in the number of patients being treated with our products and the commencement of Orenitram sales. For the three months ended June 30, 2014 and 2013, approximately 75 percent and 77 percent, respectively, of total net revenues were derived from our U.S.-based specialty pharmaceutical distributors. The tables below include a reconciliation of the accounts associated with estimated rebates, prompt-pay discounts, sales allowances and distributor fees (in thousands): Three Months Ended June 30, 2014 Prompt Pay Allowance for Distributor Rebates Discounts Sales Returns Fees Total Balance, April 1, 2014 $ 26,902 $ 2,637 $ 3,060 $ 1,910 $ 34,509 Provisions attributed to sales in: Current period 25,144 5,766 383 1,652 32,945 Prior periods 557 - 247 (66 ) 738 Payments or credits attributed to sales in: Current period (3,424 ) (2,748 ) - (710 ) (6,882 ) Prior periods (22,863 ) (2,637 ) (324 ) (2,047 ) (27,871 ) Balance, June 30, 2014 $ 26,316 $ 3,018 $ 3,366 $ 739 $ 33,439 Three Months Ended June 30, 2013 Prompt Pay Allowance for Distributor Rebates Discounts Sales Returns Fees Total Balance, April 1, 2013 $ 16,076 $ 1,997 $ 3,499 $ 416 $ 21,988 Provisions attributed to sales in: Current period 21,184 6,134 46 1,839 29,203 Prior periods 566 - - - 566 Payments or credits attributed to sales in: Current period (1,453 ) (4,083 ) - (215 ) (5,751 ) Prior periods (16,082 ) (1,399 ) (56 ) 365 (17,172 ) Balance, June 30, 2013 $ 20,291 $ 2,649 $ 3,489 $ 2,405 $ 28,834 29 -------------------------------------------------------------------------------- Table of Contents Research and Development Expense The table below summarizes research and development expense by major project and non-project component (dollars in thousands): Three Months Ended June 30, Percentage 2014 2013 Change Project and non-project component: Cardiopulmonary $ 28,274 $ 28,537 (0.9 )% Share-based compensation expense 1,047 14,158 (92.6 )% Other 10,421 11,922 (12.6 )% Total research and development expense $ 39,742 $ 54,617 (27.2 )% Share-based compensation. The decrease in share-based compensation of $13.1 million for the three months ended June 30, 2014, compared to the same three-month period in 2013, resulted primarily from a 6 percent decrease in our stock price for the three months ended June 30, 2014, compared to an 8 percent increase for the same three-month period in 2013. Selling, General and Administrative Expense The table below summarizes selling, general and administrative expense by major category (dollars in thousands): Three Months Ended June 30, Percentage 2014 2013 Change Category: General and administrative $ 47,889 $ 35,445 35.1 % Sales and marketing 22,046 17,344 27.1 % Share-based compensation (benefit) expense (1,904 ) 18,576 (110.2 )% Total selling, general and administrative expense $ 68,031 $ 71,365 (4.7 )% General and administrative. The increase in general and administrative expense of $12.4 million for the three months ended June 30, 2014, compared to the same three-month period in 2013, comprised principally the following: (1) a $7.5 million increase in professional and consulting fees, principally driven by an increase in legal fees in connection with our ongoing litigation with Sandoz and our response to a subpoena issued by the Office of Inspector General (OIG) of the Department of Health and Human Services relating to our marketing practices; (2) a $2.2 million increase in salaries and related expenses due to the growth of our operations; and (3) a $2.0 million increase in grants to non-affiliated, non-profit organizations that provide financial assistance to patients with PAH. Sales and marketing. The increase in sales and marketing expense of $4.7 million for the three months ended June 30, 2014, compared to the same three-month period in 2013, was primarily the result of $2.3 million in expenses incurred with the commercial launch of Orenitram and a $1.7 million increase in salaries and related expenses due to the growth of our sales operations. Share-based compensation. The decrease in share-based compensation of $20.5 million for the three months ended June 30, 2014, compared to the same three-month period in 2013, resulted primarily from a 6 percent decrease in our stock price for the three months ended June 30, 2014, compared to an 8 percent increase for the same three-month period in 2013. Income Taxes. The provision for income tax expense is based on an estimated annual effective tax rate that is subject to adjustment in subsequent quarterly periods if components used to estimate the annual effective tax rate are updated or revised. Our estimated annual effective tax rates were 35 percent and 33 percent as of June 30, 2014 and 2013, respectively. Our 2014 estimated annual effective tax rate increased as of June 30, 2014 primarily due to a reduction in the amount of business tax credits we expect to generate during 2014 versus our estimate of business tax credits at June 30, 2013. 30 -------------------------------------------------------------------------------- Table of Contents Six Months Ended June 30, 2014 and 2013 Revenues The following table sets forth the components of net revenues (dollars in thousands): Six Months Ended June 30, Percentage 2014 2013 Change Cardiopulmonary products: Remodulin $ 274,259 $ 238,992 14.8 % Tyvaso 228,313 204,103 11.9 % Adcirca 96,678 77,546 24.7 % Orenitram 6,632 - - % Other 6,323 5,101 24.0 % Total net revenues $ 612,205 $ 525,742 16.4 % The growth in product revenues for the six months ended June 30, 2014, compared to the same period in 2013, corresponded primarily to the continued increase in the number of patients being treated with our products and the commencement of Orenitram sales during the second quarter. For the six months ended June 30, 2014 and 2013, approximately 75 percent and 77 percent, respectively, of total net revenues were derived from our U.S.-based specialty pharmaceutical distributors. The tables below include a reconciliation of the accounts associated with estimated rebates, prompt-pay discounts, sales allowances and distributor fees (in thousands): Six Months Ended June 30, 2014 Prompt Pay Allowance for Distributor Rebates Discounts Sales Returns Fees TotalBalance, January 1, 2014 $ 22,475 $ 2,500 $ 2,862 $ 1,092 $ 28,929 Provisions attributed to sales in: Current period 51,632 12,060 767 3,653 68,112 Prior periods 6,489 - 220 227 6,936 Payments or credits attributed to sales in: Current period (26,822 ) (9,229 ) - (2,756 ) (38,807 ) Prior periods (27,458 ) (2,313 ) (483 ) (1,477 ) (31,731 ) Balance, June 30, 2014 $ 26,316 $ 3,018 $ 3,366 $ 739 $ 33,439 Six Months Ended June 30, 2013 Prompt Pay Allowance for Distributor Rebates Discounts Sales Returns Fees Total Balance, January 1, 2013 $ 15,207 $ 2,115 $ 3,350 $ 1,281 $ 21,953 Provisions attributed to sales in: Current period 37,584 11,448 204 3,536 52,772 Prior periods 986 - - 3 989 Payments or credits attributed to sales in: Current period (18,416 ) (8,799 ) - (1,131 ) (28,346 ) Prior periods (15,070 ) (2,115 ) (65 ) (1,284 ) (18,534 ) Balance, June 30, 2013 $ 20,291 $ 2,649 $ 3,489 $ 2,405 $ 28,834 31 -------------------------------------------------------------------------------- Table of Contents Research and Development Expense The table below summarizes research and development expense by major project and non-project component (dollars in thousands): Six Months Ended June 30, Percentage 2014 2013 Change Project and non-project component: Cardiopulmonary $ 56,563 $ 55,118 2.6 % Share-based compensation (benefit) expense (25,528 ) 27,734 (192.0 )% Other 21,155 22,195 (4.7 )% Total research and development expense $ 52,190 $ 105,047 (50.3 )% Share-based compensation. The decrease in share-based compensation of $53.3 million for the six months ended June 30, 2014, compared to the same six-month period in 2013, resulted primarily from a 22 percent decrease in our stock price for the six months ended June 30, 2014, compared to a 23 percent increase for the same six-month period in 2013. Selling, General and Administrative Expense The table below summarizes selling, general and administrative expense by major category (dollars in thousands): Six Months Ended June 30, Percentage 2014 2013 Change Category: General and administrative $ 91,037 $ 68,869 32.2 % Sales and marketing 40,969 34,732 18.0 % Share-based compensation (benefit) expense (33,760 ) 39,120 (186.3 )% Total selling, general and administrative expense $ 98,246 $ 142,721 (31.2 )% General and administrative. The increase in general and administrative expense of $22.1 million for the six months ended June 30, 2014, compared to the same six-month period in 2013, comprised principally the following: (1) a $12.2 million increase in professional and consulting fees, principally driven by an increase in legal-related fees in connection with ongoing litigation with Sandoz and our response to a subpoena issued by the OIG relating to our marketing practices; (2) a $4.2 million increase in salaries and related expenses due to the growth of our operations; and (3) a $4.7 million increase in grants to non-affiliated, non-profit organizations that provide financial assistance to patients with PAH. Sales and marketing. The increase in sales and marketing expense of $6.2 million for the six months ended June 30, 2014, compared to the same six-month period in 2013, was principally the result of $3.1 million in expenses incurred with the commercial launch of Orenitram during the second quarter of 2014 and a $3.6 million increase in salaries and related expenses due to the growth of our sales operations. Share-based compensation. The decrease in share-based compensation of $72.9 million for the six months ended June 30, 2014, compared to the same six-month period in 2013, resulted primarily from a 22 percent decrease in our stock price for the six months ended June 30, 2014, compared to a 23 percent increase for the same six-month period in 2013. Income Taxes. The provision for income tax expense is based on an estimated annual effective tax rate that is subject to adjustment in subsequent quarterly periods if components used to estimate the annual effective tax rate are revised. Our estimated annual effective tax rates were 35 percent and 33 percent as of June 30, 2014 and 2013, respectively. Our 2014 estimated annual effective tax rate increased as of June 30, 2014 primarily due to a reduction in the amount of business tax credits we expect to generate during 2014 versus our estimate of business tax credits at June 30, 2013. 32 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources We have funded our operations principally through sales of our commercial products and, from time-to-time, third-party financing arrangements. We believe that our current liquidity is sufficient to fund ongoing operations and future business plans as we expect demand for our commercial products to continue to grow. Furthermore, our customer base remains stable and we believe it presents minimal credit risk. However, any projections of future cash flows are inherently subject to uncertainty and we may seek other forms of financing. Cash Flows Operating Activities Net cash provided by operating activities was $56.1 million for the six-months ended June 30, 2014, compared to $181.5 million for the six months ended June 30, 2013. The $125.4 million decrease in net cash provided by operating activities was primarily due to a $130.8 million decrease in share-based compensation, a $71.0 million decrease in cash provided from accounts receivable collections and a $95.6 million use of cash to reduce our other liabilities for the six-month period ended June 30, 2014 compared to the same period in 2013. These decreases were partially offset by a $107.2 million increase in net income and a $69.7 million increase in our provision for income taxes. As a result of the 22 percent decline in our stock price during the six months ended June 30, 2014, we recognized a $62.6 million share-based compensation benefit, which contributed to an increase in our net income before taxes and therefore an increase in our provision for income taxes. In contrast, for the six months ended June 30, 2013, we recognized $68.2 million of share-based compensation expense due to our stock price increasing by 23 percent during the period. As a result, our current and deferred incomes taxes increased by $67.2 million and our share-based compensation decreased by $130.8 million during the six-month period ended June 30, 2014 compared to the same period in 2013. In addition, sales during the three-month period ended June 30, 2014 increased by 15 percent, compared to the same period in 2013, which contributed to a $71.0 million increase in accounts receivable and caused a reduction in cash provided from accounts receivable collections. Lastly, the decrease in our other liabilities of $95.6 million when comparing the six months ended June 30, 2014 to the same period in 2013, was primarily due to a $37.2 million increase in the exercise of STAP awards and a $49.4 million increase in estimated tax payments in 2014 versus 2013. Investing Activities Net cash provided by investing activities was $188.6 million for the six months ended June 30, 2014, compared to $37.2 million for the six months ended June 30, 2013. The $151.4 million increase includes a $188.0 million increase in maturing marketable investments which were not reinvested, and the proceeds of which were used principally to fund the repurchases of our common stock. This increase was partially offset by a $22.4 million increase in capital expenditures relating principally to the recently-completed construction of facilities used in our lung transplantation programs and a $14.2 million increase in cost-method investments, primarily due to the $50.0 million investment in SGI. Financing Activities Net cash used in financing activities was $264.7 million for the six months ended June 30, 2014 compared to $28.4 million used in financing activities for the six months ended June 30, 2013. The $236.3 million increase reflects an increase of $335.1 million in repurchases of our common stock offset by $75.0 million in the proceeds from borrowing under our line of credit and $23.5 million increase in proceeds and tax benefits from the exercise of stock options during the six months ended June 30, 2014 when compared to the same six-month period in 2013. 33 -------------------------------------------------------------------------------- Table of Contents Convertible Senior Notes In 2011, we issued 1.0 percent Convertible Senior Notes due September 15, 2016 (Convertible Notes) with an aggregate principal value of $250.0 million. The Convertible Notes are unsecured, unsubordinated debt obligations that rank equally with all of our other unsecured and unsubordinated indebtedness. We pay interest at 1.0 percent per annum semi-annually on March 15 and September 15 of each year. The initial conversion price is $47.69 per share and the number of underlying shares used to determine the aggregate consideration upon conversion is approximately 5.2 million shares. Conversion can occur: (1) any time after June 15, 2016; (2) during any calendar quarter that follows a calendar quarter in which the price of our common stock exceeds 130 percent of the conversion price for at least 20 days during the 30 consecutive trading-day period ending on the last trading day of the quarter; (3) during the ten consecutive trading-day period following any five consecutive trading-day period in which the trading price of the Convertible Notes is less than 95 percent of the closing price of our common stock multiplied by the then current number of shares underlying the Convertible Notes; (4) upon specified distributions to our shareholders; (5) in connection with certain corporate transactions; or (6) in the event that our common stock ceases to be listed on the NASDAQ Global Select Market, the NASDAQ Global Market or the New York Stock Exchange, or any of their respective successors. The closing price of our common stock exceeded 130 percent of the conversion price of the Convertible Notes for more than 20 trading days during the 30 consecutive trading day period ended June 30, 2014. Consequently, the Convertible Notes are convertible at the election of their holders. As this conversion right is not within our control, the Convertible Notes are classified as a current liability on our consolidated balance sheet at June 30, 2014. We are required to calculate this contingent conversion at the end of each quarterly reporting period. Therefore, the convertibility and classification of our Convertible Notes may change depending on the price of our common stock. Upon conversion, holders of our Convertible Notes are entitled to receive: (1) cash equal to the lesser of the principal amount of the notes or the conversion value (the number of shares underlying the Convertible Notes multiplied by the then-current conversion price per share); and (2) to the extent the conversion value exceeds the principal amount of the notes, shares of our common stock. In the event of a change in control, as defined in the indenture under which the Convertible Notes have been issued, holders can require us to purchase all or a portion of their Convertible Notes for 100 percent of the principal amount plus any accrued and unpaid interest. It is our expectation, based on our understanding of the historical behavior of holders of convertible notes with terms similar to ours and our experience from our previous issuance of senior convertible notes, that most, if not all, of our outstanding Convertible Notes will be held until maturity. We currently have sufficient cash and cash equivalents, borrowing capacity and, if needed, marketable investments, to fund Convertible Note conversions. Mortgage Financing In December 2010, we entered into a Credit Agreement with Wells Fargo Bank, National Association (Wells Fargo) and Bank of America, N.A., pursuant to which we obtained a $70.0 million mortgage loan (the 2010 Credit Agreement). The 2010 Credit Agreement matures in December 2014, at which time the current principal balance of $66.5 million will become due. The 2010 Credit Agreement is secured by certain of our facilities in Research Triangle Park, North Carolina and Silver Spring, Maryland. The outstanding debt bears a floating rate of interest per annum based on the one-month LIBOR, plus a credit spread of 3.75 percent, or approximately 3.91 percent as of June 30, 2014. Alternatively, we have the option to change the rate of interest charged on the loan to 2.75 percent plus the greater of: (1) Wells Fargo's prime rate, (2) the federal funds effective rate plus 0.05 percent, or (3) LIBOR plus 1.0 percent. We can prepay the loan balance without being subject to a prepayment premium or penalty. The 2010 Credit Agreement contains financial covenants, and as of June 30, 2014, we were in compliance with these covenants. We currently have sufficient cash and cash equivalents, borrowing capacity and, if needed, marketable investments, to fund the payment due at maturity of the 2010 Credit Agreement. Line of Credit In September 2013, we entered into a Credit Agreement with Wells Fargo providing for a $75.0 million revolving loan facility, which may be increased by up to an additional $75.0 million provided certain conditions are met (the 2013 Credit Agreement). In July 2014, we amended the Credit Agreement to extend its maturity to September 2015. We use this facility for general corporate purposes. At our option, amounts borrowed under the 2013 Credit Agreement bear interest at either the one-month LIBOR plus a 0.50 percent margin, or a fluctuating base rate excluding any margin. In addition, we are subject to a monthly commitment fee at a rate of 0.06 percent per annum based on the average daily unused balance of the facility. Amounts borrowed under the 2013 Credit Agreement are secured by certain of our marketable investments. As of June 30, 2014, we had $75.0 million outstanding on the line of credit, which is secured by $88.5 million of our marketable investments. The loan proceeds were used to help fund share repurchases during the second quarter of 2014. We intend to repay the outstanding line of credit balance using current cash, cash generated from operations and cash generated from maturing marketable investments. 34 -------------------------------------------------------------------------------- Table of Contents Share Tracking Awards Plans STAP awards entitle participants to receive in cash an amount equal to the appreciation in our common stock, which is measured as the increase in the closing price of our common stock between the dates of grant and exercise. Depending on the future price movements of our common stock, cash requirements associated with the exercise of these awards could be significant. We incorporate anticipated cash requirements under the STAP into our operating budgets, but actual cash requirements could exceed our expectations. From time to time, our Board of Directors may authorize increases in the number of awards available for grant. Most recently, in January 2014 our Board of Directors increased the number of awards authorized for grant under the STAP by 3 million. Share Repurchases From time to time, our Board of Directors may authorize plans to repurchase our common stock. In January 2013, our Board of Directors authorized a share repurchase program for up to $420.0 million in aggregate repurchases of our common stock (the 2013 Repurchase Program). We completed the 2013 Repurchase Program during the second quarter of 2014. In June 2014, our Board of Directors authorized the repurchase of up to an additional $500.0 million of our common stock. This program will become effective on August 1, 2014, and will remain open for up to one year. We currently have sufficient cash and cash equivalents, borrowing capacity and, if needed, marketable investments, to fund repurchases of our common stock under this program. Summary of Critical Accounting Policies The preparation of our consolidated financial statements in conformity with United States generally accepted accounting principles (GAAP) requires our management to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. We continually evaluate our estimates and judgments to determine whether they are reasonable, relevant and appropriate. These assumptions are frequently developed from historical data or experience, currently available information and anticipated developments. By their nature, our estimates are subject to an inherent degree of uncertainty; consequently, actual results may differ. We discuss critical accounting policies and estimates that involve a higher degree of judgment and complexity in Part II, Item 7-Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2013. There have been no material changes to our critical accounting policies and estimates as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2013. Recently Issued Accounting Standards In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers. ASU 2014-09 will eliminate transaction- and industry-specific revenue recognition guidance under current GAAP and replace it with a principle-based approach for determining revenue recognition. ASU 2014-09 will require that companies recognize revenue based on the value of transferred goods or services as they occur in the contract. The ASU also will require additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2016. Early application is not permitted. Entities can transition to the standard either retrospectively or as a cumulative-effect adjustment as of the date of adoption. Presently, we are assessing what effect the adoption of ASU 2014-09 will have on our consolidated financial statements and accompanying notes. 35 -------------------------------------------------------------------------------- Table of Contents |