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AUXILIUM PHARMACEUTICALS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion is qualified in its entirety by, and should be read in conjunction with, the more detailed information set forth in the consolidated financial statements and the notes thereto appearing elsewhere in this Report. Special Note Regarding Forward-Looking Statements You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and the related notes appearing at the end of this Report. Some of the information contained in this discussion and analysis or set forth elsewhere in this Report, including information with respect to our plans and strategy for our business and related financings, includes forward-looking statements that involve risks and uncertainties. You should review the "Risk Factors" section of this Report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis. In some cases you can identify forward-looking statements by terminology such as "may," "will," "should," "would," "expect," "intend," "plan," "anticipate," "believe," "estimate," "predict," "potential," "seem," "seek," "future," "continue," or "appear" or the negative of these terms or similar expressions, although not all forward-looking statements contain these identifying words. Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results, performance, achievements or 24 -------------------------------------------------------------------------------- Table of Contents prospects to be materially different from any future results, performance, achievements or prospects expressed in or implied by such forward-looking statements. Such risks and uncertainties include, among other things: † our anticipated business, operations, financial condition, strategy and future prospects; † † our ability to forecast our performance accurately; † the effect of the significant decline in sales of Testim, the decline of the TRT market in general and the future TRT market dynamics; † the commercial success of our products in the U.S. and, through our collaborators, internationally, including demand for our products; † our ability to continue successfully launching STENDRA and XIAFLEX for the treatment of PD, and our ability to obtain label expansions for STENDRA and for XIAFLEX for the treatment of multiple DC cords; † the success of the efforts of VIVUS to seek a 15-minute onset of action label expansion for STENDRA; † obtaining and maintaining third-party payor coverage and reimbursement at reasonable reimbursement rates for our products and, if approved, our product candidates; † achieving greater market acceptance of our products by physicians and patients; † obtaining approval from regulatory agencies in other countries for XIAFLEX for DC and PD; † the size of addressable markets for our products and product candidates; † maximizing revenues of our products in the currently approved indications; † competing effectively with other products in our products' therapeutic areas, including potential additional generic and branded generic competition; † our ability to successfully defend our intellectual property, including the various litigations regarding Testim in which we are currently involved; † our ability to successfully defend ourselves in the various litigations regarding, among other things, alleged negative effects of our TRT products; † growth in sales of our products; † growth of the ED markets; † our ability to successfully and timely close the Merger with QLT, and, if we close the Merger, to integrate the operations of QLT and Auxilium into the operations of the Combined Company successfully and efficiently; † our ability to integrate the remaining operations of Actient and its subsidiaries into our operations successfully and efficiently; † our ability to materialize the remaining synergies and benefits, including revenue and profit growth, from the acquisition of Actient; † the risks or costs associated with the Actient acquisition or the Merger being greater than we anticipate; † the risks associated with entering the medical device business as a result of the Actient acquisition; † the ability to manufacture or have manufactured our products and other product candidates in commercial quantities at reasonable costs and compete successfully against other products and companies; 25 -------------------------------------------------------------------------------- Table of Contents † the ability to leverage our investment in our sales force, as well as our expertise in clinical development and regulatory strategy, with the addition of new products; † the availability of, and ability to obtain, additional funds through public or private offerings of debt or equity securities; † the ability to service all of our outstanding indebtedness; † obtaining and maintaining all necessary patents or licenses; † the costs associated with acquiring and/or developing, and the ability to acquire and/or develop, additional product candidates or approved products; † the ability to enroll patients in clinical trials for our product candidates in the expected timeframes; † the ability to obtain authorization from the FDA or other regulatory authorities to initiate clinical trials of our product candidates within the expected timeframes; † the ability to deliver on our current or future pipeline; † the ability to build out our business and development pipeline in specialty therapeutic areas through corporate development and licensing activities or acquisition activities; † demonstrating the safety and efficacy of product candidates at each stage of development; † results of clinical trials; † meeting applicable regulatory standards, filing for, and receiving, required regulatory approvals; † complying with the terms of our licenses and other agreements; † changes in industry practice; † changes in the markets for, acceptance by the medical community of, and exclusivity protection for, our products and product candidates as a result of the Patient Protection and Affordable Care Act and the associated reconciliation bill or any amendments thereto or any full or partial repeal thereof; and † one-time events. These risks and uncertainties are not exhaustive. For a more detailed discussion of risks and uncertainties, see "Item 1A - Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2013, as updated by Part II, Item 1A of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2014, and "Item 1A - Risk Factors" of Part II of this Report. Other sections of this Report and our other SEC filings, verbal or written statements and presentations may include additional factors which could materially and adversely impact our future results, performance, achievements and prospects. Moreover, we operate in a very competitive and rapidly changing environment. Given these risks and uncertainties, we cannot guarantee that the future results, performance, achievements and prospects reflected in forward-looking statements will be achieved or occur. Therefore, you should not place undue reliance on forward-looking statements. We undertake no obligation to update publicly any forward-looking statement other than as required under the federal securities laws. We qualify all forward-looking statements by these cautionary statements. Special Note Regarding Market and Competitive Position Data and Clinical Data We obtained the market and competitive position data used throughout this Report from our own research, surveys or studies conducted by third parties and industry or general publications. Industry publications and surveys generally state that they have obtained information from sources believed to be reliable, but do not guarantee the accuracy and completeness of such information. While we believe that each of these studies and publications is 26 -------------------------------------------------------------------------------- Table of Contents reliable, we have not independently verified such data. Similarly, we believe our internal research is reliable but it has not been verified by any independent sources. This Report may include discussion of certain clinical studies relating to our products and/or product candidates. These studies typically are part of a larger body of clinical data relating to such products or product candidates, and the discussion herein should be considered in the context of the larger body of data. Overview We are a fully integrated specialty biopharmaceutical company with a focus on developing and commercializing innovative products for specialist audiences. With a broad range of first- and second-line products across multiple indications, Auxilium is an emerging leader in the men's healthcare area and has strategically expanded its product portfolio and pipeline in orthopedics, dermatology and other therapeutic areas. We now have a broad portfolio of 12 approved products (including one product with two indications). Among other products in the U.S., Auxilium markets Testim (testosterone gel) for the topical treatment of hypogonadism (along with, through our partner, Prasco an authorized generic version of Testim known as testosterone gel), TESTOPEL (testosterone pellets) a long-acting implantable TRT product, STENDRA (avanafil), an oral ED therapy, Edex (alprostadil for injection), an injectable treatment for ED, Osbon ErecAid, the leading vacuum device for aiding ED, XIAFLEX (collagenase clostridium histolyticum or CCH) for the treatment of PD and XIAFLEX for the treatment of DC. We also have programs in Phase 2 clinical development for the treatment of Frozen Shoulder syndrome and cellulite. Our mission is to improve the lives of patients throughout the world by successfully identifying, developing and commercializing innovative specialty biopharmaceutical products. Our vision is to be the most consistently successful and most admired specialty biopharmaceutical company. For the quarter ended June 30, 2014, we reported net revenues of $83.0 million, compared to net revenues of $100.5 million in the second quarter of 2013, a decrease of 17%. For the second quarter of 2014, XIAFLEX U.S. net revenues increased by 75% over the comparable 2013 period to $26.3 million, which amount includes sales related to XIAFLEX for PD. XIAFLEX for PD was launched in the U.S. in January 2014. For the second quarter of 2014, U.S. Testim net revenues, which include revenues from the sale of Testim and the authorized generic version of Testim launched in the U.S. in June 2014, decreased by 53% from the second quarter of 2013 to $25.2 million. U.S. revenues from our acquired subsidiary, Actient, resulted in U.S. net revenues of $21.4 million for the second quarter of 2014 and included TESTOPEL net revenues of $4.2 million, Edex net revenues of $7.5 million and other U.S. net revenues of $9.7 million. For the second quarter of 2014, STENDRA, which was launched in the U.S. in January 2014, net revenues were $6.1 million. We reported a net loss of $36.5 million, or $0.73 per share (basic and diluted), compared to net income of $42.7 million, or $0.87 per share basic and $0.86 per share diluted for the second quarter of 2013. As of June 30, 2014, we had $44.7 million in cash, cash equivalents and short-term investments, compared to $71.2 million at December 31, 2013, and outstanding debt of $299.5 million ($350.0 million at par value) in the form of the 2018 Convertible Notes and $249.9 million ($258.6 million par value) in a senior secured term loan (the "Term Loan"). We had approximately 635 employees as of June 30, 2014, including approximately 366 employees in our commercial organization, 135 employees in manufacturing and quality, 65 employees in research and development and 69 employees in administrative support. Pipeline and Research and Development Process In the R&D area, we are engaged in innovative research investigating potential treatments. An sBLA for XIAFLEX is under review by the FDA seeking a label expansion to inject multiple DC joints concurrently, which if approved, could provide a non-surgical option for treating two cords in one office visit. It is estimated that 35-40% of annual DC surgical procedures in the U.S. are performed to treat more than one DC cord at a time, so we believe such a potential label expansion, if approved, could provide physicians with another meaningful tool to combat DC effectively and efficiently. We are also conducting research in the area of Frozen Shoulder syndrome and cellulite with CCH, the active ingredient in XIAFLEX. In addition, we have ongoing collaborative programs with our partner, BioSpecifics, to study CCH in the area of human and canine lipoma. This R&D innovation, together with diversifying our approved product portfolio, is all in the interest of delivering what we believe will be long-term value to our shareholders and new treatment options to the patients we hope to serve. 27 -------------------------------------------------------------------------------- Table of Contents The product candidates in our pipeline are at various stages of preclinical and clinical development. The path to regulatory approval includes several phases of nonclinical and clinical study to collect data to support an application to regulatory authorities to allow us to market a product for treatment of a specified disease indication. There are many difficulties and uncertainties inherent in research and development and the introduction of new products. There is a high rate of failure inherent in new drug discovery and development. To bring a drug from the discovery phase to regulatory approval, and ultimately to market, takes many years and incurs significant cost. Failure can occur at any point in the process, including after the product is approved based on post-market factors. New product candidates that appear promising in development may fail to reach the market or may have only limited commercial success because of efficacy or safety concerns, inability to obtain necessary regulatory approvals, limited scope of approved uses, reimbursement challenges, difficulty or excessive costs to manufacture, or infringement of the patents or intellectual property rights of others. Delays and uncertainties in the FDA approval process and the approval processes in other countries can result in delays in product launches and lost market opportunity. Consequently, it can be very difficult to predict which products will ultimately be submitted for approval, which have the highest likelihood of obtaining approval, and which will be commercially viable and generate profits for the Company. Successful results in preclinical or phase 1/2 clinical studies may not be an accurate predictor of the ultimate safety or effectiveness of a drug or product candidate. Phase 1 Clinical Trials Phase 1 human clinical trials begin when regulatory agencies allow a request to initiate clinical investigations of a new drug or product candidate and usually involve small numbers of healthy volunteers or subjects. The trials are designed to determine the safety, metabolism, dosing and pharmacologic actions of a drug in humans, the potential side effects of the product candidates associated with increasing drug doses and, if possible, to gain early evidence of the product candidate's effectiveness. Phase 1 clinical studies generally take from 6 to 12 months or more to complete. Phase 2 Clinical Trials Phase 2 clinical trials are conducted on a limited number of patients with the targeted disease, usually involving no more than several hundred patients, to evaluate appropriate dosage and the effectiveness of a drug for a particular indication or indications and to determine the common short-term side effects and risks associated with the drug. An initial evaluation of the drug's effectiveness on patients is performed and additional information on the drug's safety and dosage range is obtained. Our Phase 2 clinical trials typically include up to 200 patients and may take approximately two years to complete. Phase 3 Clinical Trials Phase 3 clinical trials are performed after preliminary evidence suggesting effectiveness of a drug has been obtained. Phase 3 clinical trials are intended to gather additional information about the effectiveness and safety that is needed to evaluate the overall benefit-risk relationship of the drug and to provide an adequate basis for physician labeling. They typically include controlled multi-center trials and involve a larger target patient population, typically including from several hundred to several thousand patients to ensure that study results are statistically significant. During Phase 3 clinical trials, physicians monitor patients to determine efficacy and to gather further information on safety. These trials are generally global in nature and are designed to generate data necessary to submit the product to regulatory agencies for marketing approval. Phase 3 testing varies and can often last from 2 to 5 years. Regulatory Review If a product successfully completes a Phase 3 clinical trial and is submitted to governmental regulators, such as the FDA in the U.S. or the EMA in the EU, the time to final marketing approval can vary from six months (for a U.S. filing that is designated for priority review by the FDA) to several years, depending on a number of variables, such as the disease state, the strength and complexity of the data presented, the novelty of the target or compound, risk-management approval and the time required for the agency(ies) to evaluate the submission. There is no guarantee that a potential treatment will receive marketing approval, or that decisions on marketing approvals or indications will be consistent across geographic areas. 28 -------------------------------------------------------------------------------- Table of Contents Certain Significant Developments During the Period Covered by this Report Significant business developments that occurred during the second quarter of 2014 or that impacted this period include: † On April 7, 2014, we and Sobi announced that Sobi became the Market Authorisation Holder (MAH) for XIAPEX in 28 EU member countries, Norway, and Iceland on April 3, 2014. As the MAH, Sobi has now elected to file for market authorization for XIAPEX for the treatment of PD and work is on-going for that filing in the EU. † On April 14, 2014, we and Sobi announced that encore data were presented from multiple clinical trials evaluating the use of XIAFLEX / Xiapex in adult patients with PD. These data were presented at the 29th Annual European Association of Urology (EAU) Congress held April 11-15, 2014 in Stockholm, Sweden. † On May 19, 2014, we announced that new analyses of data were presented from our clinical program and pivotal IMPRESS (The Investigation for Maximal Peyronie's Reduction Efficacy and Safety Studies) trials, the Phase 3 studies that evaluated XIAFLEX (collagenase clostridium histolyticum or CCH) for the treatment of PD. These data were presented at the American Urological Association Meeting held in Orlando, Florida on May 16-21, 2014. † On June 2, 2014, we announced that James E. Fickenscher, Chief Financial Officer of the Company, is leaving the Company to pursue other interests and that his employment will end on August 15, 2014. † On June 4, 2014, we learned that the FDA granted final approval to Upsher-Smith Laboratories, Inc.'s ("Upsher-Smith") testosterone gel product, Vogelxo™. On or about July 2 2014, Upsher-Smith launched Vogelxo and an authorized generic version of Vogelxo, known as testosterone gel. As of the date of this filing, we are not aware of any rating having been assigned by the FDA to USL's Vogelxo or its authorized generic. † On June 9, 2014, we provided notice to Prasco authorizing Prasco to commence purchasing, distributing and selling an authorized generic version of Testim, known as testosterone gel, in 5 gram tubes which contain 50mg, of testosterone in the U.S. and its territories and possessions pursuant to a Distribution and Supply Agreement entered into between Prasco and the Company. Prasco commenced initial commercialization activities for the authorized generic version of Testim on June 9, 2014 and commenced shipping the product on June 10, 2014. † On June 25, 2014, we and Sobi announced that Sobi has filed for an extension of the label for Xiapex (collagenase clostridium histolyticum) with the European Medicines Agency to include the potential indication of Peyronie's disease. † As disclosed in our Current Report on Form 8-K filed with the U.S. Securities and Exchange Commission on June 26, 2014 (the "QLT Merger Form 8-K"), on June 25, 2014, we entered into the Merger Agreement among Auxilium, QLT, HoldCo, and AcquireCo. The Merger Agreement provides for the Merger, which is a business combination whereby AcquireCo will be merged with and into Auxilium. As a result of the Merger, the separate corporate existence of AcquireCo will cease and Auxilium will continue as the surviving corporation. On the date of the closing of the Merger, Auxilium will become an indirect wholly owned subsidiary of QLT. Upon consummation of the Merger, each outstanding share of Auxilium common stock, other than shares owned by Auxilium, QLT, HoldCo or AcquireCo, will be converted into the right to receive 3.1359 QLT common shares (the ''Equity Exchange Ratio''), subject to adjustment as described in the QLT Merger Form 8-K. Post-closing of the Merger, QLT will remain the ultimate parent company and is referred to as the Combined Company. Upon completion of the Merger, Auxilium stockholders will own approximately 76% of the outstanding common shares of the Combined Company on a fully diluted basis and current QLT stockholders will own approximately 24% of the outstanding common shares of the Combined Company on a fully diluted basis, subject to certain adjustments. 29 -------------------------------------------------------------------------------- Table of Contents † On July 31, 2014, we announced that Asahi Kasei successfully submitted a regulatory application to the Japanese Pharmaceutical and Medical Device Agency ("JPMDA") for XIAFLEX for DC. The review by the JPMDA is expected to be completed by mid - 2015. Pursuant to our development, commercialization and supply agreement with Asahi Kasei, we will receive a $10 million regulatory milestone payment from Asahi Kasei. Results of Operations Revision to previously issued financial statements Tenant Improvement Allowance In connection with the preparation of the consolidated financial statements for the third quarter of 2013, an incorrect classification was identified with respect to the manner in which we classified the tenant improvement allowance of $3,204 provided by the lessor in the lease for our new corporate headquarters which commenced on January 1, 2013. At recognition of the tenant improvement allowance provided, we properly recorded on our Consolidated Balance Sheets the cost of the improvements as a fixed asset and the tenant improvement allowance as a deferred rent credit. In our Consolidated Statement of Cash Flows provided in our Quarterly Report on Form 10-Q for the quarterly periods ended March 31, 2013 and June 30, 2013, the tenant improvements were incorrectly classified as cash used in investing activities and the offsetting increase in deferred rent was incorrectly classified as an adjustment of cash flows provided by operating activities. We have now determined that the tenant improvement allowance should have been netted against the purchases of property and equipment to reflect the non-cash nature of these transactions in the periods presented. The effect of the misclassification in the Consolidated Statement of Cash Flows for the three months ended March 31, 2013 and the six months ended June 30, 2013 was a $3,204 overstatement of both net cash provided by operating activities and net cash used in investing activities. We assessed this misclassification and concluded that it was not material to our previously issued financial statements. We have properly presented the tenant improvement transaction in the Consolidated Statement of Cash Flows for the nine months ended September 30, 2013 and year ended December 31, 2013. The revision of the six month period ended June 30, 2013 is reflected in this Report. Our Consolidated Statements of Operations for first and second quarters of 2013 and the Consolidated Balance Sheets as of March 31, 2013 and June 30, 2013 were not affected by this misclassification and remain unchanged. Contingent Consideration During the second quarter of 2014, we identified that we had incorrectly classified the fair value of a contingent sales milestone on our Consolidated Balance Sheet as of March 31, 2014. Contingent consideration in the amount of $22.2 million was classified as a current liability as of March 31, 2014; however, the amount should have been classified as a long term liability based on our calculation. The effect of the misclassification on the Consolidated Balance Sheet as of March 31, 2014 was a $22.2 million overstatement of current contingent consideration and an equivalent understatement of non-current contingent consideration. We assessed this misclassification and concluded that it was not material to our financial statements previously issued on our Form 10-Q for the three months ended March 31, 2014. Our Consolidated Statements of Operations and the Consolidated Statements of Cash Flows for the three months ended March 31, 2014 were not affected by this misclassification and remain unchanged. In addition, we determined that we had understated contingent consideration expense and contingent consideration liabilities by $4.2 million for the quarter ended March 31, 2014. This error was the result of using an incorrect revenue forecast to calculate the fair value of royalties included as part of our contingent consideration liabilities. The error had the impact of understating contingent consideration expense by $4.2 million on our Consolidated Statement of Operations for the three months ended March 31, 2014 as well as the contingent consideration liability being understated by the same amount ($1.8 million short-term and $2.4 million long-term) on the Consolidated Balance Sheet as of March 31, 2014. This $4.2 million error also had the effect of understating net loss reported on our Consolidated Statement of Stockholders' Equity as well as understating the net loss and contingent consideration line items within net cash flows from operating activities on our Consolidated Statement of Cash Flows; however, it did not impact total net cash provided by operating activities as reported on the Consolidated Statement of Cash Flows. We assessed this error and concluded that it was not material to our financial statements previously issued on our Form 10-Q for the three months ended March 31, 2014. Additional 30 -------------------------------------------------------------------------------- Table of Contents expense of $4,200 was recorded to contingent consideration on our Consolidated Statement of Operations during the three months ended June 30, 2014 to correct this error. Business Combinations In connection with the preparation of our consolidated financial statements for the second quarter of 2014, we identified prior period errors related to our accounting for business combinations for the year ended December 31, 2013. As of June 30, 2014, we reclassified $5.4 million from Goodwill to Intangible Assets ($3.6 million) and Contingent Consideration ($1.8 million) on the balance sheet and adjusted certain related footnotes for these items. In addition, we recorded additional amortization expense of $380 on our Consolidated statement of operations for the three months ended June 30, 2014 related to these items. These adjustments represent corrections to immaterial errors related to the classification of certain assets and liabilities as well as amortization expense recorded in connection with the acquisitions of Actient and STENDRA. We have evaluated these items, both individually and in the aggregate, in relation to the current period financial statements as well as the period in which they originated and concluded that these adjustments are not material to any of the impacted periods. These adjustments were recorded during the three months ended June 30, 2014. Three Months Ended June 30, 2014 and 2013 Net revenues. Net revenues for the three months ended June 30, 2014 and 2013 comprise the following: Three months ended June 30, 2014 2013 Change % Change (in millions) Testim revenues- Net U.S. revenues - brand $ 11.9 $ 53.2 $ (41.3 ) -78 % Net U.S. revenues - authorized generic 13.3 - 13.3 n/a International revenues 0.9 1.2 (0.3 ) -25 % 26.1 54.4 (28.3 ) -52 % XIAFLEX revenues- Net U.S. revenues 26.3 15.0 11.3 75 % International revenues 3.1 3.9 (0.8 ) -21 % 29.4 18.9 10.5 56 % Other net U.S. revenues- TESTOPEL 4.2 14.4 (10.2 ) -71 % STENDRA 6.1 0 6.1 n/a Edex 7.5 5.0 2.5 50 % Other 9.7 7.8 1.9 24 % 27.5 27.2 0.3 1 % Total net revenues $ 83.0 $ 100.5 $ (17.5 ) -17 % Revenue allowance as a percentage of gross U.S. revenues 34 % 31 % 3 % Net U.S. revenues shown in the above table represent the product sales of the Company within the U.S., net of allowances provided on such sales. In addition, net distributable profits earned pursuant to a Distribution and Supply Agreement (the "AG Agreement") entered into with Prasco are also included in net U.S. revenues in the above table. International revenues represent the amortization of deferred up-front and milestone payments the Company has received through its out-licensing agreements, together with royalties earned on product sales by the licensees. Testim Total revenues for Testim for the three months ended June 30, 2014 were $26.1 million compared to $54.4 million for the comparable period of 2013. Testim revenues for the three months ended June 30, 2014 include $13.3 million of revenues earned pursuant to the AG Agreement with Prasco. Under the AG Agreement, Prasco purchases, distributes and sells an authorized generic version of Testim (the "Generic Testosterone Product") in the 31 -------------------------------------------------------------------------------- Table of Contents United States of America and its territories. Prasco commenced initial commercialization activities for the Generic Testosterone Product on June 9, 2014 and commenced shipping the Generic Testosterone Product on June 10, 2014. Under the terms of the Agreement, we recognize revenue from shipments to Prasco at the invoice supply price when title and risk of loss transfers, which is generally at the time of shipment. We are also entitled to receive a significant percentage of the net distributable profits on sales of the Generic Testosterone Product by Prasco, which we recognize as net revenues when Prasco reports to us the net distributable profits from the ultimate sale of the Generic Testosterone Product. We have recorded all net distributable profits reported by Prasco for the three months ended June 30, 2014. The decrease of $41.3 million in branded Testim net U.S. revenues for the three months ended June 30, 2014 compared to the same period in 2013 is principally due to the following factors: † a shrinking TRT gel market and lower Testim market share, as evidenced by a decline of 32% in total Testim prescriptions for the three months ended June 30, 2014 as compared to the same period in 2013 according to National Prescription Audit data from IMS, a pharmaceutical market research firm; † continued destocking of Testim inventory in the wholesale and retail distribution channels; † a continued decrease in our highest-margin non-contracted prescriptions, resulting in a higher gross-to-net discount applying to Testim sales as a whole; and † the launch of the Generic Testosterone Product in June 2014, which we believe resulted in decreased demand for branded Testim during the three months ended June 30, 2014. We believe the shrinking TRT market has been influenced by recent communications by the FDA regarding its plans to study the safety of TRT products and publications and advertisements suggesting potential health risks associated with TRT products. Given the changing TRT market dynamics and the entry of generic alternatives to the branded gel TRT product market, including the Generic Testosterone Product as well as additional future entry of generic alternatives, we are planning for what we believe is the maturity of the TRT gel market and we expect to continue managing Testim as a mature product going forward. XIAFLEX Total revenues for XIAFLEX in the second quarter of 2014 were $29.4 million compared to $18.9 million in the second quarter of 2013. Net revenues for the three months ended June 30, 2014 include $26.3 million of net U.S. product sales of XIAFLEX compared to the $15.0 million recorded in the second quarter of 2013. This increase was due to growth in product shipments for XIAFLEX for DC as well the launch of XIAFLEX for PD in January 2014. XIAFLEX international revenues for the three months ended June 30, 2014 amounted to $3.1 million compared to $3.9 million recorded in the second quarter of 2013. The decrease in XIAFLEX international revenues resulted from the amortization of deferred revenue during the three months ended June 30, 2013 related to the Pfizer Agreement. There was no revenue recognized for the three months ended June 30, 2014 related to the Pfizer Agreement, as this agreement was terminated during the second quarter of 2013. This decrease was partially offset by increased sales of XIAFLEX by our collaboration partner, Sobi, which resulted in higher royalties for the three months ended June 30, 2014 as compared to the same period in 2013. Other net U.S. revenues Other U.S. net revenues for the three months ended June 30, 2014 include sales of the products we acquired in the April 2013 acquisition of Actient as well as our in-licensing of STENDRA in October 2013. The Actient revenues included sales of TESTOPEL, Edex and other U.S. products of $4.2 million, $7.5 million and $9.7 million, respectively, for three months ended June 30, 2014 compared to $14.4 million, $5.0 million, and $7.8 million for the same period in 2013. We announced a price increase on TESTOPEL at the beginning of March, 2014, with an effective date of April 1, 2014. Therefore, we believe that the revenues recorded in the first quarter of 2014 included purchases made by our customers in excess of their current needs in advance of the price increase. We believe that this first quarter buy-in had the impact of decreasing TESTOPEL revenues for the three months ended June 30, 2014. The decrease in net revenues from the products we acquired from Actient in April 2013 was partially offset by $6.1 million of net product sales of STENDRA, a new first-line oral therapy for ED licensed from VIVUS 32 -------------------------------------------------------------------------------- Table of Contents and launched during January 2014. We believe these revenues include a filling of the wholesale and retail channels in excess of current demand as indicated by prescriptions fulfilled in the second quarter of 2014. Revenue allowances Revenue allowances as a percentage of gross U.S. revenues for the second quarter of 2014 compared to the second quarter of 2013 increased due principally to a decrease in our highest-margin non-contracted prescriptions of Testim during the second quarter of 2014, resulting in a higher gross-to-net discount applying to branded Testim sales as a whole. In addition, the higher percentage in the second quarter of 2014 was impacted by coupons offered on sales of STENDRA in conjunction with the product launch and higher product return charges for Testim and various Actient products. These increases were partially offset by a lower level of allowances on sales of Actient products which were acquired during the second quarter of 2013 as well as the addition of revenue earned on the sale of the Generic Testosterone Product sold by Prasco under the AG Agreement. The revenues recorded under the AG Agreement are reported by Prasco to Auxilium on a net basis; therefore, there are no gross-to-net adjustments recorded on Auxilium's financial statements. We believe that our revenue allowances as a percentage of gross U.S. revenues will stabilize in subsequent periods as compared to the second quarter of 2014 as other products with lower levels of discounts become a more significant portion of our overall revenues. Cost of goods sold. Cost of goods sold were $30.0 million and $27.2 million for the three months ended June 30, 2014 and 2013, respectively. Cost of goods sold reflects the cost of product sold, royalty obligations due to our licensors (excluding contingent consideration royalties), and the amortization of the deferred costs associated with the collaboration agreements with Actelion, Asahi, Pfizer and Sobi. Cost of goods sold excludes the amortization of product rights associated with the Actient and STENDRA acquisitions. The increase in cost of goods sold in the second quarter of 2014 over the same period in 2013 was principally attributable to a $6.7 million inventory charge recorded related to excess Testim branded inventory. The excess inventory charge resulted from our decision to launch the Generic Testosterone Product, which we believe had the impact of decreasing the demand forecast for our branded Testim product. The gross margin rate on our net revenues was 64% for the three months ended June 30, 2014 compared to 73% for the same period in 2013. The decrease in the gross margin rate is primarily due to the excess inventory charge, product returns and the higher gross-to-net discount on branded Testim sales as discussed above, offset partially by a higher margin contribution on the acquired Actient products. Research and development expenses. We currently have two projects in clinical development, specifically XIAFLEX for the treatment of Frozen Shoulder syndrome and cellulite. A significant portion of the research and development expenses are for the internal personnel and infrastructure costs common to the support of these development efforts. Since we do not allocate these common costs to individual projects for external reporting purposes, we do not report research and development cost by project. Research and development expenses were $11.3 million and $13.6 million for the three months ended June 30, 2014 and 2013, respectively. This decrease in expense resulted principally from lower spending on the XIAFLEX multi-cord phase 3 clinical trial for DC. This decrease was partially offset by increased spending on the XIAFLEX Phase 2 trials for cellulite and Frozen Shoulder syndrome, which commenced during the fourth quarter of 2013. Selling, general and administrative expenses. Selling, general and administrative expenses were $69.2 million and $74.9 million for the three months ended June 30, 2014 and 2013, respectively. This decrease was primarily due to the transaction and integration costs associated with the acquired Actient operations during the second quarter of 2013, offset partially by an increase in marketing and advertising spend related to the launch of XIAFLEX for the treatment of PD and STENDRA. In addition, during the second quarter of 2014 we incurred $5.2 million of transaction expenses in connection with our pending merger with QLT. Amortization of purchased intangibles. Amortization of purchased intangibles was $20.0 million and $10.9 million for the three months ended June 30, 2014 and 2013, respectively. The increase in amortization is due to a full quarter of amortization of the finite-lived intangible assets acquired in the Actient transaction in April 2013 as well the amortization of the STENDRA intangible asset acquired in October 2013. Contingent consideration. Contingent consideration was recorded on the balance sheet at the acquisition date fair value of the Actient and STENDRA acquisitions, based on the consideration expected to be transferred in the form of milestone and royalty obligations, discounted to present value of such payments. Contingent consideration 33 -------------------------------------------------------------------------------- Table of Contents in the Consolidated statement of operations represents the change in the fair value of this contingent consideration. Contingent consideration was a credit of $20.4 million during the three months ended June 30, 2014 compared to expense of $2.3 million for the three months ended June 30, 2013. The change of $22.7 million period-over-period resulted primarily from the decrease in fair value of an Actient product net sales milestone as well as Actient royalties due to revised estimates of TESTOPEL net revenues. This credit or expense may fluctuate significantly in future periods depending on changes in estimates, including probabilities associated with achieving forecasted product revenues on which royalties are payable, the periods in which we estimate sales levels and sales level milestones will be achieved and the discount rates used. Interest expense. Interest expense was $9.5 million and $7.1 million for the three months ended June 30, 2014 and 2013, respectively. The increase period-over-period is principally due to interest expense on our Term Loan, from which we borrowed $225.0 million in April 2013 and $50.0 million in September 2013. Other income, net. Other income, net for the three months ended June 30, 2014 and 2013 relates primarily to interest earned on cash, cash equivalents and short-term investments. Income tax expense. The income tax benefit of $0.1 million for the three months ended June 30, 2014 represents an adjustment during the quarter for income taxes payable in certain state jurisdictions. The tax benefit for 2013 represents the $77.9 million release of the valuation allowance for deferred tax assets, net of recognition of income taxes on current income in certain state jurisdictions and certain discrete items of tax. As part of the required accounting for the Actient acquisition, we recorded deferred tax liabilities related to differences between the book basis and the tax basis of certain Actient amortizable assets. Six Months Ended June 30, 2014 and 2013 Net revenues. Net revenues for the six months ended June 30, 2014 and 2013 comprise the following: Six months ended June 30, 2014 2013 Change % Change (in millions) Testim revenues- Net U.S. product sales $ 22.8 $ 98.5 $ (75.7 ) -77 % Net U.S. revenues - authorized generic 13.3 - 13.3 n/a International revenues 1.8 1.4 0.4 29 % 37.9 99.9 (62.0 ) -62 % XIAFLEX revenues- Net U.S. revenues 42.9 26.9 16.0 59 % International revenues 6.3 12.7 (6.4 ) -50 % 49.2 39.6 9.6 24 % Other net U.S. revenues- TESTOPEL 36.2 14.4 21.8 151 % STENDRA 17.7 0 17.7 n/a Edex 13.0 5.0 8.0 160 % Other 17.5 7.8 9.7 124 % 84.4 27.2 57.2 210 % Total net revenues $ 171.5 $ 166.7 $ 4.8 3 % Revenue allowance as a percentage of gross U.S. revenues 36 % 32 % 4 % Net U.S. revenues shown in the above table represent the product sales of the Company within the U.S. net of allowances provided on such sales. In addition, net distributable profits earned pursuant to the AG Agreement entered into with Prasco are also included in net U.S. revenues in the above table. International revenues represent the amortization of deferred up-front and milestone payments the Company has received through its out-licensing agreements, together with royalties earned on product sales by the licensees. 34 -------------------------------------------------------------------------------- Table of Contents Testim Total revenues for Testim for the six months ended June 30, 2014 were $37.9 million compared to $99.9 million for the comparable period of 2013. Testim revenues for the six months ended June 30, 2014 include $13.3 million of Generic Testosterone Product revenues earned pursuant to the AG Agreement with Prasco. The decrease of $75.7 million in branded Testim net U.S. revenues for the six months ended June 30, 2014 compared to the same period in 2013 is principally due to the following factors: † a shrinking TRT gel market and lower Testim market share, as evidenced by a decline of 29% in total Testim prescriptions for the six months ended June 30, 2014 as compared to the same period in 2013 according to National Prescription Audit data from IMS, a pharmaceutical market research firm; † continued destocking of Testim inventory in the wholesale and retail distribution channels; and † a decrease in our highest-margin non-contracted prescriptions, resulting in a higher gross-to-net discount applying to Testim sales as a whole. We believe the shrinking TRT market has been influenced by recent communications by the FDA regarding its plans to study the safety of TRT products and publications and advertisements suggesting potential health risks associated with TRT products. Given the changing TRT market dynamics and the entry of generic alternatives to the branded gel TRT product market, including the Generic Testosterone Product, as well as potential additional future entry of generic alternatives, we are planning for what we believe is the maturity of the TRT gel market and we expect to continue managing Testim as a mature product going forward. XIAFLEX Total revenues for XIAFLEX in the first half of 2014 were $49.2 million compared to $39.6 million in the first half of 2013. Net revenues for the six months ended June 30, 2014 include $42.9 million of net U.S. product sales of XIAFLEX compared to the $26.9 million recorded in the first half of 2013. This increase was due to growth in product shipments for XIAFLEX for DC as well the launch of XIAFLEX for PD in January 2014. XIAFLEX international revenues for the six months ended June 30, 2014 amounted to $6.3 million compared to $12.7 million recorded in the first half of 2013. The decrease in XIAFLEX international revenues resulted from the amortization of deferred revenue during the six months ended June 30, 2013 related to the Pfizer Agreement. There was no revenue recognized for the six months ended June 30, 2014 related to the Pfizer Agreement, as this agreement was terminated during the second quarter of 2013. This decrease was partially offset by increased sales of XIAFLEX by our collaboration partner, Sobi, which resulted in higher royalties for the six months ended June 30, 2014 as compared to the same period in 2013. Other net U.S. revenues Other U.S. net revenues for the six months ended June 30, 2014 include sales of the products we acquired in the April 2013 acquisition of Actient as well as our in-licensing of STENDRA in October 2013. The Actient revenues included sales of TESTOPEL, Edex and other U.S. products of $36.2 million, $13.0 million and $17.5 million, respectively for six months ended June 30, 2014 compared to $14.4 million, $5.0 million and $7.8 million for the first half of 2013. The increase in net revenues from the products we acquired from Actient in April 2013 was the result of a full quarter of sales as well as price increases. In addition to the increase resulting from the Actient products, we launched STENDRA, a new first-line oral therapy for ED licensed from VIVUS during January 2014, and recognized total sales of $17.7 million for the six months ended June 30, 2014. We believe these revenues include a filling of the wholesale and retail channels in excess of demand as indicated by current prescriptions fulfilled in the second quarter of 2014. Revenue allowances Revenue allowances as a percentage of gross U.S. revenues for the first half of 2014 compared to the first half of 2013 increased due principally to a decrease in our highest-margin non-contracted prescriptions of Testim during the six months ended June 30, 2014, resulting in a higher gross-to-net discount applying to Testim sales as a whole; and specifically for the first quarter of 2014, an accrual for a liability relating to the higher rebates and allowances on all Testim units estimated to be in the wholesale and retail channels at December 31, 2013. In addition, the higher percentage in the first half of 2014 was impacted by coupons offered on sales of STENDRA in conjunction 35 -------------------------------------------------------------------------------- Table of Contents with the product launch and higher product return charges for Testim and various Actient products. These increases were partially offset by a lower level of allowances on sales of Actient products which were acquired during the second quarter of 2013 as well as the addition of revenue earned on the sale of the Generic Testosterone Product sold by Prasco under the AG Agreement. The revenues recorded under the AG Agreement are reported by Prasco to Auxilium on a net basis; therefore, there are no gross-to-net adjustments recorded on Auxilium's financial statements. Cost of goods sold. Cost of goods sold were $48.2 million and $42.3 million for the six months ended June 30, 2014 and 2013, respectively. Cost of goods sold reflects the cost of product sold, royalty obligations due to our licensors (excluding contingent consideration royalties), and the amortization of the deferred costs associated with the collaboration agreements with Actelion, Asahi, Pfizer and Sobi. Cost of goods sold excludes the amortization of product rights associated with the Actient and STENDRA acquisitions. The increase in cost of goods sold in the first half of 2014 over the same period in 2013 was principally attributable to a $6.7 million inventory charge recorded related to excess Testim branded inventory. The excess inventory charge resulted from our decision to launch the Generic Testosterone Product, which had the impact of decreasing the demand forecast for our branded Testim product. The gross margin rate on our net revenues was 72% for the six months ended June 30, 2014 compared to 75% for the same period in 2013. The decrease in the gross margin rate is primarily due to the excess inventory charge, higher product returns and the higher gross-to-net discount on branded Testim sales as discussed above, offset partially by a higher margin contribution on the acquired Actient products. Research and development expenses. Research and development expenses were $22.3 million and $25.5 million for the six months ended June 30, 2014 and 2013, respectively. This decrease in expense resulted principally from lower spending on the XIAFLEX multi-cord phase 3 clinical trial for DC and decreased spending on the Phase 3 trials for XIAFLEX for the treatment of Peyronie's. These decreases were partially offset by increased spending on the XIAFLEX Phase 2 trials for cellulite and Frozen Shoulder syndrome, which commenced during the fourth quarter of 2013. Selling, general and administrative expenses. Selling, general and administrative expenses were $147.2 million and $119.2 million for the six months ended June 30, 2014 and 2013, respectively. This increase was primarily due to the added expenses of the acquired Actient operations and an increase in marketing and advertising spend related to the launch of XIAFLEX for the treatment of PD and STENDRA. Amortization of purchased intangibles. Amortization of purchased intangibles was $39.7 million and $10.9 million for the six months ended June 30, 2014 and 2013, respectively. The increase in amortization is due to a full six months of amortization of the finite-lived intangible assets acquired in the Actient transaction in April 2013 as well the amortization of the STENDRA intangible asset acquired in October 2013. Contingent consideration. Contingent consideration was a credit of $12.7 million during the six months ended June 30, 2014 compared to expense of $2.3 million for the six months ended June 30, 2013. The change of $15.0 million period-over-period resulted primarily from the decrease in fair value of Actient product net sales milestones as well as Actient royalties due to revised estimates of TESTOPEL net revenues, offset partially by increases in STENDRA revenue forecasts. Interest expense. Interest expense was $19.0 million and $10.1 million for the six months ended June 30, 2014 and 2013, respectively. The increase period-over-period is principally due to interest expense on our Term Loan, which was entered into in April 2013. Other income, net. There was no other income, net for the six months ended June 30, 2014. Other income, net for the six months ended June 30, 2013 relates primarily to interest earned on cash, cash equivalents and short-term investments. Income tax expense. The income tax expense of $0.2 million for the six months ended June 30, 2014 represents income taxes payable in certain state taxing jurisdictions. The tax benefit for 2013 represents the $77.9 million release of the valuation allowance for deferred tax assets, net of recognition of income taxes on current income in certain state jurisdictions and certain discrete items of tax. As part of the required accounting for the Actient acquisition, we recorded deferred tax liabilities related to differences between the book basis and the tax basis of certain Actient amortizable assets. 36 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources We had approximately $44.7 million and $71.2 million in cash, cash equivalents and short-term investments as of June 30, 2014 and December 31, 2013, respectively. We believe that our current financial resources, when combined with cash generated from or used in operations, will be adequate for the Company to fund our anticipated operations for at least the next 12 months. We may, however, elect to raise additional funds to enhance our sales and marketing efforts for additional products we may acquire, commercialize any product candidates that receive regulatory approval, acquire or in-license approved products, product candidates or companies or technologies for development and to maintain adequate cash reserves to minimize financial market fundraising risks. Insufficient funds may cause us to delay, reduce the scope of, or eliminate one or more of our development, commercialization or expansion activities. Our future capital needs and the adequacy of our financial resources will depend on many factors, including: † our ability to successfully market our products; † continued demand for our products; † our ability to manage the maturity and decline of the TRT market and any decline in revenues related to our TRT products; † our ability to continue successfully launching STENDRA and XIAFLEX for the treatment of PD, and our ability to obtain label expansions for STENDRA and for XIAFLEX for the treatment of multiple DC cords; † the success of the efforts of VIVUS to seek a 15-minute onset of action label expansion for STENDRA, † the entry into the marketplace of competitive products, including additional generics or branded generics to Testim or a competing product; † our ability to successfully and timely close the Merger with QLT, and, if we close the Merger, to integrate the operations of QLT and Auxilium into the operations of the Combined Company successfully and efficiently; † our ability to integrate the remaining operations of Actient and its subsidiaries into our operations successfully and efficiently; † our ability to materialize the remaining synergies and benefits, including revenue and profit growth, from the acquisition of Actient; † the risks or costs associated with the Actient acquisition or the Merger being greater than we anticipate; † third-party payor coverage and reimbursement for our products; † the cost of manufacturing, distributing, marketing and selling our products; † the scope, rate of progress and cost of our product development activities; † the costs of supplying and commercializing our products and product candidates; † the effect of competing technological and market developments; † the cost of defending various civil litigations relating to our TRT products, including costs associated with the matters described in Part II, Item 1 of this Report under "Legal Proceedings", or the outcome of any such matters; 37 -------------------------------------------------------------------------------- Table of Contents † the cost of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights, including costs associated with the matters described in Part II, Item 1 of this Report under "Legal Proceedings", or the outcome of any such matters, or any other matter that may result from a challenge to our intellectual property rights; and † the extent to which we acquire or invest in businesses and technologies. If additional funds are required, we may raise such funds from time to time through public or private sales of equity or debt securities or from bank or other loans. Financing may not be available on acceptable terms, or at all, and our failure to raise capital when needed could materially adversely impact our growth plans and our financial condition or results of operations. Additional equity financing, if available, may be dilutive to the holders of our common stock and may involve significant cash payment obligations and covenants that restrict our ability to operate our business. Sources and Uses of Cash Cash used in operations was $17.8 million for the six months ended June 30, 2014 compared to $7.3 million for the six months ended June 30, 2013. Cash used in operations for the six months ended June 30, 2014 resulted primarily from a reduction in Testim revenues, an increase in selling and marketing costs as a result of the launch of XIAFLEX for PD and STENDRA and higher inventory levels required to meet our expected growth in product sales. Cash used in operations in 2013 resulted primarily from the pre-tax operating loss for the period, net of stock compensation and non-cash charges. Cash used in investing activities was $1.8 million for the six months ended June 30, 2014 compared to cash used in investing activities of $516.5 million for the six months ended June 30, 2013. The cash impact of investing activities for 2014 relates primarily to net redemptions of $3.6 million and our investments in property and equipment, which are primarily due to the implementation of a new accounting system as well as investments in other software projects. Cash used in investing activities for 2013 principally represents $588.9 million of cash paid in the acquisition of Actient and investments in property and equipment, offset by redemptions (net of purchases) of short-term in marketable debt securities. Cash provided by (used in) financing activities was ($3.4) million and $517.9 million for the six months ended June 30, 2014 and 2013, respectively. Cash used in financing activities for the first half of 2014 reflects principal payments on our term loan of $6.6 million and contingent consideration payments of $6.9 million related to the Actient and STENDRA acquisitions, partially offset $11.2 million of cash received from the exercise of stock options. Cash provided by financing activities in 2013 principally represents the net proceeds of $338.9 million and $214.0 million from the issuance of the 2018 Senior Convertible Notes and the Term Loan, respectively, partially offset by net payments of $28.5 related to our hedge transactions for the convertible notes. Commitments and Contractual Obligations During the six months ended June 30, 2014, there were no material changes outside of the ordinary course of business to our commitments and contractual obligations. Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements as defined in Item 303(a) (4) of Regulation S-K. New Accounting Pronouncements See Note 1(e) - New Accounting Pronouncements to the Company's Consolidated Financial Statements. |