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Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended June 30, 2016

 

OR

 

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

 

For the transition period from            to          

 

Commission file number: 001-34620

 

IRONWOOD PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

04-3404176

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification Number)

 

 

 

301 Binney Street

 

 

Cambridge, Massachusetts

 

02142

(Address of Principal Executive Offices)

 

(Zip Code)

 

(617) 621-7722

(Registrant’s telephone number, including area code)

 

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

 

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

 

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

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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

 

As of August 1, 2016, there were 129,933,366 shares of Class A common stock outstanding and 15,385,236 shares of Class B common stock outstanding.

 

 

 


 


Table of Contents

 

NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q, including the sections titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors”, contains forward-looking statements. All statements contained in this Quarterly Report on Form 10-Q other than statements of historical fact are forward-looking statements. Forward-looking statements include statements regarding our future financial position, business strategy, budgets, projected costs, plans and objectives of management for future operations. The words “may,” “continue,” “estimate,” “intend,” “plan,” “will,” “believe,” “project,” “expect,” “seek,” “anticipate” and similar expressions may identify forward-looking statements, but the absence of these words does not necessarily mean that a statement is not forward-looking.

 

These forward-looking statements include, among other things, statements about:

 

·                  the demand and market potential for our products in the countries where they are approved for marketing, as well as the revenues therefrom;

 

·                  the timing, investment and associated activities involved in commercializing LINZESS by us and Allergan plc in the U.S. and ZURAMPIC by us in the U.S.;

 

·                  the timing and execution of the launches and commercialization of CONSTELLA in the E.U.;

 

·                  the timing, investment and associated activities involved in developing, obtaining regulatory approval for, launching, and commercializing linaclotide by us and our partners worldwide;

 

·                  our ability and the ability of our partners to secure and maintain adequate reimbursement for our products;

 

·                  the ability of our partners and third-party manufacturers to manufacture and distribute sufficient amounts of linaclotide and lesinurad active pharmaceutical ingredient, drug product and finished goods, as applicable, on a commercial scale;

 

·                  our expectations regarding U.S. and foreign regulatory requirements for our products and our product candidates, including our post-approval development and regulatory requirements;

 

·                  the ability of our product candidates to meet existing or future regulatory standards;

 

·                  the safety profile and related adverse events of our products and our product candidates;

 

·                  the therapeutic benefits and effectiveness of our products and our product candidates and the potential indications and market opportunities therefor;

 

·                  our and our partners’ ability to obtain and maintain intellectual property protection for our products and our product candidates and the strength thereof;

 

·                  our and our partners’ ability to perform our respective obligations under our collaboration, license and other agreements, and our ability to achieve milestone and other payments under such agreements;

 

·                  our plans with respect to the development, manufacture or sale of our product candidates and the associated timing thereof, including the design and results of pre-clinical and clinical studies;

 

·                  the in-licensing or acquisition of externally discovered businesses, products or technologies, including expectations relating to the completion of, or the realization of the expected benefits from, such transactions;

 

·                  our expectations as to future financial performance, revenues, expense levels, payments, cash flows, profitability, tax obligations, capital raising and liquidity sources, and real estate needs, as well as the timing and drivers thereof;

 

·                  our ability to repay our outstanding indebtedness when due, or redeem or repurchase all or a portion of such debt, as well as the potential benefits of the note hedge transactions described herein;

 

·                  inventory levels and write downs, or asset impairments, and the drivers thereof, and inventory purchase commitments;

 

·                  our expectations regarding amortization of intangible assets;

 

·                  our ability to compete with other companies that are or may be developing or selling products that are competitive with our products and product candidates;

 

2



Table of Contents

 

·                  the status of government regulation in the life sciences industry, particularly with respect to healthcare reform;

 

·                  trends and challenges in our potential markets;

 

·                  our ability to attract and motivate key personnel; and

 

·                  other factors discussed elsewhere in this Quarterly Report on Form 10-Q.

 

Any or all of our forward-looking statements in this Quarterly Report on Form 10-Q may turn out to be inaccurate. These forward-looking statements may be affected by inaccurate assumptions or by known or unknown risks and uncertainties, including the risks, uncertainties and assumptions identified under the heading “Risk Factors” in this Quarterly Report on Form 10-Q. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this Quarterly Report on Form 10-Q may not occur as contemplated, and actual results could differ materially from those anticipated or implied by the forward-looking statements.

 

You should not unduly rely on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. Unless required by law, we undertake no obligation to publicly update or revise any forward-looking statements to reflect new information or future events or otherwise. You should, however, review the factors and risks we describe in the reports we will file from time to time with the U.S. Securities and Exchange Commission, or the SEC, after the date of this Quarterly Report on Form 10-Q.

 

NOTE REGARDING TRADEMARKS

 

LINZESS® and CONSTELLA® are trademarks of Ironwood Pharmaceuticals, Inc. ZURAMPIC® is a trademark of AstraZeneca AB. Any other trademarks referred to in this Quarterly Report on Form 10-Q are the property of their respective owners. All rights reserved.

 

3



Table of Contents

 

IRONWOOD PHARMACEUTICALS, INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 2016

TABLE OF CONTENTS

 

 

 

Page

 

 

 

 

PART I — FINANCIAL INFORMATION

 

Item 1.

Financial Statements (unaudited)

 

 

Condensed Consolidated Balance Sheets as of June 30, 2016 and December 31, 2015

5

 

Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2016 and 2015

6

 

Condensed Consolidated Statements of Comprehensive Loss for the Three and Six Months Ended June 30, 2016 and 2015

7

 

Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2016 and 2015

8

 

Notes to Condensed Consolidated Financial Statements

9

Item 2.

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

32

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

44

Item 4.

Controls and Procedures

45

 

 

 

 

PART II — OTHER INFORMATION

 

Item 1A.

Risk Factors

46

Item 6.

Exhibits

69

 

 

 

 

Signatures

70

 

4



Table of Contents

 

PART I — FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

Ironwood Pharmaceuticals, Inc.

Condensed Consolidated Balance Sheets

(In thousands, except share and per share amounts)

(unaudited)

 

 

 

June 30,

 

December 31,

 

 

 

2016

 

2015

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

277,332

 

$

261,287

 

Available-for-sale securities

 

48,041

 

178,107

 

Accounts receivable

 

1,272

 

2,884

 

Related party accounts receivable, net

 

51,875

 

51,634

 

Prepaid expenses and other current assets

 

7,622

 

6,293

 

Total current assets

 

386,142

 

500,205

 

Restricted cash

 

8,247

 

8,747

 

Property and equipment, net

 

17,939

 

21,075

 

Convertible note hedges

 

99,478

 

86,466

 

Intangible assets, net

 

185,935

 

 

Goodwill

 

649

 

 

Other assets

 

1,818

 

2,628

 

Total assets

 

$

700,208

 

$

619,121

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable and related party accounts payable, net

 

$

8,999

 

$

8,589

 

Accrued research and development costs

 

6,653

 

4,245

 

Accrued expenses and other current liabilities

 

20,598

 

23,301

 

Current portion of capital lease obligations

 

2,451

 

2,631

 

Current portion of deferred rent

 

7,923

 

5,544

 

Current portion of deferred revenue

 

8,519

 

7,191

 

Current portion of PhaRMA notes payable

 

35,259

 

24,964

 

Current portion of contingent consideration

 

597

 

 

Total current liabilities

 

90,999

 

76,465

 

Capital lease obligations, net of current portion

 

198

 

306

 

Deferred rent, net of current portion

 

4,409

 

6,395

 

Deferred revenue, net of current portion

 

 

1,798

 

Contingent consideration, net of current portion

 

87,052

 

 

Note hedge warrants

 

86,838

 

75,328

 

Convertible senior notes

 

227,273

 

220,620

 

PhaRMA notes payable, net of current portion

 

111,938

 

132,964

 

Other liabilities

 

10,120

 

10,120

 

Commitments and contingencies

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, $0.001 par value, 75,000,000 shares authorized, no shares issued and outstanding

 

 

 

Class A common stock, $0.001 par value, 500,000,000 shares authorized and 129,778,212 and 127,371,478 shares issued and outstanding at June 30, 2016 and December 31, 2015, respectively

 

130

 

127

 

Class B common stock, $0.001 par value, 100,000,000 shares authorized and 15,394,327 and 15,870,356 shares issued and outstanding at June 30, 2016 and December 31, 2015, respectively

 

15

 

16

 

Additional paid-in capital

 

1,226,311

 

1,205,183

 

Accumulated deficit

 

(1,145,114

)

(1,110,115

)

Accumulated other comprehensive income (loss)

 

39

 

(86

)

Total stockholders’ equity

 

81,381

 

95,125

 

Total liabilities and stockholders’ equity

 

$

700,208

 

$

619,121

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

5



Table of Contents

 

Ironwood Pharmaceuticals, Inc.

Condensed Consolidated Statements of Operations

(In thousands, except per share amounts)

(unaudited)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2016

 

2015

 

2016

 

2015

 

Collaborative arrangements revenue

 

$

54,350

 

$

27,744

 

$

120,392

 

$

56,676

 

Cost and expenses:

 

 

 

 

 

 

 

 

 

Cost of revenue, excluding amortization of acquired intangible asset

 

 

 

 

12

 

Write-down of inventory to net realizable value and loss on non-cancellable purchase commitments

 

 

8,150

 

 

8,150

 

Research and development

 

31,682

 

28,648

 

63,524

 

55,289

 

Selling, general and administrative

 

36,918

 

32,955

 

73,086

 

63,301

 

Amortization of acquired intangible asset

 

1,065

 

 

1,065

 

 

Total cost and expenses

 

69,665

 

69,753

 

137,675

 

126,752

 

Loss from operations

 

(15,315

)

(42,009

)

(17,283

)

(70,076

)

Other (expense) income:

 

 

 

 

 

 

 

 

 

Interest expense

 

(9,827

)

(5,874

)

(19,734

)

(11,094

)

Interest and investment income

 

295

 

71

 

516

 

136

 

Gain (loss) on derivatives

 

3,145

 

(208

)

1,502

 

(208

)

Other expense, net

 

(6,387

)

(6,011

)

(17,716

)

(11,166

)

Net loss

 

$

(21,702

)

$

(48,020

)

$

(34,999

)

$

(81,242

)

 

 

 

 

 

 

 

 

 

 

Net loss per share - basic and diluted

 

$

(0.15

)

$

(0.34

)

$

(0.24

)

$

(0.57

)

 

 

 

 

 

 

 

 

 

 

Weighted average number of common shares used in net loss per share — basic and diluted:

 

144,642

 

142,098

 

144,118

 

141,690

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Table of Contents

 

Ironwood Pharmaceuticals, Inc.

Condensed Consolidated Statements of Comprehensive Loss

(In thousands)

(unaudited)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2016

 

2015

 

2016

 

2015

 

Net loss

 

$

(21,702

)

$

(48,020

)

$

(34,999

)

$

(81,242

)

 

 

 

 

 

 

 

 

 

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

Unrealized gains on available-for-sale securities

 

10

 

19

 

125

 

41

 

Total other comprehensive income

 

10

 

19

 

125

 

41

 

Comprehensive loss

 

$

(21,692

)

$

(48,001

)

$

(34,874

)

$

(81,201

)

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Ironwood Pharmaceuticals, Inc.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(unaudited)

 

 

 

Six Months Ended

 

 

 

June 30,

 

 

 

2016

 

2015

 

Cash flows from operating activities:

 

 

 

 

 

Net loss

 

$

(34,999

)

$

(81,242

)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

Depreciation and amortization

 

5,320

 

6,043

 

Amortization of acquired intangible asset

 

1,065

 

 

Share-based compensation expense

 

14,903

 

12,329

 

Change in fair value of note hedge warrants

 

11,510

 

(1,393

)

Change in fair value of convertible note hedges

 

(13,012

)

1,601

 

Write-down of inventory to net realizable value and loss on non-cancellable purchase commitments

 

 

8,150

 

Loss on facility subleases

 

3,480

 

 

Accretion of discount/premium on investment securities

 

457

 

298

 

Non-cash interest expense

 

7,221

 

1,170

 

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable and related party accounts receivable

 

1,371

 

(1,210

)

Restricted cash

 

500

 

 

Prepaid expenses and other current assets

 

(1,265

)

2,676

 

Other assets

 

810

 

(458

)

Accounts payable, related party accounts payable and accrued expenses

 

(2,314

)

(5,978

)

Accrued research and development costs

 

2,408

 

1,956

 

Deferred revenue

 

(470

)

(3,596

)

Deferred rent

 

(3,087

)

(1,684

)

Net cash used in operating activities

 

(6,102

)

(61,338

)

Cash flows from investing activities:

 

 

 

 

 

Purchases of available-for-sale securities

 

(52,629

)

(202,091

)

Sales and maturities of available-for-sale securities

 

182,363

 

139,006

 

Purchases of property and equipment

 

(1,623

)

(2,840

)

Payment for acquisition of lesinurad license

 

(100,000

)

 

Proceeds from sale of property and equipment

 

 

27

 

Net cash provided by (used in) investing activities

 

28,111

 

(65,898

)

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of convertible senior notes

 

 

335,699

 

Proceeds from issuance of note hedge warrants

 

 

70,849

 

Purchase of convertible note hedges

 

 

(91,915

)

Costs associated with issuance of convertible senior notes

 

 

(10,930

)

Proceeds from exercise of stock options and employee stock purchase plan

 

6,163

 

10,941

 

Payments on capital leases

 

(828

)

(561

)

Principal payments on PhaRMA notes

 

(11,299

)

(4,694

)

Net cash (used in) provided by financing activities

 

(5,964

)

309,389

 

Net increase in cash and cash equivalents

 

16,045

 

182,153

 

Cash and cash equivalents, beginning of period

 

261,287

 

74,297

 

Cash and cash equivalents, end of period

 

$

277,332

 

$

256,450

 

 

 

 

 

 

 

Supplemental cash flow disclosure:

 

 

 

 

 

Non-cash investing activities

 

 

 

 

 

Contingent consideration

 

$

87,649

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Ironwood Pharmaceuticals, Inc.

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

1.  Nature of Business

 

Overview

 

Ironwood Pharmaceuticals, Inc. (the “Company”) is a commercial biotechnology company leveraging its proven development and commercial capabilities as it seeks to bring multiple medicines to patients. The Company is advancing innovative product opportunities in areas of large unmet need, including irritable bowel syndrome with constipation (“IBS-C”) and chronic idiopathic constipation (“CIC”), hyperuricemia associated with uncontrolled gout, refractory gastroesophageal reflux disease (“rGERD”), and vascular and fibrotic diseases.

 

The Company’s first commercial product, linaclotide, is available to adult men and women suffering from IBS-C or CIC in the United States (“U.S.”) under the trademarked name LINZESS®, and is available to adult men and women suffering from IBS-C in certain European countries under the trademarked name CONSTELLA®. The Company and its U.S. partner Allergan plc (together with its affiliates, “Allergan”) began commercializing LINZESS in the U.S. in December 2012. Under the Company’s collaboration with Allergan for North America, total net sales of LINZESS in the U.S., as recorded by Allergan, are reduced by commercial costs incurred by each party, and the resulting amount is shared equally between the Company and Allergan. The Company’s former European partner, Almirall, S.A. (“Almirall”), began commercializing CONSTELLA in Europe for the symptomatic treatment of moderate to severe IBS-C in adults in the second quarter of 2013. In October 2015, Almirall transferred its exclusive license to develop and commercialize linaclotide in Europe to Allergan, and the Company and Allergan entered into an amendment to the European license agreement (Note 4).  Currently, CONSTELLA is commercially available in certain European countries, including the United Kingdom, Italy and Spain.

 

Within the Company’s IBS-C/CIC franchise, the Company and Allergan are exploring development opportunities to enhance the clinical profile of LINZESS by seeking to expand its utility within IBS-C and CIC, as well as studying linaclotide in additional indications and populations to assess its potential to treat various gastrointestinal (“GI”) conditions. The Company and Allergan are also developing linaclotide colonic release, a targeted oral delivery formulation of linaclotide designed to potentially improve abdominal pain relief in adult IBS-C patients. The Company is also exploring linaclotide colonic release for use in additional GI disorders where lower abdominal pain is a predominant symptom such as IBS-mixed, ulcerative colitis and diverticulitis, among others.  Linaclotide is also being developed and commercialized in other parts of the world by the Company’s partners.

 

In December 2013 and February 2014, linaclotide was approved in Canada and Mexico, respectively, as a treatment for adult men and women suffering from IBS-C or CIC. Allergan has exclusive rights to commercialize linaclotide in Canada as CONSTELLA and in Mexico as LINZESS.  In May 2014, CONSTELLA became commercially available in Canada and in June 2014, LINZESS became commercially available in Mexico.  Astellas Pharma Inc. (“Astellas”), the Company’s partner in Japan, is developing linaclotide for the treatment of patients with IBS-C and chronic constipation in its territory.  In November 2015, the Company and Astellas reported positive top-line data from Astellas’ Phase III clinical trial of linaclotide in adult patients with IBS-C for Japan and in February 2016, Astellas filed a new drug application (“NDA”) seeking approval of linaclotide for the treatment of adults with IBS-C in Japan with the Japanese Ministry of Health, Labor and Welfare.  In October 2012, the Company entered into a collaboration agreement with AstraZeneca AB (together with its affiliates, “AstraZeneca”), to co-develop and co-commercialize linaclotide in China, Hong Kong and Macau, with AstraZeneca having primary responsibility for the local operational execution. In December 2015, the Company and AstraZeneca filed for approval with the China Food and Drug Administration to market linaclotide in China. The Company continues to assess alternatives to bring linaclotide to IBS-C and CIC sufferers in the parts of the world outside of its partnered territories.

 

In June 2016, the Company closed a transaction with AstraZeneca pursuant to which the Company received an exclusive license to develop, manufacture, and commercialize products containing lesinurad as an active ingredient, including ZURAMPIC®, in the U.S. Lesinurad 200mg tablets were approved as ZURAMPIC by the U.S. Food and Drug Administration (“FDA”) in December 2015 for use in combination with a xanthine oxidase inhibitor (“XOI”) for the treatment of hyperuricemia associated with uncontrolled gout. The Company is also developing a fixed-dose combination product (“FDC Product”) of lesinurad and allopurinol, an XOI, which is included under the license agreement.

 

The Company is advancing its rGERD franchise through the development of IW-3718, a gastric retentive formulation of a bile acid sequestrant.

 

Within the Company’s vascular and fibrotic franchise, it is leveraging its pharmacological expertise in guanylate cyclase pathways gained through the discovery and development of linaclotide to advance development programs targeting soluble guanylate cyclase (“sGC”). sGC is a validated mechanism with the potential for broad therapeutic utility and multiple opportunities for product development in vascular and fibrotic diseases, as well as other therapeutic areas. The Company is progressing two sGC development

 

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candidates, IW-1973 and IW-1701, which have distinct pharmacologic profiles that the Company believes may be differentiating and enable opportunities in multiple indications.

 

In April 2016, the Company announced the discontinuation of development of IW-9179 for gastroparesis, as top-line data from its exploratory Phase IIa clinical study indicated that IW-9179 did not meaningfully reduce the severity of symptoms in patients with diabetic gastroparesis. In July 2016, as part of its continued assessment and prioritization of resources, the Company discontinued assessing the potential of IW-9179 for the treatment of functional dyspepsia and is no longer advancing this program.

 

In March 2015, the Company and Exact Sciences Corp. (“Exact Sciences”) entered into an agreement to co-promote Cologuard®, the first and only FDA-approved noninvasive stool DNA screening test for colorectal cancer, and in August 2015, the Company and Allergan entered into an agreement for the co-promotion of VIBERZI™ (eluxadoline) in the U.S., Allergan’s treatment for adults suffering from IBS with diarrhea (“IBS-D”).

 

These agreements are more fully described in Note 3, Business Combinations, and Note 4, Collaboration, License and Co-Promotion Agreements, to these condensed consolidated financial statements.

 

In June 2015, the Company issued approximately $335.7 million in aggregate principal amount of 2.25% Convertible Senior Notes due 2022 (the “2022 Notes”). The Company received net proceeds of approximately $324.0 million from the sale of the 2022 Notes, after deducting fees and expenses of approximately $11.7 million (Note 10).

 

Basis of Presentation

 

The accompanying condensed consolidated financial statements and the related disclosures are unaudited and have been prepared in accordance with accounting principles generally accepted in the U.S. Additionally, certain information and footnote disclosures normally included in the Company’s annual financial statements have been condensed or omitted. Accordingly, these interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, which was filed with the Securities and Exchange Commission on February 19, 2016 (the “2015 Annual Report on Form 10-K”).

 

The unaudited interim condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and, in the opinion of management, reflect all normal recurring adjustments considered necessary for a fair presentation of the Company’s financial position as of June 30, 2016, and the results of its operations for the three and six months ended June 30, 2016 and 2015 and its cash flows for the six months ended June 30, 2016 and 2015. The results of operations for the three and six months ended June 30, 2016 and 2015 are not necessarily indicative of the results that may be expected for the full year or any other subsequent interim period.

 

Principles of Consolidation

 

The accompanying condensed consolidated financial statements include the accounts of Ironwood Pharmaceuticals, Inc. and its wholly owned subsidiaries, Ironwood Pharmaceuticals Securities Corporation and Ironwood Pharmaceuticals GmbH. All intercompany transactions and balances are eliminated in consolidation.

 

Use of Estimates

 

The preparation of condensed consolidated financial statements in accordance with U.S. generally accepted accounting principles requires the Company’s management to make estimates and judgments that may affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, and the amounts of revenues and expenses during the reported periods. On an ongoing basis, the Company’s management evaluates its estimates, judgments and methodologies. Significant estimates and assumptions in the condensed consolidated financial statements include those related to revenue recognition, available-for-sale securities, inventory valuation, and related reserves; impairment of long-lived assets; initial valuation procedures for the issuance of convertible notes; fair value of derivatives; balance sheet classification of notes payable and convertible notes; income taxes, including the valuation allowance for deferred tax assets; research and development expenses; goodwill; contingent consideration; acquired intangible assets; contingencies and share-based compensation. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ materially from these estimates under different assumptions or conditions. Changes in estimates are reflected in reported results in the period in which they become known.

 

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Summary of Significant Accounting Policies

 

The Company’s significant accounting policies are described in Note 2, “Summary of Significant Accounting Policies,” in the 2015 Annual Report on Form 10-K. During the three months ended June 30, 2016, the Company adopted the following additional significant accounting policies:

 

Business Combinations

 

The Company evaluates acquisitions of assets and other similar transactions to assess whether or not the transaction should be accounted for as a business combination by assessing whether or not the Company has acquired inputs and processes that have the ability to create outputs. If determined to be a business combination, the Company accounts for business acquisitions under the acquisition method of accounting as indicated in the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Codification (“ASC”) Topic 805, “Business Combinations”, (“ASC 805”) which requires the acquiring entity in a business combination to recognize the fair value of all assets acquired, liabilities assumed, and any non-controlling interest in the acquiree and establishes the acquisition date as the fair value measurement point. Accordingly, the Company recognizes assets acquired and liabilities assumed in business combinations, including contingent assets and liabilities, and non-controlling interest in the acquiree based on the fair value estimates as of the date of acquisition. In accordance with ASC 805, the Company recognizes and measures goodwill as of the acquisition date, as the excess of the fair value of the consideration paid over the fair value of the identified net assets acquired.

 

The consideration for the Company’s business acquisitions includes future payments that are contingent upon the occurrence of a particular event or events. The obligations for such contingent consideration payments are recorded at fair value on the acquisition date. The contingent consideration obligations are then evaluated each reporting period. Changes in the fair value of contingent consideration obligations, other than changes due to payments, are recognized as a (gain) loss on fair value remeasurement of contingent consideration in the condensed consolidated statements of operations.

 

Finite and Indefinite-Lived Intangible Assets

 

The Company records the fair value of purchased intangible assets with definite useful lives as of the transaction date of a business combination. Purchased intangible assets with definite useful lives are amortized to their estimated residual values over their estimated useful lives.  The Company evaluates the finite-lived intangible assets for impairment whenever events or changes in circumstances indicate the reduction in the fair value below their respective carrying amounts. If the Company determines that an impairment has occurred, a write-down of the carrying value and an impairment charge to operating expenses in the period the determination is made is recorded. In addition, the Company would also reassess the remaining estimated useful life of the finite-lived intangible asset.

 

In accordance with ASC Topic 350, “Intangibles — Goodwill and Other” (“ASC 350”), during the period that an asset is considered indefinite-lived, such as in-process research and development (“IPR&D”), it will not be amortized. Acquired IPR&D represents the fair value assigned to research and development assets that have not reached technological feasibility. The value assigned to acquired IPR&D is determined by estimating the costs to develop the acquired technology into commercially viable products, estimating the resulting revenue from the projects, and discounting the net cash flows to present value. The revenue and costs projections used to value acquired IPR&D are, as applicable, reduced based on the probability of success of developing a new drug. Additionally, the projections consider the relevant market sizes and growth factors, expected trends in technology, and the nature and expected timing of new product introductions by the Company and its competitors. The rates utilized to discount the net cash flows to their present value are commensurate with the stage of development of the projects and uncertainties in the economic estimates used in the projections. Upon the acquisition of IPR&D, the Company completes an assessment of whether its acquisition constitutes the purchase of a single asset or a group of assets. Multiple factors are considered in this assessment, including the nature of the technology acquired, the presence or absence of separate cash flows, the development process and stage of completion, quantitative significance and the rationale for entering into the transaction.  Indefinite-lived assets are maintained on the Company’s condensed consolidated balance sheet until either the project underlying it is completed or the asset becomes impaired.  Indefinite-lived assets are tested for impairment on an annual basis, or whenever events or changes in circumstances indicate the reduction in the fair value of the IPR&D asset below its respective carrying amount. If the Company determines that an impairment has occurred, a write-down of the carrying value and an impairment charge to operating expenses in the period the determination is made is recorded. When development of an IPR&D asset is complete the associated asset would be deemed finite-lived and would then be amortized based on its respective estimated useful life at that point.

 

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Goodwill

 

Goodwill represents the difference between the purchase price and the fair value of the identifiable tangible and intangible net assets when accounted for using the purchase method of accounting. Goodwill is not amortized, but is reviewed for impairment. The Company tests its goodwill for impairment annually, or whenever events or changes in circumstances indicate an impairment may have occurred, by comparing its carrying value to its implied fair value in accordance with ASC 350. Impairment may result from, among other things, deterioration in the performance of the acquired asset, adverse market conditions, adverse changes in applicable laws or regulations and a variety of other circumstances. If the Company determines that an impairment has occurred, a write-down of the carrying value and an impairment charge to operating expenses in the period the determination is made is recorded. In evaluating the carrying value of goodwill, the Company must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the acquired assets. Changes in strategy or market conditions could significantly impact those judgments in the future and require an adjustment to the recorded balances.

 

New Accounting Pronouncements

 

From time to time, new accounting pronouncements are issued by the FASB or other standard setting bodies that are adopted by the Company as of the specified effective date.

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which supersedes the revenue recognition requirements in ASC Topic 605, Revenue Recognition, and most industry-specific guidance. The new standard requires that an entity recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods or services. The update also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. ASU 2014-09 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017 and should be applied retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying this update recognized at the date of initial application. Early adoption is permitted beginning after December 15, 2016, including interim reporting periods within those years. In April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing (“ASU 2016-10”), which clarifies certain aspects of identifying performance obligations and licensing implementation guidance. In May 2016, the FASB issued ASU No. 2016-12, Revenue from Contracts with Customers: Narrow-Scope Improvements and Practical Expedients (“ASU 2016-12”), related to disclosures of remaining performance obligations, as well as other amendments to guidance on collectability, non-cash consideration and the presentation of sales and other similar taxes collected from customers. These standards have the same effective date and transition date as ASU 2014-09.  The Company is evaluating the method of adoption and the potential impact that ASU 2014-09, ASU 2016-10 and ASU 2016-12 may have on its financial position and results of operations.

 

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements — Going Concern: Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). ASU 2014-15 is intended to define management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures, if required. ASU 2014-15 is effective for annual reporting periods ending after December 15, 2016, and applies to annual and interim periods thereafter. The Company does not believe that the adoption of ASU 2014-15 will have a significant impact on the Company’s financial statement disclosures.

 

In April 2015, the FASB issued ASU No. 2015-05, Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement, which amends ASC 350. Under this standard, if a cloud computing arrangement includes a software license, the software license element of the arrangement should be accounted for consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the arrangement should be accounted for as a service contract. The amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2015 and may be applied on either a prospective or retrospective basis. The Company adopted this standard during the three months ended March 31, 2016. The adoption of this standard did not have a material impact on the Company’s financial position or results of operations.

 

In July 2015, the FASB issued ASU No. 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory (“ASU 2015-11”). ASU 2015-11 requires entities that measure inventory using the first-in, first-out method, to do so at the lower of cost and net realizable value. The standard defines net realizable value as the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. The standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016. Early adoption is permitted. The Company is evaluating the potential impact that adoption of ASU 2015-11 may have on the Company’s financial position or results of operations.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (“ASU 2016-02”), which supersedes the lease accounting requirements in ASC Topic 840, Leases, and most industry-specific guidance. ASU 2016-02 requires the identification of arrangements that should be accounted for as leases by lessees. In general, for lease arrangements exceeding a 12-month term, these arrangements must now be recognized as assets and liabilities on the balance sheet of the lessee. Under ASU 2016-02, a right-of-use asset and lease obligation will be recorded for all leases, whether operating or financing, while the income statement will reflect lease

 

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expense for operating leases and amortization and interest expense for financing leases. The balance sheet amount recorded for existing leases at the date of adoption of ASU 2016-02 must be calculated using the applicable incremental borrowing rate at the date of adoption. In addition, ASU 2016-02 requires the use of modified retrospective method, which will require adjustment to all comparative periods presented in the consolidated financial statements. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The Company is evaluating the potential impact that ASU 2016-02 may have on the Company’s financial position or results of operations.

 

In March 2016, the FASB issued ASU No. 2016-09, Compensation — Stock Compensation, which amends ASC Topic 718, Compensation — Stock Compensation (“ASU 2016-09”).  ASU 2016-09 identifies areas for simplification involving several aspects of accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, an option to recognize gross stock compensation expense with actual forfeitures recognized as they occur, as well as certain classifications on the statement of cash flows. The amendments are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted. The Company is evaluating the potential impact that ASU 2016-09 may have on the Company’s financial position, results of operations or statement of cash flows.

 

2.  Net Loss Per Share

 

Basic and diluted net loss per common share is computed by dividing net loss by the weighted average number of common shares outstanding during the period.

 

In June 2015, in connection with the issuance of approximately $335.7 million in aggregate principal amount of the 2022 Notes, the Company entered into convertible note hedge transactions (the “Convertible Note Hedges”). The Convertible Note Hedges are generally expected to reduce the potential dilution to the Company’s Class A common stockholders upon a conversion of the 2022 Notes, as conversion would result in fewer shares available for purchase in the market. The Convertible Note Hedges are also designed to offset any cash payments the Company is required to make in excess of the principal amount of converted 2022 Notes in the event that the market price per share of the Company’s Class A common stock, as measured under the terms of the Convertible Note Hedges, exceeds the conversion price of the 2022 Notes (Note 10). The Convertible Note Hedges are not considered for purposes of calculating the number of diluted weighted average shares outstanding, as their effect would be antidilutive.

 

Concurrently with entering into the Convertible Note Hedges, the Company also entered into certain warrant transactions in which it sold note hedge warrants (the “Note Hedge Warrants”) to the Convertible Note Hedge counterparties to acquire 20,249,665 shares of the Company’s Class A common stock, subject to customary anti-dilution adjustments. The Note Hedge Warrants could have a dilutive effect on the Company’s Class A common stock to the extent that the market price per share of the Class A common stock exceeds the applicable strike price of such warrants (Note 10). The Note Hedge Warrants are not considered for purposes of calculating the number of diluted weighted averages shares outstanding, as their effect would be antidilutive.

 

The following potentially dilutive securities have been excluded from the computation of diluted weighted average shares outstanding as their effect would be anti-dilutive (in thousands):

 

 

 

Six Months Ended

 

 

 

June 30,

 

 

 

2016

 

2015

 

Options to purchase common stock

 

22,066

 

21,149

 

Shares subject to repurchase

 

192

 

149

 

Restricted stock units

 

1,256

 

492

 

Note hedge warrants

 

20,250

 

20,250

 

2022 Notes

 

20,250

 

20,250

 

 

 

64,014

 

62,290

 

 

An insignificant number of shares issuable under the Company’s employee stock purchase plan were excluded from the calculation of diluted weighted average shares outstanding because their effects would be anti-dilutive.

 

3.  Business Combinations

 

In April 2016, the Company and AstraZeneca entered into a license agreement (the “Lesinurad License Agreement”) pursuant to which the Company received, upon closing the transaction in June 2016, an exclusive license to develop, manufacture and commercialize products containing lesinurad as an active ingredient, including ZURAMPIC (the “Products”), in the U.S. (the

 

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“Lesinurad Transaction”).  Subject to the terms of the Lesinurad License Agreement, AstraZeneca will conduct certain development activities on the Company’s behalf for (i) ZURAMPIC, including the post-marketing requirement activities currently required by the FDA, for which the Company will reimburse AstraZeneca up to $100.0 million over up to ten years, and (ii) the FDC Product, for which the Company will also reimburse AstraZeneca.  In connection with the Lesinurad License Agreement, the Company and AstraZeneca entered into a commercial supply agreement (the “Lesinurad CSA”), pursuant to which the Company relies exclusively on AstraZeneca for the commercial manufacture and supply of ZURAMPIC and, if approved, the FDC Product, and a transitional services agreement (the “Lesinurad TSA”), pursuant to which AstraZeneca will provide certain support services, including development, regulatory and commercial services, to the Company for ZURAMPIC until such activities under the Lesinurad TSA are transferred to the Company.  The Company may obtain production techniques from AstraZeneca via a manufacturing technology transfer available under the Lesinurad CSA upon provision of six-months’ notice.  The Company is responsible for commercialization of the Products in the U.S., and any additional development of the Products for commercialization in the U.S.  In addition, under the terms of the Lesinurad License Agreement, the Company will have the right of first negotiation and right of last refusal with AstraZeneca for the right to commercialize, develop and manufacture for commercialization in the U.S., products for the prevention or treatment of gout that include verinurad as at least one of its active ingredients.

 

The Company concluded that the Lesinurad Transaction included inputs and processes that have the ability to create outputs and accordingly accounted for the transaction as a business combination in accordance with ASC 805. As such, the assets acquired and liabilities assumed were recorded at fair value, with the remaining purchase price recorded as goodwill.

 

The purchase price consisted of the upfront payment to AstraZeneca of $100.0 million, which was made in June 2016, and the fair value of the contingent consideration of $87.6 million. The Company also paid approximately $1.6 million for transaction-related costs, including external consulting fees, which were expensed as incurred as selling, general and administrative expenses.  Pursuant to the terms of the Lesinurad License Agreement, the Company will also pay a tiered royalty to AstraZeneca in the single-digits as a percentage of net sales of the Products in the U.S., as well as commercial and other milestones of up to $165.0 million over the duration of the agreement. The contingent consideration was valued as approximately $87.6 million, using a discounted cash flow estimate as of the acquisition date.  The total fair value of consideration for the purchase was approximately $187.6 million.

 

The Company has preliminarily valued the acquired assets and liabilities based on their estimated fair value. These estimates are subject to change as additional information becomes available. The preliminary fair values included in the balance sheet as of June 30, 2016 are based on the best estimates of the Company. The completion of the valuation of the acquired assets and liabilities may result in adjustments to the carrying value of assets and liabilities, revision to the useful life of the finite intangible asset, the determination of any residual amount that will be allocated to goodwill and the related tax effects. The related amortization of acquired finite-lived intangible asset is also subject to revision based on the final valuation. Any adjustments to the preliminary fair values will be made as such information becomes available, but no later than June 1, 2017. The following table presents the preliminary allocation of the purchase consideration for the Lesinurad Transaction as of June 2, 2016 (the “Acquisition Date”), including the contingent consideration (in thousands):

 

As of the Acquisition Date:

 

 

 

 

Cash portion of consideration

 

$

100,000

 

Contingent consideration

 

87,649

 

Total purchase consideration

 

$

187,649

 

 

As of the Acquisition Date:

 

 

 

Developed technology — ZURAMPIC

 

$

167,900

 

IPR&D - FDC Product

 

19,100

 

Goodwill

 

649

 

Net assets acquired

 

$

187,649

 

 

The fair value of the FDC Product IPR&D was determined using a probability adjusted discounted cash flow approach, including assumptions of projected revenues, operating expenses and a discount rate of 16.0% applied to the projected cash flows.  The remaining cost of development for this asset is approximately $13.9 million, with an expected completion date of no earlier than 2017.

 

The fair value of the ZURAMPIC intangible asset was determined using a probability adjusted discounted cash flow approach, including assumptions of projected revenues, operating expenses and a discount rate of 13.5% applied to the projected cash flows.  The Company considers the ZURAMPIC intangible asset acquired to be developed technology, as it was approved by the FDA for commercialization as of the Acquisition Date. The Company believes the assumptions are representative of those a market

 

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participant would use in estimating fair value.  The ZURAMPIC intangible asset is finite lived. The amount allocated to the ZURAMPIC intangible asset will be amortized on a straight-line basis to amortization of acquired intangible assets within the Company’s condensed consolidated statements of operations over its estimated useful life of 13 years, the period of estimated future cash flows. The Company believes that the straight-line method of amortization represents the pattern in which the economic benefits of the intangible asset are consumed. As of June 30, 2016, the Company recognized accumulated amortization of $1.1 million with respect to the ZURAMPIC intangible asset. The estimated future amortization of ZURAMPIC is expected to be as follows (in thousands):

 

 

 

As of June 30, 2016

 

2016 (1)

 

$

6,420

 

2017

 

12,833

 

2018

 

12,833

 

2019

 

12,833

 

2020 and thereafter

 

121,916

 

Total

 

$

166,835

 

 


(1)         For the six months ended December 31, 2016.

 

The amount allocated to the FDC Product IPR&D is considered to be indefinite-lived until the completion or abandonment of the associated research and development efforts.  As of June 30, 2016, there was no impairment related to the FDC Product IPR&D or the ZURAMPIC intangible asset.

 

The Company allocated the excess of the purchase price over the identifiable intangible assets to goodwill. Such goodwill is not deductible for tax purposes and represents the value placed on entering new markets, expanding market share and operating synergies. As of June 30, 2016, there was no impairment of goodwill. All goodwill has been assigned to the Company’s single reporting unit, which is the single operating segment human therapeutics.

 

These fair value measurements were based on significant inputs not observable in the market and thus represent Level 3 fair value measurements (Note 5).

 

As of June 30, 2016, the estimated fair value of the Company’s contingent consideration liability did not change, compared to the Acquisition Date estimated fair value.

 

4.  Collaboration, License and Co-Promotion Agreements

 

For the three and six months ended June 30, 2016, the Company had linaclotide collaboration agreements with Allergan for North America and AstraZeneca for China, Hong Kong and Macau, as well as linaclotide license agreements with Allergan for the European territory and Astellas for Japan. The Company also had a co-promotion agreement with Exact Sciences to co-promote Cologuard in the U.S. and a co-promotion agreement with Allergan to co-promote VIBERZI in the U.S. The following table provides amounts included in the Company’s condensed consolidated statements of operations as collaborative arrangements revenue attributable to transactions from these arrangements (in thousands):

 

 

 

Collaborative Arrangements Revenue

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2016

 

2015

 

2016

 

2015

 

Linaclotide Agreements:

 

 

 

 

 

 

 

 

 

Allergan (North America)

 

$

50,036

 

$

24,381

 

$

100,009

 

$

49,707

 

Allergan (Europe)

 

110

 

 

190

 

 

AstraZeneca (China, Hong Kong and Macau)

 

164

 

466

 

294

 

1,696

 

Almirall (Europe) (1)

 

 

116

 

3

 

217

 

Astellas (Japan)

 

2,334

 

1,805

 

17,014

 

4,080

 

Co-Promotion Agreements:

 

 

 

 

 

 

 

 

 

Exact Sciences (Cologuard)

 

1,159

 

976

 

1,878

 

976

 

Allergan (VIBERZI)

 

547

 

 

1,004

 

 

Total collaborative arrangements revenue

 

$

54,350

 

$

27,744

 

$

120,392

 

$

56,676

 

 

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(1)         In October 2015, Almirall transferred its exclusive license to develop and commercialize linaclotide in Europe to Allergan.

 

Linaclotide Agreements

 

Collaboration Agreement for North America with Allergan

 

In September 2007, the Company entered into a collaboration agreement with Allergan to develop and commercialize linaclotide for the treatment of IBS-C, CIC and other GI conditions in North America. Under the terms of this collaboration agreement, the Company shares equally with Allergan all development costs as well as net profits or losses from the development and sale of linaclotide in the U.S.  In addition, the Company receives royalties in the mid-teens percent based on net sales in Canada and Mexico. Allergan is solely responsible for the further development, regulatory approval and commercialization of linaclotide in Canada and Mexico and funding any costs. The collaboration agreement for North America also includes contingent milestone payments, as well as a contingent equity investment, based on the achievement of specific development and commercial milestones. As of June 30, 2016, approximately $205.0 million in license fees and all six development milestone payments had been received by the Company, as well as a $25.0 million equity investment in the Company’s capital stock (Note 13). The Company can also achieve up to $100.0 million in a sales-related milestone if certain conditions are met, which will be recognized as collaborative arrangements revenue as earned.

 

As a result of the research and development cost-sharing provisions of the collaboration for North America, the Company offset approximately $3.2 million and approximately $5.2 million against research and development costs during the three and six months ended June 30, 2016, respectively, and approximately $4.4 million and approximately $11.9 million during the three and six months ending June 30, 2015, respectively, to reflect the obligations of each party under the collaboration to bear half of the development costs incurred. In addition, in March 2015, the Company and Allergan agreed to share certain costs relating to the manufacturing of linaclotide active pharmaceutical ingredient (“API”) and certain other manufacturing activities for the North American territory. This arrangement resulted in net amounts received from Allergan of approximately $4.3 million for costs incurred in prior periods, which were recorded by the Company as a reduction in research and development expenses during the three months ended March 31, 2015.

 

The Company and Allergan began commercializing LINZESS in the U.S. in December 2012. The Company receives 50% of the net profits and bears 50% of the net losses from the commercial sale of LINZESS in the U.S.; provided, however, that if either party provides fewer calls on physicians in a particular year than it is contractually required to provide, such party’s share of the net profits will be adjusted as set forth in the collaboration agreement for North America. Certain of these adjustments to the share of the net profits may be reduced or eliminated in connection with the co-promotion activities under the Company’s agreement with Allergan to co-promote VIBERZI in the U.S., as described below in Co-Promotion Agreement with Allergan for VIBERZI. Net profits or net losses consist of net sales of LINZESS to third-party customers and sublicense income in the U.S. less the cost of goods sold as well as selling, general and administrative expenses. LINZESS net sales are calculated and recorded by Allergan and may include gross sales net of discounts, rebates, allowances, sales taxes, freight and insurance charges, and other applicable deductions. The Company records its share of the net profits or net losses from the sale of LINZESS on a net basis and presents the settlement payments to and from Allergan as collaboration expense or collaborative arrangements revenue, as applicable.

 

The Company recognized collaborative arrangements revenue from the Allergan collaboration agreement for North America during the three and six months ended June 30, 2016 and 2015 as follows (in thousands):

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2016

 

2015

 

 

 

 

 

Collaborative arrangements revenue related to sales of LINZESS in the U.S. (1) (2)

 

$

48,333

 

$

24,275

 

$

94,980

 

$

49,413

 

Royalty revenue

 

238

 

106

 

547

 

294

 

Sale of API

 

1,465

 

 

4,482

 

 

Total collaborative arrangements revenue

 

$

50,036

 

$

24,381

 

$

100,009

 

$

49,707

 

 

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The collaborative arrangements revenue recognized in the three and six months ended June 30, 2016 and 2015 primarily represents the Company’s share of the net profits and net losses on the sale of LINZESS in the U.S. In addition, during the three and six months ended June 30, 2016, the Company recorded collaboration revenue of approximately $1.5 million and approximately $4.5 million, respectively, related to the sale of API to Allergan under the terms of the collaboration for North America, and no such amounts were recorded during the three and six months ended June 30, 2015.

 

The following table presents the amounts recorded by the Company for commercial efforts related to LINZESS in the U.S. in the three and six months ended June 30, 2016 and 2015 (in thousands):

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2016

 

2015

 

2016

 

2015

 

Collaborative arrangements revenue related to sales of LINZESS in the U.S. (1) (2) 

 

$

48,333

 

$

24,275

 

$

94,980

 

$

49,413

 

Selling, general and administrative costs incurred by the Company (1) 

 

(8,879

)

(8,314

)

(18,032

)

(16,003

)

The Company’s share of net profit

 

$

39,454

 

$

15,961

 

$

76,948

 

$

33,410

 

 


(1)         Includes only collaborative arrangement revenue or selling, general and administrative costs attributable to the cost-sharing arrangement with Allergan.

(2)         Certain of the unfavorable adjustments to the Company’s share of the LINZESS net profits may be reduced or eliminated in connection with the co-promotion activities under the Company’s agreement with Allergan to co-promote VIBERZI in the U.S., as described below in Co-Promotion Agreement with Allergan for VIBERZI. During the three and six months ended June 30, 2016, in connection with these co-promotion activities, the net profit share adjustments payable to Allergan under the linaclotide collaboration agreement for North America were reduced by approximately $1.4 million and $2.6 million, respectively.  The Company recorded approximately $1.2 million and $2.4 million of net profit share adjustments payable to Allergan during the three and six months ended June 30, 2015, respectively, as described above.

 

In May 2014, CONSTELLA became commercially available in Canada and in June 2014, LINZESS became commercially available in Mexico.  The Company records royalties on sales of CONSTELLA in Canada and LINZESS in Mexico one quarter in arrears as it does not have access to the royalty reports from its partner or the ability to estimate the royalty revenue in the period earned.  The Company recognized approximately $0.2 million and approximately $0.5 million of royalty revenues from Canada and Mexico during the three and six months ended June 30, 2016, respectively.  The Company recognized an insignificant amount and approximately $0.3 million of royalty revenues from Canada and Mexico during the three and six months ended June 30, 2015, respectively.

 

License Agreement for the European Territory with Allergan (formerly with Almirall through October 2015)

 

In April 2009, the Company entered into a license agreement with Almirall (the “European License Agreement”) to develop and commercialize linaclotide in Europe (including the Commonwealth of Independent States and Turkey) for the treatment of IBS-C, CIC and other GI conditions. Under the terms of the European License Agreement, Almirall was responsible for the expenses associated with the development and commercialization of linaclotide in the European territory and the Company was required to participate on a joint development committee over linaclotide’s development period and a joint commercialization committee while the product was being commercialized.

 

Pursuant to the terms of the European License Agreement, the Company received approximately $38.0 million, net of foreign tax withholdings, as a non-refundable up-front payment from Almirall. In November 2009, the Company achieved a development milestone triggering an equity investment and received $15.0 million from Almirall for the purchase of 681,819 shares of convertible preferred stock (Note 13).  In addition, the European License Agreement also included contingent milestone payments that could total up to $40.0 million upon achievement of specific development and commercial launch milestones. In November 2010, the Company achieved a development milestone, which resulted in an approximately $19.0 million payment, representing a $20.0 million milestone, net of foreign withholding taxes. This development milestone was recognized as collaborative arrangements revenue through September 2012.  During the years ended December 31, 2013 and 2014, the Company achieved four commercial milestones under the European License Agreement for the first commercial launch in four out of five major European Union (“E.U.”) countries set forth in the agreement, aggregating to $4.0 million. In connection with the achievement of these milestones, the Company received approximately $3.9 million, net of foreign tax withholdings.

 

In October 2015, Almirall transferred its exclusive license to develop and commercialize linaclotide in Europe to Allergan. Additionally, in October 2015, the Company and Allergan separately entered into an amendment to the European License Agreement relating to the development and commercialization of linaclotide in Europe.  Pursuant to the terms of the amendment, (i) the remaining

 

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sales-based milestones payable to the Company under the European License Agreement were modified to increase the total milestone payments such that, when aggregated with the remaining commercial launch milestones, they could total up to $42.5 million, (ii) the royalties payable to the Company during the term of the European License Agreement were modified such that the royalties based on sales volume in Europe begin in the mid-single digit percent and escalate to the upper-teens percent by calendar year 2019, and (iii) Allergan assumed responsibility for the manufacturing of linaclotide API for Europe from the Company, as well as the associated costs.  Furthermore, with the Company no longer responsible for the manufacturing of linaclotide API for Europe, the royalties under the European License Agreement are no longer reduced by the transfer price paid for the API included in the product actually sold by Allergan in Europe in any given period.  The Company concluded that these 2015 amendments to the European License Agreement were not a modification to the linaclotide collaboration agreement with Allergan for North America.

 

The commercial launch and sales-based milestones under the European License Agreement are recognized as revenue as earned. The Company recognized an insignificant amount and approximately $0.2 million of royalty revenue during the three and six months ended June 30, 2016 and 2015, respectively. The Company records royalties on sales of CONSTELLA one quarter in arrears as it does not have access to the royalty reports from Allergan or the ability to estimate the royalty revenue in the period earned.

 

License Agreement for Japan with Astellas

 

In November 2009, the Company entered into a license agreement with Astellas to develop and commercialize linaclotide for the treatment of IBS-C, CIC and other GI conditions in Japan. Astellas is responsible for all activities relating to development, regulatory approval and commercialization in Japan, as well as funding the associated costs, and the Company is required to participate on a joint development committee over linaclotide’s development period.

 

In 2009, Astellas paid the Company a non-refundable, up-front licensing fee of $30.0 million, which is being recognized as collaborative arrangements revenue on a straight-line basis over the Company’s estimate of the period over which linaclotide will be developed under the license agreement. In March 2013, the Company revised its estimate of the development period from 115 months to 85 months based on the Company’s assessment of regulatory approval timelines for Japan. During the three and six months ended June 30, 2016 and 2015, the Company recognized approximately $1.3 million and approximately $2.6 million, respectively, of revenue related to the up-front licensing fee, in each period, including approximately $0.5 million and approximately $1.0 million, respectively, of revenue in each period attributable to a revision to the estimated development period in March 2013. At June 30, 2016, approximately $3.8 million of the up-front license fee remained deferred.

 

The agreement also includes three development milestone payments that could total up to $45.0 million, none of which the Company considers substantive. The first milestone payment, consisting of $15.0 million upon enrollment of the first study subject in a Phase III study for linaclotide in Japan, was achieved in November 2014, and approximately $13.4 million was recognized as revenue through June 30, 2016, including approximately $0.5 million and approximately $1.1 million during each of the three and six months ended June 30, 2016 and 2015, respectively.  The remaining approximately $1.6 million of this milestone payment will be recognized over the remaining development period.  In February 2016, Astellas filed an NDA with the Japanese Ministry of Health, Labor and Welfare seeking approval of linaclotide for the treatment of adults with IBS-C in Japan.  In connection with this filing, a second milestone payment, consisting of $15.0 million, was achieved and approximately $0.5 million and $13.4 million was recognized as revenue during the three and six months ended June 30, 2016, respectively.  The remaining approximately $1.6 million of this milestone payment will be recognized over the remaining development period.  The third development milestone payment consists of $15.0 million upon approval of NDA by the Japanese Ministry of Health, Labor and Welfare to market linaclotide in Japan.  In addition, the Company will receive royalties which escalate based on sales volume, beginning in the low-twenties percent, less the transfer price paid for the API included in the product actually sold and other contractual deductions.

 

During the three and six months ended June 30, 2016, the Company recognized approximately $2.3 million and approximately $17.0 million, respectively, in collaborative arrangements revenue from the Astellas license agreement. During the three and six months ended June 30, 2015, the Company recognized approximately $1.8 million and approximately $4.1 million, respectively, in collaborative arrangements revenue from the Astellas license agreement, including an insignificant amount and approximately $0.5 million, respectively, from the sale of API to Astellas.

 

Collaboration Agreement for China, Hong Kong and Macau with AstraZeneca

 

In October 2012, the Company entered into a collaboration agreement with AstraZeneca (the “AstraZeneca Collaboration Agreement”) to co-develop and co-commercialize linaclotide in China, Hong Kong and Macau (the “License Territory”). The collaboration provides AstraZeneca with an exclusive nontransferable license to exploit the underlying technology in the License Territory. The parties share responsibility for continued development and commercialization of linaclotide under a joint development plan and a joint commercialization plan, respectively, with AstraZeneca having primary responsibility for the local operational execution.

 

The parties agreed to an Initial Development Plan (“IDP”) which includes the planned development of linaclotide in China, including the lead responsibility for each activity and the related internal and external costs. The IDP indicates that AstraZeneca is

 

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responsible for a multinational Phase III clinical trial (the “Phase III Trial”), the Company is responsible for nonclinical development and supplying clinical trial material and both parties are responsible for the regulatory submission process. The IDP indicates that the party specifically designated as being responsible for a particular development activity under the IDP shall implement and conduct such activities. The activities are governed by a Joint Development Committee (“JDC”), with equal representation from each party. The JDC is responsible for approving, by unanimous consent, the joint development plan and development budget, as well as approving protocols for clinical studies, reviewing and commenting on regulatory submissions, and providing an exchange of data and information.

 

The AstraZeneca Collaboration Agreement will continue until there is no longer a development plan or commercialization plan in place, however, it can be terminated by AstraZeneca at any time upon 180 days’ prior written notice. Under certain circumstances, either party may terminate the AstraZeneca Collaboration Agreement in the event of bankruptcy or an uncured material breach of the other party. Upon certain change in control scenarios of AstraZeneca, the Company may elect to terminate the AstraZeneca Collaboration Agreement and may re-acquire its product rights in a lump sum payment equal to the fair market value of such product rights.

 

In connection with the AstraZeneca Collaboration Agreement, the Company and AstraZeneca also executed a co-promotion agreement (the “Co-Promotion Agreement”), pursuant to which the Company utilized its existing sales force to co-promote NEXIUM® (esomeprazole magnesium), one of AstraZeneca’s products, in the U.S. The Co-Promotion Agreement expired in May 2014.

 

There are no refund provisions in the AstraZeneca Collaboration Agreement and the Co-Promotion Agreement (together, the “AstraZeneca Agreements”).

 

Under the terms of the AstraZeneca Collaboration Agreement, the Company received a $25.0 million non-refundable upfront payment upon execution. The Company is also eligible for $125.0 million in additional commercial milestone payments contingent on the achievement of certain sales targets. The parties will also share in the net profits and losses associated with the development and commercialization of linaclotide in the License Territory, with AstraZeneca receiving 55% of the net profits or incurring 55% of the net losses until a certain specified commercial milestone is achieved, at which time profits and losses will be shared equally thereafter.

 

Activities under the AstraZeneca Agreements were evaluated in accordance with ASC Topic 605-25, Revenue Recognition—Multiple-Element Arrangements (“ASC 605-25”), to determine if they represented a multiple element revenue arrangement. The Company identified the following deliverables in the AstraZeneca Agreements:

 

·                  an exclusive license to develop and commercialize linaclotide in the License Territory (the “License Deliverable”),

 

·                  research, development and regulatory services pursuant to the IDP, as modified from time to time (the “R&D Services”),

 

·                  JDC services,

 

·                  obligation to supply clinical trial material, and

 

·                  co-promotion services for AstraZeneca’s product (the “Co-Promotion Deliverable”).

 

The License Deliverable is nontransferable and has certain sublicense restrictions. The Company determined that the License Deliverable had standalone value as a result of AstraZeneca’s internal product development and commercialization capabilities, which would enable it to use the License Deliverable for its intended purposes without the involvement of the Company. The remaining deliverables were deemed to have standalone value based on their nature and all deliverables met the criteria to be accounted for as separate units of accounting under ASC 605-25. Factors considered in this determination included, among other things, whether any other vendors sell the items separately and if the customer could use the delivered item for its intended purpose without the receipt of the remaining deliverables.

 

The Company identified the supply of linaclotide drug product for commercial requirements and commercialization services as contingent deliverables because these services are contingent upon the receipt of regulatory approval to commercialize linaclotide in the License Territory, and there were no binding commitments or firm purchase orders pending for commercial supply at the inception of the AstraZeneca Collaboration Agreement. As these deliverables are contingent, and are not at an incremental discount, they are not evaluated as deliverables at the inception of the arrangement. These contingent deliverables will be evaluated and accounted for separately as each related contingency is resolved. As of June 30, 2016, no contingent deliverables were provided by the Company under the AstraZeneca Agreements.

 

In August 2014, the Company and AstraZeneca, through the JDC, modified the IDP and development budget to include approximately $14.0 million in additional activities over the remaining development period, to be shared by the Company and

 

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AstraZeneca under the terms of the AstraZeneca Collaboration Agreement. These additional activities serve to support the continued development of linaclotide in the License Territory, including the Phase III Trial. Pursuant to the terms of the modified IDP and development budget, certain of the Company’s deliverables were modified, specifically the R&D Services and the obligation to supply clinical trial material. The modification did not, however, have a material impact on the Company’s condensed consolidated financial statements.

 

The total amount of the non-contingent consideration allocable to the AstraZeneca Agreements was approximately $34.0 million (“Arrangement Consideration”), consisting of the $25.0 million non-refundable up-front payment and approximately $9.0 million representing 55% of the estimated costs for clinical trial material supply services and research, development and regulatory activities allocated to the Company in the IDP or as approved by the JDC in subsequent periods.  The Company allocated the Arrangement Consideration to the non-contingent deliverables based on management’s best estimated selling price (“BESP”) of each deliverable using the relative selling price method, as the Company did not have vendor-specific objective evidence or third-party evidence of selling price for such deliverables. Of the total Arrangement Consideration, approximately $29.7 million was allocated to the License Deliverable, approximately $1.8 million to the R&D Services, approximately $0.1 million to the JDC services, approximately $0.3 million to the clinical trial material supply services, and approximately $2.1 million to the Co-Promotion Deliverable in the relative selling price model, at the time of the material modification.

 

Because the Company shares development costs with AstraZeneca, payments from AstraZeneca with respect to both research and development and selling, general and administrative costs incurred by the Company prior to the commercialization of linaclotide in the License Territory are recorded as a reduction in expense, in accordance with the Company’s policy, which is consistent with the nature of the cost reimbursement. Development costs incurred by the Company that pertain to the joint development plan and subsequent amendments to the joint development plan, as approved by the JDC, are recorded as research and development expense as incurred. Payments to AstraZeneca are recorded as incremental research and development expense.

 

The Company completed its obligations related to the License Deliverable upon execution of the AstraZeneca Agreements; however, the revenue recognized in the statement of operations was limited to the non-contingent portion of the License Deliverable consideration in accordance with ASC 605-25. During the three and six months ended June 30, 2016 the Company recognized approximately $0.2 million and approximately $0.3 million, respectively, and during the three and six months ending June 30, 2015, the Company recognized approximately $0.4 million and approximately $1.6 million, respectively, in each case, in collaborative arrangements revenue related to the License Deliverable in connection with the modification to the IDP and development budget in August 2014, as these portions of the Arrangement Consideration were no longer contingent.

 

The Company also performs R&D Services and JDC services, and supplies clinical trial materials during the estimated development period. All Arrangement Consideration allocated to such services is being recognized as a reduction of research and development costs, using the proportional performance method, by which the amounts are recognized in proportion to the costs incurred. As a result of the cost-sharing arrangements under the collaboration, the Company recognized an insignificant amount in incremental research and development costs during the three and six months ended June 30, 2016, respectively, and recognized approximately $0.4 million and approximately $0.7 million in incremental research and development costs during the three and six months ended June 30, 2015, respectively.

 

The amount allocated to the Co-Promotion Deliverable was recognized as collaborative arrangements revenue using the proportional performance method, which approximates recognition on a straight-line basis beginning on the date that the Company began to co-promote AstraZeneca’s product through December 31, 2013 (the earliest cancellation date). As of December 31, 2013, the Company completed its obligation related to the Co-Promotion Deliverable; however, the revenue recognized in the statement of operations was limited to the non-contingent consideration in accordance with ASC 605-25.  During each of the three and six months ended June 30, 2016 and 2015, the Company recognized an insignificant amount as collaborative arrangements revenue related to this deliverable, as this portion of the Arrangement Consideration was no longer contingent.

 

The Company reassesses the periods of performance for each deliverable at the end of each reporting period.

 

Milestone payments received from AstraZeneca upon the achievement of sales targets will be recognized as earned.

 

Co-Promotion Agreements

 

Co-Promotion Agreement with Exact Sciences Corp. for Cologuard

 

In March 2015, the Company and Exact Sciences entered into an agreement to co-promote Exact Sciences’ Cologuard, the first and only FDA-approved noninvasive stool DNA screening test for colorectal cancer (the “Exact Sciences Co-Promotion Agreement”). Under the terms of the non-exclusive Exact Sciences Co-Promotion Agreement, the Company’s sales team promotes and educates health care practitioners regarding Cologuard, with LINZESS remaining the Company’s first-position product. Exact Sciences maintains responsibility for all other aspects of the commercialization of Cologuard outside of the co-promotion. Under the terms of the Exact Sciences Co-Promotion Agreement, the Company is compensated primarily via royalties earned on the net sales of Cologuard generated from the healthcare practitioners on whom the Company calls with such royalties being payable during the term and for up to one year following the termination of the Company’s co-promotion efforts. Through June 30, 2016, the Company received approximately $3.4 million in connection with the Exact Sciences Co-Promotion Agreement. There are no refund provisions in the Exact Sciences Co-Promotion Agreement.  Either party may terminate the agreement in the event of an uncured material breach by the other party, withdrawal of Cologuard from the U.S. market, restriction on the indications for Cologuard by the FDA, imposition of restrictive federal or state price controls, change of control of the other party, or bankruptcy or insolvency of the other party.

 

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Activities under the Exact Sciences Co-Promotion Agreement were evaluated in accordance with ASC 605-25, to determine if they represented a multiple element revenue arrangement.  The Company identified the following deliverables in the Exact Sciences Co-Promotion Agreement through June 30, 2016: (i) second position sales detailing, (ii) promotional support services, and (iii) medical education services. Each of the deliverables was deemed to have standalone value based on their nature and all deliverables met the criteria to be accounted for as separate units of accounting under ASC 605-25. The Company determined that the BESP for each of the three deliverables approximated the value allocated to the deliverables under the agreement.  The revenue related to each deliverable is recognized as collaborative arrangements revenue in the Company’s condensed consolidated statement of operations, in accordance with ASC 605-25, during the period earned.  During the three and six months ended June 30, 2016, the Company recognized approximately $1.2 million and approximately $1.9 million, respectively, as collaborative arrangements revenue related to this arrangement, and approximately $1.0 million was recognized during the three and six months ended June 30, 2015.

 

Co-Promotion Agreement with Allergan for VIBERZI

 

In August 2015, the Company and Allergan entered into an agreement for the co-promotion of VIBERZI in the U.S., Allergan’s treatment for adults suffering from IBS-D (the “VIBERZI Co-Promotion Agreement”). Under the terms of the VIBERZI Co-Promotion Agreement, the Company’s clinical sales specialists are detailing VIBERZI to the approximately 25,000 health care practitioners to whom they detail LINZESS. Allergan is responsible for all costs and activities relating to the commercialization of VIBERZI outside of the co-promotion.

 

Under the terms of the VIBERZI Co-Promotion Agreement, the Company’s promotional efforts are compensated based on the volume of calls delivered by the Company’s sales force, with the terms of the agreement reducing or eliminating certain of the unfavorable adjustments to the Company’s share of net profits stipulated by the linaclotide collaboration agreement with Allergan for North America, provided that the Company provides a minimum number of VIBERZI calls on physicians. The Company has the potential to achieve milestone payments of up to $10.0 million based on the net sales of VIBERZI in each of 2017 and 2018, and is also compensated via reimbursements for medical education initiatives.

 

The Company’s promotional efforts under the non-exclusive co-promotion began when VIBERZI became commercially available in December 2015, and will continue until December 31, 2017, unless earlier terminated by either party pursuant to the provisions of the VIBERZI Co-Promotion Agreement. Either party may also terminate the VIBERZI Co-Promotion Agreement in the event of an uncured material breach by the other party, withdrawal of necessary approvals by the FDA, for convenience, or bankruptcy or insolvency of the other party. Allergan may terminate the VIBERZI Co-Promotion Agreement if the Company does not provide the minimum number of calls on physicians for VIBERZI. Activities under the VIBERZI Co-Promotion Agreement were evaluated in accordance with ASC 605-25 to determine if they represented a multiple element revenue arrangement. The Company concluded that the VIBERZI Co-Promotion Agreement does not represent a material modification to the linaclotide collaboration agreement with Allergan for North America, as it is not material to the total arrangement consideration under the collaboration agreement, does not significantly modify the existing deliverables, and does not significantly change the term of the agreement. The Company identified the following deliverables in the VIBERZI Co-Promotion Agreement: (i) second position sales detailing of VIBERZI, and (ii) medical education services. Each of the deliverables was deemed to have standalone value based on their nature and both deliverables met the criteria to be accounted for as separate units of accounting under ASC 605-25. The Company determined the BESP for each of the deliverables approximated the value allocated to the deliverables under the agreement. As consideration is earned over the term of the agreement, the revenue will be allocated to each deliverable based on the relative selling price, using management’s BESP, and recognized as collaborative arrangements revenue in the Company’s condensed consolidated statement of operations, in accordance with ASC 605-25, during the quarter earned. During the three and six months ended June 30, 2016, in connection with the Company’s VIBERZI co-promotion activities, the net profit share adjustments payable to Allergan under the linaclotide collaboration agreement for North America were reduced by approximately $1.4 million and approximately $2.6 million, respectively.  During the three and six months ended June 30, 2016, the Company recognized approximately $0.5 million and $1.0 million, respectively, in collaboration revenue related to the VIBERZI Co-Promotion Agreement for the performance of medical education services.

 

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Other Collaboration and License Agreements

 

The Company has other collaboration and license agreements that are not individually significant to its business.  Pursuant to the terms of one agreement, the Company may be required to pay $7.5 million for development milestones, of which approximately $2.5 million had been paid as of June 30, 2016, and $18.0 million for regulatory milestones, none of which had been paid as of June 30, 2016.  In addition, pursuant to the terms of another agreement, the contingent milestones could total up to $114.5 million per product to one of the Company’s collaboration partners, including $21.5 million for development milestones, $58.0 million for regulatory milestones and $35.0 million for sales-based milestones. Further, under such agreements, the Company is also required to fund certain research activities and, if any product related to these collaborations is approved for marketing, to pay significant royalties on future sales. During the three and six months ended June 30, 2016 and 2015, the Company did not incur any research and development expense associated with the Company’s other collaboration and license agreements.

 

5.  Fair Value of Financial Instruments

 

The tables below present information about the Company’s assets that are measured at fair value on a recurring basis as of June 30, 2016 and December 31, 2015 and indicate the fair value hierarchy of the valuation techniques the Company utilized to determine such fair value. In general, fair values determined by Level 1 inputs utilize observable inputs such as quoted prices in active markets for identical assets or liabilities. Fair values determined by Level 2 inputs utilize data points that are either directly or indirectly observable, such as quoted prices, interest rates and yield curves. Fair values determined by Level 3 inputs utilize unobservable data points in which there is little or no market data, which require the Company to develop its own assumptions for the asset or liability.

 

The Company’s investment portfolio includes mainly fixed income securities that do not always trade on a daily basis. As a result, the pricing services used by the Company apply other available information as applicable through processes such as benchmark yields, benchmarking of like securities, sector groupings and matrix pricing to prepare valuations. In addition, model processes are used to assess interest rate impact and develop prepayment scenarios. These models take into consideration relevant credit information, perceived market movements, sector news and economic events. The inputs into these models may include benchmark yields, reported trades, broker-dealer quotes, issuer spreads and other relevant data. The Company validates the prices provided by its third party pricing services by obtaining market values from other pricing sources and analyzing pricing data in certain instances.

 

The following tables present the assets and liabilities the Company has measured at fair value on a recurring basis (in thousands):

 

 

 

 

 

Fair Value Measurements at Reporting Date Using

 

 

 

June 30, 2016

 

Quoted Prices
in Active Markets
for
Identical Assets
(Level 1)

 

Significant Other
Observable Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Assets:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

Money market funds

 

$

274,173

 

$

274,173

 

$

 

$

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

U.S. Treasury securities

 

20,037

 

20,037

 

 

 

U.S. government-sponsored securities

 

28,004

 

 

28,004

 

 

Convertible Note Hedges

 

99,478

 

 

 

99,478

 

Total assets

 

421,692

 

294,210

 

28,004

 

99,478

 

Liabilities:

 

 

 

 

 

 

 

 

 

Note Hedge Warrants

 

(86,838

)

 

 

(86,838

)

Contingent Consideration

 

(87,649

)

 

 

(87,649

)

Total liabilities

 

$

(174,487

)

$

 

$

 

$

(174,487

)

 

 

 

 

 

Fair Value Measurements at Reporting Date Using

 

 

 

December 31, 2015

 

Quoted Prices in
Active Markets for
Identical Assets
(Level 1)

 

Significant Other
Observable Inputs
(Level 2)

 

Significant
Unobservable Inputs
(Level 3)

 

Assets:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

Money market funds

 

$

254,903

 

$

254,903

 

$

 

$

 

U.S. government-sponsored securities

 

3,340

 

 

3,340

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

U.S. Treasury securities

 

50,091

 

50,091

 

 

 

U.S. government-sponsored securities

 

128,016

 

 

128,016

 

 

Convertible Note Hedges

 

86,466

 

 

 

86,466

 

Total assets

 

$

522,816

 

$

304,994

 

$

131,356

 

$

86,466

 

Liabilities:

 

 

 

 

 

 

 

 

 

Note Hedge Warrants

 

$

(75,328

)

$

 

$

 

$

(75,328

)

Total liabilities

 

$

(75,328

)

$

 

$

 

$

(75,328

)

 

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There were no transfers between fair value measurement levels during the three or six months ended June 30, 2016 or 2015.

 

Cash equivalents, accounts receivable, related party accounts receivable, prepaid expenses and other current assets, accounts payable, related party accounts payable, accrued expenses and the current portion of capital lease obligations at June 30, 2016 and December 31, 2015 are carried at amounts that approximate fair value due to their short-term maturities.

 

The non-current portion of the capital lease obligations at June 30, 2016 and December 31, 2015 approximates fair value as it bears interest at a rate approximating a market interest rate.

 

Convertible Note Hedges and Note Hedge Warrants

 

The Company’s Convertible Note Hedges and the Note Hedge Warrants are recorded as derivative assets and liabilities, and are classified as Level 3 under the fair value hierarchy. These derivatives are not actively traded and are valued using the Black-Scholes option-pricing model which requires the use of subjective assumptions. Significant inputs used to determine the fair value as of June 30, 2016 included the price per share of the Company’s Class A common stock, time to maturity of the derivative instruments, the strike prices of the derivative instruments, the risk-free interest rate, and the volatility of the Company’s Class A common stock. The Company has not paid and does not anticipate paying cash dividends on its shares of common stock in the foreseeable future; therefore, the expected dividend yield is assumed to be zero. Changes to these inputs could materially affect the valuation of the Convertible Note Hedges and Note Hedge Warrants.

 

The following inputs were used in the fair market valuation of the Convertible Note Hedges and Note Hedge Warrants as of June 30, 2016:

 

 

 

Convertible
Note Hedges

 

Note Hedge Warrants

 

Risk-free interest rate (1)

 

1.2

%

1.2

%

Time to maturity

 

5.9

 

6.5

 

Stock price (2)

 

$

13.08

 

$

13.08

 

Strike price (3)

 

$

16.58

 

$

21.50

 

Common stock volatility (4)

 

45.8

%

45.8

%

Dividend yield

 

%

%

 


(1)         Based on U.S. Treasury yield curve, with terms commensurate with the terms of the Convertible Note Hedges and the Note Hedge Warrants.

(2)         The closing price of the Company’s Class A common stock on the last trading day of the quarter ended June 30, 2016.

(3)         As per the respective agreements for the Convertible Note Hedges and Note Hedge Warrants.

(4)         Selected volatility based on historical volatility of the Company’s Class A common stock.

 

The Convertible Note Hedges and the Note Hedge Warrants are recorded at fair value at each reporting period and changes in fair value are recorded in other expense, net within the Company’s condensed consolidated statements of operations. Gains and losses for these derivative financial instruments are presented separately in the Company’s condensed consolidated statements of cash flows.

 

The following table reflects the change in the Company’s Level 3 convertible note derivatives from December 31, 2015 through June 30, 2016 (in thousands):

 

 

 

Convertible Note
Hedges

 

Note Hedge Warrants

 

Balance at December 31, 2015

 

$

86,466

 

$

(75,328

)

Change in fair value, recorded as a component of gain (loss) on derivatives

 

13,012

 

(11,510

)

Balance at June 30, 2016

 

$

99,478

 

$

(86,838

)

 

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Contingent Consideration

 

In connection with the Lesinurad Transaction, the Company recorded a liability of $87.6 million, representing the fair value of the contingent consideration. This valuation was based on a Monte-Carlo simulation, which includes significant estimates related to probability weighted net cash outflow projections, discounted using a yield curve equivalent to the Company’s credit risk, which was the estimated cost of debt financing for market participants. This estimate represents the probability weighted analysis of expected future milestone and royalty payments based on net sales to be made to AstraZeneca.  There were no changes in valuation techniques or in estimated fair value of the contingent consideration from the Acquisition Date through June 30, 2016. Changes to these inputs could materially affect the valuation of the contingent consideration.

 

The following table reflects the change in the Company’s Level 3 contingent consideration payable from December 31, 2015 through June 30, 2016 (in thousands):

 

 

 

Contingent
Consideration

 

Fair value at December 31, 2015

 

$

 

Additions

 

87,649

 

Changes in fair value

 

 

Payments

 

 

Balance at June 30, 2016

 

$

87,649

 

 

11% PhaRMA Notes

 

In January 2013, the Company closed a private placement of $175.0 million in aggregate principal amount of the PhaRMA Notes due on or before June 15, 2024. The estimated fair value of the PhaRMA Notes was approximately $153.6 million and approximately $166.8 million as of June 30, 2016 and December 31, 2015, respectively, and was determined using Level 3 inputs, including a quoted rate.

 

2.25% Convertible Senior Notes

 

In June 2015, the Company issued approximately $335.7 million of its 2022 Notes. The Company separately accounted for the liability and equity components of the 2022 Notes by allocating the proceeds between the liability component and equity component (Note 10).  The fair value of the 2022 Notes, which differs from their carrying value, is influenced by interest rates, the price of the Company’s Class A common stock and the volatility thereof, and the prices for the 2022 Notes observed in market trading, which are Level 2 inputs.  The estimated fair value of the 2022 Notes was approximately $346.2 million and approximately $311.6 million as of June 30, 2016 and December 31, 2015, respectively.

 

6.  Available-for-Sale Securities

 

The following tables summarize the available-for-sale securities held at June 30, 2016 and December 31, 2015 (in thousands):

 

 

 

Amortized Cost

 

Gross Unrealized
Gains

 

Gross Unrealized
Losses

 

Fair Value

 

June 30, 2016

 

 

 

 

 

 

 

 

 

U.S. Treasury securities

 

$

20,010

 

$

27

 

$

 

$

20,037

 

U.S. government-sponsored securities

 

27,992

 

13

 

(1

)

28,004

 

Total

 

$

48,002

 

$

40

 

$

(1

)

$

48,041

 

 

 

 

Amortized Cost

 

Gross Unrealized
Gains

 

Gross Unrealized
Losses

 

Fair Value

 

December 31, 2015

 

 

 

 

 

 

 

 

 

U.S. Treasury securities

 

$

50,124

 

$

 

$

(33

)

$

50,091

 

U.S. government-sponsored securities

 

128,069

 

2

 

(55

)

128,016

 

Total

 

$

178,193

 

$

2

 

$

(88

)

$

178,107

 

 

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The contractual maturities of all securities held at June 30, 2016 are one year or less. There were 2 and 32 available-for-sale securities in an unrealized loss position at June 30, 2016 and December 31, 2015, respectively, none of which had been in an unrealized loss position for more than twelve months. The aggregate fair value of these securities at June 30, 2016 and December 31, 2015 was approximately $4.0 million and approximately $167.6 million, respectively. The Company reviews its investments for other-than-temporary impairment whenever the fair value of an investment is less than amortized cost and evidence indicates that an investment’s carrying amount is not recoverable within a reasonable period of time. To determine whether an impairment is other-than-temporary, the Company considers whether it has the ability and intent to hold the investment until a market price recovery and considers whether evidence indicating the cost of the investment is recoverable outweighs evidence to the contrary. The Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity. The Company did not hold any securities with other-than-temporary impairment at June 30, 2016.

 

There were no sales of available-for-sale securities during the three or six months ended June 30, 2016 or 2015. Net unrealized holding gains or losses for the period that have been included in accumulated other comprehensive income were not material to the Company’s condensed consolidated results of operations.

 

7.  Inventory

 

The Company’s inventory represents linaclotide API that is available for commercial sale.  At June 30, 2016 and December 31, 2015, the Company did not hold any balances of such inventory.

 

The Company has entered into multiple commercial supply agreements for the purchase of linaclotide API, as the Company is responsible for supplying API to its collaboration partners outside of North America and Europe.  Two of the Company’s API supply agreements contain minimum purchase commitments.  As part of the Company’s net realizable value assessment of its inventory, the Company assesses whether it has any excess non-cancelable purchase commitments resulting from its minimum supply agreements with its suppliers of linaclotide API.  As of June 30, 2016 and December 31, 2015, the Company had an accrual for excess purchase commitments of approximately $10.1 million, which is recorded in other liabilities in the Company’s condensed consolidated balance sheet.  The Company has evaluated all remaining minimum purchase commitments under its linaclotide API supply agreements through 2023 and concluded that the minimum purchase commitments under such agreements are realizable based on the current forecasts received from the Company’s partners in these territories and the Company’s internal forecasts.

 

8.  Property and Equipment

 

Property and equipment, net consisted of the following (in thousands):

 

 

 

June 30, 2016

 

December 31, 2015

 

Manufacturing equipment

 

$

3,748

 

$

3,748

 

Laboratory equipment

 

14,110

 

13,681

 

Computer and office equipment

 

4,136

 

3,596

 

Furniture and fixtures

 

2,062

 

2,062

 

Software

 

13,316

 

12,715

 

Construction in process

 

228

 

375

 

Leased vehicles

 

2,749

 

3,039

 

Leasehold improvements

 

38,478

 

38,465

 

 

 

78,827

 

77,681

 

Less accumulated depreciation and amortization

 

(60,888

)

(56,606

)

 

 

$

17,939

 

$

21,075

 

 

9.  Accrued Expenses and Other Current Liabilities

 

Accrued expenses and other current liabilities consisted of the following (in thousands):

 

 

 

June 30, 2016

 

December 31, 2015

 

Salaries and benefits

 

$

14,814

 

$

19,582

 

Professional fees

 

1,632

 

507

 

Accrued interest

 

1,047

 

1,103

 

Other

 

3,105

 

2,109

 

 

 

$

20,598

 

$

23,301

 

 

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10.  Notes Payable

 

2.25% Convertible Senior Notes due 2022

 

In June 2015, the Company issued approximately $335.7 million aggregate principal amount of the 2022 Notes.  The Company received net proceeds of approximately $324.0 million from the sale of the 2022 Notes, after deducting fees and expenses of approximately $11.7 million. The Company used approximately $21.1 million of the net proceeds from the sale of the 2022 Notes to pay the net cost of the Convertible Note Hedges (after such cost was partially offset by the proceeds to the Company from the sale of the Note Hedge Warrants), as described below.

 

The 2022 Notes are governed by an indenture (the “Indenture”) between the Company and U.S. Bank National Association, as the trustee. The 2022 Notes are senior unsecured obligations and bear cash interest at the annual rate of 2.25%, payable on June 15 and December 15 of each year, which began on December 15, 2015.  The 2022 Notes will mature on June 15, 2022, unless earlier converted or repurchased.  The Company may settle conversions of the 2022 Notes through payment or delivery, as the case may be, of cash, shares of Class A common stock of the Company or a combination of cash and shares of Class A common stock, at the Company’s option (subject to, and in accordance with, the settlement provisions of the Indenture). The initial conversion rate for the 2022 Notes is 60.3209 shares of Class A common stock (subject to adjustment as provided for in the Indenture) per $1,000 principal amount of the 2022 Notes, which is equal to an initial conversion price of approximately $16.58 per share and 20,249,665 shares. Holders of the 2022 Notes may convert their 2022 Notes at their option at any time prior to the close of business on the business day immediately preceding December 15, 2021 in multiples of $1,000 principal amount, only under the following circumstances:

 

·                  during any calendar quarter commencing after the calendar quarter ending on September 30, 2015 (and only during such calendar quarter), if the last reported sale price of the Company’s Class A common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price for the 2022 Notes on each applicable trading day;

 

·                  during the five business day period after any five consecutive trading day period (the “measurement period”) in which the “trading price” (as defined in the Indenture) per $1,000 principal amount of the 2022 Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of the Company’s Class A common stock and the conversion rate for the 2022 Notes on each such trading day; or

 

·                  upon the occurrence of specified corporate events described in the Indenture.

 

On or after December 15, 2021, until the close of business on the second scheduled trading day immediately preceding June 15, 2022, holders may convert their 2022 Notes, in multiples of $1,000 principal amount, at the option of the holder regardless of the foregoing circumstances.

 

If a make-whole fundamental change, as described in the Indenture, occurs and a holder elects to convert its 2022 Notes in connection with such make-whole fundamental change, such holder may be entitled to an increase in the conversion rate as described in the Indenture. The Company may not redeem the 2022 Notes prior to the maturity date and no “sinking fund” is provided for by the 2022 Notes, which means that the Company is not required to periodically redeem or retire the 2022 Notes. Upon the occurrence of certain fundamental changes involving the Company, holders of the 2022 Notes may require the Company to repurchase for cash all or part of their 2022 Notes at a repurchase price equal to 100% of the principal amount of the 2022 Notes to be repurchased, plus accrued and unpaid interest.

 

The Indenture does not contain any financial covenants or restrict the Company’s ability to repurchase the Company’s securities, pay dividends or make restricted payments in the event of a transaction that substantially increases the Company’s level of indebtedness.  The Indenture provides for customary events of default. In the case of an event of default with respect to the 2022 Notes arising from specified events of bankruptcy or insolvency, all outstanding 2022 Notes will become due and payable immediately without further action or notice. If any other event of default with respect to the 2022 Notes under the Indenture occurs or is continuing, the trustee or holders of at least 25% in aggregate principal amount of the then outstanding 2022 Notes may declare the principal amount of the 2022 Notes to be immediately due and payable.  Notwithstanding the foregoing, the Indenture provides that, upon the Company’s election, and for up to 180 days, the sole remedy for an event of default relating to certain failures by the Company to comply with certain reporting covenants in the Indenture consists exclusively of the right to receive additional interest on the 2022 Notes.

 

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In accordance with accounting guidance for debt with conversion and other options, the Company separately accounted for the liability and equity components of the 2022 Notes by allocating the proceeds between the liability component and the embedded conversion option, or equity component, due to the Company’s ability to settle the 2022 Notes in cash, its Class A common stock, or a combination of cash and Class A common stock at the option of the Company. The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature. The allocation was performed in a manner that reflected the Company’s non-convertible debt borrowing rate for similar debt. The equity component of the 2022 Notes was recognized as a debt discount and represents the difference between the gross proceeds from the issuance of the 2022 Notes and the fair value of the liability of the 2022 Notes on their respective dates of issuance. The excess of the principal amount of the liability component over its carrying amount, or debt discount, is amortized to interest expense using the effective interest method over seven years, or the life of the 2022 Notes. The equity component is not remeasured as long as it continues to meet the conditions for equity classification.

 

The Company’s outstanding Convertible Note balances as of June 30, 2016 consisted of the following (in thousands):

 

Principal

 

$

335,699

 

Less: unamortized debt discount

 

(101,297

)

Less: unamortized debt issuance costs

 

(7,129

)

Net carrying amount

 

$

227,273

 

Equity component

 

$

114,199

 

 

In connection with the issuance of the 2022 Notes, the Company incurred approximately $11.7 million of debt issuance costs, which primarily consisted of initial purchasers’ discounts and legal and other professional fees. The Company allocated these costs to the liability and equity components based on the allocation of the proceeds.  The portion of these costs allocated to the equity components totaling approximately $4.0 million were recorded as a reduction to additional paid-in capital. The portion of these costs allocated to the liability components totaling approximately $7.7 million were recorded as a reduction in the carrying value of the debt on the balance sheet and are amortized to interest expense using the effective interest method over the expected life of the 2022 Notes.

 

The Company determined the expected life of the 2022 Notes was equal to their seven-year term. The effective interest rate on the liability components of the 2022 Notes for the period from the date of issuance through June 30, 2016 was 9.34%.  The following table sets forth total interest expense recognized related to the 2022 Notes during the three and six months ended June 30, 2016 (in thousands):

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2016

 

2015

 

2016

 

2015

 

Contractual interest expense

 

$

1,888

 

$

293

 

$

3,777

 

$

293

 

Amortization of debt issuance costs

 

161

 

22

 

314

 

22

 

Amortization of debt discount

 

3,204

 

495

 

6,339

 

495

 

Total interest expense

 

$

5,253

 

$

810

 

$

10,430

 

$

810

 

 

Convertible Note Hedge and Warrant Transactions with Respect to 2022 Notes

 

To minimize the impact of potential dilution to the Company’s Class A common stockholders upon conversion of the 2022 Notes, the Company entered into the Convertible Note Hedges covering 20,249,665 shares of the Company’s Class A common stock in connection with the issuance of the 2022 Notes. The Convertible Note Hedges have an exercise price of approximately $16.58 per share and are exercisable when and if the 2022 Notes are converted. If upon conversion of the 2022 Notes, the price of the Company’s Class A common stock is above the exercise price of the Convertible Note Hedges, the counterparties are obligated to deliver shares of the Company’s Class A common stock and/or cash with an aggregate value approximately equal to the difference between the price of the Company’s Class A common stock at the conversion date and the exercise price, multiplied by the number of shares of the Company’s Class A common stock related to the Convertible Note Hedge being exercised.

 

Concurrently with entering into the Convertible Note Hedges, the Company also sold Note Hedge Warrants to the Convertible Note Hedge counterparties to acquire 20,249,665 shares of the Company’s Class A common stock, subject to customary anti-dilution adjustments. The strike price of the Note Hedge Warrants is initially $21.50 per share, subject to adjustment, and such warrants are exercisable over the 150 trading day period beginning on September 15, 2022. The Note Hedge Warrants could have a

 

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dilutive effect on the Class A common stock to the extent that the market price per share of the Company’s Class A common stock exceeds the applicable strike price of such warrants.

 

The Convertible Note Hedges and the Note Hedge Warrants are separate transactions entered into by the Company and are not part of the terms of the 2022 Notes. Holders of the 2022 Notes and the Note Hedge Warrants do not have any rights with respect to the Convertible Note Hedges. The Company paid approximately $91.9 million for the Convertible Note Hedges and recorded this amount as a long-term asset on the condensed consolidated balance sheet.  The Company received approximately $70.8 million for the Note Hedge Warrants and recorded this amount as a long-term liability, resulting in a net cost to the Company of approximately $21.1 million. The Convertible Note Hedges and Note Hedge Warrants are accounted for as derivative assets and liabilities, respectively, in accordance with ASC Topic 815, “Derivatives and Hedging” (“ASC 815”) (Note 5).

 

11% PhaRMA Notes due 2024

 

In January 2013, the Company closed a private placement of $175.0 million in aggregate principal amount of notes due on or before June 15, 2024. The PhaRMA Notes bear an annual interest rate of 11%, with interest payable March 15, June 15, September 15 and December 15 of each year (each a “Payment Date”) which began on June 15, 2013. On March 15, 2014, the Company began making quarterly payments on the PhaRMA Notes equal to the greater of (i) 7.5% of net sales of LINZESS in the U.S. for the preceding quarter (the “Synthetic Royalty Amount”) and (ii) accrued and unpaid interest on the PhaRMA Notes (the “Required Interest Amount”). Principal on the PhaRMA Notes will be repaid in an amount equal to the Synthetic Royalty Amount minus the Required Interest Amount, when this is a positive number, until the principal has been paid in full. Given the principal payments on the PhaRMA Notes are based on the Synthetic Royalty Amount, which will vary from quarter to quarter, the PhaRMA Notes may be repaid prior to June 15, 2024, the final legal maturity date. The Company made principal payments of approximately $25.2 million through June 30, 2016, and expects to pay approximately $35.3 million of the principal within twelve months following June 30, 2016.

 

The PhaRMA Notes are secured solely by a security interest in a segregated bank account established to receive the required quarterly payments. Up to the amount of the required quarterly payments under the PhaRMA Notes, Allergan will deposit its quarterly profit (loss) sharing payments due to the Company under the collaboration agreement for North America, if any, into the segregated bank account. If the funds deposited by Allergan into the segregated bank account are insufficient to make a required payment of interest or principal on a particular Payment Date, the Company is obligated to deposit such shortfall out of the Company’s general funds into the segregated bank account.

 

The PhaRMA Notes may be redeemed at any time prior to maturity, in whole or in part, at the option of the Company. The Company will pay a redemption price equal to the percentage of outstanding principal balance of the PhaRMA Notes being redeemed specified below for the period in which the redemption occurs (plus the accrued and unpaid interest to the redemption date on the PhaRMA Notes being redeemed):

 

Payment Dates

 

Redemption
Percentage

 

From and including January 1, 2016 to and including December 31, 2016

 

102.75

%

From and including January 1, 2017 and thereafter

 

100.00

%

 

The PhaRMA Notes contain certain covenants related to the Company’s obligations with respect to the commercialization of LINZESS and the related collaboration agreement with Allergan for North America, as well as certain customary covenants, including covenants that limit or restrict the Company’s ability to incur certain liens, merge or consolidate or make dispositions of assets. The PhaRMA Notes also specify a number of events of default (some of which are subject to applicable cure periods), including, among other things, covenant defaults, other non-payment defaults, and bankruptcy and insolvency defaults. Upon the occurrence of an event of default, subject to cure periods in certain circumstances, all amounts outstanding may become immediately due and payable.

 

The upfront cash proceeds of $175.0 million, less a discount of approximately $0.4 million for payment of legal fees incurred on behalf of the noteholders, were recorded as notes payable at issuance. The Company also capitalized approximately $7.3 million of debt issuance costs in connection with the PhaRMA Notes, which are presented in the Company’s condensed consolidated Balance Sheet as a deduction from the associated debt liability.  The PhaRMA Notes issuance costs and discount are being amortized over the estimated term of the obligation using the effective interest method. The repayment provisions represent embedded derivatives that are clearly and closely related to the PhaRMA Notes and as such do not require separate accounting treatment.

 

The accounting for the PhaRMA Notes requires the Company to make certain estimates and assumptions about the future net sales of LINZESS in the U.S. LINZESS has been marketed since December 2012 and the estimates of the magnitude and timing of LINZESS net sales are subject to significant variability and uncertainty. These estimates and assumptions are likely to change, which may result in future adjustments to the portion of the PhaRMA Notes that is classified as a current liability, the amortization of debt issuance costs and discounts as well as the accretion of the interest expense.  Any such adjustments could be material to the Company’s condensed consolidated financial statements.

 

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11.  Commitments and Contingencies

 

Lease Commitments

 

The Company leases its facility, offsite data storage location, vehicles and various equipment under leases that expire at varying dates through 2018. Certain of these leases contain renewal options, and require the Company to pay operating costs, including property taxes, insurance, maintenance and other operating expenses.

 

The Company rents office and laboratory space at its corporate headquarters in Cambridge, Massachusetts under a non-cancelable operating lease, entered into in January 2007, as amended (“2007 Lease Agreement”). The 2007 Lease Agreement contains various provisions for renewal at the Company’s option and, in certain cases, free rent periods and rent escalation tied to the Consumer Price Index and fair market rent. The rent expense, inclusive of the escalating rent payments and free rent periods, is estimated and recognized on a straight-line basis over the lease term through January 2018.  In addition, during 2014, the Company entered into two arrangements, with the landlord’s consent, to sublease a portion of its corporate headquarters that it did not intend to use for its operations.  Effective in February 2016, the Company’s obligations due to the landlord of its corporate headquarters increased in connection with a rent escalation tied to the Consumer Price Index and fair market rent, pursuant to the terms of the 2007 Lease Agreement, which resulted in a change in the accounting estimate of rent expense. This change in accounting estimate is recognized on a prospective, straight-line basis.  Rent expenses related to the 2007 Lease Agreement, net of sublease income, recorded during the three months ended June 30, 2016 and 2015 were approximately $2.0 million and approximately $1.5 million, respectively, and during the six months ended June 30, 2016 and 2015 were approximately $7.5 million and approximately $3.0 million, respectively.  In accordance with ASC Topic 420, Exit or Disposal Cost Obligations, the Company recorded all obligations to the landlord associated with sublet space, net of sublease income due to the Company under the subleases in the period in which the change occurred. As a result, the rent expense associated with the 2007 Lease Agreement for the six months ended June 30, 2016 includes approximately $3.5 million of estimated obligations to the landlord associated with the sublet space, net of sublease income due to the Company under the subleases.

 

At June 30, 2016, future minimum lease payments under all non-cancelable lease arrangements were as follows (in thousands):

 

 

 

Operating

 

Lease Payments

 

 

 

Capital

 

 

 

Lease

 

to be Received

 

Net Operating

 

Lease

 

 

 

Payments

 

from Subleases

 

Lease Payments

 

Payments

 

2016 (1)

 

$

10,246

 

$

(3,219

)

$

7,027

 

$

1,548

 

2017

 

20,498

 

(5,665

)

14,833

 

1,112

 

2018

 

831

 

(476

)

355

 

86

 

Total future minimum lease payments

 

$

31,575

 

$

(9,360

)

$

22,215

 

$

2,746

 

Less: amounts representing interest

 

 

 

 

 

 

 

(97

)

Capital lease obligations at June 30, 2016

 

 

 

 

 

 

 

2,649

 

Less: current portion of capital lease obligations

 

 

 

 

 

 

 

(2,451

)

Capital lease obligations, net of current portion

 

 

 

 

 

 

 

$

198

 

 


(1)                                 Amounts are for the six months ending December 31, 2016.

 

Commercial Supply Commitments

 

The Lesinurad CSA with AstraZeneca provides for commercial supply of ZURAMPIC, and, if approved by the FDA, the FDC Product.  The Lesinurad CSA includes certain purchase obligations based on the Company’s forecasted demand.  As of June 30, 2016, the Company had approximately $0.3 million in such commitments related to lesinurad commercial supply.

 

12.  Employee Stock Benefit Plans

 

The Company has several share-based compensation plans under which stock options, restricted stock awards, restricted stock units (“RSUs”), and other share-based awards are available for grant to employees, directors and consultants of the Company.

 

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The following table summarizes share-based compensation expense reflected in the condensed consolidated statements of operations for the three and six months ended June 30, 2016 and 2015 (in thousands):

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2016

 

2015

 

2016

 

2015

 

Research and development

 

$

3,265

 

$

2,691

 

$

5,764

 

$

4,745

 

Selling, general and administrative

 

4,832

 

4,212

 

9,139

 

7,584

 

 

 

$

8,097

 

$

6,903

 

$

14,903

 

$

12,329

 

 

A summary of stock option activity for the six months ended June 30, 2016 is as follows:

 

 

 

Number of Shares

 

Weighted-Average Exercise Price

 

 

 

(in thousands)

 

 

 

Outstanding at December 31, 2015

 

20,566

 

$

11.18

 

Granted

 

3,608

 

10.32

 

Exercised

 

(1,441

)

3.14

 

Cancelled

 

(667

)

13.04

 

Outstanding at June 30, 2016

 

22,066

 

$

11.50

 

 

The weighted-average assumptions used to estimate the fair value of the stock options using the Black-Scholes option-pricing model were as follows for the three and six months ended June 30, 2016 and 2015:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2016

 

2015

 

2016

 

2015

 

Expected volatility

 

45.9

%

46.8

%

46.0

%

46.1

%

Expected term (in years)

 

6.0

 

6.0

 

6.0

 

6.0

 

Risk-free interest rate

 

1.5

%

1.7

%

1.5

%

1.7

%

Expected dividend yield

 

%

%

%

%

 

In 2015, the Company began granting RSUs in addition to stock options as part of the equity compensation it provides to its employees, each RSU representing the right to receive one share of the Company’s Class A common stock pursuant to the terms of the applicable award agreement and granted pursuant to the terms of the Company’s 2010 Equity Plan. The RSUs generally vest 25% per year on the approximate anniversary of the date of grant until fully vested, provided the employee remains continuously employed with the Company through each vesting date. Shares of the Company’s Class A common stock are delivered to the employee upon vesting, subject to payment of applicable withholding taxes. The fair value of all RSUs is based on the market value of the Company’s Class A common stock on the date of grant. Compensation expense, including the effect of estimated forfeitures, is recognized over the applicable service period.

 

A summary of RSU activity for the six months ended June 30, 2016 is as follows:

 

 

 

Number of Shares

 

Weighted-Average Fair Value

 

 

 

(in thousands)

 

 

 

Unvested as of December 31, 2015

 

900

 

$

13.36

 

Granted

 

505

 

10.33

 

Vested

 

(116

)

15.54

 

Forfeited

 

(33

)

13.12

 

Unvested as of June 30, 2016

 

1,256

 

$

11.94

 

 

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13.  Related Party Transactions

 

In September 2009, Allergan became a related party when the Company sold to Allergan 2,083,333 shares of the Company’s convertible preferred stock. In November 2009, Almirall became a related party when the Company sold to Almirall 681,819 shares of the Company’s convertible preferred stock (Note 4). These shares of preferred stock converted to the Company’s Class B common stock on a 1:1 basis upon the completion of the Company’s initial public offering in February 2010. Amounts due to and due from Allergan and Almirall are reflected as related party accounts payable and related party accounts receivable, respectively. These balances are reported net of any balances due to or from the related party.  As of June 30, 2016, the Company had an insignificant amount in related party accounts receivable associated with Almirall and approximately $51.9 million in related party accounts receivable, net of related party accounts payable, associated with Allergan.  As of December 31, 2015, the Company did not have any related party accounts receivable associated with Almirall and approximately $51.6 million in related party accounts receivable, net of related party accounts payable, associated with Allergan.

 

The Company has and currently obtains health insurance services for its employees from an insurance provider whose President and Chief Executive Officer became a member of the Company’s Board of Directors in April 2016.  The Company paid approximately $1.9 million and $3.8 million in insurance premiums to this insurance provider during the three and six months ended June 30, 2016, respectively, and approximately $1.7 million and $3.5 million during the three and six months ending June 30, 2015, respectively.  At June 30, 2016 and 2015, the Company had no accounts payable due to this related party.

 

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Forward-Looking Information

 

The following discussion of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and the notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K. This discussion contains forward-looking statements that involve significant risks and uncertainties. As a result of many factors, such as those set forth under “Risk Factors” in Item 1A of this Quarterly Report on Form 10-Q, our actual results may differ materially from those anticipated in these forward-looking statements.

 

Overview

 

We are a commercial biotechnology company leveraging our proven development and commercial capabilities as we seek to bring multiple medicines to patients. We are advancing innovative product opportunities in areas of large unmet need, including irritable bowel syndrome with constipation, or IBS-C, and chronic idiopathic constipation, or CIC, hyperuricemia associated with uncontrolled gout, refractory gastroesophageal reflux disease, or rGERD, and vascular and fibrotic diseases.

 

Our first commercial product, linaclotide, is available to adult men and women suffering from IBS-C or CIC in the United States, or the U.S., under the trademarked name LINZESS®, and is available to adult men and women suffering from IBS-C in certain European countries under the trademarked name CONSTELLA®. We and our U.S. partner Allergan plc (together with its affiliates), or Allergan, began commercializing LINZESS in the U.S. in December 2012. Under our collaboration with Allergan for North America, total net sales of LINZESS in the U.S., as recorded by Allergan, are reduced by commercial costs incurred by each party, and the resulting amount is shared equally between us and Allergan. Our former European partner, Almirall, S.A., or Almirall, began commercializing CONSTELLA in Europe for the symptomatic treatment of moderate to severe IBS-C in adults in the second quarter of 2013.  In October 2015, Almirall transferred its exclusive license to develop and commercialize linaclotide in Europe to Allergan, and we and Allergan entered into an amendment to the European license agreement. Currently, CONSTELLA is commercially available in certain European countries, including the United Kingdom, Italy and Spain.

 

Within our IBS-C/CIC franchise, we and Allergan are exploring development opportunities to enhance the clinical profile of LINZESS by seeking to expand its utility within IBS-C and CIC, as well as studying linaclotide in additional indications and populations to assess its potential to treat various gastrointestinal, or GI, conditions. In June 2016, the U.S. Food and Drug Administration, or FDA, accepted for review the supplemental new drug application, or sNDA, for the 72 mcg dose of linaclotide in the U.S. If approved, we and Allergan anticipate launching the 72 mcg dose of linaclotide in the U.S. in 2017 to provide a broader range of treatment options to physicians and adult CIC patients in the U.S. We and Allergan are also developing linaclotide colonic release, a targeted oral delivery formulation of linaclotide designed to potentially improve abdominal pain relief in adult IBS-C patients. In addition to IBS-C, we are exploring linaclotide colonic release for use in additional GI disorders where lower abdominal pain is a predominant symptom, including IBS-mixed, or IBS-M, ulcerative colitis and diverticulitis, among others. Linaclotide is also being developed and commercialized in other parts of the world by our partners.

 

In December 2013 and February 2014, linaclotide was approved in Canada and Mexico, respectively, as a treatment for adult men and women suffering from IBS-C or CIC. Allergan has exclusive rights to commercialize linaclotide in Canada as CONSTELLA and in Mexico as LINZESS.  In May 2014, CONSTELLA became commercially available in Canada and in June 2014, LINZESS became commercially available in Mexico.  Astellas Pharma Inc., or Astellas, our partner in Japan, is developing linaclotide for the treatment of patients with IBS-C and chronic constipation in its territory.  In November 2015, we and Astellas reported positive top-line data from Astellas’ Phase III clinical trial of linaclotide in adult patients with IBS-C for Japan and in February 2016, Astellas filed a new drug application seeking approval of linaclotide for the treatment of adults with IBS-C in Japan with the Japanese Ministry of Health, Labor and Welfare.  In October 2012, we entered into a collaboration agreement with AstraZeneca AB (together with its affiliates), or AstraZeneca, to co-develop and co-commercialize linaclotide in China, Hong Kong and Macau, with AstraZeneca having primary responsibility for the local operational execution. In December 2015, we and AstraZeneca filed for approval with the China Food and Drug Administration, or CFDA, to market linaclotide in China. We continue to assess alternatives to bring linaclotide to IBS-C and CIC sufferers in the parts of the world outside of our partnered territories.

 

In June 2016, we closed a transaction with AstraZeneca, pursuant to which we received an exclusive license to develop, manufacture, and commercialize products containing lesinurad as an active ingredient, including ZURAMPIC®, in the U.S., or the Lesinurad Transaction. Lesinurad 200mg tablets were approved as ZURAMPIC by the FDA in December 2015 for use in combination with a xanthine oxidase inhibitor, or XOI, for the treatment of hyperuricemia associated with uncontrolled gout. We are also developing a fixed-dose combination product of lesinurad and allopurinol, an XOI, which is included under the license agreement, or the FDC Product. We have accounted for the Lesinurad Transaction in accordance with Accounting Standards Codification, or ASC, Topic 805, “Business Combinations”, or ASC 805, as the Lesinurad Transaction meets the requirements of a business combination.

 

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The transaction is more fully described in Note 3, Business Combinations, to our condensed consolidated financial statements appearing elsewhere in this Quarterly Report on Form 10-Q.

 

We are advancing our rGERD franchise through the development of IW-3718, a gastric retentive formulation of a bile acid sequestrant.

 

Within our vascular and fibrotic franchise, we are leveraging our pharmacological expertise in guanylate cyclase, or GC, pathways gained through the discovery and development of linaclotide to advance development programs targeting soluble guanylate cyclase, or sGC. sGC is a validated mechanism with the potential for broad therapeutic utility and multiple opportunities for product development in vascular and fibrotic diseases, as well as other therapeutic areas. We are progressing two sGC development candidates, IW-1973 and IW-1701, which have distinct pharmacologic profiles that we believe may be differentiating and enable opportunities in multiple indications.

 

In April 2016, we announced the discontinuation of development of IW-9179 for gastroparesis, as top-line data from its exploratory Phase IIa clinical study indicated that IW-9179 did not meaningfully reduce the severity of symptoms in patients with diabetic gastroparesis. In July 2016, as part of our continued assessment and prioritization of resources, we discontinued assessing the potential of IW-9179 for the treatment of functional dyspepsia and are no longer advancing this program.

 

As part of our strategy, we have also established development and commercial capabilities that we plan to leverage as we seek to bring multiple medicines to patients. We intend to play an active role in the development and commercialization of our products in the U.S., and to establish a strong global brand by out-licensing commercialization rights in other territories to high-performing partners.

 

In March 2015, we and Exact Sciences Corp, or Exact Sciences, entered into an agreement to co-promote Cologuard®, the first and only FDA-approved noninvasive stool DNA screening test for colorectal cancer. Under the terms of the agreement, our sales team promotes and educates health care practitioners regarding Cologuard. Exact Sciences maintains responsibility for all other aspects of the commercialization of Cologuard outside of the co-promotion. We are compensated primarily via royalties earned on the net sales of Cologuard generated from the healthcare practitioners on whom we call.

 

In August 2015, we and Allergan entered into an agreement for the co-promotion of VIBERZI™ (eluxadoline) in the U.S., Allergan’s treatment for adults suffering from IBS with diarrhea, or IBS-D. Under the terms of the agreement, our clinical sales specialists are detailing VIBERZI to the approximately 25,000 health care practitioners to whom they detail LINZESS. Allergan is responsible for all costs and activities relating to the commercialization of VIBERZI outside the co-promotion. Our promotional efforts are compensated based on the volume of calls delivered by our sales force, with the terms of the agreement reducing or eliminating certain of the unfavorable adjustments to the share of net profits stipulated by the linaclotide collaboration agreement with Allergan for North America, provided that we deliver a minimum number of VIBERZI calls on physicians. We are also compensated via reimbursement for medical education initiatives.

 

In June 2015, we issued approximately $335.7 million in aggregate principal amount of 2.25% Convertible Senior Notes due 2022, or the 2022 Notes. We received net proceeds of approximately $324.0 million from the sale of the 2022 Notes, after deducting fees and expenses of approximately $11.7 million. The net proceeds from these financings are being used to support the commercialization of LINZESS in the U.S. and to fund linaclotide and other development opportunities to advance our strategy to grow a leading commercial biotechnology company, in addition to other general corporate purposes.

 

We were incorporated in Delaware on January 5, 1998 as Microbia, Inc. On April 7, 2008, we changed our name to Ironwood Pharmaceuticals, Inc. We currently operate in one reportable business segment—human therapeutics.

 

To date, we have dedicated a majority of our activities to the research, development and commercialization of linaclotide, as well as to the research and development of our other product candidates. We have incurred significant operating losses since our inception in 1998. As of June 30, 2016, we had an accumulated deficit of approximately $1.1 billion. We are unable to predict the extent of any future losses or guarantee when, or if, our company will become cash flow positive.

 

Financial Overview

 

Revenue.  Revenue to date has been generated primarily through our collaboration agreements for the development and commercialization of linaclotide with Allergan for North America and AstraZeneca for China, Hong Kong and Macau, our license agreements for the development and commercialization of linaclotide in Japan with Astellas and the development and commercialization of linaclotide in Europe with Allergan (formerly with Almirall), and our co-promotion agreements with Allergan

 

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for VIBERZI and Exact Sciences for Cologuard in the U.S. The terms of these agreements contain multiple deliverables which may include (i) licenses, (ii) research and development activities, (iii) the manufacture of finished drug product, active pharmaceutical ingredient, or API, or development materials for a partner which are reimbursed at a contractually determined rate, and (iv) co-promotion activities by our clinical sales specialists. Payments to us may include (i) up-front license fees, (ii) payments for research and development activities, (iii) payments for the manufacture of finished drug product, API or development materials, (iv) payments based upon the achievement of certain milestones, (v) payments for sales detailing, promotional support services and medical education initiatives and (vi) royalties on product sales. Additionally, we receive our share of the net profits or bear our share of the net losses from the sale of linaclotide in the U.S. and China. LINZESS launched in the U.S. in December 2012 and CONSTELLA became commercially available in certain European countries beginning in the second quarter of 2013.  Linaclotide is also approved in a number of other countries.

 

We record our share of the net profits and losses from the sales of LINZESS in the U.S. on a net basis and present the settlement payments to and from Allergan as collaboration expense or collaborative arrangements revenue, as applicable.  Net profits or losses consist of net sales to third-party customers and sublicense income in the U.S. less the cost of goods sold as well as selling, general and administrative expenses. Although we expect net sales to increase over time, the settlement payments between Allergan and us, resulting in collaborative arrangements revenue or collaboration expense, are subject to fluctuation based on the ratio of selling, general and administrative expenses incurred by each party.  In addition, our collaborative arrangements revenue may fluctuate as a result of the timing and amount of license fees and clinical and commercial milestones received and recognized under our current and future strategic partnerships as well as timing and amount of royalties from the sales of linaclotide in the European, Canadian or Mexican markets or any other markets where linaclotide receives approval.

 

Cost of Revenue.  Cost of revenue related to the sales of linaclotide API is recognized upon shipment of linaclotide API to certain of our partners outside of the U.S. Our cost of revenue consists of the internal and external costs of producing such API.

 

Write-down of Inventory to Net Realizable Value and Loss on Non-cancelable Purchase Commitments.   During the six months ended June 30, 2015, we recorded expenses of approximately $8.2 million for the write-down of inventory and an accrual for excess non-cancelable inventory purchase commitments related to linaclotide API. These charges primarily related to a reduction in the near term demand forecast for CONSTELLA in the European territory by Almirall, our former European partner; and regulatory changes made by the CFDA to the marketing approval process in China.

 

Research and Development Expense.  Research and development expense consists of expenses incurred in connection with the discovery and development of our product candidates. These expenses consist primarily of compensation, benefits and other employee-related expenses, research and development related facility costs, third-party contract costs relating to nonclinical study and clinical trial activities, development of manufacturing processes, regulatory registration of third-party manufacturing facilities, as well as licensing fees for our product candidates. We charge all research and development expenses to operations as incurred. Under our linaclotide collaboration agreements with Allergan for the U.S. and AstraZeneca for China, Hong Kong and Macau, we are reimbursed for certain research and development expenses, and we net these reimbursements against our research and development expenses as incurred. Payments to Allergan or AstraZeneca for such linaclotide territories are recorded as incremental research and development expense.

 

The core of our research and development strategy is to leverage our development capabilities, as well as our pharmacologic expertise, to bring multiple medicines to patients. We are advancing innovative product opportunities in areas of large unmet need, including IBS-C and CIC, hyperuricemia associated with uncontrolled gout, rGERD, and vascular and fibrotic diseases.

 

Linaclotide.  Linaclotide represents the largest portion of our research and development expense for our product candidates. Linaclotide is the first and, to date, only FDA-approved guanylate cyclase type-C, or GC-C, agonist. Linaclotide is approved in the U.S. and in a number of E.U. and other countries.

 

We and Allergan are exploring development opportunities in the U.S. to enhance the clinical profile of LINZESS by seeking to expand its utility within IBS-C and CIC, as well as studying linaclotide in additional indications, populations and formulations to assess its potential to treat various GI conditions.  In June 2016, the FDA accepted for review the sNDA for a 72 mcg dose of linaclotide. If approved, we and Allergan anticipate launching the 72 mcg dose of linaclotide in the U.S. in 2017 to provide a broader range of treatment options to physicians and adult CIC patients in the U.S.

 

Our linaclotide development opportunities also include linaclotide colonic release, a targeted oral delivery formulation of linaclotide designed to potentially improve abdominal pain relief in adult IBS-C patients, as well as in patients with additional GI disorders where lower abdominal pain is a predominant symptom, such as IBS-M, ulcerative colitis and diverticulitis, among others. Additionally, we and Allergan are evaluating the advancement of linaclotide as a potential treatment of the GI dysfunction associated with opioid-induced constipation, or OIC, in adult patients and have established a plan with the FDA for clinical pediatric studies with linaclotide, as described below.

 

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Lesinurad. The FDA has required a post-marketing clinical study to further evaluate the renal and cardiovascular safety of lesinurad, and has required that enrollment include patients with moderate renal impairment. AstraZeneca is conducting this trial on our behalf and we are obligated to reimburse AstraZeneca up to $100.0 million over up to ten years for completion of this post-marketing clinical study for lesinurad. We and AstraZeneca plan to submit the FDC Product containing lesinurad for FDA regulatory review during the second half of 2016. We and AstraZeneca, on our behalf, are undertaking additional development activities related to lesinurad.

 

Development Candidates.  We are advancing our rGERD franchise through the development of IW-3718, a gastric retentive formulation of a bile acid sequestrant.

 

Within our vascular/fibrotic franchise, we are leveraging our pharmacological expertise in GC pathways gained through the discovery and development of linaclotide to advance development programs targeting sGC. We are currently progressing two sGC development candidates, IW-1973 and IW-1701, which have distinct pharmacologic profiles that we believe may be differentiating and enable opportunities in multiple indications. We have additional assets in early development that we continue to advance, and we are exploring strategic options for further development of these assets.

 

In April 2016, we announced the discontinuation of development of IW-9179 for gastroparesis, as top-line data from our exploratory Phase IIa clinical study indicated that IW-9179 did not meaningfully reduce the severity of symptoms in patients with diabetic gastroparesis. In July 2016, as part of our continued assessment and prioritization of resources, we discontinued assessing the potential of IW-9179 for the treatment of functional dyspepsia and are no longer advancing this program.

 

Discovery Research. Our discovery efforts are primarily focused on identifying novel clinical candidates that draw on our proprietary and expanding expertise in GI disorders and GC.

 

The following table sets forth our research and development expenses related to our product pipeline for the three and six months ended June 30, 2016 and 2015. These expenses relate primarily to external costs associated with nonclinical studies and clinical trial costs, costs incurred to develop manufacturing processes and register manufacturing facilities with the FDA and licensing fees for our product candidates. We allocate costs related to facilities, depreciation, share-based compensation, research and development support services, laboratory supplies and certain other costs directly to programs.

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2016

 

2015

 

2016

 

2015

 

 

 

(in thousands)

 

(in thousands)

 

Linaclotide (1)

 

$

9,618

 

$

13,989

 

$

20,353

 

$

27,453

 

Lesinurad (2)

 

2,862

 

 

2,862

 

 

Development candidates:

 

 

 

 

 

 

 

 

 

GI disorders (three compounds)(3) 

 

6,188

 

4,008

 

14,770

 

7,249

 

Vascular and fibrotic disorders (two compounds)(3) 

 

7,063

 

5,750

 

13,550

 

10,758

 

Central nervous system disorders (one compound)(3) 

 

142

 

264

 

707

 

452

 

Total development candidates

 

13,393

 

10,022

 

29,027

 

18,459

 

Discovery research

 

5,809

 

4,637

 

11,282

 

9,377

 

 

 

$

31,682

 

$

28,648

 

$

63,524

 

$

55,289

 

 


(1)                                 Includes linaclotide in all indications, populations and formulations.

(2)                                 Includes lesinurad in all indications, populations and formulations.

(3)                                 Number of compounds is for the six months ended June 30, 2016.

 

Since 2004, the date we began tracking costs by program, we have incurred approximately $376.0 million of research and development expenses related to linaclotide. The expenses for linaclotide include both our portion of the research and development costs incurred by Allergan for the U.S. and AstraZeneca for China, Hong Kong and Macau and invoiced to us under the cost-sharing provisions of our collaboration agreements, as well as the unreimbursed portion of research and development costs incurred by us under such cost-sharing provisions.

 

The lengthy process of securing regulatory approvals for new drugs requires the expenditure of substantial resources. Any failure by us to obtain, or any delay in obtaining, regulatory approvals would materially adversely affect our product development efforts and our business overall.

 

In August 2012, the FDA approved LINZESS as a once-daily treatment for adult men and women suffering from IBS-C or CIC. In connection with the FDA approval, we are required to conduct certain nonclinical and clinical studies, including those aimed

 

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at understanding: (a) whether orally administered linaclotide can be detected in breast milk, (b) the potential for antibodies to be developed to linaclotide, and if so, (c) whether antibodies specific for linaclotide could have any therapeutic or safety implications. In addition, we and Allergan established a nonclinical and clinical post-marketing plan with the FDA to understand the efficacy and safety of LINZESS in pediatric patients. The first step in this plan was to undertake certain additional nonclinical studies. We and Allergan have completed these nonclinical studies and have initiated two Phase II clinical pediatric studies in IBS-C patients age seven to 17 and functional constipation patients age six to 17. We and Allergan are also exploring development opportunities to enhance the clinical profile of LINZESS by seeking to expand its utility within IBS-C and CIC, as well as studying linaclotide in additional indications, populations and formulations to assess its potential to treat various GI conditions. In October 2012, we entered into a collaboration agreement with AstraZeneca to co-develop and co-commercialize linaclotide in China, Hong Kong and Macau, with AstraZeneca having primary responsibility for the local operational execution. We cannot currently estimate with any degree of certainty the amount of time or money that we will be required to expend in the future on linaclotide for other geographic markets within IBS-C and CIC, or in additional indications, populations or formulations.

 

In December 2015, the FDA approved ZURAMPIC for use in conjunction with a XOI for the treatment of hyperuricemia associated with uncontrolled gout.  In connection with the FDA approval, the FDA has required a post-marketing clinical study to further evaluate the renal and cardiovascular safety of ZURAMPIC, and has required that enrollment include patients with moderate renal impairment. We are obligated to reimburse AstraZeneca up to $100.0 million over up to ten years for the completion of the post-marketing requirement activities currently required by the FDA. Furthermore, we and AstraZeneca, on our behalf, are undertaking additional development activities related to lesinurad.

 

We are also advancing development programs targeting diseases such as rGERD and uncontrolled gout, as well as development programs within our vascular/fibrotic franchise targeting sGC.  Given the inherent uncertainties that come with the development of pharmaceutical products, we cannot estimate with any degree of certainty how our programs will evolve, and therefore the amount of time or money that would be required to obtain regulatory approval to market them.

 

As a result of these uncertainties surrounding the timing and outcome of any approvals, we are currently unable to estimate precisely when, if ever, linaclotide or lesinurad’s utility will be expanded within their currently approved indications; if or when linaclotide or lesinurad will be developed outside of their current markets, indications, populations or formulations; or when, if ever, any of our other product candidates will generate revenues and cash flows.

 

We invest carefully in our pipeline, and the commitment of funding for each subsequent stage of our development programs is dependent upon the receipt of clear, supportive data. In addition, we intend to access externally discovered drug candidates that fit within our core strategy. In evaluating these potential assets, we apply the same investment criteria as those used for investments in internally discovered assets.

 

The successful development of our product candidates is highly uncertain and subject to a number of risks including, but not limited to:

 

·                  The duration of clinical trials may vary substantially according to the type, complexity and novelty of the product candidate.

 

·                  The FDA and comparable agencies in foreign countries impose substantial and varying requirements on the introduction of therapeutic pharmaceutical products, typically requiring lengthy and detailed laboratory and clinical testing procedures, sampling activities and other costly and time-consuming procedures.

 

·                  Data obtained from nonclinical and clinical activities at any step in the testing process may be adverse and lead to discontinuation or redirection of development activity. Data obtained from these activities also are susceptible to varying interpretations, which could delay, limit or prevent regulatory approval.

 

·                  The duration and cost of discovery, nonclinical studies and clinical trials may vary significantly over the life of a product candidate and are difficult to predict.

 

·                  The costs, timing and outcome of regulatory review of a product candidate may not be favorable, and, even if approved, a product may face post-approval development and regulatory requirements.

 

·                  There may be substantial costs, delays and difficulties in successfully integrating externally developed product candidates into our business operations.

 

·                  The emergence of competing technologies and products and other adverse market developments may negatively impact us.

 

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As a result of the factors discussed above, including the factors discussed under “Risk Factors” in Item 1A of this Quarterly Report on Form 10-Q, we are unable to determine the duration and costs to complete current or future nonclinical and clinical stages of our product candidates or when, or to what extent, we will generate revenues from the commercialization and sale of our product candidates. Development timelines, probability of success and development costs vary widely. We anticipate that we will make determinations as to which additional programs to pursue and how much funding to direct to each program on an ongoing basis in response to the data of each product candidate, the competitive landscape and ongoing assessments of such product candidate’s commercial potential. As a result of the regulatory approvals beginning in 2012, linaclotide has been generating sales in connection with commercial launches in the U.S. and a number of E.U. and other countries.

 

We expect our research and development costs will be substantial for the foreseeable future. We will continue to invest in linaclotide and lesinurad, including the investigation of ways to enhance the clinical profile within their currently approved indications, and the exploration of their potential utility in other indications, populations and formulations. We will also invest in our other product candidates as we advance them through nonclinical studies and clinical trials, in addition to funding full-time equivalents for research and development activities under our external collaboration and license agreements.

 

Selling, General and Administrative Expense.  Selling, general and administrative expense consists primarily of compensation, benefits and other employee-related expenses for personnel in our administrative, finance, legal, information technology, business development, commercial, sales, marketing, communications and human resource functions. Other costs include the legal costs of pursuing patent protection of our intellectual property, general and administrative related facility costs, insurance costs and professional fees for accounting and legal services. As we continue to invest in the commercialization of LINZESS and ZURAMPIC, we expect our selling, general and administrative expenses will be substantial for the foreseeable future. We charge all selling, general and administrative expenses to operations as incurred.

 

Under our AstraZeneca collaboration agreement for linaclotide, we are reimbursed for certain selling, general and administrative expenses and we net these reimbursements against our selling, general and administrative expenses as incurred. We include Allergan’s selling, general and administrative cost-sharing payments in the calculation of the net profits and net losses from the sale of LINZESS in the U.S. and present the net payment to or from Allergan as collaboration expense or collaborative arrangements revenue, respectively.

 

Amortization of Acquired Intangible Asset.  Amortization expense is based on the economic consumption of intangible assets. Our amortization is related to the ZURAMPIC intangible asset, which is amortized on a straight-line basis over the estimated useful life.

 

Other (Expense) Income.  Interest expense consists primarily of cash and non-cash interest costs related to our outstanding 11% PhaRMA Notes due 2024, or the PhaRMA Notes, and the 2022 Notes.  Non-cash interest expense consists of amortization of the debt discount and associated debt issuance costs associated with the PhaRMA Notes and 2022 Notes. We amortize these costs using the effective interest rate method over the life of the respective note agreements as interest expense in our statements of operations.

 

Interest income consists of interest earned on our cash, cash equivalents and marketable securities.

 

In June 2015, in connection with the issuance of the 2022 Notes, we entered into convertible note hedge transactions, or the Convertible Note Hedges. Concurrently with entering into the Convertible Note Hedges, we also entered into certain warrant transactions in which we sold note hedge warrants, or the Note Hedge Warrants, to the Convertible Note Hedge counterparties to acquire 20,249,665 shares of our Class A common stock, subject to customary anti-dilution adjustments. Gain (loss) on derivatives consists of the change in fair value of the Convertible Note Hedges and Note Hedge Warrants, which are recorded as derivative assets and liabilities. The Convertible Note Hedges and the Note Hedge Warrants are recorded at fair value at each reporting period and changes in fair value are recorded in our condensed consolidated statements of operations.

 

Critical Accounting Policies and Estimates

 

Our discussion and analysis of our financial condition and results of operations is based upon our condensed consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make certain estimates and assumptions that may affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, and the amounts of revenues and expenses during the reported periods. Significant estimates and assumptions in our condensed consolidated financial statements include those related to revenue recognition, available-for-sale securities, inventory valuation, and related reserves; impairment of long-lived assets; initial valuation procedures for the issuance of convertible notes; fair value of derivatives; balance sheet classification of notes payable and convertible notes; income taxes, including the valuation allowance for deferred tax assets; research and development expenses; goodwill; contingent consideration; acquired intangible assets; contingencies and share-based compensation. We base our estimates on our historical experience and on various other assumptions that are believed to be reasonable,

 

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the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ materially from our estimates under different assumptions or conditions. Changes in estimates are reflected in reported results in the period in which they become known.

 

During the three months ended June 30, 2016, we adopted the following significant accounting policies:

 

Business Combinations

 

We evaluate acquisitions of assets and other similar transactions to assess whether or not the transaction should be accounted for as a business combination by assessing whether or not we have acquired inputs and processes that have the ability to create outputs. If determined to be a business combination, we account for business acquisitions under the acquisition method of accounting as indicated in the Financial Accounting Standards Board, or FASB, issued ASC 805, which requires the acquiring entity in a business combination to recognize the fair value of all assets acquired, liabilities assumed, and any non-controlling interest in the acquiree and establishes the acquisition date as the fair value measurement point. Accordingly, we recognize assets acquired and liabilities assumed in business combinations, including contingent assets and liabilities, and non-controlling interest in the acquiree based on the fair value estimates as of the date of acquisition. In accordance with ASC 805, we recognize and measure goodwill as of the acquisition date, as the excess of the fair value of the consideration paid over the fair value of the identified net assets acquired.

 

The consideration for our business acquisitions include future payments that are contingent upon the occurrence of a particular event or events. The obligations for such contingent consideration payments are recorded at fair value on the acquisition date. The contingent consideration obligations are then evaluated each reporting period. Changes in the fair value of contingent consideration obligations, other than changes due to payments, are recognized as a (gain) loss on fair value remeasurement of contingent consideration in the condensed consolidated statements of operations.

 

Finite-Lived and Indefinite-Lived Intangible Assets

 

We record the fair value of purchased intangible assets with definite useful lives as of the transaction date of a business combination. Purchased intangible assets with definite useful lives are amortized to their estimated residual values over their estimated useful lives.  We evaluate the finite-lived intangible assets for impairment whenever events or changes in circumstances indicate the reduction in the fair value below their respective carrying amounts. If we determine that an impairment has occurred, a write-down of the carrying value and an impairment charge to operating expenses in the period the determination is made is recorded. In addition, we would also reassess the remaining estimated useful life of the finite-lived intangible asset.

 

In accordance with ASC Topic 350, “Intangibles — Goodwill and Other”, ASC 350, during the period that an asset is considered indefinite-lived, such as in-process research and development, or IPR&D, it will not be amortized. Acquired IPR&D represents the fair value assigned to research and development assets that have not reached technological feasibility. The value assigned to acquired IPR&D is determined by estimating the costs to develop the acquired technology into commercially viable products, estimating the resulting revenue from the projects, and discounting the net cash flows to present value. The revenue and costs projections used to value acquired IPR&D are, as applicable, reduced based on the probability of success of developing a new drug. Additionally, the projections consider the relevant market sizes and growth factors, expected trends in technology, and the nature and expected timing of new product introductions by us and our competitors. The rates utilized to discount the net cash flows to their present value are commensurate with the stage of development of the projects and uncertainties in the economic estimates used in the projections. Upon the acquisition of IPR&D, we complete an assessment of whether our acquisition constitutes the purchase of a single asset or a group of assets. Multiple factors are considered in this assessment, including the nature of the technology acquired, the presence or absence of separate cash flows, the development process and stage of completion, quantitative significance and the rationale for entering into the transaction.  Indefinite-lived assets are maintained on our condensed consolidated balance sheet until either the project underlying it is completed or the asset becomes impaired.  Indefinite-lived asset are tested for impairment on an annual basis, or whenever events or changes in circumstances indicate the reduction in the fair value of the IPR&D asset below its respective carrying amount. If we determine that an impairment has occurred, a write-down of the carrying value and an impairment charge to operating expenses in the period the determination is made is recorded. When development of an IPR&D asset is complete, the associated asset would be deemed finite-lived and would then be amortized based on its respective estimated useful life at that point.

 

Goodwill

 

Goodwill represents the difference between the purchase price and the fair value of the identifiable tangible and intangible net assets when accounted for using the purchase method of accounting. Goodwill is not amortized, but is reviewed for impairment. We test goodwill for impairment annually, or whenever events or changes in circumstances indicate an impairment may have occurred, by comparing the carrying value to its implied fair value in accordance with ASC 350. Impairment may result from, among

 

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other things, deterioration in the performance of the acquired asset, adverse market conditions, adverse changes in applicable laws or regulations and a variety of other circumstances. If we determine that an impairment has occurred, a write-down of the carrying value and an impairment charge to operating expenses in the period the determination is made is recorded. In evaluating the carrying value of goodwill, we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the acquired assets. Changes in strategy or market conditions could significantly impact those judgments in the future and require an adjustment to the recorded balances.

 

Other than as set forth above, during the six months ended June 30, 2016, there were no material changes to our critical accounting policies as reported in our Annual Report on Form 10-K for the year ended December 31, 2015, which was filed with the Securities and Exchange Commission, or SEC, on February 19, 2016, or the 2015 Annual Report on Form 10-K.

 

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Results of Operations

 

The following discussion summarizes the key factors our management believes are necessary for an understanding of our condensed consolidated financial statements.

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2016

 

2015

 

2016

 

2015

 

 

 

(in thousands)

 

(in thousands)

 

Collaborative arrangements revenue:

 

$

54,350

 

$

27,744

 

$

120,392

 

$

56,676

 

Cost and expenses:

 

 

 

 

 

 

 

 

 

Cost of revenue, excluding amortization of acquired intangible asset

 

 

 

 

12

 

Write-down of inventory to net realizable value and loss on non-cancellable purchase commitments

 

 

8,150

 

 

8,150

 

Research and development

 

31,682

 

28,648

 

63,524

 

55,289

 

Selling, general and administrative

 

36,918

 

32,955

 

73,086

 

63,301

 

Amortization of acquired intangible asset

 

1,065

 

 

1,065

 

 

Total cost and expenses

 

69,665

 

69,753

 

137,675

 

126,752

 

Other (expense) income:

 

 

 

 

 

 

 

 

 

Interest expense

 

(9,827

)

(5,874

)

(19,734

)

(11,094

)

Interest and investment income

 

295

 

71

 

516

 

136

 

Gain (loss) on derivatives

 

3,145

 

(208

)

1,502

 

(208

)

Other expense, net

 

(6,387

)

(6,011

)

(17,716

)

(11,166

)

Net loss

 

$

(21,702

)

$

(48,020

)

$

(34,999

)

$

(81,242

)

 

Three and Six Months Ended June 30, 2016 Compared to Three and Six Months Ended June 30, 2015

 

Revenue

 

 

 

June 30,

 

Change

 

June 30,

 

Change

 

 

 

2016

 

2015

 

$

 

%

 

2016

 

2015

 

$

 

%

 

 

 

(dollars in thousands)

 

 

 

(dollars in thousands)

 

 

 

Collaborative arrangements revenue

 

$

54,350

 

$

27,744

 

$

26,606

 

96

%

$

120,392

 

$

56,676

 

$

63,716

 

112

%

 

Collaborative Arrangements Revenue. The increase in revenue from collaborative arrangements of approximately $26.6 million for the three months ended June 30, 2016 compared to the three months ended June 30, 2015 was primarily related to an approximately $24.1 million increase in our share of the net profits from the sale of LINZESS in the U.S.; an approximately $1.5 million increase in revenue from the shipment of linaclotide API to one of our collaboration partners; an approximately $0.5 million increase due to the achievement of a development milestone under our license agreement with Astellas in February 2016; an approximately $0.5 million increase due to revenues from our co-promotion agreement with Allergan for VIBERZI in the U.S.; an approximately $0.2 million increase due to revenues from our co-promotion agreement with Exact Sciences for Cologuard in the U.S.; and an insignificant increase in royalty revenue based on sales of linaclotide in our partnered territories. The increases were partially offset by an approximately $0.3 million decrease in revenue recognized in connection with our collaboration agreement with AstraZeneca for linaclotide.

 

The increase in revenue from collaborative arrangements of approximately $63.7 million for the six months ended June 30, 2016 compared to the six months ended June 30, 2015 was primarily related to an approximately $45.6 million increase in our share of the net profits from the sale of LINZESS in the U.S.; an approximately $13.4 million increase due to the achievement of a development milestone under our license agreement with Astellas in February 2016; an approximately $4.0 million increase in revenue from the shipment of linaclotide API to one of our collaboration partners; an approximately $1.0 million increase due to revenues from our co-promotion agreement with Allergan for VIBERZI in the U.S.; an approximately $0.9 million increase due to

 

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revenues from our co-promotion arrangement with Exact Sciences for Cologuard in the U.S., and an approximately $0.2 million increase in royalty revenue based on sales of linaclotide in our partnered territories.  The increases were partially offset by an approximately $1.4 million decrease in license revenue related to our collaboration agreement with AstraZeneca.

 

Cost and Expenses

 

 

 

Three Months Ended

 

 

 

 

 

Six Months Ended

 

 

 

 

 

 

 

June 30,

 

Change

 

June 30,

 

Change