United Therapeutics Corporation
UNITED THERAPEUTICS CORP (Form: 10-Q, Received: 07/31/2008 07:01:06)

Table of Contents

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended June 30, 2008

 

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
Incorporation or Organization)

 

(I.R.S. Employer
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

Smaller reporting company      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 28, 2008 was 22,813,792

 

 

 



Table of Contents

 

INDEX

 

 

 

 

Page

Part I.

FINANCIAL INFORMATION (UNAUDITED)

 

 

Item 1.

Consolidated Financial Statements

 

 

 

Consolidated Balance Sheets

 

3

 

Consolidated Statements of Operations

 

4

 

Consolidated Statements of Cash Flows

 

5

 

Notes to Consolidated Financial Statements

 

6

Item 2.

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

 

18

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

32

Item 4.

Controls and Procedures

 

33

Part II.

OTHER INFORMATION

 

 

Item 1A.

Risk Factors

 

33

Item 4.

Submission of Matters to a Vote of Security Holders

 

50

Item 6.

Exhibits

 

51

SIGNATURES

 

52

 

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Table of Contents

 

PART I.       FINANCIAL INFORMATION

 

Item 1.         Consolidated Financial Statements

 

UNITED THERAPEUTICS CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

 

 

 

June 30,
2008

 

December 31,
2007

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

125,332

 

$

139,323

 

Marketable investments

 

89,137

 

150,729

 

Accounts receivable, net of allowance of none for 2008 and 2007

 

30,175

 

25,654

 

Other receivable

 

1,901

 

2,959

 

Interest receivable

 

1,342

 

1,049

 

Prepaid expenses

 

4,926

 

5,948

 

Inventories, net

 

15,292

 

13,211

 

Deferred tax assets

 

14,536

 

13,588

 

Total current assets

 

282,641

 

352,461

 

Marketable investments

 

128,272

 

9,740

 

Marketable investments and cash—restricted

 

45,037

 

44,195

 

Goodwill

 

7,465

 

7,465

 

Other intangible assets, net

 

667

 

962

 

Property, plant, and equipment, net

 

115,735

 

69,354

 

Investments in affiliates

 

1,091

 

1,247

 

Deferred tax assets

 

91,435

 

93,700

 

Other assets

 

7,475

 

7,894

 

Total assets

 

$

679,818

 

$

587,018

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

14,774

 

$

2,000

 

Accrued expenses

 

24,773

 

17,942

 

Current portion of notes and leases payable

 

249,978

 

250,012

 

Other current liabilities

 

3,696

 

2,806

 

Total current liabilities

 

293,221

 

272,760

 

Notes and leases payable, excluding current portion

 

 

2

 

Other liabilities

 

12,308

 

7,584

 

Total liabilities

 

305,529

 

280,346

 

Commitments and contingencies:

 

 

 

 

 

Common stock subject to repurchase

 

10,882

 

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 shares authorized, no shares issued

 

 

 

Common stock, par value $.01, 100,000,000 shares authorized, 27,128,993 and 26,629,189 shares issued at June 30, 2008, and December 31, 2007, respectively, and 22,747,396 and 22,247,592 outstanding at June 30, 2008, and December 31, 2007, respectively

 

271

 

266

 

Additional paid-in capital

 

592,550

 

548,327

 

Accumulated other comprehensive (loss) income

 

(2,027

)

317

 

Treasury stock at cost, 4,381,597 shares at June 30, 2008, and December 31, 2007, respectively

 

(231,619

)

(231,619

)

Retained earnings (deficit)

 

4,232

 

(21,501

)

Total stockholders’ equity

 

363,407

 

295,790

 

 

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

679,818

 

$

587,018

 

 

See accompanying notes to consolidated financial statements.

 

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Table of Contents

 

UNITED THERAPEUTICS CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(Unaudited)

 

(Unaudited)

 

Revenues:

 

 

 

 

 

 

 

 

 

Net product sales

 

$

65,497

 

$

49,381

 

$

124,650

 

$

87,788

 

Service sales

 

2,393

 

1,783

 

4,620

 

3,545

 

Distributor fees

 

666

 

667

 

1,333

 

667

 

Total revenues

 

68,556

 

51,831

 

130,603

 

92,000

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

19,141

 

17,970

 

40,217

 

46,084

 

Selling, general and administrative

 

23,093

 

20,474

 

42,424

 

35,638

 

Cost of product sales

 

6,564

 

4,791

 

12,739

 

8,606

 

Cost of service sales

 

768

 

551

 

1,479

 

1,132

 

Total operating expenses

 

49,566

 

43,786

 

96,859

 

91,460

 

Income from operations

 

18,990

 

8,045

 

33,744

 

540

 

 

 

 

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest income

 

2,804

 

1,938

 

6,412

 

5,983

 

Interest expense

 

 

(713

)

 

(1,424

)

Equity loss in affiliate

 

(43

)

(79

)

(156

)

(193

)

Other, net

 

817

 

(279

)

525

 

(220

)

Total other income, net

 

3,578

 

867

 

6,781

 

4,146

 

Income before income tax

 

22,568

 

8,912

 

40,525

 

4,686

 

Income tax expense

 

(8,237

)

(3,106

)

(14,792

)

(1,661

)

Net income

 

$

14,331

 

$

5,806

 

$

25,733

 

$

3,025

 

Net income per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.63

 

$

0.28

 

$

1.15

 

$

0.14

 

Diluted

 

$

0.59

 

$

0.26

 

$

1.07

 

$

0.14

 

Weighted average number of common shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

22,600

 

20,837

 

22,467

 

21,069

 

Diluted

 

24,328

 

22,020

 

24,120

 

22,219

 

 

See accompanying notes to consolidated financial statements.

 

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UNITED THERAPEUTICS CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

 

 

Six Months Ended
June 30,

 

 

 

2008

 

2007

 

 

 

(Unaudited)

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

25,733

 

$

3,025

 

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

 

 

 

 

 

Depreciation and amortization

 

2,002

 

1,621

 

Provision for bad debt and inventory obsolescence

 

495

 

853

 

Deferred tax expense

 

14,792

 

1,661

 

Loss on disposals of equipment

 

275

 

595

 

Options issued in exchange for services

 

13,721

 

14,170

 

Amortization of discount or premium on investments

 

(858

)

(1,990

)

Equity loss in affiliate and other

 

156

 

402

 

Excess tax benefits from stock-based compensation

 

(9,720

)

(6,009

)

Issuance of stock for license

 

 

11,013

 

Impairment loss on available-for-sale investment

 

152

 

 

Changes in operating assets and liabilities:

 

 

 

 

 

Restrictions on cash

 

2,042

 

544

 

Accounts receivable

 

(4,625

)

(822

)

Interest receivable

 

(293

)

555

 

Inventories

 

(3,284

)

(1,832

)

Prepaid expenses

 

1,022

 

3,821

 

Other assets

 

701

 

(1,639

)

Accounts payable

 

12,761

 

2,018

 

Accrued expenses

 

6,843

 

2,447

 

Other liabilities

 

4,489

 

3,448

 

Net cash provided by operating activities

 

66,404

 

33,881

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of property, plant and equipment

 

(46,903

)

(12,844

)

Purchases of held-to-maturity investments

 

(222,511

)

(96,640

)

Purchases of available-for-sale investments

 

(24,600

)

(42,650

)

Sales of available-for-sale investments

 

36,850

 

56,650

 

Maturities of held-to-maturity investments

 

149,096

 

99,507

 

Net cash (used in) provided by investing activities

 

(108,068

)

4,023

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Payments to repurchase common stock

 

 

(67,059

)

Proceeds from the exercise of stock options

 

18,003

 

13,565

 

Excess tax benefits from stock-based compensation

 

9,720

 

6,009

 

Principal payments on notes payable and capital lease obligations

 

(50

)

(4

)

Net cash provided by (used in) financing activities

 

27,673

 

(47,489

)

 

 

 

 

 

 

Net decrease in cash and cash equivalents

 

(13,991

)

(9,585

)

Cash and cash equivalents, beginning of period

 

139,323

 

91,067

 

Cash and cash equivalents, end of period

 

$

125,332

 

$

81,482

 

 

 

 

 

 

 

Supplemental schedule of cash flow information:

 

 

 

 

 

Cash paid for interest

 

$

625

 

$

580

 

Cash paid for income taxes

 

$

684

 

$

1,036

 

 

See accompanying notes to consolidated financial statements.

 

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UNITED THERAPEUTICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2008

(UNAUDITED)

 

1.       ORGANIZATION AND BUSINESS DESCRIPTION

 

United Therapeutics Corporation (United Therapeutics) is a biotechnology company focused on the development and commercialization of unique products to address the unmet medical needs of patients with chronic and life-threatening cardiovascular and infectious diseases and cancer. 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., Unither Telmed, Ltd., Unither.com, Inc., United Therapeutics Europe, Ltd., Unither Pharma, Inc., Medicomp, Inc., Unither Neurosciences, Inc., LungRx Limited, Unither Biotech Inc., and Unither Virology, LLC.

 

Our lead product is Remodulin ®  (treprostinil sodium) Injection (Remodulin), a long-lasting version of the natural vasoactive molecule, prostacyclin.  Remodulin was approved in 2002 by the United States Food and Drug Administration (FDA) for use as a continuous subcutaneous infusion for the treatment of pulmonary arterial hypertension (PAH) in patients with New York Heart Association (NYHA) class II-IV symptoms to diminish symptoms associated with exercise. In 2004, the FDA approved the intravenous infusion of Remodulin for patients who are not able to tolerate a subcutaneous infusion. In 2006, the FDA expanded its approval of Remodulin to include patients requiring transition from Flolan ® , also an intravenously administered prostacyclin.  Worldwide, Remodulin is approved for subcutaneous and/or intravenous infusion in many other countries.

 

We have generated pharmaceutical revenues from sales of Remodulin, distributor fees and arginine royalty payments 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 under the Securities Act of 1933. Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles (GAAP) 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, 2007, as filed with the Securities and Exchange Commission (SEC).

 

In the opinion of our management, the accompanying consolidated financial statements contain all adjustments, including normal recurring adjustments, necessary to present fairly United Therapeutics’ financial position as of June 30, 2008, its results of operations for the three- and six-month periods ended June 30, 2008 and 2007, and its cash flows for the six months ended June 30, 2008 and 2007. Interim results are not necessarily indicative of results for an entire year.

 

3 .       NEW ACCOUNTING STANDARD

 

In May 2008, the Financial Accounting Standards Board (FASB) issued Staff Position APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlement) , (FSP APB 14-1). FSP APB 14-1 applies to certain convertible debt instruments that may be settled in cash or other assets, or partially in cash, upon conversion. Issuers of such instruments are required under FSP APB 14-1 to account for the liability and equity components separately in a manner that reflects the issuer’s nonconvertible debt borrowing rate when interest expense is subsequently recognized. Specifically, FSP APB 14-1 requires the difference between the convertible debt proceeds and the fair value of the liability, absent any conversion rights, be assigned to the equity component and recognized as part of stockholders’ equity and as a discount for determining the carrying value of the debt. The discounted carrying value of the

 

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debt is amortized as additional interest expense using the interest method over its expected life. FSP APB 14-1 is effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years and shall be applied retrospectively to all periods presented. Our 0.50% Convertible Senior Notes due October 2011 (Convertible Senior Notes) (see Note 10) fall within the scope of this guidance. While FSP APB 14-1 does not change the cash flow requirements under our Convertible Senior Notes, non-cash interest expense will increase as a result of amortizing the discounted carrying value of our Convertible Senior Notes. We are currently assessing the impact of adopting FSP APB 14-1 and believe that adoption will have a significant impact on our consolidated financial statements.

 

4.       INVENTORIES

 

We manufacture certain chemical compounds, including treprostinil-based compounds. We engage third-party manufacturers to make our cardiac monitoring devices and to formulate Remodulin. 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 (in thousands):

 

 

 

June 30,
2008

 

December 31,
2007

 

Remodulin:

 

 

 

 

 

Raw materials

 

$

1,778

 

$

3,364

 

Work-in-progress

 

8,008

 

4,782

 

Finished goods

 

5,015

 

4,615

 

Remodulin delivery pumps and other medical supplies

 

225

 

291

 

Cardiac monitoring equipment components and medical supplies

 

266

 

159

 

Total inventories

 

$

15,292

 

$

13,211

 

 

5.       GOODWILL AND OTHER INTANGIBLE ASSETS

 

Goodwill and other intangible assets comprised the following (in thousands):

 

 

 

As of June 30, 2008

 

As of December 31, 2007

 

 

 

Gross

 

Accumulated
Amortization

 

Net

 

Gross

 

Accumulated
Amortization

 

Net

 

Goodwill

 

$

7,465

 

$

 

$

7,465

 

$

7,465

 

$

 

$

7,465

 

Intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Technology and patents

 

$

4,532

 

$

(3,865

)

$

667

 

$

4,532

 

$

(3,570

)

$

962

 

 

Total amortization expense for the three-month periods ended June 30, 2008 and 2007, was approximately $147,000 and $155,000, respectively. Total amortization expense for the six-month periods ended June 30, 2008 and 2007, was approximately $294,000 and $310,000, 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,

 

 

 

2008

 

$

588

 

2009

 

112

 

2010

 

112

 

2011

 

112

 

2012

 

38

 

 

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6.       FAIR VALUE MEASUREMENTS

 

As of January 1, 2008, we adopted the FASB Statement No. 157, Fair Value Measurements (SFAS 157). SFAS 157 defines fair value, establishes a fair value hierarchy for assets and liabilities measured at fair value and requires expanded disclosures about fair value measurements. The SFAS 157 hierarchy ranks the quality and reliability of inputs, or assumptions, used in the determination of fair value and requires financial assets and liabilities carried at fair value to be classified and disclosed in one of the following three categories:

 

Level 1 – quoted prices in active markets for identical assets and liabilities;

Level 2 – inputs other than Level 1 quoted prices that are directly or indirectly observable;

Level 3 – unobservable inputs that are not corroborated by market data.

 

We have applied the provisions of SFAS 157 to financial assets and liabilities measured at fair value on our consolidated financial statements and have deferred the application of the provisions of SFAS 157 to our non-financial assets and liabilities in accordance with FASB Staff Position FAS 157-2, Effective Date of FASB Statement No. 157 (FSP FAS 157-2), issued in February 2008. FSP FAS 157-2 defers the effective date of SFAS 157 to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years for non-financial assets and liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually).  Our non-financial assets and liabilities measured at fair value for goodwill impairment assessment fall within the scope of this deferral as well as any impairment evaluations of other intangible assets pursuant to FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets .

 

We invest in student loan backed auction-rate securities that we classify as available-for-sale and record at fair value. Because of the recent deterioration in the credit markets, auctions for these securities have failed since the first quarter of 2008. Consequently, fair value measurements have been estimated using an income-approach model (discounted cash-flow analysis). The model considers factors that reflect assumptions that we believe market participants would use in pricing similar securities.  These assumptions include, among others, the collateral underlying the investments, the creditworthiness of the counterparty, expected future cash-flows, including the next time the security is expected to have a successful auction, and risks associated with the uncertainties of the current market.

 

As a result of the decline in fair value of our auction-rate securities, which we attribute to market-related liquidity issues rather than the issuers’ creditworthiness, approximately $655,000 and $2.4 million in unrealized losses have been included in accumulated other comprehensive income for the three- and six-month periods ended June 30, 2008, respectively. Our auction-rate securities are collateralized by student loan portfolios that are substantially guaranteed by the federal government and maintain a credit rating of AAA. We believe that credit markets for these securities will improve sufficiently to enable us to liquidate these securities without significant losses in the long term. In addition, we believe our current sources of working capital, exclusive of these securities, are sufficient to fund our ongoing operations and therefore, we possess the ability to hold these securities until they become more liquid. Accordingly, we classify these investments as non-current on our consolidated balance sheet at June 30, 2008. Any future fluctuations in fair value, including recoveries of previously unrealized losses relating to these investments, would be recorded as accumulated other comprehensive income. Any adjustments in fair value that we determine to be other-than-temporary would require us to recognize associated adjustments to earnings.

 

We evaluate financial assets and liabilities subject to fair value measurements on a recurring basis to determine the appropriate level at which to classify them for each reporting period. This determination requires us to make significant subjective judgments.

 

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As of June 30, 2008, financial assets and liabilities subject to fair value measurements were as follows (in thousands):

 

 

 

As of June 30, 2008

 

 

 

Level 1

 

Level 2

 

Level 3

 

Balance

 

Assets

 

 

 

 

 

 

 

 

 

Available-for-Sale Securities (1)

 

$

1,101

 

$

 

$

34,354

 

$

35,455

 

Investments in money market funds (2)

 

43,456

 

 

 

43,456

 

Investments in short-term commercial paper (2)

 

 

32,863

 

 

32,863

 

Investments in federally-sponsored and corporate debt
securities (3)

 

 

219,777

 

 

219,777

 

Total Assets

 

$

44,557

 

$

252,640

 

$

34,354

 

$

331,551

 

Liabilities

 

 

 

 

 

 

 

 

 

Convertible Senior Notes

 

$

354,969

 

$

 

$

 

$

354,969

 

 


(1)     Included in non-current marketable investments on the accompanying consolidated balance sheet

(2)     Included in cash and cash equivalents on the accompanying consolidated balance sheet

(3)     Included in current and non-current marketable investments on the accompanying consolidated balance sheet

 

The following table provides a reconciliation of the beginning and ending balances for the major class of assets measured at fair value using significant unobservable inputs (Level 3) for the three- and six-month periods ended June 30, 2008 (in thousands):

 

 

 

Available-
for-Sale
Securities

 

 

 

 

 

Balance on April 1, 2008

 

$

35,009

 

Transfers in and/or (out) of Level 3

 

 

Total losses realized/unrealized included in earnings

 

 

Total losses included in other comprehensive income

 

(655

)

Purchases, sales, issuances and settlements, net

 

 

Balance on June 30, 2008

 

$

34,354

 

 

 

 

Available-
for-Sale
Securities

 

 

 

 

 

Balance on January 1, 2008

 

$

 

Transfers in and/or (out) of Level 3 (1)

 

36,750

 

Total losses realized/unrealized included in earnings

 

 

Total losses included in other comprehensive income

 

(2,396

)

Purchases, sales, issuances and settlements, net

 

 

Balance on June 30, 2008

 

$

34,354

 

 


(1)    Since December 31, 2007, we have estimated the fair value of our auction-rate securities we classify as available-for-sale using a discounted cash flow model as there has been insufficient market data to determine the fair value of these securities due to the deterioration of related credit markets. Accordingly, we reclassified these securities from Level 2 to Level 3 within the SFAS 157 hierarchy.

 

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For the three and six months ended June 30, 2008, there were no gains or losses included in earnings that were attributable to the change in unrealized gains or losses related to Level 3 assets held at June 30, 2008.

 

7.       SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN

 

We maintain a supplemental executive retirement plan (SERP) that is administered by our Compensation Committee. Only members of a “select group of management or highly compensated employees” within the meaning of ERISA section 201(2) are eligible to participate in the SERP.  During the quarter ended March 31, 2008, a normal revaluation of the SERP was performed as a result of adding a new participant and finalizing 2008 salary levels for SERP participants.  The revaluation process included updating any assumptions used in the actuarial calculations.  There were no material changes in the assumptions used in the revaluation process from those used at December 31, 2007.

 

In December 2007, the Compensation Committee adopted the United Therapeutics Corporation Supplemental Executive Retirement Plan Rabbi Trust Document (the Rabbi Trust) entered into with the Wilmington Trust Company. The balance in the Rabbi Trust was approximately $5.1 million and $5.0 million at June 30, 2008 and December 31, 2007, respectively.  The Rabbi Trust is irrevocable and SERP participants will have no preferred claim on, nor any beneficial ownership interest in, any assets of the Rabbi Trust.  The investments in the Rabbi Trust are classified as restricted marketable investments and cash on our consolidated balance sheets.

 

The table below discloses the components of the periodic benefit cost (in thousands):

 

 

 

Three Months Ended 
June 30,

 

Six Months Ended 
June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Service cost

 

$

666

 

$

612

 

$

1,332

 

$

1,224

 

Interest cost

 

96

 

37

 

192

 

74

 

Amortization of prior period service costs

 

36

 

15

 

72

 

30

 

Net pension expense

 

$

798

 

$

664

 

$

1,596

 

$

1,328

 

 

8.       STOCKHOLDERS’ EQUITY

 

Earnings per Common Share

 

Basic earnings per common share is 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 is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period plus dilutive potential common shares including shares issuable upon the assumed exercise of outstanding stock options and warrants using the treasury stock method.

 

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,

 

 

 

2008

 

2007

 

2008

 

2007

 

Net income (numerator)

 

$

14,331

 

$

5,806

 

$

25,733

 

$

3,025

 

Shares (denominator):

 

 

 

 

 

 

 

 

 

Weighted average outstanding shares for basic EPS

 

22,600

 

20,837

 

22,467

 

21,069

 

Convertible Senior Notes (1)

 

572

 

 

522

 

 

Dilutive effect of stock options

 

1,156

 

1,183

 

1,131

 

1,150

 

Adjusted weighted average shares for diluted EPS

 

24,328

 

22,020

 

24,120

 

22,219

 

Earnings per share

 

 

 

 

 

 

 

 

 

Basic

 

$

0.63

 

$

0.28

 

$

1.15

 

$

0.14

 

Diluted

 

$

0.59

 

$

0.26

 

$

1.07

 

$

0.14

 

 

 

 

 

 

 

 

 

 

 

Stock options and warrants excluded from calculation (2)

 

4,554

 

4,381

 

4,504

 

4,378

 

 

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(1) Pursuant to FASB Statement No. 128, Earnings per Share , and related guidance, we cannot consider the impact of shares which we have the right to receive under the terms of our call spread option with Deutsche Bank AG London in the calculation of diluted earnings per share as these shares are considered antidilutive.  At June 30, 2008, we would have been entitled to receive approximately 522,000 shares of our common stock under the call spread option, which would have reduced the dilutive effect of the same number of shares issuable from the Convertible Senior Notes.  Shares of our common stock deliverable under the call spread option would have been acquired by Deutsche Bank AG London from the open market.

(2) Certain stock options and warrants were not included in the computation of diluted 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

 

We account for our equity-based awards pursuant to FASB Statement No. 123 (revised 2004), Share-Based Payment , (SFAS 123(R)) and interpretative literature within SEC Staff Accounting Bulletins Nos. 107 and 110.  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 these assumptions can materially affect the grant-date fair value of an award.

 

Presented below are the weighted-average assumptions used in valuing the stock options granted to employees during the three- and six-month periods ended June 30, 2008 and 2007:

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Expected volatility

 

42.31

%

39.25

%

42.29

%

39.96

%

Risk-free interest rate

 

3.1

%

4.9

%

3.1

%

4.6

%

Expected term of options

 

5.5 years

 

5.7 years

 

5.6 years

 

5.9 years

 

Expected dividend yield

 

0.0

%

0.0

%

0.0

%

0.0

%

Forfeiture rate

 

5.6

%

3.3

%

5.6

%

6.4

%

 

A summary of the status and activity of our employee stock options is presented below:

 

All Employee Options

 

Number of
Shares

 

Weighted
Average
Exercise
Price

 

Weighted Average
Remaining
Contractual
Term (Years)

 

Aggregate
Intrinsic
Value
(in 000s)

 

Outstanding at January 1, 2008

 

5,613,749

 

$

57.28

 

 

 

 

 

Granted

 

116,000

 

87.58

 

 

 

 

 

Exercised

 

(469,908

)

37.02

 

 

 

 

 

Forfeited

 

(150,563

)

60.76

 

 

 

 

 

Outstanding at June 30, 2008

 

5,109,278

 

59.72

 

7.3

 

$

194,323

 

Expected to vest at June 30, 2008

 

1,630,687

 

$

64.50

 

8.7

 

$

54,220

 

Exercisable at June 30, 2008

 

3,373,017

 

$

57.73

 

6.6

 

$

134,989

 

 

The weighted-average grant-date fair value of options granted during the six months ended June 30, 2008 and 2007, was $38.43 and $26.19, respectively.

 

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Table of Contents

 

Total employee share-based compensation expense recognized for the three and six months ended June 30, 2008 and 2007, is as follows (in thousands):

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Cost of service sales

 

$

14

 

$

33

 

$

29

 

$

65

 

Research and development

 

2,401

 

2,658

 

5,070

 

4,797

 

Selling, general and administrative

 

3,839

 

5,700

 

7,447

 

8,523

 

Share-based compensation expense before taxes

 

6,254

 

8,391

 

12,546

 

13,385

 

Related income tax benefits

 

(2,314

)

(2,975

)

(4,642

)

(4,746

)

Share-based compensation expense, net of taxes

 

$

3,940

 

$

5,416

 

$

7,904

 

$

8,639

 

Share-based compensation capitalized as part of inventory

 

$

261

 

$

 

$

456

 

$

29

 

 

A summary of option exercises is as follows (dollars in thousands):

 

 

 

Three Months Ended
June 30,

 

Six Months Ended 
June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Number of options exercised

 

264,487

 

234,544

 

499,804

 

528,747

 

Cash received

 

$

9,437

 

$

5,594

 

$

18,003

 

$

13,565

 

 

Shareholder Rights Plan

 

On June 30, 2008, we entered into an Amended and Restated Rights Agreement with The Bank of New York, as Rights Agent (the Plan), which amends and restates our original Rights Agreement, dated December 17, 2000. The Plan, as amended and restated, extends the expiration date of the Preferred Share Purchase Rights (Rights) from December 29, 2010, to June 26, 2018, and increases the purchase price of each Right from $129.50 to $800.00. Each Right entitles holders to purchase one one-thousandth of a share of our Series A Junior Participating Preferred Stock. Rights are exercisable only upon the acquisition of United Therapeutics by another company, or commencement of a tender offer that would result in ownership of 15 percent or more of the outstanding shares of our voting stock by a person or group (as defined under the Plan) without our prior express written consent. We have not issued any shares of our Series A Preferred Stock .

 

9.       SHARE TRACKING AWARDS PLAN

 

On June 2, 2008, our Board of Directors (the Board) adopted the United Therapeutics Corporation Share Tracking Awards Plan (STAP). The maximum number of awards that can be granted under the STAP, subject to adjustment for specified events, is 3,000,000. Awards under the STAP convey the right to receive an amount in cash equal to the appreciation in our common stock, which is calculated as the positive difference between the closing price of our common stock on the date of grant and the date of exercise.  The Compensation Committee of the Board (the Administrator) has the sole authority to determine award terms and to grant awards to STAP participants. Unless otherwise determined by the Administrator, awards generally vest in one-third increments on each of the first three anniversaries of the grant date and expire on the tenth anniversary of the grant date. Upon exercise of a vested award, participants are entitled to receive the appreciation in cash. The STAP does not permit awards to be settled through the issuance of our common stock. Any expired, canceled, or forfeited awards may be subsequently used for future grants. Our Board has the authority to amend, alter, or terminate the Plan at any time.

 

In accordance with SFAS 123(R), we account for and classify awards granted under the STAP as a liability, as they require us to pay cash to participants upon exercise. Accordingly, we estimate the fair value of the awards using the Black-Scholes-Merton valuation model and are required to re-measure the fair value of outstanding awards at each quarterly reporting date until settlement occurs or awards are otherwise no longer outstanding. The fair value of outstanding awards is recognized as a current liability on our consolidated balance sheet adjusted for the percentage of the requisite service period that has been rendered prior to the fulfillment of the vesting requirement. The change in the fair value of outstanding awards at each reporting period is recognized as compensation expense on our consolidated statement of operations.

 

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Table of Contents

 

In estimating the fair value of our share tracking awards, we are required to use subjective assumptions that can materially impact the estimation of fair value and related compensation. These assumptions include the expected volatility, risk-free interest rate, expected term of awards, expected forfeiture rate and the expected dividend yield. We also consider the impact of our credit risk when estimating the fair value of awards due to the Plan’s cash settlement provision.

 

A description of the key inputs used in estimating the fair value of share tracking awards is provided below:

 

Expected volatility —Volatility is a measure of the amount our common stock price has fluctuated (historical volatility) or is expected to fluctuate (expected volatility) during a period. We use historical volatility based on the weekly price observations of our common stock during the period immediately preceding an award that is equal to the expected term of an award (up to a maximum of five years). We believe the volatility in the price of our common stock over the past five years provides the best estimate of future long term volatility.

 

Risk-free interest rate —The risk-free interest rate is the average interest rate consistent with the yield available on a U.S. Treasury note with a term equal to the expected term of the underlying awards.

 

Expected term of awards —An award’s expected term reflects an estimation of the time period we expect an award to remain outstanding. We adopted SEC Staff Accounting Bulletins Nos. 107 and 110 regarding the use of the simplified method in developing an estimate of the expected term. We employ this methodology for estimating the expected life of awards until such time that historical exercise behavior can be established.

 

Expected forfeiture rate —The expected forfeiture rate is an estimated percentage of awards granted that are expected to be forfeited or cancelled on an annual basis prior to becoming fully vested. We derive our estimate based on historical forfeiture experience of our stock options for similar classes of employees. We expect forfeiture experience with respect to the Plan to be materially comparable to that of our stock options, which contain similar terms and conditions.

 

Expected dividend yield —We do not pay dividends on our common stock and do not expect to do so in the future. Therefore, the dividend yield is assumed to be zero.

 

The table below presents the assumptions used to re-measure the fair value of share tracking awards at June 30, 2008:

 

Expected volatility

 

41.9

%

Risk-free interest rate

 

3.5

%

Expected term of awards

 

6.0 years

 

Expected forfeiture rate

 

5.6

%

Expected dividend rate

 

0.0

%

 

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Table of Contents

 

A summary of the status and activity of the Plan is presented below:

 

 

 

Number 
of Awards

 

Weighted
Average
Exercise
Price

 

Weighted
Average
Remaining
Contractual
Term(Years)

 

Aggregate
Intrinsic Value
(in 000’s)

 

Outstanding at June 2, 2008 (effective date of the Plan)

 

 

$

 

 

 

 

 

Granted

 

727,481

 

94.07

 

 

 

 

 

Exercised

 

 

 

 

 

 

 

Forfeited

 

(2,276

)

94.07

 

 

 

 

 

Outstanding at June 30, 2008

 

725,205

 

$

94.07

 

9.9

 

$

2,669

 

 

 

 

 

 

 

 

 

 

 

Awards exercisable at June 30, 2008

 

 

$

 

 

$

 

Awards expected to vest at June 30, 2008

 

684,500

 

$

94.07

 

9.9

 

$

2,519

 

 

The weighted average fair value of each award granted from the period beginning June 2, 2008, the effective date of the Plan, and ending June 30, 2008, was $45.70.  As of June 30, 2008, we had approximately $30.4 million of unrecognized compensation cost related to unvested awards, which is expected to be recognized over a period of 2.9 years.  As we re-measure the fair value of outstanding awards at each reporting period, the amount of unrecognized compensation cost relating to unvested awards that we report may significantly vary from period to period.

 

Compensation expense of the Plan recognized during the period beginning June 2, 2008, and ending June 30, 2008, was as follows (in thousands):

 

Cost of service sales

 

$

2

 

Research and development

 

314

 

Selling, general and administrative

 

516

 

Share-based compensation expense before taxes

 

$

832

 

Related income tax benefits

 

(308

)

Share-based compensation expense, net of taxes

 

$

524

 

 

Compensation expense of the Plan capitalized as part of inventory during the period beginning June 2, 2008, and ending June 30, 2008, was $37,300.

 

10.    DEBT

 

Convertible Senior Notes

 

On October 30, 2006, we issued at par value $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. We pay interest in arrears semi-annually on April 15 and October 15 of each year, and these interest payments began April 15, 2007. The Convertible Senior Notes are unsecured, unsubordinated obligations and rank equally with all of our other unsecured and unsubordinated indebtedness. The initial conversion price is $75.2257 per share.  Conversion can occur:  (i) anytime after July 15, 2011; (ii) during any calendar quarter commencing after the date of original issuance of the

 

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Table of Contents

 

Convertible Senior 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 Convertible Senior 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 Convertible Senior 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 (NASDAQ) 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.

 

The closing price of our common stock exceeded 120% of the conversion price for more than 20 trading days in the period of 30 consecutive trading days ending on June 30, 2008 and December 31, 2007. As a result, the holders of our Convertible Senior Notes had the right to convert their notes. As this conversion right is outside of our control, the Convertible Senior Notes have been classified as a current liability on our consolidated balance sheets as of June 30, 2008 and December 31, 2007.  The conversion contingency is calculated at the end of each quarterly reporting period; therefore, we may have classification changes due to the results of this contingent measurement.

 

In March 2008, we received notification that a holder elected to convert $22,000 of the Convertible Senior Notes.  In accordance with the terms of the Convertible Senior Notes, settlement occurred in May 2008.

 

As of June 30, 2008, the fair value of the Convertible Senior Notes outstanding was approximately $355.0 million, based on the quoted market price.

 

Interest Expense

 

Details of interest incurred have been presented below (in thousands):

 

 

 

Three Months Ended 
June 30,

 

Six Months Ended 
June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Interest expense

 

$

710

 

$

713

 

$

1,419

 

$

1,424

 

 

 

 

 

 

 

 

 

 

 

Capitalized interest (1)

 

$

(710

)

 

(1,419

)

 

Total

 

$

 

$

713

 

$

 

$

1,424

 

 


(1) Interest associated with the construction of our facilities in Maryland and North Carolina.

 

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Table of Contents

 

11.    COMPREHENSIVE INCOME

 

FASB Statement No. 130, Reporting Comprehensive Income, (SFAS 130), establishes standards for the reporting and display of comprehensive income and its components. SFAS 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, 2008 and 2007, respectively (in thousands):

 

 

 

Three Months Ended 
June 30,

 

Six Months Ended 
June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Net income

 

$

14,331

 

$

5,806

 

$

25,733

 

$

3,025

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

Foreign currency translation gain (loss) adjustment

 

(206

)

161

 

(356

)

176

 

Unrecognized prior period pension service cost, net of tax

 

23

 

10

 

(461

)

(474

)

Unrecognized actuarial pension loss, net of tax

 

 

 

(227

)

(167

)

Unrealized gain (loss) on available-for-sale securities, net of tax

 

(184

)

2,444

 

(1,300

)

2,785

 

Comprehensive income

 

$

13,964

 

$

8,421

 

$

23,389

 

$

5,345

 

 

12.    PROJECT TERMINATION COST

 

In December 2007, we announced the completion of our IMPACT I and II phase III clinical trials of OvaRex ® MAb (OvaRex) for ovarian cancer. The results of the studies did not show statistical significance. As such, we terminated our license agreement with AltaRex Medical Corp. and discontinued further development of the entire platform of antibodies licensed thereunder, including OvaRex. We expect to incur approximately $2.0 million of associated termination costs, comprising principally employee severance costs, termination benefits and contract exit costs. Payment of employee severance costs and termination benefits began in February 2008. We incurred project termination costs of approximately $1.1 million for the six-months ended June 30, 2008.

 

The following table provides a reconciliation of accrued termination benefits as of June 30, 2008 (in thousands):

 

Balance at December 31, 2007

 

$

524

 

Add:

 

 

 

Severance benefits

 

518

 

Less:

 

 

 

Payments

 

(711

)

Balance at June 30, 2008

 

$

331

 

 

13.    INCOME TAXES

 

Income tax expense for the three- and six-month periods ended June 30, 2008 and 2007, 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 for the year are revised. The effective tax rates for the three- and six-month periods ended June 30, 2008 and 2007, were approximately 37 percent and 35 percent, respectively.

 

As of June 30, 2008, we had available for federal income tax purposes approximately $12.6 million in net operating loss carryforwards and approximately $73.3 million in business tax credit carryforwards. These carryforwards expire at various dates through 2024. We are conducting a study to determine whether any limitations under Section 382 of the Internal Revenue Code had been triggered through December 31, 2007. Results of prior studies indicated that multiple limitations were triggered through November 2004. Consequently, portions of our carryforwards that were generated prior to November 2004 will be subject to certain limitations on their use. We do not believe that these limitations will cause our net operating loss and general business credit carryforwards to expire unused.

 

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Table of Contents

 

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 jurisdictions that remain subject to examination relate to our filings in years ranging from 2002 to 2007.  There have been no material changes to our unrecognized tax positions identified at December 31, 2007, and we do not believe there will be any material changes over the next twelve months.

 

14.    SEGMENT INFORMATION

 

We have two reportable business segments: pharmaceutical and telemedicine.  The pharmaceutical segment includes all activities associated with the research, development, manufacturing and commercialization of our therapeutic products. The telemedicine segment includes all activities associated with the development and manufacturing 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 therapeutic products.

 

Segment information as of and for the three- and six-month periods ended June 30, 2008 and 2007, was as follows (in thousands):

 

 

 

Three Months Ended June 30,

 

 

 

2008

 

2007

 

 

 

Pharmaceutical

 

Telemedicine

 

Consolidated
Totals

 

Pharmaceutical

 

Telemedicine

 

Consolidated
Totals

 

Revenues from external customers

 

$

66,104

 

$

2,452

 

$

68,556

 

$

49,992

 

$

1,839

 

$

51,831

 

Income before income tax

 

22,380

 

188

 

22,568

 

8,841

 

71

 

8,912

 

Interest income

 

2,804

 

 

2,804

 

1,936

 

2

 

1,938

 

Interest expense

 

 

 

 

(713

)

 

(713

)

Depreciation and amortization

 

(907

)

(121

)

(1,028

)

(702

)

(94

)

(796

)

Equity loss in affiliate

 

(43

)

 

(43

)

(79

)

 

(79

)

Total investment in equity method investees

 

1,091

 

 

1,091

 

1,375

 

 

1,375

 

Expenditures for long-lived assets

 

(33,676

)

(34

)

(33,710

)

(4,842

)

(11

)

(4,853

)

Goodwill, net

 

1,287

 

6,178

 

7,465

 

1,287

 

6,178

 

7,465

 

Total assets

 

666,812

 

13,006

 

679,818

 

460,498

 

11,296

 

471,794

 

 

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Table of Contents

 

 

 

Six Months Ended June 30,

 

 

 

2008

 

2007

 

 

 

Pharmaceutical

 

Telemedicine

 

Consolidated
Totals

 

Pharmaceutical

 

Telemedicine

 

Consolidated
Totals

 

Revenues from external customers

 

$

125,861

 

$

4,742

 

$

130,603

 

$

88,275

 

$

3,725

 

$

92,000

 

Income before income tax

 

40,145

 

380

 

40,525

 

4,563

 

123

 

4,686

 

Interest income

 

6,412

 

 

6,412

 

5,976

 

7

 

5,983

 

Interest expense

 

 

 

 

(1,424

)

 

(1,424

)

Depreciation and amortization

 

(1,765

)

(237

)

(2,002

)

(1,438

)

(183

)

(1,621

)

Equity loss in affiliate

 

(156

)

 

(156

)

(193

)

 

(193

)

Total investment in equity method investees

 

1,091

 

 

1,091

 

1,375

 

 

1,375

 

Expenditures for long-lived assets

 

(46,491

)

(412

)

(46,903

)

(12,816

)

(28

)

(12,844

)

Goodwill, net

 

1,287

 

6,178

 

7,465

 

1,287

 

6,178

 

7,465

 

Total assets

 

666,812

 

13,006

 

679,818

 

460,498

 

11,296

 

471,794

 

 

When combined, the segment information shown above agrees with the totals reported in the consolidated financial statements.  There are no inter-segment transactions.

 

For each of the three- and six-month periods ended June 30, 2008 and 2007, revenues from our three U.S.-based distributors represented approximately 83 to 85 percent of our total net revenues.

 

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 elsewhere in this Quarterly Report. 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, 2007, 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 unique products to address the unmet medical needs of patients with chronic and life-threatening cardiovascular and infectious diseases and cancer. We began operations in June 1996 and, since our inception, have devoted substantially all of our resources to acquisitions and research and development programs.

 

Our key therapeutic platforms are:

 

·       Prostacyclin analogs, which are stable synthetic forms of prostacyclin, an important molecule produced by the body that has powerful effects on blood vessel health and function;

 

·       Glycobiology antiviral agents, which are a class of small molecules that have shown pre-clinical indications of efficacy against a broad range of viruses, such as hepatitis C; and

 

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·       Monoclonal antibodies, which are antibodies that are being developed to treat cancer.

 

We focus most of our resources on these three key platforms. We also devote resources to the commercialization and development of telemedicine products and services, principally for the detection of cardiac arrhythmias.

 

We began earning pharmaceutical revenues in 2002 after receiving approval from the U.S. Food and Drug Administration (FDA) for Remodulin® (treprostinil sodium) Injection (Remodulin) our lead product, to be administered via subcutaneous (under the skin) infusion to treat pulmonary arterial hypertension (PAH). In 2004, we received FDA approval for Remodulin to be administered by intravenous (in the vein) infusion.  The FDA expanded its approval of Remodulin in 2006 for the treatment of patients transitioning from Flolan ® .  Remodulin is also approved in many other countries throughout the world for similar uses. Marketing authorization applications are currently under review in other countries.  On June 27, 2008, we filed a new drug application (NDA) with the FDA for our inhaled treprostinil formulation.

 

Revenues

 

We derive substantially all of our revenue from the sales of Remodulin.

 

Our sales and marketing team consisted of approximately 80 employees as of June 30, 2008, compared to 30 employees as of June 30, 2007.  We anticipate further growth in our sales and marketing force during 2008.  Our sales force is divided into two groups. The first group is primarily responsible for national and large regional medical practice accounts currently or historically prescribing Remodulin. The second group is primarily responsible for smaller, local, community-oriented medical practices not historically prescribing Remodulin. Our distributors supplement the efforts of our sales force. We face stiff competition from other companies that market and sell competing therapies and expect the competition to increase.

 

Remodulin is sold to patients in the United States by our distributors: Accredo Therapeutics, Inc., CuraScript, Inc., and Caremark, Inc. We also engage various international distributors to sell Remodulin outside the United States.  We sell Remodulin in bulk shipments to these distributors. Because discontinuation of our therapy can be life-threatening to patients, we require distributors to maintain minimum contingent inventory levels. Due to the minimum inventory requirements provided under our distributor agreements, 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 our distributors are affected 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 affected by the timing and magnitude of these bulk distributor orders. Bulk distributor orders are based on our distributors’ estimates of future demand and contractual requirements to maintain specific contingent inventory levels.

 

In addition to revenues derived from the sale of Remodulin, we have generated revenues from telemedicine products and services. Telemedicine products and services are for patients in the United States and are primarily designed to detect abnormal heart rhythms, called cardiac arrhythmias, and ischemic heart disease, a condition that causes poor blood flow to the heart.

 

Expenses

 

 Our operating expenses consist primarily of research and development, selling, general and administrative, cost of product sales and cost of service sales.  Since our inception, we devoted substantially all of our resources to acquisitions and to research and development programs.  Subsequent to receiving FDA approval of Remodulin in 2002, we have funded our operations mainly from collections generated from the sales of our products and services.

 

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Major Research and Development Projects

 

Our major research and development projects are focused on the use of treprostinil to treat cardiovascular diseases, glycobiology antiviral agents (a novel class of small sugar-like molecules) to treat infectious diseases, and monoclonal antibodies to treat a variety of cancers.

 

Cardiovascular Disease Projects

 

Since receiving FDA approval for the subcutaneous use of Remodulin in 2002, we have generated significant revenues from the resulting sales of Remodulin for PAH. In November 2004, the FDA approved the 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.

 

We are developing an inhaled formulation of treprostinil sodium for the treatment of PAH. In June 2005, we commenced a 12-week randomized, double-blind, placebo-controlled Phase III trial of inhaled treprostinil in patients with PAH who were also being treated with Tracleer ® , an oral endothelin receptor antagonist, or Revatio ® , a PDE-5 inhibitor. This trial, TRIUMPH-1 ( TR eprostinil I nhalation U sed in the M anagement of P ulmonary Arterial H ypertension), was conducted at approximately 36 centers in the United States and Europe. In November 2007, we announced the completion of our TRIUMPH-1 trial. The study population consisted of 235 patients. Analysis of the TRIUMPH-1 results demonstrated a highly statistically significant improvement in median six minute walk distance of approximately 20 meters (p<0.0005, using the Hodges-Lehmann estimate and non-parametric analysis of covariance in accordance with the trial’s pre-specified statistical analysis plan), in patients receiving inhaled treprostinil compared to patients receiving placebo.

 

We filed an NDA on June 27, 2008, to obtain FDA approval to market inhaled treprostinil in the United States.  The Optineb ®  inhalation device, the ultra-sonic nebulizer that was exclusively used for administration of inhaled treprostinil in the TRIUMPH-1 trial, was submitted for approval as part of this filing.  Optineb is manufactured by NEBU-TEC International Med Products Eike Kern GmbH (NEBU-TEC), a German company. Optineb is CE-marked in Europe, which means that NEBU-TEC has declared that the device conforms with European Union health and safety requirements. FDA standard review of an NDA generally takes 10 to 12 months. We plan on filing for approval in the European Union using the centralized filing process by the end of 2008.

 

We began planning an open-label study where patients on Ventavis ® , the only currently approved inhaled prostacyclin, will be switched to inhaled treprostinil in the United States. The study is expected to start in late 2008 and will continue through the FDA regulatory approval process for inhaled treprostinil, which is expected to be completed by mid-2009.

 

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 Phase III trials that study both dosing and efficacy.  The FREEDOM-C trial is a 16-week study of approximately 300 patients currently on approved background therapy using a PDE-5 inhibitor, such as Revatio ® , or an endothelin receptor antagonist, such as Tracleer ® , or a combination of both.  On May 16, 2008, we completed enrollment for the FREEDOM-C trial at 354 patients.  We expect to announce the preliminary results of the FREEDOM-C trial in the fourth quarter of 2008.  The FREEDOM-M trial is a 12-week study of approximately 150 patients, who are not on any background therapy. Both trials are being conducted at approximately 60 centers throughout the United States and the rest of the world. As of June 30, 2008, there were approximately 125 patients enrolled in the FREEDOM-M trial. As of July 29, 2008, there were approximately 128 patients enrolled in the FREEDOM-M trial.

 

We are in the early planning stages of designing a dose-ranging study for oral treprostinil to commence later in 2008 upon the completion of both FREEDOM trials. This dose-ranging study will explore the relationship of dose and therapeutic effect.

 

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We are developing a modified release formulation of beraprost (beraprost-MR) for PAH. Beraprost-MR is an oral prostacyclin analog.  In March 2007, Lung Rx amended its agreement with Toray Industries, Inc. (Toray) to assume and amend the rights and obligations of the June 2000 agreement between Toray and us concerning the commercialization of beraprost-MR.  Lung Rx is planning a Phase II clinical study to explore multiple-dose tolerability in PAH patients and a Phase III clinical trial to evaluate the efficacy of beraprost-MR for the treatment of PAH.  In October 2007, Toray announced that beraprost-MR received regulatory approval in Japan for the use in the treatment of PAH.  In July 2008, beraprost-MR was granted Orphan Medicinal Product Designation by the European Medicines Agency.

 

We incurred expenses of approximately $11.9 million and $9.3 million during the three months ended June 30, 2008 and 2007, respectively, and $26.7 million and $16.1 million during the six months ended June 30, 2008 and 2007, respectively, on our cardiovascular programs. We have spent approximately $259.1 million from inception to date on our cardiovascular programs.

 

Infectious Disease Projects

 

We are in the planning stages of conducting a Phase II clinical trial with miglustat to evaluate efficacy against hepatitis C. Miglustat is a glycobiology compound that inhibits the ability of viruses to replicate and is approved and currently marketed in the United States and Europe by Actelion Ltd for the treatment of Gaucher’s disease, a glycolipid storage disorder. Patent protection for manufacturing the compound has expired. As a result of our research agreement with the University of Oxford, we have the exclusive right to commercialize miglustat as an anti-viral agent for the treatment of hepatitis C. Our infectious disease program also includes glycobiology antiviral drug candidates in various preclinical and clinical stages of testing for the treatment of a wide variety of viruses. Through our agreement with Oxford University, we are also supporting research into new glycobiology antiviral drug candidates and technologies. We incurred expenses of approximately $220,000 and $200,000 during the three months ended June 30, 2008 and 2007, respectively, and $485,000 and $345,000 during the six months ended June 30, 2008 and 2007, respectively, on infectious disease projects.  We have spent approximately $37.0 million from inception to date on our infectious disease programs.

 

Cancer Disease Projects

 

In December 2007, we announced the completion of our IMPACT I and II pivotal trials of OvaRex ®  MAb (OvaRex), which we had exclusively licensed from AltaRex Medical Corp. (AltaRex). Results of the studies failed to reach statistical significance. The studies showed no difference between active (standard of care followed by OvaRex) and control (standard of care followed by placebo) populations. The results of IMPACT I and II were consistent with each other.

 

Based on the results of the IMPACT I and II trials, we terminated our license agreement with AltaRex and discontinued further development of our entire platform of monoclonal antibodies. We expect to incur approximately $2.0 million in total close-out costs for this program, of which we incurred approximately $1.1 million during the six months ended June 30, 2008.

 

In December 2007, we entered into two agreements with Memorial Sloan-Kettering Cancer Center (MSKCC) to exclusively license certain rights to two investigational monoclonal antibodies (3F8 and 8H9) for the treatment of neuroblastoma and metastatic brain cancer. The monoclonal antibody 3F8 is a mouse IgG3 MAb, which is currently used in an investigational setting for the treatment of neuroblastoma, a rare cancer of the sympathetic nervous system mainly affecting children. 8H9 is also a mouse monoclonal antibody, but of the IgG1 subclass. The 8H9 antibody is highly reactive with a range of human solid tumors, including brain cancers. The 8H9 antibody is in early investigational development for metastatic brain cancer. We expect to begin clinical development of these antibodies during 2008.

 

We incurred expenses of approximately $177,000 and $4.1 million during the three months ended June 30, 2008 and 2007, respectively, and $1.1 million and $7.0 million during the six months ended June 30, 2008 and 2007, respectively, on cancer projects. We spent approximately $57.9 million from inception to date on our cancer programs.

 

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Selling, general and administrative expenses

 

Selling, general and administrative expenses consist primarily of salaries and related expenses including share-based compensation expense for corporate and marketing personnel, travel, office expenses, insurance, rent and utilities, professional fees, advertising and marketing and depreciation and amortization.

 

Cost of product sales

 

Cost of product sales consists of the cost to manufacture or acquire products that are sold to customers. We manufacture treprostinil using advanced intermediate compounds purchased in bulk from third-party vendors. We have contracted with multiple vendors that have the capability to manufacture greater quantities of these compounds less expensively than if we did so ourselves. We expect to begin commercial production of treprostinil in 2008 in our new facility in Silver Spring, Maryland, coincident with the expected FDA approval of the facility. We anticipate that, upon commercialization of oral treprostinil, the need for treprostinil diethanolamine, the form of treprostinil used in our tablet, will be greater than the need for treprostinil sodium, the form of treprostinil used in Remodulin and inhaled treprostinil. Accordingly, our manufacturing process will give us the flexibility to produce both forms of treprostinil efficiently in proportion to demand.

 

Cost of service sales

 

Cost of service sales consists of the salaries, share-based compensation expense, and related overhead necessary to provide telemedicine services to customers.

 

Future Prospects

 

We have experienced annual revenue growth in excess of 30 percent each year since Remodulin was approved in 2002. Continued growth at this rate is contingent upon future commercial development of products in our pipeline. One of our goals is to expand the use of treprostinil-based drugs to treat patients at earlier stages of the PAH disease pathway. In other words, our goal is to extend the use of treprostinil from the last line of treatment for the sickest patients to front-line therapy for newly diagnosed patients.

 

On June 27, 2008, we submitted an NDA to the FDA for marketing approval of inhaled treprostinil.  If we are successful in obtaining FDA approval within our anticipated time frame, then we expect to begin selling inhaled treprostinil in 2009. We are in the later stages of development of our oral treprostinil formulation and expect to have results of our FREEDOM-C trial in late 2008. If this trial proves successful, we expect to file for approval with the FDA in 2009, and begin selling oral treprostinil in 2010, assuming a standard FDA review time period.  In addition, we intend to sign new distribution agreements for the inhaled and oral formulations of treprostinil.

 

Our trial for the inhaled formulation of treprostinil was successful and we believe that our trial for the oral formulation of treprostinil will be successful and will lead to products that generate revenues. However, for inhaled and/or oral treprostinil, we could be required to perform additional studies that would delay filing, approval and commercialization of these products. This could impede continued revenue growth at our historic rates. We believe that delays, if they occur, should not reduce revenue growth related to Remodulin. Because PAH is a progressive disease with no cure, many patients continue to deteriorate on the currently approved oral and inhaled therapies. Therefore, we believe that the market for Remodulin will continue to expand as more patients are diagnosed with PAH.

 

While we have been profitable annually since 2004, we have incurred quarterly losses. Future profitability will depend on many factors.  These factors include, but are not limited to, the selling prices of, and demand for our products and services, the degree of reimbursement by public and private insurance organizations, and the competition we face from others within our industry.

 

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We generate substantially all of our revenues from the sales of Remodulin products in the United States and in other countries.  Other sources of revenues include arginine royalties on related sales in the United States and abroad and sales of telemedicine products and services primarily designed for patients in the United States.

 

Financial Position

 

Cash, cash equivalents and marketable investments (excluding all restricted amounts) at June 30, 2008, were $342.7 million, compared to approximately $299.8 million as of December 31, 2007.  This increase resulted from the continued growth in sales of Remodulin.

 

Restricted cash and marketable investments of $45.0 million at June 30, 2008, comprise roughly $39.9 million pledged as security for our financing arrangements related to our Silver Spring, Maryland, laboratory facility and approximately $5.1 million placed in a Rabbi Trust to fund our Supplemental Executive Retirement Plan.

 

Property, plant and equipment at June 30, 2008, was approximately $115.7 million, up $46.3 million from approximately $69.4 million at December 31, 2007.  Since December 31, 2007, we have funded approximately $41.5 million toward the construction of our facilities in North Carolina and Maryland.

 

Accounts payable rose approximately $12.8 million from $2.0 million at December 31, 2007, to $14.8 million at June 30, 2008. This increase reflects the timing of payments to our vendors and increased activity with respect to our construction projects.

 

Accrued expenses were $24.8 million at June 30, 2008, compared to $17.9 million at December 31, 2007.  The increase in accrued expenses primarily corresponds to (1) increases in bonus and payroll-related expenses, (2) increases in royalties due on sales of Remodulin, and (3) increases in clinical expenses related to our oral treprostinil program.

 

Stockholders’ equity was approximately $363.4 million at June 30, 2008, up approximately $67.6 million from $295.8 million at December 31, 2007. During the six months ended June 30, 2008, we received approximately $18.0 million in proceeds from the exercise of stock options, recognized approximately $14.2 million in equity-based compensation and recorded approximately $25.7 million in net earnings.

 

Results of Operations

 

Three months ended June 30, 2008 and 2007

 

Revenues for the three months ended June 30, 2008, were approximately $68.6 million, compared to approximately $51.8 million for the three months ended June 30, 2007.

 

The following table sets forth our revenues by source (dollars in thousands):

 

 

 

Three Months Ended 
June 30,

 

 

 

2008

 

2007

 

Percentage
Change

 

Remodulin

 

$

65,427

 

$

49,177

 

33.0

%

Telemedicine services and products

 

2,451

 

1,839

 

33.2

%

Other products

 

12

 

148

 

(91.9

)%

Distributor fees

 

666

 

667

 

0.0

%

Total revenues

 

$

68,556

 

$

51,831

 

32.3

%

 

For the three months ended June 30, 2008 and 2007, approximately 88 percent and 89 percent of our net Remodulin 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

 

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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 estimate our obligation 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.

 

The table below presents a reconciliation of the liability accounts associated with estimated government rebates and prompt pay discounts and the net amount of reductions to revenues for these items (in thousands):

 

 

 

Three Months Ended 
June 30,

 

 

 

2008

 

2007

 

Liability accounts, at beginning of period

 

$

3,450

 

$

2,309

 

Additions to liability attributed to sales in:

 

 

 

 

 

Current period

 

3,518

 

3,227

 

Prior period

 

 

88

 

Payments or reductions attributed to sales in:

 

 

 

 

 

Current period

 

(3,560

)

(610

)

Prior period

 

 

(2,143

)

Liability accounts, at end of period

 

$

3,408

 

$

2,871

 

Net reductions to revenues

 

$

3,518

 

$

3,315

 

 

The table below summarizes research and development expense by major project and non-project components (dollars in thousands):

 

 

 

Three Months Ended 
June 30,

 

Percentage

 

 

 

2008

 

2007

 

Change

 

Project and non-project:

 

 

 

 

 

 

 

Cardiovascular

 

$

11,890

 

$

9,269

 

28.3

%

Cancer

 

177

 

4,061

 

(95.6

)%

Infectious disease

 

220

 

200

 

10.0

%

Share-based compensation

 

3,313

 

2,981

 

12.7

%

Other

 

3,541

 

1,459

 

142.7

%

Total research and development expense

 

$

19,141

 

$

17,970

 

6.5

%

 

The increase in cardiovascular expenses was primarily due to increased expenses of approximately $838,000 and approximately $563,000 related to our inhaled and oral treprostinil programs, respectively.

 

In December 2007, we announced the termination of our ovarian cancer program based on the results of the IMPACT I and II clinical trials of OvaRex.  Consequently, our expenditures for the three months ended June 30, 2008 related to our cancer projects were lower compared to those for the three months ended June 30, 2007.

 

The increase in the other expenses is primarily due to an increase in personnel related costs not allocable to the major projects listed above.

 

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The table below summarizes selling, general and administrative expenses by major category (dollars in thousands):

 

 

 

Three Months Ended 
June 30,

 

Percentage 

 

 

 

2008

 

2007

 

Change

 

Category:

 

 

 

 

 

 

 

General and administrative

 

$

9,444

 

$

9,066

 

4.2

%

Sales and marketing

 

9,316

 

5,708

 

63.2

%

Share-based compensation

 

4,333

 

5,700

 

(24.0

)%

Total selling, general and administrative expense

 

$

23,093

 

$

20,474

 

12.8

%

 

The increase in sales and marketing related expenses reflects increases in salary and related expenses of approximately $1.4 million as a result of increased headcount.  In addition, we incurred expenditures of approximately $1.6 million related to new marketing campaigns and initiatives.

 

During the three-months ended June 30, 2007, we recognized approximately $2.3 million in share-based compensation relating to the fair value of potential year-end stock option grants to our Chief Executive Officer in accordance with her employment agreement.  We did not recognize comparable share-based compensation during the three months ended June 30, 2008.

 

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 percent of net product sales for the three-month periods ended June 30, 2008, and June 30, 2007. Cost of service sales was approximately 32 percent of service sales for the three months ended June 30, 2008, as compared to approximately 31 percent for the three months ended June 30, 2007.

 

We recognized income tax expense of approximately $8.2 million for the three months ended June 30, 2008, compared to $3.1 million for the three months ended June 30, 2007. 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 estimates of pre-tax income for the year are revised. The estimated tax rates for the three months ended June 30, 2008 and 2007, were approximately 37 percent and 35 percent, respectively.

 

Six months ended June 30, 2008 and 2007

 

Revenues for the six months ended June 30, 2008, were approximately $130.6 million, compared to approximately $92.0 million for the six months ended June 30, 2007.

 

The following table sets forth our revenues by source (dollars in thousands):

 

 

 

Six Months Ended 
June 30,

 

 

 

2008

 

2007

 

Percentage
Change

 

Remodulin

 

$

124,500

 

$

87,327

 

42.6

%

Telemedicine services and products

 

4,741

 

3,725

 

27.3

%

Other products

 

29

 

281

 

(89.7

)%

Distributor fees

 

1,333

 

667

 

99.9

%

Total revenues

 

$

130,603

 

$

92,000

 

42.0

%

 

For the six months ended June 30, 2008 and, 2007, approximately 88 percent and 87 percent of our net Remodulin revenues, respectively, were earned from our three distributors located in the United States.

 

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The table below presents a reconciliation of the liability accounts associated with estimated government rebates and prompt pay discounts and the net reductions to revenues for these items (in thousands):

 

 

 

Six Months Ended 
June 30,

 

 

 

2008

 

2007

 

Liability accounts, at beginning of period

 

$

2,878

 

$

2,366

 

Additions to liability attributed to sales in:

 

 

 

 

 

Current period

 

7,468

 

5,778

 

Prior period

 

129

 

264

 

Payments or reductions attributed to sales in:

 

 

 

 

 

Current period

 

(4,382

)

(1,043

)

Prior period

 

(2,685

)

(4,494

)

Liability accounts, at end of period

 

$

3,408

 

$

2,871

 

Net reductions to revenues

 

$

7,597

 

$

6,042

 

 

The table below summarizes research and development expense by major project and non-project components (dollars in thousands):

 

 

 

Six Months Ended 
June 30,

 

 

 

 

 

2008

 

2007

 

Percentage
Change

 

Project and non-project:

 

 

 

 

 

 

 

Cardiovascular

 

26,672

 

$

19,050

 

40.0

%

Cancer

 

1,100

 

6,951

 

(84.2

)%

Infectious disease

 

484

 

345

 

40.3

%

Share-based compensation

 

6,580

 

5,554

 

18.5

%

R&D expense from issuance of common stock

 

 

11,013

 

(100.0

)%

Other

 

5,381

 

3,171

 

70.0

%

Total research and development expense

 

$

40,217

 

$

46,084

 

(12.7

)%

 

The increase in cardiovascular expenses was primarily due to increased expenses of approximately $3.4 million and approximately $1.7 million related to our inhaled and oral treprostinil programs, respectively.

 

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In December 2007, we announced the termination of our ovarian cancer program based on the results of the IMPACT I and II clinical trials of OvaRex.  Consequently, our expenditures for the six months ended June 30, 2008, related to our cancer projects were lower compared to those for the six months ended June 30, 2007.

 

The increase in the other expenses is primarily due to an increase in personnel related costs not allocable to the major projects listed above.

 

The research and development expense from issuance of common stock pertains to the 200,000 shares of our common stock issued to Toray in March 2007 in connection with our amended beraprost-MR license.

 

The table below summarizes selling, general and administrative expenses by major category (dollars in thousands):

 

 

 

Six Months Ended 
June 30,

 

 

 

 

 

2008

 

2007

 

Percentage
Change

 

Category:

 

 

 

 

 

 

 

General and administrative

 

$

18,282

 

$

16,705

 

9.4

%

Sales and marketing

 

16,201

 

10,410

 

55.6

%

Share-based compensation

 

7,941

 

8,523

 

(6.8

)%

Total selling, general and administrative expense

 

$

42,424

 

$

35,638

 

19.0

%

 

The increase in general and administrative expenses reflects primarily increases in salaries and related expenses of approximately $1.5 million as a result of increased headcount.  Sales and marketing related expenses rose as a result of increases in salaries and related expenses of approximately $2.3 million from an increase in headcount.  In addition, costs associated with new marketing campaigns and initiatives rose by approximately $2.2 million in the current period.

 

Cost of product sales was approximately 10 percent of net product sales for the six-month periods ended June 30, 2008 and 2007. Cost of service sales was approximately 32 percent of service sales for the six-month periods ended June 30, 2008 and 2007.

 

We recognized income tax expense of approximately $14.8 million for the six months ended June 30, 2008, compared to approximately $1.7 million for the six months ended June 30, 2007. The income tax provision is based on the estimated annual effective tax rate for the entire year. The estimated annual effective tax rate is subject to adjustment in subsequent quarterly periods as estimates of pre-tax income for the year are revised. The estimated tax rates for the six months ended June 30, 2008 and 2007, were approximately 37 percent and 35 percent, respectively.

 

Liquidity and Capital Resources

 

Until May 2002, we used the proceeds received from sales of our common stock to fund the majority of our operations.  Subsequently, we have funded our operations primarily from Remodulin-related revenues, and expect to continue to do so. We believe that our existing revenues and working capital resources consisting 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 Part II, Item 1A—Risk Factors—We have a history of losses and may not continue to be profitable and Part II,   Item 1A—Risk Factors—We may fail to meet third party projections for our revenue or profits.

 

Net cash provided by operating activities was approximately $66.4 million for the six months ended June 30, 2008, as compared to approximately $33.9 million for the six months ended June 30, 2007. The increase in cash provided by operating activities is due primarily to growth in sales of Remodulin.

 

At June 30, 2008, we had a working capital deficit of approximately $10.6 million compared to working capital of approximately $79.7 million at December 31, 2007.  The decrease in working capital reflects the use of approximately $60.1 million of our cash to invest in long-term marketable investments and spending approximately $41.5 million towards the construction of our laboratory and office facilities in North Carolina and Maryland.  Our working capital deficit at June 30, 2008, does not indicate a lack of liquidity.  We maintain adequate levels of liquid assets to satisfy our current obligations as they become due.  Furthermore, our expectation, based on our understanding of the

 

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historical behavior of holders of convertible notes with terms similar to ours, is that our 0.50% Convertible Senior Notes due October 2011 (Convertible Senior Notes) will continue to be held until they mature in October 2011.  Based on this assumption, we believe that, as of June 30, 2008, we have approximately $239.4 million of working capital available for operating needs.

 

At June 30, 2008, we held approximately $34.4 million of investments (net of approximately $2.4 million in unrealized losses) in noncurrent municipal notes with an auction reset feature (auction-rate securities). The underlying assets of these investments are student loans that are substantially backed by the federal government.  Since February 2008, auctions have failed for all of our auction-rate securities. As a result, our ability to liquidate and fully recover the carrying value of our auction-rate securities in the near term is limited. An auction failure occurs when the volume of sellers exceed buyers. All of our auction-rate securities are currently rated AAA.  If the issuers are unable to successfully close future auctions and their credit ratings deteriorate, we may be required to record an impairment charge on these investments. We anticipate that we will be able to liquidate our investments without significant losses in the long term and have the ability hold these securities until market conditions improve.  We believe these securities are not impaired, primarily due to the government guarantee of the underlying securities; however, it could take until the final maturity of the underlying notes (up to 30 years) to realize our investments’ recorded value. Based on our expected operating cash flows, and our other sources of funding, we do not anticipate the potential illiquidity of these investments will materially affect our ability to operate our business.

 

We are constructing a facility in Research Triangle Park, North Carolina, to include a manufacturing operation and offices.  The facility will be approximately 200,000 square feet.  The manufacturing operation will be used primarily to make our oral treprostinil formulation; in addition, it is expected to support the drug substance and drug product production for other programs. The offices will be used by our clinical development and sales and marketing staff, who currently occupy a leased facility in the area.  We expect to complete construction in early 2009 and incur related costs of approximately $107.1 million.

 

In December 2007, we began construction of our new combination office and laboratory facility which will connect to our existing laboratory facility in Silver Spring, Maryland. Projected costs to construct this facility are anticipated to be $99.6 million.  Construction of this facility is expected to be completed in 2009.

 

As of June 30, 2008, inception-to-date expenditures approximated $67.7 million on these construction projects.  Approximately $41.5 million was incurred during the six months ended June 30, 2008, and substantially all costs were related to the construction of the Research Triangle Park, North Carolina, facility. Based on our current amount of working capital and working capital expected to be generated from future operations, we decided to self-fund both of these construction projects.

 

We are required to pay semi-annual interest of $625,000 on April 15 and October 15 of each year to the holders of our Convertible Senior Notes until they mature in October 2011, or are otherwise converted prior to maturity.

 

Effective June 2, 2008, we adopted the STAP.  Awards granted under the STAP entitle participants to receive in cash the appreciation in our common stock, which is calculated as the positive difference between the closing price of our common stock on the date of grant and the date of exercise.  Accordingly, we could be required to make significant outlays of cash under the STAP as awards vest and participants exercise their awards.  We have changed our operating budgets’ metrics to incorporate anticipated outlays of cash under the STAP, and believe existing and future sources of funding and working capital will be sufficient to accommodate STAP expenditures.

 

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. Royalties on sales of all products currently marketed range up to 10 percent of related sales.

 

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Convertible Senior Notes

 

In October 2006, we issued at par value $250.0 million of Convertible Senior Notes. In connection with the issuance of the Convertible Senior Notes, we also entered into a call spread option.  We pay interest in arrears semi-annually on April 15 and October 15 of each year and these interest payments began April 15, 2007. The Convertible Senior Notes are unsecured unsubordinated debt obligations and rank equally with all of our other unsecured and unsubordinated indebtedness. The initial conversion price is $75.2257 per share.  Conversion can occur: (i) any time after July 15, 2011; (ii) during any calendar quarter commencing after the date of original issuance, 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 Convertible Senior 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 Convertible Senior 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.

 

The closing price of our common stock exceeded 120% of the conversion price for more than 20 trading days in the period of 30 consecutive trading days ending June 30, 2008 and December 31, 2007. As a result, the holders of our Convertible Senior Notes had the right to convert their notes. As this conversion right was outside of our control, the Convertible Senior Notes have been classified as current on our consolidated balance sheets as of June 30, 2008 and December 31, 2007.  The conversion contingency is calculated at the end of each quarterly reporting period and therefore, we may have classification changes due to the satisfaction of this contingent measurement.

 

Upon conversion, a bondholder will receive: (i) cash equal to the lesser of the principal amount of the Convertible Senior Notes or the conversion value; and (ii) to the extent the conversion value exceeds the principal amount of the Convertible Senior Notes, shares of our common stock. In accordance with the terms of the Convertible Senior Note indenture, a 20-day conversion period will begin on the third business day after notice of conversion is received with settlement of the conversion occurring on the third business day after completion of the conversion period.

 

In addition, upon a change in control, as defined in the Convertible Senior Notes indenture, the bondholders 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 additional shares of our common stock.

 

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 our laboratory facility in Silver Spring, Maryland. Under these agreements, Wachovia funded $32.0 million toward the construction of our 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 us $1 annually for use of the land.

 

We pledged a portion of our marketable investments as collateral to secure our lease obligations. At June 30, 2008, approximately $39.9 million of marketable investments and cash were pledged as collateral and are reported as restricted marketable investments and cash on our consolidated balance sheet.

 

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 selling it and repaying Wachovia the cost of its construction. We have guaranteed that if the laboratory is sold, we will pay Wachovia at least 86% of the construction cost it originally funded. The maximum potential amount of this guarantee is approximately

 

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$27.5 million, equivalent to 86% of the total construction costs of $32.0 million. We report this guarantee as a noncurrent asset (prepaid rent) and noncurrent liability (other liability) on our consolidated balance sheets. At June 30, 2008, the liability and the corresponding asset are approximately $482,000, net of accumulated amortization.

 

The laboratory lease and other agreements require, among other things, that we maintain a consolidated net worth of at least $70.0 million. The agreements contain other covenants and conditions that we must comply with throughout the lease term and upon termination of the lease. If we were unable to comply with these covenants and conditions and the non-compliance went uncured and we could not negotiate an acceptable resolution, these agreements could terminate. A termination of these agreements could result in the loss of our liquid collateral, among other consequences.

 

We pay rent to Wachovia, generally based on applying the 30-day LIBOR rate plus approximately 55 basis points to the amount Wachovia funded toward the construction of the laboratory. These monthly payments commenced when the laboratory construction was completed in May 2006 and will continue through the termination of the lease in May 2011. Monthly payments made under the lease are recognized as rent expense.

 

Wachovia’s cost of construction was $32.0 million. The current effective interest rate is approximately 3.0% (equivalent to the current 30-day LIBOR rate plus approximately 55 basis points at June 30, 2008).  Therefore, our payments to Wachovia are approximately $959,000 annually. In addition, Wachovia paid us ground rent of approximately $307,000 in June 2004 covering the construction period through May 2006. This amount is being recognized as income ratably through May 2011.

 

We intend to enter into a construction agreement prior to September 30, 2008, that will generally obligate us to complete construction of a new combination office and laboratory facility to be connected to our existing Silver Spring, Maryland, laboratory facility.  We also expect to amend our leasing agreements with Wachovia to permit us to attach the new facility to our existing Silver Spring, Maryland, laboratory. If these contemplated transactions occur, the estimated fair value of the building and our corresponding obligation to Wachovia will be recognized as a component of our property, plant and equipment and as a lease obligation on our consolidated balance sheet. Furthermore, our existing Silver Spring, Maryland, laboratory will no longer be considered a standalone structure, which is a necessary factor contributing to our current off balance sheet accounting for it. We will continue to make lease payments to Wachovia as specified in the agreements; however, those payments will be recorded as interest expense and as a reduction to the lease obligation instead of rent expense.

 

Summary of Critical Accounting Policies

 

The preparation of our consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. On an ongoing basis, we evaluate our estimates and judgments, which are based on historical and anticipated results and trends and on various other assumptions that we believe are reasonable under the circumstances, including assumptions as to future events. By their nature, our estimates are subject to an inherent degree of uncertainty and, as such, actual results may differ.  We discuss accounting policies and assumptions that involve a higher degree of judgment and complexity within Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2007.  There have been no material changes to our critical accounting policies and estimates as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2007, except for our adoption of SFAS 157 Fair Value Measurements on January 1, 2008 (see Note 6 to our consolidated financial statements included in this Quarterly Report).

 

Recent Accounting Pronouncements

 

In May 2008, the Financial Accounting Standards Board (FASB) issued Staff Position APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlement) , (FSP APB 14-1). FSP APB 14-1 applies to certain convertible debt instruments that may be settled in cash or other assets, or partially in

 

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cash, upon conversion. Issuers of such instruments are required under FSP APB 14-1 to account for the liability and equity components separately in a manner that reflects the issuer’s nonconvertible debt borrowing rate when interest expense is subsequently recognized. Specifically, FSP APB 14-1 requires the difference between the convertible debt proceeds and the fair value of the liability, absent any conversion rights, be assigned to the equity component and recognized as part of stockholders’ equity and as a discount for determining the carrying value of the debt. The discounted carrying value of the debt is amortized as part of interest expense using the interest method over its expected life. FSP APB 14-1 is effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years and shall be applied retrospectively to all periods presented. Our Convertible Senior Notes (see Note 10) fall within the scope of this guidance. While FSP APB 14-1 does not change the cash flow requirements under our Convertible Senior Notes, non-cash interest expense will increase as a result of accreting the discounted carrying value of our Convertible Senior Notes to their face value. We are currently assessing the impact of adopting FSP APB 14-1 and believe that adoption will have a significant impact on our consolidated financial statements .

 

In May 2008, the FASB issued Statement of Financial Accounting Standards No. 162, The Hierarchy of Generally Accepted Accounting Principles (SFAS 162). SFAS 162 identifies sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of non-governmental entities that are presented in conformity with generally accepted accounting principles in the United States (GAAP hierarchy). SFAS 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board’s amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles . We do not expect the adoption of SFAS 162 to have a material impact, if any, on our consolidated financial statements.

 

In March 2008, FASB issued Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities - an Amendment of FASB Statement No. 133 (SFAS 161).  The SFAS 161 requires companies to provide enhanced disclosures regarding derivative instruments and hedging activities and requires companies to better convey the purpose of derivative use in terms of the risks they intend to manage. Disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect a company’s financial position, financial performance, and cash flows are required. SFAS 161 retains the same scope as SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and is effective for fiscal years and interim periods beginning after November 15, 2008. We do not expect the adoption of SFAS 161 to have a material impact, if any, on our consolidated financial statements.

 

In February 2008, the FASB issued Staff Position FAS 140-3 on Accounting for Transfers of Financial Assets and Repurchase Financing Transactions (FSP FAS 140-3). FSP FAS 140-3 addresses the issue of whether the transfer of financial assets and the repurchase financing transactions should be viewed as two separate transactions or as one linked transaction. FSP FAS 140-3 includes a rebuttable presumption that the two transactions are linked unless the presumption can be overcome by meeting certain criteria.  FSP FAS 140-3 will be effective for fiscal years beginning after November 15, 2008 and will apply only to original transfers made after that date; early adoption will not be allowed. We do not expect the adoption of FSP FAS 140-3 to have a significant impact, if any, on our consolidated financial statements.

 

In December 2007, the FASB issued Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51 (SFAS 160). SFAS 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This statement is effective prospectively, except for certain retrospective disclosure requirements, for fiscal years beginning after December 15, 2008.  We do not expect the adoption of SFAS 160 to have any impact on our consolidated financial statements.

 

In December 2007, the FASB issued Statement No.141(R), Business Combinations—a replacement of FASB Statement No. 141 (SFAS 141 (R)).  SFAS 141(R) significantly changes the principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. SFAS 141 (R) also provides guidance for recognizing and measuring goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141 (R) is effective prospectively for fiscal

 

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years beginning after December 15, 2008, except for certain retrospective adjustments to deferred tax balances.  We are assessing the potential impact, if any, of adopting SFAS 141 (R) on our consolidated financial statements.

 

In June 2007, the FASB ratified EITF Issue No. 07-1, Accounting for Collaboration Arrangements Related to the Development and Commercialization of Intellectual Property (EITF 07-1).  EITF 07-1 provides guidance on how the parties to a collaborative agreement should account for costs incurred and revenue generated on sales to third parties and how sharing payments pursuant to a collaboration agreement should be presented in the income statement. EITF 07-1 will be effective for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years and shall be applied retrospectively.  We are assessing the potential impact, if any, of the adoption of EITF 07-1 on our consolidated financial statements.

 

Item 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

At June 30, 2008, a substantial portion of our assets was comprised of debt securities issued by corporations and federally-sponsored agencies. The market value of these investments fluctuates with changes in current market interest rates. In general, as rates increase, the market value of a debt investment would be expected to decrease. Likewise, as rates decrease, the market value of a debt investment would be expected to increase. To minimize such market risk, we hold such instruments to maturity at which time they will be redeemed at their stated or face value. At June 30, 2008, we had approximately $220.3 million in debt securities issued by federally-sponsored agencies and corporations with a weighted average stated interest rate of approximately 3.0% maturing through March 2012 and callable annually. The fair market value of this held-to-maturity portfolio at June 30, 2008, was approximately $219.8 million.

 

At June 30, 2008, a portion of our assets consisted of auction-rate securities issued by state-sponsored agencies. While these securities have long-term maturities, their interest rates are reset approximately every 7 to 28 days through an auction process. As a result, the interest income from these securities is subject to market risk since the rate is adjusted to accommodate market conditions on each reset date. Due to the deterioration in market conditions, interest earnings on some of our auction-rate securities have been subject to a greater degree of volatility.  We do not expect the increased volatility relative to the earnings on these investments to have a materially adverse impact on our operations.  At June 30, 2008, we held approximately $36.8 million in auction-rate securities with a fair market value of approximately $34.4 million and with a weighted average stated interest rate of approximately 1.4%.  For a discussion of our auction-rate securities, including our method for estimating their fair value, see Note 6 to our consolidated financial statements included in this Quarterly Report.

 

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 our laboratory facility in Silver Spring, Maryland. Under these agreements, we pay rents to Wachovia generally based on the 30-day LIBOR rate plus approximately 55 basis points applied to the amount Wachovia funded toward the construction of the laboratory. The total cost of construction was $32.0 million. These rents, therefore, are subject to the risk that the LIBOR rate may increase during the period until the lease

 

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term ends in May 2011. At June 30, 2008, the 30-day LIBOR rate was approximately 2.5%. For every movement of 100 basis points (1%) in the 30-day LIBOR rate, the rents under this lease could increase or decrease by approximately $320,000 on an annualized basis.

 

Item 4.  CONTROLS AND PROCEDURES

 

Based on their evaluation, as of June 30, 2008, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) are effective to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, summarized, processed and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and to provide reasonable assurance that such information is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. There have been no changes in our internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, such internal control over financial reporting.

 

Part II. OTHER INFORMATION

 

Item 1A.  RISK FACTORS

 

Forward-Looking Statements

 

This Quarterly Report on Form 10-Q contains forward-looking statements made pursuant to the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934 (the Exchange Act) and the Private Securities Litigation Reform Act of 1995 which are based on our beliefs and expectations as to future outcomes. These statements include, among others, statements relating to the following:

 

·                   Expectations of revenues, profitability, and cash flows;

 

·                   The timing and outcome of clinical studies and regulatory filings;

 

·                   The achievement and maintenance of regulatory approvals;

 

·                   The existence and activities of competitors;

 

·                   The pricing of Remodulin;

 

·                   The expected levels and timing of Remodulin sales;

 

·                   The dosing and rate of patient consumption of Remodulin;

 

·                   The impact of generic epoprostenol products on our Remodulin sales;

 

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·                   The outcome of potential future regulatory actions from the FDA and international regulatory agencies;

 

·                   The adequacy of our intellectual property protections and expiration dates on our patents;

 

·                   The ability of third parties to market, distribute and sell our products;

 

·                   The current and expected future value of our goodwill and recorded intangible assets;

 

·                   The ability to obtain financing in the future;

 

·                   The value of our common stock;

 

·                   The expectation of future repurchases of those shares of our common stock subject to repurchase from Toray Industries, Inc.;

 

·                   The expectation of continued profits or losses;

 

·                   The potential impacts of new accounting standards including FSP APB 14-1;

 

·                   The expected timing and impact of recording our existing Silver Spring, Maryland, laboratory and its associated liability on our consolidated balance sheet.

 

·                   The pace and timing of enrollment in clinical trials;

 

·                   The expectation and timing of receiving regulatory approvals of inhaled treprostinil;

 

·                   The timing, resubmission, completion and outcome of the applications for approval of subcutaneous Remodulin in Ireland, Spain and the United Kingdom;

 

·                   The expectation, outcome and timing of marketing approvals in European Union countries for intravenous Remodulin;

 

·                   The expected timing of milestone payments from Mochida Pharmaceutica Co., Inc. and commercial activities in Japan;

 

·                   The expected timing of payments to third parties under licensing agreements;

 

·