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Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 


 

FORM 10-Q

 

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

 

For the quarterly period ended September 30, 2014

 

OR

 

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

 

For the transition period from                  to                 .

 

Commission File Number: 000-50855

 


 

Auxilium Pharmaceuticals, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware

 

23-3016883

(State or other jurisdiction of

 

(I.R.S. Employer Identification No.)

incorporation or organization)

 

 

 

640 Lee Road, Chesterbrook, PA  19087

(Address of principal executive offices) (Zip Code)

 

(484) 321-5900

(Registrant’s telephone number, including area code)

 


 

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

 

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

 

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

 

Large accelerated filer  x

 

Accelerated filer  o

 

 

 

Non-accelerated filer  o

 

Smaller reporting company  o

 

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

 

As of October 27, 2014, the number of shares outstanding of the issuer’s common stock, $0.01 par value, was 51,021,504.

 

 

 



Table of Contents

 

AUXILIUM PHARMACEUTICALS AND SUBSIDIARIES, INC.

 

INDEX

 

PART I FINANCIAL INFORMATION

 

3

 

 

 

 

Item 1.

Unaudited Financial Statements

 

3

 

 

Consolidated Balance Sheets

 

3

 

 

Consolidated Statements of Operations

 

4

 

 

Consolidated Statements of Comprehensive Income (Loss)

 

5

 

 

Consolidated Statement of Stockholders’ Equity

 

6

 

 

Consolidated Statements of Cash Flows

 

7

 

 

Notes to Consolidated Financial Statements

 

8

 

Item 2.

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

 

28

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

45

 

Item 4.

Controls and Procedures

 

45

 

 

 

 

 

PART II OTHER INFORMATION

 

45

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

45

 

Item 1A.

Risk Factors

 

49

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

55

 

Item 5.

Other Information

 

56

 

Item 6.

Exhibits

 

56

 

 

 

 

 

SIGNATURES

 

58

 

2



Table of Contents

 

PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

 

AUXILIUM PHARMACEUTICALS, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(In thousands, except share and per share amounts)

(Unaudited)

 

 

 

September 30,
2014

 

December 31,
2013

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

74,029

 

$

47,749

 

Short-term investments

 

3,844

 

23,437

 

Accounts receivable, trade, net

 

81,930

 

89,407

 

Accounts receivable, other

 

23,806

 

7,050

 

Inventories, current

 

56,527

 

42,498

 

Prepaid expenses and other current assets

 

7,153

 

13,714

 

Deferred tax asset

 

14,737

 

14,737

 

Total current assets

 

262,026

 

238,592

 

Inventories, non-current

 

56,828

 

54,561

 

Property and equipment, net

 

33,780

 

35,270

 

Intangible assets, net

 

677,094

 

749,452

 

Goodwill

 

98,160

 

104,146

 

Other assets

 

17,092

 

19,155

 

Total assets

 

$

1,144,980

 

$

1,201,176

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

24,599

 

$

940

 

Accrued expenses

 

114,977

 

121,964

 

Deferred revenue, current portion

 

2,622

 

2,059

 

Deferred rent, current portion

 

1,439

 

1,185

 

Current portion of term loan

 

16,926

 

13,609

 

Contingent consideration, current

 

47,434

 

56,741

 

Total current liabilities

 

207,997

 

196,498

 

Term loan, long-term portion

 

278,412

 

241,536

 

Senior convertible notes

 

302,404

 

293,747

 

Deferred revenue, long-term portion

 

31,357

 

24,678

 

Deferred rent, long-term portion

 

6,440

 

7,528

 

Contingent consideration, long-term portion

 

132,972

 

161,903

 

Deferred tax liability

 

23,521

 

23,821

 

Total liabilities

 

983,103

 

949,711

 

 

 

 

 

 

 

Commitments and contingencies

 

0

 

0

 

Stockholders’ equity:

 

 

 

 

 

Series A Junior Participating Preferred stock, par value $0.01 per share; 1,500,000 shares authorized; no shares issued or outstanding

 

0

 

0

 

Preferred stock, $0.01 par value per share; 3,500,000 shares authorized; no shares issued or outstanding

 

0

 

0

 

Common stock, $0.01 par value per share; 150,000,000 shares authorized; 51,022,025 and 49,744,521 shares issued; 50,839,809 and 49,599,463 shares outstanding at September 30, 2014 and December 31, 2013, respectively

 

510

 

497

 

Additional paid-in capital

 

631,292

 

594,970

 

Accumulated deficit

 

(465,302

)

(340,180

)

Treasury stock at cost, 182,216 and 145,058 shares at September 30, 2014 and December 31, 2013, respectively

 

(4,515

)

(3,490

)

Accumulated other comprehensive loss

 

(108

)

(332

)

Total stockholders’ equity

 

161,877

 

251,465

 

Total liabilities and stockholders’ equity

 

$

1,144,980

 

$

1,201,176

 

 

See accompanying notes to consolidated financial statements.

 

3



Table of Contents

 

AUXILIUM PHARMACEUTICALS, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

(In thousands, except share and per share amounts)

(Unaudited)

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Net revenues

 

$

109,624

 

$

108,140

 

$

281,161

 

$

274,831

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Cost of goods sold

 

25,713

 

33,553

 

73,901

 

75,858

 

Research and development

 

11,222

 

11,816

 

33,519

 

37,300

 

Selling, general and administrative

 

72,492

 

62,809

 

219,713

 

182,013

 

Amortization of purchased intangibles

 

19,713

 

15,085

 

59,444

 

25,980

 

Intangible asset impairment

 

16,514

 

 

16,514

 

 

Contingent consideration

 

(12,834

)

4,671

 

(25,515

)

6,929

 

Total operating expenses

 

132,820

 

127,934

 

377,576

 

328,080

 

Loss from operations

 

(23,196

)

(19,794

)

(96,415

)

(53,249

)

Interest expense

 

(9,577

)

(8,912

)

(28,610

)

(19,050

)

Other income, net

 

22

 

105

 

22

 

268

 

Loss before income taxes

 

(32,751

)

(28,601

)

(125,003

)

(72,031

)

Income tax benefit (expense)

 

101

 

 

(119

)

77,920

 

Net income (loss)

 

$

(32,650

)

$

(28,601

)

$

(125,122

)

$

5,889

 

Net income (loss) per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.65

)

$

(0.58

)

$

(2.49

)

$

0.12

 

Diluted

 

$

(0.65

)

$

(0.58

)

$

(2.49

)

$

0.12

 

Shares used to compute net income (loss) per common share:

 

 

 

 

 

 

 

 

 

Basic

 

50,403,556

 

49,384,637

 

50,151,393

 

49,304,543

 

Diluted

 

50,403,556

 

49,384,637

 

50,151,393

 

49,611,260

 

 

See accompanying notes to consolidated financial statements.

 

4



Table of Contents

 

AUXILIUM PHARMACEUTICALS, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Loss)

(In thousands)

(Unaudited)

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Net income (loss)

 

$

(32,650

)

$

(28,601

)

$

(125,122

)

5,889

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Unrealized gains on investments, net of tax

 

165

 

41

 

224

 

171

 

Foreign currency translation adjustment

 

 

14

 

 

(27

)

Total

 

165

 

55

 

224

 

144

 

Comprehensive income (loss)

 

$

(32,485

)

(28,546

)

$

(124,898

)

6,033

 

 

See accompanying notes to consolidated financial statements.

 

5



Table of Contents

 

AUXILIUM PHARMACEUTICALS, INC. AND SUBSIDIARIES

Consolidated Statement of Stockholders’ Equity

(In thousands, except share amounts)

(Unaudited)

 

 

 

Common stock

 

Additional
paid-in

 

Accumulated

 

Treasury stock

 

Accumulated
other
comprehensive

 

 

 

 

 

Shares

 

Amount

 

capital

 

deficit

 

Shares

 

Cost

 

loss

 

Total

 

Balance, January 1, 2014

 

49,744,521

 

$

497

 

$

594,970

 

$

(340,180

)

145,058

 

$

(3,490

)

$

(332

)

$

251,465

 

Exercise of common stock options

 

1,040,121

 

10

 

21,264

 

0

 

0

 

0

 

0

 

21,274

 

Cancellation of restricted stock

 

(549

)

0

 

0

 

0

 

0

 

0

 

0

 

0

 

Stock-based compensation

 

161,492

 

2

 

13,755

 

0

 

0

 

0

 

0

 

13,757

 

Employee Stock Plan Purchases

 

76,440

 

1

 

1,303

 

0

 

0

 

0

 

0

 

1,304

 

Treasury stock acquisition

 

0

 

0

 

0

 

0

 

37,158

 

(1,025

)

0

 

(1,025

)

Comprehensive income

 

0

 

0

 

0

 

0

 

0

 

0

 

224

 

224

 

Net loss

 

0

 

0

 

0

 

(125,122

)

0

 

0

 

0

 

(125,122

)

Balance, September 30, 2014

 

51,022,025

 

$

510

 

$

631,292

 

$

(465,302

)

182,216

 

$

(4,515

)

$

(108

)

$

161,877

 

 

See accompanying notes to consolidated financial statements.

 

6



Table of Contents

 

AUXILIUM PHARMACEUTICALS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

 

 

Nine Months ended September 30,

 

 

 

2014

 

2013

 

Cash flows from operating activities:

 

 

 

 

 

Net income (loss)

 

(125,122

)

$

5,889

 

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

 

 

 

 

 

Depreciation, amortization and asset impairment

 

8,813

 

7,943

 

Stock-based compensation

 

12,633

 

11,346

 

Amortization of purchased intangibles

 

59,444

 

25,980

 

Intangible asset impairment charge

 

16,514

 

0

 

Amortization of debt discount and issuance costs

 

12,185

 

9,657

 

Contingent consideration

 

(25,515

)

6,929

 

Payment of contingent consideration and accreted interest

 

(244

)

0

 

Release of valuation allowance for deferred tax assets

 

 

(78,458

)

Inventory obsolescence reserve

 

6,200

 

0

 

Changes in operating assets and liabilities:

 

 

 

 

 

Decrease (increase) in accounts receivable

 

(9,279

)

4,198

 

Increase in inventory

 

(21,401

)

(3,611

)

Decrease in prepaid expenses, other current assets and other assets

 

7,258

 

5,121

 

Increase in accounts payable and accrued expenses

 

17,245

 

15,306

 

Increase (decrease) in deferred revenue

 

7,242

 

(10,864

)

Increase (decrease) in deferred rent

 

(834

)

303

 

Net cash used in operating activities

 

(34,861

)

(261

)

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Business acquisition, net of cash acquired

 

 

(588,349

)

Purchases of property and equipment

 

(7,468

)

(7,786

)

Purchases of short-term investments

 

(22,240

)

(73,218

)

Redemptions of short-term investments

 

42,057

 

164,428

 

Sales and redemptions of long-term investments

 

 

1,600

 

Net cash provided by (used in) investing activities

 

12,349

 

(503,325

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of term loan, net of issuance costs

 

48,222

 

262,852

 

Repayment of term loan

 

(10,089

)

(6,215

)

Proceeds from issuance of convertible debt, net of issuance costs

 

0

 

338,921

 

Payments of contingent consideration

 

(10,923

)

(9,339

)

Purchase of convertible note hedge

 

0

 

(70,000

)

Proceeds from sale of warrants

 

0

 

41,475

 

Proceeds from exercise of common stock options

 

21,274

 

409

 

Proceeds from employee stock plan purchases

 

1,304

 

962

 

Purchases of treasury stock

 

(1,025

)

(139

)

Other

 

29

 

47

 

Net cash provided by financing activities

 

48,792

 

558,973

 

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

 

(237

)

Increase in cash and cash equivalents

 

26,280

 

55,150

 

Cash and cash equivalents, beginning of period

 

47,749

 

35,857

 

Cash and cash equivalents, end of period

 

74,029

 

$

91,007

 

 

 

 

 

 

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Business acquisition:

 

 

 

 

 

Fair value of assets acquired, net of cash acquired

 

 

$

848,261

 

Purchase consideration representing compensation

 

 

8,309

 

Fair value of liabilities assumed and contingent consideration

 

 

(256,221

)

Fair value of warrants issued

 

 

(12,000

)

Net cash paid for acquisition

 

 

$

588,349

 

Interest paid

 

$

17,735

 

$

8,289

 

 

See accompanying notes to consolidated financial statements.

 

7



Table of Contents

 

AUXILIUM PHARMACEUTICALS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(In thousands, except share and per share data)

September 30, 2014
(Unaudited)

 

1.   BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

 

(a)   Basis of Presentation and Consolidation

 

The accompanying unaudited consolidated financial statements include the accounts of Auxilium Pharmaceuticals, Inc. and its wholly owned subsidiaries (the “Company”), and have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) pertaining to this Quarterly Report on Form 10-Q (this “Report”).  Certain disclosures required for complete annual financial statements are not included herein.  All significant intercompany accounts and transactions have been eliminated in consolidation.  The information at September 30, 2014 and for the respective three and nine month periods ended September 30, 2014 and 2013 is unaudited but includes all adjustments (consisting only of normal recurring adjustments) which, in the opinion of the Company’s management, are necessary to state fairly the financial information set forth herein.  The December 31, 2013 balance sheet amounts and disclosures included herein have been derived from the Company’s December 31, 2013 audited consolidated financial statements. The interim results are not necessarily indicative of results to be expected for the full fiscal year. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2013 included in the Company’s Annual Report on Form 10-K (“Form 10-K”) filed with the SEC.

 

(b)         Use of Estimates

 

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, and disclosure of contingencies at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.

 

(c)          Revenue Recognition

 

Net revenues for the three and nine months ended September 30, 2014 and 2013 comprise the following:

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

XIAFLEX revenues-

 

 

 

 

 

 

 

 

 

Net U.S. revenues

 

34,623

 

15,882

 

77,513

 

42,800

 

International revenues

 

4,025

 

1,676

 

10,367

 

14,344

 

 

 

38,648

 

17,558

 

87,880

 

57,144

 

Testim revenues-

 

 

 

 

 

 

 

 

 

Net U.S. revenues - brand

 

$

15,291

 

$

50,701

 

$

38,088

 

$

149,166

 

Net U.S. revenues — authorized generic

 

10,877

 

 

24,197

 

 

International revenues

 

668

 

1,604

 

2,455

 

2,987

 

 

 

26,836

 

52,305

 

64,740

 

152,153

 

Other net U.S. revenues-

 

 

 

 

 

 

 

 

 

TESTOPEL

 

20,194

 

20,636

 

56,384

 

35,018

 

STENDRA

 

9,310

 

 

27,032

 

 

Edex

 

7,018

 

7,958

 

20,006

 

12,990

 

Other

 

7,618

 

9,683

 

25,119

 

17,526

 

 

 

44,140

 

38,277

 

128,541

 

65,534

 

Total net revenues

 

$

109,624

 

$

108,140

 

$

281,161

 

$

274,831

 

 

8



Table of Contents

 

Net U.S. revenues shown in the above table represent the product sales of the Company within the U.S., net of allowances provided on such sales. In addition, net distributable profits earned pursuant to a Distribution and Supply Agreement (the “AG Agreement”) entered into with Prasco, LLC (“Prasco”) are also included in net U.S. revenues in the above table.  International revenues represent the amortization of deferred up-front and milestone payments the Company has received on its out-licensing agreements, together with royalties earned on product sales by the licensees.

 

Revenue is recognized when the following revenue recognition criteria are met: persuasive evidence of an arrangement exists; delivery has occurred or services have been rendered; the selling price is fixed or determinable; and collectability is reasonably assured.

 

In the U.S., the Company’s products are sold to wholesalers, which are provided fees for service based on shipment activity. The product return policies of the Company permit product returns during a specified period, dependent on the specific product, prior to the product’s expiration date until a certain number of months subsequent to the expiration date. Future product returns are estimated based on historical experience of the Company. The Company accrues the contractual rebates per unit of product for each individual payor plan using the most recent historically invoiced plan prescription volumes, adjusted for each individual plan’s prescription growth or contraction. In addition, the Company provides coupons to physicians for use with Testim and STENDRA prescriptions as promotional incentives and the Company established in September 2011 a co-pay assistance program for XIAFLEX (collagenase clostridium histolyticum or “CCH”) prescriptions. A contract service provider is utilized to process and pay claims to patients for actual coupon usage. All revenue from product sales are recorded net of the applicable provisions for wholesaler management fees, returns, rebates, and discounts in the same period the related sales are recorded. As products of the Company become more widely used and as the Company continues to add managed care and pharmacy benefit managers, actual results may differ from the Company’s previous estimates. Any adjustment resulting from differences between the Company’s estimates and actual results will be recorded as a charge or credit to revenue, as appropriate.

 

XIAFLEX for the treatment of Peyronie’s Disease (“PD”) is the first and only FDA-approved non-surgical treatment for PD in men with a palpable plaque and a curvature deformity of >30° at the start of therapy and was approved by the U.S. Food and Drug Administration (“FDA”) in December 2013.  The Company launched XIAFLEX for PD in January 2014 and revenue from sales is recognized when title and risk of loss transfers to the customers, who are specialty distributors, specialty pharmacies and wholesalers. The Company has determined that it has the ability to make reasonable estimates of product returns in order to recognize revenue at the time that title and risk of loss transfers to the customer based on the following factors: (i) the Company has sufficient historical experience with XIAFLEX for Dupuytren’s contracture (“DC”), which is the same drug and is distributed through the same distribution channels as XIAFLEX for PD; (ii) due to the price of XIAFLEX for PD and a limited patient population, the Company’s customers have not built up significant levels of inventory; and  (iii) the Company believes there is limited risk of return of inventory in the channel due to expiration based on the shelf life of inventory in the channel.

 

STENDRA, a new first-line oral therapy for erectile dysfunction (“ED”) approved by the FDA in April 2012, was in-licensed from VIVUS, Inc. (“VIVUS”) in October 2013.  The Company launched STENDRA in the U.S. in January 2014 and revenue from sales is recognized when title and risk of loss transfers to the customers, who are wholesalers. The Company has determined that it has the ability to make reasonable estimates of STENDRA product returns in order to recognize revenue at the time that title and risk of loss transfers to the customer based on the following factors: (i) the Company has sufficient historical experience with its other products, including Testim, which the Company distributes through the same distribution channels and which is prescribed by a similar physician customer base (i.e. primarily urologists and primary care physicians); (ii) the fact that STENDRA is entering a well-established market and has experienced strong initial demand; (iii)  the efficacy and label of STENDRA, which the Company believes provides a competitive advantage over the other products in the ED market and  (iv) the Company believes there is limited risk of return of inventory in the channel due to expiration based on forecast demand and the shelf life of inventory in the channel.

 

On June 9, 2014, the Company authorized Prasco to commence purchasing, distributing and selling an authorized generic version of Testim (the “Generic Testosterone Product”) in the United States of America and its territories and possessions pursuant to the AG Agreement entered into by the parties.  Prasco commenced initial commercialization activities for the Generic Testosterone Product on June 9, 2014 and commenced shipping the Generic Testosterone Product on June 10, 2014. During the term of the AG Agreement, Prasco will pay the Company a price agreed to by the parties for the Generic Testosterone Product.  Any such price will remain

 

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unchanged for an initial period of time and may thereafter be adjusted based on changes to costs and materials.  The Company recognizes revenue from shipments to Prasco at the invoice supply price and the related cost of product sales when title and risk of loss transfers, which is generally at the time of shipment. The Company is also entitled to receive a significant percentage of the net distributable profits on sales of the Generic Testosterone Product by Prasco, which the Company recognizes as net revenues when Prasco reports to the Company the net distributable profits from the ultimate sale of the Generic Testosterone Product. The Company has recorded all net distributable profits reported by Prasco for the nine months ended September 30, 2014.  Any adjustments to the net distributable profits related to Prasco’s estimated sales discounts and other deductions are recognized in the period Prasco reports the amounts to the Company. Receivables for product sold to Prasco as well the Company’s share of net distributable profits under the AG Agreement are included within Account Receivable, Other on the Company’s Consolidated balance sheet.

 

(d)         Net Income (Loss) Per Common Share

 

Basic income (loss) per common share is computed based on the weighted average number of common shares outstanding during the period. Diluted income (loss) per common share is computed based on the weighted average number of common shares outstanding and, if there is net income during the period, the dilutive impact of common stock equivalents outstanding during the period. Common stock equivalents are measured using the treasury stock method. Because the inclusion of potential common stock would be anti-dilutive for periods with a net loss, diluted net loss per share is the same as basic net loss per share for these periods.

 

The following is a reconciliation of net income (loss) and weighted average common shares outstanding for purposes of calculating basic and diluted net income (loss) per common share.

 

Basic income (loss) per share:

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

(32,650

)

$

(28,601

)

$

(125,122

)

$

5,889

 

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding

 

50,424,935

 

49,408,597

 

50,171,079

 

49,339,449

 

Weighted-average unvested restricted common shares subject to forfeiture

 

(21,379

)

(23,960

)

(19,686

)

(34,906

)

 

 

 

 

 

 

 

 

 

 

Shares used in calculating basic net income (loss) per common share

 

50,403,556

 

49,384,637

 

50,151,393

 

49,304,543

 

 

 

 

 

 

 

 

 

 

 

Basic net income (loss) per common share

 

$

(0.65

)

$

(0.58

)

$

(2.49

)

$

0.12

 

 

Diluted income (loss) per share:

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

(32,650

)

$

(28,601

)

$

(125,122

)

$

5,889

 

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding

 

50,424,935

 

49,408,597

 

50,171,079

 

49,339,449

 

Weighted-average unvested restricted common shares subject to forfeiture

 

(21,379

)

(23,960

)

(19,686

)

(34,906

)

Incremental shares from assumed conversions of stock compensation plans

 

 

 

 

306,717

 

 

 

 

 

 

 

 

 

 

 

Shares used in calculating diluted net income (loss) per common share

 

50,403,556

 

49,384,637

 

50,151,393

 

49,611,260

 

 

 

 

 

 

 

 

 

 

 

Diluted net income (loss) per common share

 

$

(0.65

)

$

(0.58

)

$

(2.49

)

$

0.12

 

 

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Diluted net income (loss) per common share is computed giving effect to all potentially dilutive securities. Potentially dilutive shares include outstanding stock options and awards, outstanding warrants, and incremental shares issuable upon conversion of 1.50% Convertible Senior Notes due 2018 (the “2018 Convertible Notes”) as described in Note (7). The following number of stock options and awards were antidilutive and, therefore, excluded from the computation of diluted net income per common share as of September 30, 2014 and 2013: 7,588,324 and 6,920,292, respectively.

 

The Company has 1,250,000 warrants outstanding issued in connection with the acquisition of Actient as discussed in Note (2) and 14,481,950 warrants sold in connection with the issuance of convertible debt as discussed in Note (7). The warrants are not considered in calculating the total dilutive weighted average shares outstanding until the price of the Company’s common stock exceeds the strike price of the warrants. When the market price of the Company’s common stock exceeds the strike price of the warrants, the effect of the additional shares that may be issued upon exercise of the warrants will be included in total dilutive weighted average shares outstanding using the treasury stock method if the impact of their inclusion is dilutive. For the three and nine months ended September 30, 2014, the Company’s average stock price, which was $21.20 and $23.52, respectively, exceeded the strike price of the 1,250,000 warrants issued in connection with the acquisition of Actient; however, these potentially dilutive shares were anti-dilutive as a result of a net loss for the periods. For the three and nine months ended September 30, 2013, the Company’s average stock price did not exceed the strike price of the 1,250,000 warrants issued in connection with the acquisition of Actient. In addition, the Company’s average stock price for the three and nine months ended September 30, 2014 and 2013 did not exceed the strike price of the 14,481,950 warrants sold in connection with the issuance of the convertible debt.

 

If the proposed Endo Merger were not to close, it is the current intention of the Company to settle conversions of the 2018 Convertible Notes through combination settlement, which involves repayment of the principal amount in cash and any excess of the conversion value over the principle amount (the “conversion spread”) in shares of common stock. Therefore, only the impact of the conversion spread will be included in total dilutive weighted average shares outstanding using the treasury stock method.  For the three and nine months ended September 30, 2014 and 2013, the Company’s average price of the Company’s common stock did not exceed the conversion price; therefore, the 2018 Convertible Notes did not have any dilutive impact on per share results.

 

The call options to purchase the Company’s common stock, which were purchased to hedge against potential dilution upon conversion of the 2018 Convertible Notes, as discussed in Note (7), are not considered in calculating the total dilutive weighted average shares outstanding, as their effect would be anti-dilutive. Upon exercise, the call options will mitigate the dilutive effect of the 2018 Convertible Notes.

 

(e)    Change in Functional Currency

 

Effective January 1, 2014, the Company changed the functional currency of its Auxilium UK Ltd subsidiary from pounds sterling to the U.S. Dollar (“USD”). Significant changes in economic facts and circumstances supported this change, including the Company’s recent collaboration agreement with Swedish Orphan Biovitrium AB (“Sobi”), whereby transactions are settled in USD.  In accordance with Accounting Standards Codification 830, Foreign Currency Matters, this change was applied on a prospective basis and translation adjustments for prior periods will not be removed from equity.  In addition, translated amounts for nonmonetary assets at December 31, 2013 became the accounting basis for those assets in the period of the change.

 

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(f)           New Accounting Pronouncements

 

In July 2013, the Financial Accounting Standards Board (“FASB”) issued an Accounting Standards Update (“ASU”) on income taxes, which provides guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, similar tax loss, or tax credit carryforward exists. This guidance is effective for the Company beginning January 1, 2014. The Company adopted this guidance as of January 1, 2014 and its adoption did not have a material effect on the Company’s consolidated financial statements.

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which requires companies to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration it expects to be entitled in exchange for those goods or services. The standard will be effective for the Company beginning in the first quarter of 2017 and early adoption is not permitted. The new standard permits the use of either the retrospective or cumulative effect transition method on adoption. The Company is evaluating the effect that ASU 2014-09 will have on its consolidated financial statements and related disclosures, including which transition method it will adopt.

 

In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements - Going Concern, which requires management to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and provide related footnote disclosures. The guidance is effective for annual and interim reporting periods beginning on or after December 15, 2016. Early adoption is permitted for financial statements that have not been previously issued. The Company does not expect this standard to have a material impact on the Company’s consolidated financial statements upon adoption.

 

(g)         Revisions to previously issued financial statements

 

Contingent Consideration

 

During the second quarter of 2014, the Company identified that it had incorrectly classified the fair value of a contingent sales milestone on its Consolidated Balance Sheet as of March 31, 2014.  Contingent consideration in the amount of $22,200 was classified as a current liability as of March 31, 2014; however, the amount should have been classified as a long term liability based on the Company’s calculation. The effect of the misclassification on the Consolidated Balance Sheet as of March 31, 2014 was a $22,200 overstatement of current contingent consideration and an equivalent understatement of non-current contingent consideration.  The Company assessed this misclassification and concluded that it was not material to the Company’s financial statements previously issued on its Form 10-Q for the three months ended March 31, 2014.  The Company’s Consolidated Statements of Operations and the Consolidated Statements of Cash Flows for the three months ended March 31, 2014 were not affected by this misclassification and remain unchanged.

 

In addition, the Company determined that it had understated contingent consideration expense and contingent consideration liabilities by $4,200 for the quarter ended March 31, 2014.  This error was the result of using an incorrect revenue forecast to calculate the fair value of royalties included as part of the Company’s contingent consideration liabilities.  The error had the impact of understating contingent consideration expense by $4,200 on the Company’s Consolidated Statement of Operations for the three months ended March 31, 2014 as well as the contingent consideration liability being understated by the same amount ($1,800 short-term and $2,400 long-term) on the Consolidated Balance Sheet as of March 31, 2014.  This $4,200 error also had the effect of understating net loss reported on the Company’s Consolidated Statement of Stockholders’ Equity as well as understating the net loss and contingent consideration line items within net cash flows from operating activities on the Company’s Consolidated Statement of Cash Flows; however, it did not impact total net cash provided by operating activities as reported on the Consolidated Statement of Cash Flows.  The Company assessed this error and concluded that it was not material to the Company’s financial statements previously issued on its Form 10-Q for the three months ended March 31, 2014.  Additional expense of $4,200 was recorded to contingent consideration on the Company’s Consolidated Statement of Operations during the three months ended June 30, 2014 to correct this error.

 

Business Combinations

 

In connection with the preparation of its consolidated financial statements for the second quarter of 2014, the Company identified prior period errors related to its accounting for business combinations for the year ended December 31, 2013.  As of June 30, 2014, the Company reclassified $5,400 from Goodwill to Intangible Assets ($3,600) and Contingent Consideration ($1,800) on the balance sheet and adjusted certain related footnotes for these

 

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items.  In addition, the Company recorded additional amortization expense of $380 on its Consolidated statement of operations for the three months ended June 30, 2014 related to these items. These adjustments represent corrections to immaterial errors related to the classification of certain assets and liabilities as well as the related amortization expense recorded in connection with the acquisitions of Actient and STENDRA. The Company has evaluated these items, both individually and in the aggregate, in relation to the current period financial statements as well as the period in which they originated and concluded that these adjustments are not material to any of the impacted periods. These adjustments were recorded during the three months ended June 30, 2014.

 

2.              BUSINESS ACQUISITIONS

 

(a) Actient

 

The Company completed the acquisition of Actient Holdings, LLC (“Actient”) on April 26, 2013 to expand its specialty therapeutic offerings and expects to benefit from greater leverage in its commercial infrastructure and significant cross-selling opportunities. The total consideration for Actient included base cash consideration of $585,000 plus adjustments for working capital and cash acquired, contingent consideration based on future sales of certain acquired products, and the issuance of 1,250,000 warrants to purchase the Company’s common stock. The Company funded the cash payments with cash on hand and a $225,000 senior secured term loan (the “Term Loan”) (see Note 7).

 

The following table summarizes the fair value of the total consideration at April 26, 2013:

 

 

 

Total
Acquisition-
Date
Fair value

 

Base cash consideration

 

$

585,000

 

Cash and working capital adjustment

 

14,863

 

Contingent consideration

 

40,569

 

Warrants

 

12,000

 

Total consideration

 

652,432

 

Consideration representing compensation

 

(8,309

)

Consideration assigned to net assets acquired

 

$

644,123

 

 

The above consideration representing compensation is the amount payable to former management of Actient upon completion of their retention period with the Company. This amount was amortized to expense by the Company as compensation cost over such retention period which ended during 2013.

 

The above contingent consideration represents a risk adjusted net present value relating to cash payments on achievement of certain sales milestones for Actient urology products as defined in the purchase agreement.

 

The warrants issued in the acquisition have a strike price of $17.80 and a 10 year life. In accordance with governing accounting guidance, the Company concluded that the warrants were indexed to its stock and therefore they have been classified as an equity instrument.

 

The transaction was accounted for as a business combination under the acquisition method of accounting. Accordingly, the assets acquired and liabilities assumed were recorded at fair value, with the remaining purchase price recorded as goodwill.

 

As of the end of the measurement period and including the items described in footnote 1(g), the Company had finalized the valuation of the acquired assets and liabilities of Actient. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition:

 

 

 

April 26, 2013

 

Cash

 

$

11,514

 

Accounts receivable, trade

 

25,511

 

Inventory

 

21,704

 

Prepaid expenses and other current assets

 

3,573

 

Property and equipment

 

2,376

 

Purchased intangibles

 

672,000

 

Goodwill

 

98,160

 

Other long-term assets

 

5,348

 

Total assets acquired

 

840,186

 

Contingent consideration assumed

 

(81,685

)

Other liabilities assumed

 

(25,415

)

Deferred tax liabilities

 

(88,963

)

Total net assets acquired

 

$

644,123

 

 

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In conjunction with the accounting associated with the Actient acquisition, the Company recorded deferred tax liabilities related principally to outside tax basis differences in the acquired subsidiaries. These deferred tax liabilities will serve as reversible temporary differences that give rise to future taxable income and, therefore, they serve as a source of income that permits the recognition of certain existing deferred tax assets of the Company. Solely on this basis, management determined that it is more likely than not that a portion of its valuation allowance was no longer required. As a result of the release of the valuation allowance, the Company recorded a tax benefit of $92,069 in its Consolidated statement of operations for the nine months ended September 30, 2013.  Based upon completion of interim tax returns and other information made available to the Company subsequent to the filing of its 2013 second and third quarter reports on Form 10-Q, and prior to the time the Company’s 2013 annual financial statements were filed with the SEC, the Company revised its original estimates of the associated tax benefit.  These revisions, which are reflected in this Report, resulted in the Company decreasing its income tax benefit and net income by $14,149 for the nine months ended September 30, 2013.

 

The difference between the total consideration and the fair value of the net assets acquired was recorded to goodwill in the consolidated balance sheet. This goodwill represents the excess of the purchase price over the fair value of the tangible and identifiable intangible assets acquired and liabilities assumed, principally representing the tax attributes of the acquisition and certain operational synergies. The above tables include immaterial adjustments for the items described in footnote 1(g).  Approximately $430,000 of the intangibles and goodwill are expected to be deductible for tax purposes.

 

Whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, the Company assesses the impairment of long-lived assets for potential impairment.  Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset.  During the third quarter of 2014, a significant customer of the Company’s Timm Medical device business communicated to the Company that it would not be renewing its contract.  As a result, the Company determined that the carrying value of the Timm Medical intangible asset exceeded its fair value and the Company recorded an asset impairment charge of $16.5 million for the three months ended September 30, 2014.  This charge was recorded to Intangible asset impairment on the Company’s Consolidated statement of operations.

 

(b) STENDRA

 

On October 10, 2013, the Company and VIVUS entered into a license and commercialization agreement (the “STENDRA License Agreement”) and commercial supply agreement (the “STENDRA Supply Agreement”). Under the STENDRA License Agreement, the Company was granted the exclusive right to commercialize VIVUS’s pharmaceutical product, STENDRA, for the treatment of any urological disease or condition in humans, including male ED, in the US and Canada and their respective territories. The Company paid to VIVUS a one-time license fee of $30,000 and $2,144 reimbursement of certain expenditures previously incurred. The STENDRA License Agreement also provides for a regulatory milestone payment and sales-based royalty and milestones payments to be made by the Company.  Under the STENDRA Supply Agreement, VIVUS will be the exclusive supplier to the Company for STENDRA under the terms of the STENDRA License Agreement.

 

These agreements were accounted for as a business combination under the acquisition method of accounting. Accordingly, the assets acquired under the STENDRA License Agreement and the related STENDRA Supply Agreement were recorded at fair value. The valuation of consideration and the assets acquired was completed as of

 

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Table of Contents

 

December 31, 2013. The following table summarizes the fair value of the total consideration and the estimated fair values of the net assets acquired at October 10, 2013.

 

 

 

Total
Acquisition-
Date
Fair value

 

Consideration:

 

 

 

Base cash consideration

 

$

32,144

 

Contingent consideration

 

94,956

 

Total consideration allocated to net assets acquired

 

$

127,100

 

 

 

 

 

Assets acquired:

 

 

 

Sample inventory

 

$

1,060

 

STENDRA product rights

 

126,040

 

Total assets acquired

 

$

127,100

 

 

The above tables include immaterial adjustments for the items described in footnote 1(g).  STENDRA product rights are being amortized to income on a straight-line basis over a seven year estimated life. The unamortized cost of this asset is tested for impairment whenever events or circumstances indicate that the carrying amount may not be recovered. The STENDRA sample inventory is being expensed as used.  The above contingent consideration represents a risk adjusted net present value relating to cash payments on achievement of certain milestones and royalty payments as defined in the STENDRA License Agreement. On September 18, 2014, the Company and VIVUS announced that the FDA approved a supplemental new drug application for STENDRA. This approval triggered a $15,000 milestone payment to VIVUS, which the Company paid in October 2014.  The present value of this $15,000 liability is included within Contingent consideration, current on the Company’s consolidated balance sheet as of September 30, 2014.

 

3.              RESTRUCTURING ACTIVITIES

 

September 2014 Restructuring Initiative

 

On September 9, 2014, the Company announced steps it is taking to reduce its costs and more fully support the Company’s goal to drive earnings growth and build shareholder value. These steps are being launched after a comprehensive assessment of the Company’s broadened product portfolio and current cost structure and what management believes to be the Company’s growth assets, commercial strengths, opportunities and challenges and the Company’s manufacturing needs and capabilities. The Company’s restructuring initiatives includes reducing headcount by approximately 20%, realigning the commercial organization from three into two sales forces, focusing its research and development efforts and expenditures and improving manufacturing efficiency.  Although the initial initiative targeted a reduction of approximately 30% of the Company’s headcount, approximately 33 employees who were initially scheduled to be terminated on December 31, 2014 are now expected to remain with the Company until the closing of the merger with Endo International plc (as described below).  These 33 employees are primarily located in the Company’s manufacturing facilities and do not impact the original $75 million of anticipated cost savings. The Company expects substantial completion of the restructuring by the end of 2014.

 

As a result of the September 2014 restructuring initiative, the Company incurred restructuring expenses during the three months ended September 30, 2014 of $9,259, consisting of $8,406 of employee severance and other benefit-related costs and a $853 non-cash impairment charge primarily related to the abandonment of several capital projects. The Company anticipates there will be additional pre-tax restructuring expenses of approximately $100, primarily attributable to contract termination fees which will be incurred throughout the remainder of 2014 and 2015. Of the restructuring costs recorded for the three months ended September 30, 2014, $7,648 are included in Selling, general and administrative expense and $1,611 are included in Research and development expense in the Company’s Consolidated statements of Operations.

 

As of September 30, 2014, the accrual related to the September 2014 restructuring was $8,026, which is included in Accrued expenses on the Company’s Consolidated balance sheet. There was no such restructuring accrual for these actions as of December 31, 2013. Changes to this accrual for the nine months ended September 30, 2014 were as follows:

 

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Table of Contents

 

 

 

Employee-
Related
Severance 
Costs

 

Asset
Impairment 
Charges

 

Total

 

Balance at December 31, 2013

 

$

 

$

 

$

 

Plus: Restructuring charge

 

8,406

 

853

 

9,259

 

Less: payments made during the period

 

(380

)

 

(380

)

Non-cash impairment

 

 

(853

)

(853

)

Balance at September 30, 2014

 

$

8,026

 

 

8,026

 

 

Actient Acquisition-Related Cost-Rationalization and Integration Initiatives

 

In connection with the acquisition of Actient, the Company undertook actions to realign its sales, sales support, and management activities and staffing, which included severance benefits to former Actient employees. For former Actient employees that agreed to continue employment with the Company for a merger transition period, the severance payable upon completion of their retention period is being expensed over their respective retention period. All severance obligations are expected to amount to $5,818, of which $5,584 was recorded to selling, general and administrative expense during the year ended December 31, 2013.  The remaining severance payments will be made through the first quarter of 2015.

 

The following table summarizes the activity within the restructuring liability:

 

 

 

Employee-
Related
Severance 
Costs

 

Balance at December 31, 2013

 

$

3,728

 

Plus: Restructuring charge

 

234

 

Less: payments made during the period

 

(3,777

)

Balance at September 30, 2014

 

$

185

 

 

4.              FAIR VALUE MEASUREMENTS

 

As of September 30, 2014, the Company held certain investments that are required to be measured at fair value on a recurring basis. The following tables present the Company’s fair value hierarchy for these financial assets as of September 30, 2014 and December 31, 2013:

 

 

 

September 30, 2014

 

 

 

Fair Value

 

Level 1

 

Level 2

 

Level 3

 

Assets

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

74,029

 

$

74,029

 

$

0

 

$

0

 

Short-term investments

 

3,844

 

824

 

3,020

 

0

 

Total financial assets

 

$

77,873

 

$

74,853

 

$

3,020

 

0

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Contingent Consideration

 

$

180,406

 

$

0

 

$

0

 

$

180,406

 

 

 

 

December 31, 2013

 

 

 

Fair Value

 

Level 1

 

Level 2

 

Level 3

 

Assets

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

47,749

 

$

47,749

 

$

0

 

$

0

 

Short-term investments

 

23,437

 

8,430

 

15,007

 

0

 

Total financial assets

 

$

71,186

 

$

56,179

 

$

15,007

 

0

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Contingent consideration

 

$

218,644

 

$

0

 

$

0

 

$

218,644

 

 

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Financial assets

 

The Company considers its short-term investments to be “available for sale” and accordingly classifies them as current, as management can sell these investments at any time at their option. The cost basis of short-term investments held at September 30, 2014 approximated the fair value of these securities. Related unrealized gains and losses are recorded as a component of accumulated other comprehensive income (loss) in the equity section of the accompanying balance sheet. The amount of unrealized loss on short-term investments amounted to $27 as of September 30, 2014.

 

Fair value for Level 1 is based on quoted market prices. Fair value for Level 2 is based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets.  Inputs are obtained from various sources including market participants, dealers and brokers.

 

There were no transfers between Level 1 and 2 during the nine months ended September 30, 2014.

 

Contingent consideration

 

The Level 3 liability is contingent consideration related to the acquisition of Actient and STENDRA described in Note 2. The range of the undiscounted amounts of contingent consideration ultimately payable is principally dependent on future sales of the products acquired.  Fair value is determined based on assumptions and projections relevant to revenues and a discounted cash flow model using a risk-adjusted discount rate of 13.6% and 15.0% for Actient and STENDRA, respectively. Assumptions include the expected value of royalties and milestone payments due on estimated settlement dates, volatility of product supply, demand and prices, and the Company’s cost of money.  The Company assesses these assumptions on an ongoing basis as additional information impacting the assumptions is obtained.  A 1% change in this discount rate would have a $3.8 million change in the contingent consideration liability. Changes in the fair value of contingent consideration related to the updated assumptions and estimates are recognized in the consolidated statements of operations.

 

The table below provides a roll forward of the fair value of contingent consideration.

 

 

 

Actient

 

STENDRA

 

Total

 

Contingent consideration 

 

 

 

 

 

 

 

Ending balance, December 31, 2013

 

$

120,444

 

$

98,200

 

$

218,644

 

Change in contingent consideration charged to operations

 

(44,924

)

19,409

 

(25,515

)

Payments of contingent consideration

 

(8,781

)

(2,142

)

(10,923

)

Adjustments

 

(400

)

(1,400

)

(1,800

)

Ending balance, September 30, 2014

 

$

66,339

 

$

114,067

 

$

180,406

 

 

The $1,800 of adjustments included in the above table is related to the items discussed in Note 1(g). The Company reduced $1,800 of Goodwill and Contingent consideration on its Consolidated balance sheet related to business combination accounting for the Actient and STENDRA acquisitions.

 

Debt outstanding

 

The Company’s Term Loan and 2018 Convertible Notes are measured at amortized cost in the Company’s Consolidated balance sheets and not fair value.

 

Management estimates that the fair value of the Term Loan outstanding at September 30, 2014 approximates its principal value of $305,051 based upon market interest rates (a Level 2 fair value measurement).  As of September 30, 2014, the principal balance outstanding of the Company’s 2018 Convertible Notes is $350,000 with a carrying value of $302,404 and a fair value of approximately $464,548 based on active trading activity in this security (a Level 1 fair value measurement).

 

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5.              INVENTORIES

 

Inventories consist of the following:

 

 

 

September 30,

 

December 31,

 

 

 

2014

 

2013

 

Raw materials

 

$

7,838

 

$

6,680

 

Work-in-process

 

81,489

 

71,890

 

Finished goods

 

24,028

 

18,489

 

 

 

113,355

 

97,059

 

Inventories, current

 

56,527

 

42,498

 

Inventories, non-current

 

$

56,828

 

$

54,561

 

 

During the nine months ended September 30, 2014, the Company recorded a $6,200 inventory charge to cost of goods sold related to excess Testim branded inventory.  The excess inventory charge resulted from the Company’s decision to launch the Generic Testosterone Product, which the Company believes had the impact of decreasing the demand forecast for the branded Testim product.

 

6.              ACCRUED EXPENSES

 

Accrued expenses consist of the following:

 

 

 

September 30,

 

December 31,

 

 

 

2014

 

2013

 

Payroll and related expenses

 

$

22,610

 

$

20,435

 

Royalty expenses

 

10,156

 

11,638

 

Research and development expenses

 

4,779

 

6,206

 

Sales and marketing expenses

 

8,047

 

15,283

 

Rebates, discounts and returns accrual

 

49,844

 

52,044

 

Interest

 

1,094

 

2,406

 

Other

 

18,447

 

13,952

 

 

 

$

114,977

 

$

121,964

 

 

7.    LONG-TERM DEBT

 

Term Loan

 

In order to partially fund a portion of the costs and related expenses of the acquisition of Actient described in Note (2), the Company entered into a term loan agreement in April 2013 with a syndicate of banks to borrow $225,000 in principal value (the “Term Loan Agreement”). In September 2013 and September 2014, the Company borrowed additional amounts of $50,000 each under the Term Loan Agreement. The original issue discount together with issuance costs of the Term Loan, amounting to $13,926, is being accreted to Interest expense over the stated term of the Term Loan Agreement and the unamortized balance has been deducted from the Term Loan balance shown in the Balance Sheet.  The net carrying amount of the Term Loan as of September 30, 2014 and December 31, 2013, was $295,338 and $255,145, respectively.

 

The Term Loan principal must be repaid in equal quarterly installments of 1.25% per quarter commencing on June 30, 2013, with the remainder of the borrowings to be paid on the maturity date of April 26, 2017, unless otherwise prepaid prior to such date in accordance with the terms of the Term Loan.  The Company can elect loans to bear interest at a rate equal to either Base Rate (as defined in the agreement) or LIBOR, plus a margin. Under the current terms of the Term Loan Agreement, the Base Rate interest rate margin is 4.00% and the LIBOR interest rate margin is 5.00%. The Term Loan Agreement also establishes a floor rate for both the Base Rate and LIBOR options. As of the date hereof, the Company has elected to base the interest rate of the borrowings on LIBOR. As of September 30, 2014, the total interest rate on the Term Loan principal was 6.25%.

 

The Term Loan currently contains no financial covenants but contains usual and customary operating and restrictive covenants for a facility of this type. Events of default under the Term Loan are also usual and customary

 

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for transactions of this type. As of September 30, 2014, the Company was in compliance with Term Loan covenants and anticipates remaining compliant.

 

The closing of the previously planned merger with QLT Inc. (“QLT”), as discussed in Note 10, would have been a “change of control,” as defined in the Term Loan Agreement, and would have been prohibited by the provisions of the Term Loan Agreement.  In addition, the de-listing of the Company’s common stock would have been prohibited by the provisions of the Term Loan Agreement.  On August 14, 2014, the Company entered into the Third Amendment Agreement (the “Third Amendment Agreement”) with Morgan Stanley Senior Funding, Inc., as administrative agent (“Agent”) and lenders holding more than 50% of the loans under the Term Loan Agreement pursuant to and under the Term Loan Agreement providing for, upon the satisfaction of the conditions precedent set forth therein, certain amendments and modifications to the Term Loan Agreement.  Now that the planned merger with QLT has been terminated, this Third Amendment Agreement to the Credit Agreement will not become effective.

 

Senior Convertible Notes

 

In January 2013, the Company issued $350,000 aggregate principal amount of the 2018 Convertible Notes, in a registered public offering. Interest is payable semi-annually in arrears on January 15 and July 15, commencing on July 15, 2013. The Company received net proceeds of $310,396 from issuance of the 2018 Convertible Notes, which amount is net of $11,079 debt issuance costs and net payments of $28,525 related to its hedge transactions. The net carrying amount of the 2018 Convertible Notes as of September 30, 2014 and December 31, 2013, was $302,404 and $293,747, respectively.

 

The initial conversion rate for the 2018 Convertible Notes is 41.3770 shares of the Company’s common stock per $1,000 principal amount of the 2018 Convertible Notes, representing an initial effective conversion price of approximately $24.17 per share of the Company’s common stock. The conversion rate is subject to adjustment for certain events as outlined in the indenture governing the 2018 Convertible Notes, but will not be adjusted for accrued and unpaid interest.  Prior to July 15, 2018, the 2018 Convertible Notes are convertible by the holders only under the following circumstances: (1) during any fiscal quarter commencing after March 31, 2013 (and only during such fiscal quarter), if the last reported sale price of the Company common stock for at least 20 trading days (whether or not consecutive) 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 applicable conversion price on each applicable trading day; (2) during the five business day period after any 10 consecutive trading day period (the “2018 Convertible Notes Measurement Period”) in which, for each trading day of such 2018 Convertible Notes Measurement Period, the trading price per $1,000 principal amount of 2018 Convertible Notes on such trading day was less than 98% of the product of the last reported sale price of the Company’s common stock on such trading day and the applicable conversion rate on such trading day; or (3) upon the occurrence of specified distributions and corporate events.

 

As of September 30, 2014, neither the first or second condition for conversion had been met.

 

On June 27, 2014, the Company provided a notice to the trustee for the Convertible Senior Notes and the holders of the Convertible Senior Notes that, in connection with the then-planned merger with QLT (the “QLT Merger”), the Convertible Senior Notes may be surrendered for conversion from the date that is 70 scheduled trading days prior to the anticipated effective date of the QLT Merger until the date that is 35 trading days after the actual effective date of the QLT Merger.  A closing date for the QLT Merger was never announced and, as described below, the QLT Merger has now been terminated.

 

On October 14, 2014, the Company provided a notice to the trustee for the Convertible Senior Notes and the holders of the Convertible Senior Notes that, in connection with the proposed merger with Endo International plc, as described below, the Convertible Senior Notes may be surrendered for conversion from the date that is 70 scheduled trading days prior to the anticipated effective date of the merger (or, if later, the business day after the Company gave notice of the merger with Endo International plc) until the date that is 35 trading days after the actual effective date of the merger or until the related fundamental change purchase date, as defined in the indenture.

 

The Company may not redeem the 2018 Convertible Notes prior to maturity. However, in the event of a fundamental change, as defined in the indenture, the holders of the 2018 Convertible Notes may require the Company to purchase all or a portion of its 2018 Convertible Notes at a purchase price equal to 100% of the

 

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principal amount of the 2018 Convertible Notes, plus accrued and unpaid interest, if any, to the repurchase date.  Holders who convert their 2018 Convertible Notes in connection with a make-whole fundamental change, as defined in the indenture, may be entitled to a make-whole premium in the form of an increase in the conversion rate.

 

In accordance with the governing accounting guidance, the Company determined that the embedded conversion option in the 2018 Convertible Notes is not required to be separately accounted for as a derivative. However, since the 2018 Convertible Notes are within the scope of the accounting guidance for debt with conversion and other options, the Company is required to separate the 2018 Convertible Notes into a liability component and equity component. The carrying amount of the liability component is calculated by measuring the fair value of a similar liability (including any embedded features other than the conversion option) that does not have an associated equity component. The carrying amount of the equity component representing the embedded conversion option is determined by deducting the fair value of the liability component from the initial proceeds ascribed to the 2018 Convertible Notes as a whole. The excess of the principal amount of the liability component over its carrying amount is amortized to interest cost over the expected life of a similar liability that does not have an associated equity component using the effective interest method. The equity component is not remeasured as long as it continues to meet the conditions for equity classification in the accounting guidance for contracts in an entity’s own equity.

 

Upon conversion of a note, holders of the 2018 Convertible Notes will receive up to the principal amount of the converted note in cash and any excess conversion value (conversion spread) in shares of its common stock. The amount of cash and the number of shares of the Company’s common stock, if any, will be based on a 60 trading day observation period as described in the indenture. As described in Note (1), the conversion spread will be included in the denominator for the computation of diluted net income per common share, using the treasury stock method, if the effect is dilutive.

 

To hedge against potential dilution upon conversion of the 2018 Convertible Notes, the Company purchased call options on its common stock. The call options give the Company the right to purchase up to 14,481,950 shares of its common stock at $24.17 per share subject to certain adjustments that correspond to the potential adjustments to the conversion rate for the 2018 Convertible Notes. The Company paid an aggregate of $70,000 to purchase these call options. The call options will expire on July 15, 2018, unless earlier terminated or exercised. To reduce the cost of the hedge, in a separate transaction, the Company sold warrants. These warrants give the holder the right to purchase up to 14,481,950 shares of the Company’s common stock at $27.36 per share, subject to certain adjustments. These warrants will be exercisable and will expire in equal installments for a period of 140 trading days beginning on October 15, 2018. The Company received an aggregate of $41,475 from the sale of these warrants. In accordance with governing accounting guidance, the Company concluded that the call options and warrants were indexed to its stock. Therefore, the call options and warrants were classified as equity instruments and will not be marked to market prospectively unless certain conditions occur. The net amount of $28,525 was recorded as a reduction to additional paid-in capital. The settlement terms of the call options provide for net share settlement and the settlement terms of the warrants provide for net share or cash settlement at the option of the Company.

 

8.   STOCKHOLDERS’ EQUITY

 

Shareholder Rights Plan

 

On September 16, 2014, the Board of Directors of the Company (the “Board”) authorized and directed the issuance, and declared a dividend distribution of one preferred share purchase right (a “Right”) for each outstanding share of common stock, par value $0.01 per share, of the Company to purchase from the Company one one-hundredth of a share of Series A Junior Participating Preferred Stock, par value $0.01 per share, of the Company (the “Preferred Stock”) at a price of $100.00 per one one-hundredth of a share of Preferred Stock, subject to adjustment as provided in the Rights Agreement (as defined below).  The dividend is payable to stockholders of record at the close of business on September 29, 2014.  The description and terms of the Rights are set forth in the Rights Agreement, dated as of September 17, 2014 and amended on October 8, 2014 (the “Rights Agreement”), between the Company and Broadridge Corporate Issuer Solutions, Inc., as Rights Agent.

 

The Rights Agreement is intended to (i) reduce the risk of coercive two tiered, front end loaded or partial offers that may not offer fair value to all stockholders, (ii) mitigate against market accumulators who through open market and/or private purchases may achieve a position of substantial influence or control without paying to selling or remaining stockholders a fair control premium, and (iii) preserve the Board’s bargaining power and flexibility to

 

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deal with third party acquirors and to otherwise seek to maximize values for all stockholders.  The overall effect of the Rights Agreement and the issuance of the Rights may be to render more difficult or discourage a merger, tender or exchange offer or other business combination involving the Company that is not approved by the Board.  The Rights Agreement is not intended to interfere with any merger, tender or exchange offer or other business combination approved by the Board.  Nor does the Rights Agreement prevent the Board from considering any offer that it considers to be in the best interest of the Company’s stockholders.

 

The Company entered into Amendment No. 1, dated as of October 8, 2014 (the “Rights Agreement Amendment”), to the Rights Agreement.  The Rights Agreement Amendment provides that the Endo Merger Agreement and related transactions (described below in Note 10), including the consummation of the Endo Merger and any related transactions, will not cause the Rights to become exercisable or cause any of the other protective features afforded to the Company under the Rights Agreement to come into effect. Under the Rights Agreement Amendment, no party to the Endo Merger Agreement or the related transactions shall be deemed to be the beneficial owner, as defined in the Rights Agreement, of any common shares held by any other party, solely by virtue of the approval, execution, delivery, and/or the existence of the Endo Merger Agreement or the related transactions or the performance of such party’s rights and obligations under the Endo Merger Agreement or the related transactions. The Rights Agreement Amendment further provides that all Rights established under the Rights Agreement shall automatically expire immediately prior to the closing of the Endo Merger.

 

Equity Compensation Plan

 

Under the Company’s 2004 Equity Compensation Plan, as amended and restated, and as approved by the stockholders of the Company (the “2004 Plan”), qualified and nonqualified stock options and stock awards may be granted to employees, non-employee directors and service providers. As of September 30, 2014, the Company had granted non-qualified stock options and stock awards under the 2004 Plan and as of September 30, 2014, there were 4,268,129 shares available for future grants under the 2004 Plan.

 

(a)         Stock Options

 

During the nine months ended September 30, 2014, the Company granted non-qualified stock options to purchase shares of the Company’s common stock pursuant to the 2004 Plan. Stock options are granted with an exercise price equal to 100% of the market value of the common stock on the date of grant, and generally have a 10-year contractual term and vest no later than four years from the date of grant (with some providing for automatic vesting upon a change of control of the Company unless an acquirer in a change of control transaction assumes such outstanding option).

 

The following tables summarize stock option activity for the nine month period ended September 30, 2014:

 

 

 

Nine Months Ended September 30, 
2014

 

 

 

 

 

Weighted

 

 

 

 

 

average

 

 

 

 

 

exercise

 

Stock options

 

Shares

 

price

 

Options outstanding:

 

 

 

 

 

Outstanding at December 31, 2013

 

7,345,535

 

$

21.82

 

Granted

 

1,307,865

 

27.50

 

Exercised

 

(1,040,121

)

20.66

 

Cancelled

 

(805,275

)

23.22

 

Outstanding at September 30, 2014

 

6,808,004

 

22.91

 

Exercisable at September 30, 2014

 

3,932,756

 

23.51

 

 

Aggregate intrinsic value of options was $50,046 which represents the total pre-tax intrinsic value, based on the Company’s stock closing price of $29.85 as of September 30, 2014, that would have been received by the option holders had all option holders exercised their options as of that date.

 

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(b) Performance-Based Restricted Stock Units (“PRSUs”)

 

During the nine months ended September 30, 2014, the Company granted a total of 217,600 PRSUs to certain senior management employees.  The PRSUs will be earned based on the Company’s total shareholder return (“TSR”) as compared to a peer group of companies at the end of the performance period, which performance period is January 1, 2014 to December 31, 2016.  These PRSUs were granted with a weighted average grant date fair value of $29.71 and the number of PRSUs reflected as granted represents the target number of shares that are eligible to vest subject to the attainment of the performance goal.  Depending on the outcome of the performance goal, a recipient may ultimately earn a number of shares greater or less than their target number of shares granted, ranging from 0% to 150% of the PRSUs granted. Shares of the Company’s common stock are issued on a one-for-one basis for each PRSU earned and participants vest in their PRSUs at the end of the performance period.

 

The fair value of the TSR PRSUs granted during the nine months ended September 30, 2014 was determined using a Monte Carlo simulation and utilized the following weighted average inputs and assumptions:

 

Closing stock price on grant date

 

$

27.70

 

Performance period starting price

 

$

20.36

 

Term of award (in years)

 

2.84

 

Volatility

 

38.29

%

Risk-free interest rate

 

0.62

%

Expected dividend yield

 

0.00

%

Fair value per TSR PSU

 

$

29.71

 

 

The performance period starting price is measured as the average closing price over the last 20 trading days prior to the performance period start. The Monte Carlo simulation model also assumed correlations of returns of the prices of the Company’s common stock and the common stocks of the comparator group of companies and stock price volatilities of the comparator group of companies.

 

Compensation expense for the PRSUs is based upon the number and value of shares expected to vest and compensation expense is recognized over the applicable vesting period. All compensation cost for the PRSUs will be recognized if the requisite service period is fulfilled, even if the market condition is never satisfied.  The following table summarizes the PSRU activity for the nine months ended September 30, 2014:

 

 

 

PRSUs

 

Weighted-average
grant date fair
value

 

Balance at December 31, 2013

 

174,333

 

$

18.44

 

Granted

 

217,600

 

29.71

 

Vested

 

(39,826

)

18.74

 

Cancelled

 

(113,285

)

21.88

 

Balance at September 30, 2014

 

238,822

 

$

27.22

 

 

(c) Restricted Stock Unit” (“RSUs”)

 

During the nine months ended September 30, 2014, the Company also granted RSUs to employees. These RSUs generally vest ratably over three years at one year intervals from the grant date.  Upon vesting, a RSU is converted into one share of the common stock of the Company. The following table summarizes the RSU activity for the nine months ended September 30, 2014:

 

 

 

RSUs

 

Weighted-average
grant date fair
value

 

Balance at December 31, 2013

 

318,888

 

$

17.93

 

Granted

 

366,313

 

29.10

 

Vested

 

(99,468

)

18.26

 

Cancelled

 

(95,905

)

24.94

 

Balance at September 30, 2014

 

489,828

 

$

24.79

 

 

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(d) Restricted Stock Awards (“RSAs”)

 

RSAs are considered issued and outstanding at the time of grant, but are still subject to vesting and forfeiture.  The compensation cost of restricted stock awards is determined by their intrinsic value on the grant date. The following table summarizes the restricted common stock activity for the nine months ended September 30, 2014:

 

 

 

Restricted Stock

 

Weighted-average
grant date fair
value

 

Balance at December 31, 2013

 

21,460

 

$

18.50

 

Granted

 

20,000

 

18.98

 

Vested

 

(14,331

)

16.88

 

Cancelled

 

(549

)

24.62

 

Balance at September 30, 2014

 

26,580

 

$

19.89

 

 

(e) Valuation and Expense Information

 

The following aggregate stock-based compensation was included in the Company’s consolidated statements of operations:

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Cost of goods sold

 

$

81

 

$

39

 

$

181

 

$

107

 

Research and development

 

150

 

675

 

1,558

 

2,077

 

Selling, general and administrative

 

3,168

 

2,656

 

10,894

 

9,162

 

Total

 

$

3,399

 

$

3,370

 

$

12,633

 

$

11,346

 

 

Stock-based compensation costs capitalized as part of inventory amounted to $7,708 at September 30, 2014 and $6,613 at December 31, 2013. As of September 30, 2014, the weighted-average period that unrecognized stock-based compensation cost related to all share-based payments will be recognized over was 2.0 years.

 

9.   LITIGATION

 

Upsher-Smith NDA Litigation

 

On or about December 28, 2012, the Company and FCB I Holdings Inc. (“FCB”) became aware of a notice from Upsher-Smith Laboratories, Inc. (“Upsher-Smith”) that advised the Company and FCB of Upsher-Smith’s filing of the Upsher-Smith NDA. This Paragraph IV certification notice refers to the 10 U.S. patents, covering Testim, that are listed in the Orange Book. These 10 patents are owned by FCB and are exclusively licensed to the Company and will expire between 2023 and 2025. On January 28, 2013, the Company and FCB filed a lawsuit in the United States District Court for the District of Delaware against Upsher-Smith for infringement of FCB’s 10 patents listed in the Orange Book as covering Testim testosterone gel (“Delaware Upsher-Smith 505(b)(2) NDA Litigation”). On December 4, 2013, the Court granted Upsher-Smith’s motion for summary judgment, and the Court entered a final judgment of non-infringement in favor of Upsher-Smith on December 30, 2013. On January 24, 2014, the Company filed a Notice of Appeal to the United States Court of Appeals for the Federal Circuit in Washington, D.C. (the “Appeals Court”) appealing the final judgment of non-infringement entered by the United States District Court for the District of Delaware. On September 18, 2014, the Appeals Court granted the Company’s unopposed motion to dismiss the appeal. This litigation is now concluded.  Subsequent to the conclusion of this litigation, Upsher-Smith filed a motion with the District Court seeking reimbursement of its legal fees by the Company.

 

The Upsher-Smith NDA was granted final approval by the FDA on June 4, 2014 with a brand name Vogelxo. On June 2, 2014, the FDA finally approved Vogelxo, and, on or about July 2, 2014, Upsher-Smith launched Vogelxo and an authorized generic version of Vogelxo, known as testosterone gel.

 

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ANDA Litigation with Actavis

 

On May 24, 2012, the Company and FCB filed a lawsuit against Actavis, Inc. (“Actavis”) (then known as Watson Pharmaceuticals, Inc.) for infringement of FCB’s 10 patents listed in the Orange Book as covering Testim testosterone gel (the “Actavis Litigation”). The lawsuit was filed in the United States District Court for the District of New Jersey on May 23, 2012 in response to a notice letter, dated April 12, 2012, sent by Actavis Laboratories, Inc. (NV) regarding its filing with the FDA of an ANDA for a generic 1% testosterone gel product. This letter also stated that the ANDA contained Paragraph IV certifications with respect to the nine patents listed in the Orange Book on that date as covering Testim. The Company’s lawsuit filed against Actavis involves those nine patents, as well as a 10th patent covering Testim that was issued on May 15, 2012 and is listed in the Orange Book. The trial commenced in September 2014 and the parties are currently preparing and filing post-trial briefing and are preparing for closing arguments, which are currently scheduled for November 18, 2014.

 

TRT Products Civil Litigation

 

As of October 27, 2014, the Company was involved in 66 individual civil actions related to its TRT products, Testim and TESTOPEL, wherein the plaintiffs allege, among other things, bodily injury and, in some cases, wrongful death, based on theories of strict liability, fraud and inadequacy of the product warning labels. The first complaint was served on the Company on February 27, 2014, shortly after the FDA announced that it had commenced a safety investigation into TRT products. These lawsuits have been filed in certain federal and state courts. In several of the complaints filed against the Company, the Company is named as a co-defendant with certain of its competitors who also sell TRT products such as AbbVie Inc., Eli Lilly and Company, Endo, Actavis, Inc. and Pfizer, Inc., and in one lawsuit, McKesson Corporation (“McKesson”), a distributor of pharmaceutical products, including TRT, has been named as a co-defendant.

 

DPT Laboratories, Inc. (“DPT”), a contract manufacturer of Testim, has also been named as a co-defendant in one current lawsuit.  Pursuant to the terms of the Company’s manufacturing agreement with DPT, the Company has acknowledged a duty to indemnify and defend DPT in this matter.  In several of the complaints filed against the Company, the Company is named as a co-defendant with its previous co-promotion partner, GlaxoSmithKline LLC (“GSK”).  Pursuant to the terms of the co-promotion agreement, the Company has acknowledged a duty to indemnify and defend GSK in these matters.

 

The Company has timely notified the carriers of those of its insurance policies with coverage it believes is applicable to the liability of the litigation related to its TRT products. The Company’s primary insurer has acknowledged that it has a duty to defend and indemnify the Company with respect to the allegations made in plaintiffs’ complaints as originally filed with the relevant courts; it has, however, reserved its rights to deny coverage on the basis of certain allegations in the relevant complaints related to dishonest, fraudulent, malicious or intentionally wrongful acts.

 

Additionally, similar lawsuits have been filed against other manufacturers of TRT products. In some of these lawsuits, certain parties have moved to request consolidation of various of the existing lawsuits into a multi-district litigation or MDL. On June 6, 2014, a Transfer Order was issued by the United States Judicial Panel on Multidistrict Litigation which created an industry-wide MDL in the Northern District of Illinois with Judge Kennelly presiding and captioned as In re: Testosterone Replacement Therapy Products Liability Litigation (“TRT MDL”). The Transfer Order further ordered that certain lawsuits be transferred to the TRT MDL, upon consent of the transferring court, for coordination or consolidation of pre-trial proceedings.

 

Based upon the number of similar complaints served on other manufacturers of TRT products, the Company believes it is reasonable to expect that the Company will be named as a defendant and/or co-defendant in additional complaints.

 

None of the complaints allege specific damage amounts.  The Company is investigating the underlying causes of actions upon which the complaints are based.  The Company filed a Motion to Dismiss in the first-filed case, in the U.S. District Court for the Central District of California.  Subsequently, the plaintiff in that case voluntarily withdrew his lawsuit.  The Company filed a similar motion in other matters.

 

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ErecAid Civil Litigation

 

On August 7, 2014, a lawsuit was filed against the Company alleging that the Osbon ErecAid Manual Vacuum Therapy System has caused injury to the plaintiffs based on theories of strict liability, design defect, failure to warn and loss of consortium. The Company was served on October 20, 2014.  The Company is investigating the underlying cause of action upon which the complaint is based and intends to vigorously defend against this civil action.

 

Slate and Actient Indemnification Matters

 

Prior to the Company’s acquisition of our wholly-owned subsidiary Actient in April of 2013, Actient entered into a merger agreement (the “Slate Merger Agreement”), dated December 19, 2011, by and among Slate Pharmaceuticals, Inc. (“Slate”), Slate Pharmaceuticals Acquisition Corp., a wholly-owned subsidiary of Actient, and Douglas E. Eckert, solely in his capacity as the representative of the former Slate stockholders and warrant holders (the “Slate Representative”). The Slate Merger Agreement provided for, among other things, indemnification of Actient in the event that Slate breached certain of its representations and warranties in the Slate Merger Agreement. The Slate Merger Agreement also provided for, among other things, certain earn-out payments to be made to the former Slate stockholders on a quarterly basis based upon the revenue generated by sales of TESTOPEL (the “Slate Earn-Out Payments”). Pursuant to the terms of the Slate Merger Agreement, the Slate Earn-Out Payments are subject to offset in order to satisfy amounts that may be due Actient under the relevant indemnification provisions of the Slate Merger Agreement. The Slate Earn-Out Payment due for the quarter ended March 31, 2014 was approximately $3.8 million (the “2014 Q1 Slate Earn-Out”), the Slate Earn-Out Payment due for the quarter ended June 30, 2014 was approximately $0.5 million (the “2014 Q2 Slate Earn-Out”) and the Slate Earn-Out Payment due for the quarter ended September 30, 2014 was approximately $2.4 million (the “2014 Q3 Slate Earn-Out”, and, collectively with the 2014 Q1 Slate Earn-Out and the 2014 Q2 Slate Earn-Out, the “2014 Slate Earn-Outs”).

 

On or about April 16, 2014, a complaint was filed against the Company alleging, among other things, that the development, design, testing, labeling, packaging, promoting, advertising, marketing, distribution and selling of certain prescription medications, including TESTOPEL, directly and proximately resulted in damages suffered by the plaintiffs (the “Amerson Action”). The Company believes that certain costs, including amounts in respect of defense, settlement, or court awarded damages, related to the matters alleged in the Amerson Action, as well as any complaints filed against the Company, or any of its affiliates or business partners that may have recourse against the Company for costs related to such complaints, properly would entitle the Company, as the ultimate parent of Actient, to indemnification pursuant to relevant provisions of the Slate Merger Agreement. Consequently, Actient withheld the 2014 Q1 Slate Earn-Out from the former Slate stockholders and paid such amounts into a third party escrow account to be held until the matters set forth in the Amerson Action, and any complaints making similar allegations that may be filed against the Company, any of its affiliates or business partners that may have recourse against the Company for costs related to such complaints, are resolved. Since the time of the Amerson Action, the Company has been named in six additional complaints related to TESTOPEL alleging causes of actions similar to those set forth in the Amerson Action.

 

On July 24, 2014, the Slate Representative filed a lawsuit in the Delaware Chancery Court, in the State of Delaware docketed as CA9940 against the Company alleging that the withholding and payment into escrow of the 2014 Q1 Earn-Out was a breach of the Slate Merger Agreement and seeking immediate payment of these funds to the Slate stockholders, declaratory judgment that the Company is not permitted to withhold future payments, and unspecified other damages.

 

Pursuant to that certain Agreement and Plan of Merger (the “Actient Merger Agreement”), dated as of April 26, 2013, by and among Actient Holdings LLC (“Actient”), the Company, Opal Acquisition, LLC, GTCR Fund IX/B, L.P., and GTCR Fund IX/A, L.P., solely in its capacity as representative (the “Actient Representative”), the former stockholders of Actient agreed to indemnify the Company for the breach of any representations and warranties in the Actient Merger Agreement.  The indemnification obligations were secured by, among other things, $25 million (the “Actient Escrow Funds”) held in escrow and due to be potentially released on September 30, 2014 as well as by potential future milestone payments.

 

On May 20, 2014, as supplemented by a letter dated August 29, 2014, the Company made an indemnification claim against the Actient Representative in connection with the TESTOPEL product liability litigation described above.  On September 29, 2014, the Company sent a Demand Certification to the escrow agent requesting that the Actient Escrow Funds be released to the Company.  On October 7, 2014, the Actient

 

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Representative notified the escrow agent that it objected to the release of the Actient Escrow Funds and that such escrow funds should remain in escrow until the dispute is resolved.  The Company anticipates that the Actient Representative will file a Complaint against the Company related to this matter.

 

QLT Merger-Related Litigation

 

On June 25, 2014, the Company entered into an Agreement and Plan of Merger (the “QLT Merger Agreement”) among the Company, QLT Inc., a British Columbia corporation (“QLT”), QLT Holding Corp., a Delaware corporation and a wholly owned subsidiary of QLT (“QLT HoldCo”), and QLT Acquisition Corp., a Delaware corporation and a wholly owned subsidiary of HoldCo (“QLT AcquireCo”). The QLT Merger Agreement provided for a business combination whereby QLT AcquireCo would be merged with and into the Company.

 

On July 21, 2014, James Novak, an alleged shareholder of the Company, filed suit in the Court of Common Pleas, Chester County, Pennsylvania, against the Company’s Board of Directors, seeking to enjoin the proposed merger between the Company and QLT on the grounds that the Board of Directors of the Company breached their fiduciary duties by approving a proposed transaction with QLT that purportedly does not reflect the true value of the Company. The complaint also names as defendants the Company, QLT, QLT Holdco and QLT AcquireCo for allegedly aiding and abetting the Company’s Board of Directors’ purported breach of fiduciary duty. On July 25, 2014, Raymon Hall, an alleged shareholder of the Company, filed suit in the Court of Common Pleas, seeking to enjoin the proposed merger with QLT on the grounds that the Board of Directors of the Company breached their fiduciary duties by approving a proposed transaction that purportedly does not reflect the true value of the Company. Plaintiff has also brought suit against QLT, QLT Holdco and QLT AcquireCo for allegedly aiding and abetting the Company directors’ purported breach of fiduciary duty. On July 28, 2014, James Wernicke, an alleged shareholder of the Company, filed suit in the Court of Common Pleas against the Company Board of Directors, seeking to enjoin the proposed merger between the Company and QLT on the grounds that the Company’s Board of Directors breached their fiduciary duties by approving a proposed transaction with QLT that purportedly does not reflect the true value of the Company. The complaint also names as defendants the Company and QLT for allegedly aiding and abetting the Company’s Board of Directors’ purported breach of fiduciary duty. On August 21, 2014, Plaintiff Hall filed an amended complaint. On August 25, 2014, Plaintiff Novak filed an amended complaint. In addition to the claims described above, both amended complaints include certain purported disclosure claims related to the disclosures made in the preliminary proxy statement/prospectus included in the registration statement on Form S-4 filed with the SEC on August 4, 2014.

 

Concurrently with the execution of the Endo Merger Agreement on October 8, 2014, the Company delivered to QLT written notice terminating the QLT Merger Agreement. In conjunction with the termination of the QLT Merger Agreement, Endo paid to QLT, on behalf of the Company, the termination fee of $28.4 million required pursuant to the terms of the QLT Merger Agreement, which amount is subject to reimbursement by the Company to Endo if the Endo Merger Agreement is terminated under certain conditions. Accordingly, the QLT Merger Agreement was terminated effective October 8, 2014.

 

With the termination of the QLT Merger Agreement, the status of these litigations is currently unclear, but the Company believes they are without merit and, if necessary, the Company intends to vigorously defend against these lawsuits.

 

General Information About Above Matters

 

The Company intends to vigorously defend against the foregoing matters.  These pending matters have not yet progressed sufficiently through discovery and/or development of important factual information and legal issues to enable the Company to determine a loss, if any, is probable.  The Company is unable to estimate the possible loss or range of loss for the legal proceedings described above.  Litigation is unpredictable and, while it is not possible to accurately predict or determine the eventual outcomes of these items, an adverse determination in one or more of these items currently pending could have a material adverse effect on the Company’s consolidated results of operations, financial position or cash flows. The Company has incurred and expects to continue to incur significant legal fees in the defense of these actions, which legal fees the Company currently expenses as incurred.

 

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Other Matters

 

The Company is party to various other actions and claims arising in the normal course of business. The Company believes that amounts accrued for awards or assessments in connection with all such matters are adequate and that the ultimate resolution of these matters will not have a material adverse effect on the Company’s financial position or the manner in which the Company conducts its business. However, there exists a reasonable possibility of loss in excess of the amounts accrued, the amount of which cannot currently be estimated. While the Company does not believe that the amount of such excess loss could be material to the Company’s financial position, any such loss could have a material adverse effect on Company’s results of operations or the manner in which the Company conducts its business in the period(s) during which the underlying matters are resolved.

 

10.  PENDING TRANSACTION

 

Merger Agreement with Endo

 

On October 8, 2014, the Company entered into an Agreement and Plan of Merger (the “Endo Merger Agreement”) with Endo International plc, a public limited company incorporated under the laws of Ireland (“Endo”), Endo U.S. Inc., a corporation incorporated under the laws of the State of Delaware (“Endo HoldCo”), and Avalon Merger Sub Inc., a corporation incorporated under the laws of the State of Delaware (“Endo AcquireCo”), providing for the merger of Endo AcquireCo with and into the Company, with the Company as the surviving corporation and a wholly-owned indirect subsidiary of Endo (the “Endo Merger”).

 

The Endo Merger Agreement provides that, upon completion of the Endo Merger, each share of the Company’s common stock issued and outstanding immediately prior to the Endo Merger (other than shares held by stockholders who exercise their appraisal rights under Delaware law and shares held by the Company as treasury stock, held by a wholly-owned subsidiary of the Company or held by Endo, Endo HoldCo, or Endo AcquireCo, which will be canceled without consideration, and shares of the Company’s common stock subject to vesting or other lapse restrictions pursuant to the Company’s equity compensation plan) will be converted into the right to receive, at the election of the holder thereof (subject to proration as described below): (1) a combination of $16.625 in cash plus 0.2440 Endo ordinary shares (the “Standard Consideration”); (2) $33.25 in cash (the “Cash Election Consideration”); or (3) 0.4880 Endo ordinary shares (the “Stock Election Consideration”). Shares of the Company’s common stock with respect to which no election is made will receive the Standard Consideration. Stockholders who make the Cash Election or the Stock Election will be subject to proration to ensure in respect of all shares of the Company’s common stock (including shares subject to a Standard Election) does not exceed $845 million (which amount is subject to adjustment on the terms set forth in the Endo Merger Agreement) and the total number of Endo shares issued to Company stockholders as a whole (including those stockholders that make the Standard Election) do not exceed 18,610,000 Endo shares.

 

The respective Boards of Directors of the Company and Endo have unanimously approved the Endo Merger Agreement, and the Board has agreed to recommend that the stockholders of the Company adopt and approve the Endo Merger Agreement, subject to certain exceptions set forth in the Endo Merger Agreement.

 

The completion of the Endo Merger is subject to the approval of stockholders of the Company. In addition, the Endo Merger is subject to other customary closing conditions, including, among others, (i) the expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, (ii) the declaration by the SEC of the effectiveness of the Registration Statement on Form S-4 to be filed by Endo with the SEC, and (iii) the approval of the listing on NASDAQ of the Endo shares to be issued in connection with the Endo Merger.

 

The Endo Merger Agreement contains certain termination rights for both the Company and Endo, including in the event that the Merger is not consummated by April 10, 2015, subject to extension by the parties to July 8, 2015 in the event that regulatory approvals have not been received. The Endo Merger Agreement further provides that, upon termination of the Endo Merger Agreement under specified circumstances, including termination of the Merger Agreement by Endo as a result of an adverse change in the recommendation of the Board, the Company may be required to pay Endo a termination fee of $70,000 and reimburse Endo for the $28,400 termination fee paid to QLT in connection with the termination of the QLT Merger Agreement (described below). Endo is required to pay the Company a termination fee of $150,000 if Endo terminates the Endo Merger Agreement due to a change in U.S. federal tax law (whether or not such change in law is yet effective) after the date of the Endo Merger Agreement that, as a result of consummating the transactions contemplated by the Endo Merger Agreement once effective, would have a material adverse effect on Endo or the Company terminates the Endo Merger Agreement because

 

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Endo fails to confirm within a specified period that Endo has no right to terminate the Endo Merger Agreement following a change in tax law.

 

Termination of Merger Agreement with QLT

 

On June 25, 2014, the Company entered into the QLT Merger Agreement among the Company, QLT, QLT HoldCo, and QLT AcquireCo. The QLT Merger Agreement provided for a business combination whereby QLT AcquireCo would be merged with and into the Company. Concurrently with the execution of the Endo Merger Agreement, the Company delivered to QLT written notice terminating the QLT Merger Agreement. In conjunction with the termination of the QLT Merger Agreement, Endo paid to QLT, on behalf of the Company, the termination fee of $28.4 million required pursuant to the terms of the QLT Merger Agreement, which amount is subject to reimbursement by the Company to Endo if the Endo Merger Agreement is terminated under certain conditions. Accordingly, the QLT Merger Agreement was terminated effective October 8, 2014.

 

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

 

The following discussion is qualified in its entirety by, and should be read in conjunction with, the more detailed information set forth in the consolidated financial statements and the notes thereto appearing elsewhere in this Report.

 

Special Note Regarding Forward-Looking Statements

 

You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and the related notes appearing at the end of this Report. Some of the information contained in this discussion and analysis or set forth elsewhere in this Report, including information with respect to our plans and strategy for our business and related financings, includes forward-looking statements that involve risks and uncertainties. You should review the “Risk Factors” section of this Report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

 

In some cases you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “would,” “expect,” “intend,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “seem,” “seek,” “future,” “continue,” or “appear” or the negative of these terms or similar expressions, although not all forward-looking statements contain these identifying words.  Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results, performance, achievements or prospects to be materially different from any future results, performance, achievements or prospects expressed in or implied by such forward-looking statements.  Such risks and uncertainties include, among other things:

 

·                  the planned Endo Merger, and whether and when the Endo Merger will successfully close;

 

·                  our anticipated business operations, financial condition, strategy and future prospects;

 

·                  our ability to forecast our performance accurately;

 

·                  the possibility that the anticipated benefits and reduction in costs from the September 2014 corporate restructuring cannot be fully realized or may take longer to realize than expected;

 

·                  the effect of cost reductions on revenue growth may be more impactful than anticipated;

 

·                  the effect of the significant decline in sales of Testim, the decline of the TRT market in general and the future TRT market dynamics;

 

·                  the commercial success of our products in the U.S. and, through our collaborators, internationally, including demand for our products;

 

·                  our ability to continue successfully launching STENDRA and XIAFLEX for the treatment of PD as well as for the treatment of multiple DC cords;

 

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·                  obtaining and maintaining third-party payor coverage and reimbursement at reasonable reimbursement rates for our products and, if approved, our product candidates;

 

·                  achieving greater market acceptance of our products by physicians and patients;

 

·                  obtaining approval from regulatory agencies in other countries for XIAFLEX for DC and PD;

 

·                  the size of addressable markets for our products and product candidates;

 

·                  maximizing revenues of our products in the currently approved indications;

 

·                  competing effectively with other products in our products’ therapeutic areas, including potential additional generic and branded generic competition;

 

·                  our ability to successfully defend our intellectual property, including the various litigations regarding our TRT products in which we are currently involved;

 

·                  our ability to successfully defend ourselves in the various litigations regarding, among other things, alleged negative effects of our TRT products;

 

·                  growth in sales of our products;

 

·                  growth of demand for ED drug therapy  in wholesale and retail markets;

 

·                  our ability to integrate the remaining operations of Actient and its subsidiaries into our operations successfully and efficiently;

 

·                  our ability to materialize the remaining synergies and benefits, including revenue and profit growth, from the acquisition of Actient;

 

·                  the risks or costs associated with the Actient acquisition being greater than we anticipate;

 

·                  the risks associated with entering the medical device business as a result of the Actient acquisition;

 

·                  the ability to manufacture or have manufactured our products and other product candidates in commercial quantities at reasonable costs and compete successfully against other products and companies;

 

·                  the ability to leverage our investment in our sales force, as well as our expertise in clinical development and regulatory strategy, with the addition of new products;

 

·                  the availability of, and ability to obtain, additional funds through public or private offerings of debt or equity securities;

 

·                  the ability to service all of our outstanding indebtedness;

 

·                  obtaining and maintaining all necessary patents or licenses;

 

·                  the costs associated with acquiring and/or developing, and the ability to acquire and/or develop, additional product candidates or approved products;

 

·                  the ability to enroll patients in clinical trials for our product candidates in the expected timeframes;

 

 

·                  the ability to obtain authorization from the FDA or other regulatory authorities to initiate clinical trials of our product candidates within the expected timeframes;

 

·                  the ability to deliver on our current or future pipeline;

 

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·                  the ability to build out our business and development pipeline in specialty therapeutic areas through corporate development and licensing activities or acquisition activities;

 

·                  demonstrating the safety and efficacy of product candidates at each stage of development;

 

·                  results and possible delays of clinical trials;

 

·                  meeting applicable regulatory standards, filing for, and receiving, required regulatory approvals;

 

·                  complying with the terms of our licenses and other agreements;

 

·                  changes in industry practice;

 

·                  changes in the markets for, acceptance by the medical community of, and exclusivity protection for, our products and product candidates as a result of the Patient Protection and Affordable Care Act and the associated reconciliation bill or any amendments thereto or any full or partial repeal thereof;

 

·                  the success of our R&D efforts to study CCH and whether those efforts will diversify our portfolio and deliver long term shareholder value and new treatment options to the patients; and

 

·                  one-time events.

 

These risks and uncertainties are not exhaustive.  For a more detailed discussion of risks and uncertainties, see “Item 1A — Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2013, as updated by Part II, Item 1A of our Quarterly Reports on Form 10-Q for the quarters ended March 31 and June 30, 2014, and “Item 1A — Risk Factors” of Part II of this Report.  Other sections of this Report and our other SEC filings, verbal or written statements and presentations may include additional factors which could materially and adversely impact our future results, performance, achievements and prospects.  Moreover, we operate in a very competitive and rapidly changing environment.  Given these risks and uncertainties, we cannot guarantee that the future results, performance, achievements and prospects reflected in forward-looking statements will be achieved or occur. Therefore, you should not place undue reliance on forward-looking statements.  We undertake no obligation to update publicly any forward-looking statement other than as required under the federal securities laws.  We qualify all forward-looking statements by these cautionary statements.

 

Special Note Regarding Market and Competitive Position Data and Clinical Data

 

We obtained the market and competitive position data used throughout this Report from our own research, surveys or studies conducted by third parties and industry or general publications. Industry publications and surveys generally state that they have obtained information from sources believed to be reliable, but do not guarantee the accuracy and completeness of such information. While we believe that each of these studies and publications is reliable, we have not independently verified such data. Similarly, we believe our internal research is reliable but it has not been verified by any independent sources.

 

This Report may include discussion of certain clinical studies relating to our products and/or product candidates. These studies typically are part of a larger body of clinical data relating to such products or product candidates, and the discussion herein should be considered in the context of the larger body of data.

 

Overview

 

We are a fully integrated specialty biopharmaceutical company with a focus on developing and commercializing innovative products for specialist audiences. With a broad range of first- and second-line products across multiple indications, we are an emerging leader in the men’s healthcare area and have strategically expanded our product portfolio and pipeline in orthopedics, dermatology and other therapeutic areas. We now have a broad portfolio of 12 approved products. Among other products in the U.S., we market edex® (alprostadil for injection), an injectable treatment for erectile dysfunction, Osbon® ErecAid®, the leading device for aiding erectile dysfunction, STENDRA® (avanafil), an oral erectile dysfunction therapy, TESTOPEL® (testosterone pellets) a long-acting implantable testosterone replacement therapy, XIAFLEX® (collagenase clostridium histolyticum or CCH) for the treatment of Peyronie’s disease and XIAFLEX for the treatment of Dupuytren’s contracture, Testim® (testosterone

 

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gel) for the topical treatment of hypogonadism and an Authorized Generic version of Testim (testosterone gel) with our partner Prasco, LLC. We also have programs in Phase 2 clinical development for the treatment of Frozen Shoulder syndrome and cellulite. Our mission is to improve the lives of patients throughout the world by successfully identifying, developing and commercializing innovative specialty biopharmaceutical products.  Our vision is to be the most consistently successful and most admired specialty biopharmaceutical company.

 

On October 8, 2014, we entered into the Endo Merger Agreement with Endo, Endo HoldCo and Endo AcquireCo, providing for the merger of Endo AcquireCo with and into the Company, with the Company as the surviving corporation and a wholly-owned indirect subsidiary of Endo (the “Endo Merger”).  The completion of the Endo Merger is subject to the approval of stockholders of the Company as well as other customary closing conditions.

 

For the quarter ended September 30, 2014, we reported net revenues of $109.6 million, compared to net revenues of $108.1 million in the third quarter of 2013, an increase of 1%.  For the third quarter of 2014, XIAFLEX U.S. net revenues increased by 118% over the comparable 2013 period to $34.6 million, which amount includes sales related to XIAFLEX for PD.  XIAFLEX for PD was launched in the U.S. in January 2014.  For the third quarter of 2014, U.S. Testim net revenues, which include revenues from the sale of Testim and the authorized generic version of Testim launched in the U.S. in June 2014, decreased by 48% from the third quarter of 2013 to $26.2 million. U.S. revenues from our acquired subsidiary, Actient, resulted in U.S. net revenues of $34.8 million for the third quarter of 2014 and included TESTOPEL net revenues of $20.2 million, Edex net revenues of $7.0 million and other U.S. net revenues of $7.6 million.  For the third quarter of 2014, STENDRA, which was launched in the U.S. in January 2014, net revenues were $9.3 million. We reported a net loss of $32.7 million, or $0.65 per share (basic and diluted), compared to net loss of $28.6 million, or $0.58 per share (basic and diluted) for the third quarter of 2013.  As of September 30, 2014, we had $77.9 million in cash, cash equivalents and short-term investments, compared to $71.2 million at December 31, 2013, and outstanding debt of $302.4 million ($350.0 million at par value) in the form of the 2018 Convertible Notes and $295.3 million ($305.1 million par value) in a senior secured term loan (the “Term Loan”).

 

We had approximately 484 employees as of September 30, 2014, including approximately 239 employees in our commercial organization, 129 employees in manufacturing and quality, 54 employees in research and development and 62 employees in administrative support.

 

Pipeline and Research and Development Process

 

In the R&D area, we are engaged in innovative research investigating potential treatments. We are conducting research in the area of Frozen Shoulder syndrome and cellulite with CCH, the active ingredient in XIAFLEX.

 

In addition, we have ongoing collaborative programs with our partner, BioSpecifics, to study CCH in the area of human and canine lipoma. This R&D innovation, together with diversifying our approved product portfolio, is all in the interest of delivering what we believe will be long-term value to our shareholders and new treatment options to the patients we hope to serve.

 

The product candidates in our pipeline are at various stages of preclinical and clinical development. The path to regulatory approval includes several phases of nonclinical and clinical study to collect data to support an application to regulatory authorities to allow us to market a product for treatment of a specified disease indication. There are many difficulties and uncertainties inherent in research and development and the introduction of new products. There is a high rate of failure inherent in new drug discovery and development. To bring a drug from the discovery phase to regulatory approval, and ultimately to market, takes many years and incurs significant cost. Failure can occur at any point in the process, including after the product is approved based on post-market factors. New product candidates that appear promising in development may fail to reach the market or may have only limited commercial success because of efficacy or safety concerns, inability to obtain necessary regulatory approvals, limited scope of approved uses, reimbursement challenges, difficulty or excessive costs to manufacture, or infringement of the patents or intellectual property rights of others. Delays and uncertainties in the FDA approval process and the approval processes in other countries can result in delays in product launches and lost market opportunity. Consequently, it can be very difficult to predict which products will ultimately be submitted for approval, which have the highest likelihood of obtaining approval, and which will be commercially viable and generate profits for the Company. Successful results in preclinical or phase 1/2 clinical studies may not be an accurate predictor of the ultimate safety or effectiveness of a drug or product candidate.

 

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Phase 1 Clinical Trials

 

Phase 1 human clinical trials begin when regulatory agencies allow a request to initiate clinical investigations of a new drug or product candidate and usually involve small numbers of healthy volunteers or subjects. The trials are designed to determine the safety, metabolism, dosing and pharmacologic actions of a drug in humans, the potential side effects of the product candidates associated with increasing drug doses and, if possible, to gain early evidence of the product candidate’s effectiveness. Phase 1 clinical studies generally take from 6 to 12 months or more to complete.

 

Phase 2 Clinical Trials

 

Phase 2 clinical trials are conducted on a limited number of patients with the targeted disease, usually involving no more than several hundred patients, to evaluate appropriate dosage and the effectiveness of a drug for a particular indication or indications and to determine the common short-term side effects and risks associated with the drug. An initial evaluation of the drug’s effectiveness on patients is performed and additional information on the drug’s safety and dosage range is obtained. Our Phase 2 clinical trials typically include up to 200 patients and may take approximately two years to complete.

 

Phase 3 Clinical Trials

 

Phase 3 clinical trials are performed after preliminary evidence suggesting effectiveness of a drug has been obtained. Phase 3 clinical trials are intended to gather additional information about the effectiveness and safety that is needed to evaluate the overall benefit-risk relationship of the drug and to provide an adequate basis for physician labeling. They typically include controlled multi-center trials and involve a larger target patient population, typically including from several hundred to several thousand patients to ensure that study results are statistically significant. During Phase 3 clinical trials, physicians monitor patients to determine efficacy and to gather further information on safety. These trials are generally global in nature and are designed to generate data necessary to submit the product to regulatory agencies for marketing approval. Phase 3 testing varies and can often last from 2 to 5 years.

 

Regulatory Review

 

If a product successfully completes a Phase 3 clinical trial and is submitted to governmental regulators, such as the FDA in the U.S. or the EMA in the EU, the time to final marketing approval can vary from nine months (for a U.S. filing that is designated for priority review by the FDA) to several years, depending on a number of variables, such as the disease state, the strength and complexity of the data presented, the novelty of the target or compound, risk-management approval and the time required for the agency(ies) to evaluate the submission. There is no guarantee that a potential treatment will receive marketing approval, or that decisions on marketing approvals or indications will be consistent across geographic areas.

 

Certain Significant Developments During the Period Covered by this Report

 

Significant business developments that occurred during the third quarter of 2014 or that impacted this period include:

 

·                  On September 16, 2014, the Board authorized and directed the issuance, and declared a dividend distribution of one preferred share purchase right for each outstanding share of common stock, par value $0.01 per share, of the Company to purchase from the Company one one-hundredth of a share of Series A Junior Participating Preferred Stock, par value $0.01 per share, of the Company at a price of $100.00 per one one-hundredth of a share of Preferred Stock, subject to adjustment as provided in the Rights Agreement.  The dividend is payable to stockholders of record at the close of business on September 29, 2014.  The description and terms of the Rights are set forth in the Rights Agreement, dated as of September 17, 2014, as amended on October 8, 2014 and as the same may be amended from time to time, between the Company and Broadridge Corporate Issuer Solutions, Inc., as Rights Agent.

 

The Rights Agreement is intended to (i) reduce the risk of coercive two tiered, front end loaded or partial offers that may not offer fair value to all stockholders, (ii) mitigate against market

 

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accumulators who through open market and/or private purchases may achieve a position of substantial influence or control without paying to selling or remaining stockholders a fair control premium, and (iii) preserve the Board’s bargaining power and flexibility to deal with third party acquirors and to otherwise seek to maximize values for all stockholders.  The overall effect of the Rights Agreement and the issuance of the Rights may be to render more difficult or discourage a merger, tender or exchange offer or other business combination involving the Company that is not approved by the Board.  The Rights Agreement is not intended to interfere with any merger, tender or exchange offer or other business combination approved by the Board, including, without limitation, the transactions contemplated by the Endo Merger Agreement.  Nor does the Rights Agreement prevent the Board from considering any offer that it considers to be in the best interest of the Company’s stockholders.

 

·                              On September 17, 2014, we issued a press release confirming receipt by the Company of an unsolicited, non-binding proposal from Endo to acquire all of the outstanding shares of our common stock at a price of $28.10 per share in cash and Endo stock, subject to due diligence, financing and other conditions, and the adoption of the Rights Agreement and the declaration of the dividend of the Rights.  On September 22, 2014, we issued a press release announcing that the Board had unanimously determined that the unsolicited, non-binding and conditional proposal from Endo was not a superior proposal under the terms of the Company’s then existing merger agreement with QLT.  In this press release, the Board unanimously reaffirmed its recommendation that the Company’s stockholders vote in favor of the adoption of the QLT merger agreement.

 

·                              On October 8, 2014, we entered into the Endo Merger Agreement with Endo, Endo HoldCo and Endo AcquireCo, providing for the merger of Endo AcquireCo with and into the Company, with the Company as the surviving corporation and a wholly-owned indirect subsidiary of Endo.

 

The Endo Merger Agreement provides that, upon completion of the Endo Merger, each share of the Company’s common stock issued and outstanding immediately prior to the Endo Merger (other than shares held by stockholders who exercise their appraisal rights under Delaware law and shares held by the Company as treasury stock, held by a wholly-owned subsidiary of the Company or held by Endo, Endo HoldCo, or Endo AcquireCo, which will be canceled without consideration, and shares of the Company’s common stock subject to vesting or other lapse restrictions pursuant to the Company’s equity compensation plan) will be converted into the right to receive, at the election of the holder thereof (subject to proration as described below): (1) a combination of $16.625 in cash plus 0.2440 Endo ordinary shares; (2) $33.25 in cash; or (3) 0.4880 Endo ordinary shares. Shares of the Company’s common stock with respect to which no election is made will receive the Standard Consideration. Stockholders who make the Cash Election or the Stock Election will be subject to proration to ensure that the total amount of cash paid in respect of all shares of the Company’s common stock (including shares subject to a Standard Election) does not exceed $845 million (which amount is subject to adjustment on the terms set forth in the Endo Merger Agreement) and the total number of Endo shares issued to Company stockholders as a whole (including those stockholders that make the Standard Election) do not exceed 18,610,000 Endo shares.

 

The respective Boards of Directors of the Company and Endo have unanimously approved the Endo Merger Agreement, and the Board has agreed to recommend that the stockholders of the Company adopt and approve the Endo Merger Agreement, subject to certain exceptions set forth in the Endo Merger Agreement.

 

The completion of the Endo Merger is subject to the approval of stockholders of the Company. In addition, the Endo Merger is subject to other customary closing conditions, including, among others, (i) the expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, (ii) the declaration by the SEC of the effectiveness of the Registration Statement on Form S-4 to be filed by Endo with the SEC, and (iii) the approval of the listing on NASDAQ of the Endo shares to be issued in connection with the Endo Merger.

 

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On October 8, 2014, we entered into Amendment No. 1 to the Rights Agreement.  The Rights Agreement Amendment provides that the Endo Merger Agreement and related transactions, including the consummation of the Endo Merger and any related transactions, will not cause the Rights to become exercisable or cause any of the other protective features afforded to the Company under the Rights Agreement to come into effect. Under the Rights Agreement Amendment, no party to the Endo Merger Agreement or the related transactions shall be deemed to be the beneficial owner, as defined in the Rights Agreement, of any common shares held by any other party, solely by virtue of the approval, execution, delivery, and/or the existence of the Endo Merger Agreement or the related transactions or the performance of such party’s rights and obligations under the Endo Merger Agreement or the related transactions. The Rights Agreement Amendment further provides that all Rights established under the Rights Agreement shall automatically expire immediately prior to the closing of the Endo Merger.

 

As previously announced, on June 25, 2014, we entered into the QLT Merger Agreement among the Company, QLT, QLT HoldCo and QLT AcquireCo. The QLT Merger Agreement provided for a business combination whereby QLT AcquireCo would be merged with and into the Company. Concurrently with the execution of the Endo Merger Agreement, we delivered to QLT written notice terminating the QLT Merger Agreement. In conjunction with the termination of the QLT Merger Agreement, Endo paid to QLT, on behalf of the Company, the termination fee of $28.4 million required pursuant to the terms of the QLT Merger Agreement, which amount is subject to reimbursement by us to Endo if the Endo Merger Agreement is terminated under certain conditions. Accordingly, the QLT Merger Agreement was terminated effective October 8, 2014.

 

·                  On July 31, 2014, we announced that Asahi Kasei successfully submitted a regulatory application to the Japanese Pharmaceutical and Medical Device Agency (“JPMDA”) for XIAFLEX for DC.  The review by the JPMDA is expected to be completed by mid-2015.  Pursuant to our development, commercialization and supply agreement with Asahi Kasei, we received a $10 million regulatory milestone payment from Asahi Kasei.

 

·                  On August 5, 2014, we announced that our Board approved the appointment of Andrew Saik to serve as the next Chief Financial Officer of the Company, whose appointment became effective as of August 18, 2014.

 

·                  As previously disclosed on Form 8-K dated June 2, 2014, effective as of August 15, 2014, the employment of Mr. James E. Fickenscher, the former Chief Financial Officer of the Company, terminated. On August 20, 2014, the Company entered into a separation of employment agreement and general release with Mr. Fickenscher in connection with his departure from the Company.

 

·                  On August 21, 2014, we issued a press release announcing positive results from a randomized, double-blind Phase 2a study of CCH for the treatment of edematous fibrosclerotic panniculopathy (EFP), commonly known as cellulite.

 

·                  On August 28, 2014, we announced that data from trials evaluating the use of CCH for treating two DC cords concurrently in adult patients with a palpable cord will be presented at the 69th Annual Meeting of the American Society for Surgery of the Hand (ASSH) being held in Boston on September 18-20, 2014.

 

·                  On September 9, 2014, we announced steps the Company is taking to reduce our costs and more fully support our goal to drive earnings growth and build shareholder value.  These steps were launched after a comprehensive assessment of our broadened product portfolio and current cost structure and what management believes to be our growth assets, commercial strengths, opportunities and challenges and our manufacturing needs and capabilities. The Company has identified annual cost savings totaling greater than $75 million, which includes significantly reducing headcount, realigning the commercial organization from three into two sales forces, focusing our research and development efforts and expenditures and improving manufacturing efficiency. In the event the Endo Merger is not consummated, we anticipate substantial completion of the restructuring by the end of 2014, with the full $75 million run-rate expected to be achieved by mid-year 2015.

 

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The majority of the Company’s initially planned approximately 30% headcount reduction occurred on September 11, 2014, with an additional 33 affected employees initially expected to exit the Company on or about December 31, 2014.  With the Endo Merger, these 33 employees will now remain with the Company until the expected closing of the Endo Merger, thereby reducing the headcount reduction to approximately 20%.

 

The Company expects that at least $75 million in operating expense reductions will include approximately $28 million in personnel-related cost reductions (before severance costs) and approximately $47 million in additional gross operating expense reductions.

 

The Company’s commercial organization will now include two sales forces instead of three:

 

·      The Agilis sales force, which markets XIAFLEX for Dupuytren’s contracture, remains intact with 44 territories and field sales representatives.

 

·      The Primera and Innovia sales forces are being merged into one sales force, which will continue to be called Innovia.  While the merger of these two sales forces reduces overall sales headcount by more than 100 employees, the restructuring increases the Innovia sales force by approximately 45% and expands its reach from 60 territories to 110 territories. This new merged Innovia sales force will focus on further strengthening the Company’s relationships with, and reach into, the urologist community and will market XIAFLEX for Peyronie’s disease, STENDRA, TESTOPEL, and edex. The Innovia sales force will also market STENDRA to a select number of high-prescribing Primary Care Physicians.

 

·                  On September 17, 2014, the FDA has conducted an Advisory Committee meeting at which the appropriate indicated population for TRT and the potential for adverse cardiovascular outcomes associated with TRT were discussed and, as a result of which, the Advisory Committee recommended narrowing the indicated population for TRT and proposed similarly narrowing labels for applicable TRT products.

 

·                  On September 18, 2014, the Company and VIVUS, Inc. issued a joint press release announcing that the U.S. Food and Drug Administration has approved a supplemental new drug application for STENDRA® (avanafil). STENDRA is now the only FDA-approved erectile dysfunction medication indicated to be taken as early as approximately 15 minutes before sexual activity.

 

·                  On September 18, 2014, we issued a press release announcing the first presentation of positive safety and efficacy data from the AUX-CC-867 MULTICORD (MULtiple Treatment Investigation of Collagenase Optimizing the Resolution of Dupuytren’s) Phase 3b study. These data were presented at the 69th Annual Meeting of the American Society for Surgery of the Hand (ASSH) held in Boston, September 18-20, 2014.

 

·                  On September 22, 2014, we entered into an Incremental Assumption Agreement (the “Agreement”) with Morgan Stanley Senior Funding, Inc., as administrative agent (“Agent”) pursuant to and under the Credit Agreement providing for a $50,000,000 senior secured term loan (the “Second Incremental Term Loan”) to be used by the Company for general corporate purposes.  The Second Incremental Term Loan is in addition to the Existing Term Loans previously extended to us under the Credit Agreement.  The Second Incremental Term Loan is on terms and conditions consistent with those set forth in the Credit Agreement and the Agreement, including interest rates equal to the base rate or LIBOR rate, at the election of the Company, plus a margin of 4.0% for base rate loans and 5.0% for LIBOR rate loans.

 

·                  On October 20, 2014, we issued a press release announcing the FDA’s approval of an sBLA for XIAFLEX for the treatment of up to two DC joints in the same hand during a single treatment visit.  In Phase 3b clinical trials, two concurrent XIAFLEX injections were safely used in the treatment of one hand with multiple affected joints.

 

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·                  The closing of the previously planned merger with QLT would have been a “change of control,” as defined in the Credit Agreement, and would have been prohibited by the terms of the Credit Agreement.  In addition, the de-listing of the Company’s common stock would have been prohibited by the terms of the Credit Agreement.

 

On August 14, 2014, we entered into the Third Amendment Agreement (the “Third Amendment Agreement”) with the Agent and lenders holding more than 50% of the loans under the Credit Agreement pursuant to and under the Credit Agreement providing for, upon the satisfaction of the conditions precedent set forth therein, certain amendments and modifications to the Credit Agreement to:

 

·                  permit the closing of the Merger and delisting of the Company’s common stock without such transactions being deemed an event of default under the Credit Agreement;

·                  join QLT and certain of its subsidiaries as parties to the Credit Agreement and the other loan documents contemplated thereunder;

·                  increase the LIBOR rate margin to 6.75% and the base rate margin to 5.75%, subject to downward adjustment contingent upon corporate ratings;

·                  add a first lien net leverage ratio financial maintenance covenant, tested on a quarterly basis.  The first lien net secured leverage ratio for each of the following quarters may not be greater than the numbers described herein:  for the fiscal quarter ending March 31, 2015, no greater than 3.75:1.00; for the fiscal quarters ending June 30, 2015 and September 30, 2015, no greater than 3.25:1.00 and for the fiscal quarter ending December 31, 2015 and each fiscal quarter thereafter, 3.00:1.00; and

·                  require the payment of a premium of 1% of any principal repaid on or prior to the second anniversary of the effectiveness of the Amendment Agreement.

 

Now that the planned merger with QLT has been terminated, this Third Amendment Agreement to the Credit Agreement will not become effective.

 

Results of Operations

 

Revision to previously issued financial statements

 

Contingent Consideration

 

During the second quarter of 2014, we identified that we had incorrectly classified the fair value of a contingent sales milestone on our Consolidated Balance Sheet as of March 31, 2014.  Contingent consideration in the amount of $22.2 million was classified as a current liability as of March 31, 2014; however, the amount should have been classified as a long term liability based on our calculation. The effect of the misclassification on the Consolidated Balance Sheet as of March 31, 2014 was a $22.2 million overstatement of current contingent consideration and an equivalent understatement of non-current contingent consideration.  We assessed this misclassification and concluded that it was not material to our financial statements previously issued on our Form 10-Q for the three months ended March 31, 2014.  Our Consolidated Statements of Operations and the Consolidated Statements of Cash Flows for the three months ended March 31, 2014 were not affected by this misclassification and remain unchanged.

 

In addition, we determined that we had understated contingent consideration expense and contingent consideration liabilities by $4.2 million for the quarter ended March 31, 2014.  This error was the result of using an incorrect revenue forecast to calculate the fair value of royalties included as part of our contingent consideration liabilities.  The error had the impact of understating contingent consideration expense by $4.2 million on our Consolidated Statement of Operations for the three months ended March 31, 2014 as well as the contingent consideration liability being understated by the same amount ($1.8 million short-term and $2.4 million long-term) on the Consolidated Balance Sheet as of March 31, 2014.  This $4.2 million error also had the effect of understating net loss reported on our Consolidated Statement of Stockholders’ Equity as well as understating the net loss and contingent consideration line items within net cash flows from operating activities on our Consolidated Statement of Cash Flows; however, it did not impact total net cash provided by operating activities as reported on the Consolidated Statement of Cash Flows.  We assessed this error and concluded that it was not material to our financial statements previously issued on our Form 10-Q for the three months ended March 31, 2014.  Additional

 

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expense of $4,200 was recorded to contingent consideration on our Consolidated Statement of Operations during the three months ended June 30, 2014 to correct this error.

 

Business Combinations

 

In connection with the preparation of our consolidated financial statements for the second quarter of 2014, we identified prior period errors related to our accounting for business combinations for the year ended December 31, 2013.  As of June 30, 2014, we reclassified $5.4 million from Goodwill to Intangible Assets ($3.6 million) and Contingent Consideration ($1.8 million) on the balance sheet and adjusted certain related footnotes for these items.  In addition, we recorded additional amortization expense of $380 on our Consolidated statement of operations for the three months ended June 30, 2014 related to these items. These adjustments represent corrections to immaterial errors related to the classification of certain assets and liabilities as well as amortization expense recorded in connection with the acquisitions of Actient and STENDRA. We have evaluated these items, both individually and in the aggregate, in relation to the current period financial statements as well as the period in which they originated and concluded that these adjustments are not material to any of the impacted periods. These adjustments were recorded during the three months ended June 30, 2014.

 

Three Months Ended September 30, 2014 and 2013

 

Net revenues.  Net revenues for the three months ended September 30, 2014 and 2013 comprise the following:

 

 

 

Three months ended September 30,

 

 

 

 

 

2014

 

2013

 

Change

 

% Change

 

 

 

(in millions)

 

 

 

XIAFLEX revenues-

 

 

 

 

 

 

 

 

 

Net U.S. revenues

 

34.6

 

15.9

 

18.7

 

118

%

International revenues

 

4.0

 

1.7

 

2.3

 

135

%

 

 

38.6

 

17.6

 

21.0

 

119

%

Testim revenues-

 

 

 

 

 

 

 

 

 

Net U.S. revenues - brand

 

$

15.3

 

$

50.7

 

$

(35.4

)

-70

%

Net U.S. revenues — authorized generic

 

10.9

 

 

10.9

 

n/a

 

International revenues

 

0.7

 

1.6

 

(0.9

)

-56

%

 

 

26.9

 

52.3

 

(25.4

)

-49

%

Other net U.S. revenues-

 

 

 

 

 

 

 

 

 

TESTOPEL

 

20.2

 

20.6

 

(0.4

)

-2

%

STENDRA

 

9.3

 

 

9.3

 

n/a

 

Edex

 

7.0

 

8.0

 

(1.0

)

-13

%

Other

 

7.6

 

9.6

 

(2.0

)

-21

%

 

 

44.1

 

38.2

 

5.9

 

15

%

Total net revenues

 

$

109.6

 

108.1

 

$

1.5

 

1

%

 

 

 

 

 

 

 

 

 

 

Revenue allowance as a percentage of gross U.S. revenues

 

26

%

31

%

-5

%

 

 

 

Net U.S. revenues shown in the above table represent the product sales of the Company within the U.S., net of allowances provided on such sales. In addition, net distributable profits earned pursuant to a Distribution and Supply Agreement (the “AG Agreement”) entered into with Prasco are also included in net U.S. revenues in the above table.  International revenues represent the amortization of deferred up-front and milestone payments the Company has received through its out-licensing agreements, together with royalties earned on product sales by the licensees.

 

XIAFLEX

 

Total revenues for XIAFLEX in the third quarter of 2014 were $38.6 million compared to $17.6 million in the third quarter of 2013, an increase of 119%. Net revenues for the three months ended September 30, 2014 include $34.6 million of net U.S. product sales of XIAFLEX compared to the $15.9 million recorded in the third quarter of 2013. This increase was due to growth in product shipments for XIAFLEX for DC as well as the launch of

 

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XIAFLEX for PD in January 2014.  XIAFLEX international revenues for the three months ended September 30, 2014 amounted to $4.0 million compared to $1.7 million recorded in the third quarter of 2013.  The increase in XIAFLEX international revenues resulted primarily from Asahi Kasei, a collaboration partner, successfully submitting a regulatory application to the Japanese Pharmaceutical and Medical Device Agency for XIAFLEX for DC during the third quarter of 2014.  Pursuant to our development, commercialization and supply agreement with Asahi Kasei, we received a $10.0 million regulatory milestone payment, of which we recognized $1.8 million during the quarter ended September 30, 2014 in accordance with our revenue recognition policy.  In addition, increased sales of XIAFLEX by another collaboration partner, Sobi, resulted in higher royalties for the three months ended September 30, 2014 as compared to the same period in 2013.

 

Testim

 

Total revenues for Testim for the three months ended September 30, 2014 were $26.9 million compared to $52.3 million for the comparable period of 2013. Testim revenues for the three months ended September 30, 2014 include $10.9 million of revenues earned pursuant to the AG Agreement with Prasco.  Under the AG Agreement, Prasco purchases, distributes and sells an authorized generic version of Testim (the “Generic Testosterone Product”) in the United States of America and its territories.  Prasco commenced initial commercialization activities for the Generic Testosterone Product on June 9, 2014 and commenced shipping the Generic Testosterone Product on June 10, 2014.  Under the terms of the Agreement, we recognize revenue from shipments to Prasco at the invoice supply price when title and risk of loss transfers, which is generally at the time of shipment. We are also entitled to receive a significant percentage of the net distributable profits on sales of the Generic Testosterone Product by Prasco, which we recognize as net revenues when Prasco reports to us the net distributable profits from the ultimate sale of the Generic Testosterone Product. We have recorded all net distributable profits reported by Prasco for the three months ended September 30, 2014.

 

The decrease of $35.4 million in branded Testim net U.S. revenues for the three months ended September 30, 2014 compared to the same period in 2013 is principally due to the following factors:

 

·                  a shrinking TRT gel market and lower Testim market share, as evidenced by a decline of 34.3% in total Testim prescriptions for the three months ended September 30, 2014 as compared to the same period in 2013 according to National Prescription Audit data from IMS, a pharmaceutical market research firm;

 

·                  continued destocking of Testim inventory in the wholesale and retail distribution channels;

 

·                  a continued decrease in our highest-margin non-contracted prescriptions, resulting in a higher gross-to-net discount applying to Testim sales as a whole;

 

·                  the launch of the Generic Testosterone Product in June 2014, which we believe resulted in decreased demand for branded Testim during the three months ended September 30, 2014; and

 

·                  the entry of other generic competition into the TRT market.

 

Given the changing TRT market dynamics and the entry of generic alternatives to the branded gel TRT product market, including the Generic Testosterone Product as well as potential additional future entry of generic alternatives, we are planning for what we believe is the maturity of the TRT gel market and we expect to continue managing Testim as a mature product going forward.

 

Other net U.S. revenues

 

Other U.S. net revenues for the three months ended September 30, 2014 include sales of the products we acquired in the April 2013 acquisition of Actient as well as our in-licensing of STENDRA in October 2013.  The Actient revenues included sales of TESTOPEL, Edex and other U.S. products of $20.2 million, $7.0 million and $7.6 million, respectively, for three months ended September 30, 2014 compared to $20.6 million, $8.0 million, and $9.6 million for the same period in 2013. The decrease in net revenues from the products we acquired from Actient in April 2013 was primarily due to a reduction in sales volumes, offset partially by price increases. These decreases in Actient revenues were offset by $9.3 million of net product sales of STENDRA, a new first-line oral therapy for

 

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ED licensed from VIVUS and launched during January 2014.  We believe the STENDRA revenues include a filling of the retail channels in excess of current demand as indicated by prescriptions fulfilled in the third quarter of 2014.

 

Revenue allowances

 

Revenue allowances as a percentage of gross U.S. revenues for the third quarter of 2014 compared to the third quarter of 2013 decreased due principally to a shift in product sales from the higher discounted Testim brand to the lower discounted XIAFLEX products as well as the Generic Testosterone Product sold by Prasco under the AG Agreement. The revenues recorded under the AG Agreement are reported by Prasco to Auxilium on a net basis; therefore, there are no gross-to-net adjustments recorded on Auxilium’s financial statements.  These decreases were partially offset by a decrease in our highest-margin non-contracted prescriptions of Testim when compared to the third quarter of 2013, resulting in a higher gross-to-net discount applying to branded Testim sales as a whole. In addition, the percentage in the third quarter of 2014 was impacted by coupons offered on sales of STENDRA in conjunction with the product launch and higher product return charges for Testim and various Actient products. We believe that our revenue allowances as a percentage of gross U.S. revenues will continue to stabilize in subsequent periods as products with lower levels of discounts become a more significant portion of our overall revenues.

 

Cost of goods sold.    Cost of goods sold were $25.7 million and $33.6 million for the three months ended September 30, 2014 and 2013, respectively. Cost of goods sold reflects the cost of product sold, royalty obligations due to our licensors (excluding contingent consideration royalties), and the amortization of the deferred costs associated with the collaboration agreements with Actelion, Asahi, Pfizer and Sobi. Cost of goods sold excludes the amortization of product rights associated with the Actient and STENDRA acquisitions.  The decrease in cost of goods sold quarter-over-quarter was primarily due to manufacturing initiatives undertaken during 2014 as well as $5.4 million of inventory cost recorded during the third quarter of 2013 related to the step-up of Actient product inventory acquired in 2013.  The step-up value was sold by the end of 2013; therefore, there was no step-up value recorded through cost of goods for the quarter ended September 30, 2014.  The gross margin rate on our net revenues was 77% for the three months ended September 30, 2014 compared to 69% for the same period in 2013. The increase in gross margin rate quarter-over-quarter was primarily due to a shift in product sales from products with a lower margin, including the Testim brand, to higher margin products, including XIAFLEX and STENDRA.

 

Research and development expenses.    We currently have two projects in clinical development, specifically XIAFLEX for the treatment of Frozen Shoulder syndrome and cellulite. A significant portion of the research and development expenses are for the internal personnel and infrastructure costs common to the support of these development efforts. Since we do not allocate these common costs to individual projects for external reporting purposes, we do not report research and development cost by project.

 

Research and development expenses were $11.2 million and $11.8 million for the three months ended September 30, 2014 and 2013, respectively. This decrease in expense resulted principally from lower spending on the XIAFLEX multi-cord phase 3 clinical trial for DC. This decrease was partially offset by increased spending on the XIAFLEX Phase 2 trials for cellulite and Frozen Shoulder syndrome, which commenced during the fourth quarter of 2013, as well as a charge of $1.6 million for employee severance and other benefit-related costs related to the restructuring announced in September 2014.

 

Selling, general and administrative expenses.    Selling, general and administrative expenses were $72.5 million and $62.8 million for the three months ended September 30, 2014 and 2013, respectively. This increase was primarily due to a charge of $6.8 million for employee severance and other benefit-related costs related to the restructuring announced in September 2014 as well the transaction costs associated with the QLT acquisition, which was terminated in October 2014.

 

Amortization of purchased intangibles.    Amortization of purchased intangibles was $19.7 million and $15.1 million for the three months ended September 30, 2014 and 2013, respectively.  The increase in amortization is due to the acquisition of Stendra product rights in October 2013.

 

Intangible asset impairment.   During the third quarter of 2014, a significant customer of the Timm Medical device business communicated to us that it would not be renewing its contract.  As a result, the Company determined that the carrying value of the Timm Medical intangible asset exceeded its fair value and the Company recorded an asset impairment charge of $16.5 million for the three and nine months ended September 30, 2014.

 

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Contingent consideration.    Contingent consideration was recorded on the balance sheet at the acquisition date fair value of the Actient and STENDRA acquisitions, based on the consideration expected to be transferred in the form of milestone and royalty obligations, discounted to present value of such payments. Contingent consideration in the Consolidated statement of operations represents the change in the fair value of this contingent consideration. Contingent consideration was a credit of $12.8 million during the three months ended September 30, 2014 compared to expense of $4.7 million for the three months ended September 30, 2013.  The change of $17.5 million period-over-period resulted primarily from the decrease in fair value of STENDRA royalties and net sales milestones as well as Actient royalties due to lower estimates of net revenues and the reversal of an Actient milestone due to the termination of an early-stage research and development project. This credit or expense may fluctuate significantly in future periods depending on changes in estimates, including probabilities associated with achieving forecasted product revenues on which royalties are payable, the periods in which we estimate sales levels and sales level milestones will be achieved and the discount rates used.

 

Interest expense.    Interest expense was $9.6 million and $8.9 million for the three months ended September 30, 2014 and 2013, respectively.  The increase period-over-period is principally due to interest expense on our Term Loan, from which we borrowed $225.0 million in April 2013, $50.0 million in September 2013 and $50.0 million in September 2014.

 

Other income, net.    Other income, net for the three months ended September 30, 2014 and 2013 relates primarily to interest earned on cash, cash equivalents and short-term investments.

 

Income tax expense.  The income tax benefit of $0.1 million for the three months ended September 30, 2014 represents an adjustment during the quarter for income taxes payable in certain state jurisdictions. There was no income tax benefit or expense for the three months ended September 30, 2013.

 

Nine Months Ended September 30, 2014 and 2013

 

Net revenues.  Net revenues for the nine months ended September 30, 2014 and 2013 comprise the following:

 

 

 

Nine months ended September 30,

 

 

 

 

 

2014

 

2013

 

Change

 

% Change

 

 

 

 

 

(in millions)

 

 

 

 

 

XIAFLEX revenues-

 

 

 

 

 

 

 

 

 

Net U.S. revenues

 

77.5

 

42.8

 

34.7

 

81

%

International revenues

 

10.4

 

14.3

 

(3.9

)

-27

%

 

 

87.9

 

57.1

 

30.8

 

54

%

Testim revenues-

 

 

 

 

 

 

 

 

 

Net U.S. product sales

 

$

38.1

 

$

149.2

 

$

(111.1

)

-74

%

Net U.S. revenues — authorized generic

 

24.2

 

 

24.2

 

n/a

 

International revenues

 

2.5

 

3.0

 

(0.5

)

-17

%

 

 

64.8

 

152.2

 

(87.4

)

-57

%

Other net U.S. revenues-

 

 

 

 

 

 

 

 

 

TESTOPEL

 

56.4

 

35.0

 

21.4

 

61

%

STENDRA

 

27.0

 

 

27.0

 

n/a

 

Edex

 

20.0

 

13.0

 

7.0

 

54

%

Other

 

25.1

 

17.5

 

7.6

 

43

%

 

 

128.5

 

65.5

 

63.0

 

96

%

Total net revenues

 

$

281.2

 

274.8

 

$

6.4

 

2

%

 

 

 

 

 

 

 

 

 

 

Revenue allowance as a percentage of gross U.S. revenues

 

32

%

31

%

1

%

 

 

 

Net U.S. revenues shown in the above table represent the product sales of the Company within the U.S. net of allowances provided on such sales. In addition, net distributable profits earned pursuant to the AG Agreement entered into with Prasco are also included in net U.S. revenues in the above table.  International revenues represent

 

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the amortization of deferred up-front and milestone payments the Company has received through its out-licensing agreements, together with royalties earned on product sales by the licensees.

 

XIAFLEX

 

Total revenues for XIAFLEX in the nine months ended September 30, 2014 were $87.9 million compared to $57.1 million in comparable period of 2013, an increase of 54%. Net revenues for the nine months ended September 30, 2014 include $77.5 million of net U.S. product sales of XIAFLEX compared to the $42.8 million recorded in the comparable period of 2013. This increase was due to growth in product shipments for XIAFLEX for DC as well the launch of XIAFLEX for PD in January 2014.  XIAFLEX international revenues for the nine months ended September 30, 2014 amounted to $10.4 million compared to $14.3 million recorded in the comparable period of 2013.  The decrease in XIAFLEX international revenues resulted from the amortization of deferred revenue during the nine months ended September 30, 2013 related to the Pfizer Agreement.  There was no revenue recognized for the nine months ended September 30, 2014 related to the Pfizer Agreement, as this agreement was terminated during the second quarter of 2013.  This decrease was partially offset by increased sales of XIAFLEX by our collaboration partner, Sobi, which resulted in higher royalties for the nine months ended September 30, 2014 as compared to the same period in 2013.

 

Testim

 

Total revenues for Testim for the nine months ended September 30, 2014 were $64.8 million compared to $152.2 million for the comparable period of 2013. Testim revenues for the nine months ended September 30, 2014 include $24.2 million of Generic Testosterone Product revenues earned pursuant to the AG Agreement with Prasco.

 

The decrease of $111.1 million in branded Testim net U.S. revenues for the nine months ended September 30, 2014 compared to the same period in 2013 is principally due to the following factors:

 

·                  a shrinking TRT gel market and lower Testim market share, as evidenced by a decline of 30.7% in total Testim prescriptions for the nine months ended September 30, 2014 as compared to the same period in 2013 according to National Prescription Audit data from IMS, a pharmaceutical market research firm;

 

·                  continued destocking of Testim inventory in the wholesale and retail distribution channels;

 

·                  a decrease in our highest-margin non-contracted prescriptions, resulting in a higher gross-to-net discount applying to Testim sales as a whole;

 

·                  the launch of the Generic Testosterone Product in June 2014, which we believe resulted in decreased demand for branded Testim during the nine months ended September 30, 2014; and

 

·                  the entry of other generic competition into the TRT market.

 

Given the changing TRT market dynamics and the entry of generic alternatives to the branded gel TRT product market, including the Generic Testosterone Product, as well as potential additional future entry of generic alternatives, we are planning for what we believe is the maturity of the TRT gel market and we expect to continue managing Testim as a mature product going forward.

 

Other net U.S. revenues

 

Other U.S. net revenues for the nine months ended September 30, 2014 include sales of the products we acquired in the April 2013 acquisition of Actient as well as our in-licensing of STENDRA in October 2013.  The Actient revenues included sales of TESTOPEL, Edex and other U.S. products of $56.4 million, $20.0 million and $25.1 million, respectively for nine months ended September 30, 2014 compared to $35.0 million, $13.0 million and $17.5 million for the comparable period of 2013.  The increase in net revenues from the products we acquired from Actient in April 2013 was the result of a full nine months of sales as well as price increases.  In addition to the increase resulting from the Actient products, we launched STENDRA, a new first-line oral therapy for ED licensed from VIVUS during January 2014, and recognized total sales of $27.0 million for the nine months ended September

 

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30, 2014. We believe these STENDRA revenues include a filling of the wholesale and retail channels in excess of demand as indicated by current prescriptions fulfilled during the nine months ended September 30, 2014.

 

Revenue allowances

 

Revenue allowances as a percentage of gross U.S. revenues for the nine months ended September 30, 2014 compared to the comparable period of 2013 increased due principally to a decrease in our highest-margin non-contracted prescriptions of Testim during the nine months ended September 30, 2014, resulting in a higher gross-to-net discount applying to Testim sales as a whole; and specifically for the first quarter of 2014, an accrual for a liability relating to the higher rebates and allowances on all Testim units estimated to be in the wholesale and retail channels at December 31, 2013.  In addition, the higher percentage in the nine months ended September 30, 2014 was impacted by coupons offered on sales of STENDRA in conjunction with the product launch and higher product return charges for Testim and various Actient products.  These increases were partially offset by a lower level of allowances on sales of Actient products which were acquired during the second quarter of 2013 as well as a shift in product sales from the higher discounted Testim brand to the lower discounted XIAFLEX products and the Generic Testosterone Product.

 

Cost of goods sold.    Cost of goods sold were $73.9 million and $75.9 million for the nine months ended September 30, 2014 and 2013, respectively. Cost of goods sold reflects the cost of product sold, royalty obligations due to our licensors (excluding contingent consideration royalties), and the amortization of the deferred costs associated with the collaboration agreements with Actelion, Asahi, Pfizer and Sobi. Cost of goods sold excludes the amortization of product rights associated with the Actient and STENDRA acquisitions. The decrease in cost of goods sold in the nine months ended September 30, 2014 over the same period in 2013 was principally due to manufacturing initiatives undertaken during 2014 as well as $9.9 million of inventory cost recorded during the third quarter of 2013 related to the step-up of Actient product inventory acquired in 2013.  The step-up value was sold by the end of 2013; therefore, there was no step-up value recorded through cost of goods for the nine months ended September 30, 2014.  These decreases were partially offset by a $6.2 million inventory charge recorded during the nine months ended September 30, 2014 related to excess Testim branded inventory.  The excess inventory charge resulted from our decision to launch the Generic Testosterone Product, which had the impact of decreasing the demand forecast for our branded Testim product. The gross margin rate on our net revenues was 74% for the nine months ended September 30, 2014 compared to 72% for the same period in 2013. The increase in gross margin rate period-over-period was primarily due to a shift in product sales from products with a lower margin, including the Testim brand, to higher margin products, including XIAFLEX and STENDRA.  This increase was partially offset by the excess inventory charge, higher product returns and the higher gross-to-net discount on branded Testim sales as discussed above.

 

Research and development expenses.    Research and development expenses were $33.5 million and $37.3 million for the nine months ended September 30, 2014 and 2013, respectively. This decrease in expense resulted principally from lower spending on the XIAFLEX multi-cord phase 3 clinical trial for DC and decreased spending on the Phase 3 trials for XIAFLEX for the treatment of Peyronie’s. These decreases were partially offset by increased spending on the XIAFLEX Phase 2 trials for cellulite and Frozen Shoulder syndrome, which commenced during the fourth quarter of 2013.

 

Selling, general and administrative expenses.    Selling, general and administrative expenses were $219.7 million and $182.0 million for the nine months ended September 30, 2014 and 2013, respectively. This increase was primarily due to the added expenses of the acquired Actient operations, an increase in marketing and advertising spend related to the launch of XIAFLEX for the treatment of PD and STENDRA and costs incurred in conjunction with our restructuring announced in September 2014.

 

Amortization of purchased intangibles.    Amortization of purchased intangibles was $59.4 million and $26.0 million for the nine months ended September 30, 2014 and 2013, respectively.  The increase in amortization is due to a full nine months of amortization of the finite-lived intangible assets acquired in the Actient transaction in April 2013 as well the amortization of the STENDRA intangible asset acquired in October 2013.

 

Intangible asset impairment.    During the third quarter of 2014, a significant customer of the Timm Medical device business communicated to us that it would not be renewing its contract.  As a result, the Company determined that the carrying value of the Timm Medical intangible asset exceeded its fair value and the Company recorded an asset impairment charge of $16.5 million for the three and nine months ended September 30, 2014.

 

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Contingent consideration.   Contingent consideration was a credit of $25.5 million during the nine months ended September 30, 2014 compared to expense of $6.9 million for the nine months ended September 30, 2013.  The change of $32.4 million period-over-period resulted primarily from the decrease in fair value of Actient product net sales milestones as well as Actient royalties due to lower estimates of TESTOPEL net revenues, offset partially by increases in STENDRA revenue forecasts.

 

Interest expense.    Interest expense was $28.6 million and $19.0 million for the nine months ended September 30, 2014 and 2013, respectively.  The increase period-over-period is principally due to interest expense on our Term Loan, which was entered into in April 2013.

 

Other income, net.    Other income, net for the nine months ended September 30, 2013 relates primarily to interest earned on cash, cash equivalents and short-term investments.

 

Income tax expense.  The income tax expense of $0.1 million for the nine months ended September 30, 2014 represents income taxes payable in certain state taxing jurisdictions. The tax benefit for 2013 represents the $77.9 million release of the valuation allowance for deferred tax assets, net of recognition of income taxes on current income in certain state jurisdictions and certain discrete items of tax.  As part of the required accounting for the Actient acquisition, we recorded deferred tax liabilities related to differences between the book basis and the tax basis of certain Actient amortizable assets.

 

Liquidity and Capital Resources

 

We had approximately $77.9 million and $71.2 million in cash, cash equivalents and short-term investments as of September 30, 2014 and December 31, 2013, respectively. We believe that our current financial resources, when combined with cash generated from or used in operations, will be adequate for the Company to fund our anticipated operations for at least the next 12 months. We may, however, elect to raise additional funds to enhance our sales and marketing efforts for additional products we may acquire, commercialize any product candidates that receive regulatory approval, acquire or in-license approved products, product candidates or companies or technologies for development and to maintain adequate cash reserves to minimize financial market fundraising risks. Insufficient funds may cause us to delay, reduce the scope of, or eliminate one or more of our development, commercialization or expansion activities. Our future capital needs and the adequacy of our financial resources will depend on many factors, including:

 

·                  the planned Endo Merger, and whether and when the Endo Merger will successfully close;

 

·                  the possibility that the anticipated benefits and reduction in costs from the September 2014 corporate restructuring cannot be fully realized or may take longer to realize than expected;

 

·                  the effect of cost reductions on revenue growth may be more impactful than anticipated;

 

·                  our ability to successfully market our products;

 

·                  continued demand for our products;

 

·                  our ability to manage the maturity and decline of the TRT market and any decline in revenues related to our TRT products;

 

·                  our ability to continue successfully launching STENDRA and XIAFLEX for the treatment of PD as well as for the treatment of multiple DC cords;

 

·                  the entry into the marketplace of competitive products, including additional generics or branded generics to Testim or a competing product;

 

·                  our ability to integrate the remaining operations of Actient and its subsidiaries into our operations successfully and efficiently;

 

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·                  our ability to materialize the remaining synergies and benefits, including revenue and profit growth, from the acquisition of Actient;

 

·                  the risks or costs associated with the Actient acquisition being greater than we anticipate;

 

·                  third-party payor coverage and reimbursement for our products;

 

·                  the cost of manufacturing, distributing, marketing and selling our products;

 

·                  the scope, rate of progress and cost of our product development activities;

 

·                  the costs of supplying and commercializing our products and product candidates;

 

·                  the effect of competing technological and market developments;

 

·                  the cost of defending various civil litigations relating to our TRT products, including costs associated with the matters described in Part II, Item 1 of this Report under “Legal Proceedings”, or the outcome of any such matters;

 

·                  the cost of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights, including costs associated with the matters described in Part II, Item 1 of this Report under “Legal Proceedings”, or the outcome of any such matters, or any other matter that may result from a challenge to our intellectual property rights; and

 

·                  the extent to which we acquire or invest in businesses and technologies.

 

If additional funds are required, we may raise such funds from time to time through public or private sales of equity or debt securities or from bank or other loans. Financing may not be available on acceptable terms, or at all, and our failure to raise capital when needed could materially adversely impact our growth plans and our financial condition or results of operations. Additional equity financing, if available, may be dilutive to the holders of our common stock and may involve significant cash payment obligations and covenants that restrict our ability to operate our business.

 

Sources and Uses of Cash

 

Cash used in operations was $34.9 million for the nine months ended September 30, 2014 compared to $0.3 million for the nine months ended September 30, 2013. Cash used in operations for the nine months ended September 30, 2014 resulted primarily from an increase in selling and marketing costs as a result of the launch of XIAFLEX for PD and STENDRA, higher inventory levels required to meet our expected growth in product sales and higher interest payments on our outstanding debt due to additional borrowings. Cash used in operations in 2013 resulted primarily from the pre-tax operating loss for the period, net of stock compensation and non-cash charges.

 

Cash provided by investing activities was $12.3 million for the nine months ended September 30, 2014 compared to cash used in investing activities of $503.3 million for the nine months ended September 30, 2013. The cash impact of investing activities for 2014 relates primarily to net redemptions of $19.8 million and our investments in property and equipment, which are primarily due to the implementation of a new accounting system as well as investments in other software projects.  Cash used in investing activities for 2013 principally represents $588.3 million of cash paid in the acquisition of Actient and $7.8 million of investments in property and equipment, offset by redemptions (net of purchases) of short-term marketable debt securities.

 

Cash provided by financing activities was $48.8 million and $559.0 million for the nine months ended September 30, 2014 and 2013, respectively. Cash provided by financing activities for the nine months ended September 30, 2014 reflects net proceeds of $48.2 million from the issuance of the additional borrowings under the Company’s Term Loan, and $21.3 million of cash received from the exercise of stock options, partially offset by principal payments on our term loan of $10.0 million and contingent consideration payments of $10.9 million related to the Actient and STENDRA acquisitions,.  Cash provided by financing activities in 2013 principally represents the net proceeds of $338.9 million and $262.9 million from the issuance of the 2018 Senior Convertible Notes and the Term Loan, respectively, partially offset by net payments of $28.5 related to our hedge transactions

 

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for the convertible notes.

 

Commitments and Contractual Obligations

During the nine months ended September 30, 2014, there were no material changes outside of the ordinary course of business to our commitments and contractual obligations, except for the debt issuance described in Note 7 to the consolidated financial statements included in this Form 10-Q.

 

Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet arrangements as defined in Item 303(a) (4) of Regulation S-K.

 

New Accounting Pronouncements

 

See Note 1(e) - New Accounting Pronouncements to the Company’s Consolidated Financial Statements.

 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk.

 

We are subject to market risks in the normal course of our business, including changes in interest rates and exchange rates. There have been no material changes in our exposure to market risks since December 31, 2013. Refer to “Item 7 A. Quantitative and Qualitative Disclosures About Market Risk” of our Annual Report on Form 10-K for the year ended December 31, 2013 for additional information.

 

Item 4.  Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures.

 

Our Chief Executive Officer and Chief Financial Officer have concluded, based on their respective evaluations as of the end of the period covered by this Report, that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Report are effective to provide reasonable assurance that the information required to be disclosed in the reports we file under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosures. A controls system cannot provide absolute assurances, however, that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

 

Changes in Internal Control over Financial Reporting.

 

There were no changes in our internal control over financial reporting that occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

PART II.  OTHER INFORMATION

 

Item 1.  Legal Proceedings.

 

Upsher-Smith NDA Litigation

 

On or about December 28, 2012, Auxilium and FCB I Holdings Inc. (“FCB”) became aware of a notice from Upsher-Smith Laboratories, Inc. (“Upsher-Smith”) that advised Auxilium and FCB of Upsher-Smith’s filing of the Upsher-Smith NDA. This Paragraph IV certification notice refers to the 10 U.S. patents, covering Testim, that are listed in the Orange Book. These 10 patents are owned by FCB and are exclusively licensed to Auxilium and will expire between 2023 and 2025. On January 28, 2013, Auxilium and FCB filed a lawsuit in the United States District Court for the District of Delaware against Upsher-Smith for infringement of FCB’s 10 patents listed in the Orange Book as covering Testim testosterone gel (“Delaware Upsher-Smith 505(b)(2) NDA Litigation”). On December 4, 2013, the Court granted Upsher-Smith’s motion for summary judgment, and the Court entered a final judgment of non-infringement in favor of Upsher-Smith on December 30, 2013. On January 24, 2014, Auxilium filed a Notice of Appeal to the United States Court of Appeals for the Federal Circuit in Washington, D.C. (the

 

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“Appeals Court”) appealing the final judgment of non-infringement entered by the United States District Court for the District of Delaware. On September 18, 2014, the Appeals Court granted Auxilium’s unopposed motion to dismiss the appeal. This litigation is now concluded.  Subsequent to the conclusion of this litigation, Upsher-Smith filed a motion with the District Court seeking reimbursement of its legal fees by Auxilium.

 

The Upsher-Smith NDA was granted final approval by the FDA on June 4, 2014 with a brand name Vogelxo. On June 2, 2014, the FDA finally approved Vogelxo, and, on or about July 2, 2014, Upsher-Smith launched Vogelxo and an authorized generic version of Vogelxo, known as testosterone gel.

 

ANDA Litigation with Actavis

 

On May 24, 2012, Auxilium and FCB filed a lawsuit against Actavis (then known as Watson Pharmaceuticals, Inc.) for infringement of FCB’s 10 patents listed in the Orange Book as covering Testim testosterone gel (the “Actavis Litigation”). The lawsuit was filed in the United States District Court for the District of New Jersey on May 23, 2012 in response to a notice letter, dated April 12, 2012, sent by Actavis Laboratories, Inc. (NV) regarding its filing with the FDA of an ANDA for a generic 1% testosterone gel product. This letter also stated that the ANDA contained Paragraph IV certifications with respect to the nine patents listed in the Orange Book on that date as covering Testim. Auxilium’s lawsuit filed against Actavis involves those nine patents, as well as a 10th patent covering Testim that was issued on May 15, 2012 and is listed in the Orange Book. The trial commenced in September 2014 and the parties are currently preparing and filing post-trial briefing and are preparing for closing arguments, which are currently scheduled for November 18, 2014.

 

TRT Products Civil Litigation

 

As of October 27, 2014, Auxilium was involved in 66 individual civil actions related to its TRT products, Testim and TESTOPEL, wherein the plaintiffs allege, among other things, bodily injury and, in some cases, wrongful death, based on theories of strict liability, fraud and inadequacy of the product warning labels. The first complaint was served on Auxilium on February 27, 2014, shortly after the FDA announced that it had commenced a safety investigation into TRT products. These lawsuits have been filed in certain federal and state courts. In several of the complaints filed against Auxilium, Auxilium is named as a co-defendant with certain of its competitors who also sell TRT products such as AbbVie Inc., Eli Lilly and Company, Endo, Actavis, Inc. and Pfizer, Inc., and in one lawsuit, McKesson Corporation (“McKesson”), a distributor of pharmaceutical products, including TRT, has been named as a co-defendant.

 

DPT Laboratories, Inc. (“DPT”), a contract manufacturer of Testim, has also been named as a co-defendant in one current lawsuit.  Pursuant to the terms of the Company’s manufacturing agreement with DPT, the Company has acknowledged a duty to indemnify and defend DPT in this matter.  In several of the complaints filed against the Company, the Company is named as a co-defendant with its previous co-promotion partner, GlaxoSmithKline LLC (“GSK”).  Pursuant to the terms of the co-promotion agreement, the Company has acknowledged a duty to indemnify and defend GSK in these matters.

 

Auxilium has timely notified the carriers of those of its insurance policies with coverage it believes is applicable to the liability of the litigation related to its TRT products. Auxilium’s primary insurer has acknowledged that it has a duty to defend and indemnify Auxilium with respect to the allegations made in plaintiffs’ complaints as originally filed with the relevant courts; it has, however, reserved its rights to deny coverage on the basis of certain allegations in the relevant complaints related to dishonest, fraudulent, malicious or intentionally wrongful acts.

 

Additionally, similar lawsuits have been filed against other manufacturers of TRT products. In some of these lawsuits, certain parties have moved to request consolidation of various of the existing lawsuits into a multi-district litigation or MDL. On June 6, 2014, a Transfer Order was issued by the United States Judicial Panel on Multidistrict Litigation which created an industry-wide MDL in the Northern District of Illinois with Judge Kennelly presiding and captioned as In re: Testosterone Replacement Therapy Products Liability Litigation (“TRT MDL”). The Transfer Order further ordered that certain lawsuits be transferred to the TRT MDL, upon consent of the transferring court, for coordination or consolidation of pre-trial proceedings.

 

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Based upon the number of similar complaints served on other manufacturers of TRT products, Auxilium believes it is reasonable to expect that Auxilium will be named as a defendant and/or co-defendant in additional complaints.

 

None of the complaints allege specific damage amounts.  The Company is investigating the underlying causes of actions upon which the complaints are based.  The Company filed a Motion to Dismiss in the first-filed case, in the U.S. District Court for the Central District of California.  Subsequently, the plaintiff in that case voluntarily withdrew his lawsuit.  The Company filed a similar motion in other matters.

 

ErecAid Civil Litigation

 

On August 7, 2014, a lawsuit was filed against Auxilium alleging that the Osbon ErecAid Manual Vacuum Therapy System has caused injury to the plaintiffs based on theories of strict liability, design defect, failure to warn and loss of consortium.  Auxilium was served on October 20, 2014.  Auxilium is investigating the underlying cause of action upon which the complaint is based and intends to vigorously defend against this civil action.

 

Slate and Actient Indemnification Matters

 

Prior to Auxilium’s acquisition of our wholly-owned subsidiary Actient in April of 2013, Actient entered into a merger agreement (the “Slate Merger Agreement”), dated December 19, 2011, by and among Slate Pharmaceuticals, Inc. (“Slate”), Slate Pharmaceuticals Acquisition Corp., a wholly-owned subsidiary of Actient, and Douglas E. Eckert, solely in his capacity as the representative of the former Slate stockholders and warrant holders (the “Slate Representative”). The Slate Merger Agreement provided for, among other things, indemnification of Actient in the event that Slate breached certain of its representations and warranties in the Slate Merger Agreement. The Slate Merger Agreement also provided for, among other things, certain earn-out payments to be made to the former Slate stockholders on a quarterly basis based upon the revenue generated by sales of TESTOPEL (the “Slate Earn-Out Payments”). Pursuant to the terms of the Slate Merger Agreement, the Slate Earn-Out Payments are subject to offset in order to satisfy amounts that may be due Actient under the relevant indemnification provisions of the Slate Merger Agreement. The Slate Earn-Out Payment due for the quarter ended March 31, 2014 was approximately $3.8 million (the “2014 Q1 Slate Earn-Out”), the Slate Earn-Out Payment due for the quarter ended June 30, 2014 was approximately $0.5 million (the “2014 Q2 Slate Earn-Out”) and the Slate Earn-Out Payment due for the quarter ended September 30, 2014 was approximately $2.4 million (the “2014 Q3 Slate Earn-Out”, and, collectively with the 2014 Q1 Slate Earn-Out and the 2014 Q2 Slate Earn-Out, the “2014 Slate Earn-Outs”).

 

On or about April 16, 2014, a complaint was filed against Auxilium alleging, among other things, that the development, design, testing, labeling, packaging, promoting, advertising, marketing, distribution and selling of certain prescription medications, including TESTOPEL, directly and proximately resulted in damages suffered by the plaintiffs (the “Amerson Action”). Auxilium believes that certain costs, including amounts in respect of defense, settlement, or court awarded damages, related to the matters alleged in the Amerson Action, as well as any complaints filed against Auxilium, or any of its affiliates or business partners that may have recourse against Auxilium for costs related to such complaints, properly would entitle Auxilium, as the ultimate parent of Actient, to indemnification pursuant to relevant provisions of the Slate Merger Agreement. Consequently, Actient withheld the 2014 Q1 Slate Earn-Out from the former Slate stockholders and paid such amounts into a third party escrow account to be held until the matters set forth in the Amerson Action, and any complaints making similar allegations that may be filed against Auxilium, any of its affiliates or business partners that may have recourse against Auxilium for costs related to such complaints, are resolved. Since the time of the Amerson Action, Auxilium has been named in six additional complaints related to TESTOPEL alleging causes of actions similar to those set forth in the Amerson Action.

 

On July 24, 2014, the Slate Representative filed a lawsuit in the Delaware Chancery Court, in the State of Delaware docketed as CA9940 against Auxilium alleging that the withholding and payment into escrow of the 2014 Q1 Earn-Out was a breach of the Slate Merger Agreement and seeking immediate payment of these funds to the Slate stockholders, declaratory judgment that Auxilium is not permitted to withhold future payments, and unspecified other damages.

 

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Pursuant to that certain Agreement and Plan of Merger (the “Actient Merger Agreement”), dated as of April 26, 2013, by and among Actient Holdings LLC (“Actient”), Auxilium, Opal Acquisition, LLC, GTCR Fund IX/B, L.P., and GTCR Fund IX/A, L.P., solely in its capacity as representative (the “Actient Representative”), the former stockholders of Actient agreed to indemnify Auxilium for the breach of any representations and warranties in the Actient Merger Agreement.  The indemnification obligations were secured by, among other things, $25 million (the “Actient Escrow Funds”) held in escrow and due to be potentially released on September 30, 2014 as well as by potential future milestone payments.

 

On May 20, 2014, as supplemented by a letter dated August 29, 2014, Auxilium made an indemnification claim against the Actient Representative in connection with the TESTOPEL product liability litigation described above.  On September 29, 2014, Auxilium sent a Demand Certification to the escrow agent requesting that the Actient Escrow Funds be released to Auxilium.  On October 7, 2014, the Actient Representative notified the escrow agent that it objected to the release of the Actient Escrow Funds and that such escrow funds should remain in escrow until the dispute is resolved.  Auxilium anticipates that the Actient Representative will file a Complaint against Auxilium related to this matter.

 

QLT Merger-Related Litigation

 

On June 25, 2014, the Company entered into the QLT Merger Agreement among the Company, QLT, QLT HoldCo, and QLT AcquireCo. The QLT Merger Agreement provided for a business combination whereby QLT AcquireCo would be merged with and into the Company.

 

On July 21, 2014, James Novak, an alleged shareholder of Auxilium, filed suit in the Court of Common Pleas, Chester County, Pennsylvania, against Auxilium’s Board of Directors, seeking to enjoin the proposed merger between Auxilium and QLT on the grounds that the Board of Directors of Auxilium breached their fiduciary duties by approving a proposed transaction with QLT that purportedly does not reflect the true value of Auxilium. The complaint also names as defendants Auxilium, QLT, QLT Holdco and QLT AcquireCo for allegedly aiding and abetting the Auxilium Board of Directors’ purported breach of fiduciary duty. On July 25, 2014, Raymon Hall, an alleged shareholder of Auxilium, filed suit in the Court of Common Pleas, seeking to enjoin the proposed merger with QLT on the grounds that the Board of Directors of Auxilium breached their fiduciary duties by approving a proposed transaction that purportedly does not reflect the true value of Auxilium. Plaintiff has also brought suit against QLT, QLT Holdco and QLT AcquireCo for allegedly aiding and abetting the Auxilium directors’ purported breach of fiduciary duty. On July 28, 2014, James Wernicke, an alleged shareholder of Auxilium, filed suit in the Court of Common Pleas against the Auxilium Board of Directors, seeking to enjoin the proposed merger between Auxilium and QLT on the grounds that the Auxilium Board of Directors breached their fiduciary duties by approving a proposed transaction with QLT that purportedly does not reflect the true value of Auxilium. The complaint also names as defendants Auxilium and QLT for allegedly aiding and abetting the Auxilium Board of Directors’ purported breach of fiduciary duty. On August 21, 2014, Plaintiff Hall filed an amended complaint. On August 25, 2014, Plaintiff Novak filed an amended complaint. In addition to the claims described above, both amended complaints include certain purported disclosure claims related to the disclosures made in the preliminary proxy statement/prospectus included in the registration statement on Form S-4 filed with the SEC on August 4, 2014. Auxilium and QLT intend to vigorously defend against these lawsuits.

 

Concurrently with the execution of the Endo Merger Agreement on October 8, 2014, the Company delivered to QLT written notice terminating the QLT Merger Agreement. In conjunction with the termination of the QLT Merger Agreement, Endo paid to QLT, on behalf of the Company, the termination fee of $28.4 million required pursuant to the terms of the QLT Merger Agreement, which amount is subject to reimbursement by the Company to Endo if the Endo Merger Agreement is terminated under certain conditions. Accordingly, the QLT Merger Agreement was terminated effective October 8, 2014.

 

With the termination of the QLT Merger Agreement, the status of these litigations is currently unclear, but Auxilium believes they are without merit and, if necessary, Auxilium intends to vigorously defend against these lawsuits.

 

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General

 

Auxilium intends to vigorously defend against these civil actions. These pending matters have not yet progressed sufficiently through discovery and/or development of important factual information and legal issues to enable Auxilium to determine a loss, if any, is probable. Auxilium is unable to estimate the possible loss or range of loss for the legal proceedings described above. Litigation is unpredictable and, while it is not possible to accurately predict or determine the eventual outcomes of these items, an adverse determination in one or more of these items currently pending could have a material adverse effect on Auxilium’s consolidated results of operations, financial position or cash flows. Auxilium has incurred and expects to continue to incur significant legal fees in the defense of these actions, which legal fees Auxilium currently expenses as incurred.

 

Other Matters

 

Auxilium is also party to various other actions and claims arising in the normal course of business that it does not believe are material. Auxilium believes that amounts accrued for awards or assessments in connection with all such matters are adequate and that the ultimate resolution of these matters will not have a material adverse effect on Auxilium’s financial position or the manner in which Auxilium conducts its business. However, there exists a reasonable possibility of loss in excess of the amounts accrued, the amount of which cannot currently be estimated. While Auxilium does not believe that the amount of such excess loss could be material to its financial position, any such loss could have a material adverse effect on Auxilium’s results of operations or the manner in which Auxilium conducts its business in the period(s) during which the underlying matters are resolved.

 

Item 1A.  Risk Factors.

 

In addition to the other information contained in this Report, you should carefully consider the factors discussed in Part I, Item 1A “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2013, as updated by Part II, Item 1 A “Risk Factors” in our Quarterly Report on Form 10-Q for the quarters ended March 31 and June 30, 2014, in evaluating our business, financial position, future results and prospects. The information presented below updates and supplements those risk factors for the matters identified below and should be read in conjunction with the risks and other information contained in our Form 10-K and this Report.  The risks described in our Form 10-K, as updated as described above and as set forth below, are not the only risks we face. Additional risks that we do not presently know or that we currently believe are immaterial could also materially and adversely affect any of our business, financial position, future results or prospects.

 

Risks Relating to the Endo Merger

 

The Endo Merger Agreement may be terminated in accordance with its terms and the merger may not be completed.

 

The Endo Merger Agreement contains a number of conditions to the parties’ obligations that must be satisfied or waived to complete the Endo Merger. Those conditions include, among others: adoption of the Endo Merger Agreement and approval of the transactions contemplated thereby by the Company stockholders, the expiration or termination of the waiting period under the HSR Act, absence of any law or order preventing or prohibiting consummation of the Endo Merger and no governmental authority instituting any proceeding seeking to enjoin or otherwise prohibit the consummation of the Endo Merger, effectiveness of the registration statement of which this proxy statement/prospectus is a part, approval of the Endo ordinary shares to be issued in the Endo Merger for listing on NASDAQ, the continued accuracy of the representations and warranties of both parties, subject to specified materiality standards, and the performance in all material respects by both parties of their obligations, covenants and agreements. These conditions to the closing of the Endo Merger may not be satisfied and, accordingly, the Endo Merger may not be completed. In addition, if the Endo Merger is not completed by April 10, 2015 (subject to extension to July 8, 2015, if the condition relating to expiration or termination of the waiting period under the HSR Act has not been satisfied or waived by the time specified in the Endo Merger Agreement), either Endo or the Company may choose not to proceed with the Endo Merger and terminate the Endo Merger Agreement. No assurance can be given that all of the conditions to the closing of the Endo Merger will be satisfied or, if they are, as to the timing of such satisfaction. In addition, Endo or the Company may elect to terminate the Endo Merger Agreement in certain other circumstances, and the parties can mutually decide to terminate the Endo Merger

 

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Agreement at any time prior to the completion of the Endo Merger, before or after the adoption of the Endo Merger Agreement by affirmative vote of holders of a majority of the shares of the Company’s common stock outstanding and entitled to vote thereon, which we refer to as the Company stockholder approval.

 

Certain changes in the U.S. federal tax laws on or before the Date of the Closing of the Endo Merger could jeopardize the consummation of the Endo Merger.

 

Endo is permitted to terminate the Endo Merger Agreement if, prior to the closing date, there is (i) a change in U.S. federal tax law (whether or not such change in law is yet effective) or any official interpretations thereof as set forth in published guidance by the U.S. Treasury Department or the IRS (other than IRS News Releases) (whether or not such change in official interpretation is yet effective) or (ii) a bill that would implement such a change that has been passed by the United States House of Representatives and the United States Senate and for which the time period for the President of the United States to sign or veto such bill has not yet elapsed, in any such case, that, as a result of consummating the transactions contemplated by the Endo Merger Agreement, in the opinion of nationally recognized U.S. tax counsel, would have a material adverse effect (as defined in the Endo Merger Agreement) on Endo. The Company is also permitted to terminate the Endo Merger Agreement if Endo fails to confirm in writing within the time periods specified in the Endo Merger Agreement that Endo has no right to terminate the Endo Merger Agreement as a result of such change in tax law or passing of a bill. Upon termination by either Endo or the Company under these circumstances, Endo is required to pay a termination fee of $150 million to the Company.

 

Obtaining required approvals necessary to satisfy the conditions to the completion of the Endo Merger may delay or prevent completion of the Endo Merger, result in additional expenditures of money and resources and/or reduce the anticipated benefits of the Endo Merger.

 

The Endo Merger is subject to closing conditions, which include the expiration or termination of the applicable waiting period under the HSR Act. Under the HSR Act, and the rules and regulations promulgated thereunder by the Federal Trade Commission, which we refer to as the FTC, the Endo Merger cannot be completed until notifications have been submitted and certain information has been furnished to the FTC and the Antitrust Division of the Department of Justice, which we refer to as the Antitrust Division, and specified waiting period requirements have been satisfied. Endo and the Company can provide no assurance that the waiting period under the HSR Act will expire or be terminated. Moreover, as a condition to granting termination of the waiting period under the HSR Act or avoiding a lawsuit challenging the Endo Merger, governmental authorities may impose requirements, limitations or costs or require divestitures or place restrictions on the conduct of Endo’s business after the Endo Merger. Under the terms of the Endo Merger Agreement, subject to certain exceptions, Endo and the Company and their respective subsidiaries are required to take certain steps and make certain undertakings imposed by governmental authorities that would apply to, or affect, their respective businesses, assets or properties. There can be no assurance that governmental authorities will not impose conditions, terms, obligations or restrictions and that such conditions, terms, obligations or restrictions will not have the effect of delaying completion of the Endo Merger, adversely impacting the ability to integrate the Company’s operations with Endo’s operations, imposing additional material costs on or materially limiting the revenues of the combined company following the Endo Merger, or otherwise adversely affecting the combined company’s businesses and results of operations after completion of the Endo Merger. This could result in a failure to complete the Endo Merger or could have a material adverse effect on the business and results of operations of the combined company.

 

Failure to complete the Endo Merger could negatively impact the stock price and the future business and financial results of the Company.

 

If the Endo Merger is not completed, the ongoing businesses of the Company may be materially and adversely affected and, without realizing any of the benefits of having completed the Endo Merger, the Company would be subject to a number of risks, including the following:

 

·            the Company will be required to pay certain costs relating to the Endo Merger, including legal, accounting, filing and other fees and mailing, financial printing and other expenses, whether or not the Endo Merger is completed;

 

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·            the current price of the Company’s common stock may reflect a market assumption that the Endo Merger will occur, meaning that a failure to complete the Endo Merger could result in a material decline in the price of the Company’s common stock;

 

·            the Company may experience negative reactions from its customers, regulators and employees;

 

·            The Endo Merger Agreement places certain restrictions on the conduct of the Company’s business prior to completion of the Endo Merger. Such restrictions, the waiver of which is subject to the consent of Endo, may prevent the Company from making certain acquisitions or taking certain other specified actions during the pendency of the Endo Merger;

 

·            Matters relating to the Endo Merger (including integration planning) have required and will continue to require substantial commitments of time and resources by the Company management, which could otherwise have been devoted to day-to-day operations and other opportunities that may have been beneficial to the Company as an independent company; and

 

·            the Company could be subject to litigation related to any failure to complete the Endo Merger or related to any enforcement proceeding commenced against the Company to perform its obligations under the Endo Merger Agreement.

 

In addition to the above risks, the Company may be required to pay to Endo a termination fee, which may materially adversely affect the Company’s financial results. If the Endo Merger is not completed, these risks may materialize and may materially and adversely affect the Company’s business, financial results and share price.

 

The Endo Merger Agreement contains provisions that restrict the Company’s ability to pursue alternatives to the Endo Merger and, in specified circumstances, could require the Company to pay Endo a termination fee of $70 million.

 

Under the Endo Merger Agreement, the Company is restricted, subject to certain exceptions, from initiating, soliciting, knowingly facilitating or knowingly encouraging any inquiry, proposal or offer with respect to a Company acquisition proposal or from participating or engaging in any discussion or negotiation, or providing information with respect to any Company acquisition proposal. The Company may terminate the Endo Merger Agreement in order to enter into an agreement with respect to a Company acquisition proposal that is a superior proposal, subject to the terms of the Endo Merger Agreement. If the Board (after consultation with the Company’s outside legal and financial advisors) determines in good faith that such Company acquisition proposal is a superior proposal and the Board effects a change of recommendation, Endo would be entitled to terminate the Endo Merger Agreement. Under such circumstances, the Company would be required to pay Endo a termination fee equal to $70 million and to reimburse Endo for the QLT termination fee paid by Endo on the Company’s behalf under the QLT Merger Agreement. These provisions could discourage a third party that may have an interest in acquiring all or a significant part of the Company from considering or proposing that acquisition, even if such third party were prepared to enter into a transaction that would be more favorable to the Company and its stockholders than the Endo Merger.

 

While the Endo Merger is pending, the Company will be subject to business uncertainties that could adversely affect its businesses.

 

Uncertainty about the effect of the Endo Merger on employees, customers and suppliers may have an adverse effect on the Company. These uncertainties may impair the Company’s ability to attract, retain and motivate key personnel until the Endo Merger is completed and for a period of time thereafter, and could cause customers, suppliers and others who deal with the Company to seek to change existing business relationships with the Company. Employee retention may be challenging during the pendency of the Endo Merger, as certain employees may experience uncertainty about their future roles. If key employees depart because of issues related to the uncertainty and difficulty of integration or a desire not to remain with the businesses, the business of the combined company following the Endo Merger could be seriously harmed. In addition, the Endo Merger Agreement restricts the Company from taking specified actions until the Endo Merger occurs, without the consent of the other party.

 

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These restrictions may prevent the Company from pursuing attractive business opportunities that may arise prior to the completion of the Endo Merger.

 

Certain plaintiffs’ law firms have announced that they are investigating the Endo Merger and could commence litigation against Auxilium or Endo and an adverse ruling in any such potential lawsuit could prevent the Merger from being completed.

 

Since the Merger was announced on October 9, 2014, certain plaintiffs’ law firms have announced that they are investigating the Endo Merger to determine whether, among other things, in their respective opinions, the Auxilium stockholders are receiving fair value and the Auxilium board of directors breached its fiduciary duties by approving a proposed transaction that might not reflect the true value of Auxilium.  One or more of these law firms, or other law firms, may initiate litigation against Auxilium, Auxilium’s directors, Endo, or Endo’s directors and may seek to enjoin the proposed Endo Merger on the grounds that the board of directors of Auxilium breached its fiduciary duties by approving a proposed transaction that purportedly does not reflect the true value of Auxilium or on any other grounds. One of the conditions to the closing of the Merger is that no order (whether temporary, preliminary or permanent) shall be in effect that prevents or prohibits completion of the Merger. As such, if any such potential litigation is commenced and the plaintiffs involved therein are successful in obtaining an injunction prohibiting us from completing the Merger, then such injunction may prevent the Merger from becoming effective, or from becoming effective within the expected time frame.

 

Risks Related to Auxilium’s September 2014 Corporate Restructuring

 

Auxilium may fail to realize some or all of the anticipated benefits and synergies of its September 2014 corporate restructuring and the September 2014 corporate restructuring may lead to disruption in Auxilium’s business, which may adversely affect any of its revenues, expenses, operating results or the value of Auxilium’s common stock.

 

As a result of the September 2014 corporate restructuring, Auxilium expects to reduce its annual operating expenses by at least $75 million, with reductions expected to be fully realized in mid-2015. It is possible that the anticipated benefits and cost savings of the September 2014 corporate restructuring may not be realized fully, or at all, or may take longer to realize than expected, and the value of Auxilium’s common stock may be adversely affected. Proper planning and effective and timely implementation is critical to avoid any significant disruption to Auxilium’s operations and to achieve the desired results. Consolidating sales forces pursuant to the September 2014 corporate restructuring could lead to disruptions in Auxilium’s ability to reach physicians or maintain or increase sales of our promoted products, which could lead to lower revenues.  Delays encountered in finalizing the September 2014 corporate restructuring and disruptions in our business resulting from the September 2014 corporate restructuring could have a material adverse effect on Auxilium’s revenues, expenses, operating results and financial condition, including the value of its common stock.

 

Risks Related to Commercialization

 

Auxilium recently lost Auxilium’s litigation with Upsher-Smith regarding the alleged infringement of Upsher-Smith’s proposed generic testosterone gel product, and the launch of a generic version of Testim could have a material adverse effect on Auxilium’s business.

 

On or about December 28, 2012, Auxilium and FCB became aware of a notice from Upsher-Smith that advised Auxilium and FCB of Upsher-Smith’s filing of a 505(b)(2) NDA containing a Paragraph IV certification under 21 U.S.C. Section 314.52(c) for testosterone gel (the “Upsher-Smith NDA”). This Paragraph IV certification notice refers to the 10 U.S. patents, covering Testim, that are listed in the Orange Book. These 10 patents are owned by FCB and are exclusively licensed to Auxilium and will expire between 2023 and 2025. On January 28, 2013, Auxilium and FCB filed a lawsuit in the United States District Court for the District of Delaware against Upsher-Smith for infringement of FCB’s 10 patents listed in the Orange Book as covering Testim testosterone gel (“Delaware Upsher-Smith 505(b)(2) NDA Litigation”). A hearing on Upsher-Smith’s previously filed motion for summary judgment was held on June 28, 2013, and by request of the Court, the parties submitted additional briefing in the weeks following the hearing. On December 4, 2013, the Court granted Upsher-Smith’s motion for summary judgment, and the Court entered a final judgment of non-infringement in favor of Upsher-Smith on December 30,

 

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2013. On January 24, 2014, Auxilium filed a Notice of Appeal to the United States Court of Appeals for the Federal Circuit in Washington, D.C. (the “Appeals Court”) appealing the final judgment of non-infringement entered by the United States District Court for the District of Delaware. On September 18, 2014, the Appeals Court granted Auxilium’s unopposed motion to dismiss the appeal. This litigation is concluded.  Subsequent to the conclusion of this litigation, Upsher-Smith filed a motion with the District Court seeking reimbursement of its legal fees by the Company.

 

The Upsher-Smith NDA was granted final approval by the U.S. Food and Drug Administration (the “FDA”) on June 4, 2014 with a brand name VogelxoTM. Upsher-Smith launched Vogelxo and an authorized generic version of Vogelxo, known as testosterone gel, on or about July 2, 2014.

 

On March 26, 2013, Auxilium submitted a Citizen’s Petition to the FDA with respect to the Upsher-Smith NDA referencing Testim in particular, and generic testosterone gels in general. Auxilium requested that, in the event of FDA approval of the Upsher-Smith NDA, the FDA: (i) refrain from designating Upsher-Smith’s testosterone gel as therapeutically equivalent to Testim and (ii) require that the label for the Upsher-Smith testosterone gel state that the product is not interchangeable with other testosterone transdermal gels. Since the approval by the FDA was pursuant to a 505(b)(2) NDA and not pursuant to an ANDA, it remains unclear at this time whether Vogelxo or its authorized generic will receive a therapeutically equivalent rating to Testim or a different rating.

 

It is unclear whether the Upsher-Smith product, Vogelxo, or its recently launched authorized generic, will receive a therapeutically equivalent rating to, and thus be freely substitutable for, Testim, or if it will receive a different rating to, and perhaps not be freely substitutable for, Testim. These Upsher-Smith products, whatever the rating, could have a materially adverse impact on Auxilium’s Testim revenues, but Auxilium believes that a product with a therapeutically equivalent rating could likely have a more severe materially adverse impact on Auxilium’s Testim revenues. The introduction of a generic or different version of Testim at any time, such as the Upsher-Smith product, whatever the rating, could significantly and potentially permanently reduce the revenue Auxilium derives from Testim or its authorized generic. Auxilium’s strategies to mitigate the effects of such a generic or different version of Testim may not be effective. A significant reduction in Auxilium’s TRT gel revenue could have a material adverse effect on Auxilium’s business, results of operations and financial condition, including without limitation, Auxilium’s liquidity and net working capital and could materially and adversely affect Auxilium’s ability to execute on Auxilium’s short and long-term business plans.

 

If testosterone replacement therapies are perceived, or are found, to create health risks, Auxilium’s sales of Testim, Testim AG, TESTOPEL and Striant may decrease and Auxilium’s operations may be harmed.

 

Publications have, from time to time, suggested potential health risks associated with TRT. Potential health risks are described in various articles, including a 2014 study published in PLOS One, a 2013 study published in the Journal of the American Medical Association, a 2009 study published in the New England Journal of Medicine, a 2002 article published in Endocrine Practice and a 1999 article published in the International Journal of Andrology. The potential health risks detailed include increased risk of heart disease, heart attack or stroke in men with a history of heart disease, fluid retention, sleep apnea, breast tenderness or enlargement, increased red blood cells, development of clinical prostate disease, including prostate cancer, increased cardiovascular disease risk and the suppression of sperm production. In March 2014, the FDA notified Auxilium that it had conducted a review of all post-marketing adverse event reports of venous thromboembolic events associated with testosterone use. The FDA considered this to be “new safety information” and noted that it believes that this new safety information should be included consistently in the labeling for testosterone products including, but not limited to, Testim, TESTOPEL and Striant. In April 2009, the FDA informed Auxilium that it had become aware, through spontaneous post-marketing adverse event reports and peer-reviewed biomedical literature, of cases of secondary exposure of children and female partners to testosterone due to drug transfer (known as transference) from adult males using testosterone gel drug products. The FDA considered this information to be “new safety information” and requested changes to the prescribing information for Testim, including a “boxed warning”, which is used to highlight warning information that is especially important to the prescriber. The FDA also required a Risk Evaluation and Mitigation Strategy (“REMS”) that includes assessments and a Medication Guide to inform patients. It is possible that studies on the effects of TRT could demonstrate these or other health risks. The FDA announced in January 2014 that it is investigating the risk of stroke, heart attack, and death in men taking FDA-approved TRT products. The FDA has conducted an Advisory Committee meeting on September 17, 2014 at which the appropriate indicated population for

 

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TRT and the potential for adverse cardiovascular outcomes associated with TRT were discussed and, as a result of which, the Advisory Committee recommended narrowing the indicated population for TRT and proposed similarly narrowing labels for applicable TRT products. Health Canada is currently working with manufacturers to update the Canadian product label for TRT products regarding possible cardiovascular risks including heart attack, stroke, blood clots in the lungs or legs, and irregular heart rate, has communicated to Canadians on the possible cardiovascular risk associated with TRT products, and is collaborating with foreign regulators including the FDA and the European Medicines Agency (“EMA”) regarding this safety concern.  These regulatory reviews, as well as negative publicity about the risks of hormone replacement therapy, including TRT, and any potential narrowing of the indicated population on the labels of Auxilium’s TRT products could adversely affect patient or prescriber attitudes and impact the TRT product sales. These factors could adversely affect Auxilium’s business.

 

Risks Related to Auxilium’s Financial Results, Auxilium’s Need for Additional Financing and Auxilium’s Stock Price

 

Provisions in Auxilium’s certificate of incorporation and bylaws, under Delaware law and Auxilium’s Stockholder Rights Plan may prevent or frustrate a change in control in management that stockholders believe is desirable.

 

Provisions of Auxilium’s certificate of incorporation and bylaws may discourage, delay or prevent a merger, acquisition or other change in control that stockholders may consider favorable, including transactions in which Auxilium stockholders might otherwise receive a premium for their shares. These provisions may also prevent or frustrate attempts by Auxilium’s stockholders to replace or remove Auxilium’s management. These provisions include:

 

·                  limitations on the removal of directors;

 

·                  advance notice requirements for stockholder proposals and nominations;

 

·                  the inability of stockholders to act by written consent or to call special meetings; and

 

·                  the ability of Auxilium’s Board of Directors to designate the terms of, and issue, new series of preferred stock without stockholder approval, which could be used to institute a rights plan that would work to dilute the stock ownership of a potential hostile acquirer, effectively preventing acquisitions that have not been approved by Auxilium’s Board of Directors.

 

The affirmative vote of the holders of at least two-thirds of Auxilium’s shares of capital stock entitled to vote is necessary to amend or repeal the above provisions of Auxilium’s certificate of incorporation. In addition, absent approval of Auxilium’s Board of Directors, Auxilium’s bylaws may only be amended or repealed by the affirmative vote of the holders of at least two-thirds of Auxilium’s shares of capital stock entitled to vote.

 

In addition, Auxilium’s Stockholder Rights Plan may discourage, delay or prevent a merger, acquisition or other change in control that stockholders may consider favorable, including transactions in which Auxilium stockholders might otherwise receive a premium for their shares. The overall effect of the Stockholder Rights Plan and the issuance of the rights may be to render more difficult or discourage a merger, tender or exchange offer or other business combination involving Auxilium that is not approved by the Auxilium Board of Directors. The Stockholder Rights Plan is not intended to interfere with any merger, tender or exchange offer or other business combination approved by the Auxilium Board of Directors, including, without limitation, the transactions contemplated by the merger agreement. Nor does the Stockholder Rights Plan prevent the Auxilium Board of Directors from considering any offer that it considers to be in the best interest of Auxilium’s stockholders.

 

In addition, Section 203 of the General Corporation Law of the State of Delaware prohibits a publicly held Delaware corporation from engaging in a business combination with an interested stockholder, generally a person which together with its affiliates owns or within the last three years has owned 15% of Auxilium’s voting stock, for a period of three years after the date of the transaction in which the person became an interested stockholder, unless

 

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the business combination is approved in a prescribed manner. Accordingly, Section 203 may discourage, delay or prevent a change in control of Auxilium.

 

Conversion of the Convertible Senior Notes may result in dilution to existing stockholders or a negative impact on liquidity.

 

On October 14, 2014, Auxilium provided a notice to the trustee for the Convertible Senior Notes and the holders of the Convertible Senior Notes that, in connection with the Endo Merger, the Convertible Senior Notes may be surrendered for conversion from the date that is 70 scheduled trading days prior to the anticipated effective date of the merger (or, if later, the business day after the Company gave notice of the merger with Endo) until the date that is 35 trading days after the actual effective date of the merger or until the related fundamental change purchase date, as defined in the indenture. In addition, the Convertible Senior Notes may again become convertible after the expiration of such period in accordance with their terms, and will be convertible on or after January 15, 2018 until maturity (July 15, 2018). If one or more holders elect to convert their Convertible Senior Notes, unless Auxilium elects to satisfy Auxilium’s conversion obligation by delivering solely shares of Auxilium’s common stock, Auxilium would be required to make cash payments to satisfy all or a portion of Auxilium’s conversion obligation based on the applicable conversion rate. If Auxilium is unable to satisfy any portion of such obligation, Auxilium would be in default. In addition, the expenditure of cash to satisfy such obligation could adversely affect Auxilium’s liquidity. In addition, even if holders do not elect to convert their Convertible Senior Notes, Auxilium could be required under applicable accounting rules to reclassify all or a portion of the outstanding principal of the Convertible Senior Notes as a current rather than long-term liability, which could result in a material reduction of Auxilium’s net working capital.

 

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds.

 

Issuer Purchases of Equity Securities

 

The following table summarizes the Company’s purchases of its common stock for the three months ended September 30, 2014:

 

Period

 

Total Number
of
Shares (or
Units)
Purchased

 

Average Price
Paid Per

Share
(or Unit)

 

Total Number of
Shares (or
Units)
Purchased as
Part of Publicly
Announced
Plans or
Programs

 

Maximum
Number (or
Approximate
Dollar Value) of
Shares (or
Units) that May
Yet Be
Purchased
Under the Plans
or Programs

 

July 1, 2014 to July 31, 2014

 

107

 

$

20.28

 

Not applicable

 

Not applicable

 

August 1, 2014 to August 31, 2014

 

35

 

$

19.34

 

Not applicable

 

Not applicable

 

September 1, 2014 to September 30, 2014

 

595

 

$

30.92

 

Not applicable

 

Not applicable

 

Total

 

737

(a)

$

28.83

 

Not applicable

 

Not applicable

 

 


(a) Represents 737 shares purchased at an average of $28.83 per share from employees pursuant to the Company’s 2004 Equity Compensation Plan to satisfy such individual’s tax liability with respect to the vesting of restricted stock awards issued in accordance with Rule 16 (b) (3) of the Securities Exchange Act of 1934.

 

Unregistered Sale of Equity Securities

 

None.

 

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Use of Proceeds

 

None.

 

Item 5.  Other Information.

 

None.

 

Item 6.  Exhibits.

 

Exhibit No.

 

Description

 

 

 

2.1

 

Agreement and Plan of Merger, dated as of October 8, 2014, by and among Auxilium Pharmaceuticals, Inc., Endo International plc, Endo U.S. Inc., and Avalon Merger Sub Inc. (filed as Exhibit 2.1 to the Registrant’s Current Report on Form 8-K filed on October 9, 2014, File No. 000.50855, and incorporated by reference herein).

 

 

 

3.1

 

Sixth Amended and Restated Certificate of Incorporation of Auxilium Pharmaceuticals, Inc. (filed as Exhibit 3.1 to the Registrant’s Quarterly Report on Form 10-Q filed on August 7, 2014, File No. 000-50855, and incorporated by reference herein).

 

 

 

3.2

 

Amended and Restated Bylaws of the Registrant as amended on June 21, 2012 (filed as Exhibit 3.2 to the Registrant’s Quarterly Report on Form 10-Q filed on July 31, 2012, File No. 000-50855, and incorporated by reference herein).

 

 

 

3.3

 

Certificate of Designations of Series A Junior Participating Preferred Stock, as filed with the Secretary of State of the State of Delaware on September 17, 2014 (filed as Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on September 17, 2014, File No. 000-50855, and incorporated by reference herein).

 

 

 

4.1

 

Rights Agreement, dated as of September 17, 2014, between the Registrant and Broadridge Corporate Issuers Solutions, Inc., as Rights Agent (filed as Exhibit 4.1 to the Registrant’s Current Report on Form 8-K filed on September 17, 2014, File No. 000-50855, and incorporated by reference herein).

 

 

 

4.2

 

Amendment No. 1 to Rights Agreement, dated October 8, 2014, by and between the Registrant and Broadridge Corporate Issuers Solutions, Inc., as Rights Agent (filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on October 9, 2014, File No. 000-50855, and incorporated by reference herein).

 

 

 

10.1

 

Incremental Assumption Agreement dated September 22, 2014, by and among, the Registrant, as borrower, and its existing domestic subsidiaries, as guarantors, the incremental term loan lenders from time to time party thereto and Morgan Stanley Senior Funding, Inc., as administrative agent, and as sole lead manager and bookrunner (filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on September 22, 2014, File No. 000-50855, and incorporated by reference herein).

 

 

 

10.2

 

Third Amendment Agreement to Credit Agreement dated August 14, 2014 by and among Auxilium Pharmaceuticals, Inc., as borrower, and its existing domestic subsidiaries, as guarantors, the certain lenders party thereto constituting required lenders under and as defined in the Credit Agreement and Morgan Stanley Senior Funding, Inc. as administrative agent, and as the sole lead manager and bookrunner (filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on August 18, 2014, File No. 000-50855, and incorporated by reference herein).

 

 

 

10.3*†

 

Employment Agreement, dated August 8, 2014, by and between the Registrant and Andrew Saik.

 

 

 

10.4*†

 

Separation of Employment Agreement and General Release, dated August 20, 2014, by and between the Registrant and James E. Fickenscher.

 

 

 

10.5

 

Termination Notice, dated October 8, 2014, from the Registrant to QLT Inc., QLT Holding Corp. and QLT Acquisition Corp. (filed as Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed on October 9, 2014, File No. 000-50855, and incorporated by reference herein).

 

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Table of Contents

 

31.1†

 

Certification of Adrian Adams, the Registrant’s Principal Executive Officer, required by Rule 13a-14(a) or Rule 15d-14(a).

 

 

 

31.2†

 

Certification of Andrew Saik, the Registrant’s Principal Financial Officer, required by Rule 13a-14(a) or Rule 15d-14(a).

 

 

 

32†

 

Certification of Adrian Adams, the Registrant’s Principal Executive Officer, and Andrew Saik, the Registrant’s Principal Financial Officer, required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350).

 

 

 

101.INS§

 

XBRL Instance Document

 

 

 

101.SCH§

 

XBRL Taxonomy Extension Schema Document

 

 

 

101.CAL§

 

XBRL Taxonomy Extension Calculation Linkbase Document

 

 

 

101.LAB§

 

XBRL Taxonomy Extension Label Linkbase Document

 

 

 

101.PRE§

 

XBRL Taxonomy Extension Presentation Linkbase Document

 

 

 

101.DEF§

 

XBRL Taxonomy Extension Definition Linkbase Document

 


                          Filed herewith.

 

*                          Indicates management contract or compensatory plan or arrangement.

 

§                          XBRL (Extensible Business Reporting Language) information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934, and is not subject to liability under those sections, is not part of any registration statement or prospectus to which it relates and is not incorporated or deemed to be incorporated by reference into any registration statement, prospectus or other document.

 

57



Table of Contents

 

SIGNATURES

 

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

 

 

AUXILIUM PHARMACEUTICALS, INC.

 

 

 

 

Date: October 30, 2014

/s/ Adrian Adams

 

Adrian Adams

 

Chief Executive Officer and President

 

(Principal Executive Officer)

 

 

 

 

 

AUXILIUM PHARMACEUTICALS, INC.

 

 

 

 

Date: October 30, 2014

/s/ Andrew Saik

 

Andrew Saik

 

Chief Financial Officer

 

(Principal Financial and Accounting Officer)

 

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Table of Contents

 

EXHIBIT INDEX

 

Exhibit No.

 

Description

 

 

 

2.1

 

Agreement and Plan of Merger, dated as of October 8, 2014, by and among Auxilium Pharmaceuticals, Inc., Endo International plc, Endo U.S. Inc., and Avalon Merger Sub Inc. (filed as Exhibit 2.1 to the Registrant’s Current Report on Form 8-K filed on October 9, 2014, File No. 000.50855, and incorporated by reference herein).

 

 

 

3.1

 

Sixth Amended and Restated Certificate of Incorporation of Auxilium Pharmaceuticals, Inc. (filed as Exhibit 3.1 to the Registrant’s Quarterly Report on Form 10-Q filed on August 7, 2014, File No. 000-50855, and incorporated by reference herein).

 

 

 

3.2

 

Amended and Restated Bylaws of the Registrant amended as of June 21, 2012 (filed as Exhibit 3.2 to the Registrant’s Quarterly Report on Form 10-Q filed on July 31, 2012, File No. 000-50855, and incorporated by reference herein).

 

 

 

3.3

 

Certificate of Designations of Series A Junior Participating Preferred Stock, as filed with the Secretary of State of the State of Delaware on September 17, 2014 (filed as Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on September 17, 2014, File No. 000-50855, and incorporated by reference herein).

 

 

 

4.1

 

Rights Agreement, dated as of September 17, 2014, between the Registrant and Broadridge Corporate Issuers Solutions, Inc., as Rights Agent (filed as Exhibit 4.1 to the Registrant’s Current Report on Form 8-K filed on September 17, 2014, File No. 000-50855, and incorporated by reference herein).

 

 

 

4.2

 

Amendment No. 1 to Rights Agreement, dated October 8, 2014, by and between the Registrant and Broadridge Corporate Issuers Solutions, Inc., as Rights Agent (filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on October 9, 2014, File No. 000-50855, and incorporated by reference herein).

 

 

 

10.1

 

Incremental Assumption Agreement dated September 22, 2014, by and among, the Registrant, as borrower, and its existing domestic subsidiaries, as guarantors, the incremental term loan lenders from time to time party thereto and Morgan Stanley Senior Funding, Inc., as administrative agent, and as sole lead manager and bookrunner (filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on September 22, 2014, File No. 000-50855, and incorporated by reference herein).

 

 

 

10.2

 

Third Amendment Agreement to Credit Agreement dated August 14, 2014 by and among Auxilium Pharmaceuticals, Inc., as borrower, and its existing domestic subsidiaries, as guarantors, the certain lenders party thereto constituting required lenders under and as defined in the Credit Agreement and Morgan Stanley Senior Funding, Inc. as administrative agent, and as the sole lead manager and bookrunner (filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on August 18, 2014, File No. 000-50855, and incorporated by reference herein).

 

 

 

10.3*†

 

Employment Agreement, dated August 8, 2014, by and between the Registrant and Andrew Saik.

 

 

 

10.4*†

 

Separation of Employment Agreement and General Release, dated August 20, 2014, by and between the Registrant and James E. Fickenscher.

 

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Table of Contents

 

10.5

 

Termination Notice, dated October 8, 2014, from the Registrant to QLT Inc., QLT Holding Corp. and QLT Acquisition Corp. (filed as Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed on October 9, 2014, File No. 000-50855, and incorporated by reference herein).

 

 

 

31.1†

 

Certification of Adrian Adams, the Registrant’s Principal Executive Officer, required by Rule 13a-14(a) or Rule 15d-14(a).

 

 

 

31.2†

 

Certification of Andrew Saik, the Registrant’s Principal Financial Officer, required by Rule 13a-14(a) or Rule 15d-14(a).

 

 

 

32†

 

Certification of Adrian Adams, the Registrant’s Principal Executive Officer, and Andrew Saik, the Registrant’s Principal Financial Officer, required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350).

 

 

 

101.INS§

 

XBRL Instance Document

 

 

 

101.SCH§

 

XBRL Taxonomy Extension Schema Document

 

 

 

101.CAL§

 

XBRL Taxonomy Extension Calculation Linkbase Document

 

 

 

101.LAB§

 

XBRL Taxonomy Extension Label Linkbase Document

 

 

 

101.PRE§

 

XBRL Taxonomy Extension Presentation Linkbase Document

 

 

 

101.DEF§

 

XBRL Taxonomy Extension Definition Linkbase Document

 


                          Filed herewith.

 

*                          Indicates management contract or compensatory plan or arrangement.

 

§                          XBRL (Extensible Business Reporting Language) information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934, and is not subject to liability under those sections, is not part of any registration statement or prospectus to which it relates and is not incorporated or deemed to be incorporated by reference into any registration statement, prospectus or other document.

 

60