United Therapeutics Corporation
UNITED THERAPEUTICS CORP (Form: 10-Q, Received: 08/02/2007 16:06:24)

 

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, 2007

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 0-26301

United Therapeutics Corporation

(Exact Name of Registrant as Specified in Its Charter)

Delaware

 

52-1984749

(State or Other Jurisdiction of

 

(I.R.S. Employer

Incorporation or Organization)

 

Identification No.)

 

 

 

1110 Spring Street, Silver Spring, MD

 

20910

(Address of Principal Executive Offices)

 

(Zip Code)

 

(301) 608-9292

(Registrant’s Telephone Number, Including Area Code)

(Former Name, Former Address and Former Fiscal Year, If Changed Since Last Report)

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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check One):

Large accelerated filer

 

x

 

Accelerated filer

 

o

 

Non-accelerated filer

 

o

 

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

The number of shares outstanding of the issuer’s common stock, par value $.01 per share, as of July 27, 2007 was 21,053,348.

 

 




INDEX

 

 

 

Page

 

Part I.

 

FINANCIAL INFORMATION (UNAUDITED)

 

 

 

 

 

Item 1.

 

Consolidated Financial Statements

 

 

1

 

 

 

 

Consolidated Balance Sheets

 

 

1

 

 

 

 

Consolidated Statements of Operations

 

 

2

 

 

 

 

Consolidated Statements of Cash Flows

 

 

3

 

 

 

 

Notes to Consolidated Financial Statements

 

 

4

 

 

Item 2.

 

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

 

 

13

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

 

30

 

 

Item 4.

 

Controls and Procedures

 

 

31

 

 

Part II.

 

OTHER INFORMATION

 

 

 

 

 

Item 1A.

 

Risk Factors

 

 

32

 

 

Item 4.

 

Submission of Matters to a Vote of Security Holders

 

 

49

 

 

Item 6.

 

Exhibits

 

 

50

 

 

SIGNATURES

 

 

51

 

 

 




PART I.    FINANCIAL INFORMATION

Item 1.                         Consolidated Financial Statements

UNITED THERAPEUTICS CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)

 

 

June 30,
2007

 

December 31,
2006

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

 

$

81,482

 

 

 

$

91,067

 

 

Marketable investments

 

 

116,886

 

 

 

136,682

 

 

Accounts receivable, net of allowance of none for 2007 and $1 for 2006

 

 

23,225

 

 

 

22,453

 

 

Inventories, net

 

 

12,796

 

 

 

12,047

 

 

Other receivable

 

 

3,048

 

 

 

1,581

 

 

Interest receivable

 

 

989

 

 

 

1,545

 

 

Due from affiliate

 

 

91

 

 

 

66

 

 

Prepaid expenses

 

 

5,627

 

 

 

9,242

 

 

Deferred tax assets

 

 

2,691

 

 

 

2,691

 

 

Total current assets

 

 

246,835

 

 

 

277,374

 

 

Marketable investments

 

 

43,445

 

 

 

36,414

 

 

Marketable investments and cash—restricted

 

 

38,459

 

 

 

38,988

 

 

Goodwill, net

 

 

7,465

 

 

 

7,465

 

 

Other intangible assets, net

 

 

2,829

 

 

 

3,140

 

 

Property, plant, and equipment, net

 

 

45,872

 

 

 

34,681

 

 

Investments in affiliates

 

 

5,164

 

 

 

4,700

 

 

Notes receivable from affiliate and employee

 

 

39

 

 

 

27

 

 

Deferred tax assets

 

 

72,871

 

 

 

65,308

 

 

Other assets

 

 

8,815

 

 

 

8,874

 

 

Total assets

 

 

$

471,794

 

 

 

$

476,971

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

Accounts payable

 

 

$

5,096

 

 

 

$

2,843

 

 

Accounts payable to affiliates and related parties

 

 

 

 

 

250

 

 

Accrued expenses

 

 

17,696

 

 

 

15,265

 

 

Current portion of notes and leases payable

 

 

12

 

 

 

10

 

 

Other current liabilities

 

 

504

 

 

 

882

 

 

Total current liabilities

 

 

23,308

 

 

 

19,250

 

 

Notes and leases payable, excluding current portion

 

 

250,008

 

 

 

250,015

 

 

Other liabilities

 

 

8,595

 

 

 

3,100

 

 

Total liabilities

 

 

281,911

 

 

 

272,365

 

 

Commitments and contingencies:

 

 

 

 

 

 

 

 

 

Common stock subject to repurchase

 

 

10,882

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

 

 

 

 

Preferred stock, par value $.01, 10,000,000 shares authorized, no shares issued

 

 

 

 

 

 

 

Series A junior participating preferred stock, par value $.01, 100,000,000 authorized, no shares issued

 

 

 

 

 

 

 

Common stock, par value $.01, 100,000,000 shares authorized, 25,360,900 and 24,632,153 shares issued at June 30, 2007 and December 31, 2006, respectively, and 20,979,303 and 21,475,078 outstanding at June 30, 2007 and December 31, 2006, respectively

 

 

254

 

 

 

246

 

 

Additional paid-in capital

 

 

444,905

 

 

 

408,804

 

 

Accumulated other comprehensive income

 

 

3,796

 

 

 

1,476

 

 

Treasury stock at cost, 4,381,597 and 3,157,075 shares at June 30, 2007 and December 31, 2006, respectively

 

 

(231,619

)

 

 

(164,560

)

 

Accumulated deficit

 

 

(38,335

)

 

 

(41,360

)

 

Total stockholders’ equity

 

 

179,001

 

 

 

204,606

 

 

Total liabilities and stockholders’ equity

 

 

$

471,794

 

 

 

$

476,971

 

 

 

See accompanying notes to consolidated financial statements.

1




UNITED THERAPEUTICS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

(Unaudited)

 

(Unaudited)

 

Revenues:

 

 

 

 

 

 

 

 

 

Net product sales

 

$

49,381

 

$

38,750

 

$

87,788

 

$

70,370

 

Service sales

 

1,783

 

1,495

 

3,545

 

3,039

 

Distributor fees

 

667

 

 

667

 

 

Total revenues

 

51,831

 

40,245

 

92,000

 

73,409

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

17,970

 

12,614

 

35,071

 

27,314

 

Research and development expense related to issuance of stock

 

 

 

11,013

 

 

Selling, general and administrative

 

20,474

 

11,871

 

35,638

 

21,950

 

Impairment of HeartBar ®    tradename

 

 

 

 

2,024

 

Cost of product sales

 

4,791

 

3,745

 

8,606

 

7,091

 

Cost of service sales

 

551

 

499

 

1,132

 

1,030

 

Total operating expenses

 

43,786

 

28,729

 

91,460

 

59,409

 

Income from operations

 

8,045

 

11,516

 

540

 

14,000

 

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest income

 

1,938

 

2,485

 

5,983

 

4,383

 

Interest expense

 

(713

)

(1

)

(1,424

)

(1

)

Equity loss in affiliate

 

(79

)

(171

)

(193

)

(378

)

Other, net

 

(279

)

5

 

(220

)

15

 

Total other income, net

 

867

 

2,318

 

4,146

 

4,019

 

Income before income tax

 

8,912

 

13,834

 

4,686

 

18,019

 

Income tax expense

 

(3,106

)

(6,161

)

(1,661

)

(8,039

)

Net income

 

$

5,806

 

$

7,673

 

$

3,025

 

$

9,980

 

Net income per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.28

 

$

0.33

 

$

0.14

 

$

0.42

 

Diluted

 

$

0.26

 

$

0.30

 

$

0.14

 

$

0.39

 

Weighted average number of common shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

20,837

 

23,591

 

21,069

 

23,483

 

Diluted

 

22,020

 

25,344

 

22,219

 

25,577

 

 

See accompanying notes to consolidated financial statements.

2




UNITED THERAPEUTICS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

 

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

 

 

(Unaudited)

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

3,025

 

$

9,980

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

1,621

 

1,220

 

Provision for bad debt and inventory obsolescence

 

853

 

286

 

Deferred tax expense

 

1,661

 

7,423

 

Loss on disposals of equipment

 

595

 

57

 

Options issued in exchange for services

 

14,170

 

8,737

 

Write down of intangible asset

 

 

2,024

 

Amortization of deferred offering costs

 

798

 

 

Amortization of discount or premium on investments

 

(1,990

)

(181

)

Equity loss in affiliate and unrealized foreign translation loss

 

402

 

206

 

Excess tax benefits from stock-based compensation

 

(6,009

)

378

 

Issuance of stock for license

 

11,013

 

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(822

)

(3,778

)

Interest receivable

 

555

 

(153

)

Inventories

 

(1,832

)

151

 

Prepaid expenses

 

3,821

 

1,118

 

Other assets

 

(2,437

)

444

 

Accounts payable

 

2,018

 

434

 

Accrued expenses

 

2,447

 

5,590

 

Other liabilities

 

3,448

 

3,424

 

Net cash provided by operating activities

 

33,337

 

37,360

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of property, plant and equipment

 

(12,844

)

(8,960

)

Purchases of held-to-maturity investments

 

(96,096

)

(20,850

)

Purchases of available-for-sale investments

 

(42,650

)

(20,600

)

Sales of available-for-sale investments

 

56,650

 

8,200

 

Maturities of held-to-maturity investments

 

99,507

 

1,000

 

Net cash provided (used) by investing activities

 

4,567

 

(41,210

)

Cash flows from financing activities:

 

 

 

 

 

Payments to repurchase common stock

 

(67,059

)

 

Proceeds from the exercise of stock options

 

13,565

 

5,804

 

Excess tax benefits from stock-based compensation

 

6,009

 

197

 

Principal payments on notes payable and capital lease obligations

 

(4

)

(9

)

Net cash provided (used) by financing activities

 

(47,489

)

5,992

 

Net increase (decrease) in cash and cash equivalents

 

(9,585

)

2,142

 

Cash and cash equivalents, beginning of period

 

91,067

 

69,180

 

Cash and cash equivalents, end of period

 

$

81,482

 

$

71,322

 

Supplemental schedule of cash flow information:

 

 

 

 

 

Cash paid for interest

 

$

580

 

$

1

 

Cash paid for income taxes

 

$

1,036

 

$

138

 

 

See accompanying notes to consolidated financial statements.

3




UNITED THERAPEUTICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2007
(UNAUDITED)

1.                  ORGANIZATION AND BUSINESS DESCRIPTION

United Therapeutics Corporation (United Therapeutics) is a biotechnology company focused on the development and commercialization of innovative therapeutic products for patients with chronic and life-threatening cardiovascular, cancer and infectious diseases. We were incorporated on June 26, 1996, under the laws of the State of Delaware and we have the following wholly-owned subsidiaries: Lung Rx, Inc. (Lung Rx), Unither Pharmaceuticals, Inc. (UPI), Unither Telmed, Ltd. (Unither Telmed and formerly Unither Telemedicine Services Corporation), Unither.com, Inc., United Therapeutics Europe, Ltd., Unither Pharma, Inc., Medicomp, Inc., Unither Nutriceuticals, Inc., Lung Rx, Ltd. and Unither Biotech Inc.

Our lead product is Remodulin ®  (treprostinil sodium). Remodulin was first approved for use on May 21, 2002, by the United States Food and Drug Administration (FDA) as a continuous subcutaneous infusion for the treatment of pulmonary arterial hypertension (PAH) in patients with NYHA class II-IV symptoms to diminish symptoms associated with exercise. On November 24, 2004, the FDA approved intravenous infusion of Remodulin, based on data establishing intravenous bioequivalence with subcutaneous Remodulin, for patients who are not able to tolerate a subcutaneous infusion. On March 21, 2006, the FDA expanded its approval of Remodulin to include patients requiring transition from Flolan ® , the only other FDA-approved intravenous prostacyclin. In addition to the United States, Remodulin is approved for subcutaneous infusion in most of Europe, Canada, Israel, Australia and several countries in South America. It is approved for intravenous infusion in Canada, Israel, Mexico, Switzerland, Argentina and Peru. Other international applications for the approval of Remodulin are pending.

We have generated pharmaceutical revenues from sales of Remodulin and arginine products in the United States, Canada, Europe, South America and Asia. In addition, we have generated non-pharmaceutical revenues from telemedicine products and services in the United States.

2.                  BASIS OF PRESENTATION

The consolidated financial statements included herein have been prepared, without audit, pursuant to Regulation S-X of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. These consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2006, as filed with the Securities and Exchange Commission.

In the opinion of our management, any adjustments contained in the accompanying unaudited consolidated financial statements are of a normal recurring nature, necessary to present fairly the financial position as of June 30, 2007, and results of operations and cash flows for the six-month periods ended June 30, 2007 and 2006, respectively. Interim results are not necessarily indicative of results for an entire year.

4




3.                  INVENTORIES

We manufacture certain chemical compounds, such as treprostinil-based compounds. We also purchase medical supplies for use in our ongoing clinical trials. We subcontract the manufacture of cardiac monitoring equipment. We contract with a third party manufacturers to make arginine products, to formulate Remodulin and to formulate clinical trial materials for our inhaled and oral treprostinil clinical trials. Clinical trial materials are expensed as research and development expense as they are used. These inventories are accounted for under the first-in, first-out method and are carried at the lower of cost or market. Inventories consisted of the following, net of reserves of approximately $454,000 and $440,000 at June 30, 2007 and December 31, 2006, respectively (in thousands):

 

 

June 30,
2007

 

December 31,
2006

 

Remodulin:

 

 

 

 

 

 

 

Raw materials

 

$

2,411

 

 

$

149

 

 

Work-in-progress

 

5,758

 

 

7,807

 

 

Finished goods

 

3,929

 

 

3,355

 

 

Remodulin delivery pumps and other medical supplies

 

473

 

 

661

 

 

Cardiac monitoring equipment components

 

91

 

 

38

 

 

Arginine products

 

134

 

 

37

 

 

Total inventories

 

$

12,796

 

 

$

12,047

 

 

 

4.                  GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill and other intangible assets were comprised as follows (in thousands):

 

 

As of June 30, 2007

 

As of December 31, 2006

 

 

 

Gross

 

Accumulated
Amortization

 

Net

 

Gross

 

Accumulated
Amortization

 

Net

 

Goodwill

 

$

7,465

 

 

$

 

 

$

7,465

 

$

7,465

 

 

$

 

 

$

7,465

 

 

Intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Technology and patents

 

$

6,164

 

 

$

(3,335

)

 

$

2,829

 

$

6,164

 

 

$

(3,024

)

 

$

3,140

 

 

 

The HeartBar product was discontinued in January 2006 and is no longer sold. As a result, an impairment related to the HeartBar product tradename totaling approximately $2.0 million was recorded during January 2006.

Total amortization expense for the three-month periods ended June 30, 2007 and 2006, was approximately $155,000 and $81,000, respectively. The total amortization expense for the six-month periods ended June 30, 2007 and 2006, was approximately $310,000 and $162,000, respectively. The aggregate amortization expense related to these intangible assets for each of the five succeeding years is estimated as follows (in thousands):

Years ending December 31,

 

 

 

 

 

2007

 

$

620

 

2008

 

620

 

2009

 

620

 

2010

 

620

 

2011

 

620

 

 

5




5.                  SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN

In May 2006, the Compensation Committee of our Board of Directors approved the United Therapeutics Corporation Supplemental Executive Retirement Plan (the SERP). The SERP is administered by the Compensation Committee. Only a member of a “select group of management or highly compensated employees” within the meaning of section 201(2) of the Employee Retirement Income Security Act may be eligible to participate in the SERP. During the quarter ending March 31, 2007, a normal revaluation of the SERP was performed after 2007 salary levels for the SERP participants were finalized. The revaluation process included updating any assumptions and inputs for the actuarial calculations used to determine the SERP benefits. During the revaluation process, the discount rate changed to 5.7%, down 0.5% from the 2006 rate of 6.2%. Pension expense for each of the three and six-month periods ending June 30, 2007 and 2006, respectively is as follows (in thousands):

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

   2007   

 

   2006   

 

   2007   

 

   2006   

 

Service cost

 

 

$

612

 

 

 

$

358

 

 

 

$

1,224

 

 

 

$

358

 

 

Interest cost

 

 

37

 

 

 

 

 

 

74

 

 

 

 

 

Amortization of prior period service costs

 

 

15

 

 

 

 

 

 

30

 

 

 

 

 

Net pension expense

 

 

$

664

 

 

 

$

358

 

 

 

$

1,328

 

 

 

$

358

 

 

 

In accordance with SFAS 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans , we recorded as part of the projected benefit obligation the unfunded actuarial loss and unamortized prior period service costs. These amounts are recorded net of tax in other comprehensive income (loss). See footnote No. 8 Comprehensive Income for the details.

The reconciliation of the beginning and ending balances in benefit obligations of the SERP is as follows (in thousands):

 

 

Six Months Ended
June 30, 2007

 

Projected benefit obligation at December 31, 2006

 

 

$

1,572

 

 

Service cost

 

 

1,224

 

 

Interest cost

 

 

74

 

 

Amortization of prior period service costs

 

 

30

 

 

Actuarial loss

 

 

254

 

 

Prior period service costs

 

 

743

 

 

Projected benefit obligation at June 30, 2007

 

 

$

3,897

 

 

 

6.                  STOCKHOLDERS’ EQUITY

Earnings per Common Share

Basic earnings per common share are computed by dividing net income by the weighted average number of shares of common stock outstanding during the respective period. Diluted earnings per common share are computed by dividing net income by the weighted average number of shares of common stock outstanding during the period plus the number of shares issuable upon the exercise of outstanding stock options and warrants using the treasury stock method.

6




At June 30, 2007, the components of basic and dilutive earnings per share were as follows (in thousands, except per share amounts):

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Net income (numerator)

 

$

5,806

 

$

7,673

 

$

3,025

 

$

9,980

 

Shares (denominator):

 

 

 

 

 

 

 

 

 

Weighted average outstanding shares for basic EPS

 

20,837

 

23,591

 

21,069

 

23,483

 

0.50% Senior Convertible Note

 

 

 

 

 

Dilutive effect of stock options

 

1,183

 

1,753

 

1,150

 

2,094

 

Adjusted weighted average shares for diluted EPS

 

22,020

 

25,344

 

22,219

 

25,577

 

Earnings per share

 

 

 

 

 

 

 

 

 

Basic

 

$

0.28

 

$

0.33

 

$

0.14

 

$

0.42

 

Diluted

 

$

0.26

 

$

0.30

 

$

0.14

 

$

0.39

 

Stock options and warrants excluded from calculation

 

4,381

 

1,154

 

4,378

 

1,094

 

 

Certain stock options and warrants were not included in the computation of earnings per share because the exercise prices of these options and warrants were greater than the average market price of our common stock during these periods; therefore their effect was antidilutive.

Stock Option Plan

Effective January 1, 2006, we adopted the provisions of FASB Statement No. 123 (revised 2004), Share-Based Payment , (SFAS 123(R)) and interpretative literature within SEC Staff Accounting Bulletin No. 107, Share-Based Payment , (SAB 107). We utilize the Black-Scholes-Merton valuation model for estimating the fair value of stock options granted. Option valuation models, including Black-Scholes-Merton, require the input of highly subjective assumptions. Changes in the assumptions used can materially affect the grant date fair value of an award. These assumptions include the risk-free rate of interest, expected dividend yield, expected volatility, and the expected life of the award.

The following are the weighted-average assumptions used in valuing the stock options granted to employees during the three and six-month periods ended June 30, 2007 and 2006:

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Expected volatility

 

39.25%

 

42.67%

 

39.96%

 

43.49%

 

Risk-free interest rate

 

4.9%

 

5.1%

 

4.6%

 

5.0%

 

Expected term of options

 

5.7 years

 

5.8 years

 

5.9 years

 

5.8 years

 

Expected dividend yield

 

0.0%

 

0.0%

 

0.0%

 

0.0%

 

Forfeiture rate

 

3.3%

 

11.7%

 

6.4%

 

11.7%

 

 

7




A summary of the status of our employee stock options as of June 30, 2007, and changes during the six months then ended, is presented below:

All Employee Options

 

 

 

Number of
Shares

 

Weighted
Average
Exercise
Price

 

Weighted Average
Remaining
Contractual
Term

 

Aggregate
Intrinsic
Value
($ in 000s)

 

Outstanding at January 1, 2007

 

5,503,765

 

 

$

43.83

 

 

 

 

 

 

 

 

Granted

 

762,112

 

 

56.98

 

 

 

 

 

 

 

 

Exercised

 

(520,747

)

 

25.58

 

 

 

 

 

 

 

 

Forfeited

 

(111,375

)

 

55.41

 

 

 

 

 

 

 

 

Outstanding at June 30, 2007

 

5,633,755

 

 

$

47.07

 

 

 

7.1

 

 

$

265,166

 

Expected to vest at June 30, 2007

 

1,858,152

 

 

$

57.83

 

 

 

9.1

 

 

$

107,465

 

Exercisable at June 30, 2007

 

3,603,875

 

 

$

41.00

 

 

 

6.0

 

 

$

147,769

 

 

The weighted-average grant-date fair value of options granted during the six months ended June 30, 2007 and 2006, was $26.19 and $27.31, respectively.

Total employee share-based compensation expense recognized for the three and six months ended June 30, 2007 and 2006, is as follows (in thousands):

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Cost of service sales

 

$

33

 

$

29

 

$

65

 

$

57

 

Research and development

 

2,658

 

1,430

 

4,797

 

3,054

 

Selling, general and administrative

 

5,700

 

2,045

 

8,523

 

4,186

 

Share-based compensation expense before taxes

 

8,391

 

3,504

 

13,385

 

7,297

 

Related income tax benefits

 

(2,975

)

(1,554

)

(4,746

)

(3,236

)

Share-based compensation expense, net of taxes

 

$

5,416

 

$

1,950

 

$

8,639

 

$

4,061

 

Share-based compensation capitalized as part of inventory

 

$

 

$

133

 

$

29

 

$

291

 

 

A summary of option exercises under all share-based payment is as follows (dollars in thousands):

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Number of options exercised

 

234,544

 

130,063

 

528,747

 

330,843

 

Cash received

 

$

5,594

 

$

2,312

 

$

13,565

 

$

5,804

 

 

Stock Repurchases

On October 17, 2006, our Board of Directors approved a stock repurchase program to repurchase up to 4.0 million shares of our common stock over a two-year period. As of December 31, 2006, a total of approximately 1.9 million shares had been repurchased under the stock repurchase program at a cost of approximately $115.5 million. Approximately 1.2 million shares of our common stock were repurchased at cost of approximately $67.1 million during the six months ended June 30, 2007. No shares of our common stock were repurchased during the three months ended June 30, 2007. As of June 30, 2007, 911,669 shares remained eligible for repurchase under this program.

8




7.                  NOTES PAYABLE

Convertible Senior Notes

On October 30, 2006, we issued $250.0 million of 0.50% Convertible Senior Notes due October 2011 (the Convertible Senior Notes). In connection with the issuance of the Convertible Senior Notes, we also entered into a call spread option. The Convertible Senior Notes were issued at par value and pay interest in cash semi-annually in arrears on April 15 and October 15 of each year, beginning on April 15, 2007. The Convertible Senior Notes are unsecured unsubordinated obligations and rank equally with all other unsecured and unsubordinated indebtedness. The Convertible Senior Notes have an initial conversion price of $75.2257 per share. The Convertible Senior Notes may only be converted: (i) anytime after July 15, 2011; (ii) during any calendar quarter commencing after the date of original issuance of the notes, if the closing sale price of our common stock for at least 20 trading days in the period of 30 consecutive trading days ending on the last trading day of the calendar quarter preceding the quarter in which the conversion occurs is more than 120% of the conversion price of the notes in effect on that last trading day; (iii) during the ten consecutive trading-day period following any five consecutive trading-day period in which the trading price for the notes for each such trading day was less than 95% of the closing sale price of our common stock on such date multiplied by the then current conversion rate; or (iv) if specified significant distributions to holders of our common stock are made, specified corporate transactions occur, or our common stock ceases to be approved for listing on The NASDAQ Global Select Market and is not listed for trading on another U.S. national or regional securities exchange. Upon conversion, a holder will receive: (i) cash equal to the lesser of the principal amount of the note or the conversion value; and (ii) to the extent the conversion value exceeds the principal amount of the note, shares of our common stock. In addition, upon a change in control, as defined in the indenture under which the Convertible Senior Notes have been issued, the holders may require us to purchase all or a portion of their Convertible Senior Notes for 100% of the principal amount plus accrued and unpaid interest, if any, plus a number of additional shares of our common stock. As of June 30, 2007, the fair value of the $250.0 million Convertible Senior Notes outstanding was approximately $257.5 million, based on the quoted market price.

8.                  COMPREHENSIVE INCOME

SFAS No. 130, Reporting Comprehensive Income, establishes standards for the reporting and display of comprehensive income and its components. SFAS No. 130 requires, among other things, that unrealized gains and losses on available-for-sale securities, certain unrecognized and unfunded pension costs and foreign currency translation adjustments be included in other comprehensive income (loss). The following statement presents comprehensive income for the three and six-month periods ended June 30, 2007 and 2006, respectively (in thousands):

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

   2007   

 

   2006   

 

   2007   

 

   2006   

 

Net income

 

 

$

5,806

 

 

 

$

7,673

 

 

 

$

3,025

 

 

 

$

9,980

 

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation gain adjustment

 

 

161

 

 

 

206

 

 

 

176

 

 

 

210

 

 

Unrecognized prior period pension service cost, net of tax

 

 

10

 

 

 

 

 

 

(474

)

 

 

 

 

Unrecognized actuarial pension loss, net of tax

 

 

 

 

 

 

 

 

(167

)

 

 

 

 

Unrealized gain (loss) on available-for-sale securities

 

 

2,444

 

 

 

(576

)

 

 

2,785

 

 

 

(914

)

 

Comprehensive income

 

 

$

8,421

 

 

 

$

7,303

 

 

 

$

5,345

 

 

 

$

9,276

 

 

 

9




9.                  INCOME TAXES

The income tax provision for the three and six-month periods ended June 30, 2007 and 2006, respectively, is based on the estimated annual effective tax rate for the entire year. The estimated effective tax rate is subject to adjustment in subsequent quarterly periods as the estimates of pretax income and of permanent book to tax return differences for the year are increased or decreased. The effective tax rate for the three and six-month periods ended June 30, 2007 and 2006, were approximately 35 percent and 44 percent, respectively. The effective tax rate for the six months ended June 30, 2006, does not include the effect of legislation to retroactively reinstate federal tax credits for qualified research expenditures which was enacted in October 2006. The cumulative effect of the legislation was recorded in the fourth quarter 2006.

As of June 30, 2007, we had available for federal income tax purposes approximately $38.5 million in net operating loss carryforwards and approximately $50.3 million in business tax credit carryforwards. These carryforwards expire at various dates through 2024. We have conducted a study to determine whether any limitations under Section 382 of the Internal Revenue Code had been triggered through December 31, 2006. Results of this study indicate that multiple limitations were triggered through November 2004. As a result, portions of our carryforwards that were generated prior to November 2004 will be subject to annual limitations on their use. We do not believe that these potential limitations will cause our net operating loss and general business credit carryforwards to expire unused.

In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement 109 (FIN 48). This statement clarifies the criteria that an individual tax position must satisfy for some or all of the benefits of that position to be recognized in a company’s financial statements. FIN 48 prescribes a recognition threshold of more-likely-than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those tax positions to be recognized in the financial statements. Effective January 1, 2007, we adopted the provisions of FIN 48 and there was no material effect on our financial statements. As a result, there was no cumulative effect related to adopting FIN 48.

We file income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. All of our U.S. federal tax returns remain open for examination since we have not utilized any of our business credits. State filings that remain subject to examination range from 2001 to 2005. We do not believe there will be any material changes in our unrecognized tax positions over the next twelve months.

Our policy is that we recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. As of the date of adoption of FIN 48, we did not have any accrued interest or penalties associated with any unrecognized tax benefits, nor was any interest expense recognized during the quarter.

10.           LICENSE AGREEMENT

In March 2007, Lung Rx entered into an agreement with Toray Industries, Inc. (Toray) to assume and amend the rights and obligations of the agreement entered into between Toray and us in June 2000 concerning the commercialization of modified release formulations of beraprost (beraprost-MR). Under our original agreement with Toray, we had exclusive North American rights to commercialize beraprost-MR in the United States for all cardiovascular diseases. The amended agreement grants us additional exclusive rights to commercialize beraprost-MR in Europe and broadens the indication to vascular disease (excluding renal disease), among other revisions. An earlier clinical trial which examined an immediate release form of beraprost as monotherapy in PAH demonstrated efficacy at 12 weeks but not at 36 weeks. However, because a number of patients did respond positively to the drug, we feel that the development of beraprost-MR as part of a combination therapy with other drugs that feature complementary mechanisms of action presents a desirable clinical opportunity. Since individual PAH patients may respond to the same

10




class of molecules in different ways, we believe that the development of other molecules within the same family is desirable. In addition, we are in the early stages of exploring the development of beraprost-MR for the treatment of other cardiovascular and cardiopulmonary conditions.

In accordance with the terms of the amended agreement, in March 2007 we issued 200,000 shares of our common stock to Toray in exchange for the cancellation of Toray’s existing right to receive an option grant to purchase 500,000 shares of our common stock (the Option Grant). Under the June 2000 Agreement, Toray’s right to receive the Option Grant was conditioned on Toray’s delivery to us of adequate documentation regarding the use of beraprost-MR in humans and its transfer of clinical trial material to us, neither of which has yet to occur. Had the Option Grant been made, the exercise price of the options would have been set at the average closing price of our common stock for the period one month prior to the delivery date. Under the terms of the amended agreement, Toray has the right to request that we repurchase the newly-issued 200,000 shares of our common stock upon 30 days prior written notice at the price of $54.41 per share, which was the average closing price of our common stock between January 11, 2007, and February 23, 2007. Based on the average closing price of our common stock for the two trading days prior to and the two trading days after March 16, 2007, we recognized a research and development expense of approximately $11.0 million in March relating to the issuance of the 200,000 shares, because beraprost-MR had not yet obtained regulatory approval for commercial sales. In accordance with the provision of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities , EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock , and EITF Topic No. D-98, Classification and Measurement of Redeemable Securities , these shares of common stock are reflected in mezzanine equity as common stock subject to repurchase valued at the repurchase price. If Toray requests that we repurchase these shares, then an amount equal to the repurchase price will be transferred to a liability account until the repurchase is completed.

The amended agreement also specifies that we make certain milestone payments to Toray during the development period and upon U.S. or European Union regulatory approval. Upon execution of the amended agreement, we made a $3.0 million payment to Toray in addition to the issuance of the 200,000 shares of our common stock discussed above. Additional annual milestone payments of $2.0 million are specified in the amended agreement and are to commence in 2008, increasing annually by $1.0 million through 2011. These payments will be expensed when incurred. These payments are contingent upon the receipt of clinical trial material and commercial drug from Toray that meet all regulatory standards and requirements, including those relating to chemistry, manufacturing and controls, and are documented to the satisfaction of U.S. and European Union regulatory authorities. In addition, if Toray elects to terminate production of beraprost-MR, no further payments would be due under the amended agreement. Conversely, if we elect to terminate development of beraprost-MR, then all remaining milestone payments would be due to Toray, unless certain regulatory standards and requirements have not been met, or if material problems have been identified with respect to manufacturing and regulatory compliance.

11.           DISTRIBUTION AGREEMENT

On March 27, 2007, we entered into an exclusive agreement with Mochida Pharmaceutical Co., Ltd. (Mochida), to distribute subcutaneous and intravenous Remodulin in Japan. Mochida will be responsible, with our assistance, for obtaining Japanese marketing authorization, including conducting necessary bridging studies. We will supply study drug at no charge to Mochida. Due to the bridging studies and required Japanese regulatory reviews, commercial activities in Japan are not expected to commence until 2010 or later. Upon receipt of marketing authorization and pricing approval, Mochida will purchase Remodulin from us at an agreed-upon transfer price. In addition, Mochida has agreed to make certain exclusive distribution rights payments to us. The first payment of $4.0 million was received in May 2007. Certain other distribution rights payments are due as follows: (1) upon Remodulin receiving orphan drug

11




status in Japan or February 1, 2008, whichever first occurs, $4.0 million; (2) upon filing a New Drug Application (NDA) in Japan, $2.0 million; and (3) upon marketing approval in Japan, $2.0 million. Payments for distribution rights received through the filing of the NDA will be recognized ratably over the estimated period of time from when the payment is due until marketing authorization is received.

12.           SEGMENT INFORMATION

We have two reportable business segments. The pharmaceutical segment includes all activities associated with the research, development, manufacture and commercialization of therapeutic products. The telemedicine segment includes all activities associated with the development and manufacture of patient monitoring products and the delivery of patient monitoring services. The telemedicine segment is managed separately because diagnostic services require different technology and marketing strategies than pharmaceutical products.

Segment information as of and for the three and six-month periods ended June 30, 2007 and 2006 was as follows (in thousands):

 

 

Three Months Ended June 30,

 

 

 

2007

 

2006

 

 

 

Pharmaceutical

 

Telemedicine

 

Consolidated
Totals

 

Pharmaceutical

 

Telemedicine

 

Consolidated
Totals

 

Revenues from external customers

 

 

$

49,992

 

 

 

$

1,839

 

 

 

$

51,831

 

 

 

$

38,682

 

 

 

$

1,563

 

 

 

$

40,245

 

 

Income (loss) before income tax

 

 

8,841

 

 

 

71

 

 

 

8,912

 

 

 

14,001

 

 

 

(167

)

 

 

13,834

 

 

Interest income

 

 

1,936

 

 

 

2

 

 

 

1,938

 

 

 

2,480

 

 

 

5

 

 

 

2,485

 

 

Interest expense

 

 

(713

)

 

 

 

 

 

(713

)

 

 

(1

)

 

 

 

 

 

(1

)

 

Depreciation and amortization

 

 

(702

)

 

 

(94

)

 

 

(796

)

 

 

(539

)

 

 

(113

)

 

 

(652

)

 

Equity loss in affiliate

 

 

(79

)

 

 

 

 

 

(79

)

 

 

(171

)

 

 

 

 

 

(171

)

 

Total investment in equity method investees

 

 

1,375

 

 

 

 

 

 

1,375

 

 

 

1,681

 

 

 

 

 

 

1,681

 

 

Expenditures for long-lived assets

 

 

(4,842

)

 

 

(11

)

 

 

(4,853

)

 

 

(7,802

)

 

 

(48

)

 

 

(7,850

)

 

Goodwill, net

 

 

1,287

 

 

 

6,178

 

 

 

7,465

 

 

 

1,287

 

 

 

6,178

 

 

 

7,465

 

 

Total assets

 

 

460,498

 

 

 

11,296

 

 

 

471,794

 

 

 

313,695

 

 

 

11,738

 

 

 

325,433

 

 

 

12




 

 

 

Six Months Ended June 30,

 

 

 

2007

 

2006

 

 

 

Pharmaceutical

 

Telemedicine

 

Consolidated
Totals

 

Pharmaceutical

 

Telemedicine

 

Consolidated
Totals

 

Revenues from external customers

 

 

$

88,275

 

 

 

$

3,725

 

 

 

$

92,000

 

 

 

$

70,097

 

 

 

$

3,312

 

 

 

$

73,409

 

 

Income (loss) before income tax

 

 

4,563

 

 

 

123

 

 

 

4,686

 

 

 

18,344

 

 

 

(325

)

 

 

18,019

 

 

Interest income

 

 

5,976

 

 

 

7

 

 

 

5,983

 

 

 

4,374

 

 

 

9

 

 

 

4,383

 

 

Interest expense

 

 

(1,424

)

 

 

 

 

 

(1,424

)

 

 

(1

)

 

 

 

 

 

(1

)

 

Depreciation and amortization

 

 

(1,438

)

 

 

(183

)

 

 

(1,621

)

 

 

(985

)

 

 

(235

)

 

 

(1,220

)

 

Equity loss in affiliate

 

 

(193

)

 

 

 

 

 

(193

)

 

 

(378

)

 

 

 

 

 

(378

)

 

Total investment in equity method investees

 

 

1,375

 

 

 

 

 

 

1,375

 

 

 

1,681

 

 

 

 

 

 

1,681

 

 

Expenditures for long-lived assets

 

 

(12,816

)

 

 

(28

)

 

 

(12,844

)

 

 

(8,650

)

 

 

(310

)

 

 

(8,960

)

 

Goodwill, net

 

 

1,287

 

 

 

6,178

 

 

 

7,465

 

 

 

1,287

 

 

 

6,178

 

 

 

7,465

 

 

Total assets

 

 

460,498

 

 

 

11,296

 

 

 

471,794

 

 

 

313,695

 

 

 

11,738

 

 

 

325,433

 

 

 

The segment information shown above equals, when combined, the consolidated totals. These consolidated totals equal the amounts reported in the consolidated financial statements without further reconciliation for those categories which are reported in the consolidated financial statements. There are no inter-segment transactions.

For the three-month periods ended June 30, 2007 and 2006, approximately 84 percent and 86 percent of our net revenues, respectively were earned from our three distributors located in the United States. For the six-month periods ended June 30, 2007 and 2006, approximately 83 percent and 84 percent of our net revenues, respectively, were earned from our distributors located in the United States.

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

The following discussion should be read in conjunction with the consolidated financial statements and related notes appearing in our Annual Report on Form 10-K for the year ended December 31, 2006. The following discussion contains forward-looking statements made pursuant to the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995 including the statements listed in the section entitled “ Part II, Item 1A—Risk Factors” below. These statements are based on our beliefs and expectations as to future outcomes and are subject to risks and uncertainties that could cause our results to differ materially from anticipated results. Factors that could cause or contribute to such differences include those discussed below and as described in our Annual Report on Form 10-K for the year ended December 31, 2006, in the section entitled “Part II, Item 1A—Risk Factors—Forward-Looking Statements” and the other cautionary statements, cautionary language and risk factors set forth in other reports and documents filed with the Securities and Exchange Commission. We undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise.

Overview

We are a biotechnology company focused on the development and commercialization of innovative therapeutic products for patients with chronic and life-threatening cardiovascular, cancer and infectious diseases. We commenced operations in June 1996 and, since our inception, have devoted substantially all of our resources to acquisitions and research and development programs.

13




United Therapeutics Products and Services

Our lead product is Remodulin ®  , a prostacyclin analog. Our prostacyclin analog acts as a stable synthetic form of prostacyclin, an important molecule produced by the body that has powerful effects on blood-vessel health and function. On May 21, 2002, the United States Food and Drug Administration (FDA) approved subcutaneous (injection under the skin) use of Remodulin (treprostinil sodium) for the treatment of PAH in patients with NYHA class II-IV symptoms to diminish symptoms associated with exercise. PAH is a life-threatening condition characterized by elevated blood pressures between the heart and lungs. In November 2004, the FDA approved intravenous (through a vein or artery) infusion of Remodulin for patients who are not able to tolerate subcutaneous infusion. This approval was based on data establishing the bioequivalence of intravenous Remodulin with subcutaneous Remodulin. In March 2006, the FDA expanded its approval of Remodulin to include patients requiring transition from Flolan ® .

Remodulin is approved for subcutaneous use in 33 countries throughout the world. The mutual recognition process to obtain approvals from European Union member countries for subcutaneous use of Remodulin was completed in August 2005, with positive decisions received from most European Union countries. We withdrew applications in Ireland, Spain and the United Kingdom. We anticipate resubmitting these applications following intravenous Remodulin approval in Europe. Licenses and pricing approvals have been received in most European Union countries, with the remainder expected during 2007. We have filed a variation to our license for approval of intravenous Remodulin through the mutual recognition process. Currently, our application is under review in France, our reference member state in the mutual recognition process. Remodulin has been approved for intravenous use in Canada, Israel, Mexico, Switzerland, Argentina and Peru. Marketing authorization applications are currently under review in other countries.

We have recently been informed that three European Union countries want us to perform repeat sterility testing of Remodulin vials sold in the European Union. France was our sponsoring country for European Union approval, and we have been operating under an understanding with the French regulatory authorities that additional sterility testing was not necessary since these tests are already performed in the United States and meet both United States and European Union regulatory requirements. We are arranging for repeat sterility testing of Remodulin vials for use in the European Union and are working with the appropriate regulatory agencies and our distributors to ensure that there is no disruption of Remodulin therapy during the repeat testing period. We expect that all patients on Remodulin in these three countries will remain on therapy, but our ability to add new patients in these three countries, and possibly additional countries, may depend on our ability to validate and repeat the sterility testing process in the European Union. We anticipate being able to complete this process in approximately one month. We have never experienced a sterility-related or other product specification failure with our Remodulin vials.

We have generated revenues from sales of Remodulin, as well as revenues and royalties on arginine products (which deliver an amino acid that is necessary for maintaining cardiovascular function) in the United States and other countries. In addition, we have generated revenues from telemedicine products and services primarily designed for patients in the United States with abnormal heart rhythms, called cardiac arrhythmias, and ischemic heart disease, a condition that causes poor blood flow to the heart. We currently fund our operations from revenues generated from the sales of our products and services.

Remodulin Marketing and Sales

Remodulin is currently marketed by our staff of approximately 30 employees who market directly to physicians who specialize in treating PAH, mainly cardiologists and pulmonologists. Our staff is augmented by the marketing resources of our distributors. We face stiff competition from several other companies that market and sell competing therapies and expect the competition to continue growing.

14




Remodulin is sold to patients in the United States by Accredo Therapeutics, Inc. (a wholly-owned subsidiary of Medco Health Solutions, Inc.), CuraScript, Inc. (a wholly-owned subsidiary of Express Scripts, Inc.), and Caremark, Inc., (a wholly-owned subsidiary of CVS Corporation), and outside of the United States by various international distributors. We sell Remodulin in bulk shipments to our distributors. Because discontinuation of our therapy can be life-threatening to patients, we require our distributors to maintain inventory levels as specified in our distribution agreements. Due to these contractual requirements, sales of Remodulin to distributors in any given quarter may not be indicative of patient demand during that quarter. In addition, inventory levels reported by distributors are impacted by the timing of their sales around the end of each reporting period. Our U.S.-based distributors typically place one order per month, usually in the first half of the month. The timing and magnitude of our sales of Remodulin are impacted by the timing and volume of these bulk orders from distributors. Bulk orders placed by our distributors are based on their estimates of the amount of drug required for existing and newly starting patients, as well as maintaining an inventory that can meet approximately thirty days’ demand as a contingent supply as specified in our distribution agreements. Effective January 1, 2007, CuraScript’s minimum inventory requirement was reduced from 60 days to 30 days to make their agreement consistent with our two other U.S. distributors. This inventory reduction resulted in a decrease in CuraScript’s inventory of approximately $2 million. Sales of Remodulin and associated pumps and supplies are recognized as revenue when delivered to our distributors.

On March 27, 2007, we entered into an exclusive agreement with Mochida Pharmaceutical Co., Ltd. (Mochida), to distribute subcutaneous and intravenous Remodulin in Japan. Mochida will be responsible, with our assistance, for obtaining Japanese marketing authorization for Remodulin, including conducting necessary bridging studies. We will supply study drug at no charge to Mochida. Due to the bridging studies and required Japanese regulatory reviews, commercial activities in Japan are not expected to commence until 2010 or later. Upon receipt of marketing authorization and pricing approval, Mochida will purchase Remodulin from us at an agreed-upon transfer price. In addition, Mochida has agreed to make certain exclusive distribution rights payments to us. The first payment of $4.0 million was received in May 2007. Certain other distribution rights payments are due as follows: (1) upon Remodulin receiving orphan drug status in Japan or February 1, 2008, whichever first occurs, $4.0 million; (2) upon filing a New Drug Application (NDA) in Japan, $2.0 million; and (3) upon marketing approval in Japan, $2.0 million. Payments for distribution rights received through the filing of the NDA will be recognized ratably over the estimated period of time from when the payment is due until marketing authorization is received.

Effective July 1, 2006, we increased the price of Remodulin to our U.S.-based distributors approximately 3.5% to $67.25 per milligram. This increase applies to sales of Remodulin made on or after July 1, 2006.

Future Prospects

We believe it is likely that many patients now being treated with non-prostacyclin therapies for PAH will require prostacyclin therapy in the near future due to disease progression. As they do, we believe our subcutaneous and intravenous formulations of Remodulin will capture a significant number of these patients. We have two products in Phase III trials, Viveta™ and OvaRex ®  . If either or both of these trials are successful, we will be working on obtaining regulatory approvals for these products and developing our commercial strategy and capabilities. Future profitability will depend on many factors, including the price, level of sales, level of reimbursement by public and private insurance payers, the impact of competitive products, and the number of patients using Remodulin and other currently commercialized products and services, as well as the results and costs of research and development projects, as discussed in the section entitled “Actual consolidated revenues and net income (loss) may be different from published securities analyst projections. In addition, we have a history of losses and may not continue to be profitable” under “Part II, Item 1A.-Risk Factors” below.

15




Major Research and Development Projects

Our major research and development projects are focused on the use of treprostinil to treat cardiovascular diseases, immunotherapeutic monoclonal antibodies (antibodies that activate a patient’s immune response) to treat a variety of cancers and glycobiology antiviral agents (a novel class of small molecules that may be effective as oral therapies) to treat infectious diseases, such as hepatitis C, dengue fever and Japanese encephalitis.

Cardiovascular Disease Projects

Subcutaneous use of Remodulin was approved by the FDA in May 2002 and material net cash inflows from the sales of Remodulin for PAH commenced thereafter. In November 2004, the FDA approved intravenous infusion of Remodulin for patients who are not able to tolerate subcutaneous infusion. This approval was based on data establishing the bioequivalence of intravenous Remodulin with subcutaneous Remodulin.

TRIUMPH-1, Tr eprostinil In halation U sed in the M anagement of P ulmonary H ypertension, a clinical trial, is currently being conducted at approximately 42 centers in the United States and Europe. In May 2006, the FDA agreed to permit us to include patients with PAH who are also being treated with Revatio™ in the study, to expand the trial size to at least 200 patients, and to assess efficacy after 150 patients had completed the trial. We did not conduct this interim efficacy assessment. Enrollment in the TRIUMPH-1 trial was completed on July 13, 2007, with 235 patients enrolled in the study.

We are developing an oral formulation of treprostinil, treprostinil diethanolamine. Two multi-national placebo-controlled clinical trials of oral treprostinil in patients with PAH commenced in October 2006. These trials are a combination of Phase II and Phase III trials, in which both dosing and efficacy are being studied. One trial, FREEDOM-C, is a 16-week study of up to 300 patients currently on background therapy using a PDE5-inhibitor, such as Revatio, or an endothelin antagonist, such as Tracleer ® , or a combination of both, with a possible interim assessment at 150 patients. The second trial, FREEDOM-M, is a 12-week study of up to 150 patients, who are not on any background therapy, with a possible interim assessment at 90 patients. Both trials will be conducted at approximately 50 centers in the United States and the rest of the world. As of June 30, 2007, there were approximately 100 and 60 patients enrolled in FREEDOM-C and FREEDOM-M, respectively. As of July 30, 2007, there were approximately 115 and 62 patients enrolled in FREEDOM-C and FREEDOM-M, respectively.

We are also developing a modified release formulation of beraprost (beraprost-MR) for PAH. Beraprost-MR is an oral analog of prostacyclin. In March 2007, Lung Rx entered into an agreement with Toray Industries, Inc. (Toray) to assume and amend the rights and obligations of the agreement entered into between Toray and us in June 2000 concerning the commercialization of a modified release formulation of beraprost. This agreement is discussed in greater detail in the section entitled “ License Agreement” below. In accordance with the terms of the agreement, we paid Toray $3.0 million in cash and issued 200,000 shares of our common stock in March 2007. As a result, we recognized a $14.0 million expense during the six months ended June 30, 2007, for these transactions. No expenses were incurred on beraprost-MR development during the three months ended June 30, 2007. We are currently awaiting delivery of beraprost-MR clinical trial material and supporting regulatory documentation from Toray.

We incurred expenses of approximately $9.3 million and $6.6 million during the three months ended June 30, 2007 and 2006, respectively, on Remodulin development. We incurred expenses of approximately $16.1 million and $15.5 million during the six months ended June 30, 2007 and 2006, respectively, on Remodulin development. Approximately $210.0 million from inception has been incurred on Remodulin development to date.

16




Cancer Disease Projects

We licensed our monoclonal antibody immunotherapies in April 2002 from AltaRex Medical Corp, a wholly-owned subsidiary of ViRexx Medical Corp. OvaRex is our lead cancer treatment product and is currently being studied in two identical Phase III clinical trials in advanced ovarian cancer (Stage III and IV) patients, IMPACT I and II, initiated in January 2003. Patients enrolled in these studies have successfully completed front-line therapy, consisting of surgery and chemotherapy. We are conducting these studies at approximately 60 centers throughout the United States. In June 2006, these trials were fully enrolled with 367 patients. The primary endpoint for these trials is the difference in time to disease relapse between patients treated with OvaRex and patients receiving a placebo. The trials will be analyzed when each study has reached at least 118 relapse events. Following relapse, patients will also be followed to assess survival rate. As of June 30, 2007, the reported number of relapse events was 128 and 112, respectively, in each of the trials. We are also developing the manufacturing processes to make OvaRex ourselves. OvaRex had previously been supplied by a contract manufacturer. We incurred expenses of approximately $4.1 million and $2.4 million during the three months ended June 30, 2007 and 2006, respectively, on OvaRex development. We incurred expenses of approximately $7.0 million and $4.5 million during the six months ended June 30, 2007 and 2006, respectively, on OvaRex development. Approximately $49.9 million from inception to date has been incurred on OvaRex development.

Infectious Disease Projects

Our infectious disease program includes glycobiology antiviral drug candidates in the preclinical and clinical stages of testing. The drugs in this program are being developed for treatment of a wide variety of viruses. In early 2003, we completed acute and chronic Phase I clinical dosing studies using UT-231B, for the treatment of hepatitis C virus, to assess safety in healthy volunteers. We initiated Phase II clinical studies in patients infected with hepatitis C virus and completed those studies in October 2004. In that trial, UT-231B did not demonstrate efficacy against the hepatitis C virus in a population of patients that had previously failed conventional treatments. We are now conducting preclinical testing of new glycobiology drug candidates. We incurred expenses of approximately $200,000 and $180,000 during the three months ended June 30, 2007 and 2006, respectively, and expenses of approximately $350,000 and $370,000 during the six months ended June 30, 2007 and 2006, respectively, for our infectious disease programs. Approximately $36.1 million from inception to date has been incurred for infectious disease programs.

Project Risks

Due to the inherent uncertainties involved in the drug development, regulatory review and approval processes, the anticipated completion dates, the cost of completing the research and development and the period in which material net cash inflows from these projects are expected to commence are not known or estimable. There are many risks and uncertainties associated with completing the development of the unapproved products discussed above, including the following:

·        Products may fail in clinical studies;

·        Hospitals, physicians and patients may not be willing to participate in clinical studies;

·        Hospitals, physicians and patients may not properly adhere to clinical study procedures;

·        The drugs may not be safe and effective or may not be perceived as safe and effective;

·        Other approved or investigational therapies may be viewed as safer, more effective or more convenient;

·        Patients may experience severe side effects during treatment;

17




·        Patients may die during the clinical study because their disease is too advanced or because they experience medical problems that are not related to the drug being studied;

·        Other ongoing or new clinical trials sponsored by other drug companies or ourselves may reduce the number of patients available for our studies;

·        Patients may not enroll in the studies at the rate we expect;

·        The FDA, international regulatory authorities or local internal review boards may delay or withhold approvals to commence clinical trials or to manufacture drugs;

·        The FDA or international regulatory authorities may request that additional studies be performed;

·        Higher than anticipated costs may be incurred due to the high cost of contractors for drug manufacture, research and clinical trials;

·        Drug supplies may not be sufficient to treat the patients in the studies; and

·        The results of preclinical testing may cause delays in clinical trials.

If our projects are not completed in a timely manner, regulatory approvals could be delayed and our operations, liquidity and financial position could suffer. Without regulatory approvals, we cannot commercialize and sell these products and, therefore, potential revenues and profits from these products could be delayed or be impossible to achieve.

License Agreement

In March 2007, Lung Rx entered into an agreement with Toray to assume and amend the rights and obligations of the agreement entered into between Toray and us in June 2000 concerning the commercialization of beraprost-MR. Under our original agreement with Toray, we had exclusive North American rights to commercialize beraprost-MR in the United States for all cardiovascular diseases. The amended agreement grants us additional exclusive rights to commercialize beraprost-MR in Europe and broadens the indication to vascular disease (excluding renal disease), among other revisions. An earlier clinical trial which examined an immediate release form of beraprost as monotherapy in PAH demonstrated efficacy at 12 weeks but not at 36 weeks. However, because a number of patients did respond positively to the drug, we feel that the development of beraprost-MR as part of a combination therapy with other drugs that feature complementary mechanisms of action presents a desirable clinical opportunity. Since individual PAH patients may respond to the same class of molecules in different ways, we believe that the development of other molecules within the same family is desirable. In addition, we are in the early stages of exploring the development of beraprost-MR for the treatment of other cardiovascular and cardiopulmonary conditions.

In accordance with the terms of the amended agreement, in March 2007 we issued 200,000 shares of our common stock to Toray in exchange for the cancellation of Toray’s existing right to receive an option grant to purchase 500,000 shares of our common stock (the Option Grant). Under the June 2000 Agreement, Toray’s right to receive the Option Grant was conditioned on Toray’s delivery to us of adequate documentation regarding the use of beraprost-MR in humans and its transfer of clinical trial material to us, neither of which has yet to occur. Had the Option Grant been made, the exercise price of the options would have been set at the average closing price of our common stock for the period one month prior to the delivery date. Under the terms of the amended agreement, Toray has the right to request that we repurchase the newly-issued 200,000 shares of our common stock upon 30 days prior written notice at the price of $54.41 per share, which was the average closing price of our common stock between January 11, 2007, and February 23, 2007. Based on the average closing price of our common stock for the two trading days prior to and the two trading days after March 16, 2007, we recognized a research and development expense of approximately $11.0 million in March relating to the issuance of the 200,000

18




shares, because beraprost-MR had not yet obtained regulatory approval for commercial sales. In accordance with the provision of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities , EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock , and EITF Topic No. D-98, Classification and Measurement of Redeemable Securities , these shares of common stock are reflected in mezzanine equity as common stock subject to repurchase valued at the repurchase price. If Toray requests that we repurchase these shares, then an amount equal to the repurchase price will be transferred to a liability account until the repurchase is completed.

The amended agreement also specifies that we make certain milestone payments to Toray during the development period and upon U.S. or European Union regulatory approval. Upon execution of the amended agreement, we made a $3.0 million payment to Toray in addition to the issuance of the 200,000 shares of our common stock discussed above. Additional annual milestone payments of $2.0 million are specified in the amended agreement and are to commence in 2008, increasing annually by $1.0 million through 2011. These payments will be expensed when incurred. These payments are contingent upon the receipt of clinical trial material and commercial drug from Toray that meet all regulatory standards and requirements, including those relating to chemistry, manufacturing and controls, and are documented to the satisfaction of U.S. and European Union regulatory authorities. In addition, if Toray elects to terminate production of beraprost-MR, no further payments would be due under the amended agreement. Conversely, if we elect to terminate development of beraprost-MR, then all remaining milestone payments would be due to Toray, unless certain regulatory standards and requirements have not been met, or if material problems have been identified with respect to manufacturing and regulatory compliance. Please see the section entitled “Certain license and assignment agreements relating to our products may restrict our ability to develop products in certain countries and/or for particular diseases and impose other restrictions on our freedom to develop and market our products” in “ Part II; Item 1A.—Risk Factors ” below for more information about the license agreement with Toray.

Financial Position

Cash, cash equivalents and marketable investments (including all unrestricted and restricted amounts and all amounts classified as current and non-current) at June 30, 2007, were approximately $280.3 million, as compared to approximately $303.2 million at December 31, 2006. The decrease of approximately $22.9 million was due primarily to the repurchase of approximately $67.1 million worth of our common stock which was offset by cash provided by operating activities of approximately $33.3 million. Restricted marketable investments and cash pledged to secure our obligations under the synthetic operating lease discussed below under “ Off Balance Sheet Arrangement” at June 30, 2007, totaled approximately $38.5 million, as compared to approximately $39.0 million at December 31, 2006.

Prepaid expenses at June 30, 2007, were approximately $5.6 million, as compared to approximately $9.2 million at December 31, 2006. The decrease was primarily due to the expensing of a portion of those assets used in operations during 2007.

Property, plant and equipment at June 30, 2007, were approximately $45.9 million as compared to $34.7 million at December 31, 2006. The increase was primarily due the acquisition of an office building adjacent to our legal and governmental affairs office that we lease in Washington, DC for $5.7 million and expenditures for our Research Triangle Park, North Carolina, and Silver Spring, Maryland, facilities projects of approximately $4.4 million.

Investments in affiliates at June 30, 2007, were approximately $5.2 million, as compared to approximately $4.7 million at December 31, 2006. The increase was due primarily to an increase in the fair value of our investment in ViRexx Medical Corp., based on quoted market prices.

Accounts payable at June 30, 2007, were approximately $5.1 million, as compared to approximately $2.8 million at December 31, 2006. The increase was due generally to the timing of payments to vendors.

19




Accrued expenses at June 30, 2007, were approximately $17.7 million, as compared to approximately $15.3 million at December 31, 2006. The increase was due to an increase in employee bonuses of approximately $737,000 and an increase in Remodulin-related royalty and Medicaid rebates of approximately $2.3 million.

Total stockholders’ equity at June 30, 2007, was approximately $179.0 million, as compared to approximately $204.6 million at December 31, 2006. For the six-month period ended June 30, 2007, we repurchased approximately 1.2 million shares of our common stock for $67.1 million which was offset by $13.6 million from the proceeds from stock option exercises, $14.2 million from the recognition of stock option expense and $8.2 million in tax benefits recognized from stock option exercise and Original Issue Discount amortization.

Results Of Operations

Three months ended June 30, 2007 and 2006

Revenues for the three months ended June 30, 2007, were approximately $51.8 million, as compared to approximately $40.2 million for the three months ended June 30, 2006. The increase of approximately $11.6 million was due primarily to growth in sales of Remodulin to our distributors.

The following sets forth our revenues by source for the periods presented (dollars in thousands).

 

 

Three Months Ended
June 30,

 

 

 

2007

 

2006

 

Percentage
Change

 

Remodulin

 

$

49,177

 

$

38,530

 

 

27.6

%

 

Telemedicine services and products

 

1,839

 

1,563

 

 

17.7

%

 

Other products

 

148

 

152

 

 

(2.6

)%

 

Distributor fees

 

667

 

 

 

N/A

 

 

Total revenues

 

$

51,831

 

$

40,245

 

 

28.8

%

 

 

For the three months ended June 30, 2007 and, 2006, approximately 84 percent and 86 percent of our net revenues, respectively, were earned from our three distributors located in the United States.

Total revenues are reported net of estimated government rebates, prompt pay discounts and fees due to distributors for services. We pay government rebates to state Medicaid agencies that pay for Remodulin. We estimate our liability for such rebates based on the historical level of government rebates invoiced by state Medicaid agencies relative to U.S. sales of Remodulin. Prompt pay discounts are offered on sales of Remodulin if the related invoices are paid in full generally within 60 days from the date of sale. We estimated our liability for prompt pay discounts based on historical payment patterns. Fees paid to distributors for services are estimated based on contractual rates for specific services applied to estimated units of service provided by the distributors for the period.

20




A roll forward of the liability accounts associated with estimated government rebates and prompt pay discounts as well as the net amount of reductions to revenues for these items are presented as follows (in thousands):

 

 

Three Months Ended
June 30,

 

 

 

2007

 

2006

 

Liability accounts, at beginning of period

 

$

2,309

 

$

1,760

 

Additions to liability attributed to sales in:

 

 

 

 

 

Current period

 

3,227

 

2,555

 

Prior period

 

88

 

 

Payments or reductions attributed to sales in:

 

 

 

 

 

Current period

 

(610

)

(458

)

Prior period

 

(2,143

)

(1,606

)

Liability accounts, at end of period

 

$

2,871

 

$

2,251

 

Net reductions to revenues

 

$

3,315

 

$

2,555

 

 

There were no product returns during the three months ended June 30, 2007 and 2006, respectively.

Research and development expenses consist primarily of salaries and related expenses, costs to acquire pharmaceutical products and product rights for development, and amounts paid to contract research organizations, hospitals and laboratories for the provision of services and materials for drug development and clinical trials. The table below summarizes research and development by major project and non-project components (dollars in thousands):

 

 

Three Months Ended
June 30,

 

 

 

 

 

2007

 

2006

 

Percentage
Change

 

Project and non-project:

 

 

 

 

 

 

 

 

 

Cardiovascular

 

$

9,269

 

$

6,596

 

 

40.5

%

 

Cancer

 

4,061

 

2,462

 

 

65.0

%

 

Infectious disease

 

200

 

180

 

 

11.1

%

 

Stock option

 

2,981

 

2,173

 

 

37.2

%

 

Other

 

1,459

 

1,203

 

 

21.3

%

 

Total research and development expense

 

$

17,970

 

$

12,614

 

 

42.5

%

 

 

The increase in expenses for the cardiovascular program is primarily attributable to our oral and inhaled projects, each of which spent approximately $1.5 million more than during the same period in 2006. The increase in expenses for the cancer program is primarily related to the development of the manufacturing process for OvaRex in our Silver Spring, Maryland, facility.

Selling, general and administrative expenses consist primarily of salaries, travel, office expenses, insurance, professional fees, provision for doubtful accounts receivable, depreciation and amortization. The table below summarizes selling, general and administrative expenses by major categories (dollars in thousands):

 

 

Three Months Ended
June 30,

 

 

 

 

 

2007

 

2006

 

Percentage
Change

 

Category:

 

 

 

 

 

 

 

 

 

General and administrative

 

$

9,066

 

$

6,465

 

 

40.2

%

 

Sales and marketing

 

5,708

 

3,361

 

 

69.8

%

 

Stock option

 

5,700

 

2,045

 

 

178.7

%

 

Total selling, general and administrative expense

 

$

20,474

 

$

11,871

 

 

72.5

%

 

 

21




The increase in general and administrative expenses was due primarily to increased expenses of approximately: (1) $1.1 million for salaries and related expenses from headcount growth to support expanding operations; (2) $265,100 for rent expense on our laboratory facility in Silver Spring, Maryland, which began operations in May 2006; and (3) $326,200 for other operating expenses supporting the growth in our operations. The increase in sales and marketing related expenses is primarily due to an increase in headcount that led to an increase in salaries and related expenses of approximately $1.8 million.

Under the terms of her employment agreement, our Chief Executive Officer (CEO) receives a year-end stock option grant based on the change of our market capitalization from the previous year. At June 30, 2007, we accrued approximately $2.3 million of stock option expense representing the fair market value of the estimated stock options that would be due at the end of 2007 based on the increase in our market capitalization from December 31, 2006 through June 30, 2007. The offset to this expense was an increase to additional paid-in capital.

Cost of product sales consists of the cost to manufacture or acquire products that are sold to customers. Cost of service sales consists of the salaries and related overhead necessary to provide telemedicine services to customers. Cost of product sales was approximately 10% of net product sales for each three-month period ended June 30, 2007 and June 30, 2006. Cost of service sales was approximately 31% of service sales for the three months ended June 30, 2007, as compared to approximately 33% for the three months ended June 30, 2006.

Equity loss in affiliate represents our share of Northern Therapeutics, Inc.’s losses. The equity loss in affiliate was approximately $79,000 for the three months ended June 30, 2007, as compared to approximately $171,000 for the three months ended June 30, 2006. Northern Therapeutics, Inc.’s loss was due primarily to expenditures for its autologous (non-viral vector) gene therapy research for PAH.

An income tax expense of approximately $3.1 million was recognized for the three months ended June 30, 2007, as compared to $6.2 million for the three months ended June 30, 2006. The income tax provision is based on the estimated annual effective tax rate for the entire year. The estimated effective tax rate is subject to adjustment in subsequent quarterly periods as the estimates of pre-tax income and of permanent book to tax return difference for the year are increased or decreased. The effective tax rate for the six months ended June 30, 2007 and 2006, was approximately 35 percent and 44 percent, respectively. The effective rate for the six months ended June 30, 2006 does not include the effect of legislation to retroactively reinstate federal tax credits for qualified research expenditures which was enacted in October 2006. The cumulative effect of the legislation was recorded in the fourth quarter 2006.

Six months ended June 30, 2007 and 2006

Revenues for the six months ended June 30, 2007, were approximately $92.0 million, as compared to approximately $73.4 million for the six months ended June 30, 2006. The increase of approximately $18.6 million was due primarily to growth in sales of Remodulin to our distributors.

The following sets forth our revenues by source for the periods presented (dollars in thousands):

 

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

Percentage
Change

 

Remodulin

 

$

87,327

 

$

69,835

 

 

25.1

%

 

Telemedicine services and products

 

3,725

 

3,312

 

 

12.5

%

 

Other products

 

281

 

262

 

 

7.3

%

 

Distributor fees

 

667

 

 

 

N/A

 

 

Total revenues

 

$

92,000

 

$

73,409

 

 

25.3

%

 

 

22




For the six months ended June 30, 2007 and, 2006, approximately 83 percent and 84 percent of our net revenues, respectively, were earned from our three distributors located in the United States.

A roll forward of the liability accounts associated with estimated government rebates and prompt pay discounts as well as the net amount of reductions to revenues for these items are presented as follows (in thousands):

 

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

Liability accounts, at beginning of period

 

$

2,366

 

$

1,590

 

Additions to liability attributed to sales in:

 

 

 

 

 

Current period

 

5,778

 

4,589

 

Prior period

 

264

 

 

Payments or reductions attributed to sales in:

 

 

 

 

 

Current period

 

(1,043

)

(2,426

)

Prior period

 

(4,494

)

(1,502

)

Liability accounts, at end of period

 

$

2,871

 

$

2,251

 

Net reductions to revenues

 

$

6,042

 

$

4,589

 

 

There were no product returns during the six months ended June 30, 2007 and 2006, respectively.

Research and development expenses consist primarily of salaries and related expenses, costs to acquire pharmaceutical products and product rights for development, and amounts paid to contract research organizations, hospitals and laboratories for the provision of services and materials for drug development and clinical trials. The table below summarizes research and development by major project and non-project components (dollars in thousands):

 

 

Six Months Ended
June 30,

 

 

 

 

 

2007

 

2006

 

Percentage
Change

 

Project and non-project:

 

 

 

 

 

 

 

 

 

Cardiovascular

 

$

19,050

 

$

15,528

 

 

22.7

%

 

Cancer

 

6,951

 

4,516

 

 

53.9

%

 

Infectious disease

 

345

 

368

 

 

(6.3

)%

 

Stock option

 

5,554

 

4,495

 

 

23.6

%

 

Other

 

3,171

 

2,407

 

 

31.7

%

 

Subtotal

 

35,071

 

27,314

 

 

28.4

%

 

R&D expense from issuance of common stock

 

11,013

 

 

 

N/A

 

 

Total research and development expense

 

$

46,084

 

$

27,314

 

 

68.7

%

 

 

The increase in cardiovascular expenses was primarily due to expensing a $3.0 million milestone payment to Toray in connection with the amended beraprost-MR license . The increase in expenses for the cancer program is related to the development of our OvaRex manufacturing processes.

23




Selling, general and administrative expenses consist primarily of salaries, travel, office expenses, insurance, professional fees, provision for doubtful accounts receivable, depreciation and amortization. The table below summarizes selling, general and administrative expenses by major categories (dollars in thousands):

 

 

Six Months Ended
June 30,

 

 

 

 

 

2007

 

2006

 

Percentage
Change

 

Category:

 

 

 

 

 

 

 

 

 

General and administrative

 

$

16,705

 

$

11,529

 

 

44.9

%

 

Sales and marketing

 

10,410

 

6,235

 

 

67.0

%

 

Stock option

 

8,523

 

4,186

 

 

103.6

%

 

Total selling, general and administrative expense

 

$

35,638

 

$

21,950

 

 

62.4

%

 

 

The increase in general and administrative expenses was due primarily to increased expenses of approximately: (1) $1.9 million for salaries and related expenses from headcount growth to support expanding operations; (2) $698,000 for rent expense due to rent on our laboratory facility in Silver Spring, Maryland, which began operations in May 2006; and (3) $692,000 for other operating expenses supporting the growth in our operations. The increase in sales and marketing related expenses is the result of an increase in salaries and related expenses of approximately $3.0 million due to an increase in headcount and travel expenses of approximately $616,000.

Under the terms of her employment agreement, our CEO receives a year-end stock option grant based on the change of our market capitalization from the previous year. At June 30, 2007, we accrued approximately $2.3 million of stock option expense representing the fair market value of the estimated stock options that would be due at the end of 2007 based on the increase in our market capitalization from December 31, 2006, through June 30, 2007. The offset to this expense was an increase to additional paid-in capital.

A write down of intangible assets related to the HeartBar product tradename totaling approximately $2.0 million was recorded during the six months ended June 30, 2006. This write down was required since the HeartBar product was discontinued in January 2006 and is no longer sold.

Cost of product sales was approximately 10% of net product sales for each of the six-month periods ended June 30, 2007 and 2006. Cost of service sales was approximately 32% of service sales for the six months ended June 30, 2007, as compared to approximately 34% for the six months ended June 30, 2006.

Interest income for the six months ended June 30, 2007, was approximately $6.0 million, as compared to interest income of approximately $4.4 million for the six months ended June 30, 2006. The increase was due primarily to an increase in market interest rates.

Equity loss in affiliate represents our share of Northern Therapeutics, Inc.’s losses. The equity loss in affiliate was approximately $193,000 for the six months ended June 30, 2007, as compared to approximately $378,000 for the six months ended June 30, 2006. Northern Therapeutics, Inc.’s loss was due primarily to expenditures for its autologous (non-viral vector) gene therapy research for PAH.

An income tax expense of approximately $1.7 million was recognized for the six months ended June 30, 2007, as compared to $8.0 million for the six months ended June 30, 2006. The income tax provision is based on the estimated annual effective tax rate for the entire year. The estimated effective tax rate is subject to adjustment in subsequent quarterly periods as the estimates of pre-tax income and of permanent book to tax return difference for the year are increased or decreased. The effective tax rate for the six months ended June 30, 2007 and 2006, was approximately 35 percent and 44 percent, respectively. The effective rate for the six months ended June 30, 2006, does not include the effect of legislation to retroactively reinstate federal tax credits for qualified research expenditures which was enacted in October 2006. The cumulative effect of the legislation was recorded in the fourth quarter 2006.

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Liquidity and Capital Resources

Until June 1999, we financed our operations principally through private placements of common stock. On June 17, 1999, we completed our initial public offering. Our net proceeds from the initial public offering and sale of the over-allotment shares, after deducting underwriting commissions and offering expenses, were approximately $56.4 million. In 2000, we issued common stock in two private placements and received aggregate net proceeds of approximately $209.0 million. Until 2002, we funded the majority of our operations from the net proceeds of such equity. Since 2004, we have funded the majority of our operations from revenues, mainly Remodulin-related, and we expect this to continue.

Our working capital at June 30, 2007, was approximately $223.5 million, as compared to approximately $258.1 million at December 31, 2006. The decrease is primarily due to our purchase of approximately $67.1 million worth of our common stock during the six months ended June 30, 2007, which was offset by cash provided by operating activities of approximately $33.3 million.

At June 30, 2007, restricted cash and marketable investments pledged to secure our obligations under the synthetic operating lease (discussed below under “ Off Balance Sheet Arrangement” ) totaled approximately $38.5 million, as compared to approximately $39.0 million at December 31, 2006.

Net cash provided by operating activities was approximately $33.3 million for the six months ended June 30, 2007, as compared to approximately $37.4 million for the six months ended June 30, 2006. The decrease in cash provided by operating activities is due primarily to the $3.0 million milestone payment to Toray under the amended agreement and the approximately $6.0 million of excess tax benefits from stock-based compensation recognized as a component of cash flows from financing activities. For the six months ended June 30, 2007, we invested approximately $12.8 million in property, plant and equipment, as compared to approximately $9.0 million in the six months ended June 30, 2006.

In April 2007, we paid approximately $573,000 in interest to the holders of our 0.05% Convertible Senior Notes. We are required to make another semi-annual interest payment of $625,000 in October 2007.

For the six months ended June 30, 2007, we also received approximately $13.6 million in stock option exercise proceeds as compared to approximately $5.8 million in the six months ended June 30, 2006. In addition, during the six months ended June 30, 2007, we repurchased approximately 1.2 million shares of our common stock for approximately $67.1 million, as compared to no shares for the six months ended June 30, 2006.

In January 2007, we purchased an office building adjacent to our leased legal and governmental affairs office in Washington, DC, for $5.7 million. We are currently constructing an approximately 200,000 square foot facility in Research Triangle Park, North Carolina, which will consist of a manufacturing operation and offices. The manufacturing operation will primarily be for oral treprostinil, although it is expected to support other programs, and the offices will be used by our clinical development and sales and marketing staffs, who currently occupy a leased facility in the area. Construction of this facility may take up to two years to complete. The project may cost up to $100 million, and we expect to fund the construction of this facility from our working capital or other financing arrangements.

Effective March 2007, we entered into a construction management agreement with DPR Construction, Inc. (DPR) based in Falls Church, Virginia. DPR will manage the construction of our manufacturing and office facility in Research Triangle Park, North Carolina. The agreement has a guaranteed maximum price clause in which DPR agrees that the construction cost of the facility will not exceed approximately $78.0 million, which amount is subject to change with agreed-upon changes to the scope of work. DPR will be responsible for covering any costs in excess of the guaranteed maximum price. If the ultimate cost of the project is less than the guaranteed maximum, we will share a portion of these savings with DPR. In addition, DPR must pay us penalties if the construction is not completed by

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February 2009, which date is subject to change based on agreed-upon changes to the scope of work. DPR has no material relationship with us or any of our affiliates.

In addition, we are in the planning phase for a new office and laboratory building which will connect to our current laboratory facility in Silver Spring, Maryland. The building of this facility is anticipated to begin in the latter half of 2007. The costs are still being estimated due to continuing design and related estimation work. We intend to finance the construction of this facility through a synthetic operating lease.

We made milestone payments totaling $20,000 pursuant to existing license agreements during each of the six months ended June 30, 2007 and 2006. Under our existing license agreements we are obligated to make royalty payments on sales of Remodulin that exceed annual net sales of $25.0 million and on all arginine products. Royalties on sales of all products currently marketed range up to 10 percent of sales of those products.

We believe that our existing revenues, together with existing capital resources (comprised primarily of unrestricted cash, cash equivalents and marketable investments), will be adequate to fund our operations. However, any projections of future cash needs and cash flows are subject to substantial uncertainty. See the section entitled “Part II, Item 1A—Risk Factors—Actual consolidated revenues and net income (loss) may be different from published securities analyst projections. In addition, we have a history of losses and may not continue to be profitable” below .

At June 30, 2007, we had, for federal income tax purposes, net operating loss carryforwards of approximately $38.5 million and business tax credit carryforwards of approximately $50.3 million, which expire at various dates from 2012 through 2025. The remaining net operating loss carryforwards are attributable to exercised stock options, the benefit of which, when realized, directly increases additional paid-in-capital. Business tax credits can offset future tax liabilities and arise from qualified research expenditures. We have been and may continue to be subject to the federal alternative minimum tax, even though we have significant net operating loss and general business credit carryforwards.

Section 382 of the Internal Revenue Code limits the utilization of net operating losses when ownership changes occur as defined by that section. We have reviewed our ownership change position pursuant to Section 382 through December 31, 2006, and have determined that ownership changes occurred in December 1997, June 1999, and November 2004 and, as a result, the utilization of certain of our net operating loss carryforwards may be limited. However, we do not expect any significant portion of our net operating loss carryforwards or general business tax credits to expire unused. A portion of the net operating loss carryforwards continues to be reserved through a valuation allowance as of June 30, 2007.

Convertible Senior Notes

On October 30, 2006, we issued $250.0 million of 0.50% Convertible Senior Notes due October 2011 (the Convertible Senior Notes). Proceeds from the offering, after deducting the initial purchaser’s, Deutsche Bank Securities Inc. (Deutsche Bank), discount and commission and estimated expenses were approximately $242.0 million. The Convertible Senior Notes were issued at par value and pay interest in cash semi-annually in arrears on April 15 and October 15 of each year, beginning in April 2007. The Convertible Senior Notes are unsecured unsubordinated obligations and rank equally with all other unsecured and unsubordinated indebtedness. The Convertible Senior Notes have an initial conversion price of $75.2257 per share. The Convertible Senior Notes may only be converted: (i) anytime after July 15, 2011; (ii) during any calendar quarter commencing after the date of original issuance of the notes, if the closing sale price of our common stock for at least 20 trading days in the period of 30 consecutive trading days ending on the last trading day of the calendar quarter preceding the quarter in which the conversion occurs is more than 120% of the conversion price of the notes in effect on that last trading day; (iii) during the ten consecutive trading-day period following any five consecutive trading-day period in which the trading price for the notes for each such trading day was less than 95% of the closing sale price of our

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common stock on such date multiplied by the then current conversion rate; or (iv) if specified significant distributions to holders of our common stock are made, specified corporate transactions occur, or our common stock ceases to be approved for listing on The NASDAQ Global Select Market and is not listed for trading on another U.S. national or regional securities exchange. Upon conversion, a holder will receive: (i) cash equal to the lesser of the principal amount of the note or the conversion value; and (ii) to the extent the conversion value exceeds the principal amount of the note, shares of our common stock. In addition, upon a change in control, as defined in the indenture under which the Convertible Senior Notes have been issued, the holders may require us to purchase all or a portion of their Convertible Senior Notes for 100% of the principal amount plus accrued and unpaid interest, if any, plus a number of additional shares of our common stock, as set forth in the related indenture. The indenture under which the Convertible Senior Notes were issued contains customary covenants.

Concurrent with the issuance of the Convertible Senior Notes, we purchased call options on our common stock in a private transaction. The call options allow us to receive up to approximately 3.3 million shares of our common stock from counterparties, equal to the amount of common stock related to the excess conversion value that we would pay to the holders of the Convertible Senior Notes upon conversion. These call options will terminate upon the earlier of the maturity dates of the related Convertible Senior Notes or the first day all of the related Convertible Senior Notes are no longer outstanding due to conversion or otherwise. The call options, which cost approximately $80.8 million, were recorded as a reduction of shareholders’ equity. The cost of call options for tax purposes creates a tax deduction since it is classified as an Original Issue Discount. The deduction is considered a permanent difference and, as such, does not create a deferred tax asset. The benefit of the deduction is recorded as an increase to additional paid-in-capital.

In a separate transaction, we sold warrants to issue shares of our common stock at an exercise price of $105.689 per share. Pursuant to this transaction, warrants for approximately 3.3 million shares of our common stock were issued. If the average price of our common stock during a defined period, ending on or about the respective settlement dates, exceeds the exercise price of the warrants, the warrants will be settled in shares of our common stock. Proceeds received from the issuance of the warrants totaled approximately $45.4 million and were recorded as an increase to additional paid-in-capital.

We also used approximately $112.4 million of the proceeds from the issuance of the Convertible Senior Notes to repurchase approximately 1.8 million outstanding shares of our common stock as part of this transaction. We intend to use the remainder of the net proceeds for working capital or other general corporate purposes, which may include acquisitions, strategic investments or joint venture arrangements. Including the shares of common stock repurchased as part of the Convertible Senior Note transaction, we have repurchased a total of approximately 3.1 million shares of our common stock for approximately $182.5 million through June 30, 2007.

Off Balance Sheet Arrangement

In June 2004, we entered into a synthetic operating lease and related agreements with Wachovia Development Corporation and its affiliates (Wachovia) to fund the construction of a laboratory facility in Silver Spring, Maryland. Under these agreements, Wachovia funded $32.0 million towards the construction of the laboratory facility on land owned by us. The construction phase commenced in 2004 and was completed in May 2006. Following construction, Wachovia leased the laboratory facility to us with a term ending in May 2011. Under the 99-year ground lease, Wachovia paid fair value rent to us for use of the land during the construction phase and will pay fair value rent after the laboratory lease is terminated. During the term of the laboratory lease, Wachovia will pay $1 per year to us for use of the land.

Wachovia receives rent from us, generally based on applying the 30-day LIBOR rate plus approximately 55 basis points to the amount funded by Wachovia towards the construction of the

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laboratory. This monthly rent commenced when the laboratory construction was completed and will continue until the termination of the lease in May 2011. Upon termination of the lease, we will generally have the option of renewing the lease (subject to approval of both parties), purchasing the laboratory at a price approximately equal to the funded construction cost, or se