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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For quarterly period ended June 30, 2012

Commission File Number 001-14169

 

 

HUMAN GENOME SCIENCES, INC.

(Exact name of registrant)

 

 

 

Delaware   22-3178468
(State of organization)  

(I.R.S. Employer

Identification Number)

14200 Shady Grove Road, Rockville, Maryland 20850-7464

(Address of principal executive offices and zip code)

(301) 309-8504

(Registrant’s telephone number)

 

 

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

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

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

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨    Smaller reporting company   ¨

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

The number of shares of the registrant’s common stock outstanding on June 30, 2012 was 199,985,391.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

     Page Number

PART I.

 

FINANCIAL INFORMATION

  

Item 1.

 

Financial Statements

  
 

Consolidated Statements of Operations and Comprehensive Loss for the three and six months ended June 30, 2012 and 2011

   3
 

Consolidated Balance Sheets at June 30, 2012 and December 31, 2011

   4
 

Consolidated Statements of Cash Flows for the six months ended June 30, 2012 and 2011

   5
 

Notes to Consolidated Financial Statements

   7

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   20

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

   31

Item 4.

 

Controls and Procedures

   32

PART II.

 

OTHER INFORMATION

  

Item 1A.

 

Risk Factors

   33

Item 6.

 

Exhibits

   56
 

Signatures

   57
 

Exhibit Index

   Exhibit Volume

 

2


Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

HUMAN GENOME SCIENCES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE LOSS

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     2012     2011  
     (in thousands, except share and per share amounts)  

Revenue:

        

Product sales

   $ 44,573      $ 20,644      $ 81,949      $ 34,754   

Manufacturing and development services

     15,489        4,000        24,996        16,264   

Research and development collaborative agreements

     280        214        525        412   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     60,342        24,858        107,470        51,430   
  

 

 

   

 

 

   

 

 

   

 

 

 

Costs and expenses:

        

Cost of product sales

     7,881        11,609        16,160        21,608   

Cost of manufacturing and development services

     21,774        6,741        41,274        18,340   

Research and development expenses

     35,439        33,403        75,008        117,887   

Selling, general and administrative expenses

     51,234        39,436        91,521        74,557   

Commercial collaboration expenses

     19,205        2,163        34,881        5,248   

Facility-related exit credits

     —          —          —          (1,717
  

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

     135,533        93,352        258,844        235,923   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

     (75,191     (68,494     (151,374     (184,493

Investment income

     1,818        2,922        3,817        6,174   

Interest expense

     (19,524     (15,452     (38,903     (30,728

Other income (expense)

     96        364        164        (2,608
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before taxes

     (92,801     (80,660     (186,296     (211,655

Income tax expense

     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ (92,801   $ (80,660   $ (186,296   $ (211,655
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted net income (loss) per share

   $ (0.46   $ (0.42   $ (0.93   $ (1.12
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding, basic and diluted

     199,590,123        190,276,862        199,281,168        189,680,061   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive loss

   $ (93,420   $ (80,247   $ (185,213   $ (212,653
  

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying Notes to Consolidated Financial Statements are an integral part hereof.

 

3


Table of Contents

HUMAN GENOME SCIENCES, INC.

CONSOLIDATED BALANCE SHEETS

 

     June 30,
2012
    December 31,
2011
 
     (in thousands)  

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 349,958      $ 402,049   

Marketable securities

     120,209        119,234   

Accounts receivable

     58,326        54,758   

Collaboration receivables

     32,409        23,013   

Inventory

     22,763        41,659   

Prepaid expenses and other current assets

     10,497        9,388   
  

 

 

   

 

 

 

Total current assets

     594,162        650,101   

Marketable securities, non-current

     204,187        279,958   

Property, plant and equipment (net of accumulated depreciation)

     245,072        251,026   

Restricted investments

     79,661        80,193   

Collaboration receivables, non-current

     5,691        22,630   

Inventory, non-current

     135,833        111,822   

Other assets

     11,044        11,846   
  

 

 

   

 

 

 

TOTAL ASSETS

   $ 1,275,650      $ 1,407,576   
  

 

 

   

 

 

 

Liabilities and Stockholders’ Equity

    

Current liabilities:

    

Accounts payable and accrued expenses

   $ 49,495      $ 47,453   

Accrued payroll and related taxes

     29,207        34,339   

Convertible debt

     205,458        198,037   

Collaboration payable

     36,905        33,230   

Deferred revenues

     9,614        9,452   

Other current liabilities

     1,046        1,038   
  

 

 

   

 

 

 

Total current liabilities

     331,725        323,549   

Convertible debt, non-current

     371,022        363,698   

Lease financing

     252,815        252,105   

Other liabilities

     19,440        11,805   
  

 

 

   

 

 

 

Total liabilities

     975,002        951,157   
  

 

 

   

 

 

 

Stockholders’ equity:

    

Preferred stock

     —          —     

Common stock

     2,000        1,988   

Additional paid-in capital

     3,280,308        3,250,878   

Accumulated other comprehensive income

     5,639        4,556   

Accumulated deficit

     (2,987,299     (2,801,003
  

 

 

   

 

 

 

Total stockholders’ equity

     300,648        456,419   
  

 

 

   

 

 

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

   $ 1,275,650      $ 1,407,576   
  

 

 

   

 

 

 

The accompanying Notes to Consolidated Financial Statements are an integral part hereof.

 

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HUMAN GENOME SCIENCES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     Six Months Ended
June 30,
 
     2012     2011  
     (in thousands)  

Cash flows from operating activities:

    

Net income (loss)

   $ (186,296   $ (211,655

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

    

Stock-based compensation expense

     21,365        15,050   

Depreciation and amortization

     12,240        10,754   

Amortization of debt discount

     14,745        12,323   

Charge for impaired investment

     —          2,909   

Facility-related exit credits

     —          (1,717

Accrued interest on marketable securities and restricted investments

     (201     124   

Other

     1,444        1,969   

Changes in operating assets and liabilities:

    

Accounts receivable

     (3,568     (12,386

Collaboration receivables

     7,543        (1,621

Inventory

     (4,595     (52,621

Prepaid expenses and other assets

     (1,378     (309

Accounts payable and accrued expenses

     1,834        (5,373

Accrued payroll and related taxes

     (5,132     (3,643

Collaboration payable

     3,675        11,089   

Deferred revenues

     162        677   

Other liabilities

     7,644        (704
  

 

 

   

 

 

 

Net cash used in operating activities

     (130,518     (235,134
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Purchase of marketable securities

     (28,372     (155,764

Proceeds from sale and maturities of marketable securities

     104,058        283,900   

Capital expenditures - property, plant, and equipment

     (5,245     (7,485

Release of restricted investments

     1,180        —     
  

 

 

   

 

 

 

Net cash provided by investing activities

     71,621        120,651   
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Purchase of restricted investments

     (165,240     (33,490

Proceeds from sale and maturities of restricted investments

     164,562        32,907   

Proceeds from issuance of common stock

     7,767        14,109   

Other

     (283     (1,041
  

 

 

   

 

 

 

Net cash provided by financing activities

     6,806        12,485   
  

 

 

   

 

 

 

Net decrease in cash and cash equivalents

     (52,091     (101,998

Cash and cash equivalents - beginning of period

     402,049        155,691   
  

 

 

   

 

 

 

Cash and cash equivalents - end of period

   $ 349,958      $ 53,693   
  

 

 

   

 

 

 

The accompanying Notes to Consolidated Financial Statements are an integral part hereof.

 

5


Table of Contents

SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION, NON-CASH OPERATING, INVESTING AND FINANCING ACTIVITIES

 

     Six Months Ended
June 30,
 
     2012      2011  
     (in thousands)  

Cash paid during the period for interest

   $ 22,628       $ 16,820   

During the six months ended June 30, 2012 and 2011, lease financing increased with respect to the Company’s leases with BioMed Realty Trust, Inc. (“BioMed”) by $710 and $876, respectively, on a non-cash basis. Because the payments are less than the amount of the calculated interest expense for the first nine years of the leases, the lease financing balance will increase through 2015.

The accompanying Notes to Consolidated Financial Statements are an integral part hereof.

 

6


Table of Contents

HUMAN GENOME SCIENCES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Quarter Ended June 30, 2012

(dollars in thousands, except per share data)

Note 1. Summary of Significant Accounting Policies

Basis of presentation

The accompanying unaudited consolidated financial statements of Human Genome Sciences, Inc. (the “Company” or “HGS”) have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information. In the opinion of the Company’s management, the consolidated financial statements reflect all adjustments necessary to present fairly the results of operations for the three and six months ended June 30, 2012 and 2011, the Company’s financial position as of June 30, 2012, and the cash flows for the six months ended June 30, 2012 and 2011. These adjustments are of a normal recurring nature. Certain prior period balances have been reclassified to conform with current period presentation.

Certain notes and other information have been condensed or omitted from the interim consolidated financial statements presented in this Quarterly Report on Form 10-Q. Therefore, these financial statements should be read in conjunction with the Company’s 2011 Annual Report on Form 10-K.

The results of operations for the three and six months ended June 30, 2012 are not necessarily indicative of future financial results.

Recent accounting pronouncements

In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-04, Fair Value Measurement (Topic 820) (“ASU 2011-04”), which contains amendments to achieve common fair value measurement and disclosures in U.S. GAAP and International Financial Reporting Standards. ASU 2011-04 explains how to measure fair value for financial reporting. The guidance does not require fair value measurements in addition to those already required or permitted by other Topics. This ASU was effective for the Company beginning January 1, 2012. The adoption of ASU 2011-04 did not have a material effect on the Company’s consolidated results of operations, financial position or liquidity.

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income (“ASU 2011-05”). This guidance is intended to increase the prominence of other comprehensive income in financial statements by presenting it in either a single statement or two-statement approach. This ASU was effective for the Company beginning January 1, 2012. The adoption of ASU 2011-05 did not have any effect on the Company’s consolidated results of operations, financial position or liquidity.

 

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Table of Contents

HUMAN GENOME SCIENCES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Quarter Ended June 30, 2012

(dollars in thousands, except per share data)

 

Note 2. GlaxoSmithKline Agreement and Plan of Merger

On July 16, 2012, GlaxoSmithKline (“GSK”) and HGS announced that the companies have signed a definitive merger agreement (“Merger Agreement”) providing for the acquisition of HGS by GSK for $14.25 per share in cash. The transaction has been approved by the boards of directors of both companies.

Under the terms of the definitive merger agreement, GSK amended its ongoing cash tender offer (“the Offer”) on July 16, 2012, to purchase all of the outstanding shares of HGS for $14.25 per share in cash. The closing of the tender offer is subject to customary conditions, including that there shall have been validly tendered and not validly withdrawn prior to the expiration of the Offer, when added to the number of Shares already owned by GSK, a majority of the Shares outstanding (determined on a fully diluted basis). The Merger Agreement also provides that, in connection with the termination of the Merger Agreement under specified circumstances involving competing transactions or a change in HGS’ board of directors’ recommendation, HGS may be required to pay GSK a termination fee of $115,000.

As a result of the Merger Agreement, the Company expects to pay its financial advisors (Goldman Sachs and Credit Suisse) a transaction fee payable at the closing of the transaction of approximately $25,000 each based on the offer price of $14.25 per share.

 

8


Table of Contents

HUMAN GENOME SCIENCES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Quarter Ended June 30, 2012

(dollars in thousands, except per share data)

 

Note 3. Investments

Available-for-sale investments, including accrued interest, as of June 30, 2012 and December 31, 2011 were as follows:

 

     June 30, 2012  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair
Value
 

Corporate debt securities

   $ 92,413       $ 1,617       $ —        $ 94,030   

Residential mortgage-backed securities

     18,298         297         (1     18,594   

Asset-backed securities

     7,580         5         —          7,585   
  

 

 

    

 

 

    

 

 

   

 

 

 

Subtotal - Marketable securities

     118,291         1,919         (1     120,209   
  

 

 

    

 

 

    

 

 

   

 

 

 

Corporate debt securities

     132,810         2,863         (87     135,586   

Residential mortgage-backed securities

     31,080         505         —          31,585   

Government-sponsored enterprise securities

     5,187         57         —          5,244   

Asset-backed securities

     31,735         37         —          31,772   
  

 

 

    

 

 

    

 

 

   

 

 

 

Subtotal - Marketable securities, non-current

     200,812         3,462         (87     204,187   
  

 

 

    

 

 

    

 

 

   

 

 

 

Cash and cash equivalents

     5,058         —           —          5,058   

Corporate debt securities

     53,784         299         (29     54,054   

Residential mortgage-backed securities

     9,682         41         (16     9,707   

Government-sponsored enterprise securities

     2,187         13         —          2,200   

Asset-backed securities

     8,619         23         —          8,642   
  

 

 

    

 

 

    

 

 

   

 

 

 

Subtotal - Restricted investments

     79,330         376         (45     79,661   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 398,433       $ 5,757       $ (133   $ 404,057   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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Table of Contents

HUMAN GENOME SCIENCES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Quarter Ended June 30, 2012

(dollars in thousands, except per share data)

 

Note 3. Investments (continued)

 

     December 31, 2011  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair
Value
 

Corporate debt securities

   $ 94,669       $ 1,123       $ (63   $ 95,729   

Residential mortgage-backed securities

     20,681         329         (2     21,008   

Asset-backed securities

     2,496         1         —          2,497   
  

 

 

    

 

 

    

 

 

   

 

 

 

Subtotal - Marketable securities

     117,846         1,453         (65     119,234   
  

 

 

    

 

 

    

 

 

   

 

 

 

Corporate debt securities

     177,725         2,866         (726     179,865   

Residential mortgage-backed securities

     47,158         737         (4     47,891   

Government-sponsored enterprise securities

     5,230         51         —          5,281   

Asset-backed securities

     46,881         49         (9     46,921   
  

 

 

    

 

 

    

 

 

   

 

 

 

Subtotal - Marketable securities, non-current

     276,994         3,703         (739     279,958   
  

 

 

    

 

 

    

 

 

   

 

 

 

Cash and cash equivalents

     11,649         1         —          11,650   

U.S. Treasury and agencies

     1,304         2         —          1,306   

Corporate debt securities

     51,773         316         (145     51,944   

Residential mortgage-backed securities

     5,977         30         (21     5,986   

Government-sponsored enterprise securities

     4,641         9         (1     4,649   

Asset-backed securities

     4,659         3         (4     4,658   
  

 

 

    

 

 

    

 

 

   

 

 

 

Subtotal - Restricted investments

     80,003         361         (171     80,193   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 474,843       $ 5,517       $ (975   $ 479,385   
  

 

 

    

 

 

    

 

 

   

 

 

 

The Company’s investments in mortgage-backed securities have no single maturity date and accordingly, have been allocated on a pro rata basis to each maturity range based on each maturity range’s percentage of the total value. See Note 9, Fair Value Measurements, for the fair value of the Company’s financial assets and liabilities.

The Company’s restricted investments with respect to its headquarters (“Traville”) lease serve as collateral for a letter of credit which serves as the security deposit for the duration of the lease, although the Company has the ability to reduce the restricted investments that are in the form of securities by substituting cash security deposits in the amount of $19,750 to be maintained with the landlord. Presently, to secure the security deposit letter of credit, the Company is required to maintain margin value of the collateral of at least $19,750.

The Company’s restricted investments with respect to its large-scale manufacturing facility (“LSM”) lease, as amended, will serve as collateral in favor of the landlord in lieu of providing the landlord with either a cash deposit or a standby letter of credit. Under the LSM lease, the Company is required to pledge to the landlord a minimum of $20,000 in marketable securities or provide the landlord with a $19,750 cash security deposit. As of June 30, 2012 and December 31, 2011, the Company has pledged marketable securities.

 

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HUMAN GENOME SCIENCES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Quarter Ended June 30, 2012

(dollars in thousands, except per share data)

 

Note 3. Investments (continued)

 

In addition, the Company is also required to maintain approximately $33,100 in restricted investments with respect to two leases with the Maryland Economic Development Corporation (“MEDCO”) for its small-scale manufacturing facility. The facility was financed primarily through a combination of bonds issued by MEDCO (“MEDCO Bonds”) and loans issued to MEDCO by certain State of Maryland agencies. The MEDCO Bonds are secured by letters of credit issued for the account of MEDCO which expire in December 2012. The Company is required to maintain restricted investments which serve as security for the MEDCO letters of credit reimbursement obligation.

Marketable securities and Restricted investments – unrealized losses

The Company owned 350 available-for-sale securities as of June 30, 2012. Of these 350 securities, 51 were in an unrealized loss position as of June 30, 2012. As of June 30, 2012 and December 31, 2011, the Company did not have any investments in a loss position for greater than 12 months. The Company has evaluated its marketable securities and restricted investments and has determined that none of these investments has an other-than-temporary impairment, as it has no intent to sell securities with unrealized losses and it is not more likely than not that the Company will be required to sell any securities with unrealized losses, given the Company’s current and anticipated financial position.

During March 2011, the Company determined that its investment in Aegera Therapeutics, Inc. (“Aegera”) had incurred an other-than-temporary impairment based on changes in Aegera’s business activities and wrote down its investment of approximately $3,150 to approximately $240. The impairment loss is included in Other income (expense) on the consolidated statement of operations and comprehensive loss for the six months ended June 30, 2011. In May 2011, Aegera was acquired by Pharmascience and the Company received proceeds of approximately $320 and recognized a gain on the sale of the investment of approximately $80, which is included in Other income (expense) on the consolidated statements of operations and comprehensive loss for the three and six months ended June 30, 2011.

Other Information

The following table summarizes maturities of the Company’s marketable securities and restricted investments as of June 30, 2012:

 

     Marketable Securities      Marketable Securities,
non-current
     Restricted Investments  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 

Less than one year

   $ 118,291       $ 120,209       $ —         $ —         $ 31,560       $ 31,660   

Due in year two through year three

     —           —           162,796         165,002         43,073         43,296   

Due in year four through year five

     —           —           33,208         34,299         2,014         2,016   

Due after five years

     —           —           4,808         4,886         2,683         2,689   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 118,291       $ 120,209       $ 200,812       $ 204,187       $ 79,330       $ 79,661   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

11


Table of Contents

HUMAN GENOME SCIENCES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Quarter Ended June 30, 2012

(dollars in thousands, except per share data)

 

Note 3. Investments (continued)

 

The Company’s net proceeds, realized gains and realized losses from its investments are as follows:

 

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

Proceeds on sale and maturities of investments

   $ 103,230      $ 130,057      $ 266,255      $ 306,908   

Realized gains

     123        61        151        180   

Realized losses

     (342     (336     (574     (832

Realized gains and losses on securities are included in investment income on the consolidated statements of operations and comprehensive loss. The cost of the securities sold is based on the specific identification method.

The Company recorded net unrealized losses on marketable securities of $742 and net unrealized gains on marketable securities of $1,289 in other comprehensive income during the three months ended June 30, 2012 and 2011, respectively. The Company recorded net unrealized gains on marketable securities of $536 and net unrealized losses on marketable securities of $186 in other comprehensive income during the six months ended June 30, 2012 and 2011, respectively. Reclassification adjustments out of accumulated other comprehensive income were $219 and $275 for losses realized in net loss during the three months ended June 30, 2012 and 2011, respectively. Reclassification adjustments out of accumulated other comprehensive income were $423 and $652 for losses realized in net loss during the six months ended June 30, 2012 and 2011, respectively.

Note 4. Collaborations and Other Agreements

GlaxoSmithKline Agreement

During 2006, the Company entered into a license agreement with GSK for the co-development and co-commercialization of BENLYSTA arising from an option GSK exercised in 2005, relating to an earlier collaboration agreement. The agreement grants GSK a co-development and co-commercialization license, under which both companies are jointly conducting activities related to the development and sale of products in the United States and abroad. The Company and GSK share Phase 3 and 4 development costs, and share sales and marketing expenses and profits of any product commercialized under the agreement. The Company has primary responsibility for bulk manufacturing and for commercial manufacturing of the finished drug product. In March 2011, the U.S. Food and Drug Administration (“FDA”) approved BENLYSTA and in July 2011 the European Commission granted marketing authorization for BENLYSTA.

GSK’s share of the collaboration profit with respect to BENLYSTA sales in the U.S. and HGS’ share of the rest of world (“ROW”) collaboration expense incurred by GSK are included in the Commercial collaboration expenses line in the consolidated statements of operations and comprehensive loss for the three and six months ended June 30, 2012 and 2011.

Research and development expenses for the three months ended June 30, 2012 and 2011 are net of $7,932 and $6,673, respectively, of costs reimbursed by GSK. Research and development expenses for the six months ended June 30, 2012 and 2011 are net of $14,043 and $11,850, respectively, of costs reimbursed by GSK. The Company shares certain research and development costs including personnel costs, outside services, clinical manufacturing and overhead with GSK under cost sharing provisions in the GSK collaboration agreement.

 

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HUMAN GENOME SCIENCES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Quarter Ended June 30, 2012

(dollars in thousands, except per share data)

 

Note 4. Collaborations and Other Agreements (continued)

 

U.S. Government Agreement

In July 2009, the U.S. Government (“USG”) agreed to purchase 45,000 additional doses of raxibacumab for the Strategic National Stockpile (“SNS”), to be delivered over a three-year period beginning in 2009. The Company expects to receive a total of approximately $142,000 from this order as deliveries are completed. The Company recognized $6,499 and $12,864 in product revenue related to raxibacumab during the three months ended June 30, 2012 and 2011, respectively. The Company recognized $12,637 and $26,895 in product revenue related to raxibacumab during the six months ended June 30, 2012 and 2011, respectively. The Company recognized $729 and $450 in manufacturing and development services revenue related to the work to conduct animal studies and other raxibacumab activities during the three months ended June 30, 2012 and 2011, respectively. The Company recognized $1,106 and $1,370 in manufacturing and development services revenue related to the work to conduct animal studies and other raxibacumab activities during the six months ended June 30, 2012 and 2011, respectively. The Company is entitled to receive approximately $20,000 under the contract with the USG if raxibacumab is licensed by the FDA.

MedImmune LLC Agreement

In 1999, the Company entered into a collaborative agreement with Cambridge Antibody Technology Ltd. (“CAT”) (assumed by MedImmune LLC (“MedImmune”) through acquisition) to jointly pursue the development of fully human monoclonal antibody therapeutics. The Company will pay MedImmune milestone payments in connection with the development of any such antibodies as well as royalty payments on the Company’s net sales of such licensed product following regulatory approval. In the event of the achievement of certain other milestones or successful product launch of other products, the Company would be obligated to pay MedImmune additional compensation. Since 1999, the Company has exercised one option and made certain payments. During the six months ended June 30, 2012, the Company did not incur any milestones obligations. During 2011, the Company made a $3,000 milestone payment in connection with the FDA approval of BENLYSTA, which is included in research and development expenses on the consolidated statement of operations and comprehensive loss for the six months ended June 30, 2011.

In 2000, the Company entered into a second agreement with CAT. The 2000 agreement provides the Company with rights to use MedImmune technology to develop and sell an unlimited number of fully human antibodies for therapeutic and diagnostic purposes. The Company will pay MedImmune clinical development milestones and royalties based on product sales. Since 2000, the Company has exercised several options and made certain payments. During the six months ended June 30, 2012 and 2011, the Company did not incur any milestone obligations.

During the three months ended June 30, 2012 and 2011, the Company incurred aggregate royalty expenses under these agreements of approximately $3,111 and $1,260, respectively, associated with U.S. sales of BENLYSTA and raxibacumab. During the six months ended June 30, 2012 and 2011, the Company incurred aggregate royalty expenses under these agreements of approximately $5,708 and $2,024, respectively, associated with U.S. sales of BENLYSTA and raxibacumab. These royalty expenses are included in cost of product sales on the consolidated statements of operations and comprehensive loss. Royalty expenses to MedImmune related to ROW sales of BENLYSTA are included in Commercial collaboration expense on the consolidated statements of operations and comprehensive loss for the three and six months ended June 30, 2012.

 

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HUMAN GENOME SCIENCES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Quarter Ended June 30, 2012

(dollars in thousands, except per share data)

 

Note 4. Collaborations and Other Agreements (continued)

 

FivePrime Therapeutics Agreement

During 2011, the Company entered into an agreement with FivePrime Therapeutics, Inc. (“FivePrime”) to develop and commercialize FivePrime’s FP-1039 product candidate for multiple cancers. The Company paid FivePrime an upfront license fee of $50,000, which is reflected in research and development expenses on the consolidated statement of operations and comprehensive loss for the six months ended June 30, 2011. The Company may be required to pay up to $445,000 in future development, regulatory and commercial milestone payments, as well as royalty payments on net sales if the product is commercialized. HGS has exclusive rights to develop and commercialize FP-1039, now known as HGS1036, for all indications in the United States, Canada and the European Union (“EU”). FivePrime has an option to co-promote HGS1036 and any next-generation products in the United States, and retains full development and commercialization rights in all other regions of the world outside the U.S., Canada and the EU. The Company incurred research and development expenses of $136 and $779 under cost sharing provisions in the FivePrime agreement during the three months ended June 30, 2012 and 2011, respectively. The Company incurred research and development expenses of $1,002 under cost sharing provisions in the FivePrime agreement during the six months ended June 30, 2012. In addition to the upfront license fee paid, the Company incurred $779 of research and development expenses during the six months ended June 30, 2011.

Note 5. Other Financial Information

Collaboration Receivables

Collaboration receivables of $32,409 as of June 30, 2012 include $16,367 due to the Company from GSK for manufacturing costs incurred to produce pre-launch commercial product that is expected to be sold within the next year. Collaboration receivables also include $7,751 in unbilled receivables from GSK in connection with the Company’s cost-sharing agreements. Collaboration receivables of $23,013 as of December 31, 2011 include $12,436 due to the Company from GSK for manufacturing costs incurred to produce pre-launch commercial product that is expected to be sold within the next year and $9,833 in unbilled receivables from GSK in connection with the Company’s cost sharing agreements.

Collaboration receivables, non-current of $5,691 and $22,630 as of June 30, 2012 and December 31, 2011, respectively, relate to the amount due to the Company from GSK for manufacturing costs incurred to produce pre-launch commercial product that is not expected to be sold within the next year.

Inventory

Inventories consist of the following:

 

     June 30, 2012      December 31, 2011  
     Current      Non-current      Current      Non-current  

Raw materials

   $ 865       $ 16,479       $ 12,183       $ 4,852   

Work-in-process

     9,326         115,929         22,567         102,887   

Finished goods

     12,572         3,425         6,909         4,083   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 22,763       $ 135,833       $ 41,659       $ 111,822   
  

 

 

    

 

 

    

 

 

    

 

 

 

Inventory that is not expected to be sold until more than 12 months from the balance sheet date is classified as non-current.

 

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HUMAN GENOME SCIENCES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Quarter Ended June 30, 2012

(dollars in thousands, except per share data)

 

Note 5. Other Financial Information (continued)

 

BENLYSTA-related inventories that were either purchased or manufactured prior to the date the Company began capitalizing BENLYSTA inventory (November 2010) were $69,729 and $92,824 as of June 30, 2012 and December 31, 2011, respectively. These inventories have a carrying value of zero, as the costs to purchase or produce this inventory were expensed as research and development expense in the period manufactured, and accordingly are not reflected in the inventory balances shown above. These inventories could be used in clinical trials, sold in the U.S. as commercial product or shipped to GSK at cost for the ROW sale of BENLYSTA.

As of June 30, 2012, the Company has inventory relating to raxibacumab beyond what is required to fulfill the second order from the USG. See Note 6, Commitments and Contingencies, for additional discussion.

Collaboration Payable

Collaboration payable of $36,905 and $33,230 as of June 30, 2012 and December 31, 2011, respectively, represents cost reimbursements due to GSK in connection with BENLYSTA.

Other Liabilities

Other liabilities of $19,440 and $11,805 as of June 30, 2012 and December 31, 2011, respectively, consist primarily of deferred rent and deferred collaboration income.

Note 6. Commitments and Contingencies

In the ordinary course of business, the Company is involved in various legal proceedings, including, among others, employment related matters, patent oppositions, patent revocations, patent infringement litigation, securities class actions, shareholder derivative litigation and other matters incidental to its business. The Company records accruals for loss contingencies to the extent that it concludes that it is probable that a liability has been incurred and the amount of the related loss can be reasonably estimated. The Company evaluates on a quarterly basis, developments in legal proceedings and other matters that could result in the recognition of a liability or a change in the amount of a liability that has been previously accrued. While it is not possible to accurately predict or determine the eventual outcome of these matters, an adverse determination in one or more of these matters currently pending could have a material adverse effect on the Company’s financial condition, results of operations or cash flows.

In November 2011, two securities class actions were filed in the U.S. District Court for the District of Maryland against the Company and a number of its current and former executive officers and directors, alleging violations of securities laws during 2010 and 2009. These actions were consolidated in March 2012. In addition, three shareholder derivative actions were filed during December 2011 and January 2012 in the U.S. District Court for the District of Maryland that are related to essentially the same allegations made in the securities class actions.

In April 2012, a class action and shareholder derivative action was filed in the Circuit Court for Montgomery County, Maryland against the Company and its current directors, alleging breaches of fiduciary duty in connection with the Board’s rejection of GSK’s unsolicited offer to acquire HGS and maintenance of allegedly improper defensive measures.

The Company believes these suits are without merit and is vigorously defending these claims. These suits are at the very early stages of the legal process, which can extend for several years. As a result, these matters have not yet progressed sufficiently though discovery and development of important factual information and legal issues to enable the Company to estimate a range of a reasonably possible loss, if any.

 

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HUMAN GENOME SCIENCES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Quarter Ended June 30, 2012

(dollars in thousands, except per share data)

 

Note 6. Commitments and Contingencies (continued)

 

As of June 30, 2012, inventory includes an aggregate of $22,035 of inventory relating to anticipated future orders for raxibacumab beyond what is required to fulfill the second order from the USG. The Company currently expects to recover the cost of this inventory through future sales of raxibacumab. If the Company does not receive additional orders for raxibacumab, it would need to record a charge to cost of product sales for this amount of inventory. During June 2012, the USG released a Request for Proposal for additional orders of anthrax antitoxins, such as raxibacumab, to which the Company plans to respond.

Note 7. Stock-Based Compensation

The Company has a stock incentive plan (the “Incentive Plan”) under which options to purchase new shares of the Company’s common stock may be granted to employees, consultants and directors at an exercise price no less than the quoted market value on the date of grant. The Incentive Plan also provides for awards in the form of stock appreciation rights, restricted (non-vested) or unrestricted stock awards, stock-equivalent units or performance-based stock awards. The Company issues both qualified and non-qualified options under the Incentive Plan. The Company also has an Employee Stock Purchase Plan (“ESPP”).

Stock-based compensation expense for the three and six months ended June 30, 2012 is not necessarily representative of the level of stock-based compensation expense in future periods due to, among other things, the fair value of additional stock option grants and other awards in future years and the vesting period of the stock options and other awards.

The Company recorded stock-based compensation expense pursuant to these plans of $10,475 (net of $500 capitalized as part of inventory production) and $8,437 (net of $2,108 capitalized as part of inventory production) during the three months ended June 30, 2012 and 2011, respectively. The Company recorded stock-based compensation expense pursuant to these plans of $21,365 (net of $520 capitalized as part of inventory production) and $15,050 (net of $3,142 capitalized as part of inventory production) during the six months ended June 30, 2012 and 2011, respectively. Stock-based compensation expense relates to stock options, restricted stock units and restricted stock awards granted under the Incentive Plan.

Under the Incentive Plan, the Company issued 901,752 and 971,497 shares of common stock in conjunction with stock option exercises during the three and six months ended June 30, 2012. The Company granted 208,800 stock options with a weighted-average grant date fair value of $7.06 per share under the Incentive Plan during the three months ended June 30, 2012. The Company granted 3,393,488 stock options with a weighted-average grant date fair value of $4.41 per share under the Incentive Plan during the six months ended June 30, 2012.

During the three months ended June 30, 2012, the Company awarded 27,800 restricted stock units (“RSUs”) with a weighted-average grant date fair value of $14.17 per share. During the six months ended June 30, 2012, the Company awarded 281,491 RSUs with a weighted-average grant date fair value of $9.39 per share. During the three months ended June 30, 2012, 8,340 RSUs vested and the Company issued 8,340 shares of common stock to non-employee directors. During the six months ended June 30, 2012, 101,282 RSUs vested and the Company issued 66,119 shares of common stock to employees and non-employee directors, net of 35,163 shares purchased to satisfy the employees’ minimum tax withholding requirement related to the RSUs vesting. The treasury stock was retired prior to June 30, 2012. During the six months ended June 30, 2012, 3,300 restricted stock awards vested.

 

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HUMAN GENOME SCIENCES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Quarter Ended June 30, 2012

(dollars in thousands, except per share data)

 

Note 7. Stock-Based Compensation (continued)

 

As of June 30, 2012, the total authorized number of shares under the Incentive Plan, including prior plans, was 59,880,583. Shares available for future equity awards were 3,746,193 as of June 30, 2012.

Note 8. Preferred Share Purchase Rights

On May 16, 2012, the Company adopted a Shareholder Rights Plan (“Rights Plan”) and declared a dividend of one preferred share purchase right (a “Right”) for each outstanding share of the Company’s common stock. Under the Rights Plan, the Company distributed one Right for each outstanding share of the Company’s common stock held by stockholders of record on May 29, 2012.

Each Right entitles the registered holder, subject to the terms of the Rights Agreement by and between the Company and American Stock Transfer & Trust Company, LLC, as Rights Agent, to purchase from the Company one one-hundredth of a share of the Company’s Series A Junior Participating Preferred Stock, par value $0.01 per share (“Preferred Stock”), at an exercise price of $37.50, subject to adjustment. The Rights become exercisable on the tenth business day after a person or group acquires or commences a tender offer or exchange offer following the date of the Rights Plan for 15% or more of the Company’s common stock without prior Board of Directors approval or immediately prior to the acceptance for payment of common stock tendered pursuant to any tender offer or exchange offer commenced by a third party prior to the date of the Rights Plan. Under the Rights Plan, ownership of the Company’s common stock in the form of derivative securities counts towards the 15% ownership threshold.

Once exercisable, the Rights permit the Company’s stockholders, other than the acquiror, to purchase the Company’s common stock having a market value of twice the exercise price of the Rights in lieu of the Preferred Stock. Alternatively, when the Rights become exercisable, the Board of Directors may authorize the issuance of one share of the Company’s common stock in exchange for each Right that is exercisable. In addition, in the event of certain business combinations, the Rights permit the purchase of common stock of an acquiror at a 50% discount. Rights held by the acquiror will become null and void in each case. At any time prior to ten business days after a person or group acquires 15% or more of the Company’s common stock, the Rights can be redeemed for $0.01 each by action of the Board of Directors. The Rights expire on May 29, 2013 unless earlier redeemed, exchanged or terminated by the Company.

On July 16, 2012, prior to the execution of the Merger Agreement, the Board of Directors approved an amendment (the “Rights Amendment”) to the Rights Plan. The Rights Amendment renders the Rights Plan inapplicable to the Merger Agreement and the transactions contemplated thereby.

 

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HUMAN GENOME SCIENCES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Quarter Ended June 30, 2012

(dollars in thousands, except per share data)

 

Note 9. Fair Value Measurements

The Company’s assets and liabilities subject to fair value measurements on a recurring basis and the related fair value hierarchy are as follows:

 

     Fair Value as of June 30, 2012  
     Level 1      Level 2      Level 3      Total  

Cash and cash equivalents

   $ 349,958       $ —         $ —         $ 349,958   
  

 

 

    

 

 

    

 

 

    

 

 

 

Corporate debt securities

   $ —         $ 94,030       $ —         $ 94,030   

Residential mortgage-backed securities

     —           18,594         —           18,594   

Asset-backed securities

     —           7,585         —           7,585   
  

 

 

    

 

 

    

 

 

    

 

 

 

Marketable securities

   $ —         $ 120,209       $ —         $ 120,209   
  

 

 

    

 

 

    

 

 

    

 

 

 

Corporate debt securities

   $ —         $ 135,586       $ —         $ 135,586   

Residential mortgage-backed securities

     —           31,585         —           31,585   

Government-sponsored enterprise securities

     —           5,244         —           5,244   

Asset-backed securities

     —           31,772         —           31,772   
  

 

 

    

 

 

    

 

 

    

 

 

 

Marketable securities, non-current

   $ —         $ 204,187       $ —         $ 204,187   
  

 

 

    

 

 

    

 

 

    

 

 

 

Money market funds

   $ 5,058       $ —         $ —         $ 5,058   

Corporate debt securities

     —           54,054         —           54,054   

Residential mortgage-backed securities

     —           9,707         —           9,707   

Government-sponsored enterprise securities

     —           2,200         —           2,200   

Asset-backed securities

     —           8,642         —           8,642   
  

 

 

    

 

 

    

 

 

    

 

 

 

Restricted investments

   $ 5,058       $ 74,603       $ —         $ 79,661   
  

 

 

    

 

 

    

 

 

    

 

 

 

The Company evaluates the types of securities in its investment portfolio to determine the proper classification in the fair value hierarchy based on trading activity and the observability of market inputs.

The Company generally obtains a single quote or price per instrument from independent third parties to help it determine the fair value of securities in Level 1 and Level 2 of the fair value hierarchy. The Company’s Level 1 cash and money market instruments are valued based on quoted prices from third parties, and the Company’s Level 1 U.S. Treasury securities are valued based on broker quotes. The Company’s Level 2 assets are valued using a multi-dimensional pricing model that includes a variety of inputs including actual trade data, benchmark yield data, non-binding broker/dealer quotes, issuer spread data, monthly payment information, collateral performance and other reference information. These are all observable inputs. The Company reviews the values generated by the multi-dimensional pricing model for reasonableness, which could include reviewing other publicly available information. During the six months ended June 30, 2012, there were no transfers between Level 1 and Level 2 of the fair value hierarchy.

The Company does not hold auction rate securities, loans held for sale, mortgage-backed securities backed by sub-prime or Alt-A collateral or any other investments that require the Company to determine fair value using a discounted cash flow approach. Therefore, the Company does not need to adjust its analysis or change its assumptions specifically to factor illiquidity in the markets into its fair values.

 

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HUMAN GENOME SCIENCES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the Quarter Ended June 30, 2012

(dollars in thousands, except per share data)

 

Note 9. Fair Value Measurements (continued)

 

The fair value of the Company’s receivables, other assets, accounts payable, accrued expenses and other payables approximate their carrying amount due to the relatively short maturity of these items. The fair value of the Company’s convertible debt is based on quoted market prices. The quoted market price of the Company’s Level 1 convertible debt was approximately $789,010 (book value of $576,480) as of June 30, 2012. With respect to its lease financing, the Company evaluated its incremental borrowing rate as of June 30, 2012, based on the current interest rate environment and the Company’s credit risk. The fair value of the Level 2 BioMed lease financing was approximately $256,200 (book value of $252,815) as of June 30, 2012 based on a discounted cash flow analysis, and current rates for corporate debt having similar characteristics and companies with similar creditworthiness.

Note 10. Net Loss Per Share

The following table sets forth the computation of basic and diluted net loss per share:

 

     Six Months Ended
June 30,
 
     2012     2011  

Numerator:

    

Net loss

   $ (186,296   $ (211,655
  

 

 

   

 

 

 

Denominator:

    

Weighted average shares outstanding, basic and diluted

     199,281,168        189,680,061   
  

 

 

   

 

 

 

Net loss per share, basic and diluted:

    

Net loss per share

   $ (0.93   $ (1.12
  

 

 

   

 

 

 

Common stock issued in connection with the Company’s ESPP and through exercised options granted pursuant to the Incentive Plan are included in the Company’s weighted average share balance based upon the issuance date of the related shares. As of June 30, 2012 and 2011, the Company had 27,132,271 and 26,405,772, respectively, of stock options and non-vested RSUs outstanding. As of June 30, 2012 and 2011, the Company had 48,735,463 and 24,238,308, respectively, of shares issuable upon the conversion of the Company’s convertible debt. The stock options and non-vested RSUs outstanding and shares issuable upon conversion of the Company’s convertible debt as of June 30, 2012 and 2011 are excluded from the weighted average shares as they are anti-dilutive. Additionally, shares due to the Company upon settlement of the Company’s capped call option contracts as of June 30, 2012 are excluded from the weighted average shares as they are anti-dilutive.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Three and six months ended June 30, 2012 and 2011

Overview

Human Genome Sciences, Inc. (“HGS”) is a biopharmaceutical company that exists to place new therapies into the hands of those battling serious disease. Our lead products are BENLYSTA® (belimumab) for systemic lupus erythematosus (“SLE”) and raxibacumab for inhalation anthrax.

BENLYSTA was approved in March 2011 by the U.S. Food and Drug Administration (“FDA”) for the treatment of adult patients with active, autoantibody-positive SLE who are receiving standard therapy. We launched BENLYSTA shortly thereafter and recognized revenue from our first BENLYSTA sales in March 2011. In July 2011, the European Commission granted marketing authorization for BENLYSTA as an add-on therapy in adult patients with active autoantibody-positive SLE, with a high degree of disease activity despite standard therapy. BENLYSTA is currently available in the United States, Canada and a number of European and other countries. In addition, regulatory submissions are pending in other countries.

We are developing BENLYSTA with our partner, GlaxoSmithKline (“GSK”), under a 2006 co-development and co-commercialization agreement. In the United States, we and GSK both have sales teams that are working together to commercialize BENLYSTA. In Germany, France and Spain, our team is working alongside GSK to commercialize BENLYSTA, and in the rest of the world GSK is leading local implementation of the commercialization of BENLYSTA. We recognize product sales revenue from BENLYSTA sales in the U.S., and GSK recognizes product sales revenue from sales in the rest of the world (“ROW”). We share profits and certain expenses with GSK on a worldwide basis. Under the agreement, we are responsible for the global supply of BENLYSTA.

We continue to deliver raxibacumab to the Strategic National Stockpile (“SNS”) for emergency use in treating inhalation anthrax. In July 2009, the U.S. Government (“USG”) exercised its option under our contract to purchase 45,000 additional doses of raxibacumab, with delivery to be completed over a three-year period. HGS expects to receive approximately $142.0 million from this second order as deliveries are completed, $130.0 million of which has been recognized as revenue through June 30, 2012. In May 2009, we submitted a Biologics License Application (“BLA”) to the FDA for raxibacumab for the treatment of inhalation anthrax. We received a Complete Response Letter in November 2009, and we continue to work closely with the FDA to obtain approval. In June 2012, we submitted a supplemental BLA to obtain approval and the FDA has set December 15, 2012 as the Prescription Drug User Fee Act (“PDUFA”) action date. HGS will receive approximately $20.0 million from the USG if raxibacumab is licensed by the FDA. In June 2012, the USG released a Request for Proposal for additional orders of anthrax antitoxins, such as raxibacumab, to which we plan to respond.

In addition to our internal pipeline, we have substantial financial rights to two novel drugs that GSK has advanced to late-stage development. The first of these is darapladib, which was discovered by GSK based on HGS technology. In two Phase 3 trials, GSK is currently evaluating whether darapladib can reduce the risk of adverse cardiovascular events such as heart attack or stroke in patients with chronic coronary heart disease and acute coronary syndrome, respectively. The combined darapladib Phase 3 program spans 42 countries and has enrolled more than 28,500 patients. The second is albiglutide, for which GSK announced that it has reviewed primary endpoint data from all of the Phase 3 studies designed to evaluate the efficacy and safety of albiglutide, versus placebo and active controls in type 2 diabetes. GSK also announced its intent to commence global regulatory submissions of albiglutide as a possible once-weekly treatment for this disease in early 2013. Albiglutide was created by HGS using its proprietary albumin-fusion technology, and the product was licensed to GSK in 2004.

We are working on potential additional indications for BENLYSTA as well as additional methods of delivery. Currently, BENLYSTA is delivered by infusion at two-week intervals for the first three doses and every four weeks thereafter. In December 2011, we initiated dosing of patients in BLISS-SC, a Phase 3 trial of the subcutaneous formulation of BENLYSTA. If this trial is successful and regulatory authorities agree, the subcutaneous formulation will make it possible for patients to self-administer BENLYSTA by injection once a week. In 2012, we initiated active lupus nephritis Phase 3 trials of BENLYSTA and plan to initiate Phase 3 trials of BENLYSTA in vasculitis.

 

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Table of Contents

Overview (continued)

 

We are also working to expand and advance our mid- and early-stage pipeline beyond BENLYSTA. A randomized Phase 2 trial is currently evaluating mapatumumab in combination with Nexavar® (sorafenib) for the treatment of advanced hepatocellular cancer. Mapatumumab is a human monoclonal antibody to TRAIL receptor 1. In March 2011, we entered into an agreement with FivePrime Therapeutics, Inc. (“FivePrime”) to develop and commercialize HGS1036 (formerly FP-1039) for multiple cancers.

Strategic partnerships are an important driver of our commercial success. We have a co-development and co-commercialization agreement with GSK for BENLYSTA, and raxibacumab is being developed under a contract with the Biomedical Advanced Research and Development Authority (“BARDA”) of the Office of the Assistant Secretary for Preparedness and Response (“ASPR”), U.S. Department of Health and Human Services (“HHS”). Our strategic partnerships with a number of pharmaceutical and biotechnology companies allow us to leverage our strengths and gain access to sales and marketing infrastructure, as well as complementary technologies. Some of these partnerships provide us with licensing or other fees, clinical development cost-sharing, milestone payments and rights to royalty payments as products are developed and commercialized. In some cases, we are entitled to certain commercialization, co-promotion, revenue-sharing and other product rights.

On July 16, 2012, GSK and HGS announced that the companies have signed a definitive merger agreement (“Merger Agreement”) providing for the acquisition of HGS by GSK for $14.25 per share in cash. The transaction was approved by the board of directors of both companies. Under the terms of the definitive merger agreement, GSK amended its ongoing cash tender offer (“the Offer”) on July 16, 2012, to purchase all of our outstanding shares for $14.25 per share in cash. The closing of the tender offer is subject to customary conditions, including that there shall have been validly tendered and not validly withdrawn prior to the expiration of the Offer, when added to the number of Shares already owned by GSK, a majority of the Shares outstanding (determined on a fully diluted basis).

As a result of the Merger Agreement, we expect to pay our financial advisors (Goldman Sachs and Credit Suisse) a transaction fee payable at the closing of the transaction of approximately $25.0 million each based on the offer price of $14.25 per share.

Critical Accounting Policies and the Use of Estimates

A “critical accounting policy” is one that is both important to the portrayal of our financial condition and results of operations and that requires management’s most difficult, subjective or complex judgments. Such judgments are often the result of a need to make estimates about the effect of matters that are inherently uncertain. The preparation of our financial statements in conformity with accounting principles generally accepted in the United States 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 revenues and expenses during the reporting period. Actual results could differ materially from those estimates. There were no significant changes in critical accounting policies from those at December 31, 2011, however the following information is in addition to, and should be read in conjunction with, the accounting policies included in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2011.

Product sales. Product sales consist of U.S. sales of BENLYSTA and raxibacumab. Revenue from product sales is recognized when persuasive evidence of an arrangement exists, delivery has occurred and title to product and associated risk of loss have passed to the customer, the price is fixed or determinable, collection from the customer is reasonably assured, all performance obligations have been met and returns can be reasonably estimated. Because we received FDA approval in the first quarter of 2011, we cannot yet make a reasonable estimate of future product returns when product is delivered to distributors. Therefore, we currently do not recognize revenue upon product shipment to specialty distributors, even though the specialty distributor is invoiced upon product shipment. Instead, we recognize revenue through the specialty distributor channel at the time of shipment to the physicians or

 

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Critical Accounting Policies and the Use of Estimates (continued)

 

their clinics. As of June 30, 2012, we have deferred revenue of approximately $3.9 million with respect to BENLYSTA, which represents product shipped to specialty distributors but not yet sold through to physicians or clinics. As of June 30, 2012, the cost of product at the specialty distributors is negligible, as it was manufactured prior to our capitalization date in 2010. Wholesalers supply product to all other healthcare providers (e.g. hospitals, pharmacies), however they do not take physical delivery of product. All wholesaler orders are drop-shipped directly to the healthcare providers. For wholesaler purchases, we currently recognize revenue upon shipment to the healthcare provider.

Product sales are recorded net of accruals for estimated rebates, chargebacks, discounts and other deductions (collectively, “sales deductions”) and returns. With the exception of allowances for prompt payment, allowances for sales deductions and returns are included in accounts payable and accrued expenses in the accompanying consolidated balance sheets.

We estimate BENLYSTA sales deductions and returns utilizing actual sales data, contracts with distributors and wholesalers and third-party market research. The following table summarizes the activity of BENLYSTA sales deductions and return amounts recorded in Accrued expenses in our consolidated balance sheet as of June 30, 2012 (in millions):

 

     Rebates &
Chargebacks
    Wholesaler/Distributor
Deductions,
Co-pay
Assistance
& Prompt
Pay
    Returns     Total  

Balance as of January 1, 2012

   $ 3.3      $ 0.7      $ 0.7      $ 4.7   

Reserve for current period sales

     2.8        1.2        0.4        4.4   

Adjustment for prior period sales

     —          (0.1     —          (0.1

Credits/payments for prior period sales

     (1.0     (0.7     —          (1.7

Credits/payments for current period sales

     (0.4     (0.3     (0.1     (0.8
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of March 31, 2012

     4.7        0.8        1.0        6.5   

Reserve for current period sales

     3.3        1.5        0.5        5.3   

Adjustment for prior period sales

     (0.4     —          —          (0.4

Credits/payments for prior period sales

     (1.2     (1.1     —          (2.3

Credits/payments for current period sales

     (0.9     (0.4     —          (1.3
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of June 30, 2012

   $ 5.5      $ 0.8      $ 1.5      $ 7.8   
  

 

 

   

 

 

   

 

 

   

 

 

 

Our estimates and assumptions are subject to inherent limitations and may need to be adjusted accordingly on a prospective basis. For reference, a 10% change to the returns allowance percentage as of June 30, 2012 would result in a $0.2 million impact to net product sales for the six months ended June 30, 2012. A 10% change to the rebate allowance percentage as of June 30, 2012 would result in a $0.5 million impact to net product sales for the six months ended June 30, 2012, and a 10% change to the co-pay allowance percentage as of June 30, 2012 would result in a $0.1 million impact to net product sales for the six months ended June 30, 2012.

We are not the principal with respect to BENLYSTA sold outside the U.S., i.e. in the ROW. Therefore, we do not record product sales with respect to this activity.

Results of Operations

Revenues. Revenues were $60.3 million and $24.9 million for the three months ended June 30, 2012 and 2011, respectively. Revenues were $107.5 million and $51.4 million for the six months ended June 30, 2012 and 2011, respectively. Total revenues include net product sales, revenues from manufacturing and development services and research and collaborative agreements.

 

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Results of Operations (continued)

 

The following table summarizes the period over period changes in net product sales (in millions):

 

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

Net Product Sales:

                

BENLYSTA

   $ 38.1       $ 7.8         388   $ 69.3       $ 7.9         777

Raxibacumab

     6.5         12.8         -49     12.6         26.9         -53
  

 

 

    

 

 

      

 

 

    

 

 

    
   $ 44.6       $ 20.6         117   $ 81.9       $ 34.8         135
  

 

 

    

 

 

      

 

 

    

 

 

    

Higher BENLYSTA revenue for the three and six months ended June 30, 2012 reflects increased demand, as BENLYSTA was approved for sale in the U.S. in March 2011. The decrease in raxibacumab revenue primarily reflects reduced shipments during the current year as we fulfill our contract obligation under the second USG order.

Manufacturing and development services revenue increased to $15.5 million for the three months ended June 30, 2012 from $4.0 million for the three months ended June 30, 2011. Manufacturing and development services revenue increased to $25.0 million for the six months ended June 30, 2012 from $16.3 million for the six months ended June 30, 2011. The increase is primarily due to certain contract manufacturing activity that occurred and concluded during the three months ended June 30, 2012.

Cost of product sales. Cost of product sales was $7.9 million and $11.6 million for the three months ended June 30, 2012 and 2011, respectively. Cost of product sales was $16.2 million and $21.6 million for the six months ended June 30, 2012 and 2011, respectively. The decrease in cost of product sales for the three and six months ended June 30, 2012 is primarily related to lower raxibacumab product sales, partially offset by increased BENLYSTA royalties and other incidental costs. Cost of product sales and gross margins for the three and six months ended June 30, 2012 and 2011 benefited from BENLYSTA product sales with no related cost of sales, other than royalties and other incidental costs, because such inventory was manufactured prior to our capitalization date and charged to research and development expenses in the period manufactured. As of June 30, 2012 and December 31, 2011, we had BENLYSTA inventory that cost approximately $69.7 million and $92.8 million, respectively, with no carrying value, and accordingly, we expect our future cost of product sales and our gross margins to benefit from utilization of this inventory, which is sold on a first-in-first-out basis, to the extent it is used commercially rather than clinically.

Cost of manufacturing and development services. Cost of manufacturing and development services was $21.8 million and $6.7 million for the three months ended June 30, 2012 and 2011, respectively. Cost of manufacturing and development services was $41.3 million and $18.3 million for the six months ended June 30, 2012 and 2011, respectively. The increase is primarily due to unabsorbed manufacturing costs, along with an increase in contract manufacturing activity in 2012. During the three and six months ended June 30, 2012, we expensed $7.0 million and $15.0 million, respectively, of unabsorbed manufacturing costs as a result of operating below normal capacity in our large-scale manufacturing (“LSM”) facility. Our manufacturing and development services costs include costs associated with contract manufacturing services and raxibacumab development services costs. Our costs with respect to contract manufacturing services can represent a significant portion of revenues, depending upon production volumes, efficiencies and product mix.

Expenses. Research and development net expenses were $35.4 million for the three months ended June 30, 2012 compared to $33.4 million for the three months ended June 30, 2011. Research and development net expenses were $75.0 million for the six months ended June 30, 2012 compared to $117.9 million for the six months ended June 30, 2011. Our research and development expenses are net of $8.1 million and $7.7 million for the three months ended June 30, 2012 and 2011, respectively, of costs reimbursed primarily by GSK. Our research and development expenses are net of $13.7 million and $14.3 million for the six months ended June 30, 2012 and 2011, respectively, of costs reimbursed primarily by GSK.

We track our research and development expenditures by type of cost incurred – research, pharmaceutical sciences, manufacturing and clinical development.

 

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Results of Operations (continued)

 

Our research costs decreased to $5.9 million for the three months ended June 30, 2012 from $7.5 million for the three months ended June 30, 2011. Our research costs decreased to $12.5 million for the six months ended June 30, 2012 from $13.8 million for the six months ended June 30, 2011. This decrease in activity for the three and six months ended June 30, 2012 is primarily due to decreased activity associated with products that were discontinued in December 2011, partially offset by increased HGS1036 activity. Our research costs for the three months ended June 30, 2012 and 2011 are net of $0.5 million and $0.8 million, respectively, of cost reimbursement primarily from GSK and Morphotek under cost sharing provisions in our collaboration agreements. Our research costs for both the six months ended June 30, 2012 and 2011 are net of $1.2 million of cost reimbursement primarily from GSK and Morphotek under cost sharing provisions in our collaboration agreements.

Our pharmaceutical sciences costs, where we focus on improving formulation, process development and production methods, increased to $5.3 million for the three months ended June 30, 2012 from $4.9 million for the three months ended June 30, 2011. The increase is primarily due to an increase in BENLYSTA subcutaneous development costs, partially offset by decreased activity related to contract manufacturing services. Pharmaceutical sciences costs decreased to $10.8 million for the six months ended June 30, 2012 from $11.0 million for the six months ended June 30, 2011. Pharmaceutical sciences costs for the three months ended June 30, 2012 and 2011 are net of $1.1 million and $1.0 million, respectively, of cost reimbursement primarily from GSK under cost sharing provisions in our collaboration agreements. Pharmaceutical sciences costs for the six months ended June 30, 2012 and 2011 are net of $2.4 million and $2.2 million, respectively, of cost reimbursement primarily from GSK under cost sharing provisions in our collaboration agreements.

Our research-related manufacturing costs were $6.8 million for both the three months ended June 30, 2012 and 2011. Our research-related manufacturing costs increased to $14.8 million for the six months ended June 30, 2012 from $11.5 million for the six months ended June 30, 2011. This increase is primarily due to HGS1036 activity, partially offset by a decrease in BENLYSTA subcutaneous and new target manufacturing costs. Our research-related manufacturing costs for the three months ended June 30, 2012 include $1.2 million due to GSK under cost sharing provisions in our collaboration agreement. Research-related manufacturing costs for the three months ended June 30, 2011 are net of $2.6 million of cost reimbursement from GSK under cost sharing provisions in our collaboration agreement. Our research-related manufacturing costs for the six months ended June 30, 2012 include $3.2 million due to GSK under cost sharing provisions in our collaboration agreement. Research-related manufacturing costs for the six months ended June 30, 2011 are net of $3.7 million of cost reimbursement from GSK under cost sharing provisions in our collaboration agreement.

Our clinical development costs increased to $17.4 million for the three months ended June 30, 2012 from $14.2 million for the three months ended June 30, 2011. This increase is primarily due to BENLYSTA subcutaneous clinical trial costs, partially offset by decreased mapatumumab activity along with decreased activity associated with products that were discontinued in December 2011. Our clinical development costs decreased to $36.9 million for the six months ended June 30, 2012 from $81.6 million for the six months ended June 30, 2011. This decrease is primarily due to the payment of a $50.0 million upfront license fee to FivePrime which was expensed during the six months ended June 30, 2011, partially offset by an increase in BENLYSTA subcutaneous clinical trial costs. Our clinical development costs for the three months ended June 30, 2012 and 2011 are net of $7.7 million and $3.3 million, respectively, of cost reimbursement primarily from GSK under cost sharing provisions in our collaboration agreements. Our clinical development costs for the six months ended June 30, 2012 and 2011 are net of $13.3 million and $7.2 million, respectively, of cost reimbursement primarily from GSK under cost sharing provisions in our collaboration agreements.

Selling, general and administrative expenses increased to $51.2 million for the three months ended June 30, 2012 from $39.4 million for the three months ended June 30, 2011. Selling, general and administrative expenses increased to $91.5 million for the six months ended June 30, 2012 from $74.6 million for the six months ended June 30, 2011. This increase is primarily due to increased commercial activities, such as marketing and educational programs and materials along with costs related to our response to a tender offer.

 

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Results of Operations (continued)

 

Commercial collaboration expenses increased to $19.2 million for the three months ended June 30, 2012 from $2.2 million for the three months ended June 30, 2011. Commercial collaboration expenses increased to $34.9 million for the six months ended June 30, 2012 from $5.2 million for the six months ended June 30, 2011. This increase is primarily due to the profit sharing of increased U.S. BENLYSTA sales activity along with our share of ROW BENLYSTA collaboration expense incurred by GSK.

Facility-related exit credits of $1.7 million for the six months ended June 30, 2011 relate to the reversal of our remaining exit reserve for certain exited space. During 2011, we decided to use this remaining exited space and therefore reversed the remaining reserve.

Investment income decreased to $1.8 million for the three months ended June 30, 2012 from $2.9 million for the three months ended June 30, 2011. Investment income decreased to $3.8 million for the six months ended June 30, 2012 from $6.2 million for the six months ended June 30, 2011. The decrease in investment income for the three and six months ended June 30, 2012 is primarily due to lower yields on our portfolio. The yield on our portfolio was 1.1% and 1.8% for the three months ended June 30, 2012 and 2011, respectively. The yield on our portfolio was 1.1% and 1.7% for the six months ended June 30, 2012 and 2011, respectively. A general decline in interest rates may adversely affect the interest earned from our portfolio as securities mature and may be replaced with securities having a lower interest rate.

Interest expense increased to $19.5 million for the three months ended June 30, 2012 compared to $15.5 million for the three months ended June 30, 2011. Interest expense increased to $38.9 million for the six months ended June 30, 2012 compared to $30.7 million for the three months ended June 30, 2011. The increase is primarily due to the issuance of our 3% Convertible Senior Notes in November 2011. Interest expense includes non-cash interest expense related to amortization of debt discount.

We had other income of $0.1 million for the three months ended June 30, 2012 compared to $0.4 million for the three months ended June 30, 2011. We had other income of $0.2 million for the six months ended June 30, 2012 compared to other expense of $2.6 million for the six months ended June 30, 2011. The change to other income from other expense for the six months ended June 30, 2012 is primarily due to a charge for an other-than-temporary impairment of our investment in Aegera Therapeutics, Inc. in March 2011. See Note 3, Investments, of the Notes to the Consolidated Financial Statements for additional discussion.

Net Income (Loss). We recorded a net loss of $92.8 million, or $0.46 per basic and diluted share, for the three months ended June 30, 2012 compared to a net loss of $80.7 million, or $0.42 per basic and diluted share, for the three months ended June 30, 2011. The increase in net loss for the three months ended June 30, 2012 is primarily due to higher commercial collaboration expense, cost of manufacturing and development services and selling, general and administrative costs, partially offset by higher revenue recognized in the current year from BENLYSTA sales. We recorded a net loss of $186.3 million, or $0.93 per basic and diluted share, for the six months ended June 30, 2012 compared to a net loss of $211.7 million, or $1.12 per basic and diluted share, for the six months ended June 30, 2011. The decrease in the net loss for the six months ended June 30, 2012 is primarily due to higher revenue recognized in the current year from BENLYSTA sales and lower research and development expenses, as the prior year included a $50.0 million, or $0.26 per basic and diluted share, upfront license fee payment to FivePrime. This favorability was partially offset by higher commercial collaboration expense, cost of manufacturing and development services and selling, general and administrative costs.

Liquidity and Capital Resources

We had working capital of $262.4 million as of June 30, 2012 compared to working capital of $326.6 million as of December 31, 2011. The decrease in our working capital is primarily due to the use of cash and marketable securities to fund our operations along with the reclassification of raxibacumab current inventory to non-current as of June 30, 2012, partially offset by an increase in receivables as of June 30, 2012.

We received FDA approval for BENLYSTA and began recognizing revenue from U.S. commercial sales of the product in March 2011. In addition to our commercial sales of BENLYSTA, we are currently completing a 2009 follow-on order from the USG for raxibacumab. We expect to receive a total of approximately $142.0 million from

 

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Liquidity and Capital Resources (continued)

 

this order as deliveries are completed, $130.0 million of which was recognized as revenue through June 30, 2012. Shipments are to be delivered over a three-year period ending in 2012. We may also receive payments under collaboration agreements, to the extent milestones are met, which would further improve our working capital position.

We manage our expenses at a level appropriate for our current and expected available resources. However, the amounts of expenditures that will be needed to carry out our business plan are subject to numerous uncertainties, which may adversely affect our liquidity and capital resources.

We are incurring significant sales and marketing costs as we develop the market for BENLYSTA in the U.S. and Europe with our BENLYSTA partner, GSK. In addition, we expect to continue to incur substantial expenses related to our research and development efforts. We have ongoing Phase 1, Phase 2 and Phase 3 trials and expect to initiate additional trials in the future, including post-marketing trials required by the FDA in connection with the approval of BENLYSTA. The duration and cost of our clinical trials are a function of numerous factors such as the type, complexity, novelty and intended use of the drug candidate, the number of patients to be enrolled in the trial, the amount of time it takes to enroll them, the length of time they must be treated and observed, and the number of clinical sites and countries for the trial.

Our clinical development expenses are dependent on the clinical phase of our drug candidates. Our expenses increase as our drug candidates move to later phases of clinical development. Product candidates listed below include only those active candidates for which an Investigational New Drug Application (“IND”) has been filed with the FDA and for which initial dosing of patients has occurred. The status of those clinical projects for which we incur clinical development expenses on our consolidated statements of operations and comprehensive loss is as follows:

 

     Clinical Trial Status  (1)  

Product Candidate

  

Indication

   As of
June 30,
2012
    As of
June 30,
2011
 

BENLYSTA

  

Systemic Lupus Erythematosus

     (2     (3

Raxibacumab

  

Anthrax

     (4     (5

HGS1036

  

Cancer

     (6     (7

Mapatumumab

  

Cancer

     Phase 2        Phase 2   

 

(1) Clinical Trial Status defined as when patients are being dosed.
(2) Product approved in the U.S. and Europe; Phase 3 sub-cutaneous formulation study underway; Phase 4 studies in planning stage.
(3) Product was approved in the U.S. in March 2011, Marketing Authorization Application filed in June 2010; European Commission granted marketing authorization in July 2011.
(4) BLA resubmitted in June 2012; the FDA has set December 15, 2012 as the PDUFA action date.
(5) BLA filed in 2009; Complete Response Letter received from the FDA; additional work ongoing.
(6) IND application filed in June 2012 to initiate a Phase 1b trial.
(7) Phase 1 trial initiated by FivePrime.

We identify our drug candidates by conducting numerous preclinical studies. We may conduct multiple clinical trials to cover a variety of indications for each drug candidate. Based upon the results from our trials, we may elect to discontinue clinical trials for certain indications or certain drugs in order to concentrate our resources on more promising drug candidates. We are advancing a number of drug candidates, including antibodies, proteins and small molecules, in part to diversify the risks associated with our research and development spending. In addition, our manufacturing plants have been designed to enable multi-product manufacturing capability.

We must receive regulatory clearance to advance each of our products into and through each phase of clinical testing. Moreover, we must receive regulatory approval to launch any of our products commercially. In order to receive such approval, the appropriate regulatory agency must conclude that our clinical data establish safety and efficacy and that our products and the manufacturing facilities meet all applicable regulatory requirements.

 

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Liquidity and Capital Resources (continued)

 

Because of the uncertainties discussed above, the costs to advance our research and development projects are difficult to estimate and may vary significantly.

Part of our business plan includes collaborating with others. For example, we entered into a collaboration agreement with GSK in 2006 with respect to BENLYSTA. We and GSK share Phase 3 and 4 development costs, and share sales and marketing expenses and profits of any product that is commercialized in accordance with the collaboration agreement.

We have collaborators who have sole responsibility for product development. For example, GSK is developing other products under separate agreements as part of our overall relationship with them. We have no control over the progress of GSK’s development plans. We cannot forecast with any degree of certainty whether any of our current or future collaborations will affect our drug development. To the extent milestones are met under existing collaboration agreements or we enter into additional collaborations with respect to our product candidates, we may receive additional payments and/or upfront fees, which would improve our liquidity.

Our future capital requirements and the adequacy of our available funds will depend on many factors, primarily including the level of BENLYSTA revenue, the scope and costs of our clinical development programs, the scope and costs of our manufacturing and process development activities, the magnitude of our discovery and preclinical development programs and the level of our commercial activities.

Our long-term strategy includes the acquisition of other biotechnology companies or in-license of additional product candidates to complement and supplement our existing product pipeline, and we may acquire such companies and in-license additional product candidates that have demonstrated positive pre-clinical and/or clinical data. Any such acquisition or in-license agreement could include consideration in the form of cash, which would have an adverse effect on our liquidity.

We have certain contractual obligations that may have a future effect on our financial condition, changes in financial condition, results of operations, liquidity, capital expenditures or capital resources. Our operating leases are not recorded on our balance sheets. Debt associated with the 2006 sale of our LSM to BioMed Realty Trust, Inc. (“BioMed”) and accompanying leaseback is recorded on our balance sheets as of June 30, 2012 and December 31, 2011. We have an option to purchase the Traville facility in 2016 for $303.0 million.

In the event our 2 1/4% Convertible Subordinated Notes due 2012 are repaid in cash rather than converted to common stock in August 2012, our existing funds and anticipated cash flows will be adversely affected. However, we still believe our existing cash and investments, cash generated from BENLYSTA sales, payments received under the raxibacumab contract and other agreements and investment income will be sufficient to fund our operations for at least the next 12 months. We continuously evaluate opportunities to refinance our existing debt or raise additional funds, and depending on market conditions we may choose to seek alternative sources of funding such as debt or equity offerings in order to strengthen our financial position. There can be no assurance that any such financing required in the future will be available on acceptable terms, if at all.

To minimize our exposure to credit risk, we invest in securities with strong credit ratings and have established guidelines relative to diversification and maturity with the objectives of maintaining safety of principal and liquidity. We do not invest in derivative financial instruments or auction rate securities, and we generally hold our investments in debt securities until maturity. However, all of our investments are classified as available-for-sale as we may determine that market or business conditions may lead us to sell a security prior to maturity.

Our unrestricted and restricted funds may be invested in U.S. Treasury securities, government agency obligations, high grade corporate debt securities and various money market instruments rated “A-” or better. Such investments reflect our policy regarding the investment of liquid assets, which is to seek a reasonable rate of return consistent with an emphasis on safety, liquidity and preservation of capital.

 

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Off-Balance Sheet Arrangements

During 1997 and 1999, we entered into two long-term leases with the Maryland Economic Development Corporation (“MEDCO”) expiring January 1, 2019 for a small-scale manufacturing facility aggregating 127,000 square feet and built to our specifications. We have accounted for these leases as operating leases. The facility was financed primarily through a combination of bonds issued by MEDCO (“MEDCO Bonds”) and loans issued to MEDCO by certain State of Maryland agencies. We have no equity interest in MEDCO.

Rent is based upon MEDCO’s debt service obligations, which contain a variable rate component. Assuming no significant changes in the current interest rate environment, our rent for 2012 is estimated to be approximately $2.0 million. The MEDCO Bonds are secured by letters of credit issued for the account of MEDCO which expire in December 2012. We are currently required to have restricted investments of approximately $33.1 million which serve as security for the MEDCO letters of credit reimbursement obligation. Upon default or early lease termination, the MEDCO Bond indenture trustee can draw upon the letters of credit to pay the MEDCO Bonds as they are tendered. In such an event, we could lose part or all of our restricted investments and could record a charge to earnings for a corresponding amount. Alternatively, we have an option through the end of the lease term to purchase this facility for an aggregate amount that declines from approximately $34.0 million in 2012 to approximately $21.0 million in 2019.

 

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Cautionary Statement Pursuant to Private Securities Litigation Reform Act of 1995 – “Safe Harbor” for Forward-looking Statements

The information in this report includes statements that are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements, including those regarding the Company’s expectations for BENLYSTA, darapladib and other assets, may be identified by the use of words such as “believes,” “plans,” “expects,” “will,” “anticipates,” “estimates” and other words of similar meaning in conjunction with, among other things, discussions of financial performance or financial condition, product sales, growth strategy, product development, regulatory approvals or expenditures.

Forward-looking statements are based on our current intentions, beliefs and expectations regarding future events. The Company cannot guarantee that any forward-looking statement will be accurate. Investors should realize that if underlying assumptions prove inaccurate or unknown risks or uncertainties materialize, actual results could differ materially from the Company’s expectations. Investors are, therefore, cautioned not to place undue reliance on any forward-looking statement. Any forward-looking statement speaks only as of the date on which such statement is made, and, except as required by law, the Company does not undertake to update any forward-looking statement to reflect new information, events or circumstances.

Some important factors that could cause the Company’s actual results to differ from the Company’s expectations in any forward-looking statement include:

 

   

our lack of commercial experience and dependence on the sales growth of BENLYSTA;

 

   

any failure to commercialize BENLYSTA successfully;

 

   

the occurrence of adverse safety events with our products, resulting in product recalls, reduced sales, withdrawals, regulatory action on the part of the FDA or the termination of clinical trials for products in development;

 

   

changes in the availability of reimbursement for BENLYSTA;

 

   

the inherent uncertainty of the timing, success of, and expense associated with, research, development, regulatory approval and commercialization of our pipeline products, including darapladib, and new indications for existing products;

 

   

uncertainty as to the future success of darapladib and GlaxoSmithKline’s ability to develop and commercialize darapladib;

 

   

substantial competition in our industry, including from branded and generic products;

 

   

the highly regulated nature of our business;

 

   

uncertainty regarding our intellectual property rights and those of others;

 

   

the ability to manufacture at appropriate scale, and in compliance with regulatory requirements, to meet market demand for our product;

 

   

our substantial indebtedness and lease obligations;

 

   

our dependence on collaborations over which we may not always have full control;

 

   

foreign exchange rate valuations and fluctuations;

 

   

the impact of our acquisitions and strategic transactions;

 

   

changes in the health care industry in the U.S. and other countries, including government laws and regulations relating to sales and promotion, reimbursement and pricing generally;

 

   

significant litigation adverse to the Company, including product liability and patent infringement claims;

 

   

our ability to attract and retain key personnel;

 

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Cautionary Statement Pursuant to Private Securities Litigation Reform Act of 1995 – “Safe Harbor” for Forward-looking Statements (continued)

 

   

increased scrutiny of the health care industry by government agencies and state attorneys general resulting in investigations and prosecutions;

 

   

risks and uncertainties associated with the tender offer by GlaxoSmithKline plc (the “Offer”);

 

   

the outcome of any litigation related to the Offer or any other offer or proposal; and

 

   

the Board of Director’s recommendation to the stockholders concerning the Offer or any other offer or proposal.

The foregoing list sets forth many, but not all, of the factors that could cause actual results to differ from the Company’s expectations in any forward-looking statement. New factors emerge from time to time and it is not possible for management to predict all such factors, nor can it assess the impact of any such factor on the business or the extent to which any factor, or combination of factors, may cause results to differ materially from those contained in any forward-looking statement. Investors should consider this cautionary statement, as well as the factors discussed in Part II, Item 1A, “Risk Factors,” when evaluating our forward-looking statements.

 

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

We do not use derivative financial instruments in our operations or investment portfolio. Our investment portfolio may be comprised of low-risk U.S. Treasuries, government-sponsored enterprise securities, high-grade debt having at least an “A-” rating at time of purchase and various money market instruments. The short-term nature of these securities, which currently have an average term of approximately nine months, decreases the risk of a material loss caused by a market change related to interest rates.

We believe that a hypothetical 100 basis point adverse move (increase) in interest rates along the entire interest rate yield curve would adversely affect the fair value of our cash, cash equivalents, marketable securities and restricted investments by approximately $4.9 million, or approximately 0.7% of the aggregate fair value of $754.0 million, as of June 30, 2012. For these reasons, and because these securities are generally held to maturity, we believe we do not have significant exposure to market risks associated with changes in interest rates related to our debt securities held as of June 30, 2012. We believe that any interest rate change related to our debt securities held as of June 30, 2012 is not material to our consolidated financial statements. As of June 30, 2012, the yield on comparable six-month investments was approximately 0.2%, as compared to our current portfolio yield of approximately 1.1%. However, given the short-term nature of these securities, a general decline in interest rates may adversely affect the interest earned from our portfolio as securities mature and may be replaced with securities having a lower interest rate.

To minimize our exposure to credit risk, we invest in securities with strong credit ratings and have established guidelines relative to diversification and maturity with the objectives of maintaining safety of principal and liquidity. We do not invest in derivative financial instruments, auction rate securities, loans held for sale or mortgage-backed securities backed by sub-prime or Alt-A collateral, and we generally hold our investments in debt securities until maturity. However, adverse changes in the credit markets relating to credit risks would adversely affect the fair value of our cash, cash equivalents, marketable securities and restricted investments.

Our facility leases for our Traville headquarters and large-scale manufacturing require us to maintain minimum levels of restricted investments of approximately $39.8 million, or $39.5 million if in the form of cash, as collateral for these facilities. Together with the requirement to maintain approximately $33.1 million in restricted investments with respect to our small-scale manufacturing facility leases, our overall level of restricted investments is currently required to be approximately $72.9 million. Although the market value for these investments may rise or fall as a result of changes in interest rates, we will be required to maintain this level of restricted investments in either a rising or declining interest rate environment.

Our convertible notes bear interest at fixed rates. As a result, our interest expense on these notes is not affected by changes in interest rates.

We have several wholly-owned European subsidiaries for commercial activities in that region. While commercial activity in these subsidiaries is increasing, we do not believe we have material exposure to foreign currency fluctuation risks at this time. Another wholly-owned subsidiary, Human Genome Sciences Pacific Pty Ltd. (“HGS Pacific”) sponsors some of our clinical trials in the Asia/Pacific region. We currently do not anticipate HGS Pacific to have any operational activity, and therefore we do not believe we will have any foreign currency fluctuation risks with respect to HGS Pacific.

 

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Item 4. Controls and Procedures

Disclosure Controls and Procedures

Our management, including our principal executive and principal financial officers, has evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2012. Our disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed in this Quarterly Report on Form 10-Q has been appropriately recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive and principal financial officers, to allow timely decisions regarding required disclosure. Based on that evaluation, our principal executive and principal financial officers have concluded that our disclosure controls and procedures are effective at the reasonable assurance level.

Changes in Internal Control

Our management, including our principal executive and principal financial officers, has evaluated any changes in our internal control over financial reporting that occurred during the quarterly period ended June 30, 2012, and has concluded that there was no change that occurred during the quarterly period ended June 30, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

Item 1A. Risk Factors

A number of risk factors could cause our actual results to differ materially from those that are indicated by forward-looking statements. Those factors include, without limitation, those listed below in addition to the other information in this Quarterly Report on Form 10-Q. You should carefully consider these risk factors in evaluating our business because these risk factors may have a significant impact on our business, financial condition and results of operations. The risks described below are not the only risks we may face. Additional risks and uncertainties not presently apparent to us, or risks that we currently consider immaterial, could also negatively affect our business, financial condition and results of operations.

If the Merger contemplated by the Merger Agreement with GSK and Merger Sub does not occur, it could have a material adverse effect on our business, results of operations, and financial condition.

On July 16, 2012, GSK and HGS announced that the companies have signed a definitive merger agreement providing for the acquisition of HGS by GSK for $14.25 per share in cash. The transaction was approved by the board of directors of both companies. Under the terms of the definitive merger agreement, GSK amended its ongoing cash tender offer on July 16, 2012, to purchase all of our outstanding shares for $14.25 per share in cash. The closing of the tender offer is subject to customary conditions, including that there shall have been validly tendered and not validly withdrawn prior to the expiration of the Offer, when added to the number of Shares already owned by GSK, a majority of the Shares outstanding (determined on a fully diluted basis). Following the successful completion of the tender offer, H. Acquisition Corp., a Delaware corporation and a wholly owned subsidiary of GSK (“Merger Sub”) will merge with and into us (the “Merger”), with HGS surviving as a wholly owned subsidiary of GSK. Upon completion of the Merger, each share of common stock outstanding immediately prior to the effective time of the Merger (excluding those shares that are held by GSK, Merger Sub and us or any of our subsidiaries) will be canceled and converted into the right to receive the tender offer price in cash.

We cannot predict whether the closing conditions for the tender offer and the Merger set forth in the definitive merger agreement will be satisfied, and the transactions contemplated by the definitive merger agreement may be delayed or even abandoned before completion if certain events occur. The merger agreement may be terminated by us, on the one hand, or GSK, on the other hand, under certain circumstances, and termination of the merger agreement may require us to pay a termination fee of approximately $115 million to GSK. If the conditions to the transactions set forth in the merger agreement are not satisfied or waived pursuant to the merger agreement, or if the transactions are not completed for any other reason, (i) the market price of our common stock could significantly decline; (ii) we will remain liable for the significant expenses that we have incurred related to the transaction, including legal and financial advisor fees, and may be required to pay the approximately $115 million termination fee; (iii) we may experience substantial disruption in our sales, research and development, and operating activities, and the loss of key personnel, customers, suppliers, and other third-party relationships, any of which could materially and adversely affect us and our business, operating results, and financial condition; and (iv) we may have difficulty attracting and retaining key personnel.

Until the closing of the transactions, it is possible that the focus of our management team and employees may be diverted, and that there may be a negative reaction to the tender offer and the Merger on the part of our customers, employees, suppliers, or other third-party relationships. The merger agreement also contains certain limitations regarding our business operations prior to completion of the Merger.

COMMERCIAL RISKS

Our near-term prospects are highly dependent on the success of BENLYSTA®, our first FDA-approved product. To the extent we fail to successfully commercialize BENLYSTA, our business, financial condition and results of operations would be materially adversely affected and the price of our common stock would likely decline.

BENLYSTA is our first U.S. Food and Drug Administration (“FDA”) approved product. In March 2011, the FDA approved BENLYSTA for the treatment of adult patients with active, autoantibody-positive systemic lupus erythematosus (“active SLE”). We believe that BENLYSTA product sales may constitute all or most of our total revenue over the next several years.

 

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The degree of market acceptance and commercial success of BENLYSTA and our ability to generate and increase revenues will depend on a number of factors, including the following:

 

   

the number of patients with systemic lupus erythematosus who are diagnosed with the disease, and those that may be treated with BENLYSTA;

 

   

the safety and efficacy of BENLYSTA, our ability to provide acceptable evidence of safety and efficacy, and the perceptions in the medical community, by regulatory agencies and among insurers and other payers of BENLYSTA’s safety and efficacy, on both a short and long-term basis;

 

   

BENLYSTA’s perceived advantages over alternative treatment methods (including relative convenience and ease of administration and prevalence and severity of any adverse events, including any unexpected adverse events of which we become aware);

 

   

the claims, limitations, warnings and other information in BENLYSTA’s labeling;

 

   

our establishment of an effective sales force and the ability of our sales, marketing and other representatives to accurately describe BENLYSTA consistent with its approved labeling;

 

   

BENLYSTA’s price and perceived cost-effectiveness;

 

   

the ability of patients and physicians and other providers to obtain and maintain sufficient coverage and reimbursement by third-party payers, including government payers;

 

   

the receipt and maintenance of marketing approvals from the United States and foreign regulatory authorities;

 

   

the growth of commercial sales in the United States and other countries;

 

   

in the United States, the ability of group purchasing organizations, or GPOs (including distributors and other network providers), to sell BENLYSTA to their constituencies;

 

   

the establishment and maintenance of commercial manufacturing capabilities ourselves or through third-party manufacturers, and our ability to meet commercial demand for BENLYSTA; and

 

   

the effectiveness of our partnership with GlaxoSmithKline (“GSK”) in successfully obtaining foreign regulatory approvals and in marketing and selling BENLYSTA in both the U.S. and abroad.

Although our market research data suggest that there are approximately 200,000 patients in the U.S. who have been diagnosed with moderate-to-severe systemic lupus and may benefit most from BENLYSTA, we cannot predict the extent to which BENLYSTA will be utilized by these patients or other patients in the rest of the world or whether physicians, healthcare insurers or maintenance organizations, or the medical community in general, will accept or utilize BENLYSTA. The potential population of patients eligible for treatment with BENLYSTA may be reduced based on the limitations for use included in the approved Package Insert, including that BENLYSTA is not approved for use in patients with severe active lupus nephritis, severe active central nervous system lupus or those taking intravenous cyclophosphamide or other biologics. Our efforts to educate the medical community and third-party payers regarding the benefits of BENLYSTA will require significant resources and may not be successful in achieving our objectives. If BENLYSTA does not achieve broad market acceptance, the revenues we generate from sales will be limited and our business may not be profitable.

 

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Data generated or analyzed with respect to BENLYSTA in clinical trials or otherwise, including with respect to adverse safety events, may result in decreased demand and lower sales or product recall, withdrawal or regulatory action.

The approval of BENLYSTA by the FDA followed completion of the Phase 3 development program for belimumab. As a condition to obtaining U.S. marketing approval of BENLYSTA, we are required to conduct additional clinical trials. The size and scope of these Phase 4 trials are significant and will be costly. The results generated in these Phase 4 trials and other emerging data about BENLYSTA could result in loss of marketing approval, changes in product labeling, or new or increased concerns about side effects or the efficacy of BENLYSTA that may decrease demand and lower sales. Foreign regulatory agencies may impose comparable post-approval requirements that require significant additional expenditures. For example, based on post-marketing surveillance, we and GSK proposed labeling amendments to FDA and the European regulatory authorities regarding hypersensitivity and infusion reactions. In Europe, GSK and the regulatory authorities agreed in February 2012 upon the label changes, and GSK also agreed to send a direct communication to European healthcare providers to inform them of these changes. In the United States, HGS and the FDA agreed in March 2012 upon label changes that have been implemented. Post-marketing studies and other emerging data about BENLYSTA, such as adverse event reports, may result in other label changes and may adversely affect sales or result in withdrawal of BENLYSTA from the market. Furthermore, the discovery of significant problems with a product or class of products similar to BENLYSTA could have an adverse effect on sales of BENLYSTA.

In addition, new data and information, including information about product misuse, may lead government agencies, professional societies, practice management groups or organizations involved in various diseases to publish guidelines or recommendations related to the use of BENLYSTA or place restrictions on sales. Such guidelines or recommendations may lead to lower sales of BENLYSTA.

If we are unable to obtain marketing approvals for BENLYSTA in additional jurisdictions, or if we are significantly delayed or limited in doing so, our results of operations and business will be materially and adversely affected and our stock price would likely decline.

In July 2011, we received marketing approval for BENLYSTA in both the European Union and in Canada. Regulatory applications have also been submitted and are currently under consideration in a number of other countries. Despite approval by the FDA and certain other jurisdictions, we cannot offer any assurances or predict with any certainty that other regulatory authorities will grant marketing approval for BENLYSTA, or the expected timeframe of such approvals. Furthermore, as was the case with FDA approval, other regulatory approvals, even if obtained, may be limited to specific indications, limit the type of patients in which the drug may be used, or otherwise require specific warning or labeling language, any of which might reduce the commercial potential of BENLYSTA. Regulatory authorities may condition BENLYSTA marketing approval on the conduct of specific post-marketing studies to further evaluate safety and efficacy, in either particular patient populations or general patient populations or both. The results of these studies, discovery of previously unknown issues involving safety or efficacy or failure to comply with post-approval regulatory requirements, including requirements with respect to manufacturing practices, reporting of adverse effects, advertising, promotion and marketing, may result in restrictions on marketing of BENLYSTA or withdrawal of BENLYSTA from the market.

If we are unable to obtain approval for expansion of the labeled uses for BENLYSTA, we may not be able to recognize the value of the product in other indications.

BENLYSTA is a human monoclonal antibody that recognizes and inhibits the biological activity of B-lymphocyte stimulator, or BLyS, and was developed as a treatment for systemic lupus erythematosus. In March 2011, the FDA approved BENLYSTA for the treatment of active SLE. We and GSK intend to conduct new clinical trials for additional approved, or labeled, uses of BENLYSTA, such as vasculitis and other autoimmune indications and seek expansion of the labeled uses in the U.S. and in other countries. We and our partner also intend to conduct additional clinical trials for alternative delivery mechanisms. If we are not able to obtain approval for label expansion or alternative delivery mechanisms, we will have incurred significant clinical trial costs without corresponding benefits, our stock price may suffer and our business and financial condition could be materially and adversely affected.

 

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We may be unable to maintain or to expand our commercial manufacturing capability and may be unable to obtain required quantities of our products for commercial use.

Except for raxibacumab and quantities of BENLYSTA manufactured to build our inventory of BENLYSTA in support of commercialization, we have limited experience manufacturing materials suitable for commercial use. The FDA and equivalent foreign regulatory organizations must determine that our facilities comply with cGMP requirements for commercial production to license them for a particular product. Although the FDA has licensed our facility for the manufacture of BENLYSTA, the FDA will routinely re-inspect our facilities for such compliance. We may not successfully establish sufficient manufacturing capabilities or manufacture our products economically or in continuing compliance with cGMPs and other regulatory requirements. For example, we believe that we have sufficient manufacturing capacity to supply commercial quantities of BENLYSTA for the next several years. In 2010, we entered into a manufacturing agreement with Lonza Sales AG pursuant to which Lonza will manufacture additional commercial quantities of BENLYSTA. However, this additional manufacturing capacity may not be available for 12 months or longer, if ever, due, in part, to the time required to obtain regulatory approvals for the manufacture of BENLYSTA in Lonza’s facility. If Lonza’s facility fails to obtain regulatory approval in a timely manner or at all, we may not be able to build or procure additional capacity in the required timeframe to meet commercial demand, and our revenues may accordingly be limited from BENLYSTA. Our revenues from BENLYSTA also will be limited if the demand for BENLYSTA exceeds our capacity to supply BENLYSTA to patients.

BENLYSTA is solely produced at our large-scale manufacturing facility in Rockville, Maryland and raxibacumab is solely produced at our small-scale manufacturing facility, which is also in Rockville, Maryland. We currently depend on single source vendors for certain components used in BENLYSTA and raxibacumab. Furthermore, the filling, finishing and packaging for both BENLYSTA and raxibacumab are solely performed by a single third party manufacturer. We cannot guarantee that one or more of these plants or vendors will not encounter problems, including but not limited to loss of power, equipment failure, component defects or viral or microbial contamination, which could adversely affect our ability to deliver adequate supply of one or more of these products to patients or customers.

If we or our third-party manufacturers fail to comply with regulatory requirements imposed on our manufacturing activities, it could have a material adverse effect on our business, financial condition and results of operations.

We have previously engaged third-party manufacturers or utilized our collaboration partners’ manufacturing capabilities to manufacture products and we expect to continue to do so in the future. If we use others to manufacture our products, we will depend on those parties to comply with cGMPs and other regulatory requirements and to deliver materials on a timely basis. In addition, because regulatory approval to manufacture a drug is generally site-specific, the FDA and other regulatory authorities will routinely inspect our manufacturing facilities and our current and future third-party manufacturers’ facilities for compliance with cGMPs. If we or our third-party manufacturers fail to comply with applicable regulatory requirements, a regulatory agency may: issue warning letters; suspend or withdraw our regulatory approval for approved or in-market products; seize or detain products or recommend a product recall; refuse to approve pending applications or supplements to approved applications filed by us; suspend any of our ongoing clinical trials; impose restrictions or obligations on our operations, including costly new manufacturing requirements; close our facilities or those of our contract manufacturers; revoke previously granted drug approvals under certain circumstances; or impose civil or criminal penalties. Any of these actions could delay our development of products, the submission of these products for regulatory approval or result in insufficient product quantity to support commercial demand. As a result, our business, financial condition and results of operations could be seriously harmed.

We maintain high levels of inventory that decrease our liquidity and substantially increase the risk of write-offs.

We maintain inventory levels in excess of twelve months to mitigate risks such as product shortage due to higher than anticipated product demand, long lead times for manufacturing finished goods, supply interruptions for raw materials and risks of production disruptions at our sole U.S. FDA-approved manufacturing site due to contamination, equipment failure or other facility-related issues. We commit capital to maintain these high inventory

 

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levels, which prevents us from using that capital for other purposes, such as research and development, and requires us to utilize more capital than might otherwise be required. Increased inventory levels also impact our liquidity and cash flows since the inventory will not be converted to cash for more than one year. Our high inventory levels also heighten the risk of inventory obsolescence and write-offs.

Various factors may cause us to be unable to price or sell our products effectively. This could have a material adverse effect on our business, financial condition and results of operations.

Although we have priced BENLYSTA for the U.S. and certain other markets, we can provide no assurance as to the maintenance of these prices or that similar prices may be set for BENLYSTA in other markets upon foreign approvals. In the U.S. market we have priced BENLYSTA at approximately $443.00 for a 120 mg vial and approximately $1,477.00 for a 400 mg vial. Thus, the average price for an annual course of treatment in the U.S. (based on a patient weight of 161 pounds) would be approximately $35,000. U.S. sales of BENLYSTA are subject to various rebates, chargebacks and other deductions that will affect the revenue recognized from these sales. In Germany, the average price for an annual course of treatment (based on the same patient weight) would be approximately €23,000 (or approximately U.S. $28,200). The current net price of BENLYSTA in Germany would be approximately €14,700 (or approximately U.S. $18,000) due to distribution and other costs and a required 16% rebate applicable to all pharmaceutical products. The price in Germany is currently undergoing review. In May 2012, the Institute for Quality and Efficiency in Healthcare (“IQWIG”), an independent sub-committee giving scientific and clinical evaluation of drug products to the German Federal Joint Committee (“G-BA”), recommended that Benlysta be categorized as “no additional benefit.” An oral hearing by G-BA was held in June 2012 at which GSK and outside experts provided additional arguments. A final decision from G-BA regarding the additional benefit categorization is expected in August 2012 and negotiations on price will take place thereafter. In Spain, the average price for an annual course of treatment (based on the same patient weight) would be approximately €12,000 (or approximately U.S. $14,700). The prices quoted above reflect an exchange rate of 1.23 dollars per euro. The price of BENLYSTA in other countries is and may be significantly lower than these prices. In addition, the prices for our products may be affected by various factors that could adversely affect our sales and profit margins, including economic analyses of the burden of the applicable disease, the perceived value of the product and third party reimbursement policies.

BENLYSTA is currently our only commercially marketed product, although we have sold raxibacumab to the U.S. Government. BENLYSTA is being marketed together with our collaborator, GSK. If we receive approval for other products that can be marketed, we may market the products either independently or together with collaborators or strategic partners. Whether we market a product independently or in collaboration with a strategic partner, we will incur significant additional expenditures and commit significant additional resources to establish and sustain the sales forces. For any products that we market together with partners, we will rely, in whole or in part, on the marketing capabilities of those parties. We may also contract with third parties to market certain of our products. We may be unable to retain an adequate number of qualified sales representatives and may encounter difficulties in retaining third parties to provide sales, marketing or distribution resources. Ultimately, we and our partners may not be successful in marketing our products.

Reimbursement policies or changes in health care systems and payer policies may result in a decline in our potential sales and a reduction in our expected revenue from our potential products.

The revenues and profitability of biopharmaceutical companies like ours may be affected by the continuing efforts of government and third-party payers to contain or reduce the costs of health care through various means. For example, in certain foreign markets pricing or profitability of therapeutic and other pharmaceutical products is subject to governmental control. In the United States, there have been, and we expect that there will continue to be, a number of federal and state proposals to implement similar governmental control. Recent United States legislation, rules and regulations instituted significant changes to the United States healthcare system that could have a material adverse effect on our business, financial condition and profitability. We cannot predict what effects, if any, this legislation might have on our company and our products as this legislation is implemented over the next few years, nor can we predict whether additional legislative or regulatory proposals may be adopted.

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and private insurance plans. Third-party payers are increasingly challenging the prices charged for medical products and services. Third-party payers may limit access to pharmaceutical products through the use of prior authorizations and step therapy. Any reimbursement granted may not be maintained or limits on reimbursement available from third parties may reduce the demand for or negatively affect the price and profitability of those products. Payers may pursue aggressive cost cutting initiatives such as comparing the effectiveness, benefits and costs of similar treatments, which could result in lower reimbursement. For example, draft guidance issued in September 2011 by the United Kingdom (“U.K.”) National Institute for Health and Clinical Excellence (“NICE”) does not recommend BENLYSTA for patients with active SLE in England and Wales because NICE does not consider it to be a cost-effective use of National Health Service resources. Policies that decrease reimbursement would likely have a material adverse effect on our business, financial condition and results of operations. Our ability to successfully commercialize our products and product candidates and the demand for our products depend, in part, on the extent to which reimbursement and access is available from such third-party payers.

Because raxibacumab is a product whose current sole purchaser is the U.S. Government, the sale of raxibacumab faces risks in addition to the risks generally associated with the sale of biopharmaceutical products, including political considerations, government contracting requirements and government spending policies.

Raxibacumab, a human monoclonal antibody developed for use in the treatment of anthrax disease, presents risks in addition to those associated with our other products. Numerous other companies and governmental agencies are known to be developing biodefense pharmaceuticals and related products to combat anthrax disease. These competitors may have financial or other resources greater than ours, they may have easier or preferred access to the likely distribution channels for biodefense products or they may develop products judged to have greater efficacy for biodefense. In addition, since the primary purchaser of biodefense products is the U.S. Government and its agencies, the success of raxibacumab will depend on government spending priorities, policies and pricing restrictions. In the case of the U.S. Government, executive or legislative action could attempt to impose production and pricing requirements on us. In the event of extreme urgency, the government might seek to compel us or we might ourselves choose to reallocate our production in ways that may not be economically beneficial to the company.

We have entered into a two-phase contract to supply raxibacumab to the U.S. Government, which may be terminated by the U.S. Government at any time. Under the first phase of the contract, we supplied ten grams of raxibacumab to the U.S. Department of Health and Human Services (“HHS”) for comparative in vitro and in vivo testing. Under the second phase of the contract, the U.S. Government ordered 20,001 doses of raxibacumab for the U.S. Strategic National Stockpile (“SNS”) for use in the treatment of anthrax disease. We completed delivery of these doses and the U.S. Government accepted our deliveries. In July 2009, the U.S. Government agreed to purchase 45,000 additional doses. As of June 30, 2012, we have delivered 41,115 doses of this second order. We, therefore, have future deliveries to make and ongoing obligations under the contract, including the obligation to seek FDA approval.

In November 2009, we received a Complete Response Letter from the FDA related to our Biologics License Application (“BLA”) for raxibacumab. In this letter, the FDA determined that it would not approve our BLA for raxibacumab in its present form and requested additional studies and data. Although the government has accepted shipment of raxibacumab subsequent to the receipt of the FDA’s Complete Response Letter, we cannot be sure that the government will continue to accept future shipments or place additional orders.

We will continue to face risks related to the requirements of the contract. If we are unable to meet our obligations associated with this contract, the U.S. Government will not be required to make future payments related to that order. Although we have received U.S. Government approval for two orders of raxibacumab, we cannot be sure we will receive additional orders.

In December 2011, the U.S. Government issued a Sources Sought Notice seeking information from manufacturers of anthrax antitoxin medical countermeasures. In December 2011, we responded to this notice with information on our continuing ability and willingness to supply raxibacumab to the U.S. Government. On June 29, 2012, the U.S. Government issued a Solicitation for the procurement of anthrax antitoxins, such as raxibacumab. HGS intends to respond to this Solicitation. We cannot be sure that the U.S. Government will award an additional order for raxibacumab.

 

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In late 2011, we completed the manufacture of all bulk raxibacumab required for the second order from the U.S. Government and then initiated manufacturing of bulk raxibacumab in anticipation of a third order. If the U.S. Government does not award us a third order, then we will not receive revenue from this manufacturing and will have incurred additional manufacturing expenses. As of June 30, 2012, we have inventory relating to an anticipated third order of raxibacumab. If we do not receive an additional order from the U.S. Government, we would need to charge cost of product sales for this amount of inventory.

If we are unable to successfully commercialize BENLYSTA or other product candidates we develop, we may not be able to recover our investment in our research, product development, manufacturing and marketing efforts.

In March 2011, we received approval from the FDA to market BENLYSTA in the United States. We have made and continue to make substantial expenditures with respect to BENLYSTA and our product candidates. We have invested significant time and resources to isolate and study genes and determine their functions. We devote substantial resources to developing proteins, antibodies and small molecules for the treatment of human disease. Before we can commercialize a product, we must rigorously test the product in the laboratory and complete extensive animal and human clinical studies. We are also devoting substantial resources to enhancing our manufacturing capabilities and to building our commercial supply inventories of BENLYSTA to support commercialization. We have and expect to continue to devote substantial resources to maintain our marketing capability for BENLYSTA and any of our other products that are approved by the FDA or other regulatory authorities. If any product we develop is not approved for commercial sale, we may be unable to recover the large investment we have made in research, development, manufacturing and marketing efforts, and our business and financial condition could be materially adversely affected.

Our forecasting of sales of BENLYSTA may continue to be difficult due to uncertainty around the rate of adoption. If our BENLYSTA revenue projections are inaccurate and our business forecasting and planning decisions do not reflect our actual results, our business may be harmed and our stock price may be adversely affected.

Our business planning requires us to forecast demand and revenues despite numerous uncertainties. Actual results of operations may deviate materially from projected results. For example, our 2011 BENLYSTA revenue was lower than anticipated. This may have been a result of factors such as: patient and physician unfamiliarity with the new drug, perhaps exacerbated by lack of experience with new drugs for SLE; cautious prescribing behavior due to lack of reimbursement history for the product and recent examples of infused rheumatology products that were subject to widespread reimbursement delays or payment refusals; a need to reorient physician treatment algorithms toward reducing SLE disease activity by addressing the underlying mechanism rather than selecting therapies for specific manifestations; confusion regarding the clinical relevance of the complex composite endpoints used in the BENLYSTA clinical trials and a broad indication, causing physicians to have difficulty in identifying appropriate patients for treatment with BENLYSTA; and a general need for physician education regarding SLE and treatment modalities due to the novelty of the treatment and the absence of a new option for the treatment of SLE for decades. The extent to which any of these factors individually or in the aggregate will continue to impact future sales of BENLYSTA is uncertain and difficult to predict. This may lead to lower than expected revenue, inefficiency in expenditures and increased difficulty in operational planning. Our expenses are relatively fixed in the short term. Shortfall in our revenue has a direct impact on our cash flow and on our business generally. In addition, fluctuations in our quarterly results can adversely affect the market price of our common stock and our ability to finance our operations.

COMPETITIVE RISKS

Our competitors may develop and market products that are, or are perceived as, less expensive, or more effective, or safer, or easier to administer or reach the market sooner. This may diminish or eliminate the commercial success of any products we may commercialize.

Key factors affecting the success of any approved product include its efficacy, safety profile, drug interactions, method and frequency of administration, pricing, reimbursement and level of promotional activity relative to those

 

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of competing products. Existing and any future competing products may provide greater therapeutic convenience or clinical or other benefits for a specific indication than our products, or may offer comparable performance at a lower cost. The introduction of more efficacious, safer, cheaper, or more convenient alternatives to our products could reduce our revenues and the value of our product development efforts or could render our technology, products or product candidates under development noncompetitive, uneconomical or obsolete.

We are aware of existing products and products in research or development by others that address the diseases we are targeting. Any of these products may compete with our product candidates. For example, a number of pharmaceutical and biotechnology companies are currently developing products targeting the same types of indications that we are targeting with BENLYSTA, and some of these competitors’ products are in clinical trials.

If we successfully develop products but those products do not achieve and maintain market acceptance, our business will not be successful. Any reduction in demand for our products as a result of a competing product could lead to reduced revenues, reduced margins, reduced levels of profitability, and loss of market share for our products. These competitive pressures could adversely affect our business and operating results.

The development and commercialization of biopharmaceutical products is highly competitive and subject to rapid technological advances. We will face competition with respect to all products we may develop or commercialize from pharmaceutical and biotechnology companies worldwide. We also expect increasing competition from governments, universities and other non-profit research organizations. These institutions conduct a significant amount of research and development in the field of biologic technologies and are increasingly aware of the commercial value of their findings. As a result, they are demanding greater patent and other proprietary rights, as well as licensing and future royalty revenues.

Many of our competitors have significantly greater financial, research and development, intellectual property estates, regulatory, manufacturing, marketing, sales and other resources than we do. As a result, our competitors may succeed in developing their products before we do and obtaining approvals from the FDA or other regulatory agencies for their products more rapidly than we do. They may be able to devote greater resources to the development, manufacture, marketing and sale of their products. They may initiate or withstand substantial price competition or otherwise more successfully market their products. Competing products or technologies might render our technology or product candidates under development noncompetitive, uneconomical or obsolete.

We may also face risks to our profitability and financial condition from generic drug or biosimilar manufacturers.

The United States has enacted legislation establishing a regulatory pathway for follow-on biologics, also known as biosimilars. This and similar regulatory and legislative activity in other countries may make it easier for generic drug manufacturers to manufacture and sell biological drugs similar or identical to BENLYSTA and raxibacumab which might affect the profitability or commercial viability of our products. An accelerated route to market for generic versions of small molecule drugs was established in the United States with the passage of the Hatch-Waxman Amendments in 1984, which also provides five years of exclusivity for small molecule drugs with additional exclusivity under certain circumstances. The passage of the Biologics Price Competition and Innovation Act (“BPCIA”) in March 2010 established a similar pathway for FDA approval of a follow-on biologic that provides 12 years of exclusivity for the original biologic and an additional six month exclusivity period if certain pediatric studies are conducted. In February 2012, the FDA released draft guidance regarding the implementation of this legislation, and the FDA held a public hearing in May 2012 to seek public comment on this guidance. The FDA may release additional guidance or regulations to implement this legislation, which may not be favorable to us. Moreover, additional legislation could adversely affect the period of exclusivity for an original biologic. For example, the Obama Administration has proposed reducing the period of exclusivity to seven years and prohibiting additional exclusivity periods for a given biologic product. The European Medicines Agency has issued guidelines for approving products through an abbreviated pathway under which more than ten biosimilars have been approved. European legislation provides ten years of exclusivity for original drugs, including biologics, and an additional one year of exclusivity for obtaining marketing approval for certain additional indications. If a generic or biosimilar version of one of our products were approved, it could have a material adverse effect on the sales and gross profits of the product and adversely affect our business and operating results.

 

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PRODUCT DEVELOPMENT RISKS

Our product development efforts depend on new technologies, which may not prove successful.

Our development of new products may depend on the use of cutting-edge, recently discovered technologies that may not previously have been successfully utilized in existing commercial products. As a result, our product development efforts involve risks of failure inherent in the use of innovative and unproven technologies and the risks associated with drug development generally. These risks include the possibility that:

 

   

these technologies or any or all of the molecules based on these technologies may be ineffective or toxic and, therefore, expose us to litigation or fail to receive or retain necessary regulatory clearances;

 

   

the products, even if safe and effective, may be difficult to manufacture on a large scale or uneconomical to market;

 

   

proprietary rights of third parties may prevent us or our collaborators from exploiting technologies or marketing products; and

 

   

third parties may market superior or equivalent products.

We have limited experience in developing and commercializing products, and we may be unsuccessful in our efforts to develop other products or new indications for BENLYSTA that will be commercially successful.

Although we are or will be conducting human studies with respect to a number of products, including potential new indications for BENLYSTA, we may not be successful in developing or commercializing any of these products or indications. We will continue to incur substantial expenditures relating to research, development, clinical studies and manufacturing efforts relating to these products, for new products and for new indications for BENLYSTA. Our ability to develop and commercialize products based on proteins, antibodies and small molecules will depend on our abilities to:

 

   

successfully complete laboratory testing and human studies;

 

   

obtain and maintain necessary intellectual property rights to our products;

 

   

obtain and maintain necessary regulatory approvals related to the efficacy and safety of our products;

 

   

maintain production facilities meeting all regulatory requirements or enter into arrangements with third parties to manufacture our products on our behalf; and

 

   

deploy sales and marketing resources appropriately, efficiently and effectively or enter into arrangements with third parties to provide these functions.

We may not be successful in developing any new products or developing BENLYSTA for new indications or obtaining required regulatory approvals. Even if regulatory approval is obtained for the commercial sale of a product or a new indication for BENLYSTA, it could take considerable time following approval, if ever, before we are likely to receive revenue from product sales or substantial royalty payments.

We are continually evaluating our business strategy and may modify this strategy in light of developments in our business and other factors.

Our ability to discover and develop new products depends on our internal research capabilities and our ability to acquire products. Although we continue to conduct research and development activities on products and have increased our activities in this area, our limited resources may not be sufficient to discover and develop new product candidates.

 

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We continue to evaluate our business strategy and, as a result, may modify our strategy in the future. In this regard, we may, from time to time, focus our product development efforts on different products or may delay or halt the development of various products, as we and our partner Novartis did with ZALBIN in 2010. In addition, as a result of changes in our strategy, we may also change or refocus our existing drug discovery, development, commercialization and manufacturing activities. This could require changes in our facilities and personnel and restructuring various financial arrangements. We cannot assure you that any product development changes that we implement will be successful.

Clinical trials for our products are expensive and protracted and their outcome is uncertain. We must invest substantial amounts of time and money that may not yield viable products.

Conducting clinical trials is a lengthy, time-consuming and expensive process. Before obtaining regulatory approvals for the commercial sale of any product we must demonstrate through laboratory, animal and human studies that the product is both effective and safe for use in humans. We will incur substantial expense and devote a significant amount of time to conducting ongoing trials and initiating new trials.

Before clinical testing in humans can begin, a drug must be subject to rigorous preclinical testing and documentation. This documentation must be reviewed by the FDA as part of an Investigational New Drug Application (“IND”). Data obtained from tests are susceptible to varying interpretations that may delay, limit or prevent regulatory approval. Furthermore, regulatory authorities may refuse or delay approval as a result of many factors, including changes in regulatory policy during the period of product development. Even if an IND is approved, preclinical studies do not assure clinical success. Many potential drugs have shown promising results in early testing but subsequently failed to obtain necessary regulatory approvals.

Clinical trials may take many years. The time required varies substantially according to the type, complexity, novelty and intended use of the product candidate. The progress of clinical trials is monitored by both the FDA and independent data monitoring committees that may require the modification, suspension or termination of a trial if it is determined to present excessive risks to patients. Our rate of commencement and completion of clinical trials may be delayed by many factors, including:

 

   

financial and personnel resources to conduct or complete trials;

 

   

our inability to manufacture sufficient quantities of materials for use in clinical trials;

 

   

our inability to enroll patients due to unavailability or variability in the number and types of patients for each study;

 

   

difficulty in maintaining contact with patients after treatment, resulting in incomplete data;

 

   

safety issues or side effects;

 

   

ineffectiveness of products during the clinical trials; or

 

   

government or regulatory delays.

Data obtained from our clinical trials may not be sufficient to support an application for regulatory approval without further studies.

Studies conducted by us or by third parties on our behalf may not demonstrate sufficient effectiveness and safety to obtain the requisite regulatory approvals for these or any other potential products. For example, we had been developing ZALBIN for many years. In 2010, we and our collaboration partner Novartis decided to end further development of ZALBIN in anticipation of a Complete Response Letter from the FDA in which we expected the FDA to conclude that our existing ZALBIN data would not support approval of our BLA. In November 2009, we received a Complete Response Letter from the FDA related to our BLA for raxibacumab. In this letter, the FDA determined that it could not approve the BLA in its present form and requested additional studies and data that would be needed prior to the FDA making a decision as to whether or not to approve the raxibacumab BLA. We are in the process of completing those studies and compiling the data and expect to file this information with the FDA in

 

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the summer of 2012. However, if we are delayed and do not complete the additional studies and generate the additional data within the time required by the FDA, we may be required to withdraw our existing BLA and resubmit our BLA after completion of such studies. This will start a new review cycle. Even if we do complete such studies and generate such data, the studies and data may not be sufficient for FDA approval. Even if FDA or other regulatory approval is obtained for a product candidate, it may be limited to specific indications, limit the type of patients in which the drug may be used, or otherwise require specific warnings or labeling language, any of which might reduce the commercial potential of the product.

We depend on third parties to conduct many of our clinical trials, and we may encounter delays in or lose some control over our efforts to develop products.

We are dependent on third-party research organizations to enroll qualified patients and conduct, supervise and monitor many of our clinical trials. Our reliance on these service providers does not relieve us of our regulatory responsibilities, including ensuring that our clinical trials are conducted in accordance with good clinical practice regulations and the plan and protocols contained in the relevant regulatory application. In addition, these organizations may not complete activities on schedule or may not conduct our preclinical studies or clinical trials in accordance with regulatory requirements or our trial design. If we are unable to obtain any necessary services on acceptable terms or if these service providers do not successfully carry out their contractual duties or meet expected deadlines, our efforts to obtain regulatory approvals for our product candidates may be delayed or prevented.

RISK FROM COLLABORATION RELATIONSHIPS AND STRATEGIC ACQUISITIONS

Our plan to use collaborations to leverage our capabilities may not be successful if we are unable to integrate our partners’ capabilities with our operations or if our partners’ capabilities do not meet our expectations.

As part of our strategy, we intend to continue to evaluate strategic partnership opportunities. In order for our future collaboration efforts to be successful, we must first identify partners whose capabilities complement and integrate well with ours. Technologies to which we gain access may prove ineffective or unsafe. Ownership of these technologies may be disputed. Our current agreements that grant us access to such technology may expire and may not be renewable or could be terminated if we or our partners do not meet our respective obligations. In addition, our partners may provide certain services for us, such as distribution services. These agreements are subject to differing interpretations and we and our partners may not agree on the appropriate interpretation of specific requirements. Our partners, among other things, may prove difficult to work with, less effective than we originally expected or unable to satisfy their financial and other commitments to us. Failure of our partners to perform as needed could place us at a competitive disadvantage.

We may not be able to generate substantial revenue from agreements with our current or future collaboration partners.

To date we have received substantial revenue from payments made under collaboration agreements with GSK and, to a lesser extent, other agreements. The research term of our initial GSK collaboration agreement and many of our other collaboration agreements expired in 2001. None of the research terms of these collaboration agreements was renewed and we may not be able to enter into additional collaboration agreements. While our partners under our initial GSK collaboration agreement have informed us that they have been pursuing research programs involving different genes for the creation of small molecule, protein and antibody drugs, we cannot assure you that any of these programs will continue or will result in any approved drugs. If our partners are unsuccessful in such research and development efforts, we will not receive any revenue from the development or commercialization of these assets.

Under our present collaboration agreements, we are entitled to certain commercialization rights, milestones and/or royalty payments based on our partners’ development of the applicable product. We may not receive revenue under these agreements if our collaborators fail to:

 

   

develop marketable products;

 

   

obtain regulatory approvals for products; or

 

   

successfully market products.

 

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Further, circumstances could arise under which one or more of our collaboration partners may allege that we breached our agreement with them and, accordingly, seek to terminate our relationship with them. Our collaboration partners may also terminate these agreements without cause or if competent scientific evidence or safety considerations do not justify moving the applicable product forward. If one or more of these agreements terminate, this could adversely affect our ability to commercialize our products and harm our business.

In addition, should the tender offer not be completed as planned, our relationship with our partner, GSK, may be adversely affected, which could hinder our ability to successfully commercialize BENLYSTA.

If one of our collaborators pursues a product that competes with our products, there could be a conflict of interest and we may not receive expected milestone or royalty payments.

Each of our collaborators is developing a variety of products, some with other partners. Our collaborators may pursue existing or alternative technologies to develop drugs targeted at the same diseases instead of using our licensed technology to develop products in collaboration with us. Our collaborators may also develop products that are similar to or compete with products they are developing in collaboration with us. If our collaborators pursue these other products instead of our products, we may not receive milestone or royalty payments.

Our efforts to acquire other biotechnology companies or in-license and develop additional product candidates may not be successful. This could have a material adverse effect on our business, financial condition and results of operations.

Our business strategy may include the acquisition of other biotechnology companies or in-license of additional product candidates to complement and supplement our existing product pipeline, and we may acquire such companies and in-license additional product candidates that have demonstrated positive pre-clinical and/or clinical data. We may not be successful in identifying, effectively evaluating, acquiring or in-licensing, and developing additional product candidates on appropriate terms. In addition, product in-licensing involves inherent risks, including uncertainties due to matters that may affect the successful development or commercialization of the in-licensed product as well as the possibility of contractual disagreements with regard to terms such as patent rights, license scope or termination rights. Competition for attractive product opportunities is intense and may require us to devote substantial resources, both managerial and financial, to a product opportunity. Even if we are successful in acquiring a product candidate, it may not result in a successfully developed, or commercialized, product. Moreover, the cost of acquiring other companies or in-licensing product candidates could be substantial and in order to acquire companies or new products we may need to raise additional financing, which if it involves the issuance of additional shares of our common stock would dilute existing stockholders. In March 2011, we entered into a development and commercialization agreement with FivePrime Therapeutics, Inc. (“FivePrime”) to develop a product for multiple cancers. We paid FivePrime an upfront license fee of $50 million and could be required to pay up to $445 million in future development, regulatory and commercial milestone payments. However, there can be no assurance that we will be able to develop and commercialize such a product or ever be able to recover our initial or subsequent investment in the development of this product. If we are unsuccessful in our efforts to acquire other companies or in-license and develop additional product candidates, or if we acquire or license unproductive assets, it could have a material adverse effect on the growth of our business.

In order to achieve the anticipated benefits of an acquisition, we must integrate the acquired company’s business, technology and employees in an efficient and effective manner. The successful combination of companies in a rapidly changing biotechnology industry may be more difficult to accomplish than in other industries. The combination of two companies requires, among other things, integration of the companies’ respective technologies and research and development efforts. We cannot assure you that this integration will be accomplished smoothly or successfully. The difficulties of integration may be increased by any need to coordinate geographically separated organizations and address differences in corporate cultures and management philosophies. The integration of certain operations will require the dedication of management resources and, accordingly, may temporarily distract attention from the day-to-day operations of the combined companies. The business of the combined companies may also be disrupted by employee retention uncertainty and lack of focus during integration. The inability of management to integrate successfully the operations of the two companies, in particular, the integration and retention of key personnel, or the inability to integrate successfully two technology platforms, could have a material adverse effect on our business, results of operations and financial condition.

 

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REGULATORY AND COMPLIANCE RISKS

If we fail to comply with the extensive health care legal and regulatory requirements applicable to us, we may be subject to significant liability.

Our activities, and the activities of our agents, including some contracted third parties, are subject to extensive government regulation and oversight both in the U.S. and in foreign jurisdictions. As discussed in other risk factors, the FDA directly regulates many of our business activities, including the conduct of preclinical and clinical studies, product manufacturing, advertising and promotion, product distribution, and adverse event reporting. Additionally, our interactions in the U.S. or abroad with physicians and other potential referral sources that prescribe or purchase our products are also subject to government regulation designed to prevent health care fraud and abuse. Relevant U.S. laws include:

 

   

the Anti-Kickback Law, which prohibits persons from, among other things, knowingly and willfully soliciting, receiving, offering or paying remuneration, directly or indirectly, in exchange for or to induce either the referral of an individual for, or the purchase, order or recommendation of, any good or service for which payment may be made under federal health care programs, such as the Medicare and Medicaid programs;

 

   

federal false claims laws which prohibit individuals or entities from, among other things, knowingly presenting, or causing to be presented, claims for payment to the government or its agents that are false or fraudulent;

 

   

laws that require transparency regarding financial arrangements with health care professionals, such as the reporting and disclosure requirements imposed by the Patient Protection and Affordable Care Act (“PPACA”); and

 

   

state law equivalents of each of the above federal laws, such as anti-kickback and false claims laws, which may apply to items or services reimbursed by state health insurance programs or any third-party payer, including commercial insurers and state transparency laws.

Moreover, recent health care reform legislation has increased the risks and consequences for some of these laws. For example, PPACA provides that the government may assert that a claim, which includes items or services resulting from a violation of the Federal Anti-Kickback Law constitutes a “false” or fraudulent claim for purposes of the Federal False Claims Act and other federal false claims statutes.

The FDA, the Office of Inspector General for the Department of Health and Human Services, the Department of Justice, states’ Attorneys General and other governmental authorities actively enforce the laws and regulations discussed above. In the U.S., pharmaceutical and biotechnology companies have been the target of numerous government prosecutions and investigations alleging violations of law, including claims asserting impermissible off-label promotion of pharmaceutical products, payments intended to influence the referral of federal or state health care business, submission of false claims for government reimbursement, or submission of incorrect pricing information.

Violations of any of the laws described above or any other applicable governmental regulations and other similar foreign laws may subject us, our employees or our agents to criminal and/or civil sanctions, including fines, civil monetary penalties, exclusion from participation in government health care programs (including Medicare and Medicaid), and the restriction or restructuring of our operations, any of which could adversely affect our ability to operate our business and our financial results. Additionally, whether or not we have complied with the law, an investigation into alleged unlawful conduct may incur significant expense, cause reputational damage, divert management time and attention, and otherwise adversely affect our business. While we have developed and instituted a corporate compliance program, we cannot guarantee that we, our employees, our consultants, contractors, or other agents are or will be in compliance with all applicable U.S. or foreign laws.

 

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Furthermore, we expect there will continue to be federal and state laws and/or regulations, proposed and implemented, that could impact our operations and business. The extent to which future legislation or regulations, if any, relating to health care fraud abuse laws and/or enforcement, may be enacted or what effect such legislation or regulation would have on our business remains uncertain.

Our growing international operations increase our risk of exposure to potential claims of bribery and corruption and potential liability related to privacy and data protection.

Failure to comply with applicable legislation such as the U.S. Foreign Corrupt Practices Act and the recently enacted U.K. Bribery Act and other similar foreign laws could expose us and senior management to civil and criminal penalties, potential debarment from public procurement, and reputational damage, any of which could materially and adversely affect our business. While we have developed and instituted a corporate compliance program, we cannot guarantee that we, our employees, our consultants, contractors, or other agents are or will be in compliance with all applicable U.S. or foreign laws.

We are also subject to a number of privacy and data protection laws and regulations globally. The legislative and regulatory landscape for privacy and data protection continues to evolve. There has been increased attention to privacy and data protection issues in both developed and emerging markets with the potential to directly affect our business, including recently enacted laws and regulations in the United States, Europe, Asia and Latin America and increased enforcement activity in the United States and other developed markets.

Because we are subject to extensive and changing government regulatory requirements, we may not be able to obtain regulatory approval of our product candidates in a timely manner, if at all.

Regulations in the United States and other countries have a significant impact on our research, product development and manufacturing activities and will be a significant factor in the marketing of our products. All of our products require regulatory approval prior to commercialization. In particular, our products are subject to rigorous preclinical and clinical testing and other premarket approval requirements by the FDA and similar regulatory authorities in other regions, such as Europe and Asia. Various statutes and regulations also govern or influence the manufacturing, safety, labeling, storage, record keeping and marketing of our products. The lengthy process of seeking these approvals, and the subsequent compliance with applicable statutes and regulations, require the expenditure of substantial resources. Any failure by us to obtain, or any delay in obtaining, regulatory approvals could materially adversely affect our ability to commercialize our products in a timely manner, or at all.

United States Regulatory Approval. Before a product can be marketed in the United States, the results of the preclinical and clinical testing must be submitted to the FDA for approval. This submission will be either a new drug application (“NDA”) or a BLA, depending on the type of drug. In responding to an application, the FDA may grant marketing approval, request additional information or deny the application if it determines that the application does not provide an adequate basis for approval. In March 2011 we received marketing approval for BENLYSTA from the FDA. We cannot assure you that any approval required by the FDA for any other product candidates will be obtained on a timely basis, or at all.

Furthermore, regulatory approvals, even if obtained, may be limited to specific indications, limit the type of patients in which the drug may be used, or otherwise require specific warning or labeling language, any of which might reduce the commercial potential of the product and materially adversely affect our results of operations and business.

The FDA may condition marketing approval on the conduct of specific post-marketing studies to further evaluate safety and efficacy, including in particular patient populations. Rigorous and extensive FDA regulation of pharmaceutical products continues after approval, particularly with respect to compliance with cGMPs, reporting of adverse effects, advertising, promotion and marketing. Discovery of previously unknown problems or failure to comply with the applicable regulatory requirements may result in restrictions on the marketing of a product or withdrawal of the product from the market as well as possible civil or criminal sanctions, any of which could materially adversely affect our business. In addition, such post-marketing studies may be expensive, time-consuming and difficult to complete in a timely fashion, any of which may limit our ability to develop other indications of existing products as well as indications for new products.

 

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Foreign Regulatory Approvals. We must obtain regulatory approval by governmental agencies in other countries prior to commercialization of our products in those countries. Foreign regulatory systems may be rigorous, costly and uncertain. In July 2011, we received marketing approval for BENLYSTA in both the European Union and in Canada. Regulatory applications have also been submitted and are currently under consideration in a number of other foreign countries. Foreign regulatory approvals, even if obtained, may be limited to specific indications, limit the type of patients in which the drug may be used, or otherwise require specific warning or labeling language, any of which might reduce the commercial potential of the product.

We are subject to environmental, health and safety laws that may restrict us from conducting our business in the most economically advantageous manner.

We are subject to various laws and regulations relating to safe working conditions, laboratory and manufacturing practices, the experimental use of animals, emissions and wastewater discharges, and the use and disposal of hazardous or potentially hazardous substances used in connection with our research, including radioactive compounds and infectious disease agents. We also cannot accurately predict the extent that regulations that might result from any future legislative or administrative action might affect our business. Any of these laws or regulations could cause us to incur additional expense or restrict our operations.

INTELLECTUAL PROPERTY RISKS

If our patents expire or are successfully challenged, our patent applications do not result in issued patents or if patent laws or the interpretation of patent laws change, our competitors may be able to obtain rights to and commercialize our discoveries or competing products.

We rely on patents to protect against exploitation of our discoveries by our competitors. For example, we and our collaborator GSK have patents and patent applications directed to compounds targeting BLyS, including BENLYSTA, in the United States and other countries. These patents and patent applications cover BENLYSTA as well as various methods of using the product. The principal patents covering BENLYSTA generally expire between 2016 and 2023 in the United States and between 2016 and 2026 in the rest of the world, subject to any additional patent term extensions and supplemental protection certificates that may be obtained. While we have filed applications for certain patent term extensions and supplemental protection certificates, certain of which have been issued, our filed and future applications may not be considered sufficient to meet the statutory requirements in all cases, and any patent term extensions and supplemental protection certificates which are issued may be subject to challenge and may not cover all competing products. We also have patents in the United States covering raxibacumab as well as various methods of treatment using the product. The U.S. patents covering raxibacumab expire between 2023 and 2027, subject to any available patent term extensions that may be obtained. Some of the U.S. patents covering some of our products in development begin to expire in 2016. The expiration of or any successful challenges to our patents, patent applications, patent term extensions and supplemental protection certificates could allow other companies to commercialize products similar or identical to our products sooner than otherwise, which could lead to reduced revenues, reduced margins, reduced levels of profitability, and loss of market share for our products, adversely affecting our business and operating results.

Our pending patent applications, including those covering full-length genes and their corresponding proteins and antibodies, may not result in the issuance of any additional patents. Our applications may not be sufficient to meet the statutory requirements for patentability in all cases or may be subject to challenge if they do issue. Important legal issues remain to be resolved as to the extent and scope of available patent protection for biotechnology products and processes in the United States and other important markets outside the United States, such as Europe and Japan. For example, in March 2012, the U.S. Supreme Court issued a decision in Mayo v. Prometheus holding that certain diagnostic methods were unpatentable laws of nature rather than patentable methods of applying laws of nature. Additionally, a 2010 U.S. district court decision involving Myriad Genetics expressed concerns regarding the patentability of isolated human genes and gene-based diagnostic methods. In July 2011, the Court of Appeals for the Federal Circuit upheld the patentability of isolated human genes, but found that diagnostic method claims reciting merely “comparison” steps were unpatentable. However, in April 2012, that

 

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decision was vacated by the U.S. Supreme Court and remanded for further consideration by the Federal Circuit in light of the Supreme Court’s Mayo decision. Foreign markets may not provide the same level of patent protection as provided under the U.S. patent system. We expect that litigation or administrative proceedings will likely be necessary to determine the validity and scope of certain of our and others’ proprietary rights. We are currently involved in a number of litigation and administrative proceedings relating to the validity and scope of protection of our patents and those of others in the United States and the rest of the world.

In addition, the “Leahy-Smith America Invents Act” was recently signed into law in the United States. Among other provisions, this law implements a “first inventor to file” system and provides opportunities for third parties to challenge issued patents and submit evidence to be considered by the Patent Office prior to the issuance of a patent. These changes could affect our ability to obtain patents on our inventions and provide additional opportunities for others to challenge our patents. These and other changes in, or different interpretations of, patent laws in the United States and other countries may result in patent laws that allow others to use our discoveries or develop and commercialize our products or prevent us from using or commercializing our discoveries and products.

HGS has brought three cases against Genentech, Inc. and City of Hope that are now pending before the United States District Court for the Central District of California alleging that U.S. Patent Nos. 6,331,415 (the “Cabilly II Patent”) and 7,923,221 (the “Cabilly III Patent”), related to the field of antibody production and manufacture are invalid, unenforceable, and not infringed by the manufacture, use, importation, offer for sale and sale of BENLYSTA and that Genentech violated numerous antitrust and unfair competition laws in obtaining and enforcing the Cabilly II patent. Genentech and City of Hope then filed counterclaims alleging, among other things, that the manufacture, offer for sale and sale of BENLYSTA infringes one or more claims of the Cabilly II patent. Genentech also brought a separate infringement action against HGS and others relating to the Cabilly III patent, which was consolidated with the HGS suits in the Central District of California. In September 2011, the Court entered an order staying the antitrust and unfair competition suit; HGS has requested that the Court lift this stay. Discovery is ongoing in the Cabilly II and III cases and Genentech has moved to dismiss HGS’ inequitable conduct counterclaims in both cases.

Additionally, we have been involved in interference proceedings brought by the United States Patent and Trademark Office (“PTO”) and may be involved in additional interference proceedings in the future. These proceedings determine the priority of inventions and, thus, the right to a patent for technology in the U.S.

We are also involved in proceedings in connection with foreign patent filings, including opposition and revocation proceedings, and may be involved in other such proceedings in the future. For example, we are involved in European (“EP”) opposition proceedings filed by Teva regarding one of HGS’ issued EP patents covering BENLYSTA; HGS filed a response to Teva’s opposition in May 2012. We are also involved in EP opposition proceedings regarding an issued patent of Biogen Idec that HGS and GSK have licensed. In this opposition, the European Patent Office (“EPO”) found Biogen Idec’s claims to a method of treating autoimmune diseases using an antibody to BLyS (such as BENLYSTA), to be valid. Merck Serono SA has appealed this decision to an EPO Technical Board of Appeal, which has scheduled a hearing in October 2012. In September 2011, Eli Lilly and Company filed a revocation proceeding in the U.K. against Biogen Idec with respect to the same Biogen Idec EP patent that is on appeal at the EPO, and in April 2012 Eli Lilly added a request for a declaration that its tabalumab product does not infringe Biogen’s patent. In March 2012, Eli Lilly initiated similar revocation and non-infringement proceedings in Ireland against the same Biogen Idec patent. The parties have agreed to postpone discovery in the Biogen Idec U.K. and Irish proceedings until after the EPO’s decision in October 2012; a trial has been scheduled in the U.K. proceedings in July 2013 and a trial is expected in the Irish proceedings in late 2013. In April 2012, Eli Lilly initiated an opposition proceeding against a related European patent of Biogen Idec that HGS and GSK have also licensed; a response is due in September 2012.

We are also involved in another revocation proceeding in the U.K. brought by Eli Lilly and Company with respect to our EP patent related to BLyS compositions, including antibodies. In 2008, the U.K. High Court ruled that this patent was invalid in the U.K. Eli Lilly had also challenged this patent at the EPO, and in late 2009, an EPO Technical Board of Appeal held that the patent was valid. Nevertheless, in early 2010, the U.K. Court of Appeal disagreed with the EPO and upheld the High Court’s invalidation of the EP patent in the U.K. The U.K. Supreme Court granted HGS permission to appeal this decision and heard the appeal the week of July 18, 2011. On November 2, 2011, the Supreme Court issued a judgment in favor of HGS and allowed HGS’ appeal, dismissed Eli

 

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Lilly’s cross-appeal, awarded HGS costs, and remanded the case to the Court of Appeal to resolve the remaining issues. A hearing on the remaining issues was held at the Court of Appeal in July 2012; a decision is pending. In addition, in February 2012, Eli Lilly & Company filed another action against HGS at the U.K. High Court regarding this U.K. patent. In this new action, Eli Lilly seeks a declaratory judgment that any supplementary protection certificate obtained for HGS’ U.K. patent based on Lilly’s tabalumab product would be invalid. In March 2012, Eli Lilly requested that the U.K. High Court refer certain legal issues regarding supplementary protection certificates to the European Union Court of Justice, and in May 2012, HGS filed a motion to dismiss the action. A hearing on Lilly’s request and HGS’ motion was held in June 2012; a decision is pending.

We are also involved in opposition proceedings we and our collaborator FivePrime initiated in February 2012 against an EP patent of Aventis Pharma S.A. related to fibroblast growth factor (“FGF”) receptor fusion proteins. In addition, we are involved in opposition proceedings we initiated in April 2012 against an EP patent of Genentech related to death receptor 4 (“DR4”) agonist antibodies.

We cannot assure you that we will be successful in any of these proceedings. Moreover, any such litigation or proceeding may result in a significant commitment of resources in the future and could force us to do one or more of the following: cease selling or using any of our products that incorporate the challenged intellectual property, which would adversely affect our revenue; obtain a license from the holder of the intellectual property right alleged to have been infringed, which license may not be available on reasonable terms, if at all; and redesign our products to avoid infringing the intellectual property rights of third parties, which may be time-consuming or impossible to do. In addition, such litigation or proceeding may allow others to use our discoveries or develop or commercialize our products. We cannot assure you that the patents we obtain or the unpatented technology we hold will afford us significant commercial protection.

If others file patent applications or obtain patents similar to ours, then the United States Patent and Trademark Office may deny our patent applications, or others may restrict the use of our discoveries.

We are aware that others, including universities, government agencies and companies working in the biotechnology and pharmaceutical fields, have filed patent applications and have been granted patents in the United States and in other countries that cover subject matter potentially useful or necessary to our business. Some of these patents and patent applications claim only specific products or methods of making products, while others claim more general processes or techniques useful in the discovery and manufacture of a variety of products. The risk of third parties obtaining additional patents and filing patent applications will continue to increase as the biotechnology industry expands. We cannot predict the ultimate scope and validity of existing patents and patents that may be granted to third parties, nor can we predict the extent to which we may wish or be required to obtain licenses to such patents, or the availability and cost of acquiring such licenses. To the extent that licenses are required, the owners of the patents could bring legal actions against us to claim damages or to stop our manufacturing and marketing of the affected products. We believe that there will continue to be significant litigation in our industry regarding patent and other intellectual property rights. Such litigation could consume a substantial portion of our resources.

Because issued patents may not fully protect our discoveries, our competitors may be able to commercialize products similar to those covered by our issued patents.

Issued patents may not provide commercially meaningful protection against competitors and may not provide us with competitive advantages. Other parties may challenge our patents or design around our issued patents or develop products providing effects similar to our products. In addition, others may discover uses for genes, proteins or antibodies other than those uses covered in our patents, and these other uses may be separately patentable. The holder of a patent covering the use of a gene, protein or antibody for which we have a patent claim could exclude us from selling a product for a use covered by its patent.

We rely on our collaboration partners to seek patent protection for the products they develop based on our research.

A significant portion of our future revenue may be derived from royalty payments from our collaboration partners. These partners face patent protection issues similar to those that we and other biotechnology or pharmaceutical companies face. As a result, we cannot assure you that any product developed by our collaboration

 

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partners will be patentable, and therefore, revenue from any such product may be limited, which would reduce the amount of any royalty payments. We also rely on our collaboration partners to effectively prosecute their patent applications. Their failure to obtain or protect necessary patents could also result in a loss of royalty revenue to us.

If we are unable to protect our trade secrets, others may be able to use our secrets to compete more effectively.

We may not be able to meaningfully protect our trade secrets. We rely on trade secret protection to protect our confidential and proprietary information. We believe we have acquired or developed proprietary procedures and materials for the production of proteins and antibodies. We have not sought patent protection for these procedures. While we have entered into confidentiality agreements with employees and collaborators, we may not be able to prevent their disclosure of these data or materials. Others may independently develop substantially equivalent information and processes.

Other parties may seek to cancel or revoke our trademarks and/or restrict the use of our trademarks.

Our trademarks, including BENLYSTA, are important to us and are generally covered by trademark applications or registrations in the United States and in other countries. Trademark protection varies in accordance with local law, and continues in some countries for as long as the mark is used and in other countries for as long as the mark is registered. Trademark registrations are generally for fixed but renewable terms. In certain instances, we rely on our collaborators to protect our trademark rights.

Our trademark applications may not be sufficient to meet the statutory requirements for registration in all cases or may be subject to challenge if they are registered. Other parties may seek to cancel or revoke our trademarks and/or restrict the use of our trademarks through litigation or administrative proceedings in both the United States and in the rest of the world. We cannot assure you that we or our collaborators will be successful in any such proceedings. Moreover, any such litigation or proceeding may require us to modify our trademarks or rebrand our products to avoid infringing the trademark rights of third parties. This may be time-consuming and could adversely affect our revenue.

FINANCIAL AND MARKET RISKS

Because of our substantial indebtedness and lease obligations, we may be unable to adjust our strategy to meet changing conditions in the future.

As of June 30, 2012, we had convertible debt of $576.5 million ($701.2 million on a face value basis) and a long-term lease financing for our large-scale manufacturing facility of $252.8 million. During the six months ended June 30, 2012, we made cash interest payments on our convertible debt of $10.1 million. During the six months ended June 30, 2012 we made cash payments on our long-term lease financing of $12.7 million. In addition, we have operating leases, primarily our long-term operating lease for our headquarters, for which we made cash payments of $10.5 million during the six months ended June 30, 2012. Our substantial debt and long-term lease obligations will have several important consequences for our future operations. For instance:

 

   

payments of interest on, and principal of, our indebtedness and our long-term lease obligations will be substantial and may exceed then current income and available cash;

 

   

we may be unable to obtain additional future financing for marketing efforts, continued clinical trials, capital expenditures or other general corporate purposes;

 

   

we may be unable to withstand changing competitive pressures, economic conditions and governmental regulations; and

 

   

we may be unable to pursue acquisitions or in-licensing of additional product candidates or otherwise take advantage of significant business opportunities that may arise.

 

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We may not have adequate financial resources available to repay our outstanding convertible debt at maturity.

As of June 30, 2012, we had $701.2 million in face value of convertible debt outstanding, including $206.7 million in face value of Convertible Subordinated Notes due 2012 (“2012 Notes”). The 2012 Notes are convertible into our common stock at a conversion price of approximately $17.78 per share in August 2012. Our recent stock price has been below the conversion price. If that were to remain the case through maturity, we would be required to pay the 2012 Notes in cash upon maturity. At this time we believe we will have sufficient unrestricted cash to pay the 2012 Notes in cash upon maturity, however, there are other potential uses for these funds. In November 2011, we completed an offering of $494.5 million in face value of Convertible Senior Notes due 2018 (“2018 Notes”). Because it may be one or more years, if ever, before we are likely to generate significant positive cash flow from operations, we may not have enough cash, cash equivalents and marketable securities available to repay all of our convertible debt upon maturity.

We are required to provide significant collateral for our letters of credit for our lease obligations and the amount of cash to provide that collateral may increase in the future.

The MEDCO financing of our small-scale manufacturing facility leases is secured by HGS letters of credit, which expire in December 2012. The amount of our required security deposits associated with these letters of credit is approximately $33.1 million. These letters of credit and cash collateral requirements increase our cost of doing business and could have an adverse impact on our overall liquidity, particularly if there was a call for a large amount of additional cash or security deposits due to an unexpectedly large downward movement in the market value of the pledged collateral. We may not be able to raise or provide the additional capital or collateral, if needed. In addition, we may be required to post additional collateral as a result of growing our business, which amounts could be significant, and may cause a significant amount of our cash to be restricted from other uses. We may not be able to raise, access or provide the additional capital as collateral, if needed which could materially adversely impact our results of operation, financial condition and cash flows.

To become a successful biopharmaceutical company, we may need additional funding. If we do not obtain this funding on acceptable terms, we may not be able to generate sufficient revenue to repay our debt, to continue our research and development efforts or to launch and successfully market our products.

We continue to expend substantial funds on our research and development programs and human studies on current and future product candidates. We also expect to expend significant funds to support commercial marketing activities, to acquire other biotechnology companies or in-license and develop additional product candidates, and to enhance our manufacturing capacity. We may need additional financing to fund these activities. We may not be able to obtain additional financing on acceptable terms, if at all. If we raise additional funds by issuing equity securities, equity-linked securities or debt securities, the new equity securities may dilute the interests of our existing stockholders and the new debt securities may contain restrictive financial covenants.

Our need for additional funding will depend on many factors, including, without limitation:

 

   

the amount of revenue or cost sharing, if any, that we are able to obtain from our collaborations, any approved products, and the time and costs required to achieve those revenues;

 

   

the timing, scope and results of preclinical studies and clinical trials;

 

   

the size and complexity of our development programs;

 

   

the timing and costs involved in obtaining regulatory approvals;

 

   

the timing and costs of increasing our manufacturing capacity;

 

   

the costs of commercializing our products, including marketing, promotional and sales costs;

 

   

the commercial success of our products;

 

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our stock price;

 

   

our ability to establish and maintain collaboration partnerships;

 

   

competing technological and market developments;

 

   

the costs involved in filing, prosecuting, enforcing and defending patent claims;

 

   

the costs involved in bringing and defending against litigation; and

 

   

scientific progress in our research and development programs.

If we are unable to raise additional funds, we may, among other things:

 

   

delay, scale back or eliminate some or all of our research and development programs;

 

   

delay, scale back or eliminate some or all of our commercialization activities;

 

   

lose rights under existing licenses;

 

   

relinquish more of, or all of, our rights to product candidates on less favorable terms than we would otherwise seek; and

 

   

be unable to operate as a going concern.

Our marketable securities and restricted investments are subject to certain risks that could materially adversely affect our overall financial position.

We invest our cash in accordance with an established internal policy and customarily in instruments that historically have been highly liquid and carried relatively low risk. However, the capital and credit markets have experienced extreme volatility and disruption. Over the past several years, the volatility and disruption reached unprecedented levels. We maintain a significant portfolio of investments in marketable debt securities and restricted investments, which are recorded at fair value. Certain of these transactions expose us to credit risk in the event of default by the issuer. To seek to minimize our exposure to credit risk, we invest in securities with strong credit ratings and have established guidelines relative to diversification and maturity with the objective of maintaining safety of principal and liquidity. We do not invest in derivative financial instruments or auction rate securities, and we generally hold our investments in debt securities until maturity. In recent years, certain financial instruments, including some of the securities in which we have invested, have sustained downgrades in credit ratings and some high quality marketable securities have suffered illiquidity or events of default. Deterioration in the credit market may have an adverse effect on the fair value of our investment portfolio. Should any of our marketable securities or restricted investments lose significant value or have their liquidity impaired, it could materially and adversely affect our overall financial position by imperiling our ability to fund our operations and forcing us to seek additional financing sooner than we would otherwise. Such financing may not be available on commercially attractive terms, or at all.

Fluctuations in foreign exchange rates could adversely affect our results of operations, financial position and cash flows.

Our European subsidiaries’ operations may be subject to volatility in foreign exchange rates as those operations expand in the future. The profit split we earn from GSK from ex-U.S. BENLYSTA sales and our share of GSK’s ex-U.S. collaboration expenses are subject to foreign currency fluctuations. As the ex-U.S. BENLYSTA profit split and expenses increase, our foreign currency exposure may become more material and could adversely affect our business, results of operations, financial condition or cash flows.

 

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We are not currently profitable and might never become profitable.

We have a history of losses and expect to continue to incur substantial losses and negative operating cash flow, and we might never achieve or maintain profitability.

OTHER BUSINESS RISKS

We may be subject to product liability or other claims from the use of BENLYSTA or other of our products that could negatively affect our future operations. We have limited product liability insurance.

Product liability and other liability risks are inherent in the testing, manufacturing, marketing and sales of biopharmaceutical formulations and products and product candidates. If the use of one or more of our products or product candidates harms people, we may be subject to costly and damaging product liability claims. This liability might result from claims made directly by patients, hospitals, clinics or other consumers, or by other companies manufacturing these products on our behalf. Our future operations may be negatively affected from litigation costs, settlement expenses, management resources and lost product sales inherent to these claims. In addition, negative publicity associated with any claims, regardless of their merit, may decrease future demand for our products. Any of these effects could have a material adverse effect on our business, financial condition and results of operations. While we will continue to attempt to take appropriate precautions, we cannot assure you that we will avoid significant product liability exposure.

Though we currently maintain product liability insurance, there is no guarantee that such insurance will provide adequate coverage against potential liabilities. We may not foresee requirements for, or be able to obtain or maintain adequate product liability insurance, when needed, on acceptable terms, if at all. As a result, our insurance may not provide adequate coverage against potential liabilities. Furthermore, our current and potential partners with whom we have collaborative agreements or our future licensees may not be willing to indemnify us against these types of liabilities and may not themselves be sufficiently insured or have sufficient liquidity to satisfy any product liability claims. Claims or losses in excess of any product liability insurance coverage that may be obtained by us could have a material adverse effect on our business, financial condition and results of operations.

Our success is dependent on our continued ability to attract, motivate and retain key personnel. If we lose or are unable to attract key management or other personnel, it could have a material adverse effect on our business, financial condition and results of operations.

Much of our progress to date has resulted from the particular scientific, technical and management skills of personnel available to us. Competition for qualified employees is intense among pharmaceutical and biotechnology companies. Part of being able to attract, motivate and retain key personnel is our ability to offer a competitive compensation package, including cash bonus and equity incentive awards. Our equity incentive awards are directly tied to our stock price. Because of the reduction in our stock price during 2011, the exercise price of a substantial number of equity incentive awards granted in the last several years exceeds the market price of our stock. As a result, an important component of our compensation package in the last several years has little or no retention value. In addition, our ability to offer attractive equity incentive awards in the future may be limited or nonexistent if we are unable to obtain stockholder approval to maintain a sufficient number of shares available for grant under our stock incentive plan. If we are unable to provide a compensation package that is competitive within our industry, or otherwise successfully compete to attract, motivate and retain qualified management and other highly skilled employees, this could materially adversely affect the implementation of our business strategy or delay the commercialization of our products. In January 2012, we eliminated approximately 150 positions resulting in the severance of approximately 100 employees and announced corresponding spending reductions to reflect current program and business requirements. Positions across the company were affected, including manufacturing, R&D and administration. This workforce reduction and the spending reduction efforts may negatively impact the morale of our remaining employees, which may adversely affect our ability to retain or attract qualified employees to fill necessary positions. If we are unable to retain the personnel we currently employ, or if we are unable to quickly replace necessary departing employees with new, qualified employees, our operations may suffer.

 

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We may be unable to fulfill the terms of our contract manufacturing agreements with our customers for manufacturing process development and supply of selected biopharmaceutical products.

To more fully utilize our existing manufacturing capacity, we have entered into agreements with customers pursuant to which we have agreed to develop manufacturing processes for, and manufacture clinical and commercial supplies of, certain biopharmaceutical products, and may enter into similar agreements with other potential customers in the future. Our receipt of revenue under these agreements is dependent on our ability to successfully manufacture such products. If we are unable to develop a validated manufacturing process for such products, are unable to deliver product that meets the manufacturing specifications, or otherwise unable to deliver product in accordance with the applicable contractual provisions, we may not receive any additional payments under such agreements. Even if successful, we may not be able to enter into additional agreements with other customers. Any current or future customers may decide to discontinue the products contemplated under these agreements, and therefore we may not receive revenue from these agreements.

RISKS RELATED TO OWNERSHIP OF OUR COMMON STOCK

The market price of our common stock may be lower or more volatile than you expected.

Our stock price, like the stock prices of many other biotechnology companies, has been highly volatile. During the preceding twelve months, the closing price of our common stock has been as low as $6.64 per share and as high as $24.96 per share. Future market fluctuations may cause the market price of our common stock to be lower or more volatile than you expected.

The price and volume fluctuations in our stock may often be unrelated to our operating performance. The market price of our common stock could fluctuate widely because of:

 

   

future announcements about our company, our competitors, or other companies engaged in drug development or sale including the results of testing, clinical trials, technological innovations or new commercial products;

 

   

regulatory actions with respect to our potential products or regulatory approvals with respect to our competitors’ products;

 

   

litigation or governmental action involving or affecting us;

 

   

changes in government regulations;

 

   

developments affecting our collaboration partners or in our relationships with our collaboration partners;

 

   

announcements relating to health care reform or changes in reimbursement policies;

 

   

our failure to acquire or maintain proprietary rights to the gene sequences we discover or the products we develop;

 

   

public concern as to the safety of our products; and

 

   

political and economic factors affecting market prices generally or our market segment or our company particularly.

In addition, the stock market in general and the NASDAQ Global Select Market and the stock of 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 our actual operating performance. In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted against companies. Recently, multiple securities and shareholder derivative class action lawsuits were filed against HGS in state and federal court in Maryland. See Note 6, Commitments and Contingencies, of the Notes to the Consolidated Financial Statements for additional discussion.

 

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The issuance and sale of shares underlying our outstanding convertible debt securities and options, as well as the sale of additional equity or equity-linked securities would dilute the holdings of our existing stockholders and may materially and adversely affect the price of our common stock.

Sales of substantial amounts of shares of our common stock or securities convertible into or exchangeable for our common stock in the public market, or the perception that those sales may occur, could cause the market price of our common stock to decline. We have used and may continue to use our common stock or securities convertible into or exchangeable for our common stock to acquire technology, product rights or businesses, or for other purposes. Our authorized capital stock consists of 400,000,000 shares of common stock, par value $0.01 per share. As of June 30, 2012, we had 199,985,391 shares of common stock outstanding. In addition, an aggregate of approximately 11,624,771 shares of our common stock are issuable upon conversion of our outstanding 2012 Notes at an applicable conversion price of $17.78 per share; an aggregate of approximately 37,110,692 shares of our common stock are issuable upon conversion of our outstanding 2018 Notes at an applicable conversion price of $13.33 per share; 26,618,209 shares of our common stock are issuable upon the exercise of options outstanding as of June 30, 2012, having a weighted-average exercise price of $15.06 per share, including 3,393,488 stock options granted during the six months ended June 30, 2012 with a weighted-average grant date fair value of $4.41 per share; and 514,062 shares of our common stock are issuable upon the vesting of restricted stock unit awards outstanding as of June 30, 2012. Furthermore, up to approximately 10,298,500 shares of our common stock are potentially due to us upon settlement of our capped call option contracts in 2018. If we issue additional equity securities, including in exchange for our outstanding convertible debt or in connection with the exercise or vesting of equity awards, the price of our common stock may be materially and adversely affected and the holdings of our existing stockholders would be diluted.

Our certificate of incorporation and bylaws could discourage acquisition proposals, delay a change in control or prevent transactions that may be in your best interests.

Provisions of our certificate of incorporation and bylaws, as well as Section 203 of the Delaware General Corporation Law, may discourage, delay or prevent a change in control of our company that you as a stockholder may consider favorable and may be in your best interest. Our certificate of incorporation and bylaws contain provisions that:

 

   

authorize the issuance of up to 20,000,000 shares of “blank check” preferred stock that could be issued by our board of directors to increase the number of outstanding shares and discourage a takeover attempt;

 

   

limit who may call special meetings of stockholders; and

 

   

establish advance notice requirements for nomination of candidates for election to the board of directors or for proposing matters that can be acted upon by stockholders at stockholders’ meetings.

Recently, a securities and shareholder derivative class action lawsuit was filed against HGS and its directors in state court in Maryland related, in part, to such provisions. See Note 6, Commitments and Contingencies, of the Notes to the Consolidated Financial Statements for additional discussion.

 

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Item 6. Exhibits

 

    2.1*   Agreement and Plan of Merger, dated as of July 16, 2012, among Human Genome Sciences, Inc., GlaxoSmithKline plc and H. Acquisition Corp. (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K, filed on July 16, 2012).
    4.1   Rights Agreement, dated as of May 16, 2012 between Human Genome Sciences, Inc. and American Stock Transfer & Trust Company, LLC, as Rights Agent, which includes the Form of Right Certificate as Exhibit A and the Form of Certificate of Designation, Preferences and Rights of Series A Junior Participating Preferred Stock as Exhibit B (incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K, filed on May 17, 2012).
    4.2   Amendment No. 1 to Rights Agreement, dated as of July 16, 2012, between Human Genome Sciences, Inc. and American Stock Transfer & Trust Company, LLC, as Rights Agent (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K, filed on July 16, 2012).
  31.1   Rule 13a-14(a) Certification of Principal Executive Officer.
  31.2   Rule 13a-14(a) Certification of Principal Financial Officer.
  32.1   Section 1350 Certification of Principal Executive Officer.
  32.2   Section 1350 Certification of Principal Financial Officer.
101.INS**   XBRL Instance Document
101.SCH**   XBRL Schema Document
101.CAL**   XBRL Calculation Linkbase Document
101.DEF**   XBRL Definition Linkbase Document
101.LAB**   XBRL Labels Linkbase Document
101.PRE**   XBRL Presentation Linkbase Document

 

* The schedules to the Agreement and Plan of Merger have been omitted from this filing pursuant to Item 601(b)(2) of Regulation S-K. The Company will furnish copies of such schedules to the U.S. Securities and Exchange Commission upon request.
** In accordance with Regulation S-T, the XBRL-related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall be deemed to be “furnished” and not “filed”.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

HUMAN GENOME SCIENCES, INC.
BY:  

/s/ H. Thomas Watkins

  H. Thomas Watkins
  President and Chief Executive Officer
  (Principal Executive Officer)
BY:  

/s/ David P. Southwell

  David P. Southwell
  Chief Financial Officer and Executive Vice President
  (Principal Financial Officer and Principal Accounting Officer)

Dated: July 26, 2012

 

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EXHIBIT INDEX

 

Exhibit
Page
Number

    
    2.1*   Agreement and Plan of Merger, dated as of July 16, 2012, among Human Genome Sciences, Inc., GlaxoSmithKline plc and H. Acquisition Corp. (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K, filed on July 16, 2012).
    4.1   Rights Agreement, dated as of May 16, 2012 between Human Genome Sciences, Inc. and American Stock Transfer & Trust Company, LLC, as Rights Agent, which includes the Form of Right Certificate as Exhibit A and the Form of Certificate of Designation, Preferences and Rights of Series A Junior Participating Preferred Stock as Exhibit B (incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K, filed on May 17, 2012).
    4.2   Amendment No. 1 to Rights Agreement, dated as of July 16, 2012, between Human Genome Sciences, Inc. and American Stock Transfer & Trust Company, LLC, as Rights Agent (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K, filed on July 16, 2012).
  31.1   Rule 13a-14(a) Certification of Principal Executive Officer.
  31.2   Rule 13a-14(a) Certification of Principal Financial Officer.
  32.1   Section 1350 Certification of Principal Executive Officer.
  32.2   Section 1350 Certification of Principal Financial Officer.
101.INS**   XBRL Instance Document
101.SCH**   XBRL Schema Document
101.CAL**   XBRL Calculation Linkbase Document
101.DEF**   XBRL Definition Linkbase Document
101.LAB**   XBRL Labels Linkbase Document
101.PRE**   XBRL Presentation Linkbase Document

 

* The schedules to the Agreement and Plan of Merger have been omitted from this filing pursuant to Item 601(b)(2) of Regulation S-K. The Company will furnish copies of such schedules to the U.S. Securities and Exchange Commission upon request.
** In accordance with Regulation S-T, the XBRL-related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall be deemed to be “furnished” and not “filed”.