UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

Form 10-Q

For the quarterly period ended June 30, 2014

OR

For the transition period from              to             

Commission File Number: 0-29801

INTERMUNE, INC.

(Exact name of Registrant as specified in its charter)

 

3280 Bayshore Boulevard

Brisbane, California 94005

(Address of principal executive offices, including zip code)

(415) 466-2200

(Registrant’s telephone number, including area code)

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

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

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

 

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

As of July 31, 2014, there were 107,969,163 outstanding shares of common stock, par value $0.001 per share, of InterMune, Inc.

 

 

 

 

 

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INTERMUNE, INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2014

INDEX

 

 

 

 

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PART I — FINANCIAL INFORMATION

 

INTERMUNE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amounts)

 

See accompanying notes to condensed consolidated financial statements.

 

 

 

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INTERMUNE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share amounts)

 

See accompanying notes to condensed consolidated financial statements.

 

 

 

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INTERMUNE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(Unaudited)

(In thousands)

 

See accompanying notes to condensed consolidated financial statements.

 

 

 

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INTERMUNE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

 

See accompanying notes to condensed consolidated financial statements.

 

 

 

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INTERMUNE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.   ORGANIZATION

Overview

InterMune, Inc. (“InterMune,” “we,” and the “Company”) is a biotechnology company focused on the research, development and commercialization of innovative therapies in pulmonology and orphan fibrotic diseases. In pulmonology, we are focused on therapies for the treatment of idiopathic pulmonary fibrosis, or IPF, a progressive and fatal lung disease. We have a product in pulmonology, pirfenidone, which is an orally active, small-molecule compound. Pirfenidone was granted marketing authorization effective February 2011 in all 28 member countries of the European Union, or the EU, for the treatment of adults with mild to moderate IPF. In September 2011, we launched commercial sales of pirfenidone in Germany under the trade name Esbriet®, and Esbriet is now also commercially available in various European countries, including key markets such as France, Italy and the UK. In addition, we launched in Canada in January 2013.

We are also pursuing the registration of pirfenidone to treat IPF in the United States. After reviewing various regulatory and clinical development options and following our discussions with the United States Food and Drug Administration, or FDA, we commenced an additional pivotal Phase 3 clinical study of pirfenidone in IPF in July 2011, known as the ASCEND trial. In February 2014, we announced top-line results of ASCEND and in May 2014 we resubmitted our Class 2 New Drug Application, or NDA, to the FDA to support regulatory registration in the United States. The FDA confirmed that the resubmitted NDA had been filed and that it has assigned a Prescription Drug User Fee Act goal date of November 23, 2014. In addition, on July 17, 2014, the FDA assigned Breakthrough Therapy Designation status for pirfenidone.

In March 2014, we completed a registered underwritten public offering of 8,625,000 shares of our common stock. The resulting aggregate net proceeds from the common stock offering were approximately $268.0 million, after deducting underwriting discounts and expenses.

In June 2014, we completed the exchange of $43.1 million in aggregate principal amount of our 2.50% convertible senior notes due 2017 Notes (the “2017 Notes”) beneficially owned by certain existing holders of our 2017 Notes for an aggregate of 3,378,457 shares of our common stock (the “Exchange Shares”), valued at $47.22 per share, plus accrued but unpaid interest. The notes were exchanged at a rate of 78.3884 shares per $1,000 note, which represents an exchange price of approximately $12.77 per share and an approximate $0.10 discount from the original conversion price of the 2017 Notes of $12.87 per share. See Note 9 to these financial statements for details of this exchange.

 

2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Our significant accounting policies and recent accounting pronouncements were described in Note 2 to our Consolidated Financial Statements included in our 2013 Annual Report on Form 10-K for the fiscal year ended December 31, 2013. There have been no significant changes in our accounting policies since December 31, 2013.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X. The financial statements include all adjustments (consisting only of normal recurring adjustments) that we believe are necessary for a fair presentation of the periods presented. The condensed consolidated balance sheet at December 31, 2013 was derived from the audited consolidated financial statements, but does not include all disclosures required by GAAP. These interim financial results are not necessarily indicative of results to be expected for the full fiscal year or any other future period and should be read in conjunction with the audited consolidated financial statements and the related notes thereto for the year ended December 31, 2013, included in our Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission, or SEC.

Revenue Recognition

Revenue is generated from product sales and recorded net of mandatory government rebates. We only ship product upon receipt of valid orders from customers, such as pharmacies and hospitals, which are in turn a result of actual patient prescriptions. Delivery is considered to have occurred when title passes to a credit-worthy customer. We include shipping and handling costs in cost of goods

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sold. Pursuant to terms and conditions of sale, our customers have no general right of product return but we permit returns if the product is damaged or defective when received by the customer. Such restriction on product returns is common practice in the markets in which we sell, and as a result, we have had no significant expenses related to product returns, damaged or expired goods.

To date, all significant amounts recorded as estimates of items that reduce gross revenue related solely to mandatory government rebates, many of which were negotiated on a confidential basis with the respective government reimbursement agencies. Our estimation of these rebates requires only the application of pre-specified rates, determined as part of pre-launch pricing negotiations with the relevant government reimbursement agencies, to sales of our product as applicable. We recognize these mandatory government rebates as reductions of product sales and the recording of these rebates is substantially mechanical in nature and does not involve the application of significant judgment. Fluctuations in the amounts recorded for these rebates relate solely to increased sales or the eventual payment of amounts due to the various government agencies. To date, we have had no significant charges or credits related to prior period estimates.

Derivative Financial Instruments

On January 22, 2013, we issued $120.8 million aggregate principal amount of 2.50% convertible senior notes due 2017 (the “2017 Notes”). As a result of our issuance of the 2017 Notes, our total potential outstanding common stock exceeded our authorized shares by approximately 4.3 million shares as of that date and we were therefore required to value the embedded conversion derivative and recognize it at fair value as a long-term liability.

On May 30, 2013, we obtained stockholder approval to an amendment to our certificate of incorporation to increase the number of our authorized shares of common stock from 100,000,000 to 175,000,000. As a result of the increase in authorized number of shares, we can now settle the 2017 Notes in cash, stock, or a combination thereof, solely at our election, the derivative associated with the embedded conversion derivative was marked to fair value at May 30, 2013 and the long-term liability was reclassified to stockholders’ equity.

See Note 10 for further details of our embedded conversion derivative.

Net Income (Loss) Per Share

Basic net loss per share is calculated based on the weighted-average number of shares of our common stock outstanding during the period, as adjusted. Diluted net loss per share is calculated based on the weighted average number of shares of our common and other dilutive securities outstanding during the period. The potential dilutive shares of our common stock resulting from the assumed exercise of outstanding stock options and shares subject to repurchase are determined under the treasury stock method. The potential dilutive shares of our common stock issuable on conversion of our convertible notes are determined using the “if-converted” method. Anti-dilutive securities, which consist of stock options, restricted stock awards and units, and shares that could be issued upon conversion of our convertible notes, are not included in the diluted net loss per share calculation.

 

For the calculation of net loss per share, anti-dilutive securities excluded were as follows:

 

 

The following table is a reconciliation of the denominator used in the calculation of basic and diluted net loss per share attributable to our common stockholders:

 

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Stock-Based Compensation

The following table reflects stock-based compensation expense recognized for the three and six month periods ended June 30, 2014 and 2013:

 

 

Under the fair value recognition provisions of Accounting Standards Codification (ASC) 718-10, Stock Compensation, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the vesting period for that portion of the award that is ultimately expected to vest. In order to estimate the value of share-based awards, we use the Black-Scholes model, which requires the use of certain subjective assumptions. The most significant assumptions are our estimates of the expected volatility, the expected term of the award and the estimated forfeiture rate.

Segment Reporting

We have determined, in accordance with ASC 280, Segment Reporting, that our business operates in one operating segment: the research, development and commercialization of innovative therapies in pulmonology and orphan fibrotic diseases.

Recent Accounting Pronouncements

In April 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-08, Presentation of Financial Statements and Property, Plant and Equipment. This ASU is an amendment to the discontinued operations accounting guidance. The amendment raises the threshold for a disposal to qualify as a discontinued operation and requires new disclosures for both discontinued operations and disposals of individually significant components that don’t qualify as discontinued operations. We adopted ASU No. 2014-08 for the period ended June 30, 2014. The adoption of this new guidance did not have an effect on our condensed consolidated balance sheets, statement of operations or cash flows.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers. This ASU is an amendment to the revenue recognition accounting guidance. The amendment clarifies the principles for recognizing revenue and develops a common revenue standard for all industries. The new guidance is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, which can be applied either prospectively or retrospectively. Early adoption is not permitted. We are evaluating the impact of adopting this prospective guidance on our consolidated results of operations and financial condition.

 

3.   DISCONTINUED OPERATIONS

On June 19, 2012, we completed the divestiture of our worldwide development and commercialization rights to the pharmaceutical product containing Interferon Gamma-1b sold by us under the trade name Actimmune for $55.0 million in cash, plus certain conditional royalty payments for a period of two years following the closing (the transaction is referred to herein as the “Asset Sale”). The Asset Sale was consummated pursuant to the terms of the Asset Purchase Agreement, dated as of May 17, 2012, by and among InterMune and Vidara Therapeutics International Limited, an Irish company, Vidara Therapeutics Holdings LLC, a Delaware limited liability company and Vidara Therapeutics Research Limited, an Irish company, as amended on June 18, 2012. The operating results of our Actimmune activities have been reclassified as discontinued operations for all periods presented. As a consequence of the divestiture, we were required to apply intraperiod tax allocation rules for the purposes of calculating our provision (benefit) for income taxes.

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Results of Discontinued Operations

Summary operating results for the discontinued operations are as follows:

 

 

 

4.   DERIVATIVE INSTRUMENTS

We conduct business throughout Europe and Canada and therefore, we are exposed to adverse movements in foreign currency exchange rates. To limit the exposure related to foreign currency changes, we enter into foreign exchange forward contracts to reduce the short-term effects of foreign currency fluctuations on assets and liabilities such as foreign currency receivables and payables. We do not enter into such contracts for trading or speculative purposes. These derivatives are not designated as hedging instruments. Gains and losses on the contracts are included in “other” as a component of other income (expense) in our condensed consolidated statements of operations and substantially offset foreign exchange gains and losses from the remeasurement of intercompany balances. Our net contract losses were $0.1 million for the three month periods ended June 30, 2014 and 2013, respectively. Our net contract losses for the six month period ended June 30, 2014 were $0.1 million compared to net gains of $0.1 million in the same period in 2013. The notional value of our outstanding currency hedges was 17.7 million Euros and 5.5 million Canadian dollars at June 30, 2014 and 9.5 million Euros at December 31, 2013, and the fair value of these outstanding derivatives at June 30, 2014 was zero and at December 31, 2013 was a loss of $0.2 million.

Our foreign exchange forward contracts expose us to credit risk to the extent that the counterparties may be unable to meet the terms of the agreement. We do, however, seek to mitigate such risks by limiting counterparties to major financial institutions. In addition, the potential risk of loss with any one counterparty resulting from this type of credit risk is monitored. We are not generally required to pledge collateral under these agreements. We do not expect material losses as a result of defaults by counterparties.

In addition to our foreign exchange forward contract derivative instruments, we also had an embedded derivative option related to our 2017 Notes. See Note 10 to these financial statements for details of our embedded conversion derivative.

 

5.   FAIR VALUE

In accordance with ASC 820-10, Fair Value Measurements and Disclosures, we determine the fair value of financial and non-financial assets and liabilities using the fair value hierarchy, which establishes three levels of inputs that may be used to measure fair value, as follows:

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The following table represents the fair value hierarchy for our financial assets which require fair value measurement on a recurring basis as of June 30, 2014 and December 31, 2013:

 

Level 2 Inputs

We estimate the fair values of our governmental related debts and corporate debt by taking into consideration valuations obtained from third-party pricing services. The pricing services utilize industry standard valuation models, including both income- and market-based approaches, for which all significant inputs are observable, either directly or indirectly, to estimate the fair value. These inputs include reported trades of and broker/dealer quotes on the same or similar securities, issuer credit spreads, benchmark securities, prepayment/default projections based on historical data, and other observable inputs. Our foreign currency derivatives contracts have maturities less than three months and all are with counterparties that have a minimum credit rating of A or equivalent by Standard & Poor’s, Moody’s Investors Service, Inc. or Fitch, Inc. We estimate the fair values of these contracts by taking into consideration valuations obtained from a third-party valuation service that utilizes an income-based industry standard valuation model for which all significant inputs are observable, either directly or indirectly. These inputs include foreign currency rates, London Interbank Offered rates (LIBOR) and swap rates. These inputs, where applicable, are at commonly quoted intervals.

The following table summarizes the carrying and fair value of our Level 2 convertible senior notes as of June 30, 2014 and December 31, 2013:

 

 

Embedded Conversion Derivative

The embedded conversion derivative on the 2017 Notes was reclassified to stockholders’ equity on May 30, 2013 in connection with the approval of an amendment to our certificate of incorporation increasing our authorized number of shares of common stock. The embedded conversion derivative was classified as Level 3 because this liability was not actively traded and was valued using a binomial lattice model. Significant inputs to this model were the remaining time to maturity, volatility and risk-free interest rate.

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The following table sets forth the changes in the estimated fair value for our Level 3 classified embedded conversion derivative:

 

 

 

6.   CASH EQUIVALENTS AND AVAILABLE-FOR-SALE SECURITIES

The following table is a summary of available-for-sale debt and equity securities included in cash and cash equivalents or available-for-sale securities:

 

 

 

 

 

Cash and cash equivalents in the tables above exclude cash of $151.2 million as of June 30, 2014 and $134.5 million as of December 31, 2013.

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Realized gains and losses calculated based on the specific identification method were immaterial for the three and six months ended June 30, 2014 and 2013.

The following is a summary of the amortized cost and estimated fair value of available-for-sale securities by contractual maturity:

 

 

 

 

7.   INVENTORIES

Inventories consist of the following:

 

 

 

8.   ACCUMULATED OTHER COMPREHENSIVE INCOME

The components of accumulated other comprehensive income, net of taxes, were as follows:

 

 

Realized gains and losses were immaterial and were reclassified to other income (expense) on the condensed consolidated statements of operations for the three and six months ended June 30, 2014 and 2013, respectively.

 

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9.   CONVERTIBLE NOTES

In June 2008, we issued $85.0 million in 5.00% convertible senior notes due 2015 (the “2015 Notes”). The 2015 Notes are senior unsecured obligations of the Company and rank equally in right of payment with all of our existing senior notes, and rank senior in right of payment to all of our existing subordinated notes. Interest accrues from the date of issuance and is payable in arrears on March 1 and September 1 of each year commencing on September 1, 2008. The 2015 Notes will mature on March 1, 2015. Holders of the 2015 Notes may surrender their notes, in integral multiples of $1,000 principal amount, for conversion any time prior to the close of business on the second business day immediately preceding the maturity date. The initial conversion rate for each $1,000 aggregate principal amount of the 2015 Notes is 52.9661 shares of common stock, equivalent to a conversion price of approximately $18.88 per share. Offering expenses and underwriting discounts in the aggregate of approximately $0.6 million related to the sale of the 2015 Notes were recorded in other assets and are being amortized to interest expense using the effective interest method over the term of the 2015 Notes, which is approximately seven years from the date of issuance. At June 30, 2014, $18.4 million of principal remained outstanding under the 2015 Notes which comes due within 12 months of the reporting date and has been reclassified to current liabilities.

In September 2011, we issued $155.3 million in 2.50% convertible senior notes due 2018 (the “2018 Notes”). The 2018 Notes are general unsecured senior obligations of the Company and rank equal in right of payment with the Company’s other senior unsecured notes and rank senior in right of payment to all of our existing and future subordinated notes. Interest accrues from the date of issuance and is payable in arrears on September 15 and March 15 of each year commencing on March 15, 2012. The 2018 Notes will mature on September 15, 2018. Holders of the 2018 Notes may surrender their notes, in integral multiples of $1,000 principal amount, for conversion any time prior to the close of business on the second business day immediately preceding the maturity date. The initial conversion rate for each $1,000 aggregate principal amount of the 2018 Notes is 31.4465 shares of common stock, equivalent to a conversion price of approximately $31.80 per share. Offering expenses and underwriting discounts in the aggregate of approximately $5.0 million related to the sale of the 2018 Notes were recorded in other assets and are being amortized to interest expense using the effective interest method over the term of the 2018 Notes, which is approximately seven years from the date of issuance. At June 30, 2014, $155.3 million of principal remained outstanding under the 2018 Notes.

In January 2013, we completed a registered underwritten public offering of 15,525,000 shares of our common stock (“Common Stock Offering”) and a concurrent registered underwritten public offering of $120.8 million aggregate principal amount of 2.50% convertible senior notes due December 15, 2017 (the “2017 Notes” and the “Convertible Note Offering”). The resulting aggregate net proceeds from the Common Stock Offering were approximately $145.7 million, after deducting underwriting discounts and expenses. The resulting aggregate net proceeds from the Convertible Note Offering were approximately $116.8 million, after deducting underwriting discounts and expenses. Interest accrues from the date of issuance and is payable in arrears on June 15 and December 15 of each year commencing on June 15, 2013. The holders of the 2017 Notes may convert their 2017 Notes into shares of our common stock at a conversion rate of 77.7001 shares per $1,000 principal amount of notes, subject to adjustment (representing a conversion price of approximately $12.87 per share). We can settle conversion of the 2017 Notes by delivery of shares, cash or a combination of shares and cash at our election.

Conversion of the 2017 Notes may occur on any day prior to September 15, 2017, under the following conditions: a) during any fiscal quarter beginning after June 30, 2013, if the last reported sale price of our common stock for at least 20 trading days during the period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter is greater than or equal to 130% of the conversion price on each applicable trading day; b) during the five consecutive business day period after any five consecutive trading day period in which the trading price of the 2017 Notes falls below 98% of the product of (i) the last reported sale price of the Company’s common stock and (ii) the applicable conversion rate on each such trading date; c) if we call the 2017 Notes for redemption, at any time prior to the close of business on the second scheduled trading day prior to the redemption date; and d) upon the occurrence of specified corporate events, as defined in the 2017 Notes. From September 15, 2017 until the close of business on the second scheduled trading day immediately preceding the December 15, 2017 maturity date, holders of the 2017 Notes may convert their notes at any time, regardless of the foregoing circumstances.

On or after June 20, 2015, we may redeem for cash all or part of the 2017 Notes (except for Notes that holders have already required us to repurchase following certain fundamental changes defined within the agreement such as an acquisition or liquidation of the Company) but only if the last reported sale price of our common stock for 20 or more trading days in a period of 30 consecutive trading days ending within 10 trading days of immediately prior to the date we provide the notice of redemption exceeds 130% of the conversion price in effect on each such trading day. The redemption price in this case will equal 100% of the principal amount of the notes to be redeemed, plus accrued and unpaid interest, if any, to, but excluding, the redemption date.

Other than restrictions relating to certain fundamental changes and consolidations, mergers or asset sales and customary anti-dilution adjustments, the 2017 Notes do not contain any financial covenants and do not restrict us from paying dividends or issuing new securities or repurchasing any of our other securities. At June 30, 2014, $77.7 million of principal remained outstanding under the 2017 Notes.

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In January 2013, we used a portion of the net proceeds from the Convertible Note Offering to repurchase approximately $66.6 million of our outstanding 2015 Notes for proceeds of $72.2 million. This repurchase was accounted for as an extinguishment of notes and we recorded a loss on extinguishment of notes of $7.9 million which comprised $5.5 million of premium paid to the holders of the 2015 Notes, $2.2 million related to the excess of the deemed issuance fair value over the issuance price (par) of the 2017 Notes (but only for those holders of the repurchased 2015 Notes who subsequently invested in our 2017 Notes) and $0.2 million related to the write-off of the initial note issuance costs for these 2015 Notes.

In June 2014, we completed the exchange of $43.1 million in aggregate principal amount of 2017 Notes beneficially owned by certain existing holders of our 2017 Notes for an aggregate of 3,378,457 shares of our common stock (the “Exchange Shares”), valued at $47.22 per share, plus accrued but unpaid interest. The notes were exchanged at a rate of 78.3884 shares per $1,000 note, which represents an exchange price of approximately $12.77 per share and an approximate $0.10 discount from the original conversion price of the 2017 Notes of $12.87 per share. This exchange was accounted for as an extinguishment of notes and we recorded a loss on extinguishment of notes of $4.9 million which comprised $1.4 million of premium paid to the holders of the 2017 Notes, $2.9 million related to the excess of the deemed issuance fair value over the issuance price (par) of the Exchange Shares and $0.6 million related to the write-off of the initial note issuance costs for these notes.

The following is a summary of the interest expense recognized on the 2017 Notes:

 

 

 

10. EMBEDDED CONVERSION DERIVATIVE

FASB Accounting Standards Codification (ASC) Topic 470 (ASC 470), Accounting for Convertible Debt Instruments That May be Settled in Cash upon Conversion (Including Partial Cash Settlement) requires the issuer of convertible debt that may be settled in shares or cash upon conversion at their option, such as our 2017 Notes, to account for their liability and equity components separately by bifurcating the embedded conversion derivative (the “derivative”) from the host debt instrument. Although ASC 470 has no impact on our actual past or future cash flows, it requires us to record non-cash interest expense as the debt discount is amortized.

As a result of the issuance of convertible notes in January 2013, our total potential outstanding common stock exceeded our authorized shares by approximately 4.3 million shares as of that date, and we were therefore required to value the derivative and recognize the fair value as a long-term liability. The fair value of this derivative at the time of issuance was $36.9 million and was recorded as the original debt discount for the purposes of accounting for the debt component of the 2017 Notes. This debt discount is being amortized as interest expense using an effective interest rate of 9.9% over the remaining 3.5 year term of the 2017 Notes.

In accordance with authoritative guidance, the embedded conversion derivative associated with the 2017 Notes required bifurcation from the 2017 Notes and was initially accounted for as a derivative liability. On May 30, 2013, upon obtaining stockholder approval for an amendment to our certificate of incorporation increasing the authorized number of shares of our common stock, the derivative liability was marked to fair value and reclassified to stockholders’ equity. Changes in the fair value were recorded in change in value of embedded conversion derivative in the condensed consolidated statements of operations. We determined the fair value of the derivative using a binomial lattice model. The key assumptions for determining the fair value at May 30, 2013 included the remaining time to maturity of 4.54 years, volatility of 50%, and the risk-free interest rate of 0.88%. The estimated fair value of the embedded conversion derivative was $34.5 million as of May 30, 2013 immediately prior to its reclassification to stockholders’ equity.

 

11. COMMITMENTS AND CONTINGENCIES

Details of our ongoing commitments and contingencies were described in Note 16 to our consolidated Financial Statements included in our 2013 Annual Report on Form 10-K for the fiscal year ended December 31, 2013. There have been no significant changes to these commitments and contingencies since December 31, 2013.

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Indemnity Agreement

On or about March 22, 2000, we entered into an Indemnity Agreement with W. Scott Harkonen M.D., who served as the Company’s Chief Executive Officer until September 30, 2003. The Indemnity Agreement obligates us to hold harmless and indemnify Dr. Harkonen against expenses (including attorneys’ fees), witness fees, damages, judgments, fines and amounts paid in settlement and any other amounts Dr. Harkonen becomes legally obligated to pay because of any claim or claims made against him in connection with any threatened, pending or completed action, suit or proceeding, whether civil, criminal, arbitrational, administrative or investigative, to which Dr. Harkonen is a party by reason of the fact that he was a director, officer, employee or other agent of the Company. The Indemnity Agreement establishes exceptions to our indemnification obligation, including but not limited to claims “on account of Dr. Harkonen’s conduct that is established by a final judgment as knowingly fraudulent or deliberately dishonest or that constituted willful misconduct,” claims “on account of Dr. Harkonen’s conduct that is established by a final judgment as constituting a breach of Dr. Harkonen’s duty of loyalty to the Company or resulting in any personal profit or advantage to which Dr. Harkonen was not legally entitled,” and claims “for which payment is actually made to Dr. Harkonen under a valid and collectible insurance policy.” The Indemnity Agreement, however, obligates us to advance all expenses, including attorneys’ fees, incurred by Dr. Harkonen in connection with such proceedings, subject to an undertaking by Dr. Harkonen to repay said amounts if it shall be determined ultimately that he is not entitled to be indemnified by the Company.

Dr. Harkonen was named as a defendant in certain civil action lawsuits instituted against us where the various complaints alleged that we fraudulently misrepresented the medical benefits of Actimmune for the treatment of IPF and promoted Actimmune for IPF. Ultimately, these complaints were dismissed. However, Dr. Harkonen also became the target of the investigation by the U.S. Department of Justice regarding the promotion and marketing of Actimmune. On March 18, 2008, a federal grand jury indicted Dr. Harkonen on two felony counts related to alleged improper promotion and marketing of Actimmune during the time Dr. Harkonen was employed by us (the “Criminal Action”). The trial in the criminal case resulted in a jury verdict on September 29, 2009, finding Dr. Harkonen guilty of one count of wire fraud related to a press release issued on August 28, 2002, and acquitting him of a second count of a misbranding charge brought under the Federal Food, Drug, and Cosmetic Act. On April 13, 2011, the Court denied Dr. Harkonen’s post-trial motions and sentenced Dr. Harkonen to three years of probation, including six months of home detention, 200 hours of community service and a fine of $20,000. The Court’s Judgment was filed on April 18, 2011. Dr. Harkonen appealed his conviction and sentence and the government cross-appealed his sentence. On March 4, 2013, the Ninth Circuit Court of Appeals issued an unpublished opinion affirming both the conviction and the sentence. Dr. Harkonen filed a petition for rehearing en banc which was denied by the Ninth Circuit Court of Appeals on May 7, 2013. On August 5, 2013, Dr. Harkonen filed a petition for a writ of certiorari seeking review by the United States Supreme Court. The U.S. Supreme Court denied Dr. Harkonen’s petition on December 16, 2013.

Prior to December 2008, insurers that issued directors & officers (“D&O”) liability insurance to the Company had advanced all of Dr. Harkonen’s expenses, including attorneys’ fees, incurred in the civil action lawsuits and Criminal Action. Those insurers included National Union Fire Insurance Company of Pittsburgh, PA (“AIG”), Underwriters at Lloyd’s, London (“Lloyd’s”), and Continental Casualty Company (“CNA”). On November 19, 2008, however, the insurer that issued a $5.0 million D&O insurance policy providing coverage excess of the monetary limits of coverage provided by AIG, Lloyd’s and CNA, Arch Specialty Insurance Company (“Arch”), advised the Company that the limits of the underlying coverage were expected to be depleted by approximately December 15, 2008; that Arch “disclaimed coverage” based on misstatements and misrepresentations allegedly made by Dr. Harkonen in documents provided in the application for the Arch policy and the underlying Lloyd’s policy; and that, based on that disclaimer, Arch would not be advancing any of Dr. Harkonen’s expenses, including attorneys’ fees, incurred in the civil action lawsuits and Criminal Action.

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

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

The matter was heard by the arbitration panel and on May 29, 2009, the arbitration panel issued an Interim Arbitration Award granting our request for a partial award requiring Arch to advance Dr. Harkonen’s legal fees and costs incurred in the civil action lawsuits and Criminal Action. Arch subsequently advanced such fees and costs, including fees and costs previously paid by the Company. The question whether Arch ultimately will be required to cover the advanced fees and costs or, instead, may recoup those fees and costs as not covered by its policy, has not been determined. Unless and until the arbitration panel rules that such fees and costs are not covered, Arch remains obligated to advance such fees and costs.

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

Now that the United States Supreme Court has denied Dr. Harkonen’s petition for writ of certiorari, leaving the verdict and judgment against Dr. Harkonen intact, Arch has taken steps to resume the arbitration and seek to recoup all or some of the $5.0 million it advanced for Dr. Harkonen’s defense back from Dr. Harkonen and/or from the Company, contending that such fees and costs are not covered by its policy. In addition, Old Republic has written a letter dated May 8, 2014, claiming that Dr. Harkonen’s attorney’s fees and costs are not covered by its policy, and demanding that Dr. Harkonen and/or the Company repay the $5.0 million Old Republic advanced for Dr. Harkonen’s defense costs. The Company believes that Arch and Old Republic are not entitled to recover such fees and costs from the Company and will assert that position in arbitration. At this time, we believe no change to the status of the application of the D&O liability insurance in general has occurred due to the judgment in the Criminal Action. Therefore, while it is reasonably possible that we may incur a loss associated with this matter, we are unable to determine the amount of such a loss or range of losses and have not accrued for any such amounts in our financial statements associated with this matter.

 

12. SUBSEQUENT EVENTS

In July 2014, we completed the exchange of $41.0 million in aggregate principal amount of 2017 Notes beneficially owned by certain noteholders for (i) 3,185,703 shares of the our common stock (the “2017 Exchange Shares”), (ii) $1.3 million aggregate cash consideration and (iii) accrued but unpaid interest. For the share portion of the overall exchange consideration, the notes were exchanged at a rate of 77.7001 shares per $1,000 note, which represents an exchange price of approximately $12.87. This exchange price was the same as the original conversion price of the 2017 Notes. Additionally, in a separately negotiated private transaction with existing holders of 2017 Notes, we completed the exchange of $11.9 million in aggregate principal amount of 2017 Notes beneficially owned by the noteholders for (i) an aggregate of 908,423 2017 Exchange Shares, (ii) approximately $1.2 million aggregate cash consideration and (iii) accrued but unpaid interest. For the share portion of the overall exchange consideration, the notes were exchanged at a rate of 76.1461 shares per $1,000 note, which represents an exchange price of approximately $13.13 and an approximate $0.26 premium on the original conversion price of the 2017 Notes of $12.87 per share.

In July 2014, we also completed the exchange of $16.9 million in aggregate principal amount of 2015 Notes beneficially owned by an existing noteholder for (i) an aggregate of 893,008 shares of our common stock (the “2015 Exchange Shares” and, together with the 2017 Exchange Shares, the “Exchange Shares”), (ii) $0.7 million aggregate cash consideration and (iii) accrued but unpaid interest. For the share portion of the overall exchange consideration, the notes were exchanged at a rate of 52.9661 shares per $1,000 note, which represents an exchange price of approximately $18.88 per share. This exchange price was the same as the original conversion price of the 2015 Notes.

 

 

Forward-Looking Statements

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

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

You should also consider carefully the statements under “Item 1A. Risk Factors” below, which address additional factors that could cause our results to differ from those set forth in the forward-looking statements. Any forward-looking statements are qualified in their entirety by reference to the factors discussed in this Report, including those discussed in this Report under “Item 1A. Risk

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

Overview

We are a biotechnology company focused on the research, development and commercialization of innovative therapies in pulmonology and orphan fibrotic diseases. In pulmonology, we are focused on therapies for the treatment of idiopathic pulmonary fibrosis, or IPF, a progressive and fatal lung disease. Pirfenidone is approved for marketing by InterMune in all 28 member countries of the European Union, or EU, and Canada as Esbriet. Pirfenidone is not approved for marketing in the United States. In May 2014, we resubmitted our Class 2 New Drug Application, or NDA, to the FDA to support regulatory registration in the United States. The FDA confirmed that the resubmitted NDA had been filed and that it has assigned a Prescription Drug User Fee Act (PDUFA) goal date of November 23, 2014. In addition, on July 17, 2014, the FDA assigned Breakthrough Therapy Designation status for pirfenidone.

In anticipation of U.S. marketing approval of pirfenidone, we have accelerated our efforts to build our global commercial infrastructure and U.S. salesforce to be prepared to launch pirfenidone in the United States. Establishing a commercial infrastructure in the United States for pirfenidone is a significant undertaking and requires a significant capital expenditure. We anticipate that our selling, general and administrative expenses will increase significantly in the short term as we continue this effort.

We continue to pursue our research programs, which are focused on the discovery of targeted, small-molecule therapeutics and biomarkers to treat and monitor serious pulmonary and fibrotic diseases. We intend to proceed with clinical development for at least one of these product candidates in the first half of 2015, further discussed in “Pre-Clinical and Clinical Programs” below.

Esbriet^® (pirfenidone)

Pirfenidone is an orally active, small-molecule compound that has been developed for the treatment of idiopathic pulmonary fibrosis. In September 2011, we launched commercial sales of pirfenidone in Germany under the trade name Esbriet. Esbriet is now also commercially available in 14 of the 15 European countries we originally targeted in our plan, including key markets beyond Germany such as France, Italy and the UK. In addition, we launched Esbriet in Canada in January 2013. We launched in the Netherlands in April 2014 and we currently expect to provide an update on Esbriet pricing and reimbursement in Spain, the only country of our original 15 priority countries yet to secure pricing and reimbursement, in the second half of 2014.

We are also pursuing the registration of pirfenidone to treat IPF in the United States. In July 2011, we commenced a Phase 3 clinical study of pirfenidone in IPF known as the ASCEND trial. Relative to our two previous studies of pirfenidone in IPF (CAPACITY), the ASCEND study utilized centralized procedures for radiographic and pathologic diagnosis of IPF. This yielded a high confidence in the diagnosis of IPF. Additionally, centralized oversight of spirometry (lung function tests) enhanced the quality control of the primary endpoint. Finally, minor modifications of entry criteria for ASCEND could further refine the study population for patients who were more likely to experience a decline in lung function during the study.

Pre-Clinical and Clinical Programs

In February 2014, we announced positive top-line data from the ASCEND study demonstrating that pirfenidone significantly reduced IPF disease progression as measured by the primary endpoint of change in percent predicted forced vital capacity, or FVC, from Baseline to Week 52 (rank ANCOVA p<0.000001). A 10% decline in percent predicted FVC in an individual IPF patient is considered clinically meaningful and strongly predicts mortality. At Week 52, 16.5% of patients in the pirfenidone group experienced an FVC decline of 10% or more or death, compared with 31.8% in the placebo group, representing a 47.9% reduction in the proportion of patients who experienced a meaningful change in FVC or death. The data also demonstrated that 22.7% of patients in the pirfenidone group experienced no decline in FVC, compared with 9.7% in the placebo group, representing a 132.5% increase in the proportion of patients for which FVC did not decrease between Baseline and Week 52.

Pirfenidone also demonstrated significant treatment effects on both of the key pre-specified secondary endpoints of six-minute walk test distance, or 6MWD and progression-free survival, or PFS. Pirfenidone reduced by 27.5% the proportion of patients who experienced a decline in 6MWD of 50 meters or greater (p=0.0360) and reduced the risk of death or disease progression by 43% compared to placebo (Hazard Ratio [HR]=0.57; 95% confidence interval, 0.43-0.77; p=0.0001). Three additional secondary endpoints

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were also pre-specified in ASCEND to measure all-cause mortality, treatment-emergent IPF-related mortality and change from Baseline to Week 52 in dyspnea (shortness of breath). The two mortality analyses were performed for the ASCEND study alone as well as for the pooled population of the ASCEND study and the previous Phase 3 CAPACITY studies through 52 weeks. In the analysis of the ASCEND study alone, there were fewer events of all-cause mortality (HR=0.55, log rank p=0.1045) and of treatment-emergent IPF-related mortality (HR=0.44, log rank p=0.2258) in the pirfenidone group compared with the placebo group. Similarly, analyses of the pooled population showed that the risk of all-cause mortality and treatment-emergent IPF-related death was reduced in the pirfenidone group by 48% (HR=0.52, log rank p=0.0107) and 68% (HR=0.32, log rank p=0.0061), respectively, compared to the placebo group. The secondary endpoint of dyspnea, measured by the UCSD Shortness of Breath Questionnaire, or SOBQ, was not achieved (p=0.1577).

Consistent with observations from the previous Phase 3 studies and post-marketing experience in Europe and Canada, pirfenidone demonstrated a favorable safety profile and was generally well-tolerated in ASCEND. The percentage of patients discontinuing treatment due to an adverse event, or AE, was 14.4% in the pirfenidone group and 10.8% in the placebo group. Serious adverse events were reported in 19.8% of patients in the pirfenidone group and 24.9% in the placebo group. Hospitalizations due to respiratory, thoracic and mediastinal AEs were reported in 3.6% of patients in the pirfenidone group and 11.2% in the placebo group.

The most common AEs with higher incidence in the pirfenidone group were primarily gastrointestinal (e.g., nausea and dyspepsia) and skin-related (e.g., rash). The GI and rash AEs were generally mild to moderate in severity, manageable, reversible and only infrequently led to treatment discontinuations.

Although elevations of aminotransferase levels of at least 3 times the upper limit of normal occurred in 2.9% of pirfenidone patients versus 0.7% of placebo patients, these elevations occurred early, were manageable and reversible, and were similar to those observed in previous pirfenidone studies.

The results of the ASCEND trial supplemented the existing Phase 3 clinical data from our CAPACITY clinical trials to support the potential registration of pirfenidone to treat patients with IPF in the United States. In May 2014, we resubmitted our Class 2 NDA to the FDA to support regulatory registration in the United States and the FDA has assigned a PDUFA goal date of November 23, 2014. In addition, on July 17, 2014, the FDA assigned Breakthrough Therapy Designation status for pirfenidone.

We initiated and began conduct of our Expanded Access Program, or EAP, for pirfenidone in the United States. The EAP is being conducted under a treatment protocol and limited to enrollment of IPF patients in the U.S. who meet specific medical criteria. Investigational drugs such as pirfenidone are not generally available until the FDA approves them. However, the FDA’s regulations have compassionate use provisions under which FDA may allow certain investigational drugs to be made available in cases where there are not comparable or satisfactory alternative therapies for serious or life-threatening illnesses. One of these provisions is an Expanded Access Program under a treatment protocol. The pirfenidone EAP is designed to provide access to the drug while marketing approval is being sought from the FDA.

In July 2013, we initiated a randomized, double-blind, placebo controlled Phase 2 clinical study, known as the PANORAMA trial, designed to evaluate the safety and tolerability of N–acetylcysteine (NAC) in patients with IPF and who are currently being treated with Esbriet (pirfenidone). NAC is a pharmaceutical drug and nutritional supplement used primarily as a mucolytic agent and in the management of paracetamol/acetaminophen overdose. NAC is an antioxidant that has been used alone or in combination with other agents, including Esbriet, for the treatment of IPF. However, NAC is not approved for the treatment of IPF by any major regulatory agency and no controlled data currently exists regarding the safety and tolerability of Esbriet and NAC in combination. We enrolled 123 patients in the PANORAMA trial, however, as a result of the outcome of the National Institutes of Health study, PANTHER, which demonstrated that NAC provided no benefit to IPF patients, no additional patients will be enrolled in PANORAMA.  Patients already enrolled will be followed according to protocol to provide a safety analysis of NAC administered on top of pirfenidone.  Results will be reported by the end of 2015. The PANORAMA trial was initially designed to enroll up to 250 patients at approximately 70 centers in Europe for a treatment period of six months.

In October 2013, we initiated the LOTUSS trial, a Phase 2, multinational, open-label, 16-week, randomized, parallel-group, safety and tolerability study of Esbriet (pirfenidone) in patients with systemic sclerosis-related interstitial lung disease (SSc-ILD). Systemic sclerosis (SSc), also known as scleroderma, is an autoimmune connective tissue disorder resulting in, among other features, excessive collagen production and tissue fibrosis. SSc is a multiorgan disease that can involve the lungs, skin, heart, gut and kidneys. Most affected patients are women and are between 30 to 50 years old at diagnosis. Lung involvement (SSc-ILD) eventually occurs in more than 70% of SSc patients, and is the leading cause of functional impairment as well as the leading cause of mortality in this population. There are currently no licensed pharmacological agents approved to treat SSc-ILD although some patients receive immunosuppressive drugs. Therefore, we believe SSc-ILD represents a significant unmet medical need. In November 2013, pirfenidone was granted orphan drug status for the treatment of SSC-ILD in the United States. We have completed enrollment for our LOTUSS trial, which will conclude in the fourth quarter of 2014, and we currently expect to report results at a medical meeting in 2015.

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In March 2014, we announced ITMN-30162 and ITMN-14440, our two lead pirfenidone analogs. These product candidates have displayed anti-fibrotic activity at very low doses in animal models, pharmacokinetic profiles that predict once or twice-daily dosing in humans and, based on non-clinical studies, a reduced potential for GI and photosensitivity effects. Both ITMN-30162 and ITMN-14440 are in preclinical development and we intend to proceed with clinical development for at least one of these product candidates in the first half of 2015.

Our Strategy

Consistent with the corporate strategy we outlined during the fourth quarter of 2013, our first priority remains the successful commercialization of Esbriet in IPF, including planning and executing a successful launch in the United States if Esbriet is approved. We are also conducting two clinical studies, LOTUSS and PANORAMA, to expand and explore the growth of Esbriet in IPF and in other indications. We have stopped enrolling patients in our PANORAMA trial due to the recent results of the PANTHER study, but enrolled patients will be followed according to protocol. Our LOTUSS trial, is a Phase 2, multinational, open-label, randomized, parallel-group, safety and tolerability study of Esbriet in patients with SSc-ILD which we recently completed enrollment in this trial. We are also investing in internal programs to expand Esbriet in IPF, including new formulations for Esbriet, as well as broadening our pipeline beyond Esbriet and IPF into other specialty fibrotic diseases through our internal research capability and business development initiatives focused on broadening our pipeline, and continue to evaluate opportunities as they arise.

Other Recent Developments

In March 2014, we completed a registered underwritten public offering of 8,625,000 shares of our common stock. The resulting aggregate net proceeds from the common stock offering were approximately $268.0 million, after deducting underwriting discounts and expenses.

In June 2014, we settled an exchange of $43.1 million in aggregate principal amount of our 2.50% convertible senior notes due 2017 (the “2017 Notes”) beneficially owned by certain existing holders of our 2017 Notes for an aggregate of 3,378,457 shares of our common stock (the “Exchange Shares”), valued at $47.22 per share, plus accrued but unpaid interest. The notes were exchanged at a rate of 78.3884 shares per $1,000 note, which represents an exchange price of approximately $12.77 per share and an approximate $0.10 discount from the original conversion price of the 2017 Notes of $12.87 per share.

In July 2014, we settled an exchange of $41.0 million in aggregate principal amount of 2017 Notes beneficially owned by certain noteholders for (i) 3,185,703 shares of the our common stock (the “2017 Exchange Shares”), (ii) $1.3 million aggregate cash consideration and (iii) accrued but unpaid interest. For the share portion of the overall exchange consideration, the notes were exchanged at a rate of 77.7001 shares per $1,000 note, which represents an exchange price of approximately $12.87. This exchange price was the same as the original conversion price of the 2017 Notes. Additionally, in a separately negotiated private transaction with existing holders of 2017 Notes, we settled an exchange of $11.9 million in aggregate principal amount of 2017 Notes beneficially owned by the noteholders for (i) an aggregate of 908,423 2017 Exchange Shares, (ii) approximately $1.2 million of aggregate cash consideration and (iii) accrued but unpaid interest. For the share portion of the overall exchange consideration, the notes were exchanged at a rate of 76.1461 shares per $1,000 note, which represents an exchange price of approximately $13.13 and an approximate $0.26 premium on the original conversion price of the 2017 Notes of $12.87 per share.

In July 2014, we also completed the exchange of $16.9 million in aggregate principal amount of 2015 Notes beneficially owned by an existing noteholder for (i) an aggregate of 893,008 shares of our common stock (the “2015 Exchange Shares” and, together with the 2017 Exchange Shares, the “Exchange Shares”), (ii) $0.7 million aggregate cash consideration and (iii) accrued but unpaid interest. For the share portion of the overall exchange consideration, the notes were exchanged at a rate of 52.9661 shares per $1,000 note, which represents an exchange price of approximately $18.88 per share. This exchange price was the same as the original conversion price of the 2015 Notes.

Critical Accounting Policies

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

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

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in the accounting estimate that are reasonably likely to occur periodically, could materially change the financial statements. We believe there have been no significant changes during the six months ended June 30, 2014 to the items that we disclosed as our critical accounting policies and estimates under Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report on Form 10-K for the year ended December 31, 2013.

Results of Operations

Comparison of the three and six months ended June 30, 2014 and 2013

Revenue

 

Revenue for the three months ended June 30, 2014 increased $21.4 million, or 148%, compared to the same period in 2013. For the six months ended June 30, 2014, revenue increased $41.1 million, or 165%, compared to the same period in 2013. Revenue increased as a result of i) continued growth in existing markets, including Canada, France, Germany, Italy and our Mid-Sized European countries, as well as ii) increased disease awareness and marketing efforts.

Cost of Goods Sold and Gross Margin

 

Cost of goods sold consists of both direct and indirect manufacturing costs, amortization of acquired product rights and royalties to Shionogi related to sales of Esbriet in the EU commencing on January 1, 2013. Manufacturing costs include product costs, distribution, inventory write-downs and internal supply chain management costs. The following table summarizes the major components of cost of goods sold:

 

Cost of goods sold for the three months ended June 30, 2014 increased $3.8 million, or 197%, compared to the same period in 2013. For the six months ended June 30, 2014, cost of goods sold increased $4.8 million, or 112%, compared to the same period in 2013. Historically, our higher COGS as a percentage of revenue included the costs of delayed launches such as product repackaging, relabeling and shipping activities. The decrease in manufacturing costs as a percentage of revenue is also a result of i) increased economies of scale from improved production planning associated with the completion of pricing and reimbursement in our targeted countries, and ii) absorption of fixed costs such as the amortization of our acquired product rights and other internal supply chain costs, over an increased number of units produced. The increase in inventory reserve in the three and six months ended June 30, 2014, relates to write-offs of surplus inventory.

Research and Development Expenses

 

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Research and development expenses for the three months ended June 30, 2014 increased $12.2 million, or 44%, compared to the same period in 2013. For the six months ended June 30, 2014, research and development increased $18.4 million, or 34%, compared to the same period in 2013. Increases in research and development related primarily to completion and evaluation activities for our ASCEND clinical trial in the U.S., which was initiated in July 2011 and related NDA filing activities. We also initiated two additional clinical studies in 2013, LOTUSS and PANORAMA, in order to research expanded uses of Esbriet as well as combined therapy with existing compounds, in addition to PASSPORT, a trial to satisfy post-approval regulatory requirements in the EU. Additionally, we initiated work to prepare for an Early Access Program, or EAP, in the first quarter of 2014 in order to provide Esbriet to U.S. patients prior to FDA approval under the FDA’s compassionate use provisions.

Milestone Payments to Third Parties

We made no third-party payments in the six months ended June 30, 2014 and 2013 related to contractual milestone obligations that were charged directly to expense. In 2011, we received authorization to market Esbriet in the EU and made a milestone payment of $20.0 million in the aggregate to Marnac and KDL and have capitalized such payment as acquired product rights. This asset is being amortized to cost of goods sold over the estimated useful life of 20 years and we incurred approximately $0.3 million of amortization expense in the three months ended June 30, 2014 and 2013, respectively, and $0.5 million of amortization expense in the six months ended June 30, 2014 and 2013, respectively.

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses for the three months ended June 30, 2014 increased $15.4 million, or 41%, compared to the same period in 2013. For the six months ended June 30, 2014, selling, general and administrative increased $29.7 million, or 44%, compared to the same period in 2013. This increase is primarily attributed to increased headcount in connection with our accelerated efforts to build our commercial infrastructure to be prepared to launch pirfenidone in the United States in the fourth quarter of 2014 (previously targeted for the first quarter of 2015), assuming FDA approval during the fourth quarter of 2014. We expect that the build-out of the U.S. commercial organization will be substantially complete by the end of the third quarter of 2014.

Interest Income

 

The increase in interest income for the three and six months ended June 30, 2014 compared to the same periods in 2013 is due to higher average balances in marketable securities in the second quarter and first six months of 2014, respectively.

Interest Expense

 

Interest expense primarily relates to coupon interest on our 2015 Notes, 2017 Notes and 2018 Notes and the related amortization of note issuance costs. Additionally, we recognized expense due to accretion on our note discount in connection with the January 2013 issuance of our 2.50% convertible senior notes due 2017. Increase in interest expense is attributed to the use of an effective interest rate to amortize our note discount over the remaining term of the 2017 Notes.

Fair Value of Embedded Conversion Derivative

 

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The embedded conversion derivative in the 2017 Notes was initially recorded at $36.9 million based on our fair value measurement at the January 2013 note issuance date. This conversion feature is periodically marked to fair value which resulted in an increase of $6.3 million for the three months ending June 30, 2013 and a net decrease of $2.4 million for the six months ended June 30, 2013. On May 30, 2013, upon obtaining stockholder approval of the additional authorized shares of our common stock, the derivative liability was marked to fair value and reclassified to stockholders’ equity. The expense of $6.3 million recorded in the three months ended June 30, 2013 primarily resulted from an increase in our stock price during the period. The estimated fair value of the embedded conversion derivative was $34.5 million immediately prior to its reclassification to stockholders’ equity. Refer to Note 10 to these financial statements for further discussion of the embedded conversion derivate in the 2017 Notes.

Loss on Extinguishment of Notes

 

For the three and six months ended June 30, 2014, this loss is attributed to the extinguishment of the portion of our 2017 Notes exchanged for common stock in June 2014. For the six months ended June 30, 2013, this loss is attributed to the extinguishment of the portion of our 2015 Notes repaid in connection with the issuance of our 2017 Notes in January 2013.

Other

 

Other expense in the three and six months ended June 30, 2014 and the three and six months ended June 30, 2013 consisted primarily of currency gains and losses related to the unhedged portion of our non-dollar denominated balance sheet exposures in connection with our European operations.

Income Tax Provision Allocated to Continuing Operations

 

Income tax provision allocated to continuing operations results from our estimate of taxes payable in various foreign jurisdictions in which we sell our Esbriet product. We expect our tax expense to increase as our foreign operations continue to grow.

Liquidity and Capital Resources

Our principal sources of liquidity are our existing cash, cash equivalents and available-for-sale securities, as well as from cash generated from operations and proceeds from our convertible note and equity financings in June 2008, September 2011, January 2013, November 2013 and March 2014.

At June 30, 2014, our capital resources consisted of cash, cash equivalents and available-for-sale securities of $560.2 million. In March 2014, we completed a registered underwritten public offering of 8,625,000 shares of our common stock. The resulting aggregate net proceeds from the common stock offering were approximately $268.0 million, after deducting underwriting discounts and expenses.

Based on our current expectations, we believe our existing cash, cash equivalents and available-for-sale securities will be sufficient to meet our planned operations through at least the next 12 months. Our future capital requirements will depend on many factors including our revenue growth, the timing and scope of our commercial infrastructure expansion in the United States, the timing and extent of spending to support our development and clinical efforts and strategic initiatives, the expansion of sales, marketing and administrative activities, the timing of introduction of our product into new markets and the continuing market acceptance of our products. In particular, in order to continue to grow our commercial operations successfully, we may need to continue to increase the number of our managerial, operational, financial and other employees in the European Economic Area, or EEA, and Canada, and if pirfenidone is approved for sale in the United States we will need to do so in the United States, as well. We have accelerated our efforts to build our commercial infrastructure to be prepared to launch pirfenidone in the United States in the fourth quarter of 2014 (previously targeted for the first quarter of 2015), assuming FDA approval during the fourth quarter of 2014. Establishing a

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commercial infrastructure in the United States for pirfenidone will require significant capital expenditures, which may require us to raise additional capital.

Certain of our available cash and cash equivalents are held in accounts managed by third-party financial institutions and consist of invested cash and cash in our core operating accounts. The invested cash is invested in interest bearing funds managed by third-party financial institutions. We can provide no assurances that access to our invested cash and cash equivalents will not be impacted by adverse conditions in the financial markets. In addition, at any point in time we could have balances that exceed the Federal Deposit Insurance Corporation insurance limits. While we monitor the cash balances in our operating accounts on a regular basis, these cash balances could be impacted and we may be unable to access our cash if the underlying financial institutions fail or if we become subject to other adverse conditions in the financial markets. To date we have not experienced a lack of access to cash in any of our third-party financial institution accounts.

Cash Flows from Operating Activities

Cash used in operating activities was $109.0 million during the six months ended June 30, 2014, comprised primarily of a net loss of $124.8 million and working capital changes of $4.0 million partially offset by non-cash charges of $19.9 million primarily consisting of depreciation, stock-based compensation, amortization of note discount and note issuance costs and loss on extinguishment of notes.

 

Cash used in operating activities was $111.7 million during the six months ended June 30, 2013, comprised primarily of a net loss of $112.7 million and non-cash charges of $14.8 million primarily consisting of depreciation, stock-based compensation, amortization of note discount and note issuance costs, changes in the fair value of our embedded derivative and loss on extinguishment of notes.

Cash Flows from Investing Activities

Cash used in investing activities was $157.4 million during the six months ended June 30, 2014, and was comprised primarily of purchases of available-for-sale securities of $259.3 million, partially offset by maturities and sales of available-for-sale securities of $103.2 million.

Cash used in investing activities was $39.6 million during the six months ended June 30, 2013, and was comprised primarily of purchases of available-for-sale securities of $148.3 million, partially offset by maturities and sales of available-for-sale securities of $109.2 million.

Cash Flows from Financing Activities

Cash provided by financing activities of $283.5 million for the six months ended June 30, 2014 was due to the registered underwritten public offering of 8,625,000 shares of our common stock. The aggregate net proceeds from this offering were approximately $268.0 million. Additionally, $16.1 million was provided by proceeds from the issuance of common stock under our employee stock benefit plans.

Cash provided by financing activities of $191.7 million for the six months ended June 30, 2013 was due to the registered underwritten public offering of 15,525,000 shares of our common stock and a concurrent registered underwritten public offering of $120.8 million aggregate principal amount of 2.50% convertible senior notes due 2017. The aggregate net proceeds from these concurrent offerings were approximately $262.5 million. This was offset by the repurchase of $72.2 million of 5.00% convertible senior notes due 2015.

Contractual Obligations

Contractual obligations represent future cash commitments and liabilities under agreements with third parties, and exclude contingent liabilities, such as milestone payments, for which we cannot reasonably predict future payments. Our future contractual obligations and commitments are discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013 and are supplemented by the discussion herein.

Off-Balance Sheet Arrangements

As of June 30, 2014, we did not have any material off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.

Recent Accounting Pronouncements

See “Note 2: Summary of Significant Accounting Policies” of the Financial Statements in Part I, Item 1 of this Report.

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Interest Rate and Market Risk

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

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

The table below presents the original principal amounts and weighted-average interest rates by year of maturity for our investment portfolio by final maturity date and our convertible notes as of June 30, 2014:

 

Foreign Currency Exchange Risk

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

We enter into foreign exchange forward contracts to reduce the short-term effects of foreign currency fluctuations on assets and liabilities such as foreign currency receivables and payables. These derivatives are not designated as hedging instruments. Gains and losses on the contracts are included in “other” as a component of other income (expense) in our condensed consolidated statements of operations and substantially offset foreign exchange gains and losses from the remeasurement of intercompany balances.

Our foreign exchange forward contracts expose us to credit risk to the extent that the counterparties may be unable to meet the terms of the agreement. We do, however, seek to mitigate such risks by limiting our counterparties to major financial institutions. In

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addition, the potential risk of loss with any one counterparty resulting from this type of credit risk is monitored. Management does not expect material losses as a result of defaults by counterparties.

Evaluation of Disclosure Controls and Procedures

We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Exchange Act, that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Based on their evaluation, our CEO and CFO have concluded that our disclosure controls and procedures were effective as of June 30, 2014 to provide reasonable assurance that the objectives of our disclosure control system were met.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the quarter ended June 30, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations on the Effectiveness of Controls

Internal control over financial reporting may not prevent or detect all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Also, projections of any evaluation of effectiveness of internal control to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Accordingly, our disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the objectives of our disclosure control system are met and, as set forth above, our Chief Executive Officer and Chief Financial Officer have concluded, based on their evaluation as of the end of the period covered by this Report, that our disclosure controls and procedures were effective at the reasonable assurance level to ensure the information required to be disclosed in this report is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

PART II — OTHER INFORMATION

 

Indemnity Agreement

On or about March 22, 2000, we entered into an Indemnity Agreement with W. Scott Harkonen M.D., who served as the Company’s Chief Executive Officer until September 30, 2003. The Indemnity Agreement obligates us to hold harmless and indemnify Dr. Harkonen against expenses (including attorneys’ fees), witness fees, damages, judgments, fines and amounts paid in settlement and any other amounts Dr. Harkonen becomes legally obligated to pay because of any claim or claims made against him in connection with any threatened, pending or completed action, suit or proceeding, whether civil, criminal, arbitrational, administrative or investigative, to which Dr. Harkonen is a party by reason of the fact that he was a director, officer, employee or other agent of the Company. The Indemnity Agreement establishes exceptions to our indemnification obligation, including but not limited to claims “on account of Dr. Harkonen’s conduct that is established by a final judgment as knowingly fraudulent or deliberately dishonest or that constituted willful misconduct,” claims “on account of Dr. Harkonen’s conduct that is established by a final judgment as constituting a breach of Dr. Harkonen’s duty of loyalty to the Company or resulting in any personal profit or advantage to which Dr. Harkonen was not legally entitled,” and claims “for which payment is actually made to Dr. Harkonen under a valid and collectible insurance policy.” The Indemnity Agreement, however, obligates us to advance all expenses, including attorneys’ fees, incurred by Dr. Harkonen in connection with such proceedings, subject to an undertaking by Dr. Harkonen to repay said amounts if it shall be determined ultimately that he is not entitled to be indemnified by the Company.

Dr. Harkonen was named as a defendant in certain civil action lawsuits instituted against us where the various complaints alleged that we fraudulently misrepresented the medical benefits of Actimmune for the treatment of IPF and promoted Actimmune for IPF. Ultimately, these complaints were dismissed. However, Dr. Harkonen also became the target of the investigation by the U.S. Department of Justice regarding the promotion and marketing of Actimmune. On March 18, 2008, a federal grand jury indicted Dr. Harkonen on two felony counts related to alleged improper promotion and marketing of Actimmune during the time Dr. Harkonen

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was employed by us (the “Criminal Action”). The trial in the criminal case resulted in a jury verdict on September 29, 2009, finding Dr. Harkonen guilty of one count of wire fraud related to a press release issued on August 28, 2002, and acquitting him of a second count of a misbranding charge brought under the Federal Food, Drug, and Cosmetic Act. On April 13, 2011, the Court denied Dr. Harkonen’s post-trial motions and sentenced Dr. Harkonen to three years of probation, including six months of home detention, 200 hours of community service and a fine of $20,000. The Court’s Judgment was filed on April 18, 2011. Dr. Harkonen appealed his conviction and sentence and the government cross-appealed his sentence. On March 4, 2013, the Ninth Circuit Court of Appeals issued an unpublished opinion affirming both the conviction and the sentence. Dr. Harkonen filed a petition for rehearing en banc which was denied by the Ninth Circuit Court of Appeals on May 7, 2013. On August 5, 2013, Dr. Harkonen filed a petition for a writ of certiorari seeking review by the United States Supreme Court. The U.S. Supreme Court denied Dr. Harkonen’s petition on December 16, 2013.

Prior to December 2008, insurers that issued directors & officers (“D&O”) liability insurance to the Company had advanced all of Dr. Harkonen’s expenses, including attorneys’ fees, incurred in the civil action lawsuits and Criminal Action. Those insurers included National Union Fire Insurance Company of Pittsburgh, PA (“AIG”), Underwriters at Lloyd’s, London (“Lloyd’s”), and Continental Casualty Company (“CNA”). On November 19, 2008, however, the insurer that issued a $5.0 million D&O insurance policy providing coverage excess of the monetary limits of coverage provided by AIG, Lloyd’s and CNA, Arch Specialty Insurance Company (“Arch”), advised the Company that the limits of the underlying coverage were expected to be depleted by approximately December 15, 2008; that Arch “disclaimed coverage” based on misstatements and misrepresentations allegedly made by Dr. Harkonen in documents provided in the application for the Arch policy and the underlying Lloyd’s policy; and that, based on that disclaimer, Arch would not be advancing any of Dr. Harkonen’s expenses, including attorneys’ fees, incurred in the civil action lawsuits and Criminal Action.

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

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

The matter was heard by the arbitration panel and on May 29, 2009, the arbitration panel issued an Interim Arbitration Award granting our request for a partial award requiring Arch to advance Dr. Harkonen’s legal fees and costs incurred in the civil action lawsuits and Criminal Action. Arch subsequently advanced such fees and costs, including fees and costs previously paid by the Company. The question whether Arch ultimately will be required to cover the advanced fees and costs or, instead, may recoup those fees and costs as not covered by its policy, has not been determined. Unless and until the arbitration panel rules that such fees and costs are not covered, Arch remains obligated to advance such fees and costs.

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

Now that the United States Supreme Court has denied Dr. Harkonen’s petition for writ of certiorari, leaving the verdict and judgment against Dr. Harkonen intact, Arch has taken steps to resume the arbitration and seek to recoup all or some of the $5.0 million it advanced for Dr. Harkonen’s defense back from Dr. Harkonen and/or from the Company, contending that such fees and costs are not covered by its policy. In addition, Old Republic has written a letter dated May 8, 2014, claiming that Dr. Harkonen’s attorney’s fees and costs are not covered by its policy, and demanding that Dr. Harkonen and/or the Company repay the $5.0 million Old Republic advanced for Dr. Harkonen’s defense costs. The Company believes that Arch and Old Republic are not entitled to recover such fees and costs from the Company and will assert that position in arbitration. At this time, we believe no change to the status of the application of the D&O liability insurance in general has occurred due to the judgment in the Criminal Action. Therefore, while it

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is reasonably possible that we may incur a loss associated with this matter, we are unable to determine the amount of such a loss or range of losses and have not accrued for any such amounts in our financial statements associated with this matter.

 

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

Risks Related to Our Dependence on Pirfenidone

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

In February 2011, we were granted marketing authorization to commercialize Esbriet (pirfenidone) in all 28 member states of the European Union, or EU, for the treatment of adults with mild to moderate idiopathic pulmonary fibrosis, or IPF. We have since launched the product in various countries within the European Economic Area, or EEA, which is comprised of the 28 member states of the European Union plus Norway, Iceland and Liechtenstein, as well as having launched in Canada. In February 2014, we announced positive top-line data from our Phase 3 clinical trial of pirfenidone, ASCEND, demonstrating that pirfenidone significantly reduced IPF disease progression as measured by the primary endpoint of change in percent predicted FVC from Baseline to Week 52. However, pirfenidone is still under investigation for the treatment of IPF in the United States and has not been approved by the U.S. Food and Drug Administration, or FDA.

Because we do not currently have a product candidate other than pirfenidone in clinical development, our future success depends on the continued commercialization of Esbriet in the EEA and Canada and on obtaining regulatory approval from the FDA to market pirfenidone for the treatment of IPF in the United States. We resubmitted the pirfenidone Class 2 NDA to the FDA in May 2014 to support regulatory registration in the United States. The FDA confirmed that the resubmitted NDA had been filed and that it has assigned a PDUFA goal date of November 23, 2014. In addition, on July 17, 2014, the FDA assigned Breakthrough Therapy Designation status for pirfenidone. Although the FDA has granted Breakthrough Therapy Designation to pirfenidone, which is intended to expedite review, there is no guarantee that such designation will actually result in expedited FDA review of our resubmitted NDA. If our pirfenidone product is approved by the FDA, our future success will depend on our successful commercialization of pirfenidone in the United States together with continued commercialization of Esbriet in the EEA and Canada.

We may not succeed in our ongoing commercial efforts in the EEA or Canada, or, if pirfenidone is approved by the FDA, in our efforts to commercialize pirfenidone in the United States. We may experience delays in receiving, or may never receive, regulatory approval to market and sell pirfenidone in the United States. We may experience delays and unforeseen difficulties in the commercialization of Esbriet in one or more of the EEA member states or Canada. We could also experience significant competition in both the EEA, Canada and, if approved, the United States, which could negatively affect our commercialization efforts.

If we also fail to develop future product candidates for any reason, including the reasons stated in “Risks Related to the Development of Our Products and Product Candidates,” we will continue to be dependent on the successful commercialization of pirfenidone. If we do not successfully commercialize Esbriet in the EEA and Canada and/or receive regulatory approval in the United States for pirfenidone for the treatment of IPF and subsequently successfully commercialize pirfenidone in the United States, our ability to generate additional revenue will be jeopardized and, consequently, our business will be seriously harmed.

The results of our ASCEND Phase 3 clinical trial may fail to demonstrate to the FDA sufficient efficacy of pirfenidone to permit approval by the FDA and may have a negative effect on sales of Esbriet in the EEA and Canada.

In November 2009, we submitted an NDA to the FDA seeking approval of pirfenidone for IPF. Following submission of the NDA, the FDA convened an Advisory Committee to review the application and make a recommendation regarding approval. Although the Advisory Committee recommended approval of pirfenidone to reduce the decline in lung function in patients with IPF, the FDA issued us a Complete Response Letter on May 4, 2010, requesting an additional clinical trial to support the efficacy of pirfenidone in IPF. Our NDA was supported by our CAPACITY 1 and CAPACITY 2 trials, which were designed using FVC as the primary endpoint, as opposed to mortality, even though the FDA had advised us that mortality would be the preferred endpoint and that the FDA was uncertain as to what would constitute a clinically meaningful treatment effect of pirfenidone based on FVC change. We met the primary endpoint of FVC change with statistical significance in our CAPACITY 2 trial but not in our CAPACITY 1 trial. While in

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our view the totality of the data from CAPACITY 1 and CAPACITY 2 supported the efficacy and safety of pirfenidone in IPF, the FDA disagreed with our view, issued a Complete Response Letter, and requested additional efficacy data.

We have evaluated our clinical development options to gain FDA approval of pirfenidone for the treatment of IPF within the United States, and we initiated an additional Phase 3 clinical trial known as the ASCEND trial during the second quarter of 2011. In February 2014, we announced top-line data from ASCEND, demonstrating that pirfenidone significantly reduced IPF disease progression as measured by the primary endpoint of change in percent predicted FVC from Baseline to Week 52. We do not have a Special Protocol Assessment, or SPA, in place with the FDA for the ASCEND trial, and the results of this Phase 3 clinical trial, together with the results of our CAPACITY trials, may not be satisfactory to the FDA to support approval of pirfenidone. The ASCEND trial was a 52-week trial with FVC as the primary endpoint. Key secondary endpoints included change in six-minute walk test (6MWT) distance and progression-free survival, which is based on the earliest of time to death, FVC decrement of 10% or greater, or decrement in 6MWT distance of 50 meters or more. In our meeting with the FDA in March 2011 relating to our plans for the ASCEND trial, the FDA indicated that it would prefer a trial with a longer duration (72 weeks) if designed with a FVC endpoint. While the FDA indicated that a 52-week trial with a FVC endpoint could support approval, the FDA further indicated that a trial with a FVC endpoint would need to provide supportive evidence of an effect on mortality. Additional secondary endpoints in ASCEND do include all-cause mortality and on-treatment IPF-related deaths (both evaluated independently in ASCEND as well as pooled with the previous CAPACITY data), and dyspnea. A pre-specified analysis of the pooled population across ASCEND and the two Phase 3 CAPACITY studies taking CAPACITY mortality data through Week 52 showed that the risk of all-cause mortality was reduced by 48% in the pirfenidone group compared to the placebo group.

Whether data from our ASCEND trial when combined with the data from our CAPACITY trials will be sufficient to demonstrate an effect on mortality and/or to obtain FDA approval of pirfenidone for the treatment of IPF will be the subject of review by the FDA after our Class 2 NDA resubmission in May 2014. If the results of the ASCEND trial are not satisfactory to the FDA to support regulatory approval of pirfenidone in the United States, then we will not be able to market and sell Esbriet in the United States. Further, a negative regulatory outcome by the FDA for pirfenidone may negatively affect the sales of Esbriet in the EEA and Canada and/or may be considered by EEA or Canadian regulatory agencies when assessing reimbursement for Esbriet, which may lead to a reduction in the amount of reimbursement amounts in certain countries. Additionally, as in any clinical trial, discovery of unknown problems with pirfenidone in the ASCEND trial could negatively impact the approved safety and efficacy profile and result in possible reduced sales or product withdrawal in the EEA and Canada. Because of our dependence on the commercial success of Esbriet in the EEA and Canada, a negative regulatory outcome by the FDA could materially and adversely affect our business and prospects, including, but not limited to, negatively impacting the pricing and reimbursement guidelines for Esbriet in one or more countries in the EEA and Canada and thereby negatively impacting Esbriet revenue and our financial results. For additional risks related to clinical studies and government regulations, see the risks under “Risks Related to Government Regulation and Approval of Our Products and Product Candidates.”

We cannot assure you of the timing of FDA review of our resubmitted NDA or whether pirfenidone will ultimately be approved for sale in the U.S.

We resubmitted our NDA for pirfenidone to the FDA in May 2014, to which the FDA assigned a PDUFA goal date of November 23, 2014, and our financial plans currently relate to timely approval of such NDA. The process of obtaining FDA regulatory approval often takes many years and can vary substantially based upon the type, complexity and novelty of the products involved. Furthermore, this approval process is extremely complex, expensive and uncertain. While pursuant to the Prescription Drug User Fee Act, we expect that the FDA’s review of our NDA for pirfenidone will be completed by the date assigned by the FDA, we cannot assure you that the FDA will act within this timeframe. Furthermore, although the FDA has granted Breakthrough Therapy Designation to pirfenidone, which is intended to expedite review, there is no guarantee that such designation will actually result in expedited FDA review of our resubmitted NDA, nor guarantee that pirfenidone will ultimately be approved for sale in the U.S. Delays in approvals or rejections of marketing applications may be based upon many factors, including regulatory requests for additional analyses, reports, data and studies, regulatory questions regarding data and results, changes in regulatory policy during the period of product development and the emergence of new information regarding pirfenidone. A delay in receipt of, or a failure to receive, approval for our NDA of pirfenidone for any reason would have a significant adverse effect on our prospects and stock price. Further, any delay in approval of our NDA may place pirfenidone at a competitive disadvantage, may increase our need for additional resources, have an adverse effect on our operations and a negative effect on our stock price.

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Risks Related to the Commercialization of Our Products and Product Candidates

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

As of June 30, 2014, we have agreed pricing and /or reimbursement levels for Esbriet in Austria, Belgium, Denmark, Finland, France, Germany, Iceland, Italy, Ireland, Luxembourg, the Netherlands, Norway, Sweden, the UK and Canada. We have developed estimates of anticipated pricing in other countries, including in the United States, if pirfenidone is approved for sale. These estimates are our expectations, which are based upon the lethal nature of IPF, the lack of any approved therapies for IPF, the Orphan Drug designation of Esbriet, our perception of the overall cost benefit of Esbriet and the current pricing of therapies with a similar product profile, such as treatments for pulmonary hypertension.

Due to efforts to contain health care costs, the reimbursement institutions in the countries in which we seek approval for sale of Esbriet may not agree to our estimated level of pricing and reimbursement. Various countries that have approved Esbriet have mechanisms that may result in a reduction in our estimated level of governmental pricing and reimbursement. Furthermore, in various countries in the EEA and Canada, we may be subject to additional negotiated and confidential governmental clauses and/or discounts which, while customary and routine for reimbursed drugs in these countries, may also adversely impact our realized Esbriet price. The agreed prices of our product may be subject to renegotiation at any time, at the discretion of the authorities, or may be subject to top-down reductions affecting all products or specific categories of products in a certain country.

For example, in Germany, pricing is subject to the rules of the Act on the Reform of the Market for Medicinal Products, or AMNOG, which provide terms that an orphan drug must be re-evaluated once the drug cost of 50 million Euros, inclusive of VAT and before rebate deduction, to the German health system in any 12-month period have been met. Therefore, upon reaching that sales level, we will be required to submit a full Esbriet dossier to Germany’s Federal Joint Committee and will be subject to the processes set forth by AMNOG. The current price agreement between SpiKK and InterMune is valid through September 15, 2014, upon which time either party can terminate the existing contract and start new negotiations, which may lead to a more significant rebate for Esbriet.

Similarly, in France, IPF is currently in the category of Affections de Longue Durée, or ALD’s (Long Term Diseases) which qualifies Esbriet for a certain level of reimbursement. However, the Transparency Commission of the French National Authority for Health, the French agency responsible for assessing medicinal products and advising the health authorities on whether those products provide sufficient benefit to be covered by French National Health Insurance, may revise the criteria by which it defines ALD’s and IPF may not qualify as an ALD. In such case, IPF patients may not be fully reimbursed for the use of Esbriet for the treatment of IPF which may lead to decreased Esbriet utilization and negatively impact our ability to generate revenue from Esbriet sales in France.

In Italy, the Board of the Italian Medicines Agency, or AIFA, approved the pricing and reimbursement conditions for Esbriet under a risk-sharing arrangement, pursuant to which patients’ FVC will be measured six months after initiation of Esbriet therapy. Patients whose percent predicted FVC declines in absolute terms by 10% or more during the first six-month treatment period will not be eligible for reimbursement and their cost of therapy during their treatment period will be credited to the National Health Care System. We expect that between 10% and 15% of patients that initiate therapy will have such an FVC decline.

In England and Wales, the Appraisal Committee of the National Institute for Health and Care Excellence, or NICE, recommended pirfenidone as an option for treating IPF patients whose FVC is between 50% and 80% of predicted at the initiation of therapy, but recommended that treatment with pirfenidone for these patients should be discontinued if there is evidence of disease progression, as defined by a decline in percentage predicted FVC of 10% or more within any 12-month period. Based on clinical study experience with Esbriet, we expect that between 10% and 15% of patients could meet this definition of disease progression in a given 12-month period.

An unfavorable outcome following the pricing and reimbursement review period in any country may result in lower than expected pricing and reimbursement guidelines in such country, as well as in other countries that reference their pricing to that country. In addition, a negative regulatory outcome by the FDA could materially and adversely impact the pricing and reimbursement guidelines for Esbriet in any country in the EEA or Canada and thereby negatively impact Esbriet revenue from such country. This would adversely impact the anticipated revenue from Esbriet.

Expansion of our global commercial infrastructure is a significant undertaking that requires substantial financial and managerial resources, and we may encounter delays or may not be successful in our efforts. In addition, we have already expended substantial resources in advance of potential approval of our NDA for pirfenidone.

Implementing the global commercial infrastructure with the size necessary to support our commercial operations in Europe and Canada and to initiate a commercial launch of pirfenidone in the United States is a significant undertaking that requires substantial

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financial and managerial resources. To support our anticipated marketing efforts, we have begun to implement a commercial infrastructure within the United States, which requires substantial resources and which will require a significant undertaking in order to meet our accelerated anticipated commercial launch of third quarter 2014, and continue to grow our commercial infrastructure in Europe and Canada. In order to successfully grow our commercial operations, we will need to increase the number of our managerial, operational, financial and other employees in the EU, Canada and the U.S., which will require additional financial resources and require significant management attention. The growth of our commercial infrastructure may be more costly than anticipated due to factors beyond our control, such as higher than expected recruitment and training costs or requiring additional sales personnel in order to address the U.S. market. In addition, integrating a commercial infrastructure of this size into our existing organization requires significant management resources and planning. Further, we are expending a substantial amount of resources in anticipation of the approval of our NDA for pirfenidone, which is not guaranteed. In the event the FDA does not approve our NDA, or there is a substantial delay in the approval of our NDA, we will have spent significant resources that we will, in many circumstances, be unable to recoup resulting in an adverse effect to our operating and financial results.

Additionally, we may encounter unforeseen delays in establishing our commercial operations, which may further increase the cost of, and the resources required for, successful commercialization. Given our limited commercial history, we do not have significant experience in a commercial launch of this size and may therefore be unsuccessful. We may not be successful in establishing the required commercial operation (including, but not limited to, failing to attract, retain and motivate the necessary skilled personnel and failing to develop a successful marketing strategy), which would negatively impact our ability to commercialize Esbriet and generate revenue from the sale of Esbriet.

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

The development of our products and product candidates is an expensive process, and we anticipate that the annual cost of treatment for the diseases for which we are seeking approval will be significant. These costs will vary for different diseases based on the dosage and method of administration. Accordingly, we may decide not to market any of our products or product candidates for an approved disease because we believe that it may not be commercially successful. Market acceptance of and demand for our products and product candidates, including Esbriet in the EEA, Canada, and, if approved, in the United States, will depend on many factors, including but not limited to:

 We are in the early stages of Esbriet commercialization in most of the countries in Europe and Canada and we are still developing information with regard to the market acceptance of Esbriet. As a result, we may have to revise our estimates regarding the acceptance of Esbriet under our current pricing structure, and/or reevaluate and/or change the current pricing for Esbriet. For more information, please see the risk factor above titled “Our revenue from sales of Esbriet in the EEA and Canada are dependent upon the pricing and reimbursement guidelines adopted in each of the various countries in the EEA and Canada, which levels may vary and may fall significantly below our current expectations.”

Our products or product candidates may cause undesirable side effects or have other properties that could delay or prevent their regulatory approval, limit the commercial profile of an approved label, or result in significant negative consequences following marketing approval, if any.

Undesirable side effects caused by Esbriet could cause us or regulatory authorities to interrupt, delay or halt clinical trials and could result in a more restrictive label or the delay or denial of regulatory approval by the FDA or other comparable foreign authorities where we have not currently obtained approval. To date, patients treated with Esbriet have experienced some drug-related side effects. Additionally, if we or others later identify undesirable side effects caused by Esbriet, a number of potentially significant negative consequences could result, including:

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Any of these events could prevent us from achieving or maintaining market acceptance of the affected product or could substantially increase the costs and expenses of commercializing the product, which in turn could delay or prevent us from generating significant revenues from its sale. If such side effects are found to be serious, we may be unable to market and sell pirfenidone or such other product, and may be forced to modify, delay, or discontinue our operations, which could materially diminish the value of your investment.

 

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

The pricing and profitability of our products may be subject to control by governmental and other third-party payors. In addition, in many foreign markets, the pricing and/or profitability of prescription pharmaceuticals are subject to governmental control. In the United States, we expect that there will continue to be federal and state proposals to implement similar governmental controls, such as those imposed in recent years. For example, the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act, or collectively, the Affordable Care Act contains a number of provisions, including those governing enrollment in federal healthcare programs, reimbursement changes and fraud and abuse measures, all of which will impact existing government healthcare programs and will result in the development of new programs. The Affordable Care Act, among other things, (i) increases the minimum Medicaid rebates owed by manufacturers under the Medicaid Drug Rebate Program, extends the rebate program to individuals enrolled in Medicaid managed care organizations, and addresses new methodologies by which rebates owed by manufacturers under the Medicaid Drug Rebate Program are calculated for drugs that are inhaled, infused, instilled, implanted or injected, and for drugs that are line extension products; (ii) establishes annual fees and taxes on manufacturers of certain branded prescription drugs, and (iii) enacts a new Medicare Part D coverage gap discount program, in which manufacturers must agree to offer 50% point-of-sale discounts off negotiated prices of applicable brand drugs to eligible beneficiaries during their coverage gap period, as a condition for the manufacturer’s outpatient drugs to be covered under Medicare Part D.

Other significant legislative changes have been proposed and adopted in the United States since the Affordable Care Act was enacted. On August 2, 2011, the Budget Control Act of 2011 among other things, created measures for spending reductions by Congress. A Joint Select Committee on Deficit Reduction, tasked with recommending a targeted deficit reduction of at least $1.2 trillion for the years 2013 through 2021, was unable to reach required goals, thereby triggering the legislation’s automatic reduction to several government programs. This includes aggregate reductions of Medicare payments to providers up to 2% per fiscal year, which went into effect on April 1, 2013. On January 2, 2013, the American Taxpayer Relief Act of 2012 was signed into law, which, among other things, further reduced Medicare payments to several providers, including hospitals, imaging centers and cancer treatment centers. We expect that additional state and federal healthcare reform measures will be adopted in the future, any of which could limit the amounts that federal and state governments will pay for healthcare products and services, which could result in reduced demand for our products once approved or additional pricing pressures.

In addition to legislation and controls impacting pricing pressures in healthcare, our ability to successfully commercialize Esbriet or other product candidates for particular diseases, is highly dependent on the extent to which coverage and reimbursement for such products is available at all or in part from:

The continuing efforts of governmental and other third-party payors to contain or reduce the cost of healthcare through various means may adversely affect our ability to successfully commercialize our products. If governmental and other third-party payors do not provide adequate coverage and reimbursement levels for Esbriet, or our other current or future products, market acceptance of our products will be reduced, and our sales will suffer. For more information, please see the risk factor above titled “Our revenue from sales of Esbriet in the EEA and Canada are dependent upon the pricing and reimbursement guidelines adopted in each of the various countries in the EEA and Canada, which levels may vary and may fall well below our current expectations.”

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

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

Even if we are successful in developing effective drugs, our products may not compete effectively with our competitors’ current or future products. We expect that Esbriet may compete in the EEA and Canada and, if approved by the FDA in the United States, with other products that are being developed for the treatment of IPF, including possible generic versions of pirfenidone in the U.S., EEA, Canada and potentially other markets following the expiration of, or in the absence of market exclusivity. Pirfenidone has certain formulation and method of use patents that protect it, but it has no composition of matter patent protection. Unless we have (i) Orphan Drug designation and enjoy the associated marketing exclusivity, (ii) other market or data exclusivity protection or (iii) other types of patent protection in a particular jurisdiction, we may face competition from a lower cost version of pirfenidone in such a jurisdiction earlier than we might like.

There are many pharmaceutical companies, biotechnology companies, public and private universities, government agencies and research organizations actively engaged in research and development of products, some of which may target the same indications as our product candidates. In particular, Boehringer Ingelheim, or BI, has published Phase 2 and Phase 3 data for BIBF-1120 (nintedanib), a multiple kinase inhibitor that is being studied to treat several types of cancers and has showed efficacy in IPF. More recently, BI has completed two global Phase 3 studies (INPULSIS™-1 and INPULSIS™-2) evaluating the efficacy and safety of nintedanib for the treatment of IPF and results were presented at the American Thoracic Society (ATS) International Conference and published in May 2014. In July 2014, the FDA granted Breakthrough Therapy designation for nintedanib in IPF. Gilead has a humanized monoclonal antibody compound, GS-6624 (simtuzumab), currently in Phase 2 clinical development for the treatment of IPF. Bristol-Myers Squibb has an LPA1 receptor antagonist which is now in a Phase 2 (BMS-986020) study as a potential treatment of IPF. Furthermore, there are at least seven products in various stages of Phase 1 or Phase 2 development for IPF, including two anti-IL-13 monoclonal antibodies from Roche and MedImmune, FG-3019 from Fibrogen, STX-100 from Biogen Idec (acquirer of Stromedix), SAR156597 from Sanofi, GSK2126458 from GSK and PRM-151 from Promedior. Other pirfenidone formulations and similar or altered chemical structures are also in various stages of research and development. Nintedanib, as well as the other product candidates, if approved, will compete with Esbriet, potentially decreasing our sales and the prospects for pirfenidone.

BI and these other competitors are larger, more established, fully integrated pharmaceutical companies and biotechnology companies that have substantially greater capital resources, existing competitive products, larger research and development staffs and facilities, greater experience in drug development and in obtaining regulatory approvals and greater marketing capabilities than we do.

Risks Related to the Development of Our Products and Product Candidates

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

To gain approval to market a product for the treatment of a specific disease, we must provide the FDA, the European Medicines Agency, or EMA, and other foreign regulatory authorities with clinical data that adequately demonstrate to the satisfaction of the FDA or foreign regulatory authorities the safety and efficacy of that product for the proposed indication. Drug development is a long, expensive and uncertain process, and delay or failure can occur at any stage of any of our clinical trials. A number of companies in the pharmaceutical industry, including biotechnology companies, have suffered significant setbacks in clinical trials, even after promising results in earlier preclinical or clinical trials. These setbacks have been caused by, among other things, preclinical findings made while clinical studies were underway and safety or efficacy observations made in clinical studies. Success in preclinical testing and early clinical trials does not ensure that later clinical trials will be successful, and the results of clinical trials by other parties may not be

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indicative of the results in trials we may conduct. For example, in March 2007, we terminated our development of Actimmune for patients with IPF as a result of our decision to discontinue the INSPIRE trial on the recommendation of the study’s independent DMC. For specific risks related to the pirfenidone development program, please see the risk factor titled “If our clinical trials fail to demonstrate to the satisfaction of the FDA, the EMA, and foreign regulatory authorities that any of our products or product candidates are safe and effective for the treatment of particular diseases, the FDA, the EMA, and foreign regulatory authorities may require us to conduct additional clinical trials or may not grant us marketing approval for such products or product candidates for those diseases” below.

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

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

Patient enrollment, a significant factor in the timing of clinical trials, is affected by many factors, including the size and nature of the patient population, the proximity of patients to clinical sites, the eligibility criteria for the trial, the design of the clinical trial, competing clinical trials and clinicians’ and patients’ perceptions as to the potential advantages of the drug being studied in relation to other available therapies, including any new drugs that may be approved for the indications we are investigating. For example, we experienced slower than anticipated patient enrollment in our ASCEND and PANORAMA clinical trials.

We could also encounter delays if a clinical trial is suspended or terminated by us, by the Institutional Review Boards, or IRBs, or Ethics Committees of the institutions in which such trials are being conducted, by the Data Monitoring Committee, or DMC, for such trial or by the FDA, EEA Competent Authorities, or other regulatory authorities. Such authorities may impose such a suspension or termination due to a number of factors, including failure to conduct the clinical trial in accordance with regulatory requirements or our clinical protocols, inspection of the clinical trial operations or trial site by the FDA, EEA Competent Authorities, or other regulatory authorities resulting in the imposition of a clinical hold, unforeseen safety issues or adverse side effects, failure to demonstrate a benefit from using a drug, changes in governmental regulations or administrative actions or lack of adequate funding to continue the clinical trial. For example, in March 2007, we terminated our development of Actimmune for patients with IPF after discontinuing the INSPIRE trial on the recommendation of the study’s independent DMC.

Our development costs will further increase if we have material delays in our current clinical trials for pirfenidone or if we need to perform more or larger clinical trials than initially planned for future product candidates. We are conducting our LOTUSS trial, a Phase 2, multinational, open-label, randomized, parallel-group, designed to study the safety and tolerability of pirfenidone in patients with systemic sclerosis-related interstitial lung disease. Any modifications to trial design for this study would increase our development costs. If there are any significant delays for any of our other current or planned clinical trials, our business, financial condition, financial results and the commercial prospects for our products and product candidates will be harmed, and our prospects for profitability will be impaired. In addition, delays or discontinuations of our clinical trials could require us to cease development efforts of a product candidate in part or altogether, which will harm our business or financial condition and the commercial prospects for such product and product candidate.

 

Whether we will have any future products other than those based on pirfenidone is largely dependent on the success of our research and development programs, which are at an early stage, and our business development efforts. Our drug candidates

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other than pirfenidone are still in early stages of development and we may not be able to successfully discover, develop, obtain regulatory approval for or commercialize any such drug candidates.

We intend to invest significant time and financial resources in our research and development programs. We currently have one product in the EEA and Canada, Esbriet, based on pirfenidone. Whether we will have any future products other than those based on pirfenidone depends substantially upon our ability to discover, develop, obtain regulatory approval for and commercialize our other drug candidates successfully. Our research and development programs are prone to the significant and likely risks of failure inherent in drug development. We currently do not, and may never, have any other drug candidates in clinical trials, and we have not identified drug candidates for many of our research programs.

Before obtaining regulatory approvals for the commercial sale of any drug candidate for a target indication, we must demonstrate with substantial evidence gathered in well-controlled clinical trials, and, with respect to approval in the United States, to the satisfaction of the FDA, or, with respect to approval in other countries, similar regulatory authorities in those countries, that the drug candidate is safe and effective for use for that target indication. Satisfaction of these and other regulatory requirements is costly, time consuming, uncertain, and subject to unanticipated delays. Despite our efforts, our drug candidates may not:

Positive results in preclinical studies of a drug candidate may not be predictive of similar results in humans during clinical trials, and promising results from early clinical trials of a drug candidate may not be replicated in later clinical trials. Interim results of a clinical trial do not necessarily predict final results. A number of companies in the pharmaceutical and biotechnology industries have suffered significant setbacks in late-stage clinical trials even after achieving promising results in early-stage development. Accordingly, the results from completed preclinical studies and clinical trials for our drug candidates may not be predictive of the results we may obtain in later stage trials or studies. Our preclinical studies or clinical trials may produce negative or inconclusive results, and we may decide, or regulators may require us, to conduct additional preclinical studies or clinical trials, or to discontinue clinical trials altogether. For example, the National Institutes of Health study, PANTHER, recently demonstrated that NAC provided no benefit to IPF patients. We have therefore decided not to enroll additional patients into our PANORAMA trial of NAC added to Esbriet therapy in mild-to-moderate IPF patients.

Because our internal research and development capabilities are limited, and because new product approvals can take many years, we may be unsuccessful in developing new products or product candidates internally, and therefore may need to negotiate with pharmaceutical and biotechnology companies, academic scientists and other researchers to sell or license products or technology to us. The success of this strategy depends partly upon our ability to identify and select promising product candidates and approved products, negotiate licensing or acquisition agreements with their current owners and finance these arrangements, including via collaboration and development arrangements with third parties. Further, any product candidate that we acquire will most likely require additional development efforts prior to commercial sale, including pre-clinical or clinical testing and approval by the FDA and other foreign regulatory authorities. All product candidates are prone to risks of failure typical of pharmaceutical product development, including the possibility that a product candidate will not be shown to be sufficiently safe and effective for approval by regulatory authorities.

We do not expect any of our drug candidates to be commercially available for several years and some or all may never become commercially available. Accordingly, we may never generate revenues through the sale of products other than those based on pirfenidone.

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

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

We are not permitted to market our product candidates in the United States until we receive approval of an NDA from the FDA, or in any foreign countries until we receive the requisite approval from such countries. Before obtaining regulatory approvals for the commercial sale of any product candidate for a target indication, we must demonstrate with evidence gathered in preclinical and well-controlled clinical trials, and, with respect to approval in the United States, to the satisfaction of the FDA and, with respect to approval in other countries, similar regulatory authorities in those countries, that the product candidate is safe and effective for that target indication and that the manufacturing facilities, processes and controls are adequate. Our failure to adequately demonstrate the safety and effectiveness of any of our products or product candidates for the treatment of particular diseases may delay or prevent our receipt of the FDA’s and foreign regulatory authorities’ approval and, ultimately, may prevent commercialization of our products and product candidates for those diseases.

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The FDA, the EMA and other foreign regulatory authorities have substantial discretion in deciding whether, based on the benefits and risks in a particular disease, any of our products or product candidates should be granted approval for the treatment of that particular disease. Even if we believe that a clinical trial or trials have demonstrated the safety and statistically significant efficacy of any of our products or product candidates for the treatment of a disease, the results may not be satisfactory to the FDA, EMA or other foreign regulatory authorities. The FDA, the EMA and other foreign regulatory authorities, including their advisory committees, operate under different frameworks, which may affect the selection of preclinical and clinical data they will review, and furthermore may interpret such data in different ways than us, which could delay, limit or prevent regulatory approval. In addition, even if advisory committees to the FDA recommend approval of our product candidates, such recommendations are non-binding and the FDA may not approve our NDA for the product candidates. For example, nine of the twelve members of the Pulmonary-Allergy Drugs Advisory Committee, or PADAC, of the FDA recommended approval of pirfenidone to reduce decline in lung function in patients with IPF. However, notwithstanding the PADAC approval recommendation, we subsequently received a Complete Response Letter from the FDA requesting an additional clinical trial to support the efficacy of pirfenidone. If regulatory delays are significant or regulatory approval is limited or denied altogether, our financial results and commercial prospects will be harmed, and our prospects for profitability will be significantly impaired.

Both our CAPACITY and ASCEND trials were conducted without a SPA with the FDA. The FDA’s SPA process creates a written agreement between the sponsoring company and the FDA regarding clinical study design and other clinical study issues that can be used to support approval of a product candidate. We did not obtain a SPA agreement with the FDA and therefore there was no assurance that the results would provide a sufficient basis in the view of the FDA for the FDA to grant regulatory approval of a new drug application for pirfenidone for the treatment of IPF. In addition, while the FDA will consider and approve NDAs based on various endpoints, the FDA had indicated that mortality is the ideal endpoint for IPF clinical trials. We designed and conducted CAPACITY 1, CAPACITY 2 and ASCEND based on FVC change as the primary endpoint, as opposed to mortality. The FDA had advised us that they were uncertain as to what would constitute a clinically meaningful treatment effect of pirfenidone on this endpoint. The primary endpoint of FVC change was met with statistical significance in CAPACITY 2 but not in CAPACITY 1. In 2010, the FDA determined that our NDA application was not adequate to support the efficacy of pirfenidone for the treatment of IPF and issued to us a Complete Response Letter requesting an additional clinical trial to support the efficacy of pirfenidone in IPF. Following issuance of the Complete Response Letter, we initiated the ASCEND trial during the third quarter of 2011.

In February 2014, we announced positive top-line data from ASCEND, demonstrating that pirfenidone significantly reduced IPF disease progression as measured by the primary endpoint of change in percent predicted FVC from Baseline to Week 52, and in May 2014 we published additional data. However, the results of ASCEND may not be sufficient to cause the FDA to grant regulatory approval for the sale of pirfenidone in the United States. Even if such approval is granted, the FDA may require an indication statement in the label of the approved product. In addition, in July 2014, we submitted to the EMA a variation to our Esbriet marketing authorization updating the Summary of Product Characteristics to include ASCEND clinical data. However, the EMA may fail to approve our proposed label revision. If the FDA fails to approve pirfenidone for sale in United States, or if the claims permitted by such approval are limited, or if the EMA fails to approve our proposed label revision, our business and prospects, may be materially and adversely affected, because of, among other factors, the potential negative impact on the pricing and reimbursement guidelines for Esbriet in any country in the EU and the consequent negative impact on Esbriet revenue from such country. For additional information related to the risk of the Phase 3 clinical study, please see the risk factor titled “Risks Related to Our Dependence on Pirfenidone—The results of our ASCEND Phase 3 clinical trial may fail to demonstrate to the FDA sufficient efficacy of pirfenidone to permit approval by the FDA and may have a negative effect on sales of Esbriet in the EEA and Canada.”

Even in the circumstances that we receive FDA approval for pirfenidone, and successfully launch the product in the United States, there may be unforeseen adverse events that may cause us to update our label with additional safety information, limit our indication or require us to withdraw our product from the market. We may or may not be able to re-launch the product. Given our status as a company with one marketed product and early stage pipeline at this time, this could have a material adverse effect on our ability to generate additional revenue, and consequently, our business will be seriously harmed.

We are subject to extensive and rigorous governmental regulation, including the requirement of FDA, EMA or other regulatory approval before our products and product candidates may be lawfully marketed. Even after we receive regulatory approval, we will be subject to ongoing obligations and continued regulatory review, which may result in significant additional expense.

The regulatory review and approval process of governmental authorities is lengthy, expensive and uncertain, and regulatory standards may change during the development of a particular product candidate. We are not permitted to market our product candidates in the United States or other countries until we have received requisite regulatory approvals. The FDA review process typically takes significant time to complete and approval is never guaranteed. Any regulatory approvals that we may receive may be subject to limitations on the indications for which the product may be marketed or the conditions of approval, or contain requirements for potentially costly post-marketing testing, including Phase IV clinical trials, and surveillance to monitor the safety and efficacy of the product candidate. Markets outside of the United States, such as the EEA, also have requirements for approval of drug candidates

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with which we must comply prior to marketing. Obtaining regulatory approval for marketing of a product candidate in one country does not ensure we will be able to obtain regulatory approval in other countries, but a failure or delay in obtaining regulatory approval in one country may have a negative effect on the regulatory process in other countries. Also, any regulatory approval of any of our products or product candidates, once obtained, may be withdrawn.

Both before and after the approval of our product candidates and product, we, our product candidates, our product, our operations, our facilities, our suppliers, our distributors, our contract manufacturers, our contract research organizations, or CROs, and our contract testing laboratories are subject to extensive regulation by governmental authorities in the United States, the EEA and other countries, with regulations differing from country to country. In the United States, the FDA regulates, among other things, the pre-clinical testing, clinical trials, manufacturing, safety, efficacy, potency, labeling, storage, record keeping, quality systems, advertising, promotion, sale and distribution, marketing, and import and export of therapeutic products. These requirements include submissions of safety and other post-marketing information and reports, registration, as well as continued compliance with current good manufacturing practice, or cGMP, requirements and current good clinical practices, or, GCPs, for any clinical trials that we conduct post-approval. Similar requirements exist in the EEA. In addition, quality control and manufacturing procedures must continue to conform to cGMPs regulations after approval, and the FDA, and EEA Competent Authorities periodically inspect manufacturing facilities to assess compliance with cGMP. Accordingly, we and others with whom we work must continue to expend time, money, and effort in all areas of regulatory compliance, including manufacturing, production, and quality control. Later discovery of previously unknown problems with a product, including adverse events of unanticipated severity or frequency, or with our third-party manufacturers or manufacturing processes, or failure to comply with regulatory requirements, may result in, among other things, one or more of the following actions: notices of violation, untitled letters, warning letters, fines and other monetary penalties, unanticipated expenditures, delays in approval or refusal to approve a product candidate; product recall or seizure; interruption of manufacturing or clinical trials; operating restrictions; injunctions; and criminal prosecution. Any failure to receive the marketing approvals necessary to commercialize our product candidates could harm our business.

The policies of the FDA, the EMA, and EEA Member States may change and additional government regulations may be enacted that could prevent, limit or delay regulatory approval of our product candidates. The FDA has increased its attention to product safety concerns in light of recent high profile safety issues with certain drug products in the United States. Moreover, heightened Congressional scrutiny on the adequacy of the FDA’s drug approval process and the agency’s efforts to assure the safety of marketed drugs has resulted in proposed agency initiatives and new legislation addressing drug safety issues. If adopted, any new legislation or agency initiatives could result in delays or increased costs during the period of product development, clinical trials and regulatory review and approval, as well as increased costs to assure compliance with any new post-approval regulatory requirements. These restrictions or requirements could require us to conduct costly studies. If we are slow or unable to adapt to changes in existing requirements or the adoption of new requirements or policies, or if we are not able to maintain regulatory compliance, we may lose any marketing approval that we may have obtained, which would adversely affect our business, prospects and ability to achieve or sustain profitability.

Our failure or alleged failure to comply with federal, state and foreign laws governing the promotion of our products, including anti-kickback, false claims and anti-corruption could result in civil and/or criminal sanctions and/or harm our business.

If we obtain FDA approval for any of our product candidates and begin commercializing those products in the United States, our operations may be directly, or indirectly through our customers, subject to various federal and state fraud and abuse laws, including, without limitation, the federal Anti-Kickback Statute, the federal False Claims Act, and physician sunshine laws and regulations. These laws may impact, among other things, our proposed sales, marketing, and education programs. In addition, we may be subject to patient privacy regulation by both the federal government and the states in which we conduct our business. The laws that may affect our ability to operate include:

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Because of the breadth of these laws and the narrowness of the statutory exceptions and safe harbors available, it is possible that some of our business activities could be subject to challenge under one or more of such laws. In addition, recent health care reform legislation has strengthened these laws. For example, the recently enacted Affordable Care Act, among other things, amends the intent requirement of the federal Anti-Kickback Statute and criminal healthcare fraud statutes. A person or entity no longer needs to have actual knowledge of the statute or specific intent to violate it. In addition, the Affordable Care Act provides that the government may assert that a claim including items or services resulting from a violation of the federal Anti-Kickback Statute constitutes a false or fraudulent claim for purposes of the False Claims Act.

Achieving and sustaining compliance with these laws may prove costly. In addition, any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal expenses and divert our management’s attention from the operation of our business. If our operations are found to be in violation of any of the laws described above or any other governmental regulations that apply to us, we may be subject to penalties, including civil and criminal penalties, damages, fines, the exclusion from participation in federal and state healthcare programs, imprisonment, or the curtailment or restructuring of our operations, any of which could adversely affect our ability to operate our business and our financial results.

We are also subject to the U.S. Foreign Corrupt Practices Act and anti-corruption laws, and similar laws in foreign countries, such as the U.K. Bribery Act of 2010, which became effective on July 1, 2011. In general, there is a worldwide trend to strengthen anticorruption laws and their enforcement. Any violation of these laws by us or our agents or distributors could create a substantial liability for us, subject our officers and directors to personal liability and also cause a loss of reputation in the market. Becoming familiar with and implementing the infrastructure necessary to comply with laws, rules and regulations applicable to new business activities and mitigate and protect against corruption risks could be quite costly. In addition, failure by us or our agents or distributors to comply with these laws, rules and regulations could delay our expansion and could adversely affect our business.

We are subject to similar laws in foreign countries where we conduct business. For example, within the EEA, the control of unlawful marketing and promotional activities is a matter of national law in each of the member states. The member states of the EEA closely monitor perceived unlawful marketing and promotional activities by companies. We could face civil, criminal and administrative sanctions if any member state determines that we have breached our obligations under its national laws. Industry associations also closely monitor the activities of member companies. If these organizations or authorities name us as having breached our obligations under their regulations, rules or standards, our reputation would suffer and our business and financial condition could be adversely affected.

If we fail to comply with our reporting and payment obligations under governmental programs in the U.S. for our products, we could be subject to penalties, sanctions and fines which could have a material adverse effect on our business, financial condition, results of operations and future business prospects.

We anticipate participating in the Medicare Part D Coverage Gap Discount Program, the Medicaid Drug Rebate Program and other federal and state government pricing programs in the U.S., and we may participate in additional government programs for our products, once approved, in the future. These programs generally will require us to pay rebates or provide discounts to government payors and their sponsors, enrollees or beneficiaries in connection with drugs that are dispensed and reimbursed under these programs. In some cases, such as with the Medicaid Drug Rebate Program, the rebates are based on pricing information that we report on a monthly and quarterly basis to the government agencies that administer the programs. The terms, scope and complexity of these government pricing programs change frequently and compliance requirements are subject to interpretation by the government or other regulatory bodies. Our activities relating to the reporting of prices for products we market in the future, the reporting of Medicaid rebate information and other information affecting federal and state and third-party reimbursement for our products, and the sale and marketing of our products, could become subject to scrutiny. Responding to a government inquiry, investigation or enforcement action, could be expensive and time-consuming, and could have a material adverse effect on our business, financial condition and results of operation.

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With respect to the Medicare Part D program, the Centers for Medicare & Medicaid Services, the agency responsible for administering this outpatient drug program, or CMS, may impose civil monetary penalties on us from time to time for failure to meet certain regulatory requirements. CMS recently imposed two civil monetary penalties related to our failure to pay specified Part D sponsors within the required time frame, neither of which resulted in material amounts of money. Similar penalties may be imposed on us for these or other violations in the future. We do not believe that such penalties will have a material adverse effect on our business.

Risks Related to Manufacturing and Our Dependence on Third Parties

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

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

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

 

We rely on third-party manufacturers to manufacture our clinical and commercial drug supplies, and our commercialization of any product or product candidates could be stopped, delayed or made less profitable if those third parties fail to obtain the approval of the FDA, Competent Authorities of the Member States of the EEA or comparable regulatory authorities, fail to provide us with sufficient quantities of drug product or fail to do so at acceptable quality levels or prices.

We do not currently have the resources, facilities or experience internally to manufacture Esbriet or any of our product candidates on a commercial scale or for purposes of clinical trials. Completion of our clinical trials and commercialization of our products requires access to, or development of, manufacturing facilities that meet FDA standards to manufacture a sufficient supply of our products. The FDA, the EMA and foreign regulatory authorities must approve facilities that manufacture our products for commercial purposes, as well as the manufacturing processes and specifications for the product. We depend on, and we expect to continue to depend on, third parties for the manufacture of our product candidates for preclinical and clinical purposes, and we rely on third parties with FDA and/or EEA Competent Authority-approved manufacturing facilities for the manufacture of Esbriet for commercial purposes. We do not control the manufacturing process of, and are completely dependent on, our contract manufacturing partners for cGMP compliance. If our contract manufacturers cannot successfully manufacture material that conforms to our specifications and the strict regulatory requirements of the FDA, the EMA or other regulatory authorities, they will not be able to secure and/or maintain regulatory approval for their manufacturing facilities. In addition, we have no control over the ability of our contract manufacturers to maintain adequate quality control, quality assurance and qualified personnel. If the FDA, EEA Competent Authorities, or comparable foreign regulatory authorities do not approve these facilities for the manufacture of our product candidates or if it withdraws any such approval in the future, we may need to find alternative manufacturing facilities, which would significantly impact our ability to develop, obtain regulatory approval for or market our product candidates, if approved.

We have a long-term supply contract with DSM Fine Chemicals, Signa C.V. and ACIC Fine Chemicals Inc. for the active pharmaceutical ingredient for Esbriet and a contract with Catalent for the manufacture of the drug product for Esbriet. If we do not perform our obligations under these agreements, these agreements may be terminated.

Our strategy to contract with third parties for the manufacture of our products and product candidates presents many risks, including, but not limited to, the following:

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

Our failure to set up an integrated supply chain in the United States may adversely affect our ability to commercialize a pirfenidone product if such a product is approved by the FDA for sale in the United States.

We do not currently have, nor do we plan to acquire, the infrastructure or internal capability to produce our commercial supply of a pirfenidone product in the United States if such a product receives FDA approval. We intend to contract with a third party supplier to provide our commercial supply of any pirfenidone products approved by the FDA for sale in the United States. However, we cannot guarantee that we will be able to find a such a third party supplier on terms acceptable to us or at all. Furthermore, the FDA must approve facilities that manufacture our products for commercial purposes in the United States, as well as the manufacturing processes and specifications for the product.

In addition, we would not directly control the manufacturing of, and would be completely dependent on, our contract manufacturers for compliance with the cGMP for manufacture of both active drug substances and finished drug products. If our contract manufacturers cannot successfully manufacture material that conforms to our specifications and the strict regulatory requirements of the FDA, they will not be able to secure and/or maintain regulatory approval for their manufacturing facilities. In addition, we would have no direct control over the ability of our contract manufacturers to maintain adequate quality control, quality assurance and qualified personnel. Furthermore, we expect that any contract manufacturers would be engaged with other companies to supply and/or manufacture materials or products for such companies, which would expose our manufacturers to regulatory risks for the production of such materials and products. As a result, failure to meet the regulatory requirements for the production of those materials and products could generally affect the regulatory clearance of our contract manufacturers’ facility. If the FDA did not approve these facilities for the manufacture of a pirfenidone product or if it withdrew its approval in the future, we would need to find alternative manufacturing facilities, which would negatively impact our ability to generate revenue from sales of pirfenidone products in the United States.

A disruption in our ability to manufacture or ship Esbriet or a disruption in our distribution channels could result in significant product delays and adversely affect our results. This risk is exacerbated if we do not have back up providers of supply chain services.

We currently rely on single-source partners to provide services to us at many stages in our supply chain. Consequently should any of our single-source partners be unable to provide service, we may be unable to satisfy customer orders on a timely basis, if at all.

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We currently ship Esbriet from third-party packaging facilities to our distributors in the EEA. A disruption in our ability to ship Esbriet to our distributors in the EEA or a disruption in our distribution channels in the EEA for any reason, including as a result of a natural disaster, terrorism or failure of our commercial carrier, could result in product delivery delays. If this were to occur, we may be unable to satisfy customer orders on a timely basis, if at all.

A significant disruptive event to our ability to manufacture or distribute Esbriet could adversely affect our ability to generate revenue from Esbriet and materially affect our business and results of operations and our ability to be prepared to launch a pirfenidone product in the United States, if approved for sale by the FDA.

 

We rely on third parties to conduct, monitor and manage our clinical trials, and those third parties may not perform satisfactorily.

We have relied upon and plan to continue to rely upon third-party CROs and other third parties, such as medical institutions and clinical investigators, to conduct, monitor and manage data for our ongoing preclinical and clinical programs. For example, we used CROs to conduct our Phase 3 ASCEND trial for pirfenidone. We rely on these third parties for execution of our preclinical and clinical trials, and control only certain aspects of their activities. Nevertheless, we are responsible for ensuring that each of our studies is conducted in accordance with the applicable protocol, legal, regulatory and scientific standards, and our reliance on the CROs does not relieve us of our regulatory responsibilities. We and our CROs are subject to GCP requirements, which are regulations and guidelines enforced by the FDA, EEA Competent Authorities, and comparable foreign regulatory authorities for all of our products in clinical development. Regulatory authorities enforce these GCPs through periodic inspections of trial sponsors, principal investigators and trial sites. If we or our CROs fail to comply with applicable GCPs, the clinical data generated in our clinical trials may be deemed unreliable and the FDA or comparable foreign regulatory authorities may require us to perform additional clinical trials before approving our marketing applications. We cannot assure you that upon inspection by a given regulatory authority, such regulatory authority will determine that any of our clinical trials comply with GCP regulations. In addition, our clinical trials must be conducted with product produced under cGMP regulations. Our failure to comply with these regulations may require us to repeat clinical trials, which would delay the regulatory approval process.

If any of our relationships with these third parties terminate, we may not be able to enter into arrangements with alternative CROs or other third parties or to do so on commercially reasonable terms. In addition, these third parties are not our employees, and except for remedies available to us under our agreements with them, we cannot control whether or not they devote sufficient time and resources to our clinical and preclinical programs. If our third parties need to be replaced, if they do not successfully carry out their contractual duties or meet expected deadlines, or if the quality or accuracy of the data they obtain is compromised due to the failure to adhere to our clinical protocols, regulatory requirements or for other reasons, our clinical trials may be extended, delayed or terminated and we may be delayed in or prevented from obtaining regulatory approvals for our product candidates, and may not be able to successfully commercialize our products and product candidates. As a result, our results of operations and the commercial prospects for our product candidates would be harmed, our costs could increase and our ability to generate revenues could be delayed.

Switching or adding CROs and other third parties involves additional cost and requires management time and focus. In addition, there is a natural transition period when a new CRO commences work. As a result, delays occur, which can materially impact our ability to meet our desired clinical development timelines. Though we carefully manage our relationships with these third parties, there can be no assurance that we will not encounter similar challenges or delays in the future or that these delays or challenges will not have a material adverse impact on our business, financial condition and prospects. We may not be able to locate any necessary acceptable replacements or enter into favorable agreements with them, if at all.

Risks Related to Our Intellectual Property Rights

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

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

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

Furthermore, the Leahy-Smith America Invents Act, or AIA, reformed certain patent laws in the United States and may create additional uncertainty regarding patents. Among the significant changes are switching from a “first-to-invent” system to a “first-to-file” system, and the implementation of new procedures that permit competitors to challenge our patents in the U.S. Patent and Trademark Office after grant.

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

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

In the EEA, patents are subject to a post-grant opposition period, and enforcement of patents is on a country-by-country basis subject to varying, complex and evolving national requirements and standards. Competitors could challenge the validity of our patent claims and challenge whether their product actually infringes those claims. Such challenges would involve complex legal and factual questions and entail considerable costs and investment of effort. In June 2012, opposition proceedings were filed in the European Patent Office against our European patent 2324831 B1, requesting that the patent be revoked on the basis that the invention is not patentable. The European Patent Office Opposition Division rendered its formal decision in December 2013, and the patent was not revoked. Both parties to the proceeding have appealed, and we intend to continue to vigorously defend the patent. We can provide no assurances regarding the outcome of this matter.

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

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We may be required to disclose clinical or other information the disclosure of which could compromise our ability to obtain, maintain or protect certain proprietary rights necessary for the development and commercialization of our products or product candidates.

We are also subject, in the U.S. and elsewhere, to various regulatory schemes that require disclosure of clinical trial data and/or allow access to our data via freedom of information requests.

For example, in September 2012, we were notified by the EMA that we had received a request in accordance with Regulation 1049/2001/EC regarding public access to documents held by institutions of the EU. The request was made by a potential competitor and sought access to aspects of our Esbriet MAA. We are in the process of challenging the disclosure on the grounds, among others, that it would harm our intellectual property interests by placing confidential information into the public domain as potential prior art, and that such disclosure would harm our commercial interests and provide competitors with an unfair gain. There can be no assurance that we will ultimately be successful in preventing disclosure of the data in our MAA. There can be no assurance that we will ultimately be successful in preventing disclosure of the data in our MAA.

Additionally, we were notified by Health Canada in October 2013 that an access to information request had been lodged in accordance with Canada’s Access to Information Act, seeking access to documents covering important aspects of our Esbriet NDA. We successfully argued that the scope of this request be limited but there can be no assurance that such arguments will be successful in the future.

In the event that our proprietary data becomes public as a result of freedom of information requests, our competitive advantages may be diminished and our ability to obtain patent protection for certain inventions reflected in such data may be adversely affected.

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

The pirfenidone molecule itself has no composition of matter patent protection in the United States or elsewhere. Because the extent and scope of patent protection for pirfenidone is limited, orphan drug designation is especially important. In the EU we have been granted orphan drug designation for pirfenidone for the treatment of IPF by the EMA, and we have been granted the associated market exclusivity until 2021. In the EU, the EMA’s Committee for Orphan Medicinal Products, or COMP, grants orphan drug designation to promote the development of products that are intended for the diagnosis, prevention or treatment of a life-threatening or chronically debilitating condition affecting not more than 5 in 10,000 persons in the European Union Community. Additionally, designation is granted for products intended for the diagnosis, prevention or treatment of a life-threatening, seriously debilitating or serious and chronic condition and when, without incentives, it is unlikely that sales of the drug in the EU would be sufficient to justify the necessary investment in developing the drug. In the EU, orphan drug designation also entitles a party to financial incentives such as reduction of fees or fee waivers and 10 years of market exclusivity is granted following approval. This period may be reduced to 6 years if the orphan drug designation criteria are no longer met, including where it is shown that the product is sufficiently profitable not to justify maintenance of market exclusivity.

We have received orphan drug designation for pirfenidone for the treatment of IPF by the FDA. Under the Orphan Drug Act, the FDA may designate a product as an orphan drug if it is intended to treat a rare disease or condition, defined as a patient population of fewer than 200,000 in the United States, or a patient population greater than 200,000 in the United States where there is no reasonable expectation that the cost of developing the drug will be recovered from sales in the United States. In the United States, orphan drug designation entitles a party to financial incentives such as opportunities for grant funding towards clinical trial costs, tax advantages and user-fee waivers. In addition, if a product receives the first FDA approval for the indication for which it has orphan designation, the product is entitled to orphan drug exclusivity, which means the FDA may not approve any other application to market the same drug for the same indication for a period of 7 years, except in limited circumstances, such as a showing of clinical superiority over the product with orphan exclusivity or where the manufacturer is unable to assure sufficient product quantity. If we do not obtain orphan drug exclusivity for our pirfenidone in the United States, our competitors may then market and sell the same drug to treat the same condition sooner than if we had obtained orphan drug exclusivity and our revenues will be reduced. Moreover, we may not have the ability to prevent others from commercializing pirfenidone for (i) IPF after the orphan drug designation exclusivity period in the EU, and, if granted, in the United States, expires, (ii) uses covered by other patents held by third parties or (iii) other uses in the public domain for which there is no patent protection. Consequently, following expiration of orphan drug exclusivity protection in the EU, and, if granted, in the United States, we must rely primarily on the protection afforded by formulation and method of use patents relating to the safe and/or effective use of pirfenidone for IPF.

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Although pirfenidone has received orphan drug marketing exclusivity in the EU for the treatment of patients with IPF and orphan drug designation in the United States, that exclusivity and designation may not effectively protect the product from competition. We may not be the first to obtain marketing approval in the United States for IPF due to the uncertainties associated with developing pharmaceutical products. Further, even if we obtain orphan drug exclusivity for pirfenidone in the United States, that exclusivity may not effectively protect the product from competition because different drugs with different active moieties can be approved for the same condition. Moreover, even after an orphan drug is approved, the FDA can subsequently approve the same drug with the same active moiety for the same condition if the FDA concludes that the later drug is safer, more effective, or makes a major contribution to patient care.

We could face competition from third-party products that have pirfenidone as the active pharmaceutical ingredient.

In addition, other third parties have obtained patents in the United States and elsewhere relating to formulation and methods of use of pirfenidone for the treatment of certain diseases. As a result, it is possible that we could face competition from third-party products that have pirfenidone as the active pharmaceutical ingredient. If a third-party were to obtain FDA approval in the United States for the use of pirfenidone, or regulatory approval in another jurisdiction, for an indication before we did, such third-party would be first to market and could establish the price for pirfenidone in these jurisdictions. Third-party products approved in another jurisdiction may be imported into the EU or other jurisdictions where the sale of Esbriet is approved.

Importation of third-party products, or of our own Esbriet product from jurisdictions where prices are lower than in the importing jurisdiction, whether or not such importation is legal, could adversely impact our ability to implement our pricing strategy for the product and may limit our ability to maximize the commercial potential of pirfenidone in the United States and elsewhere. The presence of a lower priced competitive product with the same active pharmaceutical ingredients as our product could lead to use of the competitive product for our anti-fibrotic indications. This could lead to pricing pressure for pirfenidone, which would adversely affect our ability to generate revenue from the sale of pirfenidone for anti-fibrotic indications.

Pirfenidone is the only commercially approved drug approved for the treatment of mild to moderate IPF. The incidence and prevalence of IPF that currently provide the basis of orphan drug designation in the European Union and the United States could change over time, and it is possible that orphan drug designation could be lost in these markets should the patient population exceed that required to maintain orphan drug status in these countries.

Market exclusivity afforded by orphan drug designation is generally offered as an incentive to drug developers to invest in developing and commercializing products for unique diseases that impact a limited number of patients. With respect to the United States, the FDA may grant orphan drug designation to drugs intended to treat a rare disease or condition, which is generally a disease or condition that affects fewer than 200,000 individuals in the United States, or a patient population greater than 200,000 in the United States where there is no reasonable expectation that the cost of developing the drug will be recovered from sales in the United States. Qualification to maintain orphan drug status is generally monitored by the regulatory authorities during the orphan drug exclusivity period, currently ten years and seven years from the date of approval in the EU and United States, respectively. IPF is currently a poorly diagnosed disease in these markets. It is possible that with the approval of Esbriet in the EU, and the potential approval of pirfenidone in the United States, the incidence and prevalence numbers for IPF could change in these markets. Should the incidence and prevalence of IPF patients who are eligible to receive pirfenidone for the treatment of IPF in these markets materially increase, it is possible that the orphan drug designation, and related market exclusivity, in these jurisdictions could be lost.

Our current intellectual property portfolio may not be sufficient to protect pirfenidone from competition for the treatment of mild to moderate IPF in adults after our orphan drug exclusivity expires in the European Union, and if we obtain approval and orphan drug exclusivity in the United States.

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

We have five granted patents and a number of pending patent applications in Europe relating to Esbriet’s formulation and use in IPF patients, particularly related to the safe and efficacious usage of the product. This collection of patents is expected to provide patent protection in Europe until 2033. We also have 16 issued patents in the United States relating to the formulation or safe and/or effective use of Esbriet in IPF patients, and a number of pending U.S. patent applications. In addition we have numerous pending patent applications under active prosecution in other foreign jurisdictions. The laws regarding patentability and enforceability of patents such as ours vary on a country by country basis, and there can be no assurance that we will be able to obtain or enforce patents in any given country.

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These patents can be challenged by our competitors in various jurisdictions who may argue such patents are invalid or unenforceable or lack sufficient written description or enablement, or that the claims of the issued patents should be limited or narrowly construed. For example, in June 2012, opposition proceedings were filed in the European Patent Office against InterMune’s European patent 2324831 B1, requesting that the patent be revoked on the basis that the invention is not patentable. Although the patent was not revoked by the EPO, and while we intend to vigorously defend the patent, we have no assurance regarding the outcome of this matter. Additionally, even if the validity of these patents were upheld in a patent challenge, a court may refuse to stop the other party from practicing the activity at issue. Any of these outcomes would limit our ability to exclusively market pirfenidone for the treatment in adults of mild to moderate IPF in the EU, and if approved for commercial use by the FDA, in the United States, as well as certain other countries where we have filed for patent protection.

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

We are party to a collaboration agreement with Shionogi that gives us an option to exercise a license for access to certain patient level data from the Shionogi Phase 3 clinical trial with pirfenidone in patients with IPF, which we refer to as SP3, to be used, along with other Shionogi clinical study information, as “pivotal study data” (as defined in the agreement) in connection with our regulatory filings. While we do not currently intend to use SP3 patient level data as pivotal study data in our regulatory filings in the United States or in other jurisdictions, we may elect to do so at a later point in time and be required to make certain royalty payments under the collaboration agreement. Should we breach this agreement with Shionogi, we may lose our ability to use Shionogi’s patient level data in our regulatory filings in the United States or in other jurisdictions, which could adversely affect our ability to obtain regulatory approval of pirfenidone in such jurisdictions.

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

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

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

We may not control the patent prosecution of intellectual property that we license from third parties. Accordingly, we would be unable to exercise the same degree of control over this intellectual property as we would exercise over intellectual property that we own, and, as a result, we may lose our rights to such intellectual property and incur substantial costs. At the present time, there are no licensed patent matters for pirfenidone that fall into this category.

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

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

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

Under some of our research and development agreements, inventions discovered in certain cases become jointly owned by our corporate partner and us and in other cases become the exclusive property of one of us. It can be difficult to determine who owns a particular invention, and disputes could arise regarding those inventions. These disputes could be costly and could divert management’s attention from our business. Our research collaborators and scientific advisors have some rights to publish our data and proprietary information in which we have rights. Such publications may impair our ability to obtain patent protection or protect our proprietary information, which could impair our ability to generate revenue.

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

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

We have incurred net losses since inception, and our accumulated deficit was approximately $1.4 billion at June 30, 2014. We expect to incur substantial additional net losses prior to achieving profitability, if ever. The extent of our future net losses and the timing of our profitability are highly uncertain, and we may never achieve profitable operations. We are planning to expand the number of diseases for which our products may be marketed, and this expansion will require significant expenditures. We have not generated operating profits to date from our products. If the time required for us to achieve profitability is longer than we anticipate, we may not be able to continue our business.

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

We believe our existing cash, cash equivalents and available-for-sale securities, along with anticipated cash flows from our sales of Esbriet, will be sufficient to fund our operating expenses, debt obligations and capital requirements under our current business plan through at least the next twelve months. However, our current plans and assumptions may change, and our capital requirements may increase. In particular, initiating the establishment of a commercial infrastructure in the United States to market Esbriet will require significant financial resources. Further, we may decide to prioritize one or more product development efforts or other programs within or outside of IPF as a result of our implementing our strategic initiatives, which may result in an increase in expenses. We have no committed sources of capital and do not know whether additional financing will be available when needed, or, if available, that the terms will be favorable to our stockholders or us. If additional funds are not available, we may be forced to delay or terminate clinical trials, delay or cease executing our three point strategic plan, curtail operations or obtain funds through collaborative and licensing arrangements that may require us to relinquish commercial rights or potential markets, or grant licenses on terms that are not favorable to us. If adequate funds are not available, we will not be able to successfully execute our business plan.

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

Because we have limited resources and research and development is an expensive process, we must regularly assess the most efficient allocation of our research and development resources. Accordingly, we may choose to delay our research and development efforts for a promising product candidate or we may elect to terminate our programs for and, in certain cases, our licenses to, such product candidates or programs in order to allocate resources to another program, which could cause us to fall behind our initial timetables for development of certain product candidates. For example, we may decide to delay, cease or forgo developing pirfenidone for a particular indication or a new potential product candidate, including our LOTUSS trial or other discovery program, and allocate our resources solely to the commercialization of Esbriet for IPF. Additionally, the National Institutes of Health study, PANTHER, recently demonstrated that NAC provided no benefit to IPF patients. We have therefore decided not to enroll additional patients into our PANORAMA trial of NAC added to Esbriet therapy in mild-to-moderate IPF patients. As a result, we may not be able to fully realize the value of some of our product candidates in a timely manner, since they will be delayed in reaching the market, or may not reach the market at all. If we terminate a preclinical program in which we have invested significant resources, we will have expended resources on a program that will not provide a full return on our investment and missed the opportunity to have allocated those resources to potentially more productive uses.

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

Our investment securities consist of high-grade corporate debt securities, government agency securities and direct government obligation securities. Due to recent credit market and global economic conditions, markets for certain fixed-income securities have been volatile and have experienced limitations in liquidity. If there is insufficient demand for the securities we hold, we may not have liquid access to our investments and may be required to recognize an impairment for those securities should we conclude that such impairment is other-than-temporary.

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

We initiated our commercial launch of Esbriet in Germany in September 2011 and subsequently in Austria, Belgium, Canada, Denmark, Finland, France, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Sweden and the UK and we plan to initiate commercial launches in additional countries in the EEA in the future. While we have attempted to forecast demand for Esbriet in Germany, other European countries and Canada, until we have a sufficient history of commercial sales in such jurisdictions, we cannot know with certainty whether our inventory of Esbriet is in excess of or insufficient to meet demand. Furthermore, we have just recently established our sales organization in the EEA and we do not yet know if the size of the sales organization is sufficient to successfully commercialize Esbriet, which makes accurately forecasting demand more difficult. In addition, we are building our organization for U.S. commercialization in preparation for FDA approval, which would be our first entry into the U.S. market and, if approved, will need to adjust our inventory forecasts in consideration of the U.S. market. If we fail to accurately forecast demand for Esbriet, we may face temporary supply shortages, which would impair our ability to generate revenue from such demand, or excess inventories, which may result in additional charges for such excess inventory.

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

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

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

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

Insurance coverage is increasingly difficult to obtain or maintain.

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

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

As of June 30, 2014, we had 392 full-time employees, and our success depends on our continued ability to attract, retain and motivate highly qualified management, scientific and commercial personnel, especially in Europe, and on our ability to develop relationships with leading academic scientists. Competition for personnel and academic collaborations is intense. We are highly dependent on our current management and key scientific and technical personnel, including Daniel G. Welch, our Chairman, Chief Executive Officer and President, as well as the other principal members of our management. None of our employees, including members of our management team, has a long-term employment contract, and any of our employees can leave at any time. Our success will depend in part on retaining the services of our existing management and key personnel and attracting and retaining new highly qualified personnel. In addition, we may need to hire additional personnel and develop additional academic collaborations if we expand our research and development activities. We do not know if we will be able to attract, retain or motivate personnel or cultivate academic collaborations. Our inability to hire, retain or motivate qualified personnel or cultivate academic collaborations would harm our business.

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

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

Security breaches and other disruptions could compromise our information and expose us to liability, which would cause our business and reputation to suffer.

Security breaches and other disruptions could compromise our information and expose us to liability, which would cause our business and reputation to suffer. In the ordinary course of our business, we collect and store sensitive data, including intellectual property, our proprietary business information and that of our customers, suppliers and business partners, and personally identifiable information of our customers and employees, in our data centers and on our networks. The secure processing, maintenance and transmission of this information is critical to our operations and business strategy. Despite our security measures, our information technology and infrastructure may be vulnerable to attacks by hackers or breached due to employee error, malfeasance or other disruptions. Any such breach could compromise our networks and the information stored there could be accessed, publicly disclosed, lost or stolen. Any such access, disclosure or other loss of information could result in legal claims or proceedings, liability under laws that protect the privacy of personal information, and regulatory penalties, disrupt our operations and the services we provide to customers, and damage our reputation, and cause a loss of confidence in our products and services, which could adversely affect our business.

Risks Related to our Securities

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

We have now and will continue to have a significant amount of indebtedness. As of July 31, 2014, we had $1.5 million of outstanding indebtedness under our 2015 Notes, $24.7 million of outstanding indebtedness under our 2017 Notes and $155.3 million of outstanding indebtedness under our 2018 Notes. We may also incur additional indebtedness to meet future financing needs. Our indebtedness could have significant negative consequences for our business, results of operations and financial condition, including:

In June 2014, we completed the exchange of $43.1 million of our outstanding 2017 Notes for 3,378,457 shares of our common stock and in July 2014, we completed the exchange of an additional $52.9 million of our outstanding 2017 Notes for 4,094,126 shares of our common stock and cash. Also in July 2014, we completed the exchange of $16.9 million of our outstanding 2015 Notes for 893,008 shares of our common stock and cash. As a result of these exchanges, our remaining debt service obligation as of July 31, 2014 on our existing notes through December 31, 2014, is $2.3 million in cash payments. We cannot assure you that we will continue to maintain sufficient cash reserves or that our business will ever generate cash flow from operations at levels sufficient to permit us to pay principal, premium, if any, and interest on our indebtedness, or that our cash needs will not increase. If we are unable to generate sufficient cash flow or otherwise obtain funds necessary to make required payments, or if we fail to comply with the various requirements of our indebtedness then outstanding, we would be in default, which would permit the holders of the affected indebtedness to accelerate the maturity of such indebtedness and could cause defaults under our other indebtedness. A default under any of our indebtedness could have a material adverse effect on our business, results of operations and financial condition.

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We may not have the ability to raise the funds necessary to finance any required repurchases of our existing notes, which would constitute an event of default under our indentures.

If a fundamental change occurs under our indenture for the 2017 Notes or 2018 Notes or if a designated event, such as the termination of trading of our common stock on The NASDAQ Global Select Market or a specified change of control transaction, occurs under our 2015 Notes indenture prior to their applicable maturities, we may be required to repurchase all or part of such notes. While the 2015 Notes indenture would allow us in certain circumstances to pay the redemption price for the 2015 Notes in shares of our common stock if a designated event were to occur, the 2017 Notes indenture and the 2018 Notes indenture would not allow us to pay the applicable repurchase prices in shares of our common stock if a fundamental change were to occur. We may not have sufficient funds to pay the repurchase prices for all the notes tendered.

We have not established a sinking fund for payment of our outstanding notes, nor do we anticipate doing so. In addition, we may in the future enter into credit agreements or other agreements that may contain provisions prohibiting redemption or repurchase of the existing notes under certain circumstances, or may provide that a designated event or fundamental change constitutes an event of default under that agreement. If a designated event, with respect to the 2015 Notes, or a fundamental change, with respect to the 2017 and 2018 Notes, occurs at a time when we are prohibited from repurchasing or redeeming the existing notes, we could seek a waiver from the holders of these notes or attempt to refinance these notes. If we were not able to obtain consent, we would not be permitted to repurchase or redeem the existing notes. Our failure to repurchase or redeem tendered notes would constitute an event of default under the 2015 Notes indenture, the 2017 Notes indenture and the 2018 Notes indenture, which might constitute a default under the terms of our other indebtedness.

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

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

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

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Future sales of our common stock in the public market or the issuance of securities senior to our common stock could adversely affect the market price of our common stock and, in turn, the trading price of the notes.

Sales by us or our stockholders of a substantial number of shares of our common stock in the public markets, shares issued upon the exercise of outstanding options or similar equity instruments or conversions of our outstanding notes, or the perception that these sales, exercises, or conversions might occur, could cause the market price of our common stock to decline and, in turn, the trading price of our notes may decline, or could impair our ability to raise capital through a future sale of, or pay for acquisitions using, our equity or equity-related securities. In addition, the market price of our common stock also could be affected by possible sales of our common stock by investors in our notes who view conversions of such notes as a more attractive means of equity participation in our company and by hedging or arbitrage trading activity that we expect to develop involving our common stock by holders of such notes. The hedging or arbitrage could, in turn, affect the trading price of the notes and/or the market price of any shares of our common stock that holders of the notes receive upon conversion of their notes.

We may issue shares of our common stock or equity securities senior to our common stock in the future for a number of reasons, including to finance our operations and business strategy, to adjust our ratio of debt-to-equity, to satisfy our obligations upon the exercise of options, upon conversion of our existing notes or for other reasons. No prediction can be made as to the effect, if any, that future sales or issuance of shares of our common stock or other equity securities, or the availability of shares of our common stock or such other equity securities for future sale or issuance, will have on the market price of our common stock.

We have filed registration statements covering the approximately 11.5 million shares of common stock that are either issuable upon the exercise or vesting of outstanding options or awards reserved for future issuance pursuant to our stock plans as of June 30, 2014.

The issuance of shares of our common stock issued in connection with the exercise of stock options, vesting of restricted stock units or similar equity instruments, or the conversion of our outstanding notes or other instruments we may issue in the future would dilute the notional percentage ownership held by our existing security holders.

At times, the market price of our common stock has fluctuated significantly, and as a result an investment in our stock could decline in value.

The market price of our common stock has been and is likely to continue to be extremely volatile. During the twelve-month period ended June 30, 2014, the closing price of our common stock on The NASDAQ Global Select Market ranged from a high of $47.22 in June 2014 to a low of $9.70 in July 2013. The market price of our common stock could be subject to wide fluctuations in response to a variety of factors, many of which we cannot control, including:

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

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

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

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

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

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

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

 

None.

 

Not applicable.

 

Not applicable.

 

None.

 

See the Exhibit Index following the signature page to this Quarterly Report on Form 10-Q for a list of exhibits filed or furnished with this report, which Exhibit Index is incorporated herein by reference.

 

 

 

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SIGNATURES

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

 

 

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INDEX TO EXHIBITS

 

 

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