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EX-23.1 - CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - INTERMUNE INCd297459dex231.htm
EX-31.1 - CERTIFICATION REQUIRED BY RULE 13A-14(A) OR RULE 15D-14(A) - INTERMUNE INCd297459dex311.htm
EX-21.1 - LIST OF SUBSIDIARIES - INTERMUNE INCd297459dex211.htm
EX-31.2 - CERTIFICATION REQUIRED BY RULE 13A-14(A) OR RULE 15D-14(A) - INTERMUNE INCd297459dex312.htm
EX-32.1 - CERTIFICATION REQUIRED BY RULE 13A-14(B) OR RULE 15D-14(B) AND SECTION 1350 - INTERMUNE INCd297459dex321.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

Form 10-K

ANNUAL REPORT

PURSUANT TO SECTIONS 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

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

For the fiscal year ended December 31, 2011

or

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

For the transition period from              to             

Commission file number 0-29801

 

 

INTERMUNE, INC.

(Exact name of registrant as specified in its charter)

 

Delaware   94-3296648
(State or other jurisdiction of
incorporation or organization)
  (IRS Employer
identification No.)

3280 Bayshore Boulevard

Brisbane, CA 94005

(Address of principal executive offices, including Zip Code)

(415) 466-2200

(Registrant’s telephone number, including area code)

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Exchange on which Registered

Common Stock, $0.001 par value   The NASDAQ Stock Market LLC.

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  þ    No  ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934.    Yes  ¨    No  þ

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

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

 

Large accelerated filer   þ   Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)   Smaller reporting company   ¨

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

As of June 30, 2011, the aggregate market value (based upon the closing sales price of such stock as reported on The NASDAQ Global Select Market on such date) of the voting and non-voting stock held by non-affiliates of the registrant was $1,663,819,185, which excludes an aggregate of 14,267,023 shares of the registrant’s common stock held by officers and directors and by each person known by the registrant to own 10% or more of the registrant’s outstanding common stock as of June 30, 2011. Exclusion of shares held by any person should not be construed to indicate that such person possesses the power, direct or indirect, to direct or cause the direction of the management or policies of the registrant, or that such person is controlled by or under common control with the registrant. As of January 31, 2012, the number of outstanding shares of the registrant’s common stock was 65,334,741 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive Proxy Statement for the 2012 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this Form 10-K are incorporated by reference in Part III, Items 10-14 of this Annual Report on Form 10-K.

 

 

 


Table of Contents

INTERMUNE, INC.

ANNUAL REPORT ON FORM 10-K

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2011

TABLE OF CONTENTS

 

PART I

     1   

ITEM 1.

  

BUSINESS

     1   

ITEM 1A.

  

RISK FACTORS

     19   

ITEM 1B.

  

UNRESOLVED STAFF COMMENTS

     44   

ITEM 2.

  

PROPERTIES

     44   

ITEM 3.

  

LEGAL PROCEEDINGS

     44   

ITEM 4.

  

MINE SAFETY DISCLOSURES

     46   

PART II

     47   

ITEM 5.

  

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

     47   

ITEM 6.

  

SELECTED FINANCIAL DATA

     48   

ITEM 7.

  

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     51   

ITEM 7A.

  

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     64   

ITEM 8.

  

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     66   

ITEM 9.

  

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURES

     104   

ITEM 9A.

  

CONTROLS AND PROCEDURES

     104   

ITEM 9B.

  

OTHER INFORMATION

     105   

PART III

     106   

ITEM 10.

  

DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

     106   

ITEM 11.

  

EXECUTIVE COMPENSATION

     106   

ITEM 12.

  

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

     106   

ITEM 13.

  

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

     106   

ITEM 14.

  

PRINCIPAL ACCOUNTING FEES AND SERVICES

     106   

PART IV

     107   

ITEM 15.

  

EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

     107   

SIGNATURES

     113   


Table of Contents

PART I

 

ITEM 1. BUSINESS

Forward Looking Statements

This Annual Report on Form 10-K (the “Annual Report”) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements involve substantial risks and uncertainty. You can identify these statements by forward-looking words such as “may,” “will,” “expect,” “intend,” “anticipate,” “believe,” “estimate,” “plan,” “could,” “should” and “continue” or similar words. These forward-looking statements may also use different phrases.

We have based these forward-looking statements on our current expectations and projections about future events. These forward-looking statements, which are subject to risks, uncertainties and assumptions about us, may include, among other things, statements which address our strategy and operating performance and events or developments that we expect or anticipate will occur in the future, including, but not limited to, statements about:

 

   

product and product candidate development;

 

   

the market or markets for our products or product candidates;

 

   

the ability of our products to treat patients in our markets;

 

   

pricing for Esbriet® in the various jurisdictions in the European Union;

 

   

timing and expectations of our clinical trials and when our products or product candidates may be approved by regulatory authorities for marketing in various territories;

 

   

timing and expectations regarding assessments of the benefit of Esbriet®, reimbursement of Esbriet® by national health authorities and payors in various countries, including our expectations regarding the timing of Germany’s Federal Joint Committee assessment of Esbriet® for the treatment of mild to moderate IPF and any changes to reimbursement guidelines for Esbriet as a result of such assessment;

 

   

opportunities to establish development or commercial alliances;

 

   

commercial launch preparations, including the timing of launches in the various European Union jurisdictions and the implementation of the infrastructure required for the commercial launches;

 

   

the scope and enforceability of our intellectual property rights, including the anticipated durations of patent protection and marketing exclusivity under orphan drug regulations in the European Union, United States and other jurisdictions, and including claims that we or our collaborators may infringe third party intellectual property rights or otherwise be required to pay license fees and or royalties under such third party rights;

 

   

governmental regulation and approval;

 

   

requirement of additional funding to complete research and development and commercialize products;

 

   

liquidity and sufficiency of our cash resources;

 

   

future revenue, including those from product sales and collaborations, adequacy of revenue reserve levels, future expenses, future financial performance and trends;

 

   

our future research and development expenses and other expenses; and

 

   

our operational and legal risks.

You should also consider carefully the statements under “Item 1A. Risk Factors” below, which address additional factors that could cause our results to differ from those set forth in the forward-looking statements.

 

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Any forward-looking statements are qualified in their entirety by reference to the factors discussed in this Annual Report, including those discussed in this Annual Report under “Item 1A. Risk Factors” below. Because the factors referred to above, as well as the factors discussed in this Annual Report under “Item 1A. Risk Factors” below, could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements made by us or on our behalf, you should not place undue reliance on any forward-looking statement. Further, any forward-looking statement speaks only as of the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for us to predict which factors will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. When used in this Annual Report, unless otherwise indicated, “InterMune,” “we,” “our,” “us” or the “Company” refers to InterMune, Inc.

Overview

We are a biotechnology company focused on the research, development and commercialization of innovative therapies in pulmonology and orphan fibrotic diseases. Pulmonology is the field of medicine concerned with the diagnosis and treatment of lung conditions. We have an advanced-stage product candidate in pulmonology, pirfenidone, that was granted marketing authorization effective February 2011 in all 27 member countries of the European Union (“EU”) for the treatment of adults with mild to moderate idiopathic pulmonary fibrosis (“IPF”). In September 2011, we launched commercial sales of pirfenidone in Germany under the trade name Esbriet®, and we are continuing to prepare for the commercial launch of Esbriet® in the other countries in the EU. Subject to EU country reimbursement timelines, we currently plan to conclude pricing and reimbursement discussions for Esbriet in France, Spain and Italy during the second quarter of 2012 and launch in those countries as soon as practicable after concluding discussions. We currently plan to conclude the discussions with the authorities in the United Kingdom in October of 2012, and launch Esbriet as soon as practicable thereafter. In addition to launches in the so called “Top 5” EU countries, we expect to launch Esbriet in Austria, Denmark, Ireland and Norway in the first half of 2012, and in Belgium, the Netherlands, Finland and Sweden in the second half of 2012. We are also pursuing the registration of pirfenidone to treat IPF in the United States. After reviewing various regulatory and clinical development options and following our discussions with the United States Food and Drug Administration (“FDA”), we commenced an additional pivotal Phase 3 clinical study of pirfenidone in IPF to support United States approval in July 2011, referred to as the ASCEND trial, the results of which are expected to be available in mid-2013. The results of the ASCEND trial will supplement the existing Phase 3 clinical study data from our CAPACITY clinical trials to support the registration of pirfenidone to treat IPF in the United States. In addition, we currently have rights to one approved and marketed product, Actimmune, which is approved in the United States and numerous other countries for the treatment of chronic granulomatous disease (“CGD”) and severe, malignant osteopetrosis.

In September 2011, we completed a registered underwritten public offering of 4.6 million shares of our common stock and a concurrent registered underwritten public offering of $155.3 million aggregate principal amount of 2.50% convertible senior notes due 2018. The aggregate net proceeds from our concurrent offerings was approximately $255.0 million, after deducting underwriting discounts and commissions and related offering expenses. We currently intend to use the net proceeds from these offerings to fund the commercial launch of Esbriet in the EU, to fund our ASCEND trial and for general corporate purposes.

In addition to our pulmonology programs, we previously focused on the field of hepatology, which is concerned with the diagnosis and treatment of disorders of the liver, primarily to expand treatment options for patients suffering from chronic hepatitis C virus (“HCV”) infection. From October 2006 to October 2010, we had a research and development collaboration agreement with Hoffmann-LaRoche Inc. and F.Hoffmann-La Roche Ltd. (collectively, “Roche”) for products from our HCV protease inhibitor program, including our compound danoprevir (formerly known as RG7227 and ITMN-191). In October 2010, we sold our worldwide rights to danoprevir to Roche for $175.0 million in cash. In December 2010, we entered into a new research collaboration

 

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agreement with Roche with respect to other protease inhibitors for the treatment of HCV. Research efforts under this agreement ceased as of June 30, 2011, and in 2011, we decided to cease further investment in this therapeutic area. As a result of our collaboration with Roche and our independent internal efforts, we have a hepatology portfolio of pre-clinical small molecule compounds for the treatment of HCV.

We were incorporated in California in 1998 and reincorporated in Delaware in 2000 in connection with our initial public offering. We have established wholly-owned subsidiaries in various countries, primarily to support our expected commercialization of Esbriet in Europe including subsidiaries in the United Kingdom, Germany, France, Switzerland, Spain, Italy, the Netherlands, Sweden, Austria and Canada. Our worldwide corporate headquarters are in Brisbane, California and our European headquarters are in Muttenz, Switzerland.

Our total revenue and income (loss) from continuing operations for each of the years ended, and our total assets as of December 31, 2011, 2010 and 2009 are summarized in the following table:

 

     2011     2010      2009  
     (In thousands)  

Total revenue (1)

   $ 25,630      $ 259,291       $ 48,700   

Net income (loss)

     (154,774     122,374         (116,020

Total assets

     472,623        305,147         114,727   

 

(1) Total revenue in 2010 includes $175.0 million from the sale of our rights to danoprevir to Roche and the acceleration of $57.3 million of previously deferred revenue related to the termination of our 2006 collaboration agreement with Roche.

Approved Products

Esbriet® (Pirfenidone)

Pirfenidone, a treatment for IPF, a progressive and fatal lung disease, has completed the global Phase 3 CAPACITY clinical development program. In 2004, both the FDA and the European Medicines Agency, or EMA, granted orphan drug status to pirfenidone for the treatment of IPF. In March 2010, we filed a Marketing Authorisation Application, or MAA, with the EMA seeking approval of pirfenidone to be used in adults for the treatment of mild to moderate IPF. In December 2010, the Committee for Medicinal Products for Human Use, or CHMP, of the EMA adopted a positive opinion recommending the granting of our MAA for pirfenidone within the EU. We received notification of ratification of the CHMP opinion by the European Commission in March 2011, which authorized the marketing of Esbriet® (pirfenidone) in all 27 member states of the EU effective February 28, 2011. In addition, the European Commission has since authorized the marketing of Esbriet® in Norway and Iceland.

In connection with our receipt of marketing authorization in the European Union, we have committed to conduct routine safety surveillance of spontaneous adverse drug reactions (“ADRs”) and to conduct a PASS (“Post Authorization Safety Study”) in the form of a registry to systematically collect and monitor ADRs in patients who have been prescribed Esbriet. The PASS Registry is expected to enroll 1,000 patients over two years and to follow these patients for a similar period. We also will conduct a drug-drug interaction study to determine the impact of the antibiotic ciprofloxacin, a moderate CYP1A2 inhibitor, on the pharmacokinetics and safety of Esbriet in 25 healthy subjects. In addition, to help ensure the safe use of Esbriet, we have implemented a risk management plan (“RMP”) that includes routine safety monitoring of certain adverse reactions, a patient information leaflet and a safety checklist for physicians.

To support our planned marketing efforts for Esbriet® in the EU, we are actively expanding our commercial infrastructure within the EU. In December 2010, we announced several additions to our senior leadership team in support of our planned commercialization of Esbriet® as well as the establishment of our European headquarters in Switzerland. Since that time we have grown our European organization significantly, including the

 

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appointment of General Managers in Germany, France, Italy, Spain, the United Kingdom and the mid-sized European countries. In addition, we have hired our commercial and medical teams in the so-called “Top 5” EU countries to support our commercial launch of Esbriet® in the EU.

In January 2010, the FDA accepted our New Drug Application, or NDA, for pirfenidone for the treatment of patients with mild to moderate IPF and granted priority review status for our NDA. In March 2010, the Pulmonary-Allergy Drugs Advisory Committee, or PADAC, of the FDA voted 9-3 in favor of recommending approval of our NDA for pirfenidone to reduce the decline in lung function in patients with IPF. However, in May 2010, we received a Complete Response Letter from the FDA requesting that we conduct an additional clinical trial to provide additional evidence of the efficacy of pirfenidone to reduce the decline in lung function in patients with IPF. After review of various regulatory and clinical development options to gain approval of pirfenidone for commercial sale within the United States, in January 2011, we reported our intention to conduct an additional Phase 3 clinical trial that, if successful, would demonstrate a clinically meaningful effect on forced vital capacity in patients with mild to moderate IPF, referred to as the ASCEND trial. In July 2011, we announced that the first patient had been enrolled in the ASCEND trial. We currently expect to receive the results from this trial in mid-2013.

Idiopathic Pulmonary Fibrosis (IPF): IPF is a disease characterized by progressive scarring, or fibrosis, of the lungs, which leads to their deterioration and destruction. The cause of IPF is unknown. The prognosis is poor for patients with IPF, which occurs primarily in persons 40 to 80 years old with a median survival time from diagnosis of two to five years. Published epidemiology studies suggest there is a range of between 85,000 and 141,000 IPF patients in Europe, with approximately 113,000 being the median estimate. Our research suggests that there is a range of between 50,000 and 90,000 diagnosed cases of IPF in the United States. Approximately two-thirds of the affected patients are believed to have mild to moderate disease severity, and, therefore, may be eligible for treatment with Esbriet®. In the United States, it is believed that approximately 30,000-35,000 new IPF cases develop each year, with a similar rate of incidence in the EU. Pirfenidone is the only commercially approved drug for the treatment of mild to moderate IPF and is now approved in (i) the EU and is sold by us under the trade name Esbriet®, (ii) Japan and is sold by Shionogi under the tradename Pirespa® (iii) India and is sold by Cipla Ltd. under the trade name Pirfenex®, and (iv) China and is sold by Shanghai Genomics.

Actimmune®

Actimmune is currently approved in the United States for the treatment of chronic granulomatous disease and severe, malignant osteopetrosis. Actimmune is also approved for commercial use in both indications in numerous other countries. However, a significant portion of the sales of Actimmune in the United States have been for off-label indications, primarily for the treatment of IPF. In 1998 we obtained a license from Genentech, Inc. (“Genentech”) to exclusively develop, use and sell Actimmune in particular fields in the United States, Canada and Japan. For the years ended December 31, 2010, 2009 and 2008, sales of Actimmune accounted for all of our product revenue.

Chronic granulomatous disease: CGD is a life-threatening congenital disorder that causes patients, primarily children, to be vulnerable to severe, recurrent bacterial and fungal infections. This results in frequent and prolonged hospitalizations and commonly results in death. In 1990, Actimmune was approved by the FDA for reducing the frequency and severity of serious infections associated with CGD, and is the only FDA-approved drug for this disease.

Severe, malignant osteopetrosis: Severe, malignant osteopetrosis is a life-threatening, congenital disorder that primarily affects children. This disease results in increased susceptibility to infection and an overgrowth of bony structures that may lead to blindness and/or deafness. In 2000, Actimmune was approved by the FDA for delaying time to disease progression in patients with severe, malignant osteopetrosis, and is the only FDA-approved drug for this disease.

 

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Primary Therapeutic Focus

Our business is primarily focused on the development and commercialization of therapies within the specialized areas of pulmonology and orphan fibrotic diseases.

Pulmonology

Pulmonology is the specialized branch of medicine that is focused on diseases of the lungs and respiratory tract. Our current focus in this area of medicine is on the treatment of IPF, including the development and commercialization of pirfenidone.

Research Pipeline

Pulmonology and Orphan fibrotic diseases

We have several pre-clinical research programs in the areas of IPF and orphan fibrotic diseases.

HCV/Sale of Danoprevir Rights

From October 2006 to October 2010, we had a research and development collaboration agreement with Roche to discover and develop novel HCV protease inhibitors, including our compound danoprevir (formerly known as RG7227 and ITMN-191), an orally available HCV protease inhibitor, which we had progressed from pre-clinical testing into Phase 2b clinical development. In October 2010, we sold our worldwide rights to danoprevir to Roche for $175.0 million in cash and terminated our October 2006 collaboration agreement. Roche has agreed to reimburse us for any future royalty and milestone obligations that we may continue to have to Novartis Corporation (Novartis) and Array BioPharma, Inc. (Array) related to the continued development and commercialization of danoprevir by Roche. In December 2010, we entered into a new research collaboration agreement with Roche with respect to other protease inhibitors for the treatment of HCV. Research efforts under this agreement ceased as of June 30, 2011 and we decided to cease further investment in this therapeutic area. As a result of our collaboration with Roche and our independent internal efforts, we have a portfolio of pre-clinical small molecule compounds for the treatment of HCV.

Our Strategy

We intend to use our current capital resources and any potential revenue provided by sales of Actimmune and Esbriet to:

 

   

Pursue the commercial launch of Esbriet in Germany, France, the United Kingdom, Italy, and Spain and other select European countries which started in the third quarter of 2011 and will continue through 2012;

 

   

Continue our pursuit of the approval of pirfenidone for commercial sale in the United States by conducting our Phase 3 clinical study, ASCEND, during 2012 and 2013;

 

   

Fund drug discovery and preclinical development activities to identify novel potential treatments of IPF and orphan fibrotic diseases; and

 

   

Continue to evaluate appropriate product acquisition candidates and opportunistically pursue strategic alliances and collaborative arrangements that we believe could complement our existing focus in the areas of pulmonology and orphan fibrotic diseases or in areas that we believe are advantageous to pursue.

License, Collaboration and Other Agreements

Pirfenidone

Marnac, Inc./KDL GmbH (Pirfenidone)

In 2002, we licensed from Marnac and its co-licensor, KDL, their worldwide rights, excluding Japan, Korea and Taiwan to develop and commercialize pirfenidone for all fibrotic diseases, including renal, liver and

 

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pulmonary fibrosis. Under the agreement terms, we received an exclusive license from Marnac and KDL in exchange for an up-front cash payment of $18.8 million, future milestone payments and up to 9% royalty payments. Effective November 21, 2007, we entered into asset purchase agreements with Marnac and KDL whereby we effectively terminated the prior license agreement by purchasing, among other things, the pirfenidone-related assets covered by such prior license agreement and as a result no longer have milestone or royalty obligations thereunder to Marnac and KDL. Under the terms of the asset purchase agreements, we made payments of approximately $13.7 million and are required to make future milestone payments in connection with the continued development and regulatory approval of pirfenidone in certain countries. For example, we made a milestone payment of $13.5 million in March 2009 in connection with our decision to proceed with regulatory approval for pirfenidone. In March 2011, we received authorization to market Esbriet in the EU and made a milestone payment of $20.0 million in the aggregate to Marnac and KDL and have capitalized such payment as acquired product rights. A future contingent payment of up to an additional $20.0 million is required to be made by us only if positive Phase 3 data and product approval in the United States is achieved. The asset purchase agreements do not affect the rights to pirfenidone in Japan, Korea and Taiwan, which rights are licensed by Marnac and KDL to Shionogi.

Shionogi Clinical Data License

In February 2010, we entered into an agreement with Shionogi that gives us an option to exercise a license to obtain access to certain patient level data from the Shionogi Phase 3 clinical trial with pirfenidone in patients with IPF (“SP3”). This license provides that we pay Shionogi a royalty on pirfenidone sales in a particular jurisdiction for a specified period of time in the event (i) we use the SP3 patient level data as “pivotal study data” (as defined in the license) in connection with a particular regulatory filing in such jurisdiction, and (ii) the regulatory filing that uses SP3 patient level data as pivotal study data is approved. We did not use SP3 patient level data as pivotal study data in our recently approved EU MAA. Similarly, we did not use SP3 patient level data as pivotal study data in our US NDA, as indicated by the FDA in its Complete Response Letter relating to our US NDA for pirfenidone to treat patients with IPF. Going forward, we may elect to use SP3 patient level data as pivotal study data in our regulatory filings in the United States or in other jurisdictions. Should we elect to do so, and should the regulatory filing containing such SP3 patient level data be approved, we may owe a royalty to Shionogi on sales of pirfenidone in such jurisdiction for a specified period of time.

Actimmune

Genentech, Inc. License Agreement (Actimmune®)

In 1998, we obtained a license from Genentech through Connetics Corporation (“Connetics”) for patents relating to Actimmune. The license from Genentech terminates on the later of May 5, 2018 or the date that the last of the patents licensed under the agreement expires. Under this agreement we have the exclusive license to develop and commercialize Actimmune in the United States and Canada for the treatment and prevention of all human diseases and conditions, including infectious diseases, pulmonary fibrosis and cancer, but excluding arthritis and cardiac and cardiovascular diseases and conditions. In Japan, we have the exclusive license rights to commercialize Actimmune for the treatment and prevention of all infectious diseases caused by fungal, bacterial or viral agents, including in patients with CGD or osteopetrosis. We also have a non-exclusive license to make or have made Actimmune for clinical and commercial purposes within our field of use in the United States and Canada. Under the Genentech license, we pay Genentech royalties on the revenue from sales of Actimmune based on a royalty rate of 45% for the first $3.7 million of revenue and 10% for any additional revenue. We are also required to make one-time payments to Genentech upon the occurrence of specified milestone events, which include certain regulatory submissions and approval to market Actimmune for the treatment of particular categories of diseases, however we have no further development plans for Actimmune. We made royalty payments of approximately $90.1 million in the aggregate, but no milestone payments, under this agreement through December 31, 2011. Our rights under this agreement could revert to Genentech if we commit a material breach of the agreement.

 

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Connetics Corporation (acquired by Stiefel Laboratories, Inc.) (Actimmune®)

Through an assignment and option agreement with Connetics in 1998, we paid Connetics $5.7 million to acquire rights to Actimmune and we remain obligated to pay to Connetics a royalty of 0.25% of our net United States sales for Actimmune until our net United States sales cumulatively surpass $1.0 billion. Above $1.0 billion, we are obligated to pay a royalty of 0.5% of our net United States sales of Actimmune. Through a separate purchase agreement, we paid Connetics $0.4 million to acquire rights related to the use of Actimmune to treat scleroderma and are obligated to pay Connetics a royalty of 4.0% on our net revenue from sales of Actimmune for the treatment of scleroderma. We made royalty payments of approximately $1.9 million in the aggregate through December 31, 2011. There are no milestone payments pursuant to this agreement.

Hepatology

Roche Asset Purchase Agreement (Danoprevir)

In October 2010, we entered into an asset purchase agreement with Roche (the “Asset Purchase Agreement”) to sell our worldwide development and commercialization rights in danoprevir to Roche for $175.0 million in cash. In connection with this transaction our 2006 License and Collaboration Agreement with Roche was terminated. The assets purchased by Roche pursuant to the Asset Purchase Agreement included certain specified intellectual property, as well as certain regulatory filings, assumed contracts, books and records, and product data, in each case, related to danoprevir. In connection with the Asset Purchase Agreement, Roche also assumed certain of our liabilities and obligations arising out of or related to certain of the assumed contracts, including potential future milestone and royalty obligations payable to Novartis Corporation and Array in connection with the further development of danoprevir by Roche. In addition, we granted Roche an exclusive, irrevocable, non-terminable, fully paid-up license of certain of our intellectual property rights for use by Roche in the development and commercialization of danoprevir.

2006 Roche License and Collaboration Agreement (Protease Inhibitors)

In October 2006 we entered into a collaboration agreement with Roche to research, develop and commercialize products from our HCV protease inhibitor program, including danoprevir, which entered Phase 2b clinical trials in 2009. Upon entering into the agreement, we received an upfront payment of $60.0 million from Roche. During the term of the agreement we also received milestone payments totaling $45.0 million over the period of 2007, 2008 and 2009. In connection with the sale of our rights in danoprevir to Roche in October 2010, this collaboration agreement was terminated.

2010 Roche Collaboration Agreement (Second-generation Protease Inhibitors)

In December 2010, we entered into an agreement with Roche related to the discovery and development next-generation protease inhibitors for the treatment of HCV. Roche funded all research costs related related to these efforts during the period of July 1, 2010 to June 30, 2011. Work under this agreement has concluded and InterMune now owns all rights to the next-generation NS3/4A protease inhibitors developed under this agreement.

Novartis Corporation (Small Molecule HCV Therapeutics)

In 2004, we entered into a license agreement with Novartis which granted us the right to discover, develop and commercialize small molecule therapeutic agents against certain HCV targets that are covered by patents owned by Novartis. This agreement provides for the payment of certain milestones and royalties in connection with the development and commercialization of these therapeutic agents, including danoprevir. In connection with our sale of danoprevir to Roche, Roche agreed to assume and pay any future milestones and royalties that may become due under this agreement in connection with the further development and commercialization of danoprevir. The provisions of this license agreement also continue to apply to certain of our pre-clinical HCV compounds.

 

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Array BioPharma Inc. (Small Molecule HCV Therapeutics)

In 2002, we entered into a drug discovery collaboration agreement to create small molecule therapeutics targeting HCV with Array. Joint research activities under this agreement expired in June 2007, however Array will continue to be entitled to receive milestone payments and low single-digit royalties in connection with the development and commercialization of compounds derived from the collaborative efforts. In December 2004, the agreement was amended to provide a mechanism for us to purchase Array’s interest in certain co-owned intellectual property rights arising from the collaboration, subject to ongoing milestone and royalty payments. In late 2004, we purchased Array’s co-ownership rights in danoprevir, subject to ongoing milestone and royalty obligations. In connection with our 2010 divestiture of danoprevir to Roche, Roche has agreed to assume and pay to Array any milestones and royalties that may become due in connection with the further development and commercialization of danoprevir. The provisions of this license agreement also continue to apply to certain of our pre-clinical HCV compounds discovered in collaboration with Array.

Manufacturing

We enter into contractual arrangements with qualified third-party manufacturers to manufacture and package our products and product candidates. This manufacturing strategy enables us to direct financial resources to the development and commercialization of products rather than diverting resources to establishing a manufacturing infrastructure.

ACIC Fine Chemical, Inc. and Signa C.V. (pirfenidone)

On May 13, 2004, we entered into a purchase agreement with ACIC Fine Chemicals Inc. (“ACIC”) to supply us with a finite amount of API for the manufacturing of pirfenidone. Under a separate agreement with Signa C.V. (“Signa”), ACIC sub-contracted the manufacturing of this finite amount of API for pirfenidone to Signa. Under this agreement, we acquired the API for pirfenidone from ACIC on an as-needed purchase order basis.

In January 2009, we entered into a definitive supply agreement with Signa and ACIC for the clinical and commercial supply of the API for pirfenidone, which agreement replaces and supersedes the purchase agreement described above. The supply agreement generally provides for the exclusive supply by Signa and ACIC and the exclusive purchase (except in certain limited circumstances) by us of the API for pirfenidone with respect to the territories where we hold exclusive rights to pirfenidone. Under the terms of this supply agreement, we are not required to make minimum annual purchases. The pirfenidone API will be purchased by us based upon a rolling forecast. The supply agreement was made effective as of December 17, 2008 and will continue for the longer of (i) 10 years thereafter or (ii) seven years from the date of approval of a finished product containing the API for pirfenidone. If Signa and ACIC are not able to supply all of our requirements for the API for pirfenidone, we may purchase the API from a second source third party supplier. Either party has the right to terminate the supply agreement if the other party materially breaches its obligations thereunder or in the event the manufacture, use, sale or importation of the API is found to be infringing of a third party’s intellectual property rights and such third party is unwilling to provide either Signa and ACIC or us with a license. In addition, we have the right to terminate the supply agreement in the event it is not commercially reasonable for us to sell or purchase the API or a finished product containing the API. In light of our receipt of marketing authorization of Esbriet® in the EU, we have assigned this agreement to InterMune International AG, our wholly-owned subsidiary and European headquarters located in Muttenz, Switzerland.

Catalent Pharma Solutions LLC (pirfenidone)

In September 2009, we entered into a commercial manufacturing agreement with Catalent Pharma Solutions, LLC (“Catalent”) to process and encapsulate the API for pirfenidone and to supply us with bulk pharmaceutical pirfenidone product for commercial use. The agreement generally provides for the exclusive supply by Catalent and the exclusive purchase (except in certain limited circumstances) by us of the bulk

 

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pharmaceutical pirfenidone product with respect to certain territories where we hold exclusive rights to pirfenidone. In the fourth year of the agreement, Catalent’s exclusive supply and our exclusive purchase obligations under the agreement will only apply to 50% of our commercial requirements for the bulk pharmaceutical pirfenidone product in the United States while supply and purchase obligations of the parties under the agreement will be non-exclusive for the other geographical territories subject to the agreement. Furthermore, after the fifth year of the agreement, the supply and purchase obligations of the parties under the agreement will become non-exclusive for all territories subject to the agreement. Under the terms of this agreement, we are not required to make any minimum annual purchases. The bulk pharmaceutical pirfenidone product is required to be purchased by us based upon a rolling forecast. The agreement was made effective as of September 10, 2009 and is scheduled to continue for an initial term of five (5) years from the date of our commercial launch of pirfenidone, if approved by a regulatory agency, subject to renewal. If Catalent is not able to supply all of our requirements for the bulk pharmaceutical pirfenidone product, we may purchase such product from a second source supplier. Either party has the right to terminate the supply agreement if the other party materially breaches its obligations thereunder. In light of our receipt of marketing authorization of Esbriet® (pirfenidone) in the EU, we have assigned this agreement to InterMune International AG, our wholly-owned subsidiary and European headquarters located in Muttenz, Switzerland.

Boehringer Ingelheim Austria GmbH (Actimmune®)

In January 2000, we entered into an agreement with BI for the clinical and commercial supply of Actimmune. The agreement, which had been amended from time to time, generally provided for the exclusive supply by BI and exclusive purchase by us of Actimmune. This contractual obligation to BI was denominated in euros. Prior to the failure of the INSPIRE trial, we had future purchase obligations of approximately $91.6 million. Following the unsuccessful outcome from the Phase 3 INSPIRE trial that was discontinued in March 2007, we entered into a termination agreement (“Termination Agreement”) with BI. The Termination Agreement provided for the termination of the existing supply agreement dated January 2000, as amended, for the clinical and commercial supply of Actimmune conditioned upon and coincident with the entry by us and BI into a new agreement for the clinical and commercial supply of Actimmune. In consideration of the entry into the Termination Agreement, we incurred approximately $6.8 million in termination expenses during the second quarter of 2007. Pursuant to the Termination Agreement and new supply agreement, we eliminated $91.6 million in future purchase commitments for Actimmune for the years 2007 to 2012. On June 29, 2007, we entered into a new agreement with BI for the clinical and commercial supply of Actimmune (“Supply Agreement”). Under the terms of the new Supply Agreement, we are not required to make any minimum annual purchase commitments and BI is not required to commit to reserving any minimum annual capacity for the manufacture of Actimmune. On a going forward basis, the product will be purchased based upon a rolling forecast. The new Supply Agreement was effective as of June 29, 2007 and will expire on December 31, 2012. We are currently in discussions with BI to extend the term of the Supply Agreement. Either party has the right to terminate the Supply Agreement if the other party materially breaches its obligations thereunder. In addition, we have the right to terminate the Supply Agreement immediately in the event that health authorities prevent distribution of Actimmune for all indications.

Patents and Proprietary Rights

Based on our own internal research efforts and observations made during our clinical trials, we have filed numerous patents relating to the safe and effective use of pirfenidone to treat patients with IPF and other diseases. In addition, we have filed for patents on a number of small molecules to treat HCV, pulmonary and fibrotic diseases.

Pirfenidone

The composition of matter patents for pirfenidone expired in the 1990’s. In 2002, we licensed from Marnac and its co-licensor KDL certain worldwide rights, excluding Japan, Korea and Taiwan, to develop and

 

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commercialize pirfenidone for all fibrotic diseases, including renal, liver and pulmonary fibrosis covered by certain of their use patents. Effective November 21, 2007, we entered into asset purchase agreements with Marnac and KDL whereby we effectively terminated the prior license agreement by purchasing, among other things, the pirfenidone-related assets covered by such prior license agreement. Among the patents we purchased under the asset purchase agreements are U.S. Patent Nos. 5,310,562; 5,962,478; 6,090,822, 6,300,349 and related foreign equivalents. When U.S. Patent No. 5,310,562 expires in 2011, we will not be able to use this patent to block others from marketing pirfenidone for the treatment of fibrotic disorders in the United States, except to the extent we are able to secure additional intellectual property in connection with novel treatment methods. We also own the European counterpart of U.S. Patent Nos. 5,962,478 and 6,300,349, validated in Germany and the United Kingdom, and have sought extended patent protection for Esbriet through 2021 by filing applications for a Supplemental Patent Certificate in these countries. In addition to the patents we acquired from Marnac and KDL, we have been pursuing additional pirfenidone-related intellectual property including patent rights relating to the safe and effective use of pirfenidone based upon observations from our extensive clinical development of pirfenidone. We currently have five additional patents granted in the European Union covering the safe and/or efficacious administration of pirfenidone to IPF patients, as well as nine issued patents in the United States covering the formulation or uses of pirfenidone. These patents have expiration dates between 2026 and 2030, and we currently anticipate that these patents will provide us with additional market exclusivity in the European Union following the expiration of orphan drug status in 2021. Certain of these patents have application beyond the treatment of IPF. Certain of these patents have application beyond the treatment of IPF. We will only enjoy market exclusivity for a particular indication in countries in which we have (i) regulatory exclusivity such as orphan drug status, (ii) new chemical entity data exclusivity, or (iii) patent protection. For a description of certain intellectual property issues relating to the intellectual property we acquired and the other intellectual property we are pursuing, please see “Item 1A. Risk Factors-Following expiration of orphan drug designation in the European Union, and if approved for commercial use by the FDA in the United States, our current intellectual property portfolio may not be sufficient to protect the continued exclusivity of pirfenidone for the treatment in adults of mild to moderate IPF” below.

Actimmune®

We have acquired an exclusive license under certain Genentech patents to develop, use and sell interferon gamma-1b, the active ingredient in Actimmune, in particular fields in the United States, Canada and Japan under our license agreement with Genentech. This license agreement covers more than 12 United States patents and related foreign patents and/or patent applications filed in Japan and Canada. Certain of the United States patents covering DNA vectors and host cells relating to interferon gamma-1b expired in 2005 and 2006 without material impact to our business. In addition, a United States patent relating to the composition of interferon gamma-1b will expire in 2013or 2014. Other material United States patents expire between 2009 and 2013. Under the Genentech license, we pay Genentech royalties on the sales of Actimmune, and are required to make one-time payments to Genentech upon the occurrence of specific milestone events, which include the submission of a BLA with the FDA for approval to market Actimmune for the treatment of particular categories of diseases, the receipt of FDA approval to market Actimmune for the treatment of particular categories of diseases and the achievement of certain annual revenue targets for Actimmune. Two United States composition-of-matter patents acquired from Amgen covering interferon-gamma analogs, including interferon gamma-1b, expire in 2022 while one Canadian patent acquired from Amgen expires in 2024.

HCV Small Molecules

We hold patent rights related to a variety of small molecules for the potential treatment of HCV, including protease, polymerase and NS5A inhibitors. We invented a series of protease inhibitors in collaboration with Array to which we hold and exclusive license. In late 2004, we purchased from Array its co-ownership rights in patents related to the HCV protease inhibitor, danoprevir, such that we held exclusive ownership rights in the patent applications and issued patents covering danoprevir. We sold these patents, as well as certain wholly owned patents, to Roche in connection with our divestiture of danoprevir in 2010.

 

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Competition

Pirfenidone for IPF

Pirfenidone is the only approved therapy in the world for the treatment of IPF. In March 2011, we received marketing authorization for pirfenidone in the EU for use in adults for the treatment of mild to moderate IPF. We launched pirfenidone in Germany in September 2011 under the trade name Esbriet®. Pirfenidone is also approved for the treatment of IPF in (i) Japan and is marketed by Shionogi under the tradename Pirespa®, (ii) India and is sold by Cipla Ltd. under the trade name Pirfenex®, and (iii) China and is sold by Shanghai Genomics. There is currently no FDA approved therapy available for the treatment of IPF, however, we are currently conducting an additional Phase 3 clinical trial in IPF known as ASCEND that we currently anticipate will help support approval of pirfenidone to treat IPF in the United States. We believe that the primary competition for pirfenidone in the EU and in the U.S (if pirfenidone is approved by the FDA for the treatment of IPF) will initially consist of off-label use of products that are approved for other indications including corticosteroids and N-acetylcysteine (NAC). The competitive landscape for new IPF products has seen numerous failures but continues to evolve. In late 2011, a placebo-controlled study conducted by the NHLBI comparing corticosteroids, NAC and Azathioprine (triple therapy) to NAC alone stopped the triple therapy arm of the study due to toxicity. The remaining arm of this trial, studying NAC- alone is projected to be completed by late 2013. In 2007, a Phase 3 clinical trial for bosentan was initiated by Actelion Pharmaceuticals, Ltd. (“Actelion”) and initial results were published in March 2010. Bosentan failed to meet its primary endpoint in this clinical trial and as a result, Actelion has ceased further development of this compound to treat IPF. Actelion also conducted an exploratory study with macitentan, a tissue-targeting endothelin receptor antagonist, in patients with IPF. The results of this macitentan IPF study were announced in August 2011 and the efficacy data did not support conducting a phase 3 IPF study with macitentan since no difference was observed between placebo and macitentan with regard to liver enzyme elevations. Actelion is also investigating macitentan in patients with pulmonary arterial hypertension (PAH) in a phase 3 trial, the results of which Actelion is expecting in the first half of 2012. In January 2009, Gilead Sciences, Inc. (“Gilead”) initiated a Phase 3 clinical study of ambrisentan for the treatment of IPF that was halted in December 2010 due to lack of efficacy. In December 2010, Gilead acquired Arresto Biosciences (Arresto) thereby gaining access to Arresto’s Phase 1 humanized monoclonal antibody compound, AB0024, currently in clinical development for the treatment of IPF. Boehringer Ingelheim recently presented Phase 2 data for BIBF-1120, a triple kinase inhibitor that has showed some potential efficacy at high doses in IPF. Boehringer Ingelheim has begun enrolling a global phase 3 clinical trial for BIBF-1120 in IPF. Additionally, there are seven products in various stages of phase 2 development for IPF, including CC-4047 and CC-930 from Celgene, CNTO-888 from Janssen (J&J), FG-3019 from Fibrogen, GC-1008 from Sanofi, QAX-576 from Novartis and STX-100 from Stromedix (currently in the process of being acquired by Biogen Idec).

Actimmune® for CGD and Severe Malignant Osteopetrosis

Actimmune is the only FDA approved therapy for CGD and severe, malignant osteopetrosis and we are not aware of any competitive products available or in development for these indications. However, in general, our products and product candidates face competition, or potential competition, from other currently available or development-stage therapies.

Commercial Operations

Pirfenidone (Esbriet®)

To support our anticipated marketing efforts in Europe for the sale of Esbriet, we continue to expand our commercial infrastructure within the EU, including an increase to our employee headcount in that region. On December 17, 2010, we announced several additions to our senior leadership team in support of our commercialization efforts in addition to the announcement of the establishment of our European headquarters in Reinach, Switzerland. In September 2011 we launched Esbriet in Germany. Subject to EU country reimbursement timelines, we currently plan to conclude pricing and reimbursement discussions for Esbriet in France, Spain and Italy during the second quarter of 2012 and launch in those countries as soon as possible after

 

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concluding discussions. We currently plan to conclude the discussions with the authorities in the United Kingdom in October of 2012, and launch Esbriet as soon as possible thereafter. In addition to launches in the so called “Top 5” EU countries, we expect to launch Esbriet in Austria, Denmark, Ireland and Norway in the first half of 2012, and in Belgium, the Netherlands, Finland and Sweden in the second half of the year. As of December 31, 2011 we had a total of 64 employees in various offices located in Europe. In Europe, Esbriet is expected to be sold primarily through distributors to hospitals and pharmacies.

Actimmune®

While we do not actively promote Actimmune for any indication, we continue to support the supply and reimbursement of Actimmune for its labeled indications, CGD and severe, malignant osteopetrosis. In the United States, Actimmune is sold primarily to distributors and specialty pharmacies who distribute directly to patients. During the year ended December 31, 2011, the primary specialty pharmacies and distributors for Actimmune were CuraScript, Inc. (formerly Priority Healthcare, Inc.), Nova Factor, Inc. and Caremark, Inc., which accounted for 42%, 22% and 22%, respectively, of our total net product sales.

Medical Affairs

We have Medical Affairs personnel in the US and Europe that maintain and provide current, scientific-based information about Actimmune, Esbriet and pulmonology in general for the benefit of heath care providers, patients and caregivers, as well as our employees. Our Medical Affairs team also supports medical education, medical information, and our publication efforts.

Total Revenue by Geographic Region

Our total revenue by region for the years ended December 31, 2011, 2010 and 2009, were as follows (in thousands):

 

     2011      2010      2009  

United States

   $ 19,961       $ 19,875       $ 25,231   

Europe and other (1)

     5,669         239,416         23,469   
  

 

 

    

 

 

    

 

 

 

Total

   $ 25,630       $ 259,291       $ 48,700   
  

 

 

    

 

 

    

 

 

 

 

(1) Total Europe and other revenue in 2010 includes $175.0 million from the sale of our rights to danoprevir to Roche and the acceleration of $57.3 million of previously deferred revenue related to the termination of our 2006 collaboration agreement with Roche.

Government Regulation and Product Approval

The FDA and comparable regulatory agencies in state and local jurisdictions and in foreign countries impose substantial requirements upon the clinical development, manufacture and marketing of pharmaceutical products. These agencies and other federal, state and local entities regulate research and development activities and the testing, manufacture, quality control, safety, effectiveness, labeling, storage, record keeping, approval, advertising and promotion of our products. The EMA, or European Medicines Agency, is a centralized body of the European Union whose main responsibility is the protection and promotion of public health through the evaluation and supervision of medicines for human use. The EMA coordinates the evaluation and supervision of medicinal products, including our product Esbriet, throughout the 27 European Union member states in a network of 42 national competent authorities.

The process required by the FDA before our potential products, or previously approved products to be marketed for the treatment of new diseases in the United States generally involves the following:

 

   

preclinical laboratory and animal tests;

 

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submission of an IND, which must become effective before clinical trials may begin;

 

   

adequate and well-controlled human clinical trials to establish the safety and efficacy of the proposed drug for its intended use; and

 

   

FDA approval of a new BLA, a new NDA, or a BLA or NDA supplement.

Prior to commencing a clinical trial in the United States, we must submit an IND to the FDA. The IND automatically becomes effective 30 days after receipt by the FDA, unless the FDA, within the 30-day time period, raises concerns or questions about the application. In such a case, the IND sponsor and the FDA must resolve any outstanding concerns before the clinical trial can begin. Our submission of an IND may not result in FDA authorization to commence such a clinical trial. Further, an independent institutional review board (“IRB”) for each medical center proposing to conduct the clinical trial must review and approve the plan for any clinical trial before it commences. For purposes of NDA or BLA approval, human clinical trials in the United States are typically conducted in three sequential phases that may overlap.

 

   

Phase 1: The drug is initially introduced into healthy human subjects or patients and tested for safety, dosage tolerance, absorption, metabolism, distribution and excretion.

 

   

Phase 2: Studies are conducted in a limited patient population to identify possible adverse effects and safety risks, to determine the efficacy of the product for specific targeted diseases and to determine dosage tolerance, optimal dosage and dosage frequency. These Phase 2 clinical trials may be divided into early Phase 2 clinical trials, which are referred to as Phase 2a clinical trials, during which pilot studies are performed to determine initial activity and late Phase 2 clinical trials, which are referred to as Phase 2b clinical trials, that generally consist of controlled trials often involving several hundred patients in traditional drug development programs.

 

   

Phase 3: When Phase 2 clinical trials demonstrate that a dosage range of the product is effective and has an acceptable safety profile, Phase 3 clinical trials are undertaken to further evaluate dosage, to provide statistically and clinically significant evidence of clinical efficacy and to further test for safety in an expanded patient population at multiple clinical study sites. It is possible for a drug that appears promising in a Phase 2 clinical trial to fail in a more rigorous and reliable Phase 3 clinical trial.

In the case of products for severe or life-threatening diseases such as IPF, the initial human testing is often conducted in patients rather than in healthy volunteers. Because these patients already have the target disease, these studies may provide initial evidence of efficacy traditionally obtained in Phase 2 clinical trials, and thus these trials are frequently referred to as Phase 1/2 clinical trials.

The FDA and regulatory authorities in other territories may require, or companies may pursue, additional clinical trials after a product is approved. These are called Phase 4 studies. The results of Phase 4 studies can confirm the effectiveness of a drug and can provide important safety information to augment the FDA’s adverse drug reaction reporting system. For example, in connection with our receipt of marketing authorization for Esbriet in the EU, we committed to conduct routine safety surveillance of spontaneous adverse drug reactions (ADRs) and to conduct a PASS (Post Authorization Safety Study) in the form of a registry to systematically collect and monitor ADRs in patients who have been prescribed Esbriet. Also, we have ongoing Phase 4 post-marketing commitments to the FDA relating to Actimmune for the treatment of osteopetrosis including a registry and drug interaction study which was completed and submitted to the FDA in 2006.

The results of product development, preclinical studies and clinical trials are submitted to the FDA as part of a BLA or NDA, or as part of a BLA or NDA supplement for approval as a treatment for a new disease if the product is already approved for a disease. The FDA may deny approval of a BLA, NDA or BLA or NDA supplement if the applicable regulatory criteria are not satisfied, or it may require additional clinical data. Even if such data are submitted, the FDA may ultimately decide that the BLA, NDA or BLA or NDA supplement does not satisfy the criteria for approval.

 

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Once issued, the FDA may withdraw product approval if compliance with regulatory standards is not maintained or if problems occur after the product reaches the market. In addition, the FDA may require testing and surveillance programs to monitor the effect of approved products that have been commercialized, and the FDA has the power to prevent or limit further marketing of a product based on the results of these post-marketing programs.

A company seeking approval of an abbreviated new drug application (“ANDA”), for the use of an approved drug that is subject to another company’s patent may have to certify to that patent and notify the owner of the NDA and patent for such drug that it is seeking approval. If the patent owner or licensee files a patent infringement lawsuit, FDA approval of the ANDA for which certification is made may be deferred pending the outcome of the lawsuit.

Satisfaction of FDA requirements or similar requirements of state, local and foreign regulatory agencies typically takes several years and the actual time required may vary substantially, based upon the type, complexity and novelty of the product or disease. Government regulation may delay or prevent marketing of potential products or of approved products for new diseases for a considerable period of time and impose costly procedures upon our activities. We cannot be certain that the FDA or any other regulatory agency will grant approvals for our product candidates or for use of our approved products for new diseases on a timely basis, if at all. Success in early stage clinical trials does not ensure success in later stage clinical trials. Data obtained from clinical activities is not always conclusive and may be susceptible to varying interpretations, which could delay, limit or prevent regulatory approval. Even if a product receives regulatory approval, the approval may be significantly limited to specific diseases, patient subgroups and dosages. Further, even after regulatory approval is obtained, later discovery of previously unknown problems with a product may result in restrictions on the product or even complete withdrawal of the product from the market. Further, the FDA’s policies may change and additional government regulations may be enacted which could prevent or delay regulatory approval of our potential products or approval of new diseases for our existing products. Delays in obtaining, or failures to obtain, initial regulatory approval for any of our product candidates, or additional regulatory approvals for new indications of our approved products, would harm our business. In addition, we cannot predict what adverse governmental regulations may arise from future United States or foreign governmental action.

Any products we manufacture or distribute pursuant to FDA approvals are subject to continuing regulation by the FDA, including record-keeping requirements and reporting of adverse experiences with these products. Drug manufacturers and their subcontractors are required to register their establishments with the FDA and other government agencies, and are subject to periodic unannounced inspections by the FDA and certain state agencies for compliance with good manufacturing practices, which impose certain procedural and documentation requirements upon us and our third-party manufacturers. We cannot be certain that we or our present or future suppliers will be able to comply with the good manufacturing practices regulations and other FDA regulatory requirements.

Under the Orphan Drug Act, the FDA may grant orphan drug designation to drugs intended to treat a rare disease or condition, which is generally a disease or condition that affects fewer than 200,000 individuals in the United States. Orphan drug designation must be requested before submitting an NDA or BLA for that orphan indication. After the FDA grants orphan drug designation, the generic identity of the drug and its potential orphan use are disclosed publicly by the FDA. Orphan drug designation does not convey any advantage in or shorten the duration of the regulatory review and approval process. If a product that has orphan drug designation is the first to subsequently receive FDA approval for the disease for which it has such designation, the product is entitled to orphan drug exclusivity for seven years in the United States (i.e., the FDA may not approve any other applications to market the same drug for the same disease for seven years, except in very limited circumstances). The EMA has granted orphan drug designation for Esbriet and therefore we currently expect to have 10 years of market exclusivity as a result of this designation in the European Union. We have filed and intend to file for orphan drug designation for those diseases we target that meet the criteria for orphan drug exclusivity. Pirfenidone has been granted orphan drug designation for the treatment of IPF by the FDA and EMA. Although

 

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obtaining FDA and EMA approval to market a product with orphan drug exclusivity can be advantageous, there can be no assurance that we will be able to maintain this designation for pirfenidone, nor can there be any assurance that we will be granted orphan drug designation for additional diseases or that orphan drug exclusivity will provide us with a material commercial advantage.

Physicians may prescribe legally available drugs for uses that are not described in the product’s labeling and that differ from those tested by us and approved by the FDA. Such off-label uses are common across medical specialties. For example, we are aware that physicians are prescribing Actimmune for the treatment of IPF, although we do not promote Actimmune for the treatment of IPF, and the FDA has not approved the use of Actimmune for the treatment of this disease. Substantially all of our Actimmune revenue is derived from physicians’ prescriptions for off-label use. The FDA does not regulate the behavior of physicians in their choice of treatments. The FDA does, however, restrict manufacturer’s communications on the subject of off-label use. While a company may engage in truthful, non-misleading, and non-promotional speech concerning its products, it cannot promote FDA-approved drugs for off-label uses. A company may also educate physicians about a particular disease state and how that disease is properly diagnosed so that patients who qualify for the clinical trial might be identified and may survey physicians who are lawfully prescribing our products for off-label uses to monitor patients’ experiences, particularly as to whether safety issues have arisen. A company may also, pursuant to FDA policies, respond to unsolicited requests from health care professionals and engage in appropriate scientific exchange of information about unapproved uses. We have engaged in these lawful activities in the past and continue to engage in some of them today. We have policies and procedures in place to regulate the lawful promotion of our marketed products within their labeled indications. Employees are trained to follow these policies and procedures and must certify that they will abide by them. The FDA actively enforces regulations prohibiting promotion of off-label uses and the promotion of products for which marketing approval has not been obtained. While we believe we are currently in compliance with the FDA’s regulations relating to off-label promotion, the regulations are subject to varying interpretations which continue to evolve. Failure to comply with these requirements in the past or with respect to future activities can result in regulatory enforcement action by the FDA and other governmental bodies, which would have an adverse effect on our revenue, business and financial prospects.

Research and Development

Our research and development expenses were $75.0 million, $67.5 million and $89.1 million for the years ended December 31, 2011, 2010 and 2009.

Facilities

All of our facilities and long-lived assets are located in the United States and Europe. Our facilities in the United States currently consist of approximately 70,000 square feet of office space located at our headquarters at 3280 and 3260 Bayshore Boulevard, Brisbane, California. In December 2000, we entered into a ten-year lease for this facility. In July 2010, we extended the lease agreement on our current facility for an additional term that expires in April 2016. We also currently maintain offices located in Muttenz, Switzerland, our European headquarters; Berlin, Germany; Milan, Italy; Paris, France; London, England; Madrid, Spain; and Stockholm, Sweden. We believe that our facilities are adequate for our current needs, and that suitable additional or substitute space will be available in the future to replace our existing facilities, if necessary, or to accommodate expansion of our operations, both here in the U.S. and in Europe.

Employees

As of January 31, 2012, we had 201 full-time employees, of which, 73 are located in Europe. Of the full-time employees, 71 were engaged in research and development and 130 were engaged in selling, general and administrative positions. We believe that we have good relationships with our employees.

 

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Available Information

We file electronically with the United States Securities and Exchange Commission (“SEC”) our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We make available on our website at http://www.intermune.com, free of charge, copies of these reports as soon as reasonably practicable after filing these reports with, or furnishing them to, the SEC. You can also request copies of such documents by contacting our Investor Relations department at (415) 466-2242 or by sending an e-mail to ir@intermune.com.

Executive Officers of the Registrant

The following table provides information regarding our executive officers and key employees as of February 15, 2012:

 

Name

  Age    

Title

Daniel G. Welch     54      Chairman, Chief Executive Officer and President
Williamson Z. Bradford, M.D., Ph.D.      50      Senior Vice President, Clinical Science and Biometrics
Alan H. Cohen, M.D.     51      Senior Vice President, Medical Affairs
Giacomo Di Nepi     58      Senior Vice President and Managing Director, Europe
John C. Hodgman     57      Senior Vice President of Finance and Chief Financial Officer
Marianne A. Porter, Ph.D.     57      Senior Vice President, Chief Regulatory and Drug Safety Officer
Steven B. Porter, M.D., Ph.D.     54      Chief Medical Officer and Senior Vice President, Clinical Affairs
Scott Seiwert, Ph.D.     45      Senior Vice President, Research and Technical Development
Robin J. Steele, Esq.     56      Senior Vice President, General Counsel and Corporate Secretary

Daniel G. Welch. Mr. Welch has served as our Chairman, Chief Executive Officer and President since May 2008. Prior to that, Mr. Welch served as our Chief Executive Officer and President and a member of our board of directors since September 2003. From March 2003 to September 2003, Mr. Welch served as a consultant to Warburg Pincus LLC, a global equity investor. From August 2002 to January 2003, Mr. Welch served as chairman and chief executive officer of Triangle Pharmaceuticals, Inc., a pharmaceutical company. From October 2000 to June 2002, Mr. Welch served as president of the pharmaceutical division of Elan Corporation, PLC, a pharmaceutical company. From September 1987 to August 2000, Mr. Welch served in various senior management roles at Sanofi-Synthelabo and its predecessor companies Sanofi and Sterling Winthrop, including vice president of worldwide marketing. From November 1980 to September 1987, Mr. Welch was with American Critical Care, a division of American Hospital Supply. He currently serves on the Board of Directors of one public company, Seattle Genetics, Inc. and is also a director of one private company. Mr. Welch holds a B.S. from the University of Miami and an MBA from the University of North Carolina.

Williamson Z. Bradford, M.D, Ph.D. Dr. Bradford has served as our Senior Vice President, Clinical Science and Biometrics since January 2008. From July 2001 to January 2008, Dr. Bradford held several positions including most recently Vice President of Clinical Science, responsible for our pulmonary development efforts. From 1999-2001, Dr. Bradford served as Director, Clinical Science at IntraBiotics Pharmaceuticals, Inc., a pharmaceutical company, and from 1998-1999, Dr. Bradford served as Clinical Scientist at Genentech, Inc., a pharmaceutical company. Prior to 1998, Dr. Bradford held various academic and clinical positions including Assistant Professor of Medicine at the University of California, San Francisco (UCSF). Dr. Bradford holds an M.D. from the University of North Carolina at Chapel Hill, School of Medicine, a Ph.D. from the University of California, Berkeley, School of Public Health, and was trained in internal medicine and infectious diseases at UCSF. He is board-certified in infectious diseases and serves as an Assistant Clinical Professor of Medicine in the Division of Infectious Diseases at UCSF.

Alan H. Cohen, M.D. Dr. Cohen has served as Senior Vice President, Medical Affairs at InterMune since November 2009. Prior to joining InterMune, Dr. Cohen served as Vice President of Clinical Development and

 

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Medical Affairs at MAP Pharmaceuticals, overseeing clinical development programs for that company’s respiratory franchise, as well as new product planning for inhalation devices and aerosol reformulations. From 2006 to 2008, he served as Chief Medical Officer and Vice President of Global Medical Affairs, Safety & Pharmacovigilance at Jazz Pharmaceuticals, supporting orphan drugs in the areas of sleep medicine, inborn errors of metabolism, toxicology and CNS disorders. From 2001 to 2005 he served as Senior Director of Medical Affairs at MedImmune, Inc., where he was involved in drug discovery, monoclonal antibodies against respiratory pathogens and influenza vaccines. Dr. Cohen is a board-certified pediatric pulmonologist and currently holds an appointment as an adjunct clinical faculty member at the Stanford University School of Medicine. Dr. Cohen is a member of the Clinical Advisory Board of Aridis, Inc. and a Board Member of SJ Pharmaceuticals, LLC.

Giacomo Di Nepi. Giacomo Di Nepi has served as InterMune’s Senior Vice President and Managing Director, Europe since October 2009. Previously, he served as a consultant to InterMune on European commercial strategy. From 2006 to 2008, Mr. Di Nepi was CEO of Takeda Pharmaceuticals, Europe, based in London, with responsibility for Takeda’s European business, its geographic expansion and the setup of its newly formed European Headquarters. Between 1996 and 2006, he was with Novartis in Europe and the United States, most recently in Switzerland as Global Head of the Transplantation, Immunology and Infectious Diseases Business Unit, with direct responsibility from Development to Sales. He previously served as CEO of Novartis Italy and in Marketing and Sales roles in the U.S. subsidiary. From 1980 to 1996, Mr. Di Nepi was a Partner with McKinsey & Co. and was responsible for the Italian and a Core Member of the Global Pharmaceutical Practice. He served as Vice President of Farmindustria, the Italian Industry Association, and a member of the EFPIA Heads of Europe Committee. Mr. Di Nepi holds a degree in Economics from Bocconi University, Milan, Italy and an MBA from INSEAD, Fontainebleau, France.

John C. Hodgman. Mr. Hodgman has served as our Senior Vice President of Finance and Chief Financial Officer since August 2006. Prior to joining InterMune, Mr. Hodgman served as President and Chief Executive Officer of Aerogen, Inc. from June 2005 to October 2005 until its acquisition by Nektar. From August 1998 to December 2005, he served as President and Chief Executive Officer of Cygnus, Inc. and he served as Chairman of the Board of Cygnus from August 1999 to November 2008. Mr. Hodgman also served as Vice President of Finance, Chief Financial Officer of Cygnus from August 1994 to August 1998 in addition to serving as President of Cygnus’ Diagnostic Division. He currently serves on the Board of Directors of two public companies, Immersion Corporation and AVI BioPharma, Inc. Mr. Hodgman holds a B.S. from Brigham Young University and an M.B.A. from the University of Utah.

Marianne A. Porter, Ph.D. Dr. Porter has served as our Senior Vice President, Chief Regulatory and Drug Safety Officer since January 2006. From January 2004 to January 2006, Dr. Porter served as our Senior Vice President, Regulatory/Medical Affairs and Drug Safety. From April 2002 to January 2004, Dr. Porter served as our Senior Vice President of Global Regulatory Operations and Corporate Compliance. From December 1999 to April 2002, Dr. Porter served as senior director of clinical development/regulatory affairs at Genentech, Inc., a pharmaceutical company. From July 1998 to November 1999, Dr. Porter served as senior director of clinical development at PathoGenesis Corporation, a pharmaceutical company. From May 1995 to July 1998, Dr. Porter served as department head of clinical affairs for Amgen Inc., a pharmaceutical company. From January 1981 to April 1995, Dr. Porter held management positions in clinical development at Alcon Laboratories, Solvay Pharmaceuticals and Parke-Davis/Warner Lambert, each a pharmaceutical company, and was a regional sales representative at American McGaw, a division of American Hospital Supply. Dr. Porter holds a Ph.D. and M.S. from Florida State University. In February 2012, Dr. Porter notified us that she intends to leave the Company in the third quarter of 2012.

Steven B. Porter, M.D., Ph.D. Dr. Porter has served as our Chief Medical Officer and Senior Vice President, Clinical Affairs since January 2006. Dr. Porter served as our Senior Vice President of Clinical Affairs from January 2004 to January 2006. From July 2001 to January 2004, Dr. Porter served as our Vice President of Clinical Research. From 1999 to June 2001, Dr. Porter was employed at IntraBiotics Pharmaceuticals, Inc., a pharmaceutical company, most recently as Senior Director, Clinical Science and Clinical Affairs. From 1997 to

 

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1999, Dr. Porter served as Senior Director, Clinical Affairs at Shaman Pharmaceuticals, Inc., a pharmaceutical company, and from 1996 to 1997, Dr. Porter served as Associate Director, Clinical Research at Bayer Corporation. Dr. Porter received his M.D., and Ph.D. from Vanderbilt University School of Medicine. He completed his residency in internal medicine at the University of California, San Francisco and his fellowship in infectious diseases at the University of California, San Francisco and Stanford University. In February 2012, Dr. Porter notified us that he intends to leave the Company in the third quarter of 2012.

Scott Seiwert, Ph.D. Dr. Seiwert has served as our Senior Vice President, Research and Technical Development since January 2010. Dr. Seiwert served as our Vice President, Research from 2005 to December 2009. He joined InterMune in 2003 as Senior Director of Research. Dr. Seiwert began his career in biotechnology with a research internship in the laboratory of Dr. David Goeddel at Genentech, Inc. in 1986. He then served as Associate Director and Director of Research at Ribozyme Pharmaceuticals, Inc. (now Merck and Co.) from 1999 to 2003. Dr. Seiwert holds a Ph.D. in Molecular Biophysics and Biochemistry from the Yale School of Medicine and received a B.S. degree in Biochemistry and Molecular Biology from the University of California at Santa Cruz. Dr. Seiwert is a former Helen Hay Whitney Research Fellow and an independent investigator at the University of Colorado at Boulder. Professional awards include the Pharmacia/Science Prize for Young Scientists and the Kenneth Thimann Prize in Natural Sciences. Dr. Seiwert serves on National Institutes of Health grant review panels, is a member of the HCV Drug Resistance Advisory Group and is an ad hoc reviewer for several scientific journals.

Robin J. Steele, Esq. Ms. Steele has served as our Senior Vice President, General Counsel and Corporate Secretary since May 2004. From 1998 to April 2003, Ms. Steele worked with Elan Pharmaceuticals, Inc., a global pharmaceutical company headquartered in Dublin, Ireland, most recently as Vice President, Legal Affairs in San Diego. Prior to joining Elan, Ms. Steele was in private practice and served as outside counsel to a variety of life science and technology based companies in the San Francisco Bay Area. Ms. Steele holds a B.A. in Biology from University of Colorado, Boulder, a J.D. from Hastings College of the Law, University of California, San Francisco, and a L.L.M. in Taxation from New York University School of Law.

 

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ITEM 1A. RISK FACTORS

An investment in our common stock is risky. Stockholders and potential purchasers of shares of our stock should carefully consider the following risk factors in addition to other information and risk factors in this Annual Report. We are identifying these risk factors as important factors that could cause our actual results to differ materially from those contained in any written or oral forward-looking statements made by or on behalf of InterMune. We are relying upon the safe harbor for all forward-looking statements in this Report, and any such statements made by or on behalf of InterMune are qualified by reference to the following cautionary statements, as well as to those set forth elsewhere in this Annual Report.

Risks Related to Our Dependence on Pirfenidone

We are dependent on the commercial success of Esbriet (pirfenidone) for the treatment of IPF in the European Union, which only just recently received marketing authorization, and on the regulatory approval of pirfenidone for the treatment of IPF in the United States and other countries, which may never occur.

We commenced operations in 1998 and have incurred significant losses to date. Our revenue has been limited primarily to sales of Actimmune derived from physicians’ prescriptions for the off-label use of Actimmune in the treatment of IPF and from upfront license fees and milestone payments in connection with our collaboration with Roche. In March 2007, we discontinued our development of Actimmune for treatment of IPF. In October 2010, we sold to Roche all of our worldwide rights to danoprevir for $175.0 million in cash, and terminated our collaboration with Roche from which we had derived our collaboration revenue. As a result, our future success is currently dependent on the regulatory and commercial success of pirfenidone for the treatment of IPF in Europe and the United States. In March 2011, Esbriet (pirfenidone) was granted marketing authorization for commercial use in the EU for the treatment of adults with mild to moderate IPF; however, pirfenidone is still under investigation for the treatment of IPF in the United States and has not been approved by the FDA. In September 2011, we launched commercial sales of Esbriet in Germany. Subject to EU country reimbursement timelines, we currently plan to conclude pricing and reimbursement discussions for Esbriet in France, Spain and Italy during the second quarter of 2012 and launch in those countries as soon as practicable after concluding discussions. We currently plan to conclude the discussions with the authorities in the United Kingdom in October of 2012, and launch Esbriet as soon as practicable thereafter. In addition to launches in the so called “Top 5” EU countries, we expect to launch Esbriet in Austria, Denmark, Ireland and Norway in the first half of 2012, and in Belgium, the Netherlands, Finland and Sweden in the second half of 2012. Because we do not currently have a product candidate other than pirfenidone in clinical development, our future success is dependent on building a commercial operation in Europe to successfully commercialize Esbriet in the EU, obtaining regulatory approval from the FDA to market pirfenidone for the treatment of IPF in the United States, and, if approved by the FDA, successfully commercializing pirfenidone in the United States.

If we do not successfully commercialize Esbriet in the EU and/or receive regulatory approval in the United States for pirfenidone for the treatment of IPF, our ability to generate additional revenue will be jeopardized and, consequently, our business will be seriously harmed. We may not succeed in our commercial efforts in the EU, or, if approved by the FDA, in the United States, or we may never receive regulatory approval in the United States for pirfenidone, any of these will have a material adverse effect on our business and prospects. In the near term, we may experience delays and unforeseen difficulties in the launch of Esbriet in one or more of the European Member states, including as a result of obtaining unfavorable pricing and/or reimbursement, which could negatively affect our stock price. We may also experience delays in obtaining regulatory approval in the United States for pirfenidone, if it is approved at all and our stock price may be negatively affected.

In addition, we anticipate incurring additional expenses and utilizing significant existing cash resources as we continue our commercialization efforts in Germany, continue our preparations for the commercial launch of Esbriet in other countries in the EU, conduct the new Phase 3 ASCEND trial to support the approval of pirfenidone to treat IPF in the United States and continue to grow our operational capabilities, particularly in the EU. This represents a significant investment in the regulatory and commercial success of pirfenidone, which is uncertain.

 

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We may also fail to develop future product candidates for the reasons stated in “Risks Related to the Development of Our Products and Product Candidates.” If this were to occur, we will continue to be dependent on the successful commercialization of pirfenidone, our development costs may increase and our ability to generate revenue could be impaired.

We have initiated the ASCEND Phase 3 clinical trial to support potential FDA approval of pirfenidone for the treatment of IPF, the results of which may fail to demonstrate to the FDA sufficient efficacy of pirfenidone and may have a negative effect on sales of Esbriet in the European Union.

We have evaluated our clinical development options to gain FDA approval of pirfenidone for the treatment of IPF within the United States and initiated an additional Phase 3 clinical trial known as the “ASCEND” trial during the second quarter of 2011. We do not have a Special Protocol Assessment, or SPA, in place with the FDA for the ASCEND trial, and the results of this Phase 3 clinical trial, together with the results of our CAPACITY trials, may not be satisfactory to the FDA to support approval of pirfenidone. The ASCEND trial is a 52 week trial with a forced vital capacity, or FVC, endpoint. In our meeting with the FDA in March 2011 relating to our plans for the ASCEND trial, the FDA indicated that it would prefer a trial with a longer duration (72 week) if designed with a FVC endpoint. While the FDA indicated that a 52 week trial with a FVC endpoint could support approval, the FDA further indicated that a trial with a FVC endpoint would need to provide supportive evidence of an effect on mortality. Consistent with our prior interactions with the FDA in connection with our CAPACITY clinical trials, the FDA indicated a preference for a mortality endpoint.

Whether data from our ASCEND trial when combined with the data from our CAPACITY trials will be sufficient to obtain FDA approval of pirfenidone for the treatment of IPF will depend on the results from the trial and be the subject of review by the FDA at the time of our anticipated NDA resubmission. If the results of the ASCEND trial are not satisfactory to the FDA to support regulatory approval of pirfenidone in the United States, then we will not be able to sell Esbriet in the United States, and sales of Esbriet in the EU may be negatively affected. Additionally, as in any clinical trial, discovery of unknown problems with pirfenidone in the ASCEND trial could negatively impact the approved safety and efficacy profile and result in possible reduced sales or product withdrawal in the EU. Because of our dependence on the commercial success of Esbriet in the EU, a negative outcome in the ASCEND trial or a negative regulatory outcome by the FDA could materially and adversely affect our business and prospects. For additional risks related to clinical studies and government regulations, see the risks under “Risks Related to Government Regulation and Approval of Our Products and Product Candidates.”

Risks Related to the Commercialization of Our Products and Product Candidates

Our revenue from sales of Esbriet in the European Union is dependent upon the pricing and reimbursement guidelines adopted in each of the various countries in the European Union, which levels may fall well below our current expectations.

We have currently priced Esbriet in Germany, Austria and Norway and have developed estimates of anticipated pricing in other countries in the EU. These estimates are our expectations, which are based upon the lethal nature of IPF, the lack of any approved therapies for IPF, the Orphan Drug designation of Esbriet, our perception of the overall cost benefit of Esbriet and the current pricing in the EU of therapies with a similar product profile, such as treatments for pulmonary hypertension. However, due to efforts to provide for containment of health care costs, one or more EU countries may not support our estimated level of governmental pricing and reimbursement for Esbriet, particularly in light of the budget crises faced by a number of countries in the EU, which would negatively impact anticipated revenue from Esbriet in the EU.

In December 2011, the Institute for Quality and Efficiency in Health Care (the “IQWiG”), a non-profit private foundation established in Germany to provide advisory evaluations of the benefits and costs of medical interventions to Germany’s Federal Joint Committee (the “G-BA”), published its report on the benefit assessment of Esbriet concluding that there is no additional benefit of pirfenidone for the treatment of mild to moderate IPF.

 

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However, under German law, drugs designated with an orphan drug status are deemed as having an additional benefit, leading the IQWiG to assess the Esbriet additional benefit as given but not quantifiable. We have submitted a detailed response to the IQWiG concerning the assumptions and methodology applied by the IQWiG in its assessment. However, there can be no assurance that the IQWiG will revise its assessment to G-BA based on our response. We currently expect a decision by the G-BA by March 15, 2012. In the event that the G-BA follows the IQWiG initial assessment and concludes that Esbriet does not provide additional benefit for the treatment of mild to moderate IPF, the G-BA may lower its reimbursement guidelines with respect to Esbriet and necessitate that we lower our pricing of Esbriet, which would also negatively impact anticipated revenue from Esbriet in Germany. Such an outcome in Germany may result in lower than expected pricing and reimbursement guidelines in other countries in the EU which would adversely impact the anticipated revenue from Esbriet in the EU.

Expansion of our commercial infrastructure in the European Union is a significant undertaking that requires substantial financial and managerial resources, and we may not be successful in our efforts. We may also encounter unexpected or unforeseen delays in establishing a commercial infrastructure in the European Union, which may negatively impact our timing of and ability to launch our commercial efforts for Esbriet.

In March 2011, the European Commission granted marketing authorization for Esbriet (pirfenidone) in adults for the treatment of mild to moderate IPF. The approval authorizes marketing of Esbriet in all 27 EU member states. In September 2011, we launched commercial sales of Esbriet in Germany. Subject to EU country reimbursement timelines, we currently plan to conclude pricing and reimbursement discussions for Esbriet in France, Spain and Italy during the second quarter of 2012 and launch in those countries as soon as possible after concluding discussions. We currently plan to conclude the discussions with the authorities in the United Kingdom in October of 2012, and launch Esbriet as soon as possible thereafter. In addition to launches in the so called “Top 5” EU countries, we expect to launch Esbriet in Austria, Denmark, Ireland and Norway in the first half of 2012, and in Belgium, the Netherlands, Finland and Sweden in the second half of the year. A commercial launch of this size is a significant undertaking that requires substantial financial and managerial resources. To support our anticipated marketing efforts in Europe, we are currently working to expand our commercial infrastructure within the EU, including an increase to our employee headcount in that region and the establishment of our European headquarters in Muttenz, Switzerland. Further, in December 2010, we transferred all of our non-U.S. rights to research, develop and commercialize pirfenidone for IPF to our wholly-owned Swiss subsidiary, InterMune International AG. However, in order to successfully launch our commercial operations, we will need to expand the number of our managerial, operational, financial and other employees in the EU, which will require additional financial resources and require significant management attention. We may not be successful in establishing a commercial operation in the EU (including, but not limited to, failing to attract, retain and motivate the necessary skilled personnel and failing to develop a successful marketing strategy), the effect of which will have a negative outcome on our ability to commercialize Esbriet and generate revenue from the sale of Esbriet.

Additionally, we may encounter unexpected or unforeseen delays in establishing our commercial operations that delay the launch of our commercial operations in one or more EU member states. These delays may increase the cost of and the resources required for successful commercialization of Esbriet in the EU. Given our limited commercial history, we do not have significant experience in a commercial launch of this size.

Even if regulatory authorities approve our products or product candidates for the treatment of the diseases that we are targeting, our products may not be marketed or commercially successful.

The development of our products and product candidates is an expensive process, and we anticipate that the annual cost of treatment for the diseases for which we are seeking approval will be significant. These costs will vary for different diseases based on the dosage and method of administration. Accordingly, we may decide not to

 

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market any of our products or product candidates for an approved disease because we believe that it may not be commercially successful. Market acceptance of and demand for our products and product candidates, including Esbriet in the EU, will depend on many factors, including, but not limited to:

 

   

cost of treatment;

 

   

pricing and availability of alternative products;

 

   

our ability to obtain third-party coverage or reimbursement for our products or product candidates to treat a particular disease;

 

   

perceived efficacy relative to other available therapies;

 

   

shifts in the medical community to new treatment paradigms or standards of care;

 

   

relative convenience and ease of administration; and

 

   

prevalence and severity of adverse side effects associated with treatment.

In addition, we have only just begun our commercial sales of Esbriet in Germany and have limited information with regard to the market acceptance of Esbriet. As a result, we may have to revise our estimates regarding the acceptance of Esbriet under our current pricing structure, reevaluate and/or change the current pricing for Esbriet. In addition, based on the initial assessment of the IQWiG, German’s Federal Joint Commission may revise its reimbursement guidelines for Esbriet necessitating a reduction in the price of Esbriet. For more information, please see the risk factor above titled “Our revenue from sales of Esbriet in the European Union is dependent upon the pricing and reimbursement guidelines adopted in each of the various countries in the European Union, which levels may fall well below our current expectations.”

The pricing and profitability of our products may be subject to control by the government and other third-party payors, and if third-party payors do not provide coverage or reimburse patients for Esbriet, Actimmune or our other current or future products, our revenue and prospects for profitability will suffer.

The pricing and profitability of our products may be subject to control by the government and other third-party payors. In many foreign markets, the pricing and/or profitability of prescription pharmaceuticals are subject to governmental control. In the United States, we expect that there will continue to be federal and state proposals to implement similar governmental controls, such as the omnibus healthcare reform legislation recently adopted by the U.S. government. As a result, our ability to successfully commercialize Esbriet, Actimmune or other product candidates for particular diseases, is highly dependent on the extent to which coverage and reimbursement for such products is available from:

 

   

private health insurers, including managed care organizations;

 

   

governmental payors, such as state-run payors in the EU, as well as federal programs/payors such as Medicaid, the U.S. Public Health Service Agency and Veterans’ Administration; and

 

   

other third-party payors.

The continuing efforts of governmental and other third-party payors to contain or reduce the cost of healthcare through various means may adversely affect our ability to successfully commercialize our products. If governmental and other third-party payors do not provide adequate coverage and reimbursement levels for Esbriet, or our other current or future products, market acceptance of our products will be reduced, and our sales will suffer. For example, if Germany’s Federal Joint Commission concludes that Esbriet does not provide additional benefit for the treatment of mild to moderate IPF based on the IQWiG’s initial assessment, the Joint Committee may lower its reimbursement guidelines with respect to Esbriet and necessitate that we lower our pricing of Esbriet, which would also negatively impact revenue from Esbriet in Germany. Although we cannot predict the full effects on our business of the implementation of the healthcare reform bill in the United States, it is possible that this legislation or other similar legislation will result in decreased reimbursement for prescription

 

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drugs, which may further exacerbate industry-wide pressure to reduce the prices charged for prescription drugs. In addition, increasing emphasis on managed care in the United States will continue to put pressure on the pricing of pharmaceutical products. These new and any future cost-control initiatives could decrease the price that we would receive for Actimmune, Esbriet, if approved for use in the United States, or any other products that we may develop in the future, which would reduce our revenue and potential profitability.

Additionally, significant uncertainty exists as to the coverage and reimbursement status of pharmaceutical products, particularly with respect to products that are prescribed by physicians for off-label use. Many domestic third-party payors provide coverage or reimbursement only for FDA-approved indications. If any large or many third-party payors decide to deny reimbursement for Actimmune used to treat IPF, sales of Actimmune would decline, and our revenue would suffer. Often, third-party payors make the decision to reimburse an off-label prescription based on whether that product has a compendia listing. A drug compendia is produced by a compendia body, such as the United States Pharmacopoeia Drug Information, that lists approved indications that a product has received from the FDA. The compendia bodies also evaluate all of the clinical evidence to determine whether an off-label use of a product should be listed in the compendia as medically appropriate. A compendia listing of an off-label use is a condition typically required by third-party payors, such as Medicare and private payors, to cover that use. Applications for a compendia listing are often based upon the publication of certain data in peer reviewed journals whose publication is often outside the applicant’s control. We do not have a compendia listing for Actimmune and we do not intend to seek to achieve acceptance by a compendia body for Actimmune for the treatment of IPF. As a result, additional third-party payors may decide to deny reimbursement for Actimmune for the treatment of IPF and fewer physicians may prescribe Actimmune for such treatment. If either of these were to occur, sales of Actimmune would decline and our revenue would suffer.

Medicare generally does not provide coverage for drugs, like Actimmune, that are administered by injection in the home. Moreover, in connection with the Medicare Prescription Drug Improvement and Modernization Act of 2003, Medicare has recently discussed the possibility of refusing to provide coverage for products for a specific indication unless the product has been approved by the FDA for that indication. If Medicare were to make a formal decision not to cover the off-label use of products, it may have a negative impact on the willingness of private third-party payors to provide coverage for the off-label use of products such as Actimmune.

If the specialty pharmacies and distributors that we rely upon to sell our products fail to perform, our business may be adversely affected.

Our success depends on the continued customer support efforts of our network of specialty pharmacies and distributors. A specialty pharmacy is a pharmacy that specializes in the dispensing of injectable or infused medications for complex or chronic conditions, which often require a high level of patient education and ongoing management. The use of specialty pharmacies and distributors involves certain risks, including, but not limited to, risks that these specialty pharmacies and distributors will:

 

   

not provide us with accurate or timely information regarding their inventories, the number of patients who are using Actimmune or Actimmune complaints;

 

   

not effectively sell or support Actimmune;

 

   

reduce their efforts or discontinue to sell or support Actimmune;

 

   

not devote the resources necessary to sell Actimmune in the volumes and within the time frames that we expect;

 

   

be unable to satisfy financial obligations to us or others; or

 

   

cease operations.

Any such failure may result in decreased product sales and lower product revenue, which would harm our business.

 

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The activities of competitive drug companies, or others, may limit our products’ revenue potential or render them obsolete.

Our commercial opportunities will be reduced or eliminated if our competitors develop or market products that, compared to our products or product candidates:

 

   

are more effective;

 

   

have fewer or less severe adverse side effects;

 

   

are better tolerated;

 

   

have better patient compliance;

 

   

receive better reimbursement terms;

 

   

are more accepted by physicians;

 

   

are more adaptable to various modes of dosing;

 

   

have better distribution channels;

 

   

are easier to administer; or

 

   

are less expensive, including but not limited to a generic version of pirfenidone.

Even if we are successful in developing effective drugs, our products may not compete effectively with our competitors’ current or future products. We expect that Esbriet may compete in the EU and, if approved by the FDA in the U.S., may compete with other products that are being developed for the treatment of IPF, including possible generic versions of pirfenidone in the U.S., EU and potentially other markets following the expiration of, or in the absence of market exclusivity. Pirfenidone has no composition of matter patent protection. Unless we have (i) Orphan Drug designation, (ii) data exclusivity protection or (iii) other types of patent protection in a particular jurisdiction, we may face competition from a lower cost generic version of pirfenidone in such a jurisdiction. In addition, there are many pharmaceutical companies, biotechnology companies, public and private universities, government agencies and research organizations actively engaged in research and development of products, some of which may target the same indications as our product candidates. For example, in December 2010, Gilead entered into an agreement to acquire Arresto gaining Gilead access to Arresto’s Phase 1 humanized monoclonal antibody compound, AB0024, currently in clinical development for the treatment of IPF. Additionally, Boehringer Ingelheim, or BI, has recently presented phase 2 data for BIBF-1120, a triple kinase inhibitor that has showed some potential efficacy at high doses in IPF. BI has publicly posted its Phase 3 trial design for BIBF-1120 in IPF and patient enrollment has begun. Furthermore, there are seven products in various stages of phase 2 development for IPF, including CC-4047 and CC-930 from Celgene, CNTO-888 from Janssen (J&J), FG-3019 from Fibrogen, GC-1008 from Sanofi, QAX-576 from Novartis and STX-100 from Stromedix (currently in the process of being acquired by Biogen Idec). Our competitors include larger, more established, fully integrated pharmaceutical companies and biotechnology companies that have substantially greater capital resources, existing competitive products, larger research and development staffs and facilities, greater experience in drug development and in obtaining regulatory approvals and greater marketing capabilities than we do.

Our supply agreement with BI may restrict our ability to establish alternative sources of Actimmune in a timely manner or at an acceptable cost, which may cause us to be unable to meet demand for Actimmune and to lose potential revenue.

Our supply agreement with BI expires in December 2012. If we are unable to renew our supply agreement with BI, or cannot do so at an acceptable cost, we may need to qualify a new supplier or may suffer a shortage of commercial supply of Actimmune or a higher cost of product, either of which would have a material and adverse effect on our revenue, business and financial prospects.

 

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Risks Related to the Development of Our Products and Product Candidates

Drug development is a long, expensive and uncertain process, and delay or failure can occur at any stage of any of our clinical trials.

To gain approval to market a product for the treatment of a specific disease, we must provide the FDA and foreign regulatory authorities with clinical data that adequately demonstrate the safety and efficacy of that product for the intended indication applied for in the NDA or respective regulatory file. Drug development is a long, expensive and uncertain process, and delay or failure can occur at any stage of any of our clinical trials. A number of companies in the pharmaceutical industry, including biotechnology companies, have suffered significant setbacks in clinical trials, even after promising results in earlier preclinical or clinical trials. These setbacks have been caused by, among other things, preclinical findings made while clinical studies were underway and safety or efficacy observations made in clinical studies. Success in preclinical testing and early clinical trials does not ensure that later clinical trials will be successful, and the results of clinical trials by other parties may not be indicative of the results in trials we may conduct. For example, in March 2007, we terminated our development of Actimmune for patients with IPF as a result of our decision to discontinue the INSPIRE trial on the recommendation of the study’s independent DMC. We do not intend to conduct further development of Actimmune for the treatment of IPF. For specific risks related to the pirfenidone development program, please see the risk factor titled “If our clinical trials fail to demonstrate to the FDA and foreign regulatory authorities that any of our products or product candidates are safe and effective for the treatment of particular diseases, the FDA and foreign regulatory authorities may require us to conduct additional clinical trials or may not grant us marketing approval for such products or product candidates for those diseases” below.

We do not know whether future clinical trials will be initiated, or will be completed on schedule, or at all.

The commencement or completion of any of our clinical trials may be delayed, halted, or discontinued for numerous reasons, including, but not limited to, the following:

 

   

we may not be able to identify or develop a product candidate that can be successful for clinical development;

 

   

the FDA or other regulatory authorities do not approve a clinical trial protocol or place a clinical trial on clinical hold;

 

   

patients do not enroll in clinical trials at the rate we expect;

 

   

patients experience adverse side effects or unsafe toxicity levels;

 

   

patients withdraw or die during a clinical trial for a variety of reasons, including adverse events associated with the advanced stage of their disease and medical problems that may or may not be related to our products or product candidates;

 

   

the interim results of the clinical trial are inconclusive or negative;

 

   

our trial design, although approved, is inadequate to demonstrate safety and/or efficacy;

 

   

third-party clinical investigators do not perform our clinical trials on our anticipated schedule or consistent with the clinical trial protocol and good clinical practices or other third-party organizations do not perform data collection and analysis in a timely or accurate manner;

 

   

our contract laboratories fail to follow good laboratory practices; or

 

   

sufficient quantities of the trial drug are not available.

Our development costs will increase if we have material delays in our current clinical trials for pirfenidone or if we need to perform more or larger clinical trials than as may be initially planned for future product candidates. If there are any significant delays for any of our other current or planned clinical trials, our business, financial condition, financial results and the commercial prospects for our products and product candidates will be harmed, and our prospects for profitability will be impaired.

 

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In addition, delays or discontinuations of our clinical trials could require us to cease development efforts of a product candidate in part or altogether, which will harm our business or financial condition and the commercial prospects for such product and product candidate.

Risks Related to Government Regulation and Approval of our Products and Product Candidates

If our clinical trials fail to demonstrate to the FDA and foreign regulatory authorities that any of our products or product candidates are safe and effective for the treatment of particular diseases, the FDA and foreign regulatory authorities may require us to conduct additional clinical trials or may not grant us marketing approval for such products or product candidates for those diseases.

We are not permitted to market our product candidates in the United States until we receive approval of an NDA from the FDA, or in any foreign countries until we receive the requisite approval from such countries. Before obtaining regulatory approvals for the commercial sale of any product candidate for a target indication, we must demonstrate with evidence gathered in preclinical and well-controlled clinical trials, and, with respect to approval in the United States, to the satisfaction of the FDA and, with respect to approval in other countries, similar regulatory authorities in those countries, that the product candidate is safe and effective for use for that target indication and that the manufacturing facilities, processes and controls are adequate. Our failure to adequately demonstrate the safety and effectiveness of any of our products or product candidates for the treatment of particular diseases may delay or prevent our receipt of the FDA’s and foreign regulatory authorities’ approval and, ultimately, may prevent commercialization of our products and product candidates for those diseases. The FDA and foreign regulatory authorities have substantial discretion in deciding whether, based on the benefits and risks in a particular disease, any of our products or product candidates should be granted approval for the treatment of that particular disease. Even if we believe that a clinical trial or trials has demonstrated the safety and statistically significant efficacy of any of our products or product candidates for the treatment of a disease, the results may not be satisfactory to the FDA or foreign regulatory authorities. Preclinical and clinical data can be interpreted by the FDA and foreign regulatory authorities, including their advisory committees, in different ways, which could delay, limit or prevent regulatory approval. In addition, even if advisory committees to the FDA recommend approval of our product candidates, such recommendations are non-binding and the FDA may not approve our NDA for the product candidates. For example, nine of the twelve members of the Pulmonary-Allergy Drugs Advisory Committee, or PADAC, of the FDA recommended approval of pirfenidone to reduce decline in lung function in patients with IPF. However, notwithstanding the PADAC approval recommendation, we subsequently received a Complete Response Letter from the FDA requesting an additional clinical trial to support the efficacy of pirfenidone. If regulatory delays are significant or regulatory approval is limited or denied altogether, our financial results and the commercial prospects for those of our products or product candidates involved will be harmed, and our prospects for profitability will be significantly impaired.

Our CAPACITY trials were conducted without a SPA with the FDA. The FDA’s SPA process creates a written agreement between the sponsoring company and the FDA regarding clinical study design and other clinical study issues that can be used to support approval of a product candidate. We did not obtain a SPA agreement with the FDA and therefore there was no assurance that the results would provide a sufficient basis in the view of the FDA for the FDA to grant regulatory approval of a new drug application for pirfenidone for the treatment of IPF. In addition, while the FDA will consider and approve NDAs based on various endpoints, the FDA had indicated that mortality is the ideal endpoint for IPF clinical trials. We designed and conducted CAPACITY 1 and CAPACITY 2 based on FVC change as the primary endpoint, as opposed to mortality. The FDA had advised us that they were uncertain as to what would constitute a clinically meaningful treatment effect of pirfenidone on this endpoint and reviewed the effect of pirfenidone not only based on FVC change but also based on the totality of the data, including the effect of pirfenidone on all of the specified efficacy endpoints as well as the safety data to help determine the risk-benefit profile of pirfenidone in IPF patients. The primary endpoint of FVC change was met with statistical significance in CAPACITY 2 but not in CAPACITY 1. Therefore, we did not replicate the efficacy of pirfenidone for the treatment of IPF in a second pivotal study.

 

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Moreover, because the data base for the Shionogi Phase 3 study was not included in our NDA, the FDA did not consider this study to support the efficacy of pirfenidone. Rather the adequacy of our application to support the efficacy of pirfenidone for the treatment of IPF was determined by the FDA during the review of our NDA. While in our view the totality of the data from CAPACITY 1 and CAPACITY 2 support the efficacy and safety of pirfenidone in IPF, the FDA disagreed with our view and decided that such data does not adequately support approval of our NDA filing and issued to us a Complete Response Letter on May 4, 2010 requesting an additional clinical trial to support the efficacy of pirfenidone in IPF. We began a new Phase 3 clinical study, the ASCEND trial, during the second quarter of 2011. We did not obtain a SPA agreement with the FDA with respect to the ASCEND trial. The results of this Phase 3 clinical trial may not be satisfactory to the FDA to receive regulatory approval. For additional information related to the risk of the new Phase 3 clinical study, please see the risk factor under the caption “Risks Related to Our Dependence on Pirfenidone—We have initiated the ASCEND Phase 3 clinical trial to support potential FDA approval of pirfenidone for the treatment of IPF, the results of which may fail to demonstrate to the FDA sufficient efficacy of pirfenidone and may have a negative effect on sales of Esbriet in the European Union.”

We are subject to extensive and rigorous governmental regulation, including the requirement of FDA or other regulatory approval before our products and product candidates may be lawfully marketed.

Both before and after the approval or our product candidates and product, we, our product candidates, our product, our operations, our facilities, our suppliers, and our contract manufacturers, contract research organizations, and contract testing laboratories are subject to extensive regulation by governmental authorities in the United States and other countries, with regulations differing from country to country. In the United States, the FDA regulates, among other things, the pre-clinical testing, clinical trials, manufacturing, safety, efficacy, potency, labeling, storage, record keeping, quality systems, advertising, promotion, sale and distribution of therapeutic products. Failure to comply with applicable requirements could result in, among other things, one or more of the following actions: notices of violation, untitled letters, warning letters, fines and other monetary penalties, unanticipated expenditures, delays in approval or refusal to approve a product candidate; product recall or seizure; interruption of manufacturing or clinical trials; operating restrictions; injunctions; and criminal prosecution. We or the FDA, or an institutional review board, may suspend or terminate human clinical trials at any time on various grounds, including a finding that the subjects are being exposed to an unacceptable health risk. Any failure to receive the marketing approvals necessary to commercialize our product candidates could harm our business.

The regulatory review and approval process of governmental authorities is lengthy, expensive and uncertain, and regulatory standards may change during the development of a particular product candidate. We are not permitted to market our product candidates in the United States or other countries until we have received requisite regulatory approvals. The FDA review process typically takes significant time to complete and approval is never guaranteed. If a product is approved, the FDA may limit the indications for which the product may be marketed, require extensive warnings on the product labeling, impose restricted distribution programs, require expedited reporting of certain adverse events, or require costly ongoing requirements for post-marketing clinical studies and surveillance or other risk management measures to monitor the safety or efficacy of the product. Markets outside of the United States such as the EU also have requirements for approval of drug candidates with which we must comply prior to marketing. Obtaining regulatory approval for marketing of a product candidate in one country does not ensure we will be able to obtain regulatory approval in other countries, but a failure or delay in obtaining regulatory approval in one country may have a negative effect on the regulatory process in other countries. Also, any regulatory approval of any of our products or product candidates, once obtained, may be withdrawn.

The FDA has increased its attention to product safety concerns in light of recent high profile safety issues with certain drug products, in the United States. Moreover, heightened Congressional scrutiny on the adequacy of the FDA’s drug approval process and the agency’s efforts to assure the safety of marketed drugs has resulted in proposed agency initiatives and new legislation addressing drug safety issues. If adopted, any new legislation or

 

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agency initiatives could result in delays or increased costs during the period of product development, clinical trials and regulatory review and approval, as well as increased costs to assure compliance with any new post-approval regulatory requirements. These restrictions or requirements could require us to conduct costly studies.

In addition, we, our suppliers, our operations, our facilities, our contract manufacturers, our contract research organizations, and our contract testing laboratories are required to comply with extensive FDA requirements both before and after approval of our products. For example, we are required to report certain adverse reactions and production problems, if any, to the FDA, and to comply with certain requirements concerning advertising and promotion for our product candidates and our products. Also, quality control and manufacturing procedures must continue to conform to current Good Manufacturing Practices, or cGMP, regulations after approval, and the FDA periodically inspects manufacturing facilities to assess compliance with cGMP. Accordingly, we and others with whom we work must continue to expend time, money, and effort in all areas of regulatory compliance, including manufacturing, production, and quality control. In addition, discovery of safety issues may result in changes in labeling or restrictions on a product manufacturer or NDA holder, including removal of the product from the market.

If the FDA imposes significant restrictions or requirements related to our products for any disease, or withdraws its approval of any of our products for any disease for which it has been approved, our revenue would decline.

The FDA and foreign regulatory authorities may impose significant restrictions on the use or marketing of our products or impose additional requirements for post-approval studies. Later discovery of previously unknown problems with any of our products or their manufacture may result in further restrictions, including withdrawal of the product from the market. In this regard, the FDA has conducted routine inspections of our manufacturing contractors, and some were issued a standard “notice of inspectional observations.” While we believe that all of these observations are being appropriately corrected, failure to correct any deficiency could result in manufacturing delays. Our existing approvals, and any new approval for any other disease that we target, if granted, could be withdrawn for failure to comply with regulatory requirements or to meet our post-approval commitments. For example, we have ongoing Phase 4 post-marketing commitments to the FDA relating to Actimmune for the treatment of osteopetrosis, including a registry and drug interaction study. The failure to adequately address these ongoing Phase 4 commitments could result in a regulatory action or restriction, such as withdrawal of the relevant product’s approval by the FDA. If approval for a disease is withdrawn, we could no longer market the affected product for that disease. In addition, governmental authorities could seize our inventory of such product, force us to recall any product already in the market, or subject us to criminal or civil penalties, if we fail to comply with FDA or other governmental regulations.

For a description of restrictions relating to the off-label promotion of our products, please see the risk factor titled, “If we fail to comply or have in the past failed to comply with FDA or other government regulations prohibiting the promotion of off-label uses and the promotion of products for which marketing approval has not been obtained, we could be subject to regulatory enforcement action by the FDA or other governmental authorities as well as follow-on actions filed by consumers and other end-payors, which actions could result in substantial fines, sanctions and damage awards against us, any of which could harm our business” below.

If we fail to comply or have in the past failed to comply with FDA or other government regulations prohibiting the promotion of off-label uses and the promotion of products for which marketing approval has not been obtained, we could be subject to regulatory enforcement action by the FDA or other governmental authorities as well as follow-on actions filed by consumers and other end-payors, which actions could result in substantial fines, sanctions and damage awards against us, any of which could harm our business.

The FDA has authority to regulate advertising and promotional labeling for our products under the Federal Food, Drug, and Cosmetic Act and implementing regulations. In general, that authority requires advertising and promotional labeling to be truthful and not misleading, and consistent with the information in the product’s

 

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approved label, including that a product may be marketed only for the approved indications. Physicians may prescribe commercially available drugs for uses that are not described in the product’s labeling and that differ from those uses tested by us and approved by the FDA. Such off-label uses are common across medical specialties. For example, even though the FDA has not approved the use of Actimmune for the treatment of IPF, we are aware that physicians are prescribing, and have prescribed in the past, Actimmune for the treatment of IPF. Substantially all of our Actimmune revenue is derived from physicians’ prescriptions for off-label use for IPF. The FDA does not regulate the behavior of physicians in their choice of treatments. The FDA and other governmental agencies do, however, restrict manufacturers’ communications on the subject of off-label use. Companies may not promote FDA-approved drugs for off-label uses. Accordingly, we may not promote Actimmune for the treatment of IPF. The FDA and other governmental authorities actively enforce regulations prohibiting promotion of off-label uses. The federal government has levied large civil and criminal fines against manufacturers for alleged improper promotion, including us in October 2006 in connection with our reaching a comprehensive settlement with the government to resolve all claims as related to our promotional activities with respect to Actimmune. The FDA has also requested that companies enter into consent decrees or permanent injunctions under which certain promotional conduct is changed or curtailed. We are aware of many instances, including our own experience as it relates to Actimmune, in which the Office of the Inspector General of the FDA has sought and secured criminal penalties and/or a corporate integrity agreement against pharmaceutical manufacturers requiring payment of substantial fines and monitoring of certain promotional activities to ensure compliance with FDA regulations. We engage in medical education activities that are subject to scrutiny under the FDA’s regulations relating to off-label promotion. While we believe we are currently in compliance with these regulations, the regulations are subject to varying interpretations, which are evolving.

If the FDA or any other governmental agency initiates an enforcement action against us and it is determined that we violated prohibitions relating to off-label promotion in connection with past or future activities, we could be subject to civil and/or criminal fines and sanctions such as those noted above in this risk factor, any of which would have an adverse effect on our revenue, business and financial prospects. As a follow-on to such governmental enforcement actions, consumers and other end-payors of the product may initiate action against us claiming, among other things, fraudulent misrepresentation, civil RICO, unfair competition, violation of various state consumer protection statutes, and unjust enrichment. For example, as a follow-on to the subpoena we received from the U.S. Department of Justice with respect to our promotional and marketing activities in connection with Actimmune and the resulting settlement we reached with the government in October 2006, we have had various class action suits filed against us by consumers and other end-payors of Actimmune. If the plaintiffs in such follow-on actions are successful, we could be subject to various damages, including compensatory damages, treble damages, punitive damages, restitution, disgorgement, prejudgment and post-judgment interest on any monetary award, and the reimbursement of the plaintiffs’ legal fees and costs, any of which would also have an adverse effect on our revenue, business and financial prospects.

In addition, some of the agreements pursuant to which we license our products, including our license agreement relating to Actimmune, contain provisions requiring us to comply with applicable laws and regulations, including the FDA’s restriction on the promotion of FDA-approved drugs for off-label uses. As a result, if it were determined that we violated the FDA’s rules relating to off-label promotion in connection with our marketing of Actimmune, we may be in material breach of our license agreement for Actimmune. If we failed to cure a material breach of this license agreement, we could lose our rights to certain therapeutic uses for Actimmune under the agreement.

Our failure or alleged failure to comply with anti-kickback and false claims laws could result in civil and/or criminal sanctions and/or harm our business.

We are subject to various federal and state laws pertaining to health care “fraud and abuse” including anti-kickback laws and false claims laws. Subject to certain exceptions, the anti-kickback laws make it illegal for a prescription drug manufacturer to knowingly and willfully solicit, offer, receive or pay any remuneration in exchange for, or to induce, the referral of business, including the purchase or prescription of a particular drug.

 

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The federal government has published regulations that identify “safe harbors” or exemptions for certain payment arrangements that do not violate the anti-kickback statutes. Due to the breadth of the statutory provisions and the absence of guidance in the form of regulations or court decisions addressing some of our practices, it is possible that our practices might be challenged under anti-kickback or similar laws. False claims laws prohibit anyone from knowingly presenting, or causing to be presented, for payment to third party payors (including Medicare and Medicaid) claims for reimbursed drugs or services that are false or fraudulent, claims for items or services not provided as claimed or claims for medically unnecessary items or services. Our activities relating to the reporting of wholesaler or estimated retail prices for our products, the reporting of Medicaid rebate information and other information affecting federal and state and third-party payment for our products, and the sale and marketing of our products, could become subject to scrutiny under these laws.

In addition, pharmaceutical companies have been prosecuted under the False Claims Act in connection with their “off-label” promotion of drugs. For information regarding allegations with respect to “off-label” promotion by us, please see the risk factor titled “If we fail to comply or have in the past failed to comply with FDA or other government regulations prohibiting the promotion of off-label uses and the promotion of products for which marketing approval has not been obtained, we could be subject to regulatory enforcement action by the FDA or other governmental authorities as well as follow-on actions filed by consumers and other end-payors, which actions could result in substantial fines, sanctions and damage awards against us, any of which could harm our business” above.

If the government were to allege that we were, or convict us of, violating these laws, there could be a material adverse effect on us, including a substantial fine, decline in our stock price, or both. Our activities could be subject to challenge for the reasons discussed above and due to the broad scope of these laws and the increasing attention being given to them by law enforcement authorities.

Risks Related to Manufacturing and Our Dependence on Third Parties

The manufacturing and manufacturing development of our products and product candidates present technological, logistical and regulatory risks, each of which may adversely affect our potential revenue.

The manufacturing and manufacturing development of pharmaceuticals, and, in particular, biologics such as Actimmune, are technologically and logistically complex and heavily regulated by the FDA and other governmental authorities. The manufacturing and manufacturing development of our products and product candidates present many risks, including, but not limited to, the following:

 

   

It may not be technically feasible to scale up an existing manufacturing process to meet demand or such scale-up may take longer than anticipated; and

 

   

Failure to comply with strictly enforced good manufacturing practices regulations and similar foreign standards may result in delays in product approval or withdrawal of an approved product from the market. For example, the FDA has conducted routine inspections of our manufacturing contractors, and some were issued a standard “notice of observations.” Failure to correct any deficiency could result in manufacturing delays.

Any of these factors could delay clinical trials, regulatory submissions and/or commercialization of our products for particular diseases, interfere with current sales, entail higher costs and result in our being unable to effectively sell our products.

Our manufacturing strategy, which relies on third-party manufacturers, exposes us to additional risks as a result of which we may lose potential revenue.

We do not have the resources, facilities or experience to manufacture any of our products or product candidates ourselves. Completion of our clinical trials and commercialization of our products requires access to, or development of, manufacturing facilities that meet FDA standards to manufacture a sufficient supply of our

 

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products. The FDA, the EU and foreign regulatory authorities must approve facilities that manufacture our products for commercial purposes, as well as the manufacturing processes and specifications for the product. We depend on third parties for the manufacture of our product candidates for preclinical and clinical purposes, and we rely on third parties with FDA-approved manufacturing facilities for the manufacture of Actimmune for commercial purposes. We have a long-term supply contract with BI for Actimmune, a long-term supply contract with Signa C.V. and ACIC Fine Chemicals Inc. for Esbriet active pharmaceutical ingredient and a contract with Catalent for the manufacture of the drug product for Esbriet. However, if we do not perform our obligations under these agreements, these agreements may be terminated.

Our manufacturing strategy for our products and product candidates presents many risks, including, but not limited to, the following:

 

   

If market demand for our products is less than our purchase obligations to our manufacturers, we may incur substantial penalties and substantial inventory write-offs.

 

   

Manufacturers of our products are subject to ongoing periodic inspections by the EU, FDA and other regulatory authorities for compliance with strictly enforced good manufacturing practices regulations and similar foreign standards, and we do not have control over our third-party manufacturers’ compliance with these regulations and standards.

 

   

When we need to change third party manufacturers of a particular pharmaceutical product, the EU, FDA and foreign regulatory authorities must approve the new manufacturers’ facilities and processes prior to our use or sale of products it manufactures for us. This requires demonstrated compatibility of product, process and testing and compliance inspections. Delays in transferring manufacturing technology between third parties could delay clinical trials, regulatory submissions and commercialization of our product candidates.

 

   

Our manufacturers might not be able or may refuse to fulfill our commercial or clinical trial needs, which would require us to seek new manufacturing arrangements and may result in substantial delays in meeting market or clinical trial demands. For example, our current long-term supply contract with Signa C.V. and ACIC Fine Chemicals Inc. for the active pharmaceutical ingredient for Esbriet does not impose any obligation on Signa C.V. or ACIC Fine Chemicals Inc. to reserve a minimum annual capacity for the production of such ingredient, which could impair our ability to obtain product from them in a timely fashion.

 

   

We may not have intellectual property rights, or may have to share intellectual property rights, to any improvements in the manufacturing processes or new manufacturing processes for our products.

 

   

Our product costs may increase if our manufacturers pass their increasing costs of manufacture on to us.

 

   

If third-party manufacturers do not successfully carry out their contractual duties or meet expected deadlines, we may not be able to obtain or maintain regulatory approvals for our products and product candidates and we may experience stock-outs. This would adversely impact our ability to successfully commercialize our products and product candidates. Furthermore, we may not be able to locate any necessary acceptable replacement manufacturers or enter into favorable agreements with such replacement manufacturers in a timely manner, if at all.

 

   

If our agreement with a third-party manufacturer expires, we may not be able to renegotiate a new agreement with that manufacturer on favorable terms, if at all. If we cannot successfully complete such renegotiation, we may not be able to locate any necessary acceptable replacement manufacturers or enter into favorable agreements with such replacement manufacturers in a timely manner, if at all. For example, our current supply agreement with BI for Actimmune is set to expire at the end of December 2012. If we are unable to negotiate an extension of this supply agreement with BI before it expires, we would need to secure a replacement manufacturer and negotiate acceptable terms with such replacement manufacturer. If we are unable to do so in a timely basis, or at all, we may experience a stock-out as well as lose our ability to maintain our regulatory approvals for Actimmune.

 

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Any of these factors could delay clinical trials, regulatory submissions or commercialization of our products for particular diseases, interfere with current sales, entail higher costs and result in our being unable to effectively sell our products.

A disruption in our ability to ship Esbriet from our packaging facilities in the United States to our distributor in the European Union or a disruption in our distribution channels in the European Union could result in significant product delays and adversely affect our results.

We currently ship Esbriet from packaging facilities in the U.S. to our distributor in the EU. A disruption in our ability to ship Esbriet to our distributor in the EU or a disruption in our distribution channels in the EU for any reason, including as a result of a natural disaster, terrorism or failure of our commercial carrier, could result in product delivery delays. If this were to occur, we may be unable to satisfy customer orders on a timely basis, if at all. A significant disruptive event to our ability to distribute Esbriet could adversely affect our ability to generate revenue from Esbriet and materially affect our business and results of operations.

We rely on third parties to conduct clinical trials for our products and product candidates, and those third parties may not perform satisfactorily.

If our third-party contractors do not successfully carry out their contractual duties or meet expected deadlines, we may be delayed in or prevented from obtaining regulatory approvals for our products and product candidates, and may not be able to successfully commercialize our products and product candidates for targeted diseases. We do not have the ability to independently conduct clinical trials for all of our products and product candidates, and we rely on third parties such as contract research organizations, medical institutions and clinical investigators to perform this function. For example, we use contract research organizations to conduct our new Phase 3 ASCEND trial for pirfenidone. Our ability to monitor and audit the performance of these third parties is limited. If these third parties do not perform satisfactorily, our clinical trials may be extended or delayed, resulting in potentially substantial cost increases to us and other adverse impacts on our product development efforts. We may not be able to locate any necessary acceptable replacements or enter into favorable agreements with them, if at all.

Risks Related to Our Intellectual Property Rights

We may not be able to obtain, maintain and protect certain proprietary rights necessary for the development and commercialization of our products or product candidates.

Our commercial success will depend in part on obtaining and maintaining patent protection on our products and product candidates and successfully defending these patents against third-party challenges. Our ability to commercialize our products will also depend in part on the patent positions of third parties, including those of our competitors. The patent positions of pharmaceutical and biotechnology companies can be highly uncertain and involve complex legal and factual questions. No consistent policy regarding the breadth of claims allowed in biotechnology patents has emerged to date. Accordingly, we cannot predict with certainty the scope and breadth of patent claims that may be afforded to other companies’ patents. In addition, each country has its own rules regarding the allowability and enforceability of certain types of patents and therefore there can be no assurance that our patents applications will be granted or that our issued patents will be enforceable in any given jurisdiction. We could incur substantial costs in litigation if we are required to defend against patent suits brought by third parties, or if we initiate suits to protect our patent rights.

Any litigation, including any interference proceedings to determine priority of inventions, oppositions to patents in foreign countries or litigation against our partners may be costly and time consuming and could harm our business. Litigation may be necessary in some instances to determine the validity, enforceability, scope and infringement of certain of our proprietary rights. Litigation may be necessary in other instances to determine the validity, scope or non-infringement of patent rights claimed by third parties to be pertinent to the manufacture,

 

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use or sale of our products. Ultimately, the outcome of such litigation could adversely affect the validity and scope of our patent or other proprietary rights or hinder our ability to manufacture and market our products.

The degree of future protection for our proprietary rights is uncertain, and we cannot ensure that:

 

   

we were the first to make the inventions covered by each of our pending patent applications;

 

   

we were the first to file patent applications for these inventions;

 

   

others will not independently develop similar or alternative technologies or duplicate any of our technologies;

 

   

any of our pending patent applications will result in issued patents;

 

   

any of our issued patents or those of our licensors will be valid and enforceable;

 

   

any patents issued to us or our collaborators will provide a basis for commercially viable products or will provide us with any competitive advantages or will not be challenged by third parties;

 

   

we will develop additional proprietary technologies that are patentable; or

 

   

the patents of others will not have a material adverse effect on our business.

For example, the pirfenidone molecule itself has no composition of matter patent protection in the United States or elsewhere. We must therefore rely primarily on the protection afforded by formulation and method of use patents relating to the use of pirfenidone for the treatment in adults of mild to moderate IPF. While many countries such as the United States permit method of use patents relating to the use of drug products, in some countries the law relating to patentability of such use claims is evolving and may be unfavorably interpreted to prevent us from patenting some or all of our pending patent applications. There are some countries that currently do not allow such method of use patents, or that significantly limit the types of uses that are patentable.

In the EU, patents are subject to a post-grant opposition period, and enforcement of patents is on a country-by-country basis subject to varying, complex and evolving national requirements and standards. Competitors could challenge the validity of our patent claims and challenge whether their product actually infringes those claims. Such challenges would involve complex legal and factual questions and entail considerable costs and investment of effort.

Others have filed and in the future may file patent applications covering uses and formulations of pirfenidone, or interferon gamma-1b, or other products in our development program. If a third party has been or is in the future issued a patent that blocked our ability to commercialize any of our products, alone or in combination, for any or all of the diseases that we are targeting, we would be prevented from commercializing that product or combination of products for that disease or diseases unless we obtained a license from the patent holder. We may not be able to obtain such a license to a blocking patent on commercially reasonable terms, if at all. If we cannot obtain, maintain and protect the necessary proprietary rights for the development and commercialization of our products or product candidates, our business and financial prospects will be impaired.

The pirfenidone molecule itself has no composition of matter patent protection in the United States or elsewhere, and may only be protected for the treatment of IPF by orphan drug designation in the United States and European Union.

The pirfenidone molecule itself has no composition of matter patent protection in the United States or elsewhere. In the EU we have been granted orphan drug designation for pirfenidone for the treatment of IPF by the EMA, which provides for ten years of market exclusivity until March 2021. The exclusivity period afforded by orphan drug designation in the United States begins on first NDA approval for this product in IPF and ends seven years thereafter. Therefore, we may not have the ability to prevent others from commercializing

 

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pirfenidone for (i) IPF after the orphan drug designation exclusivity period ends, (ii) uses of pirfenidone covered by other patents held by third parties or (iii) other uses of pirfenidone in the public domain for which there is no patent protection. We are relying on exclusivity granted from orphan drug designation in IPF to protect pirfenidone from competitors in this indication and, following expiration of orphan drug protection in the EU, and if approved for commercial use by the FDA, in the United States, we must rely primarily on the protection afforded by formulation and method of use patents relating to the safe and/or effective use of pirfenidone for IPF. We cannot provide any assurance that we will be able to maintain this orphan drug designation. Furthermore, although pirfenidone has received orphan drug marketing exclusivity for the treatment of patients with IPF, the FDA and/or the EMA can still approve different drugs for use in treating the same indication or disease, which would create a more competitive market for us and our revenues will be diminished.

In addition, other third parties have obtained patents in the United States and elsewhere relating to formulation and methods of use of pirfenidone for the treatment of certain diseases. As a result, it is possible that we could face competition from third party products that have pirfenidone as the active pharmaceutical ingredient. If a third party were to obtain FDA approval in the United States for the use of pirfenidone, or regulatory approval in another jurisdiction, for an indication before we did, such third party would be first to market and could establish the price for pirfenidone in these jurisdictions. This could adversely impact our ability to implement our pricing strategy for the product and may limit our ability to maximize the commercial potential of pirfenidone in the United States and elsewhere. The presence of a lower priced competitive product with the same active pharmaceutical ingredients as our product could lead to use of the competitive product for our anti-fibrotic indications. This could lead to pricing pressure for pirfenidone, which would adversely affect our ability to generate revenue from the sale of pirfenidone for anti-fibrotic indications.

Pirfenidone is the only commercially approved drug approved for the treatment of mild to moderate IPF. There are no other existing approved treatments. Therefore the incidence and prevalence of IPF that currently provide the basis of orphan drug designation in the European Union and the United States could change over time, and it is possible that orphan drug designation could be lost in these markets should the patient population exceed that required to maintain orphan drug status in these countries.

Market exclusivity afforded by orphan drug designation is generally offered as an incentive to drug developers to invest in developing and commercializing products for unique diseases that impact a limited number of patients. With respect to the United States, the FDA may grant orphan drug designation to drugs intended to treat a rare disease or condition, which is generally a disease or condition that affects fewer than 200,000 individuals in the United States. Qualification to maintain orphan drug status is generally monitored by the regulatory authorities during the orphan drug exclusivity period, currently seven years and ten years from the date of approval in the EU and United States, respectively. IPF is currently a poorly diagnosed disease in these markets. It is possible that with the approval of Esbriet in the EU, and the potential approval of pirfenidone in the United States, that the incidence and prevalence numbers for IPF could change in these markets. Should the incidence and prevalence of IPF patients who are eligible to receive pirfenidone for the treatment of IPF in these markets materially increase, it is possible that the orphan drug designation, and related market exclusivity, in these jurisdictions could be lost.

Following expiration of orphan drug designation in the European Union, and if approved for commercial use by the FDA, in the United States, our current intellectual property portfolio may not be sufficient to protect the continued exclusivity of pirfenidone for the treatment in adults of mild to moderate IPF.

Because the pirfenidone molecule itself has no composition of matter patent protection in the United States or elsewhere, following expiration of orphan drug designation in the EU, and if approved for commercial use by the FDA, in the United States, we must rely primarily on the protection afforded by the formulation and method of use patents relating to the safe and/or effective use of pirfenidone for the treatment in adults of mild to moderate IPF.

We have five granted patents and a number of pending patent applications in Europe relating to Esbriet’s formulation and use in IPF patients, particularly related to the safe and efficacious usage of the product. This

 

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collection of patents is expected to provide patent protection in Europe until 2030, and includes a granted patent that relates to the effect of food on the pharmacokinetics and safety of Esbriet, which expires in late 2026, a granted patent which relates to the safe and efficacious usage of Esbriet in patients who develop elevation in liver transaminase levels, which expires in late 2029, a granted patent relating to the titration of the dosing of Esbriet at the initiation of therapy, which expires in late 2027, a granted patent relating to the safe usage of Esbriet with respect to fluvoxamine that expires in 2030, and a granted patent relating to the safe usage of Esbriet with respect to smoking that expires in 2030. We also have nine issued patents in the United States relating to the formulation or safe and/or effective use of Esbriet in IPF patients, and a number of pending U.S. patent applications. In addition we have numerous pending patent applications under active prosecution in other foreign jurisdictions. The laws regarding patentability and enforceability of patents such as ours varies on a country by country basis.

These patents can be challenged by our competitors in various jurisdictions who may argue such patents are invalid or unenforceable, lack sufficient written description or enablement, or that the claims of the issued patents should be limited or narrowly construed. Additionally, even if the validity of these patents were upheld in a patent challenge, a court may refuse to stop the other party from practicing the activity at issue on the ground that its activities are not covered by our patents. Any of these outcomes would limit our ability to exclusively market pirfenidone for the treatment in adults of mild to moderate IPF in the EU, and if approved for commercial use by the FDA, in the United States, as well as certain other countries where we have filed for patent protection.

If we breach our agreement with Shionogi, we may lose our ability to develop and commercialize pirfenidone in other jurisdictions.

In February 2010, we entered into an agreement with Shionogi that gives us an option to exercise a license for access to certain patient level data from the Shionogi Phase 3 clinical trial with pirfenidone in patients with IPF, which we refer to as SP3, to be used as “pivotal study data” (as defined in the agreement) in connection with our regulatory filings. We did not use SP3 patient level data as pivotal study data in our recently approved MAA or in any other submissions in connection with review of the MAA. Similarly, we did not use SP3 patient level data as pivotal study data in our U.S. NDA or in any other submissions in connection with review of the U.S. NDA. However, going forward, we may elect to use SP3 patient level data as pivotal study data in our regulatory filings in the United States or in other jurisdictions. Should we breach our agreement with Shionogi, we may lose our ability to use Shionogi’s patient level data in our regulatory filings in the United States or in other jurisdictions, which could adversely affect our ability to obtain regulatory approval of pirfenidone in such jurisdictions.

Within the next few years various patents relating to interferon gamma-1b will expire and we will lose our ability to rely upon the intellectual property we currently own or have licensed to prevent others from marketing interferon gamma-1b in the United States, which may impair our ability to generate revenue.

We have licensed certain patents relating to interferon gamma-1b, the active ingredient in Actimmune, from Genentech (a wholly-owned subsidiary of Roche). A U.S. patent relating to the composition of interferon gamma-1b expires in 2014. Other material U.S. patents relating to interferon gamma-1b expire between 2009 and 2013. We also previously purchased certain patents relating to interferon gamma analogs from Amgen Inc. in 2002 including two U.S. patents issued on August 30, 2005 that will expire on August 30, 2022. When these various patents expire, we will be unable to use these patents to try to block others from marketing interferon gamma-1b in the United States and, as a result, sales of Actimmune may decline and our ability to generate revenue may decrease.

If we breach our license agreement with Genentech, we may lose our ability to develop and market Actimmune.

We license certain patents and trade secrets relating to Actimmune from Genentech. If we breach this agreement with Genentech, they may be able to terminate the respective license, and we would have no further rights to utilize the licensed patents or trade secrets to develop and market Actimmune, which could adversely affect our revenue and financial prospects.

 

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Litigation or third-party claims of intellectual property infringement could require us to spend substantial time and money and could adversely affect our ability to develop and commercialize products.

Our commercial success depends in part on our ability and the ability of our collaborators to avoid infringing patents and proprietary rights of third parties. Third parties may accuse us, or our collaborators, of employing their proprietary technology in our products, or in the materials or processes used to research or develop our products, without authorization. Any legal action against our collaborators or us claiming damages and/or seeking to stop our commercial activities relating to the affected products, materials and processes could, in addition to subjecting us to potential liability for damages, require our collaborators or us to obtain a license to continue to utilize the affected materials or processes or to manufacture or market the affected products. We cannot predict whether we, or our collaborators, would prevail in any of these actions or whether any license required under any of these patents would be made available on commercially reasonable terms, if at all. If we are unable to obtain such a license, we, or our collaborators, may be unable to continue to utilize the affected materials or processes or manufacture or market the affected products or we may be obligated by a court to pay substantial royalties and/or other damages to the patent holder. Even if we are able to obtain such a license, the terms of such a license could substantially reduce the commercial value of the affected product or products and impair our prospects for profitability. Accordingly, we cannot predict whether or to what extent the commercial value of the affected product or products or our prospects for profitability may be harmed as a result of any of the liabilities discussed above. Furthermore, infringement and other intellectual property claims, with or without merit, can be expensive and time-consuming to litigate and can divert management’s attention from our core business.

If the owners of the intellectual property we license fail to maintain the intellectual property, we may lose our rights to develop our products or product candidates.

We generally do not control the patent prosecution of intellectual property that we license from third parties. Accordingly, we are unable to exercise the same degree of control over this intellectual property as we would exercise over intellectual property that we own, and, as a result, we may lose our rights to such intellectual property and incur substantial costs. For example, if Genentech fails to maintain the intellectual property rights related to Actimmune licensed to us, we may lose our rights to develop and market certain therapeutic uses for Actimmune and may be forced to incur substantial additional costs to maintain or protect our intellectual property rights or to compel Genentech to do so.

If our employees, consultants and vendors do not comply with their confidentiality agreements or our trade secrets otherwise become known, our ability to generate revenue and profits may be impaired.

Patent prosecution may not be appropriate or obtainable for certain of our technologies, and we may instead protect such proprietary information as trade secrets. We protect these rights mainly through confidentiality agreements with our corporate partners, employees, consultants and vendors.

These agreements generally provide that all confidential information developed or made known to an individual or company during the course of their relationship with us will be kept confidential and will not be used or disclosed to third parties except in specified circumstances. In the case of employees and consultants, our agreements generally provide that all inventions made by the individual while engaged by us will be our exclusive property. We cannot be certain that these parties will comply with these confidentiality agreements, that we will have adequate remedies for any breach, or that our trade secrets will not otherwise become known or be independently discovered by our competitors. If our trade secrets become known, we may lose a competitive advantage and our ability to generate revenue may therefore be impaired.

By working with corporate partners, research collaborators and scientific advisors, we are subject to disputes over intellectual property, and our ability to obtain patent protection or protect proprietary information may be impaired.

Under some of our research and development agreements, inventions discovered in certain cases become jointly owned by our corporate partner and us and in other cases become the exclusive property of one of us. It

 

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can be difficult to determine who owns a particular invention, and disputes could arise regarding those inventions. These disputes could be costly and could divert management’s attention from our business. Our research collaborators and scientific advisors have some rights to publish our data and proprietary information in which we have rights. Such publications may impair our ability to obtain patent protection or protect our proprietary information, which could impair our ability to generate revenue.

Risks Related to Our Financial Results and Other Risks Related to Our Business

If we continue to incur net losses for an extended period of time, we may be unable to continue our business.

We have incurred net losses since inception, and our accumulated deficit was approximately $947.9 million at December 31, 2011. We expect to incur substantial additional net losses prior to achieving profitability, if ever. The extent of our future net losses and the timing of our profitability are highly uncertain, and we may never achieve profitable operations. We are planning to expand the number of diseases for which our products may be marketed, and this expansion will require significant expenditures. To date, we have generated revenue primarily through the sale of Actimmune. However, Actimmune sales have decreased in recent periods and we expect this trend to continue into the future. We have not generated operating profits to date from our products. If the time required for us to achieve profitability is longer than we anticipate, we may not be able to continue our business.

If we fail to obtain the capital necessary to fund our operations, we will be unable to successfully execute our business plan.

We believe our existing cash, cash equivalents and available-for-sale securities, along with anticipated cash flows from our sales of Esbriet and Actimmune, will be sufficient to fund our operating expenses, debt obligations and capital requirements under our current business plan through at least the next twelve months. However, our current plans and assumptions may change, and our capital requirements may increase. We have no committed sources of capital and do not know whether additional financing will be available when needed, or, if available, that the terms will be favorable to our stockholders or us. If additional funds are not available, we may be forced to delay or terminate clinical trials, curtail operations or obtain funds through collaborative and licensing arrangements that may require us to relinquish commercial rights or potential markets, or grant licenses on terms that are not favorable to us. If adequate funds are not available, we will not be able to successfully execute our business plan.

Revenue from the sale of Actimmune has been declining and is expected to decline further.

Physicians may choose not to prescribe Actimmune or provide fewer patient referrals for Actimmune for the treatment of IPF for a variety of reasons, some of which are because:

 

   

Actimmune is not approved by the FDA for the treatment of IPF, and we therefore are unable to market or promote Actimmune for the treatment of IPF;

 

   

in our initial and Phase 3 INSPIRE clinical trials, Actimmune failed to meet the primary and secondary endpoints;

 

   

physicians prefer to enroll their patients in clinical trials for the treatment of IPF;

 

   

Actimmune does not have a drug compendia listing, often a criterion used by third-party payors to decide whether or not to reimburse off-label prescriptions;

 

   

physicians’ patients are unable to receive or lose reimbursement from a third-party reimbursement organization;

 

   

physicians are not confident that Actimmune has a clinically significant treatment effect for IPF; or

 

   

a competing product shows a clinically significant treatment effect for IPF.

 

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Budget or cash constraints may force us to delay our efforts to develop certain products in favor of developing others, which may prevent us from meeting our stated timetables and commercializing those products as quickly as possible, or take certain cost saving efforts that could harm our financial results.

Because we are an emerging company with limited resources, and because research and development is an expensive process, we must regularly assess the most efficient allocation of our research and development resources. Accordingly, we may choose to delay our research and development efforts for a promising product candidate or we may elect to terminate our programs for and, in certain cases, our licenses to, such product candidates or programs in order to allocate resources to another program, which could cause us to fall behind our initial timetables for development of certain product candidates. As a result, we may not be able to fully realize the value of some of our product candidates in a timely manner, since they will be delayed in reaching the market, or may not reach the market at all. If we terminate a preclinical program in which we have invested significant resources, we will have expended resources on a program that will not provide a full return on our investment and missed the opportunity to have allocated those resources to potentially more productive uses.

Due to cash constraints or for strategic business reasons we may decide to take certain actions that reduce our expenses. For example, we sold to Roche our worldwide development and commercialization rights to danoprevir and received $175.0 million from the sale of such rights. On a forward-looking basis we will not incur the expense associated with further investment in danoprevir; however, our rights to share profits from sales of danoprevir in the United States have also been terminated and, as a result, our business and future financial results may be harmed.

Negative conditions in the global markets may impair the liquidity of a portion of our investment portfolio.

Our investment securities consist of high-grade corporate debt securities, government agency securities and direct government obligation securities. Due to recent credit market and global economic conditions, markets for certain fixed-income securities have been volatile and have experienced limitations in liquidity. If there is insufficient demand for the securities we hold, we may not have liquid access to our investments and may be required to recognize an impairment for those securities should we conclude that such impairment is other-than-temporary. For example, as recently as September 30, 2010 we held in our investment portfolio $4.8 million of auction rate securities that had experienced illiquid market conditions requiring us to previously adjust the carrying-value of these securities. As of December 31, 2010, all of our auction rate securities had been sold or redeemed.

Failure to accurately forecast demand for our products could result in additional charges for excess inventories or non-cancelable purchase obligations or supply shortages.

We base many of our operating decisions on anticipated revenue trends and competitive market conditions, which are difficult to predict. We acquire inventories and enter into non-cancelable purchase obligations in order to meet demand for our products based on these projections. For the years ended December 31, 2010 and 2009, we recorded charges of $0.5 million and $0.3 million, respectively, for excess inventories related to Actimmune from previous years’ contractual purchases. No charges were recorded in 2011 for excess inventories. We could be required to record additional charges for excess inventories and/or non-cancelable purchase obligations if demand for Actimmune decreases faster than we anticipate.

In addition, we initiated our commercial launch of Esbriet in Germany in September 2011, and we currently plan to initiate commercial launches in additional countries in the EU in 2012. While we have attempted to forecast demand for Esbriet in Germany and the EU, until we have a sufficient history of commercial sales in such jurisdictions, we cannot know with certainty whether our inventory of Esbriet is in excess of or insufficient to meet demand. Further, we have just recently established our sales organization in the EU and we do not yet know if the size of the sales organization is sufficient to successfully commercialize Esbriet, which makes accurately forecasting demand more difficult. If we fail to accurately forecast demand for Esbriet, we may face temporary supply shortages, which will impair our ability to generate revenue from such demand, or excess inventories, which may result in additional charges for such excess inventory.

 

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If product liability lawsuits are brought against us, we may incur substantial liabilities.

The testing, marketing and sale of medical products entail an inherent risk of product liability. We have product liability risk for all of our product candidates and for all of the clinical trials we conduct, including our discontinued INSPIRE trial. If product liability costs exceed our liability insurance coverage, we may incur substantial liabilities. Whether or not we were ultimately successful in product liability litigation, such litigation would consume substantial amounts of our financial and managerial resources, and might result in adverse publicity, all of which would impair our business. While we believe that our clinical trial and product liability insurance currently provides adequate protection to our business, we may not be able to maintain our clinical trial insurance or product liability insurance at an acceptable cost, if at all, and this insurance may not provide adequate coverage against potential claims or losses.

If we materially breach the representations and warranties we made to Roche under the Asset Purchase Agreement or any of our other contractual obligations, Roche has the right to seek indemnification from us for damages it suffers as a result of such breach. These amounts could be significant.

We have agreed to indemnify Roche and its affiliates against losses suffered as a result of our material breach of representations and warranties and our other obligations in the Asset Purchase Agreement for our sale of our worldwide development and commercialization rights to danoprevir. If one or more of our representations and warranties were not true at the time we made them to Roche, we would be in breach of the Asset Purchase Agreement. In the event of a breach by us, Roche has the right to seek indemnification from us for damages suffered by Roche as a result of such breach. The amounts for which we could become liable to Roche may be significant.

Our use of hazardous materials, chemicals, viruses and radioactive compounds exposes us to potential liabilities.

Our research and development activities involve the controlled use and disposal of hazardous materials, chemicals, infectious disease agents and various radioactive compounds. Although we believe that our safety procedures for handling and disposing of such materials comply with the standards prescribed by state and federal regulations, we cannot completely eliminate the risk of accidental contamination or injury from these materials. In the event of such an accident, we could be held liable for significant damages or fines, which may not be covered by or may exceed our insurance coverage.

Insurance coverage is increasingly difficult to obtain or maintain.

While we currently maintain clinical trial and product liability insurance, directors’ and officers’ liability insurance, general liability insurance, property insurance and warehouse and transit insurance, first- and third-party insurance is increasingly more costly and narrower in scope, and we may be required to assume more risk in the future. If we are subject to third-party claims or suffer a loss or damage in excess of our insurance coverage, we may be required to share that risk in excess of our insurance limits. Furthermore, any first- or third-party claims made on our insurance policies may impact our future ability to obtain or maintain insurance coverage at reasonable costs, if at all.

Failure to attract, retain and motivate skilled personnel and cultivate key academic collaborations will delay our product development programs and our business development efforts.

As of January 31, 2012, we had 201 full-time employees, and our success depends on our continued ability to attract, retain and motivate highly qualified management, scientific and commercial personnel, especially in Europe, and on our ability to develop relationships with leading academic scientists. Competition for personnel and academic collaborations is intense. We are highly dependent on our current management and key scientific and technical personnel, including Daniel G. Welch, our Chairman, Chief Executive Officer and President, as well as the other principal members of our management. None of our employees, including members of our

 

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management team, has a long-term employment contract, and any of our employees can leave at any time. Our success will depend in part on retaining the services of our existing management and key personnel and attracting and retaining new highly qualified personnel. In addition, we may need to hire additional personnel and develop additional academic collaborations if we expand our research and development activities. We do not know if we will be able to attract, retain or motivate personnel or cultivate academic collaborations. Our inability to hire, retain or motivate qualified personnel or cultivate academic collaborations would harm our business.

Our ability to use our net operating losses and certain other tax attributes may be subject to annual limitations under federal and state tax law that could materially affect our ability to utilize such losses and attributes.

If a corporation undergoes an “ownership change” within the meaning of section 382 of the Internal Revenue Code, or section 382, the corporation’s ability to utilize any net operating losses, or NOLs, and certain tax credits and other attributes generated before such an ownership change, is limited. We believe that we have in the past experienced ownership changes within the meaning of section 382 that have resulted in limitations under section 382 (and similar state provisions) on the use of our NOLs and other tax attributes. Future changes in ownership could result in additional ownership changes within the meaning of section 382 that could further limit our ability to utilize our NOLs and certain other tax attributes.

Risks Related to our Securities

Our significant level of indebtedness could limit cash flow available for our operations, expose us to risks that could adversely affect our business, financial condition and results of operations and impair our ability to satisfy our obligations under our outstanding notes.

We have now and will continue to have, a significant amount of indebtedness. As of December 31, 2011, we had $85.0 million of outstanding indebtedness under our 2015 Notes and $155.3 million indebtedness under our 2018 Notes. We may also incur additional indebtedness to meet future financing needs. Our indebtedness could have significant negative consequences for our business, results of operations and financial condition, including:

 

   

increasing our vulnerability to adverse economic and industry conditions;

 

   

limiting our ability to obtain additional financing;

 

   

requiring the dedication of a substantial portion of our cash flow from operations to service our indebtedness, thereby reducing the amount of our cash flow available for other purposes;

 

   

limiting our flexibility in planning for, or reacting to, changes in our business;

 

   

dilution experienced by our existing stockholders as a result of the conversion of our 2015 notes into shares of common stock; and

 

   

placing us at a possible competitive disadvantage with less leveraged competitors and competitors that may have better access to capital resources.

As of December 31, 2011, our annual debt service obligation on our 2015 and 2018 Notes was $8.1 million. We cannot assure you that we will continue to maintain sufficient cash reserves or that our business will continue to generate cash flow from operations at levels sufficient to permit us to pay principal, premium, if any, and interest on our indebtedness, or that our cash needs will not increase. If we are unable to generate sufficient cash flow or otherwise obtain funds necessary to make required payments, or if we fail to comply with the various requirements of our outstanding notes or any indebtedness which we may incur in the future, we would be in default, which would permit the holders of the affected notes or other indebtedness to accelerate the maturity of such notes or other indebtedness and could cause defaults under the company’s other notes and indebtedness. Any default under our notes or any indebtedness which we may incur in the future could have a material adverse effect on our business, results of operations and financial condition.

 

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We may fail to meet our publicly announced financial guidance or other expectations about our business, which would cause our stock to decline in value and affect the trading price of our outstanding notes.

There are a number of reasons why we might fail to meet our financial guidance or other expectations about our business, including, but not limited to, the following:

 

   

negative developments or setbacks in our application to obtain marketing approval for pirfenidone in the United States, including negative results of the ASCEND trial that we initiated in the second quarter of 2011, slower than anticipated enrollment in the ASCEND trial and/or a negative response from the FDA to our anticipated NDA resubmission based on data from this trial;

 

   

delays or unexpected difficulties in our commercial launch of Esbriet in the EU;

 

   

lower than expected pricing and reimbursement levels for Esbriet in the EU, including any adverse decisions by Germany’s Federal Joint Commission stemming from the IQWiG benefit assessment;

 

   

if only a subset of or no affected patients respond to therapy with any of our products or product candidates;

 

   

the actual dose or efficacy of the product for a particular condition may be different than currently anticipated;

 

   

negative publicity about the results of our clinical studies, such as the failure of pirfenidone to meet its primary endpoint and the PFS secondary endpoint in the CAPACITY 1 trial, or those of others with similar or related products may reduce demand for our products and product candidates;

 

   

the treatment regimen may be different in duration than currently anticipated;

 

   

treatment may be sporadic;

 

   

we may not be able to sell a product at the price we expect;

 

   

we may not be able to accurately calculate the number of patients using the product;

 

   

we may not be able to supply enough product to meet demand;

 

   

there may be current and future competitive products that have greater acceptance in the market than our products do;

 

   

we may decide to divest a product;

 

   

our development activities may proceed faster than planned;

 

   

we may decide to change our marketing and educational programs;

 

   

clinical trial participation may reduce product sales; or

 

   

physicians’ prescriptions or patient referrals for Actimmune may decline.

If we fail to meet our revenue and/or expense projections and/or other financial guidance for any reason, our stock could decline in value. The market price of our common stock, as well as the general level of interest rates and our credit quality, will likely significantly affect the trading price of our notes.

Failure to maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002 could have a material adverse effect on our stock price and the trading price of our outstanding notes.

Section 404 of the Sarbanes-Oxley Act of 2002 and the related rules and regulations of the Securities and Exchange Commission, or the Commission, require an annual management assessment of the effectiveness of our internal control over financial reporting and a report by our independent registered public accounting firm attesting to the effectiveness of our internal control over financial reporting at the end of the fiscal year. If we fail

 

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to maintain the adequacy of our internal control over financial reporting, as such standards are modified, supplemented or amended from time to time, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002 and the related rules and regulations of the Commission. If we cannot in the future favorably assess, or our independent registered public accounting firm is unable to provide an unqualified attestation report on, the effectiveness of our internal control over financial reporting, investor confidence in the reliability of our financial reports may be adversely affected, which could have a material adverse effect on our stock price and the trading price of our outstanding notes.

Substantial sales of shares or the issuance of additional stock may negatively impact the market price of our common stock and the trading price of our outstanding notes.

If our stockholders sell substantial amounts of our common stock, including shares issued upon the exercise of outstanding options or conversion of our outstanding notes, the market price of our common stock and, in turn, the trading price of our notes, may decline. In addition, the existence of our notes may encourage short selling by market participants. These sales also might make it more difficult for us to sell equity or equity related securities in the future at a time and price that we deem appropriate. We are unable to predict the effect that sales may have on the then-prevailing market price of our common stock and the trading price of our outstanding notes.

We have filed registration statements covering the approximately 8.2 million shares of common stock that are either issuable upon the exercise of outstanding options or reserved for future issuance pursuant to our stock plans as of December 31, 2011.

As of December 31, 2011, we had an aggregate of approximately 17.1 million shares of common stock authorized but unissued and not reserved for issuance under our option and compensation plans or under other convertible or derivative instruments. We may issue all of these shares without any action or approval by our stockholders. The issuance of these unreserved shares in connection with acquisitions or otherwise, as well as any shares of our common stock issued in connection with the exercise of stock options, restricted stock units, under convertible or derivative instruments or otherwise would dilute the notional percentage ownership held by the our security holders. In addition, we may issue a substantial number of shares of our common stock upon conversion of our outstanding notes.

At times, the market price of our common stock has fluctuated significantly, and as a result an investment in our stock could decline in value. Future fluctuations in our stock price may also impact the trading price of our outstanding notes and make them more difficult to resell.

The market price of our common stock has been and is likely to continue to be extremely volatile. During the twelve-month period ended December 31, 2011, the closing price of our common stock on The NASDAQ Global Select Market ranged from a high of $51.08 in April 2011 to a low of $10.99 in December 2011. The market price of our common stock could be subject to wide fluctuations in response to a variety of factors, many of which we cannot control, including:

 

   

general economic and political conditions and specific conditions in the biotechnology industry;

 

   

changes in expectations as to our future financial performance, including financial estimates or publication of research reports by securities analysts;

 

   

strategic actions taken by us or our competitors, such as acquisitions or restructurings;

 

   

announcements of new products or technical innovations by us or our competitors;

 

   

actions taken by institutional shareholders; and

 

   

speculation in the press or investment community.

 

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In addition, the stock market in general, and the stock price of companies listed on NASDAQ, and biotechnology companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of these companies. Broad market and industry factors may negatively affect the market price of our common stock, regardless of actual operating performance. Periods of volatility in the market price of a company’s securities frequently results in securities class action and shareholder derivative litigation against that company. This type of litigation can result in substantial costs and a diversion of management’s attention and resources.

Because our outstanding notes are convertible into shares of our common stock, volatility or depressed market prices of our common stock could have a similar effect on the trading price of our outstanding notes. Holders who receive shares of our common stock upon conversion of our notes will also be subject to the risk of volatility and depressed market prices of our common stock.

Provisions of Delaware law, our charter documents and the indentures governing our outstanding notes may impede or discourage a takeover, which could cause the market price of our common stock to decline.

Provisions of our Amended and Restated Certificate of Incorporation and Bylaws, as well as provisions of Delaware law, could make it more difficult for a third party to acquire us, even if doing so would benefit our stockholders. In addition, these provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors. Because our board of directors is responsible for appointing the members of our management team, these provisions could in turn affect any attempt by our stockholders to replace current members of our management team. These provisions:

 

   

establish a classified board of directors so that not all members of our board may be elected at one time;

 

   

authorize the issuance of up to 5,000,000 shares of “blank check” preferred stock that could be issued by our board of directors to increase the number of outstanding shares and hinder a takeover attempt;

 

   

limit who may call a special meeting of stockholders;

 

   

prohibit stockholder action by written consent, thereby requiring all stockholder actions to be taken at a meeting of our stockholders; and

 

   

establish advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted upon at stockholder meetings.

In addition, Section 203 of the Delaware General Corporation Law, which prohibits business combinations between us and one or more significant stockholders unless specified conditions are met, may discourage, delay or prevent a third party from acquiring us.

The repurchase rights in our outstanding notes triggered by the occurrence of a fundamental change and the additional shares of our common stock by which the conversion rates are increased in connection with certain make-whole fundamental change transactions could also discourage a potential acquirer.

We have never paid dividends on our capital stock, and we do not anticipate paying any cash dividends in the foreseeable future.

We have never declared or paid any dividends on our capital stock. We currently intend to retain all of our future earnings, if any, to finance our operations and do not anticipate paying any cash dividends on our capital stock in the foreseeable future. As a result, holders who convert their notes and receive shares of our common stock will not realize a return on their investment unless the market price of our common stock appreciates, which we cannot assure.

 

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ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

 

ITEM 2. PROPERTIES

Our facilities currently consist of approximately 55,898 square feet of office space located at our headquarters at 3280 Bayshore Boulevard, Brisbane, California. In December 2000, we entered into a ten-year lease for this building, subsequently extended for an additional five years. In May 2006, we entered into an amendment to our existing lease to expand our existing office and laboratory space by approximately 15,000 square feet on the first floor of 3260 Bayshore Boulevard, Brisbane, California. In July 2010, we extended the lease agreement on our current facilities for an additional term that expires in April 2016. In 2011 we signed a lease agreement for the new location of our European headquarters in Muttenz, Switzerland, where we moved to in February 2012, which expires in approximately 5 years. In January 2011, we entered into a lease agreement in Berlin, Germany and we also currently maintain offices located in Milan, Italy; Paris, France; London, England; Madrid, Spain; and Stockholm, Sweden and expect to enter into future lease agreements where we have established additional subsidiaries. We believe that our facilities are adequate for our current needs, and that suitable additional or substitute space will be available in the future to replace our existing facility, if necessary, or to accommodate expansion of our operations.

 

ITEM 3. LEGAL PROCEEDINGS

Class Action Lawsuits

In May 2008, a complaint was filed in the United States District Court for the Northern District of California entitled Deborah Jane Jarrett, Nancy Isenhower, and Jeffrey H. Frankel v. InterMune, Inc., W. Scott Harkonen, and Genentech, Inc., Case No. C-08-02376. Plaintiffs alleged that they were administered Actimmune, and they purported to sue on behalf of a class of consumers and other end-payors of Actimmune. The complaint alleged that the Company fraudulently misrepresented the medical benefits of Actimmune for the treatment of IPF and promoted Actimmune for IPF. The complaint asserted various claims against the Company, including civil RICO, unfair competition, violation of various state consumer protection statutes, and unjust enrichment. The complaint sought various damages in an unspecified amount, including compensatory damages, treble damages, punitive damages, restitution, disgorgement, prejudgment and post-judgment interest on any monetary award, and the reimbursement of the plaintiffs’ legal fees and costs, as well as equitable relief. Between June 2008 and September 2008, three additional complaints were filed in the United States District Court for the Northern District of California alleging similar facts. In February 2009, the Court consolidated the four complaints for pretrial purposes.

On September 1, 2010, after two rounds of motions to dismiss, the Court granted defendants’ third motions to dismiss, dismissing all remaining claims in all consolidated cases with prejudice and entered judgment accordingly. On October 1, 2010, the remaining plaintiffs in all cases filed notices of appeal, appealing the judgment to the United States Court of Appeals for the Ninth Circuit. The United States Court of Appeals for the Ninth Circuit heard oral argument in the appeals on November 29, 2011 and, on December 30, 2011, issued a memorandum disposition affirming the judgment of the district court dismissing the complaints. The Court of Appeals’ mandate issued on January 23, 2012. The time for plaintiffs to seek rehearing of the Court of Appeals’ ruling has expired, but the time for plaintiffs to file a petition for certiorari with the United States Supreme Court has not yet expired.

We currently do not know whether the plaintiffs will file a petition for certiorari with the United States Supreme Court. As a result, we do not know if we will have to continue to defend the actions.

Indemnity Agreement

On or about March 22, 2000, the Company entered into an Indemnity Agreement with W. Scott Harkonen M.D., who served as the Company’s chief executive officer until June 30, 2003. The Indemnity Agreement

 

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obligates the Company to hold harmless and indemnify Dr. Harkonen against expenses (including attorneys’ fees), witness fees, damages, judgments, fines and amounts paid in settlement and any other amounts Dr. Harkonen becomes legally obligated to pay because of any claim or claims made against him in connection with any threatened, pending or completed action, suit or proceeding, whether civil, criminal, arbitrational, administrative or investigative, to which Dr. Harkonen is a party by reason of the fact that he was a director, officer, employee or other agent of the Company. The Indemnity Agreement establishes exceptions to the Company’s indemnification obligation, including but not limited to claims “on account of [Dr. Harkonen’s] conduct that is established by a final judgment as knowingly fraudulent or deliberately dishonest or that constituted willful misconduct,” claims “on account of [Dr. Harkonen’s] conduct that is established by a final judgment as constituting a breach of [Dr. Harkonen’s] duty of loyalty to the Corporation or resulting in any personal profit or advantage to which [Dr. Harkonen] was not legally entitled,” and claims “for which payment is actually made to [Dr. Harkonen] under a valid and collectible insurance policy.” The Indemnity Agreement, however, obligates the Company to advance all expenses, including attorneys’ fees, incurred by Dr. Harkonen in connection with such proceedings, subject to an undertaking by Dr. Harkonen to repay said amounts if it shall be determined ultimately that he is not entitled to be indemnified by the Company.

Dr. Harkonen was been named as a defendant in the civil action lawsuits described above, and also became the target of the investigation by the U.S. Department of Justice regarding the promotion and marketing of Actimmune. On March 18, 2008, a federal grand jury indicted Dr. Harkonen on two felony counts related to alleged improper promotion and marketing of Actimmune during the time Dr. Harkonen was employed by the Company (the “Criminal Action”). The trial in the criminal case resulted in a jury verdict on September 29, 2009, finding Dr. Harkonen guilty of one count of wire fraud related to a press release issued on August 28, 2002, and acquitting him of a second count of a misbranding charge brought under the Federal Food, Drug, and Cosmetic Act. On April 13, 2011, the Court denied Dr. Harkonen’s post-trial motions and sentenced Dr. Harkonen to three years of probation, including six months of home detention, 200 hours of community service and a fine of $20,000. The Court’s Judgment was filed on April 18, 2011. Dr. Harkonen filed a timely notice of appeal and currently is appealing his conviction and sentence. The government has indicated that it will pursue a cross-appeal regarding Dr. Harkonen’s sentence. Briefing is underway. Under the terms of the Indemnity Agreement, the Company has an obligation to indemnify Dr. Harkonen for reasonable legal fees and costs incurred in connection with defending this action, including the proceedings on appeal.

Prior to December 2008, insurers that issued directors & officers (“D&O”) liability insurance to the Company had advanced all of Dr. Harkonen’s expenses, including attorneys’ fees, incurred in the civil action lawsuits and Criminal Action. Those insurers included National Union Fire Insurance Company of Pittsburgh, PA (“AIG”), Underwriters at Lloyd’s, London (“Lloyd’s”), and Continental Casualty Company (“CNA”). On November 19, 2008, however, the insurer that issued a $5 million D&O insurance policy providing coverage excess of the monetary limits of coverage provided by AIG, Lloyd’s and CNA, Arch Specialty Insurance Company (“Arch”), advised the Company that the limits of the underlying coverage were expected to be depleted by approximately December 15, 2008; that Arch “disclaims coverage” based on misstatements and misrepresentations allegedly made by Dr. Harkonen in documents provided in the application for the Arch policy and the underlying Lloyd’s policy; and, based on that disclaimer, Arch would not be advancing any of Dr. Harkonen’s expenses, including attorneys’ fees, incurred in the civil action lawsuits and Criminal Action.

As a result of Arch’s disclaimer of coverage and refusal to advance expenses, including attorneys’ fees, the Company had, as of approximately December 15, 2008, become obligated to advance such expenses incurred by Dr. Harkonen in the civil action lawsuits and Criminal Action.

On January 13, 2009, the Company submitted to the American Arbitration Association (“AAA”) a Demand for Arbitration, InterMune, Inc. v. Arch Specialty Insurance Co., No. 74 194 01128 08 JEMO. Dr. Harkonen also is a party to the Arbitration. The Demand for Arbitration sought an award compelling Arch to advance Dr. Harkonen’s legal fees and costs incurred in the civil action lawsuits and the Criminal Action, and to advance other former officers’ legal fees and costs incurred in relation to the Department of Justice investigation.

 

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The matter was heard by the arbitration panel and on May 29, 2009, the arbitration panel issued an Interim Arbitration Award granting the Company’s request for a partial award requiring Arch to advance Dr. Harkonen’s legal fees and costs incurred in the civil action lawsuits and Criminal Action. Arch subsequently advanced such fees and costs, including fees and costs previously paid by the Company. The question whether Arch ultimately will be required to cover the advanced fees and costs or, instead, may recoup those fees and costs as not covered by its policy, has not been determined. Unless and until the arbitration panel rules that such fees and costs are not covered, Arch remains obligated to advance such fees and costs. At this time the Company believes no change to the status of the interim Arbitration Award or to the application of the D&O liability insurance in general has occurred due to the trial court judgment, and therefore the Company has not recorded any accrued liabilities associated with this matter.

In late 2009, Arch advised the Company that Arch had exhausted the $5.0 million limit of liability of the Arch D&O insurance policy, and that defense cost invoices submitted to Arch collectively exceed the Arch policy’s limit. The Company therefore advised the insurer that issued a $5.0 million D&O insurance policy providing coverage excess of the monetary limits of coverage provided by Arch, Old Republic Insurance Company (“Old Republic”), that the limits of the underlying coverage had been depleted, and the Company submitted invoices for legal services rendered on behalf of Dr. Harkonen and other individuals who were targets of the U.S. Department of Justice’s investigation to Old Republic for payment. Old Republic agreed to advance Dr. Harkonen’s legal fees and costs incurred in the civil action lawsuits and Criminal Action, but declined to reimburse the Company for payments made on behalf of other individuals who were targets of the U.S. Department of Justice’s investigation. In mid-2010, Old Republic advised the Company that Dr. Harkonen’s defense fees and costs had exhausted the $5 million limit of the Old Republic insurance policy as of the second quarter of 2010. There is no additional insurance coverage available to cover the cost of Dr. Harkonen’s continuing defense. Defense fees and costs incurred over and above this final $5 million of insurance coverage therefore are, in the absence of any available insurance, to be advanced by the Company pursuant to the terms of the Indemnity Agreement. We expect amounts to be paid by the Company to continue into the future until the Criminal Action is finally adjudicated, however we are unable to predict what our total liability could be with any degree of certainty.

 

ITEM 4. MINE SAFETY DISCLOSURES

None.

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Since the initial public offering of our common stock, $0.001 par value, on March 24, 2000, our common stock has traded on The NASDAQ Global Select Market under the symbol “ITMN.”

The following table sets forth the high and low sales prices of our common stock, as reported on The NASDAQ Global Select Market for the fiscal periods indicated:

 

Fiscal Year:

   High      Low  

2011

     

First Quarter

   $ 47.19       $ 35.09   

Second Quarter

     51.08         32.71   

Third Quarter

     37.15         20.20   

Fourth Quarter

     26.36         10.99   

2010

     

First Quarter

   $ 47.25       $ 13.45   

Second Quarter

     48.14         8.58   

Third Quarter

     13.62         8.64   

Fourth Quarter

     38.05         12.53   

As of January 31, 2012, we had 231 stockholders of record. In addition, we believe that a significant number of beneficial owners of our common stock hold their shares in street name.

Dividend Policy

We have never declared or paid any dividends on our capital stock. We currently intend to retain all of our future earnings, if any, to finance our operations and do not anticipate paying any cash dividends on our capital stock in the foreseeable future.

 

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Performance Graph

We show below the cumulative total return to our stockholders during the period from December 31, 2006 through December 31, 2011 in comparison to the cumulative return on the NASDAQ Composite and the AMEX Biotechnology Index during that same period. The results assume that $100 was invested on December 31, 2006.

 

LOGO

 

     Base  period
December

2006
     Years Ending December 31,  

Company/Index

      2007      2008      2009      2010      2011  

InterMune, Inc.

     100       $ 43.35       $ 34.41       $ 42.41       $ 118.37       $ 40.98   

NASDAQ Composite

     100         110.26         65.65         95.19         112.10         110.81   

AMEX Biotechnology Index

     100         104.28         85.80         124.91         172.04         144.70   

The information under “Performance Graph” is not soliciting material, is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference in any filing of InterMune, Inc. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the filing date of this 10-K and irrespective of any general incorporation language in those filings.

 

ITEM 6. SELECTED FINANCIAL DATA

The selected consolidated financial data that appears below has been derived from our audited consolidated financial statements. This historical data should be read in conjunction with our Consolidated Financial Statements and the related Notes to Consolidated Financial Statements contained in this Annual Report, and with the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of this Annual Report. The selected consolidated statement of operations data for each of the three years in the period ended December 31, 2011, 2010 and 2009 and the selected consolidated balance sheet data as of December 31, 2011 and 2010 are derived from the audited consolidated financial statements included elsewhere in this Annual Report. The selected consolidated statement of operations data for the years ended December 31, 2008 and 2007 and the selected consolidated balance sheet data as of December 31, 2009, 2008 and 2007 are derived from audited financial statements not included in this Report.

 

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In December 2005, we sold our Infergen product, including related intellectual property rights and inventory, to Valeant. The operating results of our Infergen activities, which include allocations of research and development and selling, general and administrative expenses, have been reclassified as discontinued operations through 2008, the end of Infergen related activities.

 

     Year Ended December 31,  
     2011     2010     2009 (1)     2008 (1)     2007 (1)  
     (In thousands, except per share data)  

Statement of Operations Data:

          

Revenue, net:

          

Actimmune

   $ 20,223      $ 20,040      $ 25,428      $ 29,880      $ 53,420   

Esbriet

     2,778        —          —          —          —     

Collaboration revenue

     2,629        239,251        23,272        18,272        13,272   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue, net

     25,630        259,291        48,700        48,152        66,692   

Costs and expenses:

          

Cost of goods sold

     8,707        6,337        6,997        8,989        14,109   

Research and development

     74,973        67,470        89,138        104,206        105,939   

Acquired research and development and milestone payments (2)

     —          —          15,250        —          13,725   

General and administrative

     90,192        55,505        37,461        30,635        29,577   

Restructuring charges

     —          1,300        697        —          10,246   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

     173,872        130,612        149,543        143,830        173,596   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) income from operations

     (148,242     128,679        (100,843     (95,678     (106,904

Loss on extinguishment of debt

     —          —          (11,014     (1,294     —     

Interest income

     556        571        1,727        5,616        10,699   

Interest expense and other (expense) income

     (7,066     (6,800     (3,736     (15,243     (11,143
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) income from continuing operations before income taxes

     (154,752     122,450        (113,866     (106,599     (107,348

Income tax expense (benefit)

     22        76        2,154        —          (2,275
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) income from continuing operations

     (154,774     122,374        (116,020     (106,599     (105,073

Discontinued operations:

          

Income (loss) from discontinued operations

     —          —          —          103        4,994   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income

   $ (154,774   $ 122,374      $ (116,020   $ (106,496   $ (100,079
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Per common share:

          

Continuing operations—basic

   $ (2.58   $ 2.26      $ (2.62   $ (2.73   $ (2.97

Discontinued operations—basic

     —          —          —          —       0.15   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income—basic

   $ (2.58   $ 2.26      $ (2.62   $ (2.73   $ (2.82
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Continuing operations—diluted

   $ (2.58   $ 2.13      $ (2.62   $ (2.73   $ (2.97

Discontinued operations—diluted

     —          —          —          —       0.15   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income—diluted

   $ (2.58   $ 2.13      $ (2.62   $ (2.73   $ (2.82
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Shares used in computing basic net income (loss) per share

     60,100        54,202        44,347        38,982        35,493   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Shares used in computing diluted net income (loss) per share

     60,100        61,377        44,347        38,982        35,493   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

* Less than $0.01 per share

 

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     As of December 31,  
     2011     2010     2009 (1)     2008 (1)     2007 (1)  
     (In thousands)  

Balance sheet data:

          

Cash, cash equivalents and available-for-sale securities (3)

   $ 425,110      $ 295,073      $ 99,604      $ 154,713      $ 235,292   

Working capital

     409,047        231,482        59,520        96,680        214,463   

Total assets

     472,623        305,147        114,727        171,810        261,233   

Long-term obligations

     240,250        85,000        125,524        155,085        128,263   

Accumulated deficit

     (947,869     (793,095     (915,469     (799,449     (692,953

Total stockholders’ equity (deficit)

   $ 198,168      $ 149,300      $ (105,800   $ (110,371   $ 9,637   

 

(1) On January 1, 2009, we adopted Financial Accounting Standards Board, Accounting Standards Codification (“ASC”) Topic 470 (“ASC 470”), formerly APB 14-1, Accounting for Convertible Debt Instruments That May be Settled in Cash upon Conversion (Including Partial Cash Settlement). The adoption required retrospective application; therefore, our previously reported net loss for the years ended December 31, 2008 and 2007 have been adjusted to reflect additional interest expense of $8.6 million, or $0.22 per share and $10.5 million or $0.30 per share, respectively. The retrospective adoption of ASC 470 decreased the debt issuance costs included in other assets by an aggregate of $0.4 million and $1.2 million; decreased convertible senior notes included in long-term liabilities by $14.9 million and $41.7 million; and decreased total stockholders’ deficit by $14.5 million and $40.5 million as of December 31, 2008 and 2007, respectively.
(2) These charges represent acquired research and development and milestone payments for projects that were in development, had not reached technical feasibility and had no foreseeable alternative future uses at the time of acquisition or when the milestone became payable. Please see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations” and Note 6 of the Notes to Consolidated Financial Statements.
(3) Includes $12.7 million and $17.5 million of non-current available-for-sale securities as of December 31, 2009 and 2008, respectively.

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

We are a biotechnology company focused on the research, development and commercialization of innovative therapies in pulmonology and orphan fibrotic diseases. We have an advanced-stage product candidate in pulmonology, pirfenidone, that was granted marketing authorization effective February 2011 in all 27 member countries of the European Union (“EU”) for the treatment of adults with mild to moderate idiopathic pulmonary fibrosis (“IPF”). For an overview of additional information relating to our business, including Actimmune and our product development programs, please see the discussion in “Item 1. Business—Overview.”

Pirfenidone (Esbriet®)

Pirfenidone is an orally active, small molecule compound under development for the treatment of idiopathic pulmonary fibrosis. In September 2011, we launched commercial sales of pirfenidone in Germany under the trade name Esbriet®, and we are continuing to prepare for the commercial launch of Esbriet® in the other countries in the EU. Subject to EU country reimbursement timelines, we currently plan to conclude pricing and reimbursement discussions for Esbriet in France, Spain and Italy during the second quarter of 2012 and launch in those countries as soon as practicable after concluding discussions. We currently plan to conclude the discussions with the authorities in the United Kingdom in October of 2012, and launch Esbriet as soon as practicable thereafter. In addition to launches in the so called “Top 5” EU countries, we expect to launch Esbriet in Austria, Denmark, Ireland and Norway in the first half of 2012, and in Belgium, the Netherlands, Finland and Sweden in the second half of 2012.

To support our anticipated commercialization efforts of Esbriet in Europe, we are currently investing in the establishment of a commercial infrastructure within the EU, including an increase to our employee headcount in that region. On December 17, 2010, we announced several additions to our senior leadership team in support of our commercialization efforts as well as announcing the establishment of our European headquarters in Reinach, Switzerland, subsequently moved to Muttenz, Switzerland in early 2012. In December 2010, we transferred all of our non-U.S. rights to research, develop and commercialize pirfenidone for IPF to our wholly-owned Swiss subsidiary, InterMune International AG. Based on our current intellectual property portfolio, we expect to have exclusive rights to sell pirfenidone within the European Union through 2030.

In 2011, we initiated a new Phase 3 clinical study to evaluate pirfenidone in IPF known as ASCEND in an effort to support approval of pirfenidone for the treatment IPF in the United States.

Concurrent Public Offering

In September 2011, we completed a registered underwritten public offering of 4.6 million shares of our common stock and a concurrent registered underwritten public offering of $155.3 million aggregate principal amount of 2.50% convertible senior notes due 2018. The aggregate net proceeds from our concurrent offerings was approximately $255.0 million, after deducting underwriting discounts and commissions and related offering expenses. We currently intend to use the net proceeds from these offerings to fund the commercial launch of Esbriet in the EU, to fund our ASCEND trial and for general corporate purposes.

Sale of Danoprevir Rights to Roche

In October 2006, we entered into a collaboration agreement with Roche, subsequently amended, to develop and commercialize products from our HCV protease inhibitor program, including danoprevir. Pursuant to our collaboration with Roche, we had successfully progressed the danoprevir compound from pre-clinical testing into Phase 2b clinical development. In October 2010, we sold our worldwide development and commercialization rights in danoprevir to Roche for $175.0 million in cash. In connection with this transaction, the collaboration

 

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agreement that we and Roche entered into in October 2006 was terminated. Roche has agreed to reimburse us for royalty and milestone obligations that we continue to have to Novartis Corporation and Array related to danoprevir.

Significant Licenses and Agreements

We are highly dependent on technology that we have licensed or acquired from third parties. Actimmune, which is one of our two marketed products, is subject to a license agreement with Genentech, Inc. Effective November 2007, we entered into asset purchase agreements with Marnac and KDL whereby we effectively terminated our prior license agreement with them by purchasing, among other things, the pirfenidone-related assets covered by such prior license agreement and as a result no longer have milestone or royalty obligations thereunder to Marnac and KDL. Under the terms of the asset purchase agreements, we are required to make future milestone payments in connection with the continued development and regulatory approval of pirfenidone in certain countries. The majority of our clinical development pipeline is also based on technology that we have licensed from third parties. Details of these agreements can be found elsewhere in this Report under “Item 1. Business—License, Collaboration and Other Agreements,” Notes 6 and 7 of the Notes to Consolidated Financial Statements, and under the heading “Results of Operations” below.

We paid $13.5 million in March 2009 in connection with our decision to proceed with regulatory approval for pirfenidone and an additional $1.7 million in connection with our clinical progress of danoprevir. We may be required to make future contingent milestone payments to the owners of our licensed products or the suppliers of our drug compounds in accordance with our license, commercialization and collaboration agreements in the aggregate amount of $42.1 million if all of the remaining milestones per the agreements are achieved. These milestones include development, regulatory approval, commercialization and sales milestones. Of the remaining $42.1 million in aggregate milestone payments, $20.0 million in contingent payments would be made by us only if positive Phase 3 data and product approval in the United States is achieved for pirfenidone. Potential milestone payments of $9.6 million are related to the further development of Actimmune, which we have no current plans to pursue, and therefore we do not expect to pay these amounts. Included in the $42.1 million in future aggregate milestone payments are aggregate milestone payments of $11.3 million payable to Array and Novartis, of which Roche has agreed to reimburse us in connection with our sale of danoprevir to Roche.

Issuance of Convertible Debt

In February 2004, we issued 0.25% convertible senior notes due March 1, 2011 (the “2011 Notes”) in an aggregate principal amount of $170.0 million. As of March 1, 2011, the holders of all of our then-outstanding 2011 Notes, approximately $45.0 million in aggregate principal, elected to convert the outstanding 2011 Notes into an aggregate of 2,078,561 shares of our common stock. As a result, there are no 2011 Notes that remain outstanding and we have no further obligations under the indenture governing the 2011 Notes.

On June 24, 2008, we issued $85.0 million in aggregate principal amount of 5.00% Convertible Senior Notes due 2015 (the “2015 Notes”) to certain Holders of our then outstanding 2011 Notes in exchange for $85.0 million in aggregate principal amount of their 2011 Notes. The 2015 Notes are senior unsecured obligations of the Company and rank equally in right of payment with all of our existing and future senior debt and rank senior in right of payment to all of our existing and future subordinated debt. The 2015 Notes were exchanged by us with the Holders exclusively and solely for the 2011 Notes in a transaction exempt from registration under Section 3(a)(9) of the Securities Act of 1933, as amended.

The 2015 Notes mature on March 1, 2015 and bear interest at a rate of 5.00% per annum. The holders of the 2015 Notes may convert their 2015 Notes into shares of our common stock at a conversion rate of 52.9661 shares per $1,000 principal amount of notes (representing a conversion price of approximately $18.88 per share), subject to adjustment. The conversion rate for the 2015 Notes will be increased in certain circumstances that constitute a fundamental change of the Company and in connection with a withholding tax redemption. We can only settle conversion of the 2015 Notes by delivery of shares of common stock.

 

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In April 2009, we entered into exchange agreements with certain holders of our convertible notes to issue, in the aggregate, approximately 2.1 million shares of common stock, valued at approximately $36.1 million, in exchange for, in the aggregate, $32.3 million principal amount of the convertible notes, representing approximately 38% of the aggregate principal outstanding of our 2011 Notes at the date of the exchanges.

In September 2009, we entered into an exchange agreement with certain holders of our convertible notes to issue approximately 0.2 million shares of common stock, valued at approximately $4.0 million, in exchange for approximately $3.8 million principal amount of the convertible notes, representing approximately 7% of the aggregate principal outstanding of our 2011 Notes at the date of the exchange.

Additionally, in September 2009, we entered into exchange agreements with certain holders of our convertible notes to issue approximately 0.3 million shares of common stock, valued at approximately $4.3 million, in exchange for approximately $4.0 million principal amount of the convertible notes, representing approximately 8% of the aggregate principal outstanding of our 2011 Notes at the date of the agreements. All of the convertible notes we acquired pursuant to the exchange agreements in September 2009 were retired upon the closing of the exchanges in October 2009 upon completion of ten trading days of our common stock necessary to determine the final number of shares to be issued.

All of the convertible notes we acquired pursuant to the exchange agreements in April and September 2009 were retired upon the closing of the debt exchanges.

Need for Additional Capital

We commenced operations in 1998 and have incurred significant losses to date. Our revenue has been limited primarily to sales of Actimmune, which has been declining in recent years. We expect to continue to incur net losses in the near term as we continue our preparations for the commercial launch of Esbriet in the European Union (other than Germany), including expanding our commercial infrastructure and related employee headcount, continue the development of pirfenidone for approval in the United States with the ongoing ASCEND Phase 3 clinical study, continue our research in the area of orphan fibrotic diseases, and continue to grow our operational capabilities. Although we believe that our existing cash, cash equivalents and available-for-sale securities, together with anticipated cash flows from sales of Esbriet and Actimmune will be sufficient to fund our operating expenses, debt obligations and capital requirements under our current business plan through at least the next 12 months, we may continue to require substantial additional funding in the future to realize the full commercial potential of our approved products and to complete our currently contemplated research and development activities. As a result, we may attempt to raise additional funds through equity and/or debt financings, collaborative arrangements with corporate partners or from other sources. If additional capital is not available to us or is not available to us on terms that are favorable, we may be forced to curtail our research and development activities, our commercialization activities, or we may be required to cease our operations entirely.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe are reasonable. These estimates are the basis for our judgments about the carrying values of assets and liabilities, which in turn may impact our reported revenue and expenses. We have discussed the development, selection and disclosure of these estimates with the Audit Committee of our board of directors. Actual results may differ from these estimates under different assumptions or conditions.

An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates

 

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that reasonably could have been used, or changes in the accounting estimate that are reasonably likely to occur periodically, could materially change the financial statements. We believe that the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

Convertible Debt

On January 1, 2009, we adopted Financial Accounting Standards Board, Accounting Standards Codification (“ASC”) Topic 470 (“ASC 470”). ASC 470 requires the issuer of convertible debt that may be settled in shares or cash upon conversion at their option, such as our $45.0 million 2011 Notes, to account for their liability and equity components separately by bifurcating the conversion option from the debt instrument, classifying the conversion option in equity and then accreting the resulting discount on the debt as additional interest expense over the expected life of the debt. The value assigned to the debt component is the estimated fair value, as of the issuance date, of similar debt without the conversion feature. This required management to make estimates and assumptions regarding interest rates as of the date of original issuance, in addition to estimates and assumptions regarding interest rates as of our June 2008 debt extinguishment and the 2009 debt exchanges.

Stock-based Compensation

Beginning January 1, 2006, we account for stock-based compensation in accordance with ASC Topic 718-10. Under the fair value recognition provisions, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the vesting period. In order to estimate the value of share-based awards, we use the Black-Scholes model, which requires the use of certain subjective assumptions. The most significant assumptions are our estimates of the expected volatility and the expected term of the award. In addition, judgment is also required in estimating the amount of share-based awards that are expected to be forfeited. If actual results differ significantly from any of these estimates, stock-based compensation expense and our results of operations could be materially impacted.

If all of the remaining and outstanding restricted stock awards that were granted in the past four years beginning in 2008 became vested, we would recognize approximately $11.5 million in compensation expense over a weighted average remaining period of 2.2 years. If all of the remaining nonvested and outstanding stock option awards that have been granted became vested, we would recognize approximately $24.6 million in compensation expense over a weighted average remaining period of 2.2 years. However, no compensation expense will be recognized for any stock awards that do not vest.

Revenue Recognition and Revenue Reserves

Revenue on product sales is recognized when persuasive evidence of an arrangement exists, the price is fixed, and final delivery has occurred and there is a reasonable assurance of collectibility of the amounts receivable from the customer. Therefore, revenue is generally recognized upon delivery when title passes to a credit-worthy customer. Reserves are recorded at the time revenue is recognized for estimated returns, rebates, chargebacks and cash discounts, if applicable. We sell Actimmune to a limited number of customers, mainly specialty pharmacies and distributors. We obtain written purchase authorizations from our customers for a specified amount of product at a specified price. Regarding Actimmune, we are obligated to accept returns from customers if the pharmaceuticals they purchased have reached their expiration date. We have demonstrated the ability to make reasonable and reliable estimates of Actimmune returns based on historical experience. Due to the nature of our business model and based on historical experience, these estimates are not highly subjective. We review all sales transactions for potential rebates, chargebacks and discounts each month and monitor product ordering cycles and actual returns, product expiration dates and wholesale inventory levels to estimate potential product return rates. We believe that our reserves are adequate. For each of the periods presented below, we have not made any shipments as a result of incentives and/or in excess of our customers’ ordinary course of business inventory levels. Specialty wholesalers maintain low inventory levels and manage their inventory levels to optimize patient-based need (demand) and generally do not overstock Actimmune.

 

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Regarding our launch of Esbriet in Germany in September 2011, we only ship product upon receipt of valid orders from customers such as pharmacies and hospitals which are the result of actual patient prescriptions. Pursuant to German Medicinal Products Law, a customer has no right to return the product; therefore we have not established a reserve for product returns, though we have established a reserve for the mandatory rebate as allowed under the applicable German health care regulations, which is included in the Medicaid and other rebates section below.

The tables below present the amounts reported as revenue reductions for the periods indicated (in thousands, except percentages):

 

      Year ended December 31,  

Reductions to Revenue

   2011     2010     2009  

Cash discounts

   $ 513      $ 491      $ 507   

Product returns

     (151     91        167   

Chargebacks

     2,007        1,977        1,569   

Medicaid and other rebates

     3,934        2,564        1,901   
  

 

 

   

 

 

   

 

 

 

Total

   $ 6,303      $ 5,123      $ 4,144   
  

 

 

   

 

 

   

 

 

 
     Year ended December 31,  
     2011     2010     2009  

Gross product revenue

   $ 29,304      $ 25,163      $ 29,572   

Revenue reductions as a % of gross product revenue

      

Cash discounts

     1.8     2.0     1.7

Product returns

     (0.5 )%      0.3     0.6

Chargebacks

     6.8     7.9     5.3

Medicaid and other rebates

     13.4     10.2     6.4
  

 

 

   

 

 

   

 

 

 

Total

     21.5     20.4     14.0
  

 

 

   

 

 

   

 

 

 

In 2011, chargebacks were approximately 6.8% of gross revenue, but prior to 2009, had fallen within a range of 1.0% to 5.0% in any given year depending on the customer base. The increase in the past three years above this range is primarily attributed to the TRICARE Pharmacy Program (“TRICARE”) which became effective January 2008 and is administered by the Department of Defense. Excluding TRICARE, chargebacks would have been approximately 5.9% in 2011, which would have increased reported revenue by approximately $0.5 million. In 2011, Medicaid rebates were approximately 13.4% of gross revenue, showing steady increases since 2009. The increase in Medicaid rebate revenue reductions from 6.4% in 2009 and 10.2% in 2010 to 13.1% in 2011 is due to price increases for Actimmune implemented during 2009 and 2010. The Medicaid program limits price increases to a rate similar to the rate of inflation. Our price increases exceeded this limit, thereby significantly increasing our rebates to customers for those patients under the Medicaid program. Additionally, in 2011, we began selling Esbriet in Germany and the required mandatory rebate as described above is included herein.

The source of information that we monitor in assisting us with computing chargebacks is from the Federal Supply Schedule, Veterans Administration and Public Health System pricing documents. These documents establish the maximum price allowable for the sale of our product to a government customer. The chargeback amount per unit is computed as the difference between our sales price to the wholesaler and the selling price from the wholesaler to a government customer. Chargebacks are processed directly by the wholesalers and are deducted from payments to us.

The source of information that we monitor in assisting us with computing Medicaid rebates is from each of the 50 states. Medicaid rebates are billed directly to us from each state. Billings from the states, which are based

 

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on end user reports submitted by pharmacies to the state agencies, are typically received within 45 days after the end of each calendar quarter. We use historical billing and payment trends to assist us in determining an estimated Medicaid rebate amount each period.

Clinical Trial Accruals

We accrue costs for clinical trial activities performed by contract research organizations based upon the estimated amount of work completed on each study. These estimates may or may not match the actual services performed by the organizations as determined by patient enrollment levels and related activities. We monitor patient enrollment levels and related activities to the extent possible through internal reviews, correspondence with contract research organizations and review of contractual terms. However, if we have incomplete or inaccurate information, we may overestimate or underestimate activity levels associated with various studies at a given point in time. In the event we underestimate, we could be required to record significant additional research and development expenses in future periods when the actual activity level becomes known. All such costs are charged to research and development expenses as incurred. To date, we have not experienced changes in estimates that have led to material research and development expense adjustments being recorded in subsequent periods.

Inventory Reserves

Our inventories are stated at the lower of cost or market and our inventory costs are determined using the specific identification method which approximates first-in first-out. We enter into purchase obligations to purchase our inventory based upon sales forecasts to enable us to mitigate some of the risk associated with the long lead times required to manufacture our products.

We write off the cost of inventory and reserve for future minimum purchase commitments, if any, that we consider to be in excess of forecasted future demand. We define excess inventory as inventory that will expire before it can be sold, based on future sales forecasts. In making these assessments, we are required to make judgments as to the future demand for current or committed inventory purchase levels. Actimmune has an expiration date of 36 months from the date of manufacture and the raw material used in the manufacture of Esbriet has a shelf life of 60 months from the date of manufacture and an additional 36 months once encapsulated into pill form. As part of our on-going excess inventory assessment for Actimmune and Esbriet, we also estimate the expiration date of any Actimmune or Esbriet to be manufactured in the future.

Projected revenue trends resulted in us recording charges during 2010 and 2009 of $0.5 million and $0.3 million, respectively, to cost of goods sold for excess inventories. There were no charges to cost of goods sold in 2011 for excess inventories. If Actimmune or Esbriet revenue levels experienced in future periods are substantially below our current expectations, we could be required to record additional charges for excess inventories. Please refer to the statements under “Item 1A. Risk Factors” in this Report to gain a better understanding of the possible reasons why actual results may differ from our estimates.

Results of Operations

Comparison of years ended December 31, 2011, 2010 and 2009

Revenue

For the year ended December 31, 2011, we recorded total net revenue of $25.6 million, which includes Esbriet product revenue of $2.8 million, Actimmune product revenue of $20.2 million and collaboration revenue of $2.6 million. This compares to $259.3 million and $48.7 million of total revenue for the same periods in 2010 and 2009, respectively. The substantial decrease in revenue in 2011 as compared to 2010 is primarily due to the sale of our worldwide rights in danoprevir to Roche in October 2010 which resulted in the recognition of $175.0 million in collaboration revenue from the sale proceeds along with the acceleration of $57.3 million of previously

 

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deferred revenue related to the termination of our 2006 collaboration agreement with Roche. We reported an increase in revenue in 2010 as compared to 2009 because of the sale of danoprevir as noted above. This increase was partially offset by the year over year decrease we reported in Actimmune product sales from $25.4 million in 2009 to $20.0 million in 2010. Additional collaboration revenue in 2010 also includes approximately $4.5 million of revenue related to the new collaboration agreement we entered into with Roche in December 2010, representing reimbursement for research services performed on their behalf. The $2.6 million of collaboration revenue for 2011 represents the remaining reimbursement for research services under the 2010 Roche agreement, which has since been terminated. The $23.3 million of collaboration revenue for 2009 includes a $20.0 million milestone payment which had been assessed as substantive and at-risk at the initiation of the 2006 agreement and was therefore recognized as revenue when the milestone was achieved, as defined in the former collaboration agreement. In 2010 and 2009, respectively, collaboration revenue included approximately $2.5 million and $3.3 million of amortization of the aggregate $70.0 million in upfront payments received from Roche in 2006 and 2007. For each of the years ended December 31, 2010 and 2009, Actimmune accounted for all of our product revenue and was approximately $20.0 million and $25.4 million, respectively. A significant portion of these sales were derived from physicians’ prescriptions for the off-label use of Actimmune in the treatment of IPF.

Cost of Goods Sold

Cost of goods sold includes product manufacturing costs, royalties, distribution costs and inventory writedowns. Cost of goods sold for the year ended December 31, 2011 was $8.7 million, compared to $6.3 million and $7.0 million in 2010 and 2009, respectively. Gross margin for our products was 62%, 68% and 72% for each of the years ended December 31, 2011, 2010 and 2009, respectively. The decline in gross margin for the year ended December 31, 2011 compared with the same period in 2010 is primarily the result of a one-time $2.0 million royalty payment made to Roche for reaching specified Actimmune sales targets in mid-2011. Additionally, in connection with our receipt of authorization to market Esbriet in the European Union, we made a milestone payment of $20.0 million and have capitalized such payment as acquired product rights. This asset is being amortized to cost of goods sold over the estimated useful life of Esbriet and we incurred approximately $0.8 million of amortization expense in 2011. Excluding the royalty payment and amortization, product gross margin in 2011 was approximately 74%. Included in 2010 and 2009 cost of goods sold are charges of $0.5 million and $0.3 million, respectively, recorded for excess inventories. There were no charges in 2011 recorded for excess inventories and purchase commitments. Excluding the charges for excess inventory and purchase commitments in 2010 and 2009, gross margins were approximately 71% and 74% of Actimmune product revenue for each of the years ended December 31, 2010 and 2009, respectively.

Research and Development Expenses

Research and development (“R&D”) expenses were $75.0 million, $67.5 million and $89.1 million for the years ended December 31, 2011, 2010 and 2009, respectively, representing an increase of 11% in 2011 from 2010 and a decrease of 24% in 2010 from 2009. The increase in 2011 R&D expenses as compared to 2010 is primarily due to the preparation and initiation of the ASCEND trial and an increase in stock compensation expense of approximately $2.3 million related to awards tied to the European Commission’s decision to grant marketing authorization for Esbriet, partially offset by decreased expenses associated with a discontinuation of investment in the HCV portfolio following the divestiture of danoprevir in October of 2010 and completion of InterMune’s research agreement with Roche in June 2011. The decrease in 2010 as compared to 2009 is primarily due to the timing of the preparation of regulatory filings related to pirfenidone and the divestiture of danoprevir in October 2010. Based on current budgeted programs, R&D expense is expected to be in a range of $95.0 million to $115.0 million in 2012.

The following table lists our current product development programs and the research and development expenses recognized in connection with each program during the indicated periods. The category titled “Programs—Non-specific” is comprised of facilities and personnel costs that are not allocated to a specific development program or discontinued programs and $5.7 million, $3.5 million and $3.2 million of stock-based

 

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compensation expense in 2011, 2010 and 2009, respectively. Our management reviews each of these program categories in evaluating our business. For a discussion of the risks and uncertainties associated with developing our products, as well as the risks and uncertainties associated with potential commercialization of our product candidates, see the specific sections under “Item 1A. Risk Factors” above.

 

     Year ended December 31,  

Development Program

   2011      2010      2009  
     (In thousands)  

Pulmonology

   $ 50,077       $ 32,601       $ 47,636   

Hepatology (1)

     2,432         13,895         26,794   

Programs—Non-specific

     22,464         20,974         14,708   
  

 

 

    

 

 

    

 

 

 

Total

   $ 74,973       $ 67,470       $ 89,138   
  

 

 

    

 

 

    

 

 

 

 

(1) Effective in 2011, we discontinued our HCV development program.

Historically, the largest component of our total operating expense was our ongoing investment in research and development and, in particular, the clinical development of our product pipeline. The process of conducting the clinical research necessary to obtain FDA approval is costly and time consuming. Current FDA requirements for a new human drug to be marketed in the United States include:

 

   

the successful conclusion of preclinical laboratory and animal tests, if appropriate, to gain preliminary information on the product’s safety;

 

   

the submission of an IND with the FDA to conduct human clinical trials for drugs;

 

   

the successful completion of adequate and well-controlled human clinical investigations to establish the safety and efficacy of the product for its recommended use; and

 

   

the submission by a company and acceptance and approval by the FDA of an NDA or BLA for a drug product to allow commercial distribution of the drug.

In light of the factors mentioned above, we consider the active management and development of our clinical pipeline to be crucial to our long-term success. The actual probability of success for each candidate and clinical program may be impacted by a variety of factors, including, among others, the quality of the candidate, the validity of the target and disease indication, early clinical data, investment in the program, competition, manufacturing capability and commercial viability. Due to these factors, it is difficult to give accurate guidance on the anticipated proportion of our research and development investments or the future cash inflows from these programs. In addition, due to these same factors and others, we are unable to reasonably estimate the efforts needed and, therefore, the costs we will incur to complete any of our projects or the estimated time to complete such projects. We are also unable to provide costs incurred for specific research and development projects within each major development program as well as the cumulative costs incurred to date given that we do not maintain specific financial records to this level of detail. However, a substantial majority of our resources have been invested in our pirfenidone and former danoprevir projects in order to advance them into Phase 3 and Phase 2 clinical development, respectively. Effective in 2011, we have decided to cease further investment within our hepatology research programs and this therapeutic area.

The actual probability of success for each candidate and clinical program may be impacted by a variety of factors, including, among others, the quality of the candidate, the validity of the target and disease indication, early clinical data, investment in the program, competition, manufacturing capability and overall safety and efficacy profile as ultimately decided upon by the FDA. Due to these factors, we believe it is difficult to give accurate guidance on the anticipated proportion of our research and development investments or the future cash inflows from these programs. In addition, due to these same factors and others, we are unable to reasonably estimate the efforts needed and, therefore, the costs we will incur to complete any of our projects or the estimated time to complete such projects.

 

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Milestone Payments to Third Parties

We made no third-party payments in 2011 or 2010 related to contractual milestone obligations that were charged directly to expense. In 2009, we made milestone payments of approximately $15.2 million including approximately $1.7 million in milestone payments made in connection with the initiation of the Phase 2b study of danoprevir and a $13.5 million milestone payment related to our pirfenidone program.

Selling, General and Administrative Expenses

General and administrative (“SG&A”) expenses were $90.2 million, $55.5 million and $37.5 million for the years ended December 31, 2011, 2010 and 2009, respectively, representing year over year increases of 63% and 48%, respectively. The increased spending for the year ended December 31, 2011 compared with the same period in 2010 is attributed to the creation of our European infrastructure and investments in the pre-launch and launch of Esbriet in Europe, including but not limited to additional headcount, as well as legal costs in connection with the global prosecution of our intellectual property portfolio, other regulatory and corporate matters, as well as expenses in connection with indemnification obligations to our former CEO. The increase in our SG&A expenses in 2010 compared with 2009 were primarily attributable to costs related to our preparation for the potential commercialization of pirfenidone in the U.S., the beginnings of a European infrastructure late in 2010 and transaction costs associated with the sale of danoprevir to Roche in October 2010. Based on current budgeted programs, SG&A expense is expected to be in a range of $120.0 million to $145.0 million in 2012.

Restructuring Charges

Following our receipt of the Complete Response Letter from the FDA requesting an additional clinical trial to support the efficacy of pirfenidone, we initiated a reduction in force in May 2010 resulting in an aggregate restructuring charge of approximately $1.3 million during 2010, consisting primarily of severance and benefits payments made to terminated employees.

In connection with the completion and announcement of our CAPACITY trial results, we initiated a reduction in force in February 2009. We incurred approximately $0.7 million of restructuring charges during 2009 consisting primarily of severance payments made to terminated employees.

Loss on extinguishment of debt

In April and September 2009, we entered into exchange agreements with certain holders of our 2011 Notes to issue approximately 2.6 million shares of common stock in exchange for approximately $40.1 million principal amount of the 2011 Notes then outstanding, see Issuance of Convertible Debt above. The exchange agreements were treated as induced conversions as the holders received a greater number of shares of common stock than would have been issued under the original conversion terms of the convertible notes. At the time of the exchange agreements, none of the conversion contingencies were met. Under the original terms of the convertible notes, the amount payable on conversion was to be paid in cash, and the remaining conversion obligation (stock price in excess of conversion price) was payable in cash or shares, at our option. Under the terms of the exchange agreements, all of the settlement was paid in shares. The difference in the value of the shares of common stock sold under the exchange agreements and the value of the shares used to derive the amount payable under the original conversion agreements resulted in a loss on extinguishment of debt of approximately $13.2 million in the aggregate (the inducement loss). As required by ASC 470, upon derecognition of the 2011 Notes, we remeasured the fair value of the liability and equity components using a borrowing rate for similar non-convertible debt that would be applicable to us at the date of the exchange agreements. Because borrowing rates increased, the remeasurement of the components of the convertible notes resulted in a gain on extinguishment of approximately $2.8 million (the revaluation gain). As a result, we recognized a net loss on extinguishment of debt of approximately $11.0 million during the year ended December 31, 2009, calculated as the inducement loss, plus an allocation of advisory fees of approximately $0.6 million; less the revaluation gain. For more information, see Note 13 of the Notes to Consolidated Financial Statements.

 

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Interest Income

Interest income was approximately $0.6 million for each of the years ended December 31, 2011 and 2010 compared with $1.7 million for the year ended December 31, 2009. This decrease in interest income reflects a conservative portfolio and therefore much lower average interest rates throughout 2011 and 2010 compared with 2009.

Interest Expense

Interest expense decreased to $6.4 million for the year ended December 31, 2011 compared to $8.4 million and $10.1 million for the years ended December 31, 2010 and 2009, respectively. The decrease in interest expense in 2011 compared with 2010 reflects a decline in the amortization of the debt discount on our 0.25% convertible notes due and converted on March 1, 2011. As a result of the conversion, debt discount amortization was approximately $0.7 million in 2011, compared to $3.8 million recorded in 2010. The decrease in interest expense in 2010 as compared to 2009 was primarily due to a decline in the amortization of the debt discount related to our 2011 Notes, following the reduction in our convertible note obligation in 2009, see Issuance of Convertible Debt above. During 2010, the amortization of debt discount was approximately $3.8 million, compared with $4.6 million in 2009, which reflects our adoption on January 1, 2009 of the guidance in ASC 470. Additionally, 2010 and prior reflects declining interest expense recorded in connection with our liability under the government settlement reached in October 2006.

Other Income (Expense)

Other income (expense) was $(0.7) million for the year ended December 31, 2011 compared to $1.6 million for the year ended December 31, 2010 and $6.4 million of other income in 2009. Other expense in 2011 consists primarily of currency losses related to the unhedged portion of our non-dollar denominated balance sheet exposures in connection with our European expansion. Other income in 2010 is comprised primarily of realized gains of approximately $1.1 million from the sale of all of our remaining auction rate securities and includes approximately $0.7 million related to the receipt of a federal research and development grant in the fourth quarter of 2010 pursuant to the Federal Qualifying Therapeutic Discovery Project (“QTDP”), partially offset by other expenses. Other income in 2009 consists primarily of realized gains of approximately $6.0 million from the sale of our shares of Targanta common stock.

Provision for Income Taxes

Due to our continuing operating losses and the uncertainty of our recognizing the potential future benefits from other non-operating losses, we recorded a minimal provision for taxes for the year ended December 31, 2011 and a provision of approximately $0.1 million for income taxes for the year ended December 31, 2010. We recorded a $2.3 million deferred tax benefit in 2007, primarily related to net operating losses that we had concluded to be realizable based on our estimate of future taxable income resulting from future potential sales of our shares of Targanta common stock. The $2.3 million tax benefit was reversed in 2009 following our sale of Targanta shares in 2009. As of December 31, 2011, we had federal net operating loss carryforwards of approximately $331.6 million. The net operating loss carryforwards will expire at various dates beginning in 2025 if not utilized. We also have federal research and development tax credits of approximately $9.4 million that will begin to expire in the year 2020 and federal Orphan Drug credit carryforwards of approximately $94.9 million that will begin to expire in the year 2022. In addition, we had net operating loss carryforwards for state income tax purposes of approximately $427.9 million that begin to expire in 2015 and state research and development tax credits of approximately $10.0 million that do not expire. In general, Section 382 of the Internal Revenue Code (“IRC”) of 1986, as amended, imposes annual limitations on the utilization of net operating loss carryforwards, other tax carryforwards and certain built-in losses, as defined under that Section, upon an ownership change. In general, an ownership change occurs if the aggregate stock ownership of certain stockholders increases by more than 50 percentage points over such stockholders’ lowest percentage ownership

 

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during the testing period (generally three years). We have analyzed our historical ownership changes and removed any net operating loss carryforwards that will expire unutilized from our deferred tax balances as a result of IRC Section 382 limitations.

In accordance with ASC 810-10-45-8, we recorded a deferred charge during the year ended December 31, 2010 related to the deferral of income tax expense on inter-company profits that resulted from the sale of our non-U.S. economic rights to Esbriet® to InterMune International AG, a wholly owned subsidiary formed in 2010. The deferred charge is included in other assets in the accompanying consolidated balance sheets and will be amortized as a component of income tax expense in the accompanying consolidated statements of operations over the estimated life of the intellectual property.

We adopted the provisions of ASC Topic No. 740, previously referred to as FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 on January 1, 2007. Implementation of ASC Topic No. 740 did not result in any adjustment to our Consolidated Statements of Operations or a cumulative adjustment to accumulated deficit.

Liquidity and Capital Resources

At December 31, 2011, we had cash, cash equivalents and available-for-sale securities of $425.1 million compared to $295.1 million at December 31, 2010. In September 2011, we completed a registered underwritten public offering of 4.6 million shares of our common stock and a concurrent registered underwritten public offering of $155.3 million aggregate principal amount of 2.5% convertible senior notes due 2018 (“2018 Notes”). The aggregate net proceeds from our concurrent offerings were approximately $255.0 million. The proceeds from these offerings were offset by additional funds used in the commercial launch of Esbriet in the EU and for general corporate purposes. We believe that our cash, cash equivalents and available-for-sale securities as of December 31, 2011 are sufficient to fund our operations, as currently contemplated, for at least the next 12 months. Some of these available cash and cash equivalents are held in accounts managed by third party financial institutions and consist of invested cash and cash in our core operating accounts. The invested cash is invested in interest bearing funds managed by third party financial institutions. We can provide no assurances that access to our invested cash and cash equivalents will not be impacted by adverse conditions in the financial markets. In addition, at any point in time we could have balances that exceed the Federal Deposit Insurance Corporation insurance limits. While we monitor the cash balances in our operating accounts on a regular basis, these cash balances could be impacted and we may be unable to access our cash if the underlying financial institutions fail or if we become subject to other adverse conditions in the financial markets. To date we have not experienced a lack of access to cash in any of our third party financial institution accounts.

The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we invest our excess cash in debt instruments of the U.S. federal and state governments and their agencies and high-quality corporate issuers, and, by policy, restrict our exposure by imposing concentration limits and credit worthiness requirements for all corporate issuers. Beginning in February 2008, auctions failed for our entire portfolio of auction rate securities which had substantially limited the liquidity of those instruments. However, in 2010, we sold or redeemed our remaining portfolio of auction rate securities.

Operating Activities

Cash used in operating activities was approximately $137.5 million during the year ended December 31, 2011, comprised primarily of a net loss of $154.8 million, described more fully above under the section heading, Results of Operations, as well as changes to our working capital. Significant changes in working capital consisted of increases in accounts receivable, product inventory and prepaid expenses principally related to the initial launch of Esbriet in Germany in September 2011. Additionally, accounts payable, accrued compensation and other accrued liabilities increased as a result of significant increases in headcount in Europe and the initiation of the ASCEND clinical trial in the U.S. in mid-2011.

 

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Investing Activities

Investing activities consumed approximately $85.3 million in cash flow during the year ended December 31, 2011, primarily due to purchases of investments totaling $377.9 million and the acquisition of product rights of $20.0 million, partially offset by maturities and sales of available-for-sale securities totaling $314.8 million.

Financing Activities

Cash provided by financing activities of approximately $289.6 million for the year ended December 31, 2011 was due to the receipt of $255.0 million in net proceeds from our concurrent public offerings of convertible debt and equity in September 2011 along with proceeds from the exercise of employee stock options and purchases of common stock under our employee stock purchase plan of approximately $34.6 million.

We expect to incur net losses in the near term as we continue our preparations for the commercial launch of Esbriet in the European Union, continue the development of pirfenidone for approval in the United States with the ongoing ASCEND study, continue our research in the area of orphan fibrotic diseases, and continue to grow our operational capabilities. We believe that our existing cash, cash equivalents and available-for-sale securities, together with anticipated cash flows from sales of Esbriet and Actimmune will be sufficient to fund our operating expenses, debt obligations and capital requirements under our current business plan through at least the next 12 months. This forward-looking statement involves risks and uncertainties, and actual results could vary as a result of a number of factors, including the factors discussed under “Item 1A. Risk Factors.” This forward-looking statement is also based upon our current plans and assumptions, which may change, and our capital requirements, which may increase in future periods. Our future capital requirements will depend on many factors, including, but not limited to:

 

   

capital requirements related to our commercial launch of Esbriet in Germany and preparations for the commercial launch of Esbriet in other European Union jurisdictions, including the expansion of our commercial infrastructure and related personnel and facility expenses;

 

   

the timing and financial requirements of the ongoing Phase 3 clinical study of pirfenidone in the U.S. (ASCEND);

 

   

sales of Esbriet and Actimmune or any of our product candidates in development that receive commercial approval;

 

   

pricing and reimbursement from third-payors for Esbriet and Actimmune;

 

   

our ability to partner our programs or products;

 

   

the progress of our research and development efforts;

 

   

the scope and results of preclinical studies and clinical trials;

 

   

the costs, timing and outcome of regulatory reviews;

 

   

determinations as to the commercial potential of our product candidates in development;

 

   

the pace of expansion of administrative expenses;

 

   

the status of competitive products and competitive barriers to entry;

 

   

the establishment and maintenance of manufacturing capacity through third-party manufacturing agreements;

 

   

the establishment of collaborative relationships with other companies;

 

   

the payments of annual interest on our long-term debt; and

 

   

the timing and size of payments we may receive from potential collaboration agreements.

 

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As a result, we may require substantial additional capital and may attempt to raise additional funds through equity or debt financings, collaborative arrangements with corporate partners or from other sources. We have no commitments for such fund raising activities at this time. Furthermore, additional funding may not be available to finance our operations when needed or, if available, the terms for obtaining such funds may not be favorable or may result in dilution to our stockholders.

Off-Balance Sheet Arrangements

With the exception of standard operating leases, we have not engaged in any off-balance sheet arrangements, including the use of structured finance, special purpose entities or variable interest entities.

Contractual Obligations

Contractual obligations represent future cash commitments and liabilities under agreements with third parties, and exclude contingent liabilities, such as milestone payments, for which we cannot reasonably predict future payments. The following chart represents our contractual obligations as of December 31, 2011, aggregated by type (in millions):

 

Contractual Obligations

   Total      2012      2013-2014      2015-2016      After 2016  

Long-term debt obligations (1)

   $ 282.4       $ 8.3       $ 16.3       $ 94.9       $ 162.9   

Operating leases

     12.2         2.9         5.6         3.4         0.3   

Non-cancelable purchase obligations—Other (2)

     7.1         6.3         0.8         —           —     

Research and development commitments (3)

     43.9         25.0         18.9         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total contractual cash obligations (4)

   $ 345.6       $ 42.5       $ 41.6       $ 98.3       $ 163.2   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) These amounts include accrued interest and principal amounts of both the 5.00% convertible senior notes due 2015 and the 2.50% convertible senior notes due 2018.
(2) These amounts consist of clinical related obligations and inventory purchase commitments.
(3) These amounts consist of clinical, process development and other related obligations and are cancelable upon discontinuation of the trial.
(4) We may also be required to make contingent milestone payments in the aggregate of up to $62.1 million to the licensors of certain of our licensed products or the suppliers of our drug compounds in accordance with the specific license, commercialization and collaboration agreements if all of the milestones per the agreements are achieved, which include development and regulatory approval milestones. These amounts are not included in the above table. Included in the $62.1 million in future aggregate milestone payments are aggregate milestone payments of $11.3 million payable to Array and Novartis, of which Roche has agreed to reimburse us in connection with our sale of danoprevir to Roche.

The operating leases for our facilities require letters of credit secured by a restricted cash balance with our bank. The amount of each letter of credit approximates six to twelve months of operating rent payable to the landlord of each facility.

Recent Accounting Pronouncements

In June 2011, the FASB issued ASU No. 2011-05, Presentation of Comprehensive Income. This ASU gives an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU No. 2011-05 is effective on a retrospective basis for us on January 1, 2012. We do not expect that this new guidance will have a material impact on our consolidated financial statements.

In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements

 

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in U.S. GAAP and IFRSs. This ASU is the result of joint efforts by the FASB and International Accounting Standards Board to develop a single, converged fair value framework. While this ASU is largely consistent with existing fair value measurement principles in U.S. GAAP, it expands ASC No. 820, Fair Value Measurement existing disclosure requirements for fair value measurements and makes other amendments. Many of these amendments were made to eliminate unnecessary wording differences between U.S. GAAP and International Financial Reporting Standards, which could change how fair value measurement guidance in ASC 820 is applied. ASU No. 2011-04 is effective on a prospective basis for us on January 1, 2012. We are currently evaluating whether this new guidance will have a material impact on our consolidated financial statements.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate and Market Risk

The securities in our investment portfolio are not leveraged, are classified as available-for-sale and are, due to their short-term nature, subject to minimal interest rate risk. We currently do not hedge our interest rate risk exposure. Because of the short-term maturities of our investments, we do not believe that a change in market rates would have a significant negative impact on the value of our investment portfolio.

The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. To achieve this objective, we maintain our portfolio of cash equivalents and short-term and long-term investments in a variety of securities, including obligations of U.S. government-sponsored enterprises, municipal notes which may have an auction reset feature, corporate notes and bonds, commercial paper, and money market funds. These securities are classified as available for sale and consequently are recorded on the balance sheet at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income. Substantially all investments mature within approximately one year from the date of purchase. Our holdings of the securities of any one issuer, except obligations of U.S. government-sponsored enterprises, do not exceed 10% of the portfolio. If interest rates rise, the market value of our investments may decline, which could result in a realized loss if we are forced to sell an investment before its scheduled maturity. We do not utilize derivative financial instruments to manage our interest rate risks.

The table below presents the original principal amounts and weighted-average interest rates by year of maturity for our investment portfolio as of December 31, 2011 by effective maturity (in millions, except percentages):

 

     2012     2013     2014      2015     2016 and
beyond
    Total     Fair value at
December 31,
2011
 

Assets:

               

Available-for-sale securities

   $ 203.8      $ 93.3      $ —         $ —        $ —        $ 297.1      $ 296.9   

Average interest rate

     0.3     0.3     —           —          —          0.3     —     

Liabilities:

               

2.50% convertible senior notes due 2018

   $ —        $ —        $ —         $ —        $ 155.3      $ 155.3      $ 112.6   

Average interest rate

     —          —          —           —          2.5     2.5     —     

5.00% convertible senior notes due 2015

   $ —        $ —        $ —         $ 85.0      $ —        $ 85.0      $ 84.1   

Average interest rate

     —          —          —           5.0     —          5.0     —     

 

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The table below presents the original principal amounts and weighted-average interest rates by year of maturity for our investment portfolio as of December 31, 2010 by effective maturity (in millions, except percentages):

 

     2011     2012     2013      2014      2015 and
beyond
    Total     Fair value at
December 31,
2010
 

Assets:

                

Available-for-sale securities

   $ 236.6      $ 41.2      $ —         $ —         $ —        $ 277.8      $ 278.1   

Average interest rate

     0.3     0.6     —           —           —          0.3     —     

Liabilities:

                

0.25% convertible senior notes due 2011

   $ 45.0      $ —        $ —         $ —         $ —        $ 45.0      $ 74.1   

Average interest rate

     0.25     —          —           —           —          0.25     —     

5.00% convertible senior notes due 2015

   $ —        $ —        $ —         $ —         $ 85.0      $ 85.0      $ 173.9   

Average interest rate

     —          —          —           —           5.00     5.00     —     

Foreign Currency Market Risk

In connection with our continuing expansion efforts, we now conduct business throughout Europe in several currencies, including the euro, Swiss franc and British pound, among others. Therefore, we are exposed to adverse movements in foreign currency exchange rates. To limit the exposure related to foreign currency changes, we enter into foreign currency contracts. The Company does not enter into such contracts for trading or speculative purposes.

We enter into foreign exchange forward contracts to reduce the short-term effects of foreign currency fluctuations on assets and liabilities such as foreign currency receivables and payables. These derivatives are not designated as hedging instruments. Gains and losses on the contracts are included in other income (expense) and substantially offset foreign exchange gains and losses from the remeasurement of intercompany balances or other current assets or liabilities denominated in currencies other than the functional currency of the reporting entity.

The Company’s foreign exchange forward contracts expose us to credit risk to the extent that the counterparties may be unable to meet the terms of the agreement. The Company does, however, seek to mitigate such risks by limiting its counterparties to major financial institutions. In addition, the potential risk of loss with any one counterparty resulting from this type of credit risk is monitored. Management does not expect material losses as a result of defaults by counterparties.

Global Market and Economic Conditions

In the United States and internationally, market and economic conditions have been challenging with tighter credit conditions and sluggish economic growth beginning in 2008. For the fiscal year ended December 31, 2010, concerns about the systemic impact of inflation, energy costs, geopolitical issues, the availability and cost of credit, the U.S. mortgage market, high unemployment and a declining real estate market in the U.S. and added concerns fueled by the federal government interventions in the U.S. financial and credit markets contributed to instability in both United States and international capital and credit markets and have diminished expectations for the U.S. and global economy. These conditions, which continued into 2011, combined with volatile energy prices, declining business and consumer confidence and continued high unemployment have contributed to volatility in the markets and a broad economic slowdown.

As a result of these market conditions, the cost and availability of capital and credit has been and may continue to be adversely affected by illiquid credit markets and wider credit spreads. If volatile and adverse market conditions continue, they may limit our ability to timely borrow or access the capital and credit markets to meet liquidity needs, resulting in an adverse effect on our financial condition and results of operations. The economic slowdown may lead to reduced opportunities to raise sufficient additional capital to enable us to fund future operations, which would have a negative impact on our business. In addition, the biotechnology industry has fluctuated significantly in the past and has experienced significant downturns in connection with, or in anticipation of, a deterioration in general economic conditions and we cannot accurately predict how severe and prolonged any downturn might be.

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

Report of Independent Registered Public Accounting Firm

   67

Consolidated Balance Sheets

   68

Consolidated Statements of Operations

   69

Consolidated Statements of Stockholders’ Equity (Deficit)

   70

Consolidated Statements of Cash Flows

   71

Notes to Consolidated Financial Statements

   72

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders of InterMune, Inc.

We have audited the accompanying consolidated balance sheets of InterMune, Inc. as of December 31, 2011 and 2010, and the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2011. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of InterMune, Inc. at December 31, 2011 and 2010, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2011, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), InterMune, Inc.’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 29, 2012 expressed an unqualified opinion thereon.

 

/s/ Ernst & Young LLP
Redwood City, California
February 29, 2012

 

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INTERMUNE, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)

 

     December 31,  
     2011     2010  
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 177,428      $ 110,584   

Available-for-sale securities

     247,682        184,489   

Accounts receivable, net of allowances of $56 and $36 at December 31, 2011 and 2010, respectively

     3,764        1,710   

Inventories

     6,220        1,151   

Prepaid expenses and other current assets

     8,044        3,609   
  

 

 

   

 

 

 

Total current assets

     443,138        301,543   

Property and equipment, net

     2,341        1,246   

Acquired product rights, net

     19,250        —     

Other assets (includes restricted cash of $1,427 and $1,432 at December 31, 2011 and 2010, respectively)

     7,894        2,358   
  

 

 

   

 

 

 

Total assets

   $ 472,623      $ 305,147   
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current liabilities:

    

Accounts payable

   $ 10,068      $ 7,994   

Accrued compensation

     9,044        6,578   

Convertible notes, current portion

     —          44,300   

Other accrued liabilities

     14,979        11,189   
  

 

 

   

 

 

 

Total current liabilities

     34,091        70,061   

Convertible notes, less current portion

     240,250        85,000   

Other long term liabilities

     114        786   

Commitments and contingencies

    

Stockholders’ equity:

    

Preferred stock, $0.001 par value; 5,000 shares authorized, no shares issued and outstanding at December 31, 2011 and 2010, respectively

     —          —     

Common stock, $0.001 par value, 100,000 shares authorized; 65,302 and 56,594 shares issued and outstanding at December 31, 2011 and 2010, respectively

     65        57   

Additional paid-in capital

     1,144,947        942,375   

Accumulated other comprehensive income (loss)

     1,025        (37

Accumulated deficit

     (947,869     (793,095
  

 

 

   

 

 

 

Total stockholders’ equity

     198,168        149,300   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 472,623      $ 305,147   
  

 

 

   

 

 

 

See Accompanying Notes to Consolidated Financial Statements

 

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INTERMUNE, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

 

     Year Ended December 31,  
     2011     2010     2009  
     (In thousands, except per share amounts)  

Revenue, net

      

Actimmune

   $ 20,223      $ 20,040      $ 25,428   

Esbriet

     2,778        —          —     

Collaboration revenue

     2,629        239,251        23,272   
  

 

 

   

 

 

   

 

 

 

Total revenue, net

     25,630        259,291        48,700   

Costs and expenses:

      

Cost of goods sold

     8,707        6,337        6,997   

Research and development

     74,973        67,470        89,138   

Acquired research and development and milestone expense

     —          —          15,250   

Selling, general and administrative

     90,192        55,505        37,461   

Restructuring charges

     —          1,300        697   
  

 

 

   

 

 

   

 

 

 

Total costs and expenses

     173,872        130,612        149,543   
  

 

 

   

 

 

   

 

 

 

(Loss) income from operations

     (148,242     128,679        (100,843

Other income (expense):

      

Loss from extinguishment of debt

     —          —          (11,014

Interest income

     556        571        1,727   

Interest expense

     (6,408     (8,399     (10,129

Other income (expense)

     (658     1,599        6,393   
  

 

 

   

 

 

   

 

 

 

(Loss) income from operations before income taxes

     (154,752     122,450        (113,866

Income tax expense, net

     22        76        2,154   
  

 

 

   

 

 

   

 

 

 

Net (loss) income

   $ (154,774   $ 122,374      $ (116,020
  

 

 

   

 

 

   

 

 

 

Per common share:

      

Net (loss) income—basic

   $ (2.58   $ 2.26      $ (2.62
  

 

 

   

 

 

   

 

 

 

Net (loss) income—diluted

   $ (2.58   $ 2.13      $ (2.62
  

 

 

   

 

 

   

 

 

 

Shares used in computing basic net income (loss) per share

     60,100        54,202        44,347   
  

 

 

   

 

 

   

 

 

 

Shares used in computing diluted net income (loss) per share

     60,100        61,377        44,347   
  

 

 

   

 

 

   

 

 

 

 

See Accompanying Notes to Consolidated Financial Statements

 

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INTERMUNE, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)

 

    Common Stock     Additional
Paid-In

Capital
    Accumulated
Other
Comprehensive

Income (Loss)
    Accumulated
Deficit
    Total
Stockholders’

Equity
(Deficit)
 
    Shares     Amount          
    (In thousands)  

Balances at December 31, 2008

    39,330      $ 39      $ 690,454      $ (1,415   $ (799,449   $ (110,371

Net unrealized gain on available-for-sale securities

    —          —          —          2,990        —          2,990   

Net loss

    —          —          —          —          (116,020     (116,020
           

 

 

 

Comprehensive loss

              (113,030

Exercise of stock options

    99        —          1,199        —          —          1,199   

Stock issued under employee stock purchase plan

    71        —          790        —          —          790   

Issuance of common stock in a public offering at $16.35 per share, net of issuance costs of $2,365

    4,025        4        63,440        —          —          63,444   

Issuance of common stock in exchange for convertible debt

    2,633        3        44,355        —          —          44,358   

Issuance of restricted stock to employees, net of forfeitures

    515        1        2,554        —          —          2,555   

Stock compensation related to employee stock benefit plans

    —          —          5,255        —          —          5,255   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances at December 31, 2009

    46,673      $ 47      $ 808,047      $ 1,575      $ (915,469   $ (105,800

Net unrealized loss on available-for-sale securities

    —          —          —          (1,609     —          (1,609

Foreign currency translation adjustment

    —          —          —          (3     —          (3

Net income

    —          —          —          —          122,374        122,374   
           

 

 

 

Comprehensive income

              120,762   

Exercise of stock options

    1,184        1        15,842        —          —          15,843   

Stock issued under employee stock purchase plan

    121        —          1,319        —          —          1,319   

Issuance of common stock in a public offering at $14.10 per share, net of issuance costs of $6,676

    8,050        8        106,824        —          —          106,832   

Issuance of restricted stock to employees, net of forfeitures

    566        1        3,021        —          —          3,022   

Stock compensation related to employee stock benefit plans

    —          —          7,322        —          —          7,322   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances at December 31, 2010

    56,594      $ 57      $ 942,375      $ (37   $ (793,095   $ 149,300   

Net unrealized gain on available-for-sale securities

    —          —          —          101        —          101   

Foreign currency translation adjustment

    —          —          —          961        —          961   

Net loss

    —          —          —          —          (154,774     (154,774
           

 

 

 

Comprehensive net loss

              (153,712

Exercise of stock options

    1,850        1        33,500        —          —          33,501   

Stock issued under employee stock purchase plan

    90        —          1,129        —          —          1,129   

Issuance of common stock in exchange for convertible debt

    2,079        2        44,961        —          —          44,963   

Issuance of common stock in a public offering at $24.00 per share, net of issuance costs of $5,612

    4,600        5        104,783        —          —          104,788   

Issuance of restricted stock to employees, net of forfeitures

    89        —          7,017        —          —          7,017   

Stock compensation related to employee stock benefit plans

    —          —          11,182        —          —          11,182   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances at December 31, 2011

    65,302      $ 65      $ 1,144,947      $ 1,025      $ (947,869   $ 198,168   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See Accompanying Notes to Consolidated Financial Statements

 

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INTERMUNE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     For the Year Ended December 31,  
     2011     2010     2009  
     (In thousands)  

Cash flows used for operating activities:

      

Net (loss) income

   $ (154,774   $ 122,374      $ (116,020

Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:

      

Stock-based compensation expense

     18,199        10,343        7,809   

Amortization of debt discount, debt issuance costs and acquired product rights

     1,733        3,990        5,045   

Depreciation expense

     1,176        2,443        3,583   

Loss on extinguishment of debt

     —          —          10,414   

Other

     961        —          —     

Deferred taxes

     —          —          2,275   

Deferred rent

     (124     (680     (508

Net realized (gains) on sales and writedowns of available-for-sale securities

     (15     (1,078     (6,736

Changes in operating assets and liabilities:

      

Accounts receivable

     (2,054     2,124        (711

Inventories

     (5,069     1,420        (1,322

Prepaid expenses

     (4,435     (374     (40

Other assets

     (831     (442     (49

Accounts payable and accrued compensation

     3,992        (2,324     (8,643

Other accrued liabilities

     3,790        3,458        (4,993

Liability under government settlement

     —          (9,193     (14,472

Deferred collaboration revenue

     —          (59,717     (3,272
  

 

 

   

 

 

   

 

 

 

Net cash (used in ) provided by operating activities

     (137,451     72,344        (127,640

Cash flows from investing activities:

      

Purchase of property and equipment

     (2,271     (336     (354

Purchases of available-for-sale securities

     (377,885     (301,475     (101,135

Maturities of available-for-sale securities

     228,549        184,322        77,168   

Sales of available-for-sale securities

     86,259        14,727        39,769   

Acquisition of product rights

     (20,000     —          —     
  

 

 

   

 

 

   

 

 

 

Net cash (used in) provided by investing activities

     (85,348     (102,762     15,448   

Cash flows from financing activities:

      

Proceeds from issuance of common stock in a public offering, net of issuance costs

     104,788        106,832        63,444   

Proceeds from convertible senior notes, net of issuance costs

     150,225        —          —     

Proceeds from issuance of common stock under employee stock benefit plans

     34,630        17,163        1,990   
  

 

 

   

 

 

   

 

 

 

Net cash provided by financing activities

     289,643        123,995        65,434   
  

 

 

   

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     66,844        93,577        (46,758

Cash and cash equivalents at beginning of year

     110,584        17,007        63,765   
  

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of year

   $ 177,428      $ 110,584      $ 17,007   
  

 

 

   

 

 

   

 

 

 

Supplemental disclosure of cash flow information:

      

Interest paid

   $ 4,306      $ 4,485      $ 5,444   

Non-cash financing activities:

      

Issuance of common stock in exchange for convertible debt

   $ 44,963      $ —        $ —     

Extinguishment of debt, net of unamortized debt discount, in exchange for common stock

   $ —        $ —        $ 34,131   

See Accompanying Notes to Consolidated Financial Statements

 

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InterMune, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1. ORGANIZATION AND BASIS OF PRESENTATION

Overview

We are a biotechnology company focused on the research, development and commercialization of innovative therapies in pulmonology and orphan fibrotic diseases. Pulmonology is the field of medicine concerned with the diagnosis and treatment of lung conditions. We have an advanced-stage product candidate in pulmonology, pirfenidone, that was granted marketing authorization effective February 2011 in all 27 member countries of the European Union (“EU”) for the treatment of adults with mild to moderate idiopathic pulmonary fibrosis (“IPF”). In September 2011, we launched commercial sales of pirfenidone in Germany under the trade name Esbriet®, and we are continuing to prepare for the commercial launch of Esbriet® in the other countries in the EU. We are also pursuing the registration of pirfenidone to treat IPF in the United States. After reviewing various regulatory and clinical development options and following our discussions with the United States Food and Drug Administration (“FDA”), we commenced an additional pivotal Phase 3 clinical study of pirfenidone in IPF in July 2011, known as the ASCEND trial, which is expected to be completed in mid-2013. The results of the ASCEND trial are expected to supplement the existing Phase 3 clinical study data from our CAPACITY clinical trials to support the registration of pirfenidone to treat IPF in the United States. In addition, we currently have rights to one approved and marketed product, Actimmune, which is approved in the United States and numerous other countries for the treatment of chronic granulomatous disease (“CGD”) and severe, malignant osteopetrosis. Previously, we also focused on the field of hepatology, which is concerned with the diagnosis and treatment of disorders of the liver. We have a hepatology portfolio of small molecule compounds that are currently in the pre-clinical research stage. However, in May 2011, we announced that we no longer plan to invest further in the field of hepatology.

In September 2011, we completed a registered underwritten public offering of 4.6 million shares of our common stock and a concurrent registered underwritten public offering of $155.3 million aggregate principal amount of 2.5% convertible senior notes due 2018 (“2018 Notes”). The aggregate net proceeds from our concurrent offerings was approximately $255.0 million, after deducting underwriting discounts and commissions and related offering expenses. We currently intend to use the net proceeds from these offerings to fund the commercial launch of Esbriet in the EU, to fund our ASCEND trial and for general corporate purposes.

 

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The consolidated financial statements include the accounts of InterMune and its wholly-owned subsidiaries, InterMune Canada Inc. and InterMune Ltd. (U.K.) along with our subsidiaries located in Germany, France, Switzerland, Spain, Italy, the Netherlands, Sweden and Austria. All inter-company balances and transactions have been eliminated.

Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates and assumptions.

We evaluate our estimates and assumptions on an ongoing basis, including those related to our allowances for doubtful accounts, product returns, chargebacks, cash discounts and rebates; excess/obsolete inventories; acquired product rights, the effects of inventory purchase commitments on inventory; certain accrued clinical and

 

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preclinical expenses and contingent liabilities; provision for income taxes and interest rates with respect to the accounting guidance for our convertible debt. We base our estimates on historical experience and on various other specific assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources.

Cash, Cash Equivalents and Available-For-Sale Securities

Cash and cash equivalents consist of highly liquid investments with original maturities, when purchased, of less than three months. We classify all of our debt securities as available-for-sale. Available-for-sale securities are carried at fair value, with unrealized gains and losses, reported in accumulated other comprehensive income (loss), a separate component of stockholders’ equity (deficit). We have estimated the fair value amounts by using quoted market prices or through a discounted cash flow analysis. The cost of securities sold is based on the specific identification method.

Other-than-temporary impairment. All of our available-for-sale securities are subject to a periodic impairment review. We recognize an impairment charge when a decline in the fair value of our investments below the cost basis is judged to be other-than-temporary. Factors considered in determining whether a loss is temporary include the length of time and extent to which the investments’ fair value has been less than the cost basis, the financial condition and near-term prospects of the investee, extent of the loss related to credit of the issuer, the expected cash flows from the security, our intent to sell or hold the security and whether or not we will be required to sell the security before the recovery of its amortized cost.

Fair Value of Other Financial Instruments

Other financial instruments, including accounts receivable, accounts payable and accrued liabilities, are carried at historical cost, which we believe approximates fair value because of the short-term nature of these instruments. The fair value of our $155.3 million 2.5% convertible senior notes due 2018 was $112.6 million and the fair value of our $85.0 million 5.0% convertible senior notes due 2015 was $84.1 million at December 31, 2011. As of December 31, 2010, the fair value of our $45.0 million convertible senior notes due and converted in 2011 and our $85.0 million convertible senior notes due 2015 was $74.1 million and $173.9 million, respectively. For both 2011 and 2010, we determined the fair value of the outstanding balances of our notes using readily available market information.

Foreign Currency Exchange Risk

In connection with our continuing expansion efforts, we now conduct business throughout Europe in several currencies, including the euro, Swiss franc and British pound, among others. Therefore, we are exposed to adverse movements in foreign currency exchange rates. To limit the exposure related to foreign currency changes, we enter into foreign currency contracts. The Company does not enter into such contracts for trading or speculative purposes.

We enter into foreign exchange forward contracts to reduce the short-term effects of foreign currency fluctuations on assets and liabilities such as foreign currency receivables and payables. These derivatives are not designated as hedging instruments. Gains and losses on the contracts are included in other income (expense) and substantially offset foreign exchange gains and losses from the remeasurement of intercompany balances or other current assets or liabilities denominated in currencies other than the functional currency of the reporting entity.

The Company’s foreign exchange forward contracts expose us to credit risk to the extent that the counterparties may be unable to meet the terms of the agreement. The Company does, however, seek to mitigate such risks by limiting its counterparties to major financial institutions. In addition, the potential risk of loss with any one counterparty resulting from this type of credit risk is monitored. Management does not expect material losses as a result of defaults by counterparties.

 

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Inventory Valuation

Inventories are stated at the lower of cost or market. Cost is determined by the specific identification method. Inventories were $6.2 million and $1.2 million at December 31, 2011 and December 31, 2010, respectively, and consisted of $5.5 million of Esbriet and $0.7 million of Actimmune.

Because of the long lead times required to manufacture Actimmune and Esbriet, we enter into purchase obligations to satisfy our estimated inventory requirements. We evaluate the need to provide reserves for contractually committed future purchases of inventory that may be in excess of forecasted future demand. In making these assessments, we are required to make judgments as to the future demand for current as well as committed purchases. We are also required to make judgments as to the expiration dates since the products are not usable beyond their expiration date. As part of our excess inventory assessment for Actimmune and Esbriet, we also consider the expiration dates of future manufactured quantities under these purchase obligations.

During the years ended December 31, 2010 and 2009 we charged $0.5 million and $0.3 million, respectively, to cost of goods sold for inventory write downs resulting from the estimated excess of inventory compared to forecasted inventory requirements. We did not have any inventory write downs during the year ended 2011.

Concentration of Risks

Cash equivalents and investments are financial instruments that potentially subject us to concentration of risk to the extent recorded on the balance sheet. We have established guidelines for investing excess cash utilizing diversification strategies and maturities that we believe maintain safety and liquidity. The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we invest our excess cash in debt instruments of the U.S. federal and state governments and their agencies and high-quality corporate issuers, and, by policy, restrict our exposure to any single corporate issuer by imposing concentration limits. To reduce our exposure due to adverse shifts in interest rates we maintain investments with relatively short effective maturities.

Property and Equipment

Property and equipment are stated at cost and depreciated using the straight-line method over the estimated useful lives of the assets as follows:

 

     Useful Lives

Computer and laboratory equipment

   3 to 5 years

Office furniture and fixtures

   3 to 5 years

Leasehold improvements

   Length of lease

Acquired Product Rights

Initial payments for the acquisition of products that, at the time of acquisition, are already marketed or are approved by the FDA or the European Commission (“EC”) for marketing are capitalized and amortized ratably over the estimated life of the products. At the time of acquisition, the product life is estimated based upon the term of the agreement, the remaining patent life of the product and our assessment of future sales and profitability of the product, which we currently estimate to be 20 years. We assess this estimate regularly during the amortization period and adjust the asset value and/or useful life when appropriate. Initial payments for the acquisition of products that, at the time of acquisition, are under development or are not approved by the FDA or EC for marketing, have not reached technical feasibility and have no foreseeable alternative future uses are expensed as research and development costs.

 

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Impairment of Long-Lived Assets

In accordance with ASC Topic No. 360, previously referred to as Statement of Financial Accounting Standard (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” if indicators of impairment exist, we assess the recoverability of the affected long-lived assets by determining whether the carrying value of such assets can be recovered through undiscounted future operating cash flows. If impairment is indicated, we will measure the amount of such impairment by comparing the carrying value of the asset to the present value of the expected future cash flows associated with the use of the asset. We have recognized no impairment losses on long-lived assets during the three years ended December 31, 2011.

Revenue Recognition and Revenue Allowances

We recognize revenue from product sales generally upon delivery when title passes to a credit-worthy customer and record provisions for estimated returns, rebates, chargebacks and cash discounts against revenue. We are obligated to accept from customers the return of pharmaceuticals that have reached their expiration date. We believe that we are able to make reasonable and reliable estimates of product returns, rebates, chargebacks and cash discounts based on historical experience and other known or anticipated trends and factors. We review all sales transactions for potential rebates, chargebacks and discounts each month and believe that our reserves are adequate. We include shipping and handling costs in cost of goods sold.

Our European revenue from sales of Esbriet began in September 2011 and has been limited to Germany up through the end of 2011. We only ship product upon receipt of valid orders from customers such as pharmacies and hospitals which are in turn a result of actual patient prescriptions. Pursuant to German Medicinal Products Law, a customer has no right to return the product; therefore we have not established a reserve for product returns, though we have established a reserve for the mandatory rebate as allowed under the applicable German health care regulations.

Our revenue arrangements with multiple elements are divided into separate units of accounting if certain criteria are met, including whether the delivered element has stand-alone value to the customer and whether there is objective and reliable evidence of the fair value of the undelivered items. The consideration we receive is allocated among the separate units based on their respective fair values, and the applicable revenue recognition criteria are applied to each of the separate units. Advance payments received in excess of amounts earned are classified as deferred revenue until earned.

Collaboration revenue derived from our 2006 agreement with Roche includes upfront license fees and milestone payments. Nonrefundable upfront license fees that require our continuing involvement in the form of research, development, or other commercialization efforts by us are recognized as revenue ratably over the estimated term of our continuing involvement. Milestone payments received under our collaboration agreements that relate to events that are substantive and at risk at the initiation of the agreement are recognized as revenue when the milestones, as defined in each respective contract, are achieved and collectibility of the milestone is assured.

In December 2010, we entered into a new agreement with Roche that focused on research to identify and develop next-generation protease inhibitors for the treatment of HCV. Under terms of the agreement, Roche funded all research costs related to the programs for the period from July 1, 2010 through June 30, 2011, the effective term of the research program. During 2011, we received $2.6 million from Roche as a reimbursement for research services performed which has been recorded as collaboration revenue. We will also be entitled to receive certain milestones and royalties in connection with the continued development and commercialization by Roche of any licensed compounds resulting from the research program.

Research and Development Expenses

Research and development (“R&D”) expenses include salaries, contractor and consultant fees, external clinical trial expenses performed by contract research organizations (“CRO”), licensing fees, acquired intellectual

 

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property with no alternative future use and facility and administrative expense allocations. In addition, we fund R&D at research institutions under agreements that are generally cancelable at our option. Research costs typically consist of applied research and preclinical and toxicology work. Pharmaceutical manufacturing development costs consist of product formulation, chemical analysis and the transfer and scale-up of manufacturing at our contract manufacturers. Clinical development costs include the costs of Phase 1, Phase 2 and Phase 3 clinical trials. These costs are a significant component of our research and development expenses.

We accrue costs for clinical trial activities performed by contract research organizations and other third parties based upon the estimated amount of work completed on each study as provided by the CRO. These estimates may or may not match the actual services performed by the organizations as determined by patient enrollment levels and related activities. We monitor patient enrollment levels and related activities using available information; however, if we underestimate activity levels associated with various studies at a given point in time, we could be required to record significant additional R&D expenses in future periods when the actual activity level becomes known. We charge all such costs to R&D expenses. Non-refundable advance payments are capitalized and expensed as the related goods are delivered or services are performed.

Collaboration agreements with co-funding arrangements resulting in a net receivable or payable for R&D expenses are recognized as the related R&D expenses by both parties are incurred. As a result of the termination of the 2006 collaboration agreement with Roche in October 2010, there were no such payables or receivables recorded at December 31, 2011 or December 31, 2010. Reimbursements from Roche under the 2006 agreement had been credited directly to R&D expense and amounted to $4.4 million for the year ended December 31, 2010.

Advertising Costs

We expense advertising costs as incurred. We incurred approximately $0.1 million of advertising costs in 2011 and none in 2010 or 2009.

Commitments and Contingencies

From time to time, the Company may be a party to various legal proceedings related to its business, including but not limited to civil complaints and matters relating to our Indemnity agreement with our former chief executive officer. This agreement obligates us to advance all expenses, including attorneys’ fees, incurred by our former chief executive officer in connection with any legal or similar proceeding, subject to initial coverage of these expenses through our insurance policies. Our policy is to accrue for defense costs as the related legal services are performed on our behalf and on behalf of our former chief executive officer, who has exhausted all insurance coverage previously available under our original indemnity agreement with him. Given our former chief executive officer has appealed his recent sentence, we expect to continue to indemnify him for reasonable legal fees and costs incurred in connection with his defense for the foreseeable future until the legal proceeding against him is finally completed with no further right to appeal. See Note 16.

Income Taxes

We adopted the provisions of ASC Topic No. 740 on January 1, 2007. This guidance requires companies to determine whether it is “more likely than not” that a tax position will be sustained upon examination by the appropriate taxing authorities before any tax benefit can be recorded in the financial statements. It also provides guidance on the recognition, measurement, classification and interest and penalties related to uncertain tax positions.

We file income tax returns in the U.S. federal and various state and local as well as foreign jurisdictions. Tax years beginning in 1998 through 2010 remain open to examination by the major taxing authorities to which we are subject. Our policy is to record interest related to uncertain tax positions as interest and any penalties as other expense in our statement of operations. As of the date of adoption of this guidance and through December 31, 2011, we did not have any interest or penalties associated with unrecognized tax benefits.

 

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Comprehensive Income (Loss)

ASC Subtopic No. 220-10, previously referred to as SFAS No. 130, “Reporting Comprehensive Income,” requires components of other comprehensive income, including unrealized gains or losses on our available-for-sale securities, to be included in total comprehensive income (loss). Total comprehensive income (loss) for each of the periods presented is disclosed in Note 12 below. Other comprehensive income (loss) includes certain changes in stockholders’ equity (deficit) that are excluded from net loss. Specifically, we include in other comprehensive income (loss) changes in the fair value of our available-for-sale investments, foreign currency translation adjustments and derivatives, if any, designated as cash flow hedges.

Net (Loss) Income Per Share

We compute basic net (loss) income per share by dividing the net (loss) income for the period by the weighted average number of common shares outstanding during the period, as adjusted. We deduct shares subject to repurchase by us from the outstanding shares to arrive at the weighted average shares outstanding. We compute diluted net income per share by dividing the net income for the period by the weighted average number of common and potential common shares outstanding during the period. The dilutive effect of potentially dilutive securities is reflected in diluted earnings per common share by application of the treasury stock method. For the computation of net loss per share we exclude dilutive securities, composed of potential common shares issuable upon the exercise of stock options and common shares issuable on conversion of our convertible notes, because of their anti-dilutive effect.

For the calculation of net loss per share, securities excluded were as follows (in thousands):

 

     As of December 31,  
     2011      2010      2009  

Common stock options

     4,112         —           4,707   

Shares issuable upon conversion of convertible notes

     9,384         —           6,581   

The following table is a reconciliation of the numerator and denominator used in the calculation of basic and diluted net (loss) income per share attributable to our common stockholders (in thousands, except per share data):

 

     Year Ended December 31,  
     2011     2010     2009  

Numerator:

      

Net (loss) income used in the calculation of net (loss) income per share—basic

   $ (154,774   $ 122,374      $ (116,020

Add: Amortization of convertible debt discount

     —          3,776        —     

Amortization of convertible debt issuance costs

     —          214        —     

Convertible debt interest expense

     —          4,358        —     
  

 

 

   

 

 

   

 

 

 

Net (loss) income used in the calculation of net (loss) income per share—diluted

   $ (154,774   $ 130,722      $ (116,020
  

 

 

   

 

 

   

 

 

 

Denominator:

      

Weighted-average shares of common stock outstanding

     61,071        55,083        44,987   

Less: weighted-average shares subject to repurchase

     (971     (881     (640
  

 

 

   

 

 

   

 

 

 

Weighted-average shares used in computing net (loss) income per share—basic

     60,100        54,202        44,347   

Add: convertible debt shares

     —          6,581        —     

Add: weighted-average stock options outstanding (treasury stock method)

     —          594        —     
  

 

 

   

 

 

   

 

 

 

Weighted-average shares used in computing net (loss) income per share—diluted

     60,100        61,377        44,347   
  

 

 

   

 

 

   

 

 

 

 

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The calculation of basic and diluted net income (loss) per share is as follows (in thousands, except per share data):

 

     Year Ended December 31,  
     2011     2010      2009  

Net (loss) income used in the calculation of net (loss) income per share—basic

   $ (154,774   $ 122,374       $ (116,020

Net (loss) income used in the calculation of net (loss) income per share—diluted

   $ (154,774   $ 130,722       $ (116,020

Per common share:

       

Continuing operations—basic

   $ (2.58   $ 2.26       $ (2.62

Net (loss) income—basic

     (2.58     2.26         (2.62
  

 

 

   

 

 

    

 

 

 

Continuing operations—diluted

   $ (2.58     2.13         (2.62

Net (loss) income—diluted

     (2.58   $ 2.13       $ (2.62
  

 

 

   

 

 

    

 

 

 

Shares used in computing basic net (loss) income per share

     60,100        54,202         44,347   

Shares used in computing diluted net (loss) income per share

     60,100        61,377         44,347   

Stock-Based Compensation

ASC 718-10, previously referred to as SFAS 123(R), requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our Consolidated Statement of Operations. Upon adoption, we retained our method of valuation for share-based awards granted beginning in fiscal 2006 with the use of the Black-Scholes option-pricing model (“Black-Scholes model”). Our determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to our expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors.

As stock-based compensation expense recognized in the Consolidated Statement of Operations for fiscal years 2011, 2010 and 2009 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. ASC 718-10 requires forfeitures to be estimated at the time of grant and adjusted, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Stock-based compensation expense recognized under ASC 718-10 for the years ended December 31, 2011, 2010 and 2009 was $18.2 million, $10.3 million and $7.8 million, respectively. For additional information, see Note 14.

Recent Accounting Pronouncements

In June 2011, the FASB issued ASU No. 2011-05, Presentation of Comprehensive Income. This ASU gives an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU No. 2011-05 is effective on a retrospective basis for us on January 1, 2012. We do not expect that this new guidance will have a material impact on our consolidated financial statements.

In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This ASU is the result of joint efforts by the FASB and International Accounting Standards Board to develop a single, converged fair value framework. While this ASU is largely consistent with existing fair value measurement principles in U.S. GAAP, it expands ASC No. 820, Fair Value Measurement existing disclosure requirements for fair value measurements and makes other amendments. Many of these

 

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amendments were made to eliminate unnecessary wording differences between U.S. GAAP and International Financial Reporting Standards, which could change how fair value measurement guidance in ASC 820 is applied. ASU No. 2011-04 is effective on a prospective basis for us on January 1, 2012. We are currently evaluating whether this new guidance will have a material impact on our consolidated financial statements.

 

3. RESTRUCTURING CHARGES

Following our receipt of a Complete Response Letter from the FDA requesting an additional clinical trial to evidence the efficacy of pirfenidone, we initiated a reduction in force in May 2010 resulting in an aggregate restructuring charge of approximately $1.3 million during 2010, consisting of severance and benefits payments made to terminated employees.

Following the completion and announcement of our CAPACITY trial results, we initiated a reduction in force in February 2009 upon which we incurred approximately $0.7 million of restructuring charges consisting of severance payments to terminated employees.

The activity in the accrued restructuring balance, included within accrued compensation on the balance sheet, was as follows for 2009 and 2010 (in thousands):

 

     Restructuring
Liabilities at
December 31,
2008
     Charges      Cash
Payments
    Restructuring
Liabilities at
December 31,
2009
     Charges      Cash
Payments
    Restructuring
Liabilities at
December 31,
2010
 

Workforce reduction

   $ 38       $ 697       $ (735   $ —         $ 1,300       $ (1,300   $ —     

 

4. SALE OF DANOPREVIR RIGHTS

In October 2010, we sold our worldwide development and commercialization rights in danoprevir to Roche for $175.0 million in cash, all of which was included in collaboration revenue in our Consolidated Statement of Operations for the year ended December 31, 2010. Upon closing, we have no further deliverables or continuing obligations under this collaboration. In connection with this transaction, the collaboration agreement that we and Roche entered into in October 2006 along with its amendments was terminated which resulted in the accelerated recognition of approximately $57.3 million in previously deferred revenue. This amount is included in collaboration revenue in our Consolidated Statement of Operations for the year ended December 31, 2010.

 

5. INVESTMENT IN TARGANTA COMMON STOCK

In 2001, we entered into an asset purchase and license agreement with Eli Lilly pursuant to which we acquired worldwide rights to oritavancin. The agreement provided us with exclusive worldwide rights to develop, manufacture and commercialize oritavancin.

In December 2005, we sold the oritavancin compound to Targanta Therapeutics (“Targanta”). The terms of the agreement included upfront and clinical related contingent milestone payments of up to $9.0 million, of which $4.0 million had been received through March 31, 2009. We also received a convertible promissory note that, assuming certain clinical milestones were achieved, could have been valued at up to $25.0 million in principal amount from Targanta, which note was initially secured by the oritavancin assets. Upon the achievement by Targanta of certain corporate objectives, the notes were designed to convert into capital stock of Targanta, subject to certain limitations in the amount of voting stock that we could hold. Effective February 2007, these objectives were met by Targanta and, upon conversion of the promissory note, we received approximately 1.7 million shares of Targanta Series C preferred stock in exchange for the convertible promissory note. In October 2007, Targanta completed an initial public offering of its common stock at a price of $10.00 per share. Upon completion of the offering, our investment in Targanta was automatically converted into approximately 3.0 million shares of Targanta common stock and warrants to purchase approximately 0.1 million additional shares of Targanta common stock. These shares had been restricted for resale and were subject to a lock-up agreement that expired in April 2009.

 

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In January 2009, The Medicines Company announced its intent to acquire Targanta for $2.00 per share, or approximately $42.0 million and on January 27, 2009 commenced a tender offer to acquire all outstanding shares of Targanta. We tendered our shares and received approximately $6.0 million in March 2009 upon closing of the transaction, which has been included in other income in our consolidated statements of operations for the year ended December 31, 2009. We may also receive up to an additional $4.05 per share in contingent cash payments upon the achievement of specified regulatory and commercial milestones. No amounts related to this contingent consideration had been received through December 31, 2011.

 

6. ACQUIRED PRODUCT RIGHTS AND LICENSES

Marnac, Inc./KDL GmbH (Pirfenidone)

In 2002, we licensed from Marnac and its co-licensor, KDL, their worldwide rights (excluding Japan, Korea and Taiwan) to develop and commercialize pirfenidone for all fibrotic diseases, including renal, liver and pulmonary fibrosis. Under the agreement terms, we received an exclusive license from Marnac and KDL in exchange for an up-front cash payment of $18.8 million and future milestone and up to 9% royalty payments. Effective November 2007, we entered into asset purchase agreements with Marnac and KDL whereby we effectively terminated the prior license agreement by purchasing, among other things, the pirfenidone-related assets covered by such prior license agreement. Under the terms of the asset purchase agreements, we made payments of approximately $13.7 million. We also made a milestone payment of $13.5 million in March 2009 in connection with our decision to proceed with regulatory approval for pirfenidone. In March 2011, we received authorization to market Esbriet (pirfenidone) in the European Union and made a milestone payment of $20.0 million in the aggregate to Marnac and KDL and have capitalized such payment as acquired product rights. This asset is being amortized to cost of goods sold over the estimated useful life of Esbriet of twenty years and we incurred approximately $0.8 million of amortization expense in 2011. Amortization expense for each of the next five years is expected to be $1.0 million per year. A future contingent payment of up to an additional $20.0 million is required to be made by us only if positive Phase 3 data and product approval in the United States is achieved. The asset purchase agreements do not affect the rights to pirfenidone in Japan, Korea and Taiwan, which rights are licensed by Marnac and KDL to Shionogi & Company LTD (“Shionogi”). Since the original 2002 license agreement has been effectively terminated as a result of our acquisition of such pirfenidone-related assets from Marnac and KDL, we no longer have milestone or royalty obligations thereunder.

The following table reflects our acquired product rights under these agreements (in thousands):

 

     As of December 31,  
     2011      2010  

Gross carrying amount

   $ 20,000       $ —     

Accumulated amortization

     750         —     
  

 

 

    

 

 

 

Net carrying amount

   $ 19,250         —     
  

 

 

    

 

 

 

Genentech, Inc. License Agreement (Actimmune®)

In 1998, we obtained a license from Genentech, Inc. (“Genentech”) through Connetics Corporation (“Connetics”) for patents relating to Actimmune. The license from Genentech terminates on the later of May 5, 2018 or the date that the last of the patents licensed under the agreement expires. Our licensed Actimmune rights include exclusive and non-exclusive licenses. The exclusive licenses include the right to develop and commercialize Actimmune in the United States and Canada for the treatment and prevention of all human diseases and conditions, including infectious diseases, pulmonary fibrosis and cancer, but excluding arthritis and cardiac and cardiovascular diseases and conditions. The non-exclusive licenses include the right to make or have made Actimmune for clinical and commercial purposes within our field of use in the United States and Canada. In Japan, we have the exclusive license rights to commercialize Actimmune for the treatment and prevention of all infectious diseases caused by fungal, bacterial or viral agents, including in patients with CGD or osteopetrosis. We

 

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also have the opportunity, under specified conditions, to obtain further rights to Actimmune in Japan and other countries. In addition, we received an exclusive sublicense under certain of Genentech’s patents outside the United States, Canada and Japan under the BI agreement discussed below. Under the Genentech license, we pay Genentech royalties on the revenue from sales of Actimmune based on a royalty rate of 45% for the first $3.7 million of revenue and 10% for any additional revenue, and are required to make one-time payments to Genentech upon the occurrence of specified milestone events, which include the submission of a BLA with the FDA for approval to market Actimmune for the treatment of particular categories of diseases, the receipt of FDA approval to market Actimmune for the treatment of particular categories of diseases and the achievement of certain annual revenue targets for Actimmune. We made royalty payments of approximately $90.1 million in the aggregate, but no milestone payments, under this agreement through December 31, 2011. If all of the milestones under this agreement are achieved, we would be required to make further milestone payments of $9.6 million, although we have no further development plans for Actimmune. Our rights to certain therapeutic uses for Actimmune under this agreement could revert to Genentech if we commit a material breach of the agreement.

Connetics Corporation (acquired by Stiefel Laboratories, Inc.) (Actimmune®)

Through an assignment and option agreement with Connetics, we paid Connetics $5.7 million to acquire rights to Actimmune and are obligated to pay to Connetics a royalty of 0.25% of our net United States sales for Actimmune until our net United States sales cumulatively surpass $1.0 billion. Above $1.0 billion, we are obligated to pay a royalty of 0.5% of our net United States sales of Actimmune. Through a separate purchase agreement, we paid Connetics $0.4 million to acquire rights related to scleroderma and are obligated to pay Connetics a royalty of 4.0% on our net revenue from sales of Actimmune for the treatment of scleroderma. We made royalty payments of approximately $1.9 million in the aggregate through December 31, 2011. There are no milestone payments pursuant to this agreement.

Novartis Corporation (Small Molecule Therapeutics)

In 2004, we entered into a license agreement with Novartis which granted us the right to discover, develop and commercialize small molecule therapeutic agents against certain HCV targets that are covered by patents owned by Novartis. In consideration for this license, we paid Novartis a nonrefundable fee of approximately $0.4 million in 2004 and are required to make milestone payments based on the clinical progress of danoprevir. In 2006, we expensed $0.5 million upon initiation of the Phase 1a clinical trials for danoprevir, and made a milestone payment of approximately $0.8 million in 2009 associated with the initiation of the Phase 2b clinical trial for danoprevir. Assuming that all of the remaining milestones under this agreement are achieved, we will be required to make future milestone payments of $3.8 million, of which Roche has agreed to reimburse us in connection with our sale of danoprevir to Roche. In addition, Novartis is entitled to receive royalties on future product sales of danoprevir based on royalty rates that are in the single digits. The agreement with Novartis provides that the Company’s obligation to make milestone payments and pay royalties will extend until August 24, 2024, notwithstanding the expiration of the last valid patent covered by the agreement. Novartis has the right to terminate the agreement at its sole discretion in the event of a material uncured breach by the Company or if the Company challenges patents covered by the agreement, as set forth in the agreement. The agreement is also subject to certain customary provisions regarding termination upon a bankruptcy event, as set forth in the agreement.

 

7. SPONSORED RESEARCH AND COLLABORATION AGREEMENTS

2010 Roche Collaboration Agreement (Protease Inhibitors)

In December 2010, we entered into a new agreement with Roche that will focus on research to identify and develop next-generation protease inhibitors for the treatment of HCV. Under terms of the agreement, Roche will fund all research costs related to the programs for the term of the research program, July 1, 2010 to June 30, 2011. The deliverable in this arrangement consists solely of research services performed by us on behalf of

 

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Roche. For the years ended December 31, 2011 and 2010, we received approximately $2.6 million and $4.5 million, respectively, in reimbursements under this agreement that was recorded as collaboration revenue.

2006 Roche License and Collaboration Agreement (Protease Inhibitors)

In October 2006 we entered into a collaboration agreement with Roche. Under the arrangement, we agreed to collaborate with Roche to develop and commercialize products from our HCV protease inhibitor program. The collaboration agreement included our former lead candidate danoprevir compound, which entered Phase 2b clinical trials in 2009. We also agreed to collaborate with Roche on a research program to identify, develop and commercialize novel second-generation HCV protease inhibitors.

Under the terms of the Roche collaboration agreement, we agreed to conduct Phase 1 studies of danoprevir, and thereafter Roche agreed to lead clinical development and commercialization. Upon entering into the agreement, we received an upfront payment of $60.0 million from Roche. The agreement provided for us to potentially receive up to an aggregate of $470.0 million in milestone payments. One such milestone payment of $10.0 million was received in January 2007, which was not deemed to be substantive and at-risk at the execution of the Collaboration Agreement. Therefore, the upfront payment of $60.0 million and this $10.0 million milestone payment were deferred and were recognized ratably as collaboration revenue over the previous estimated life of the collaboration agreement and our expected period of continued involvement in the arrangement. In 2007, 2008 and 2009 we also received $10.0 million, $15.0 million and $20.0 million in milestone payments, respectively, which were recognized as revenue upon receipt. Roche agreed to fund 67% of the global development costs of danoprevir and, upon approval for commercialization by the FDA, we agreed to co-commercialize the product in the United States and share profits on a 50-50 basis with Roche. We were also entitled to receive royalties on any sales of the product outside of the United States. In November 2008, October 2009 and April 2010, we amended the Roche collaboration agreement among other things to extend the research program (and consequently the research exclusivity period whereby each party was prohibited from engaging in certain competitive research activities) for an additional amount of time and to provide for certain funding by Roche of activities taking place during such extended research period.

Our collaboration revenue for the years ended December 31, 2010, and 2009 includes the recognition of deferred revenue of $2.5 million and $3.3 million, respectively.

In October 2010, we sold our worldwide development and commercialization rights in danoprevir to Roche for $175.0 million in cash that was recorded as revenue in 2010. In connection with this transaction, the collaboration agreement that we and Roche entered into in October 2006, along with subsequent amendments, was terminated which resulted in the accelerated recognition of approximately $57.3 million in previously deferred revenue in the fourth quarter of 2010. As part of the arrangement, Roche agreed to reimburse us for royalty and milestone obligations that we continue to have to Novartis Corporation and Array related to danoprevir.

Array BioPharma Inc. (Small Molecule Therapeutics)

In 2002, we entered into a drug discovery collaboration agreement to create small molecule therapeutics targeting HCV with Array. Joint research activities under this agreement expired in June 2007, however Array will continue to be entitled to receive milestone payments and low single-digit royalties in connection with the development and commercialization of compounds derived from the collaborative efforts. In December 2004, the agreement was amended to provide a mechanism for us to purchase Array’s interest in certain co-owned intellectual property rights arising from the collaboration, subject to ongoing milestone and royalty payments. In late 2004, we purchased Array’s co-ownership rights in danoprevir, subject to ongoing milestone and royalty obligations. In April 2005, we initiated a second research collaboration with Array with respect to a new hepatology target and have since terminated that agreement. We made a milestone payment of $1.0 million under this agreement in 2009 associated with the initiation of the Phase 2b clinical study of danoprevir. We did not make any payments to Array

 

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in 2011 or 2010. Assuming that all of the remaining milestones under the Array agreements are achieved, we will be required to make future milestone payments of $7.5 million, of which Roche has agreed to reimburse us in connection with our sale of danoprevir to Roche. The provisions of this license agreement also continue to apply to certain of our pre-clinical HCV compounds discovered in collaboration with Array.

 

8. DERIVATIVE INSTRUMENTS

In connection with our continuing expansion efforts, we now conduct business throughout Europe in several currencies, including the euro, Swiss franc and British pound, among others. Therefore, we are exposed to adverse movements in foreign currency exchange rates. To limit the exposure related to foreign currency changes, we enter into foreign currency contracts. The Company does not enter into such contracts for trading or speculative purposes. In the fourth quarter of 2011, the Company established a foreign currency hedging program.

We enter into foreign exchange forward contracts to reduce the short-term effects of foreign currency fluctuations on assets and liabilities such as foreign currency receivables and payables. These derivatives are not designated as hedging instruments. Gains and losses on the contracts are included in other income (expense) and substantially offset foreign exchange gains and losses from the remeasurement of intercompany balances or other current assets or liabilities denominated in currencies other than the functional currency of the reporting entity. Our net gains from entering into derivative financial instruments not designated as hedges in 2011 was approximately $0.6 million. The notional value of our outstanding currency hedges at December 31, 2011 was approximately 11.4 million euros and the fair value of these outstanding derivatives at December 31, 2011 was zero.

The Company’s foreign exchange forward contracts expose us to credit risk to the extent that the counterparties may be unable to meet the terms of the agreement. The Company does, however, seek to mitigate such risks by limiting its counterparties to major financial institutions. In addition, the potential risk of loss with any one counterparty resulting from this type of credit risk is monitored. The Company does not generally require collateral to be pledged under these agreements. Management does not expect material losses as a result of defaults by counterparties.

 

9. FAIR VALUE

In accordance with portions of ASC Topic No. 820, formerly SFAS 157, the following table represents the fair value hierarchy for our financial assets measured at fair value on a recurring basis as of December 31, 2011 and December 31, 2010 (in thousands):

 

December 31, 2011

   Level 1      Level 2      Level 3      Total  

Money market funds

   $ 82,693       $ —         $ —         $ 82,693   

Obligations of government-sponsored enterprises

     —           140,887         —           140,887   

Corporate debt securities