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Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

x

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

 

For the quarterly period ended 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: 0-27488

 

INCYTE CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware

 

94-3136539

(State or other jurisdiction of
incorporation or organization)

 

(IRS Employer
Identification No.)

 

 

 

1801 Augustine Cut-Off

Wilmington, DE  19803

 

19803

(Address of principal executive offices)

 

(Zip Code)

 

(302) 498-6700

(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.  x Yes  o No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  x Yes  o No

 

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

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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

 

The number of outstanding shares of the registrant’s Common Stock, $0.001 par value, was 168,941,857 as of October 23, 2014.

 

 

 



Table of Contents

 

INCYTE CORPORATION

 

INDEX

 

PART I: FINANCIAL INFORMATION

3

 

 

 

Item 1.

Financial Statements

3

 

 

 

 

Condensed Consolidated Balance Sheets

3

 

 

 

 

Condensed Consolidated Statements of Operations

4

 

 

 

 

Condensed Consolidated Statements of Comprehensive Loss

5

 

 

 

 

Condensed Consolidated Statements of Cash Flows

6

 

 

 

 

Notes to Condensed Consolidated Financial Statements

7

 

 

 

Item 2.

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

20

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

34

 

 

 

Item 4.

Controls and Procedures

34

 

 

 

PART II: OTHER INFORMATION

35

 

 

 

Item 1A.

Risk Factors

35

 

 

 

Item 6.

Exhibits

51

 

 

 

 

Signatures

52

 

 

 

 

Exhibit Index

53

 

2



Table of Contents

 

PART I:    FINANCIAL INFORMATION

Item 1.    Financial Statements

 

INCYTE CORPORATION

Condensed Consolidated Balance Sheets

(in thousands)

 

 

 

September 30,
2014

 

December 31,
2013*

 

 

 

(unaudited)

 

 

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

382,004

 

$

471,429

 

Marketable securities—available-for-sale

 

150,355

 

37,575

 

Restricted investments

 

500

 

500

 

Accounts receivable, net

 

109,599

 

35,374

 

Inventory

 

402

 

406

 

Deferred income taxes

 

775

 

895

 

Prepaid expenses and other current assets

 

18,979

 

9,620

 

 

 

 

 

 

 

Total current assets

 

662,614

 

555,799

 

 

 

 

 

 

 

Restricted investments

 

14,125

 

14,500

 

Inventory

 

17,529

 

14,937

 

Property and equipment, net

 

75,258

 

26,848

 

Other assets, net

 

15,739

 

17,484

 

 

 

 

 

 

 

Total assets

 

$

785,265

 

$

629,568

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ DEFICIT

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

26,605

 

$

19,102

 

Accrued compensation

 

26,481

 

28,079

 

Interest payable

 

4,456

 

1,909

 

Accrued and other current liabilities

 

54,236

 

46,062

 

Deferred revenue—Collaborative agreements

 

12,882

 

12,890

 

 

 

 

 

 

 

Total current liabilities

 

124,660

 

108,042

 

 

 

 

 

 

 

Convertible senior notes

 

681,313

 

661,567

 

Other liabilities

 

52,382

 

26,803

 

Deferred income taxes

 

775

 

895

 

Deferred revenue—Collaborative agreements

 

15,726

 

25,369

 

 

 

 

 

 

 

Total liabilities

 

874,856

 

822,676

 

 

 

 

 

 

 

Stockholders’deficit:

 

 

 

 

 

Preferred stock, $0.001 par value; 5,000,000 shares authorized; none issued or outstanding as of September 30, 2014 and December 31, 2013

 

 

 

Common stock, $0.001 par value; 400,000,000 shares authorized; 168,851,082 and 162,984,680 shares issued and outstanding as of September 30, 2014 and December 31, 2013, respectively

 

169

 

163

 

Additional paid-in capital

 

1,656,901

 

1,541,773

 

Accumulated other comprehensive gain

 

1,914

 

1,993

 

Accumulated deficit

 

(1,748,575

)

(1,737,037

)

Total stockholders’ deficit

 

(89,591

)

(193,108

)

 

 

 

 

 

 

Total liabilities and stockholders’deficit

 

$

785,265

 

$

629,568

 

 


*   The condensed consolidated balance sheet at December 31, 2013 has been derived from the audited financial statements at that date.

 

See accompanying notes.

 

3



Table of Contents

 

INCYTE CORPORATION

Condensed Consolidated Statements of Operations

(in thousands, except per share amounts)

(unaudited)

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Revenues:

 

 

 

 

 

 

 

 

 

Product revenues, net

 

$

97,837

 

$

60,201

 

$

251,513

 

$

162,589

 

Product royalty revenues

 

12,093

 

8,184

 

34,259

 

19,893

 

Contract revenues

 

88,214

 

16,737

 

101,643

 

75,211

 

Other revenues

 

3

 

1

 

107

 

182

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

198,147

 

85,123

 

387,522

 

257,875

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

Cost of product revenues

 

221

 

155

 

576

 

463

 

Research and development

 

88,537

 

71,704

 

248,806

 

185,417

 

Selling, general and administrative

 

39,446

 

26,447

 

117,320

 

71,956

 

 

 

 

 

 

 

 

 

 

 

Total costs and expenses

 

128,204

 

98,306

 

366,702

 

257,836

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

69,943

 

(13,183

)

20,820

 

39

 

Interest and other income, net

 

885

 

385

 

2,410

 

829

 

Interest expense

 

(11,463

)

(7,699

)

(34,312

)

(29,720

)

Debt exchange expense on senior note conversions

 

 

(1,491

)

(265

)

(11,262

)

 

 

 

 

 

 

 

 

 

 

Income (loss) before income taxes

 

$

59,365

 

$

(21,988

)

$

(11,347

)

$

(40,114

)

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

72

 

49

 

191

 

162

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

59,293

 

$

(22,037

)

$

(11,538

)

$

(40,276

)

 

 

 

 

 

 

 

 

 

 

Net income (loss) per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.35

 

$

(0.14

)

$

(0.07

)

$

(0.28

)

Diluted

 

$

0.33

 

$

(0.14

)

$

(0.07

)

$

(0.28

)

 

 

 

 

 

 

 

 

 

 

Shares used in computing net income (loss) per share:

 

 

 

 

 

 

 

 

 

Basic

 

168,592

 

155,067

 

167,288

 

143,899

 

Diluted

 

189,046

 

155,067

 

167,288

 

143,899

 

 

See accompanying notes.

 

4



Table of Contents

 

INCYTE CORPORATION

Condensed 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)

 

$

59,293

 

$

(22,037

)

$

(11,538

)

$

(40,276

)

 

 

 

 

 

 

 

 

 

 

Other comprehensive gain (loss):

 

 

 

 

 

 

 

 

 

Unrealized gain (loss) on marketable securities, net of tax

 

(166

)

15

 

(79

)

130

 

Other comprehensive gain (loss)

 

(166

)

15

 

(79

)

130

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income (loss)

 

$

59,127

 

$

(22,022

)

$

(11,617

)

$

(40,146

)

 

See accompanying notes.

 

5



Table of Contents

 

INCYTE CORPORATION

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

 

 

 

Nine Months Ended
September 30,

 

 

 

2014

 

2013

 

Cash flows from operating activities:

 

 

 

 

 

Net loss

 

$

(11,538

)

$

(40,276

)

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

 

 

 

 

 

Depreciation and amortization of debt discounts

 

29,192

 

20,355

 

Stock-based compensation

 

46,253

 

28,577

 

Debt exchange expense on senior note conversions

 

265

 

11,262

 

Excess tax benefit from stock based compensation

 

(74

)

 

Changes in operating assets and liabilities:

 

 

 

 

 

Restricted cash

 

375

 

 

Accounts receivable

 

(74,225

)

37,754

 

Prepaid expenses and other assets

 

(10,078

)

2,644

 

Inventory

 

(2,588

)

(6,554

)

Accounts payable

 

7,503

 

4,251

 

Accrued and other liabilities

 

6,102

 

13,075

 

Deferred revenue — Collaborative agreements

 

(9,651

)

(50,219

)

Net cash (used in) provided by operating activities

 

(18,464

)

20,869

 

Cash flows from investing activities:

 

 

 

 

 

Capital expenditures

 

(22,021

)

(2,236

)

Purchases of marketable securities

 

(113,281

)

(15,024

)

Maturities of marketable securities

 

381

 

(203

)

Net cash used in investing activities

 

(134,921

)

(17,463

)

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of common stock under stock plans

 

64,151

 

55,921

 

Excess tax benefit from stock based compensation

 

74

 

 

Cash paid in connection with exchange of 4.75% convertible senior notes due 2015

 

(265

)

(11,262

)

Net cash provided by financing activities

 

63,960

 

44,659

 

Net (decrease) increase in cash and cash equivalents

 

(89,425

)

48,065

 

Cash and cash equivalents at beginning of period

 

471,429

 

224,057

 

Cash and cash equivalents at end of period

 

$

382,004

 

$

272,122

 

 

 

 

 

 

 

Supplemental Schedule of Cash Flow Information

 

 

 

 

 

Interest paid

 

$

5,245

 

$

9,500

 

Incomes taxes paid

 

$

167

 

$

140

 

Reclassification to additional paid in capital in connection with conversion of Pfizer convertible subordinated note due 2014

 

$

 

$

9,373

 

Reclassification to additional paid in capital in connection with exchange of 4.75% convertible senior notes due 2015

 

$

4,656

 

$

149,915

 

Purchase of property and equipment financed by direct financing lease

 

$

26,815

 

$

 

 

See accompanying notes.

 

6



Table of Contents

 

INCYTE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(Unaudited)

 

1.     Organization and business

 

Incyte Corporation (“Incyte,” “we,” “us,” or “our”) is a biopharmaceutical company focused on developing and commercializing proprietary small molecule drugs, primarily for oncology. Our pipeline includes compounds in various stages, ranging from preclinical to late stage development, and a commercialized product, JAKAFI® (ruxolitinib). Our operations are treated as one operating segment.

 

2.     Summary of significant accounting policies

 

Basis of presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  The condensed consolidated balance sheet as of September 30, 2014 and the condensed consolidated statements of operations, comprehensive loss and cash flows for the three and nine months ended September 30, 2014 and 2013, are unaudited, but include all adjustments, consisting only of normal recurring adjustments, which we consider necessary for a fair presentation of the financial position, operating results and cash flows for the periods presented.  The condensed consolidated balance sheet at December 31, 2013 has been derived from audited financial statements.

 

Although we believe that the disclosures in these financial statements are adequate to make the information presented not misleading, certain information and footnote information normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission.

 

Results for any interim period are not necessarily indicative of results for any future interim period or for the entire year. The accompanying financial statements should be read in conjunction with the financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2013.

 

Principles of Consolidation.  The consolidated financial statements include the accounts of Incyte Corporation and our wholly owned subsidiaries. All inter-company accounts, transactions, and profits have been eliminated in consolidation.

 

Use of Estimates.  The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

 

Concentrations of Credit Risk.  Cash, cash equivalents, marketable securities, trade receivables and restricted investments are financial instruments which potentially subject us to concentrations of credit risk. The estimated fair value of financial instruments approximates the carrying value based on available market information. We primarily invest our excess available funds in notes and bills issued by the U.S. government and its agencies and corporate debt securities and, by policy, limit the amount of credit exposure to any one issuer and to any one type of investment, other than securities issued or guaranteed by the U.S. government. Our receivables mainly relate to our product sales of JAKAFI and collaborative agreements with pharmaceutical companies. We have not experienced any significant credit losses on cash, cash equivalents, marketable securities, trade receivables or restricted investments to date and do not require collateral on receivables.

 

Cash and Cash Equivalents.  Cash and cash equivalents are held in banks or in custodial accounts. Cash equivalents are defined as all liquid investments and money market funds with maturity from date of purchase of 90 days or less that are readily convertible into cash.

 

Marketable Securities—Available-for-Sale.  All marketable securities are classified as available-for-sale. Available-for-sale securities are carried at fair value, based on quoted market prices and observable inputs, with unrealized gains and losses, net of tax, reported as a separate component of stockholders’ deficit. We classify marketable securities that are available for use in current operations as current assets on the consolidated balance sheets. Realized gains and losses and declines in value judged to be other than temporary for available-for-sale securities are included in “Interest and other income, net.” The cost of securities sold is based on the specific identification method.

 

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Table of Contents

 

Accounts Receivable.  As of September 30, 2014 and December 31, 2013, we had no allowance for doubtful accounts. We provide an allowance for doubtful accounts based on experience and specifically identified risks. Accounts receivable are carried at fair value and charged off against the allowance for doubtful accounts when we determine that recovery is unlikely and we cease collection efforts.

 

Inventory.  Inventories are determined at the lower of cost or market value with cost determined under the specific identification method and may consist of raw materials, work in process and finished goods. We began capitalizing inventory in mid-November 2011 once the U.S. Food and Drug Administration (“FDA”) approved JAKAFI as the related costs were expected to be recoverable through the commercialization of the product. Costs incurred prior to approval of JAKAFI have been recorded as research and development expense in our statements of operations. As a result, cost of product revenues for approximately the next 24 to 27 months will reflect a lower average per unit cost of materials.

 

The raw materials and work-in-process inventory is not subject to expiration and the shelf life for finished goods inventory is 24 or 36 months from the start of manufacturing of the finished goods. We evaluate for potential excess inventory by analyzing current and future product demand relative to the remaining product shelf life. We build demand forecasts by considering factors such as, but not limited to, overall market potential, market share, market acceptance and patient usage. We classify inventory as current on the consolidated balance sheets when we expect inventory to be consumed for commercial use within the next twelve months.

 

Property and Equipment.  Property and equipment is stated at cost, less accumulated depreciation and amortization. Depreciation is recorded using the straight-line method over the estimated useful lives of the respective assets (generally three to five years). Leasehold improvements are amortized over the shorter of the estimated useful life of the assets or lease term.

 

Management continually reviews the estimated useful lives of technologically sensitive equipment and believes that those estimates appropriately reflect the current useful life of our assets. In the event that a currently unknown significantly advanced technology became commercially available, we would re-evaluate the value and estimated useful lives of our existing equipment, possibly having a material impact on the financial statements.

 

Lease Accounting.  We account for operating leases by recording rent expense on a straight-line basis over the expected life of the lease, commencing on the date we gain possession of leased property. We include tenant improvement allowances and rent holidays received from landlords and the effect of any rent escalation clauses as adjustments to straight-line rent expense over the expected life of the lease.

 

Capital leases are reflected as a liability at the inception of the lease based on the present value of the minimum lease payments or, if lower, the fair value of the property. Assets under capital leases are recorded in property and equipment, net on the consolidated balance sheets and depreciated in a manner similar to other property and equipment.

 

Certain construction projects are accounted for as direct financing arrangements, whereby we record, over the construction period, the full cost of the asset in property and equipment, net on the consolidated balance sheets. A corresponding liability is also recorded, net of leasehold improvements paid for by us, and is amortized over the expected lease term through monthly rental payments using the effective interest method.

 

Income Taxes.  We account for income taxes using the asset and liability approach which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and amounts reportable for income tax purposes. In addition, we follow the guidance related to accounting for uncertainty in income taxes. This guidance creates a single model to address uncertainty in tax positions and clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before it is recognized in the financial statements.

 

Financing Costs Related to Long-term Debt.  Costs associated with obtaining long-term debt are deferred and amortized over the term of the related debt using the effective interest method. Such costs are included in other assets, net on the consolidated balance sheet.

 

Grant Accounting.  Grant amounts received from government agencies for operations are deferred and are amortized into income over the service period of the grant. Grant amounts received for purchases of capital assets are deferred and amortized into interest and other income, net over the useful life of the related capital assets. Such amounts are recorded in other liabilities on the consolidated balance sheet.

 

Net Income (Loss)Per Share.  Our basic and diluted income (losses) per share are calculated by dividing the net income (loss) by the weighted average number of shares of common stock outstanding during all periods presented. Options to purchase stock and shares

 

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issuable upon the conversion of convertible debt are included in diluted earnings per share calculations, unless the effects are anti-dilutive.

 

Accumulated Other Comprehensive Income (Loss).  Accumulated other comprehensive income (loss) consists of unrealized gains or losses on marketable securities and restricted cash and investments.

 

Revenue Recognition.  Revenues are recognized when (1) persuasive evidence of an arrangement exists, (2) delivery has occurred or services have been rendered, (3) the price is fixed or determinable and (4) collectability is reasonably assured. Revenues are deferred for fees received before earned or until no further obligations exist. We exercise judgment in determining that collectability is reasonably assured or that services have been delivered in accordance with the arrangement. We assess whether the fee is fixed or determinable based on the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment. We assess collectability based primarily on the customer’s payment history and on the creditworthiness of the customer.

 

Product Revenues

 

Our product revenues consist of U.S. sales of JAKAFI and are recognized once we meet all four revenue recognition criteria described above. In November 2011, we began shipping JAKAFI to our specialty pharmacy customers, which in turn dispense JAKAFI to patients in fulfillment of prescriptions.

 

We recognize revenues for product received by our specialty pharmacy customers net of allowances for customer credits, including estimated rebates, chargebacks, discounts, returns, distribution service fees, patient assistance programs, and Medicare Part D coverage gap reimbursements. Product shipping and handling costs are included in cost of product revenues.

 

Customer Credits:  Our specialty pharmacy customers are offered various forms of consideration, including allowances, service fees and prompt payment discounts. We expect our specialty pharmacy customers will earn prompt payment discounts and, therefore, we deduct the full amount of these discounts from total product sales when revenues are recognized. Service fees are also deducted from total product sales as they are earned.

 

Rebates:  Allowances for rebates include mandated discounts under the Medicaid Drug Rebate Program. Rebate amounts are based upon contractual agreements or legal requirements with public sector (e.g. Medicaid) benefit providers. Rebates are amounts owed after the final dispensing of the product to a benefit plan participant and are based upon contractual agreements or legal requirements with public sector benefit providers. The accrual for rebates is based on statutory discount rates and expected utilization as well as historical data we have accumulated since product launch. Our estimates for expected utilization of rebates are based in part on third party market research data, and data received from our specialty pharmacy customers. Rebates are generally invoiced and paid in arrears so that the accrual balance consists of an estimate of the amount expected to be incurred for the current quarter’s activity, plus an accrual balance for known prior quarters’ unpaid rebates. If actual future rebates vary from estimates, we may need to adjust prior period accruals, which would affect revenue in the period of adjustment.

 

Chargebacks:  Chargebacks are discounts that occur when contracted customers purchase directly from a specialty pharmacy, or an intermediary distributor. Contracted customers, which currently consist primarily of Public Health Service institutions, non-profit clinics, and Federal government entities purchasing via the Federal Supply Schedule, generally purchase the product at a discounted price. The specialty pharmacy or distributor, in turn, charges back to us the difference between the price initially paid by the specialty pharmacy or distributor and the discounted price paid to the specialty pharmacy or distributor by the customer. The accrual for chargebacks is based on the estimated contractual discounts on the inventory levels on hand in our distribution channel. If actual future chargebacks vary from estimates, we may need to adjust prior period accruals, which would affect revenue in the period of adjustment.

 

Medicare Part D Coverage Gap:  Medicare Part D prescription drug benefit mandates manufacturers to fund 50% of the Medicare Part D insurance coverage gap for prescription drugs sold to eligible patients. Our estimates for the expected Medicare Part D coverage gap are based on historical invoices received and in part from data received from our specialty pharmacy customers. Funding of the coverage gap is generally invoiced and paid in arrears so that the accrual balance consists of an estimate of the amount expected to be incurred for the current quarter’s activity, plus an accrual balance for known prior quarters. If actual future funding varies from estimates, we may need to adjust prior period accruals, which would affect revenue in the period of adjustment.

 

Co-payment assistance:  Patients who have commercial insurance and meet certain eligibility requirements may receive co-payment assistance. We accrue a liability for co-payment assistance based on actual program participation and estimates of program redemption using data provided by third-party administrators.

 

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Table of Contents

 

Product Royalty Revenues

 

Royalty revenues on commercial sales for ruxolitinib (marketed as JAKAVI® outside the United States) by Novartis Pharmaceutical International Ltd. (“Novartis”) are based on net sales of licensed products in licensed territories as provided by Novartis. We recognize royalty revenues in the period the sales occur.

 

Contract and License Revenues

 

Under agreements involving multiple deliverables, services and/or rights to use assets that we entered into prior to January 1, 2011, the multiple elements are divided into separate units of accounting when certain criteria are met, including whether the delivered items have stand-alone value to the customer and whether there is objective and reliable evidence of the fair value of the undelivered items. When separate units of accounting exist, consideration is allocated among the separate elements based on their respective fair values. The determination of fair value of each element is based on objective evidence from historical sales of the individual elements by us to other customers. If such evidence of fair value for each undelivered element of the arrangement does not exist, all revenue from the arrangement is deferred until such time that evidence of fair value for each undelivered element does exist or until all elements of the arrangement are delivered. When elements are specifically tied to a separate earnings process, revenue is recognized when the specific performance obligation tied to the element is completed. When revenues for an element are not specifically tied to a separate earnings process, they are recognized ratably over the term of the agreement. We assess whether a substantive milestone exists at the inception of our agreements. For all milestones within our arrangements that are considered substantive, we recognize revenue upon the achievement of the associated milestone. If a milestone is not considered substantive, we would recognize the applicable milestone payment over the remaining period of performance under the arrangement. Further information about our collaborative arrangements can be found below in Note 7, License Agreements. As of September 30, 2014, all remaining potential milestones under our collaborative arrangements are considered substantive.

 

On January 1, 2011, updated guidance on the recognition of revenues for agreements with multiple deliverables became effective and applies to any agreements we may enter into on or after January 1, 2011. This updated guidance (i) relates to whether multiple deliverables exist, how the deliverables in a revenue arrangement should be separated and how the consideration should be allocated; (ii) requires companies to allocate revenues in an arrangement using estimated selling prices of deliverables if a vendor does not have vendor-specific objective evidence or third-party evidence of selling price; and (iii) eliminates the use of the residual method and requires companies to allocate revenues using the relative selling price method. During the three and nine months ended September 30, 2014 and 2013, we did not enter into any agreements that are subject to this updated guidance. If we enter into an agreement with multiple deliverables after January 1, 2011 or amend existing agreements, this updated guidance could have a material effect on our financial statements.

 

Our collaborations often include contractual milestones, which typically relate to the achievement of pre-specified development, regulatory and commercialization events. These three categories of milestone events reflect the three stages of the life-cycle of our drugs, which we describe in more detail in the following paragraphs.

 

The regulatory review and approval process, which includes preclinical testing and clinical trials of each drug candidate, is lengthy, expensive and uncertain. Securing approval by the FDA requires the submission of extensive preclinical and clinical data and supporting information to the FDA for each indication to establish a drug candidate’s safety and efficacy. The approval process takes many years, requires the expenditure of substantial resources, involves post-marketing surveillance and may involve ongoing requirements for post-marketing studies. Before commencing clinical investigations of a drug candidate in humans, we must submit an Investigational New Drug application (“IND”), which must be reviewed by the FDA.

 

The steps generally required before a drug may be marketed in the United States include preclinical laboratory tests, animal studies and formulation studies, submission to the FDA of an IND for human clinical testing, performance of adequate and well-controlled clinical trials in three phases, as described below, to establish the safety and efficacy of the drug for each indication, submission of a new drug application (“NDA”) to the FDA for review and FDA approval of the NDA.

 

Similar requirements exist within foreign regulatory agencies as well. The time required satisfying the FDA requirements or similar requirements of foreign regulatory agencies may vary substantially based on the type, complexity and novelty of the product or the targeted disease.

 

Preclinical testing includes laboratory evaluation of product pharmacology, drug metabolism, and toxicity, which includes animal studies, to assess potential safety and efficacy as well as product chemistry, stability, formulation, development, and testing. The results of the preclinical tests, together with manufacturing information and analytical data, are submitted to the FDA as part of an IND. The FDA may raise safety concerns or questions about the conduct of the clinical trials included in the IND, and any of these

 

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concerns or questions must be resolved before clinical trials can proceed. We cannot be sure that submission of an IND will result in the FDA allowing clinical trials to commence. Clinical trials involve the administration of the investigational drug or the marketed drug to human subjects under the supervision of qualified investigators and in accordance with good clinical practices regulations covering the protection of human subjects. Clinical trials typically are conducted in three sequential phases, but the phases may overlap or be combined. Phase I usually involves the initial introduction of the investigational drug into healthy volunteers to evaluate its safety, dosage tolerance, absorption, metabolism, distribution and excretion. Phase II usually involves clinical trials in a limited patient population to evaluate dosage tolerance and optimal dosage, identify possible adverse effects and safety risks, and evaluate and gain preliminary evidence of the efficacy of the drug for specific indications. Phase III clinical trials usually further evaluate clinical efficacy and safety by testing the drug in its final form in an expanded patient population, providing statistical evidence of efficacy and safety, and providing an adequate basis for labeling. We cannot guarantee that Phase I, Phase II or Phase III testing will be completed successfully within any specified period of time, if at all. Furthermore, we, the institutional review board for a trial, or the FDA may suspend clinical trials at any time on various grounds, including a finding that the subjects or patients are being exposed to an unacceptable health risk.

 

Generally, the milestone events contained in our collaboration agreements coincide with the progression of our drugs from development, to regulatory approval and then to commercialization. The process of successfully discovering a new development candidate, having it approved and successfully commercialized is highly uncertain. As such, the milestone payments we may earn from our partners involve a significant degree of risk to achieve. Therefore, as a drug candidate progresses through the stages of its life-cycle, the value of the drug candidate generally increases.

 

Research and Development Costs.  Our policy is to expense research and development costs as incurred. We often contract with clinical research organizations (“CROs”) to facilitate, coordinate and perform agreed upon research and development of a new drug. To ensure that research and development costs are expensed as incurred, we record monthly accruals for clinical trials and preclinical testing costs based on the work performed under the contract.

 

These CRO contracts typically call for the payment of fees for services at the initiation of the contract and/or upon the achievement of certain clinical trial milestones. In the event that we prepay CRO fees, we record the prepayment as a prepaid asset and amortize the asset into research and development expense over the period of time the contracted research and development services are performed. Most professional fees, including project and clinical management, data management, monitoring, and medical writing fees are incurred throughout the contract period. These professional fees are expensed based on their percentage of completion at a particular date. Our CRO contracts generally include pass through fees. Pass through fees include, but are not limited to, regulatory expenses, investigator fees, travel costs, and other miscellaneous costs, including shipping and printing fees. We expense the costs of pass through fees under our CRO contracts as they are incurred, based on the best information available to us at the time. The estimates of the pass through fees incurred are based on the amount of work completed for the clinical trial and are monitored through correspondence with the CROs, internal reviews and a review of contractual terms. The factors utilized to derive the estimates include the number of patients enrolled, duration of the clinical trial, estimated patient attrition, screening rate and length of the dosing regimen. CRO fees incurred to set up the clinical trial are expensed during the setup period.

 

Under our clinical trial collaboration agreements, we may be reimbursed for certain development costs incurred.  Such costs are recorded as a reduction of research and development expense in the period in which the related expense is incurred.

 

Stock Compensation.  Share-based payment transactions with employees, which include stock options, restricted stock units (“RSUs”) and performance shares (“PSUs”), are recognized as compensation expense over the requisite service period based on their estimated fair values on the dates of grant.  The stock compensation process requires significant judgment and the use of estimates, particularly surrounding Black-Scholes assumptions such as stock price volatility over the option term and expected option lives, as well as expected forfeiture rates and the probability of PSUs vesting.  The fair value of stock options, which are subject to graded vesting, are recognized as compensation expense over the requisite service period using the accelerated attribution method.  The fair value of RSUs, which are generally subject to cliff vesting, are recognized as compensation expense over the requisite service period using the straight line attribution method.  The fair value of PSUs are recognized as compensation expense beginning at the time in which the performance conditions are deemed probable of achievement, over the remaining requisite service period. We recorded $15.5 million and $46.3 million of stock compensation expense on our unaudited condensed consolidated statements of operations for the three and nine months ended September 30, 2014, respectively. We recorded $9.5 million and $28.6 million of stock compensation expense on our unaudited condensed consolidated statements of operations for the three and nine months ended September 30, 2013, respectively.

 

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Recent Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, “Revenue from Contracts with Customers,” which provides a five-step approach to be applied to all contracts with customers.  ASU No. 2014-09 also requires expanded disclosures about revenue recognition.  ASU No. 2014-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods.  We are currently analyzing the impact of ASU No. 2014-09 on our results of operations and, at this time, we are unable to determine the impact, if any.

 

3.     Fair value of financial instruments

 

FASB accounting guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability (“the exit price”) in an orderly transaction between market participants at the measurement date. The standard outlines a valuation framework and creates a fair value hierarchy in order to increase the consistency and comparability of fair value measurements and the related disclosures. In determining fair value we use quoted prices and observable inputs. Observable inputs are inputs that market participants would use in pricing the asset or liability based on market data obtained from sources independent of us. The fair value hierarchy is broken down into three levels based on the source of inputs as follows:

 

Level 1—Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities.

 

Level 2—Valuations based on observable inputs and quoted prices in active markets for similar assets and liabilities.

 

Level 3—Valuations based on inputs that are unobservable and models that are significant to the overall fair value measurement.

 

Our marketable securities consist of investments in U.S. government agencies, corporate debt securities and non-agency mortgage-backed securities that are classified as available-for-sale.

 

At September 30, 2014 and December 31, 2013, our Level 2 corporate debt securities and mortgage-backed securities are valued using readily available pricing sources which utilize market observable inputs, including the current interest rate and other characteristics for similar types of instruments.

 

The following fair value hierarchy table presents information about each major category of our financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2014 (in thousands):

 

 

 

Fair Value Measurement at Reporting Date Using:

 

 

 

 

 

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

 

Significant Other
Observable
Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Balance as of
September 30,
2014

 

Cash and cash equivalents

 

$

382,004

 

$

 

$

 

$

382,004

 

Corporate debt securities

 

 

146,697

 

 

146,697

 

Mortgage-backed securities

 

 

3,658

 

 

3,658

 

Total assets

 

$

382,004

 

$

150,355

 

$

 

$

532,359

 

 

The following fair value hierarchy table presents information about each major category of our financial assets measured at fair value on a recurring basis as of December 31, 2013 (in thousands):

 

 

 

Fair Value Measurement at Reporting Date Using:

 

 

 

 

 

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

 

Significant Other
Observable
Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Balance as of
December 31, 2013

 

Cash and cash equivalents

 

$

471,429

 

$

 

$

 

$

471,429

 

Corporate debt securities

 

 

33,655

 

 

33,655

 

Mortgage-backed securities

 

 

3,920

 

 

3,920

 

Total assets

 

$

471,429

 

$

37,575

 

$

 

$

509,004

 

 

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The following is a summary of our marketable security portfolio as of September 30, 2014 and December 31, 2013, respectively.

 

 

 

Amortized
Cost

 

Net
Unrealized
Gains

 

Net
Unrealized
Losses

 

Estimated
Fair Value

 

 

 

(in thousands)

 

September 30, 2014

 

 

 

 

 

 

 

 

 

Corporate debt securities

 

$

146,920

 

$

 

$

(223

)

$

146,697

 

Mortgage backed securities

 

1,517

 

2,141

 

 

3,658

 

 

 

$

148,437

 

$

2,141

 

$

(223

)

$

150,355

 

December 31, 2013

 

 

 

 

 

 

 

 

 

Corporate debt securities

 

$

33,685

 

$

 

$

(30

)

$

33,655

 

Mortgage backed securities

 

1,897

 

2,023

 

 

3,920

 

 

 

$

35,582

 

$

2,023

 

$

(30

)

$

37,575

 

 

Our corporate debt securities generally have contractual maturity dates of between 12 to 18 months. Because of the potential for prepayment on mortgage-backed securities, they are not categorized by contractual maturity.

 

4.     Concentration of Credit Risk

 

In December 2009, we entered into a license, development and commercialization agreement with Eli Lilly and Company (“Lilly”). In November 2009, we entered into a collaboration and license agreement with Novartis. The concentration of credit risk related to our collaborative partners is as follows:

 

 

 

Percentage of Total
Contract Revenues for the
Three Months Ended September 30,

 

Percentage of Total
Contract Revenues for the
Nine Months Ended September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

 

 

 

 

 

 

 

 

Collaboration Partner A

 

96

%

81

%

91

%

87

%

Collaboration Partner B

 

4

%

19

%

9

%

13

%

 

Collaboration Partner A and Collaboration Partner B comprised in the aggregate 66% and 28% of the accounts receivable balance as of September 30, 2014 and December 31, 2013, respectively.

 

Our product revenues are concentrated in a limited number of specialty pharmacy customers. The concentration of credit risk related to our specialty pharmacy customers is as follows:

 

 

 

Percentage of Total Net
Product Revenues for the
Three Months Ended September 30,

 

Percentage of Total Net
Product Revenues for the
Nine Months Ended September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Customer A

 

29

%

29

%

29

%

29

%

Customer B

 

23

%

15

%

22

%

17

%

Customer C

 

10

%

12

%

10

%

11

%

Customer D

 

8

%

10

%

10

%

11

%

 

We are exposed to risks associated with extending credit to specialty pharmacy customers related to the sale of products. Customer A, Customer B, Customer C and Customer D comprised in the aggregate 25% and 49% of the accounts receivable balance as of September 30, 2014 and December 31, 2013, respectively.

 

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5.     Inventory

 

Our inventory balance consists of the following:

 

 

 

September 30,
2014

 

December 31,
2013

 

 

 

(in thousands)

 

Raw materials

 

$

591

 

$

591

 

Work-in-process

 

16,938

 

14,346

 

Finished goods

 

402

 

406

 

 

 

17,931

 

15,343

 

Inventories—current

 

402

 

406

 

Inventories—non-current

 

$

17,529

 

$

14,937

 

 

Inventories, stated at the lower of cost or market, consist of raw materials, work in process and finished goods. At September 30, 2014, $0.4 million of inventory was classified as current on the consolidated balance sheets as we expect this inventory to be consumed for commercial use within the next twelve months. At September 30, 2014, $17.5 million of inventory was classified as non-current on the consolidated balance sheets as we did not expect this inventory to be consumed for commercial use within the next twelve months. We obtain a number of inventory components from single source suppliers due to technology, availability, price, quality or other considerations. The loss of a single source supplier, the deterioration of its relationship with a single source supplier, or any unilateral violation of the contractual terms under which we are supplied components by a single source supplier could adversely affect our total revenues and gross margins.

 

The raw materials and work-in-process inventory is not subject to expiration and the shelf life for finished goods inventory is 24 or 36 months from the start of manufacturing of the finished goods. We evaluate for potential excess inventory by analyzing current and future product demand relative to the remaining product shelf life. We build demand forecasts by considering factors such as, but not limited to, overall market potential, market share, market acceptance and patient usage.

 

6.     Property and Equipment

 

Property and equipment consists of the following:

 

 

 

September 30,
2014

 

December 31,
2013

 

 

 

(in thousands)

 

Office equipment

 

$

2,469

 

$

2,332

 

Laboratory equipment

 

21,384

 

20,228

 

Computer equipment

 

15,458

 

13,930

 

Leasehold improvements

 

2,517

 

2,454

 

Assets under construction

 

68,313

 

20,377

 

 

 

110,141

 

59,321

 

Less accumulated depreciation and amortization

 

(34,883

)

(32,473

)

 

 

$

75,258

 

$

26,848

 

 

In 2013, we entered into a lease agreement for a new corporate headquarters, which consists of approximately 190,000 square feet of laboratory and office space located in Wilmington, Delaware. The term of this lease is 15 years from the date of commencement. The lease commenced on October 1, 2014 with a monthly lease rate of $0.5 million for the first 10 years of the lease with the monthly lease rate increasing annually during the last five years of lease.

 

We will account for the lease as a direct financing arrangement whereby over the construction period, we recorded the value of the facility (consisting of the estimated fair value of the existing shell, plus construction costs to be incurred) as a capital asset, with a corresponding lease liability, net of approximately $10.8 million of build out costs to be paid for by us during the construction period. In addition, we have posted a $15.0 million letter of credit for the facility lease for the benefit of the landlord, which is collateralized by a restricted investments account for the same amount. This amount was recorded as restricted investments on the consolidated balance sheets and will be reduced over a period of time during the duration of the lease. The letter of credit could be subject to accelerated reductions if we meet certain pre-defined financial targets.

 

Through September 30, 2014 we recorded a total of $68.3 million of assets under construction within property and equipment on our consolidated balance sheet, which consisted of the estimated fair value of the existing shell of $15.2 million prior to the build out, and

 

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a total of $53.1 million of build-out costs recorded through September 30, 2014. We have paid a total of $19.4 million through September 30, 2014 for our portion of the build out and other costs incurred through that date. The corresponding lease liability of $48.9 million is included within other liabilities on the consolidated balance sheet at September 30, 2014.

 

7.     License agreements

 

In November 2009, we entered into a Collaboration and License Agreement with Novartis. Under the terms of the agreement, Novartis received exclusive development and commercialization rights outside of the United States to our JAK inhibitor ruxolitinib and certain back-up compounds for hematologic and oncology indications, including all hematological malignancies, solid tumors and myeloproliferative diseases. We retained exclusive development and commercialization rights to JAKAFI (ruxolitinib) in the United States and in certain other indications. Novartis also received worldwide exclusive development and commercialization rights to our c-MET inhibitor compound INC280 (INCB28060) and certain back-up compounds in all indications. We retained options to co-develop and to co-promote INC280 in the United States.

 

Under this agreement, we received an upfront payment and immediate milestone payment totaling $210.0 million and were initially eligible to receive up to $1.2 billion in milestone payments across multiple indications upon the achievement of pre-specified events, including up to $174.0 million for the achievement of development milestones, up to $495.0 million for the achievement of regulatory milestones and up to $500.0 million for the achievement of commercialization milestones.  As of September 30, 2014, we have recognized in the aggregate $97.0 million for the achievement of development milestones and $135.0 million for the achievement of regulatory milestones.

 

During the nine months ended September 30, 2014, under this agreement, we recognized a $60.0 million regulatory milestone related to reimbursement of JAKAVI® (ruxolitinib) in Europe, recognized and received a $25.0 million regulatory milestone for the approval of JAKAVI in Japan for the treatment of patients with myelofibrosis and a $7.0 million development milestone based on the formal initiation by Novartis of a Phase II clinical trial evaluating INC280 in non-small cell lung cancer.  In 2013, we recognized and received a $25.0 million development milestone payment under this agreement based on the formal initiation by Novartis of a Phase II clinical trial evaluating INC280. In 2012, we recognized and received a $40.0 million regulatory milestone payment under this agreement for the achievement of a predefined milestone for the European Union regulatory approval of Jakavi. In 2011, we recognized and received a $15.0 million development milestone payment under this agreement for the achievement of a predefined milestone in the Phase I dose-escalation trial for INC280 in patients with solid tumors and a $10.0 million regulatory milestone payment for the approval of JAKAFI in the United States. We determined the 2014, 2013, 2012 and 2011 milestones to be substantive as their achievement required substantive efforts by us and was at risk until the milestones were ultimately achieved. We also are eligible to receive tiered, double-digit royalties ranging from the upper-teens to the mid-twenties on future ruxolitinib net sales outside of the United States. Since the achievement of the $60.0 million regulatory milestone related to reimbursement of JAKAVI in Europe, we are obligated to pay to Novartis tiered royalties in the low single digits on future ruxolitinib net sales within the United States. Each company is responsible for costs relating to the development and commercialization of ruxolitinib in its respective territories, with costs of collaborative studies shared equally. Novartis is responsible for all costs relating to the development and commercialization of INC280 after the initial Phase I clinical trial, which has been completed.

 

The Novartis agreement will continue on a program-by-program basis until Novartis has no royalty payment obligations with respect to such program or, if earlier, the termination of the agreement or any program in accordance with the terms of the agreement. Royalties are payable by Novartis on a product-by-product and country-by-country basis until the latest to occur of (1) the expiration of the last valid claim of the licensed patent rights covering the licensed product in the relevant country, (2) the expiration of regulatory exclusivity for the licensed product in such country and (3) a specified period from first commercial sale in such country of the licensed product by Novartis or its affiliates or sublicensees. The agreement may be terminated in its entirety or on a program-by-program basis by Novartis for convenience. The agreement may also be terminated by either party under certain other circumstances, including material breach.

 

We determined that there were two deliverables under the agreement: (i) the ex U.S. license for ruxolitinib and (ii) our obligations in connection with our participation on the joint development committee for myelofibrosis and polycythemia vera/essential thrombocythemia. We concluded that these deliverables should be accounted for as a single unit of accounting and the $150.0 million upfront payment received in December 2009 and the immediate $60.0 million milestone payment received in January 2010 should be recognized on a straight line basis through December 2013, when we estimated we would complete our obligations in connection with our participation on the joint development committee for myelofibrosis and polycythemia vera, our estimated performance period under the agreement. We completed this substantive performance obligation related to this arrangement in December 2013.

 

At December 31, 2009, we recorded $10.9 million of reimbursable costs incurred prior to the effective date of the agreement as deferred revenue on the condensed consolidated balance sheet. These costs were recognized on a straight line basis through

 

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December 2013 consistent with the aforementioned upfront and milestone payments. Future reimbursable costs incurred after the effective date of the agreement with Novartis will be recorded net against the related research and development expenses. At September 30, 2014 and December 31, 2013, $0.7 million and $1.7 million, respectively, of reimbursable costs were included in accounts receivable on the condensed consolidated balance sheets. Research and development expenses for the three and nine months ended September 30, 2014 were net of $0.5 million and $2.7 million, respectively, of costs reimbursed by Novartis. Research and development expenses for the three and nine months ended September 30, 2013 were net of $1.7 million and $3.6 million, respectively, of costs reimbursed by Novartis.

 

Contract revenue under the Novartis agreement was $85.0 million and $92.0 million for the three and nine months ended September 30, 2014, respectively. Contract revenue under the Novartis agreement was $13.5 million and $65.6 million for the three and nine months ended September 30, 2013, respectively.

 

Lilly

 

In December 2009, we entered into a License, Development and Commercialization Agreement with Lilly. Under the terms of the agreement, Lilly received exclusive worldwide development and commercialization rights to our JAK inhibitor baricitinib, and certain back-up compounds for inflammatory and autoimmune diseases. We received an upfront payment of $90.0 million, and were initially eligible to receive up to $665.0 million in substantive milestone payments across multiple indications upon the achievement of pre-specified events, including up to $150.0 million for the achievement of development milestones, up to $365.0 million for the achievement of regulatory milestones and up to $150.0 million for the achievement of commercialization milestones. As of September 30, 2014, we have recognized and received in the aggregate $99.0 million for the achievement of development milestones.

 

In 2012, we recognized a $50.0 million development milestone under this agreement for the achievement of a predefined milestone for the initiation of the rheumatoid arthritis Phase III program for baricitinib. In 2010, we recognized and received a $30.0 million development milestone payment based upon the initial three month data in the Phase IIa clinical trial of baricitinib for the treatment of rheumatoid arthritis and a $19.0 million development milestone payment for the Phase IIb clinical trial initiation of baricitinib for the treatment of rheumatoid arthritis. We determined the 2012 and 2010 milestones to be substantive as their achievement required substantive efforts by us and was at risk until the milestones were ultimately achieved. We also could receive tiered, double-digit royalty payments on future global net sales with rates ranging up to 20% if the product is successfully commercialized.

 

We retained options to co-develop our JAK inhibitors with Lilly on a compound-by-compound and indication-by-indication basis. Lilly will be responsible for all costs relating to the development and commercialization of the compounds unless we elect to co-develop any compounds or indications. If we elect to co-develop any compounds and/or indications, we would be responsible for funding 30% of the associated future global development costs from the initiation of a Phase IIb trial through regulatory approval. We would receive an incremental royalty rate increase across all tiers resulting in effective royalty rates ranging up to the high twenties on potential future global net sales for compounds and/or indications that we elect to co-develop. We also retained an option to co-promote products in the United States. In July 2010, we elected to co-develop baricitinib with Lilly in rheumatoid arthritis and we are responsible for funding 30% of the associated future global development costs for this indication from the initiation of the Phase IIb trial through regulatory approval. We have retained certain mechanisms to give us cost protection as baricitinib advances in clinical development. We can defer our portion of co-development study costs by indication if they exceed a predetermined level. This deferment would be credited against future milestones or royalties and we would still be eligible for the full incremental royalties related to the co-development option. In addition, even if we have started co-development funding for any indication, we can at any time opt out and stop future co-development cost sharing. If we elect to do this we would still be eligible for our base royalties plus an incremental pro-rated royalty commensurate with our contribution to the total co-development cost for those indications for which we co-funded. The Lilly agreement will continue until Lilly no longer has any royalty payment obligations or, if earlier, the termination of the agreement in accordance with its terms. Royalties are payable by Lilly on a product-by-product and country- by-country basis until the latest to occur of (1) the expiration of the last valid claim of the licensed patent rights covering the licensed product in the relevant country, (2) the expiration of regulatory exclusivity for the licensed product in such country and (3) a specified period from first commercial sale in such country of the licensed product by Lilly or its affiliates or sublicensees. The agreement may be terminated by Lilly for convenience, and may also be terminated under certain other circumstances, including material breach.

 

We determined that there were two deliverables under the agreement: (i) the worldwide license and (ii) our obligations in connection with a co-development option. We concluded that these deliverables should be accounted for as a single unit of accounting and the $90.0 million upfront payment should be recognized on a straight line basis as revenue through December 2016, our estimated performance period under the agreement. Reimbursable costs incurred after the effective date with Lilly will be recorded net against the related research and development expenses. Contract revenue under the Lilly agreement was $3.2 million and $9.6 million, respectively, for each of the three and nine months ended September 30, 2014 and 2013.

 

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8.     Stock compensation

 

We recorded $15.5 million and $46.3 million of stock compensation expense on our unaudited condensed consolidated statements of operations for the three and nine months ended September 30, 2014, respectively. We recorded $9.5 million and $28.6 million of stock compensation expense on our unaudited condensed consolidated statements of operations for the three and nine months ended September 30, 2013, respectively.

 

Stock compensation expense included within our condensed consolidated statements of operations included research and development expense of $8.4 million, $25.2 million, $6.4 million and $19.6 million for the three and nine months ended September 30, 2014 and 2013, respectively. Stock compensation expense included within our condensed consolidated statements of operations also included selling, general and administrative expense of $7.1 million, $21.1 million, $3.1 million and $9.0 million for the three and nine months ended September 30, 2014 and 2013, respectively.

 

We utilized the Black-Scholes valuation model for estimating the fair value of the stock compensation granted, with the following weighted-average assumptions:

 

 

 

Employee Stock Options

 

Employee Stock Purchase Plan

 

 

 

For the
Three
Months
Ended

 

For the
Nine
Months
Ended

 

For the
Three
Months
Ended

 

For the
Nine
Months
Ended

 

 

 

September 30,

 

September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

2014

 

2013

 

2014

 

2013

 

Average risk-free interest rates

 

1.30

%

1.05

%

1.21

%

0.59

%

0.56

%

0.27

%

0.56

%

0.27

%

Average expected life (in years)

 

4.50

 

4.34

 

4.54

 

4.25

 

0.50

 

0.50

 

0.50

 

0.50

 

Volatility

 

51

%

47

%

51

%

47

%

48

%

53

%

48

%

51

%

Weighted-average fair value (in dollars)

 

21.82

 

12.18

 

25.56

 

7.34

 

9.36

 

3.84

 

9.36

 

3.81

 

 

The risk-free interest rate is derived from the U.S. Federal Reserve rate in effect at the time of grant. The expected life calculation is based on the observed and expected time to the exercise of options by our employees based on historical exercise patterns for similar type options. Expected volatility is based on the historical volatility of our common stock over the period commensurate with the expected life of the options. A dividend yield of zero is assumed based on the fact that we have never paid cash dividends and have no present intention to pay cash dividends.

 

The following table summarizes activity under all stock option plans:

 

 

 

Shares
Available for
Grant

 

Number
Outstanding

 

Weighted
Average
Exercise
Price per
Share

 

Balance at December 31, 2013

 

5,376,614

 

20,123,089

 

$

15.16

 

Shares added

 

3,400,000

 

 

 

Options granted

 

(1,769,143

)

1,769,143

 

60.15

 

RSUs and PSUs granted

 

(805,092

)

805,092

 

 

Options exercised

 

 

(5,159,405

)

11.77

 

Options cancelled

 

195,037

 

(195,037

)

27.13

 

PSUs and RSUs cancelled

 

14,800

 

(14,800

)

 

Balance at September 30, 2014

 

6,412,216

 

17,328,082

 

$

20.89

 

Exercisable, September 30, 2014

 

 

11,424,384

 

$

14.66

 

 

In January 2014, we began granting RSUs and PSUs to our employees at the share price on the date of grant.   Each RSU represents the right to acquire one share of our common stock. We granted a total of 349,766 RSUs during the nine months ended September 30, 2014 which will cliff vest in three years and will be recognized as stock compensation expense over this period.  Also, in January 2014, Hervé Hoppenot, our President and Chief Executive Officer, was granted a one-time grant of 400,000 RSUs outside of our 2010 Stock Incentive Plan. Vesting of the RSUs will be subject to Mr. Hoppenot’s continued employment on the applicable

 

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vesting dates, with one-sixth of the RSUs vesting at the end of each of the calendar years 2014 through 2019, subject to earlier acceleration of vesting upon the occurrence of certain events in accordance with the terms of his employment agreement.

 

We granted a total of 55,326 PSUs during the nine months ended September 30, 2014.  The PSUs contain performance conditions which are not deemed probable of achievement at September 30, 2014, therefore, no stock compensation expense has been recognized during the nine months ended September 30, 2014 for these awards.  We will begin to recognize stock compensation expense for these awards when and if the performance conditions are deemed probable of achievement.  The actual number of shares of our common stock into which each PSU may convert are subject to a multiplier of up to 125% based on the level at which the performance conditions are achieved.

 

Based on our historical experience of employee turnover, we have assumed an annualized forfeiture rate of 5% for our options and RSUs.  Under the true-up provisions of the stock compensation guidance, we will record additional expense if the actual forfeiture rate is lower than we estimated, and will record a recovery of prior expense if the actual forfeiture is higher than we estimated.

 

Total compensation cost of options and RSUs granted but not yet vested, as of September 30, 2014, was $59.4 million, for which the cost of the options and RSUs are expected to be recognized over the weighted average period of 3.0 years.  Total compensation cost of PSUs granted but not yet vested, as of September 30, 2014, was $3.5 million which will begin to be recognized should the performance conditions be deemed probable of occurrence.

 

9.     Debt

 

The components of the convertible notes are as follows (in thousands):

 

 

 

 

 

 

 

Carrying Amount

 

Debt

 

2014 Interest Rates
September 30

 

Maturities

 

September 30,
2014

 

December 31,
2013

 

4.75% Convertible Senior Notes due 2015

 

4.75

%

2015

 

$

84,483

 

$

84,193

 

0.375% Convertible Senior Notes due 2018

 

0.375

%

2018

 

311,258

 

301,037

 

1.25% Convertible Senior Notes due 2020

 

1.25

%

2020

 

285,572

 

276,337

 

Less current portion

 

 

 

 

 

 

 

 

 

 

 

 

 

$

681,313

 

$

661,567

 

 

The carrying amount and fair value of our convertible notes are as follows (in thousands):

 

 

 

September 30, 2014

 

December 31, 2013

 

 

 

Carrying
Amount

 

Fair Value

 

Carrying
Amount

 

Fair Value

 

4.75% Convertible Senior Notes due 2015

 

$

84,483

 

$

509,092

 

$

84,193

 

$

556,272

 

0.375% Convertible Senior Notes due 2018

 

311,258

 

446,955

 

301,037

 

448,350

 

1.25% Convertible Senior Notes due 2020

 

285,572

 

455,393

 

276,337

 

454,913

 

 

 

$

681,313

 

$

1,411,440

 

$

661,567

 

$

1,459,535

 

 

The fair values of the 4.75% Convertible Senior Notes due 2015 (the “2015 Notes”), the 0.375% Convertible Senior Notes due 2018 (the “2018 Notes”) and the 1.25% Convertible Senior Notes due 2020 (the “2020 Notes”) are based on data from readily available pricing sources which utilize market observable inputs and other characteristics for similar types of instruments, and, therefore, these convertible notes are classified within Level 2 in the fair value hierarchy. During the nine months ended September 30, 2014, we entered into a negotiated agreement with a holder of the 2015 Notes pursuant to which the holder agreed to exchange $4.9 million aggregate principal amount of the 2015 Notes for the shares of our stock into which the 2015 Notes were convertible, aggregating 0.6 million shares, and $0.3 million in cash. We recorded $0.3 million in debt exchange expense on senior note conversions for the nine months ended September 30, 2014.

 

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10.    Net income (loss) per share

 

Net income (loss) per share was calculated as follows for the periods indicated:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

(in thousands, except per share data)

 

2014

 

2013

 

2014

 

2013

 

Basic Net Income (Loss) Per Share

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

59,293

 

$

(22,037

)

$

(11,538

)

$

(40,276

)

Weighted average common shares outstanding

 

168,592

 

155,067

 

167,288

 

143,899

 

 

 

 

 

 

 

 

 

 

 

Basic net income (loss) per share

 

$

0.35

 

$

(0.14

)

$

(0.07

)

$

(0.28

)

 

 

 

 

 

 

 

 

 

 

Diluted Net Income (Loss) Per Share

 

 

 

 

 

 

 

 

 

Diluted net income (loss)

 

$

62,167

 

$

(22,037

)

$

(11,538

)

$

(40,276

)

 

 

 

 

 

 

 

 

 

 

Common shares outstanding (weighted average)

 

168,592

 

155,067

 

167,288

 

143,899

 

Dilutive stock options and RSU’s

 

10,038

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Dilutive 2015 Notes

 

10,416

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares used to compute diluted net income (loss) per share

 

189,046

 

155,067

 

167,288

 

143,899

 

 

 

 

 

 

 

 

 

 

 

Diluted net income (loss) per share

 

$

0.33

 

$

(0.14

)

$

(0.07

)

$

(0.28

)

 

The following potential common shares were excluded from the calculations as their effect would be anti-dilutive:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Stock options

 

2,275,884

 

21,065,995

 

17,328,082

 

21,065,995

 

Common shares issuable upon conversion of the 2015 Notes

 

 

24,958,298

 

10,415,861

 

24,958,298

 

Common shares issuable upon conversion of the 2018 Notes

 

7,245,263

 

 

7,245,263

 

 

Common shares issuable upon conversion of the 2020 Notes

 

7,245,263

 

 

7,245,263

 

 

Total potential common shares excluded from diluted net loss per share computation

 

16,766,410

 

46,024,293

 

42,234,469

 

46,024,293

 

 

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

 

The following discussion of our financial condition and results of operations as of and for the three and nine months ended September 30, 2014 should be read in conjunction with the condensed consolidated financial statements and notes to those statements included elsewhere in this Quarterly Report on Form 10-Q and our audited consolidated financial statements as of and for the year ended December 31, 2013 included in our Annual Report on Form 10-K for the year ended December 31, 2013 previously filed with the SEC.

 

This report contains forward-looking statements that involve risks and uncertainties. These statements relate to future periods, future events or our future operating or financial plans or performance. Often, these statements include the words “believe,” “expect,” “target,” “anticipate,” “intend,” “plan,” “seek,” “estimate,” “potential,” or words of similar meaning, or future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” or “may,” or the negative of these terms, and other similar expressions. These forward-looking statements include statements as to:

 

·                  the discovery, development, formulation, manufacturing and commercialization of our compounds, our drug candidates and JAKAFI®/JAKAVI® (ruxolitinib);

 

·                  conducting clinical trials internally, with collaborators, or with clinical research organizations;

 

·                  our collaboration and strategic relationship strategy; anticipated benefits and disadvantages of entering into collaboration agreements;

 

·                  our licensing, investment and commercialization strategies, including our plans to commercialize JAKAFI;

 

·                  the regulatory approval process, including obtaining U.S. Food and Drug Administration and other international health authorities approval for our products in the United States and abroad;

 

·                  the safety, effectiveness and potential benefits and indications of our drug candidates and other compounds under development;

 

·                  the timing and size of our clinical trials; the compounds expected to enter clinical trials; timing of clinical trial results;

 

·                  our ability to manage expansion of our drug discovery and development operations;

 

·                  future required expertise relating to clinical trials, manufacturing, sales and marketing;

 

·                  obtaining and terminating licenses to products, compounds or technology, or other intellectual property rights;

 

·                  the receipt from or payments pursuant to collaboration or license agreements resulting from milestones or royalties;

 

·                  plans to develop and commercialize products on our own;

 

·                  plans to use third party manufacturers;

 

·                  expected expenses and expenditure levels; expected uses of cash; expected revenues and sources of revenues;

 

·                  expected losses; fluctuation of losses;

 

·                  our profitability; the adequacy of our capital resources to continue operations;

 

·                  the need to raise additional capital;

 

·                  the costs associated with resolving matters in litigation;

 

·                  our expectations regarding competition;

 

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·                  our investments, including anticipated expenditures, losses and expenses;

 

·                  our patent prosecution and maintenance efforts; and

 

·                  our indebtedness, and debt service obligations.

 

These forward-looking statements reflect our current views with respect to future events, are based on assumptions and are subject to risks and uncertainties. These risks and uncertainties could cause actual results to differ materially from those projected and include, but are not limited to:

 

·                  our ability to successfully commercialize JAKAFI;

 

·                  our ability to maintain at anticipated levels, reimbursement for JAKAFI from government health administration authorities, private health insurers and other organizations;

 

·                  our ability to establish and maintain effective sales, marketing and distribution capabilities;

 

·                  the risk of reliance on other parties to manufacture JAKAFI, which could result in a short supply of JAKAFI, increased costs, and withdrawal of regulatory approval;

 

·                  our ability to maintain regulatory approvals to market JAKAFI;

 

·                  our ability to achieve a significant market share in order to achieve or maintain profitability;

 

·                  the risk of civil or criminal penalties if we market JAKAFI in a manner that violates health care fraud and abuse and other applicable laws, rules and regulations;

 

·                  our ability to discover, develop, formulate, manufacture and commercialize our drug candidates;

 

·                  the risk of unanticipated delays in research and development efforts;

 

·                  the risk that previous preclinical testing or clinical trial results are not necessarily indicative of future clinical trial results;

 

·                  risks relating to the conduct of our clinical trials;

 

·                  changing regulatory requirements;

 

·                  the risk of adverse safety findings;

 

·                  the risk that results of our clinical trials do not support submission of a marketing approval application for our drug candidates;

 

·                  the risk of significant delays or costs in obtaining regulatory approvals;

 

·                  risks relating to our reliance on third party manufacturers, collaborators, and clinical research organizations;

 

·                  risks relating to the development of new products and their use by us and our current and potential collaborators;

 

·                  risks relating to our inability to control the development of out-licensed compounds or drug candidates;

 

·                  risks relating to our collaborators’ ability to develop and commercialize drug candidates;

 

·                  costs associated with prosecuting, maintaining, defending and enforcing patent claims and other intellectual property rights;

 

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·                  our ability to maintain or obtain adequate product liability and other insurance coverage;

 

·                  the risk that our drug candidates may not obtain or maintain regulatory approval;

 

·                  the impact of technological advances and competition;

 

·                  our ability to compete against third parties with greater resources than ours;

 

·                  risks relating to changes in pricing and reimbursements in the markets in which we may compete;

 

·                  competition to develop and commercialize similar drug products;

 

·                  our ability to obtain patent protection and freedom to operate for our discoveries and to continue to be effective in expanding our patent coverage;

 

·                  the impact of changing laws on our patent portfolio;

 

·                  developments in and expenses relating to litigation;

 

·                  our ability to in-license compounds or drug candidates or other technology;

 

·                  our substantial leverage;

 

·                  our ability to obtain additional capital when needed;

 

·                  fluctuations in net cash provided and used by operating, financing and investing activities;

 

·                  our history of operating losses; and

 

·                  the risks set forth under “Risk Factors.”

 

Given these risks and uncertainties, you should not place undue reliance on these forward-looking statements. Except as required by federal securities laws, we undertake no obligation to update any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.

 

In this report all references to “Incyte,” “we,” “us,” “our” or the “Company” mean Incyte Corporation and our subsidiaries, except where it is made clear that the term means only the parent company.

 

Incyte and JAKAFI are our registered trademarks. We also refer to trademarks of other corporations and organizations in this Quarterly Report on Form 10-Q.

 

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Overview

 

Incyte is a biopharmaceutical company focused on the discovery, development and commercialization of proprietary small molecule drugs to treat serious unmet medical needs. We began our drug discovery and development operations in 2001, and our research efforts are primarily in oncology, where we believe our expertise in target selection, medicinal chemistry, and preclinical and clinical development can be most effectively leveraged.  In November 2011, JAKAFI® (ruxolitinib) became commercially available in the United States as a treatment for patients with intermediate or high-risk myelofibrosis (MF), a rare, life-threatening blood cancer. JAKAFI is marketed in the United States through our own specialty sales force and commercial team. Under our collaboration agreement with Novartis International Pharmaceutical Ltd., Novartis received exclusive development and commercialization rights to ruxolitinib outside of the United States for all hematologic and oncologic indications and sells ruxolitinib outside of the United States under the name JAKAVI®.

 

In 2003, we initiated a research and development program to explore the inhibition of enzymes called janus associated kinases (JAK). The JAK family is composed of four tyrosine kinases—JAK1, JAK2, JAK3 and Tyk2—that are involved in the signaling of a number of cytokines and growth factors. JAKs are central to a number of biologic processes, including the formation and development of blood cells and the regulation of immune functions. Dysregulation of the JAK-STAT signaling pathway has been associated with a number of diseases, including myeloproliferative neoplasms, other hematological malignancies, solid tumors, rheumatoid arthritis, psoriasis and other chronic inflammatory diseases. Myeloproliferative neoplasms are a closely related group of blood diseases in which blood cells, specifically platelets, white blood cells, and red blood cells, grow or act abnormally in the bone marrow. These diseases include myelofibrosis, polycythemia vera and essential thrombocythemia.

 

We have discovered multiple potent, selective and orally bioavailable JAK inhibitors that are selective for JAK1 or JAK1 and JAK2. JAKAFI is the most advanced compound in our JAK program. It is an oral JAK1 and JAK2 inhibitor and was approved by the U.S. Food and Drug Administration (FDA) in November 2011 as a treatment for patients with intermediate or high-risk MF, which includes primary MF, post-polycythemia vera MF and post-essential thrombocythemia MF. We estimate there are between 16,000 and 18,500 patients with MF in the United States. Based on the modern prognostic scoring systems referred to as International Prognostic Scoring System and Dynamic International Prognostic Scoring System, we believe intermediate and high-risk patients represent 80 percent to 90 percent of all patients with MF in the United States and encompass patients over the age of 65, or patients who have or have ever had any of the following: anemia, constitutional symptoms, elevated white blood cell or blast counts, or platelet counts less than 100,000 per microliter of blood.

 

JAKAFI was the first FDA-approved JAK inhibitor for any indication and the first product approved for use in MF. The FDA has also granted JAKAFI orphan drug status for MF as well as for polycythemia vera (PV) and essential thrombocythemia. In August 2012, the European Commission approved ruxolitinib as JAKAVI for the treatment of disease-related splenomegaly or symptoms in adult patients with primary MF (also known as chronic idiopathic MF), post-polycythemia vera MF or post-essential thrombocythemia MF. We have retained all development and commercialization rights to JAKAFI in the United States and are eligible to receive development and commercial milestones as well as royalties from product sales outside the United States. We hold patents that cover the composition of matter and use of ruxolitinib through late 2027, excluding additional potential patent term extensions.  We believe ruxolitinib may have potential as a treatment for other cancers.

 

In June 2014, we presented full results from RESPONSE, the registration trial of ruxolitinib in patients with advanced polycythemia vera (PV), conducted under a special protocol assessment (SPA) agreement with the FDA.  The trial, comparing ruxolitinib to best available therapy, met its primary endpoint of achieving phlebotomy independence and reducing spleen size by 35 percent or more.  The safety profile of ruxolitinib was generally consistent with previous studies.  Global submissions seeking regulatory approval of ruxolitinib in PV are underway, and the supplemental New Drug Application (sNDA) for ruxolitinib as a potential treatment for patients with PV who have had an inadequate response to or are intolerant of hydroxyurea was submitted to the FDA in June 2014. The Prescription Drug User Fee Act (PDUFA) date for the sNDA for ruxolitinib in PV is December 5, 2014.

 

In July 2014, we announced that the RELIEF trial measuring disease-related symptoms in patients with PV did not meet its primary endpoint of the proportion of subjects achieving at least a  50% reduction in a cluster of PV-related symptoms at week 16 compared to baseline, although positive trends in favor of ruxolitinib versus continued hydroxyurea were observed. Further analyses of RELIEF have been conducted, supporting the underpowering of the study, and the results of these analyses are expected to be presented at an upcoming scientific meeting.

 

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Full results from the Phase II proof-of-concept RECAP trial of ruxolitinib in patients with refractory metastatic pancreatic cancer were presented in June 2014 and suggest a demonstrable survival benefit in a pre-specified subgroup of patients with elevated C-reactive protein (CRP). The Company and the FDA have agreed on an SPA for a registration trial for advanced or metastatic pancreatic cancer. Under the SPA, the Phase III JANUS 1 trial can be limited to patients with elevated CRP and there is no requirement to develop a companion diagnostic. The global Phase III program includes a second nearly identical Phase III trial, JANUS 2. JANUS 1 initiated in March 2014, and JANUS 2 initiated in June 2014. The FDA has granted orphan status for ruxolitinib for the treatment of pancreatic cancer.

 

Elevated CRP has negative prognostic significance in many tumor types, and we believe that JAK inhibition may represent a new treatment approach for other solid tumors. To test this hypothesis, we have initiated three blinded proof-of-concept Phase II trials evaluating ruxolitinib in non-small cell lung cancer, breast cancer and colorectal cancer. The primary endpoint for each trial will be overall survival.

 

We have a second oral JAK1 and JAK2 inhibitor, baricitinib, which is subject to a collaboration agreement with Eli Lilly and Company in which Lilly received exclusive worldwide development and commercialization rights for the compound for inflammatory and autoimmune diseases. We could receive tiered, double-digit royalty payments on future global sales of products subject to the agreement with rates ranging up to 20 percent if the products are successfully commercialized. This collaboration also contains an option for us to co-develop compounds for any inflammatory and autoimmune disease, whereby we fund 30 percent of development costs from Phase IIb through regulatory approval for that indication in exchange for tiered royalties ranging up to the high twenties on potential future sales. We exercised our co-development option for the development of baricitinib in rheumatoid arthritis in 2010. The Phase III program of baricitinib in patients with rheumatoid arthritis is ongoing. Baricitinib is also in Phase II trials for patients with moderate-to-severe psoriasis and patients with diabetic nephropathy. We have decided not to exercise our co-development option for psoriasis, and the timeframe for exercising our co-development option for diabetic nephropathy has not yet occurred.

 

We have a portfolio of wholly-owned JAK1 inhibitors. Our lead JAK1 inhibitor, INCB39110, has completed proof-of-concept studies in patients with psoriasis, rheumatoid arthritis and myelofibrosis. While the results of the psoriasis and rheumatoid arthritis studies were positive, for strategic reasons, we are pursuing oncologic indications with INCB39110.  The clinical program to evaluate INCB39110 in solid tumors includes one ongoing Phase I open-label safety study in combination with gemcitabine and nab-paclitaxel and two blinded proof-of-concept Phase II trials in non-small cell lung cancer.  The first Phase II trial was initiated in the second quarter of 2014, and both trials are designed with overall survival as the primary endpoint.  Our second JAK1 inhibitor, INCB47986, was in a Phase II proof-of-concept trial in patients with rheumatoid arthritis. Based on recent preclinical toxicological findings we have terminated the clinical development of this compound. These preclinical toxicological findings have not been observed in any other of our JAK inhibitor programs.

 

We have an oral IDO1 inhibitor, INCB24360, which belongs to a new class of agents known as immuno-oncology agents. IDO1 is an enzyme whose increased levels in multiple solid tumor types are associated with decreased survival. IDO1 inhibition shifts the immune system from an immunosuppressive state to an activated state, allowing the body to mount a more effective anti-tumor immune response. While preclinical data suggest that IDO1 inhibition can provide anti-tumor effects as monotherapy, based on the significant synergy exhibited in combination with checkpoint inhibitors as well as emerging clinical data, we believe that the optimal development strategy for our IDO1 inhibitor is in combination with other immuno-oncology therapies. The Phase I/II dose-ranging trial of INCB24360 in combination with ipilimumab for metastatic melanoma has completed enrollment, but for strategic reasons we have decided to focus the current development of INCB24360 in combination with anti-PD-1 and anti-PD-L1 therapies.

 

We have four clinical trial agreements in place to evaluate the safety and efficacy of INCB24360 in combination with four different checkpoint inhibitors: Merck’s anti-PD-1 immunotherapy, pembrolizumab; MedImmune’s investigational anti-PD-L1 immunotherapy, MEDI4736; Bristol-Myers Squibb’s investigational anti-PD-1 immunotherapy, nivolumab; and Genentech’s investigational anti-PD-L1 immunotherapy, MPDL3280A. These four agreements are non-exclusive and involve multiple tumor types, including non-small cell lung, melanoma, ovarian, colorectal, squamous cell carcinoma of the head and neck, pancreatic and diffuse large B-cell lymphoma.  The Phase I/II trial of INCB24360 in combination with pembrolizumab has been initiated.

 

We have other orally available small molecule compounds that are in various stages of clinical development, including a PI3K-delta inhibitor, INCB40093, which is being studied as both monotherapy and in combination with our JAK1 inhibitor, INCB39110, in patients with B-lymphoid malignancies.

 

We have a number of programs in preclinical development, and we intend to continue our investment in drug discovery to expand our pipeline.

 

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Our current pipeline includes the following compounds:

 

Target/Drug Compound

 

Indication

 

Status

ONCOLOGY

 

 

 

 

JAK1 and JAK2

 

 

 

 

JAKAFI(1)

 

Intermediate or High-Risk Myelofibrosis(7)

 

FDA Approved—Marketed

Ruxolitinib(1)

 

Polycythemia Vera

 

Phase III — sNDA Submitted

Ruxolitinib(1)

 

Pancreatic Cancer

 

Phase III

Ruxolitinib(1)

 

Advanced Malignancies

 

Phase I

Ruxolitinib(1)

 

Breast Cancer

 

Phase II

Ruxolitinib(1)

 

Non-Small Cell Lung Cancer

 

Phase II

Ruxolitinib(1)

 

Colorectal Cancer

 

Phase II

JAK1

 

 

 

 

INCB39110

 

Advanced Malignancies

 

Phase I

INCB39110

 

Non-Small Cell Lung Cancer

 

Phase II

 

 

 

 

 

PI3K-delta

 

 

 

 

INCB40093

 

B-lymphoid Malignancies

 

Phase I

JAK1+PI3K-delta

 

 

 

 

INCB39110+INCB40093

 

B-lymphoid Malignancies

 

Phase I

IDO1

 

 

 

 

INCB24360

 

Metastatic Melanoma

 

Phase II

INCB24360(2)

 

Non-Small Cell Lung Cancer

 

Phase I/II

c-MET

 

 

 

 

INC280(3)

 

Solid Tumors

 

Phase I/II

INC280(3)

 

Hepatocellular Carcinoma

 

Phase II

INC280(3)

 

Non-Small Cell Lung Cancer

 

Phase II

 

 

 

 

 

INFLAMMATION

 

 

 

 

JAK1 and JAK2

 

 

 

 

Baricitinib(4)

 

Rheumatoid Arthritis

 

Phase III

Baricitinib(5)

 

Psoriasis

 

Phase IIb

Baricitinib(6)

 

Diabetic Nephropathy

 

Phase II

 


(1)                                 We licensed rights outside the United States to Novartis and retained U.S. rights.

 

(2)                                 In combination with Merck’s anti-PD-1 immunotherapy, pembrolizumab (MK-3475).

 

(3)                                 We licensed worldwide rights to Novartis and retained co-development and co-promotion options.

 

(4)                                 We licensed worldwide rights to Lilly, have elected to co-develop with Lilly, and retained a co-promotion option.

 

(5)                                We licensed worldwide rights to Lilly and retained a co-promotion option.

 

(6)                                 We licensed worldwide rights to Lilly and retained co-development and co-promotion options.

 

(7)                                 Several clinical trials in patients with myelofibrosis are ongoing, including long-term extension studies, alternative dosing studies, joint global trials with Novartis and trials in patients with low platelet counts.

 

The therapeutic and commercial value of new medicines is difficult to predict, and conducting clinical trials for our drug candidates in development is a lengthy, time-consuming and expensive process. Therefore, if we are unable to successfully commercialize JAKAFI or develop and commercialize some of our other drug candidates over the next several years, our business, financial condition and results of operations would be adversely impacted. To date, we have not, and we may never, achieve sustained revenues sufficient to offset expenses. We may incur net losses in future periods, and we may never achieve or maintain profitability. We also expect that our operating results may fluctuate from period to period and that those fluctuations may be substantial.

 

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Critical Accounting Policies and Significant Estimates

 

The preparation of financial statements requires us to make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an on-going basis, we evaluate our estimates. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form our basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from those estimates under different assumptions or conditions.

 

We believe the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our consolidated financial statements:

 

·                                                                  Revenue recognition;

 

·                                                                  Research and development costs;

 

·                                                                  Stock compensation;

 

·                                                                  Investments;

 

·                                                                  Inventory; and

 

·                                                                  Convertible debt accounting

 

Revenue Recognition. Revenues are recognized when (1) persuasive evidence of an arrangement exists, (2) delivery has occurred or services have been rendered, (3) the price is fixed or determinable and (4) collectability is reasonably assured. Revenues are deferred for fees received before earned or until no further obligations exist. We exercise judgment in determining that collectability is reasonably assured or that services have been delivered in accordance with the arrangement. We assess whether the fee is fixed or determinable based on the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment. We assess collectability based primarily on the customer’s payment history and on the creditworthiness of the customer. Our product revenues consist of U.S. sales of JAKAFI and are recognized once we meet all four revenue recognition criteria described above. In November 2011, we began shipping JAKAFI to our specialty pharmacy customers, which in turn dispense JAKAFI to patients in fulfillment of prescriptions.

 

We recognize revenues for product received by our specialty pharmacy customers net of allowances for customer credits, including estimated rebates, chargebacks, discounts, returns, distribution service fees, patient assistance programs, and Medicare Part D coverage gap reimbursements. Product shipping and handling costs are included in cost of product revenues.

 

Customer Credits:  Our specialty pharmacy customers are offered various forms of consideration, including allowances, service fees and prompt payment discounts. We expect our specialty pharmacy customers will earn prompt payment discounts and, therefore, we deduct the full amount of these discounts from total product sales when revenues are recognized. Service fees are also deducted from total product sales as they are earned.

 

Rebates:  Allowances for rebates include mandated discounts under the Medicaid Drug Rebate Program. Rebate amounts are based upon contractual agreements or legal requirements with public sector (e.g. Medicaid) benefit providers. Rebates are amounts owed after the final dispensing of the product to a benefit plan participant and are based upon contractual agreements or legal requirements with public sector benefit providers. The accrual for rebates is based on statutory discount rates and expected utilization as well as historical data we have accumulated since product launch. Our estimates for expected utilization of rebates are based on data received from our specialty pharmacy customers. Rebates are generally invoiced and paid in arrears so that the accrual balance consists of an estimate of the amount expected to be incurred for the current quarter’s activity, plus an accrual balance for known prior quarters’ unpaid rebates. If actual future rebates vary from estimates, we may need to adjust prior period accruals, which would affect revenue in the period of adjustment.

 

Chargebacks:  Chargebacks are discounts that occur when contracted customers purchase directly from a specialty pharmacy, or an intermediary distributor. Contracted customers, which currently consist primarily of Public Health Service institutions, non-profit clinics, and Federal government entities purchasing via the Federal Supply Schedule, generally purchase the product at a discounted price. The specialty pharmacy or distributor, in turn, charges back to us the difference between the price initially paid by the specialty pharmacy or distributor and the discounted price paid to the specialty pharmacy or distributor by the customer. The accrual for chargebacks is based on the estimated contractual discounts on the inventory levels on hand in our distribution channel. If actual

 

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future chargebacks vary from estimates, we may need to adjust prior period accruals, which would affect revenue in the period of adjustment.

 

Medicare Part D Coverage Gap:  Medicare Part D prescription drug benefit mandates manufacturers to fund 50% of the Medicare Part D insurance coverage gap for prescription drugs sold to eligible patients. Our estimates for the expected Medicare Part D coverage gap are based on historical invoices received and in part from data received from our specialty pharmacy customers. Funding of the coverage gap is generally invoiced and paid in arrears so that the accrual balance consists of an estimate of the amount expected to be incurred for the current quarter’s activity, plus an accrual balance for known prior quarters. If actual future funding varies from estimates, we may need to adjust prior period accruals, which would affect revenue in the period of adjustment.

 

Co-payment assistance:  Patients who have commercial insurance and meet certain eligibility requirements may receive co-payment assistance. We accrue a liability for co-payment assistance based on actual program participation and estimates of program redemption using data provided by third-party administrators.

 

Product Royalty Revenues

 

Royalty revenues on commercial sales for JAKAVI by Novartis are estimated based on information provided by Novartis. We exercise judgment in determining whether the information provided is sufficiently reliable for us to base our royalty revenue recognition thereon. If actual royalties vary from estimates, we may need to adjust prior period which would affect royalty revenue in the period of adjustment.

 

Contract and License Revenues

 

Under agreements involving multiple deliverables, services and/or rights to use assets that we entered into prior to January 1, 2011, the multiple elements are divided into separate units of accounting when certain criteria are met, including whether the delivered items have stand-alone value to the customer and whether there is objective and reliable evidence of the fair value of the undelivered items. When separate units of accounting exist, consideration is allocated among the separate elements based on their respective fair values. The determination of fair value of each element is based on objective evidence from historical sales of the individual elements by us to other customers. If such evidence of fair value for each undelivered element of the arrangement does not exist, all revenue from the arrangement is deferred until such time that evidence of fair value for each undelivered element does exist or until all elements of the arrangement are delivered. When elements are specifically tied to a separate earnings process, revenue is recognized when the specific performance obligation tied to the element is completed. When revenues for an element are not specifically tied to a separate earnings process, they are recognized ratably over the term of the agreement. We assess whether a substantive milestone exists at the inception of our agreements. For all milestones within our arrangements that are considered substantive, we recognize revenue upon the achievement of the associated milestone. If a milestone is not considered substantive, we would recognize the applicable milestone payment over the remaining period of performance under the arrangement. As of September 30, 2014, all remaining potential milestones under our collaborative arrangements are considered substantive.

 

On January 1, 2011, updated guidance on the recognition of revenues for agreements with multiple deliverables became effective and applies to any agreements we may enter into on or after January 1, 2011. This updated guidance (i) relates to whether multiple deliverables exist, how the deliverables in a revenue arrangement should be separated and how the consideration should be allocated; (ii) requires companies to allocate revenues in an arrangement using estimated selling prices of deliverables if a vendor does not have vendor-specific objective evidence or third-party evidence of selling price; and (iii) eliminates the use of the residual method and requires companies to allocate revenues using the relative selling price method. During the three and nine months ended September 30, 2014 and 2013, we did not enter into any agreements that are subject to this updated guidance. If we enter into an agreement with multiple deliverables after January 1, 2011 or amend existing agreements, this updated guidance could have a material effect on our financial statements.

 

Our collaborations often include contractual milestones, which typically relate to the achievement of pre-specified development, regulatory and commercialization events. These three categories of milestone events reflect the three stages of the life-cycle of our drugs, which we describe in more detail in the following paragraphs.

 

The regulatory review and approval process, which includes preclinical testing and clinical trials of each drug candidate, is lengthy, expensive and uncertain. Securing approval by the U.S. Food and Drug Administration (FDA) requires the submission of extensive preclinical and clinical data and supporting information to the FDA for each indication to establish a drug candidate’s safety and efficacy. The approval process takes many years, requires the expenditure of substantial resources, involves post-marketing surveillance and may involve ongoing requirements for post-marketing studies. Before commencing clinical investigations of a drug candidate in humans, we must submit an Investigational New Drug application (IND), which must be reviewed by the FDA.

 

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The steps generally required before a drug may be marketed in the United States include preclinical laboratory tests, animal studies and formulation studies, submission to the FDA of an IND for human clinical testing, performance of adequate and well-controlled clinical trials in three phases, as described below, to establish the safety and efficacy of the drug for each indication, submission of a new drug application (NDA) to the FDA for review and FDA approval of the NDA.

 

Similar requirements exist within foreign regulatory agencies as well. The time required to satisfy the FDA requirements or similar requirements of foreign regulatory agencies may vary substantially based on the type, complexity and novelty of the product or the targeted disease.

 

Preclinical testing includes laboratory evaluation of product pharmacology, drug metabolism, and toxicity, which includes animal studies, to assess potential safety and efficacy as well as product chemistry, stability, formulation, development, and testing. The results of the preclinical tests, together with manufacturing information and analytical data, are submitted to the FDA as part of an IND. The FDA may raise safety concerns or questions about the conduct of the clinical trials included in the IND, and any of these concerns or questions must be resolved before clinical trials can proceed. We cannot be sure that submission of an IND will result in the FDA allowing clinical trials to commence. Clinical trials involve the administration of the investigational drug or the marketed drug to human subjects under the supervision of qualified investigators and in accordance with good clinical practices regulations covering the protection of human subjects. Clinical trials typically are conducted in three sequential phases, but the phases may overlap or be combined. Phase I usually involves the initial introduction of the investigational drug into healthy volunteers to evaluate its safety, dosage tolerance, absorption, metabolism, distribution and excretion. Phase II usually involves clinical trials in a limited patient population to evaluate dosage tolerance and optimal dosage, identify possible adverse effects and safety risks, and evaluate and gain preliminary evidence of the efficacy of the drug for specific indications. Phase III clinical trials usually further evaluate clinical efficacy and safety by testing the drug in its final form in an expanded patient population, providing statistical evidence of efficacy and safety, and providing an adequate basis for labeling. We cannot guarantee that Phase I, Phase II or Phase III testing will be completed successfully within any specified period of time, if at all. Furthermore, we, the institutional review board for a trial, or the FDA may suspend clinical trials at any time on various grounds, including a finding that the subjects or patients are being exposed to an unacceptable health risk.

 

Generally, the milestone events contained in our collaboration agreements coincide with the progression of our drugs from development, to regulatory approval and then to commercialization. The process of successfully discovering a new development candidate, having it approved and successfully commercialized is highly uncertain. As such, the milestone payments we may earn from our partners involve a significant degree of risk to achieve. Therefore, as a drug candidate progresses through the stages of its life-cycle, the value of the drug candidate generally increases.

 

Research and Development Costs.  Our policy is to expense research and development costs as incurred. We often contract with clinical research organizations (CROs) to facilitate, coordinate and perform agreed upon research and development of a new drug. To ensure that research and development costs are expensed as incurred, we record monthly accruals for clinical trials and preclinical testing costs based on the work performed under the contract.

 

These CRO contracts typically call for the payment of fees for services at the initiation of the contract and/or upon the achievement of certain clinical trial milestones. In the event that we prepay CRO fees, we record the prepayment as a prepaid asset and amortize the asset into research and development expense over the period of time the contracted research and development services are performed. Most professional fees, including project and clinical management, data management, monitoring, and medical writing fees are incurred throughout the contract period. These professional fees are expensed based on their percentage of completion at a particular date. Our CRO contracts generally include pass through fees. Pass through fees include, but are not limited to, regulatory expenses, investigator fees, travel costs, and other miscellaneous costs, including shipping and printing fees. We expense the costs of pass through fees under our CRO contracts as they are incurred, based on the best information available to us at the time. The estimates of the pass through fees incurred are based on the amount of work completed for the clinical trial and are monitored through correspondence with the CROs, internal reviews and a review of contractual terms. The factors utilized to derive the estimates include the number of patients enrolled, duration of the clinical trial, estimated patient attrition, screening rate and length of the dosing regimen. CRO fees incurred to set up the clinical trial are expensed during the setup period.

 

Under our clinical trial collaboration agreements, we may be reimbursed for certain development costs incurred.  Such costs are recorded as a of reduction research and development expense in the period in which the related expense is incurred.

 

Stock Compensation.  Share-based payment transactions with employees, which include stock options, restricted stock units (RSUs) and performance shares (PSUs), are recognized as compensation expense over the requisite service period based on their estimated fair values on the dates of grant.  The stock compensation process requires significant judgment and the use of estimates, particularly

 

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surrounding Black-Scholes assumptions such as stock price volatility over the option term and expected option lives, as well as expected forfeiture rates and the probability of PSUs vesting.  The fair value of stock options, which are subject to graded vesting, are recognized as compensation expense over the requisite service period using the accelerated attribution method.  The fair value of RSUs, which are generally subject to cliff vesting, are recognized as compensation expense over the requisite service period using the straight line attribution method.  The fair value of PSUs are recognized as compensation expense beginning at the time in which the performance conditions are deemed probable of achievement, over the remaining requisite service period. We recorded $15.5 million and $46.3 million of stock compensation expense for the three and nine months ended September 30, 2014, respectively.  We recorded $9.5 million and $28.6 million of stock compensation expense for the three and nine months ended September 30, 2013, respectively.

 

Investments.  We carry our investments at their respective fair values. We periodically evaluate the fair values of our investments to determine whether any declines in the fair value of investments represent an other-than-temporary impairment. This evaluation consists of a review of several factors, including the length of time and extent that a security has been in an unrealized loss position, the existence of an event that would impair the issuer’s future repayment potential, the near term prospects for recovery of the market value of a security and if we intend to sell or if it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis. If management determines that such an impairment exists, we would recognize an impairment charge. Because we may determine that market or business conditions may lead us to sell our marketable securities prior to maturity, we classify our marketable securities as “available-for-sale.” Investments in securities that are classified as available-for-sale and have readily determinable fair values are measured at fair market value in the balance sheets, and unrealized holding gains and losses for these investments are reported as a separate component of stockholders’ equity until realized. We classify marketable securities that are available for use in current operations as current assets on the consolidated balance sheets.

 

Inventory.  Inventories are determined at the lower of cost or market value with cost determined under the specific identification method and may consist of raw materials, work in process and finished goods. We began capitalizing inventory in mid-November 2011 once the FDA approved JAKAFI as the related costs were expected to be recoverable through the commercialization of the product. Costs incurred prior to approval of JAKAFI have been recorded as research and development expense in our statements of operations. As a result, cost of product revenues for approximately the next 24 to 27 months will reflect a lower average per unit cost of materials.

 

The raw materials and work-in-process inventory is not subject to expiration and the shelf life for finished goods inventory is 24 or 36 months from the start of manufacturing of the finished goods. We evaluate for potential excess inventory by analyzing current and future product demand relative to the remaining product shelf life. We build demand forecasts by considering factors such as, but not limited to, overall market potential, market share, market acceptance and patient usage. We classify inventory as current on the consolidated balance sheets when we expect inventory to be consumed for commercial use within the next twelve months.

 

Convertible Debt Accounting.  We perform an assessment of all embedded features of a debt instrument to determine if (1) such features should be bifurcated and separately accounted for, and (2) if bifurcation requirements are met, whether such features should be classified and accounted for as equity or liability instruments. If the embedded feature meets the requirements to be bifurcated and accounted for as a liability, the fair value of the embedded feature is measured initially, included as a liability on the consolidated balance sheet, and re-measured to fair value at each reporting period. Any changes in fair value are recorded in the consolidated statement of operations. We monitor, on an ongoing basis, whether events or circumstances could give rise to a change in our classification of embedded features.

 

We determined the embedded conversion options in the 0.375% convertible senior notes due 2018 (the 2018 Notes) and the 1.25% convertible senior notes due 2020 (the 2020 Notes) are not required to be separately accounted for as derivatives. However, since the 2018 Notes and the 2020 Notes can be settled in cash or common shares or a combination of cash and common shares at our option, we are required to separate the 2018 Notes and 2020 Notes into a liability and equity component. The carrying amount of the liability component is calculated by measuring the fair value of a similar liability 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. The excess of the principal amount of the liability component over its carrying amount is amortized to interest expense over the expected life of the 2018 Notes and 2020 Notes using the effective interest method. The equity component is not re-measured as long as it continues to meet the conditions for equity classification for contracts in an entity’s own equity.

 

The fair value of the liability component of the 2018 notes was estimated at $299.4 million at issuance. Therefore, the difference between the $375.0 million face value of the 2018 Notes and the $299.4 million estimated fair value of the liability component will be amortized to interest expense over the term of the 2018 Notes through November 15, 2018 using the effective interest method.

 

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The fair value of the liability component of the 2020 Notes was estimated at $274.8 million at issuance. Therefore, the difference between the $375.0 million face value of the 2020 Notes and the $274.8 million estimated fair value of the liability component will be amortized to interest expense over the term of the 2020 Notes through November 15, 2020 using the effective interest method.

 

The estimated fair value of the liability components at the date of issuance for the 2018 Notes and 2020 Notes were determined using valuation models and are complex and subject to judgment. Significant assumptions within the valuation models included an implied credit spread, the expected volatility and dividend yield of our common stock and the risk free interest rate for notes with a similar term.

 

Recent Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board issued ASU No. 2014-09, “Revenue from Contracts with Customers,” which provides a five-step approach to be applied to all contracts with customers.  ASU No. 2014-09 also requires expanded disclosures about revenue recognition.  ASU No. 2014-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods.  We are currently analyzing the impact of ASU No. 2014-09 on our results of operations and, at this time, we are unable to determine the impact, if any.

 

Results of Operations

 

We recorded net income of $59.3 million and basic and diluted net income per share of $0.35 and $0.33, respectively, for the three months ended September 30, 2014, as compared to a net loss of $22.0 million and basic and diluted net loss per share of $0.14 in the corresponding period in 2013.  We recorded a net loss of $11.5 million and basic and diluted net loss per share of $0.07 for the nine months ended September 30, 2014, as compared to a net loss of $40.3 million and basic and diluted net loss per share of $0.28 in the corresponding period in 2013.

 

Revenues.

 

 

 

For the Three Months Ended,
September 30,

 

For the Nine Months Ended,
September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

(in millions)

 

(in millions)

 

Product revenues, net

 

$

97.8

 

$

60.2

 

$

251.5

 

$

162.6

 

Product royalty revenues

 

12.1

 

8.2

 

34.3

 

19.9

 

Contract revenues

 

88.2

 

16.7

 

101.6

 

75.2

 

Other revenues

 

 

 

0.1

 

0.2

 

Total revenues

 

$

198.1

 

$

85.1

 

$

387.5

 

$

257.9

 

 

Our product revenues, net from JAKAFI for the three and nine months ended September 30, 2014, were $97.8 million and $251.5 million, respectively. Our product revenues, net from JAKAFI for the three and nine months ended September 30, 2013, were $60.2 million and $162.6 million, respectively. The increase in net product revenues from JAKAFI for the three and nine months ended September 30, 2014, respectively, as compared to the corresponding periods in 2013 is related to growth in underlying demand.  Product revenues from the sale of JAKAFI are recorded net of estimated product returns, pricing discounts including rebates offered pursuant to mandatory federal and state government programs and chargebacks, prompt pay discounts and distribution fees and co-pay assistance. Our revenue recognition policies require estimates of the aforementioned sales allowances each period.

 

The following table provides a summary of activity with respect to our sales allowances and accruals for the nine months ended September 30, 2014:

 

Nine Months Ended September 30, 2014

 

Discounts and
Distribution
Fees

 

Government
Rebates and
Chargebacks

 

Co-Pay
Assistance
and Other
Discounts

 

Product
Returns

 

Total

 

Balance at January 1, 2014

 

$

803

 

$

3,435

 

$

108

 

$

292

 

$

4,638

 

Allowances for current period sales

 

7,682

 

20,809

 

630

 

761

 

29,882

 

Allowances for prior period sales

 

(9

)

(188

)

 

 

(197

)

Credits/payments for current period sales

 

(6,794

)

(16,125

)

(526

)

(226

)

(23,671

)

Credits/payments for prior period sales

 

(274

)

(2,394

)

(61

)

(552

)

(3,281

)

Balance at September 30, 2014

 

$

1,408

 

$

5,537

 

$

151

 

$

275

 

$

7,371

 

 

Product royalty revenues on commercial sales of JAKAVI by Novartis are based on net sales of licensed products in licensed territories as provided by Novartis. Our net product royalty revenues for the three and nine months ended September 30, 2014, were

 

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$12.1 million and $34.3 million, respectively.  Our net product royalty revenues for the three and nine months ended September 30, 2013, were $8.2 million and $19.9 million, respectively.

 

Our contract revenues were $88.2 million and $101.6 million for the three and nine months ended September 30, 2014, respectively. Our contract revenues were $16.7 million and $75.2 million for the three and nine months ended September 30, 2013, respectively. Contract revenues were derived from the straight line recognition of revenue associated with the Novartis and Lilly upfront fees over the estimated performance periods as well as milestone payments earned during the periods. The upfront fees related to the Novartis agreement included a $150.0 million upfront payment received in 2009, a $60.0 million immediate milestone payment received in 2010 and $10.9 million of reimbursable costs incurred prior to the effective date of the agreement. The upfront fees related to the Lilly agreement consisted of a $90.0 million upfront payment received in 2010.  During the nine months ended September 30, 2014, under the Novartis agreement, we recognized a $60.0 million regulatory milestone related to reimbursement of JAKAVI® in Europe, recognized and received a $25.0 million regulatory milestone for the approval of JAKAVI in Japan for the treatment of patients with myelofibrosis and a $7.0 million development milestone based on the formal initiation by Novartis of a Phase II clinical trial evaluating INC280 in non-small cell lung cancer.  For the three and nine months ended September 30, 2013 contract revenues included a $25.0 million milestone payment from Novartis for INC280.

 

Cost of Product Revenues

 

We began capitalizing inventory in mid-November 2011 once the FDA approved JAKAFI as the related costs were expected to be recoverable through the commercialization of the product. Costs incurred prior to FDA approval of $9.6 million were recorded as research and development expenses in our statements of operations prior to commercialization of JAKAFI. At September 30, 2014, inventory with $2.6 million of product costs incurred prior to FDA approval had not yet been sold. We expect to sell the pre- commercialization inventory over the next 24 to 27 months; however, the time period over which this inventory is consumed will depend on a number of factors, including the amount of future JAKAFI sales, and the ability to utilize inventory prior to its expiration date. As a result, cost of product revenues for approximately the next 24 to 27 months will reflect a lower average per unit cost of materials. Cost of product revenues was $0.2 million and $0.6 million for the three and nine months ended September 30, 2014, respectively. Cost of product revenues was $0.2 million and $0.5 million for the three and nine months ended September 30, 2013, respectively. We expect future cost of product revenues to range in the mid-single digits as a percentage of net product sales subsequent to the utilization of all of the remaining pre-launch inventory.

 

Operating Expenses.

 

Research and development expenses.

 

 

 

For the Three Months Ended,
September 30,

 

For the Nine Months Ended,
September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

(in millions)

 

(in millions)

 

Salary and benefits related

 

$

24.6

 

$

16.9

 

$

66.8

 

$

50.8

 

Stock compensation

 

8.4

 

6.4

 

25.2

 

19.6

 

Clinical research and outside services

 

47.7

 

41.1

 

133.1

 

94.1

 

Occupancy and all other costs

 

7.8

 

7.3

 

23.7

 

20.9

 

 

 

 

 

 

 

 

 

 

 

Total research and development expenses

 

$

88.5

 

$

71.7

 

$

248.8

 

$

185.4

 

 

We currently track research and development costs by natural expense line and not costs by project. Salary and benefits related expense increased from the three and nine months ended September 30, 2013 to three and nine months ended September 30, 2014 due to increased development headcount to sustain our development pipeline. Stock compensation expense may fluctuate from period to period based on the number of awards granted, stock price volatility and expected option lives, as well as expected option forfeiture rates which are used to value equity-based compensation. The increase in clinical research and outside services expense from the three and nine months ended September 30, 2013 to the three and nine months ended September 30, 2014 was primarily the result of increased development costs to advance our clinical pipeline. Research and development expenses for the three and nine months ended September 30, 2014 and 2013 were net of $0.9 million, $3.1 million, $1.7 million and $3.6 million, respectively, of costs reimbursed by our collaborative partners. Research and development expenses may fluctuate from period to period depending upon the stage of certain projects and the level of pre-clinical and clinical trial related activities. Many factors can affect the cost and timing of our clinical trials, including requests by regulatory agencies for more information, inconclusive results requiring additional clinical trials, slow patient enrollment, adverse side effects among patients, insufficient supplies for our clinical trials and real or perceived lack of effectiveness or safety of our investigational drugs in our clinical trials. In addition, the development of all of our products will be subject to extensive governmental regulation. These factors make it difficult for us to predict the timing and costs of the further development and approval of our products.

 

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In July 2010, we elected to co-develop baricitinib with Lilly in rheumatoid arthritis and we are responsible for funding 30% of the associated future global development costs for this indication from the initiation of the Phase IIb trial through regulatory approval. We have retained certain mechanisms to give us cost protection as baricitinib advances in clinical development. We can defer our portion of co-development study costs by indication if they exceed a predetermined level. This deferment would be credited against future milestones or royalties and we would still be eligible for the full incremental royalties related to the co-development option. In addition, even if we have started co-development funding for any indication, we can at any time opt out, which will stop future co-development cost sharing. If we elect to do this we would still be eligible for our base royalties plus an incremental pro-rated royalty commensurate with our contribution to the total co-development cost for those indications for which we contributed funding.

 

Selling, general and administrative expenses.

 

 

 

For the Three Months Ended,
September 30,

 

For the Nine Months Ended,
September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

(in millions)

 

(in millions)

 

Salary and benefits related

 

$

13.0

 

$

8.7

 

$

37.7

 

$

24.9

 

Stock compensation

 

7.1

 

3.1

 

21.1

 

9.0

 

Other contract service and outside costs

 

19.3

 

14.6

 

58.5

 

38.1

 

 

 

 

 

 

 

 

 

 

 

Total selling, general and administrative expenses

 

$

39.4

 

$

26.4

 

$

117.3

 

$

72.0

 

 

Salary and benefits related expense increased from the three and nine months ended September 30, 2013 to the three and nine months ended September 30, 2014 due to increased headcount. This increased headcount was due to the commercialization efforts related to JAKAFI for intermediate or high-risk myelofibrosis. Stock compensation expense may fluctuate from period to period based on the number of awards granted, stock price volatility and expected option lives, as well as expected option forfeiture rates which are used to value equity-based compensation. The increase in other contract services and outside costs was primarily the result of increased marketing activities for JAKAFI for intermediate or high-risk myelofibrosis and preparation for the anticipated launch in polycythemia vera.

 

Interest Expense.    Interest expense for the three and nine months ended September 30, 2014 was $11.4 million and $34.3 million, respectively as compared to $7.7 million and $29.7 million, respectively, for the same periods in 2013.  Included in interest expense for the three and nine months ended September 30, 2014, were $8.9 million and $26.6 million, respectively, of non-cash charges to amortize the discounts on our 4.75% convertible senior notes due 2015 (the 2015 Notes), the 2018 Notes and the 2020 Notes as compared to $4.7 million and $17.9 million, respectively, to amortize the discounts on the 2015 Notes for the same periods in 2013.

 

Debt exchange expense on senior note conversions.  Debt exchange expense on senior note conversions for the three and nine months ended September 30, 2014, was $0.0 million and $0.3 million, respectively, and was related to the exchange of $4.9 million in aggregate principal amount of our 2015 Notes for the underlying shares of common stock and cash.   Debt exchange expense for the three and nine months ended September 30, 2013, was $1.5 million and $11.3 million, respectively, related to the exchange of $37.3 million and $181.0 million, respectively, in aggregate principal amount of 2015 Notes for the underlying shares of common stock and cash.

 

Liquidity and Capital Resources

 

We had net losses from inception in 1991 through 1996 and in 1999 through September 30, 2014. Because of those losses, we had an accumulated deficit of $1.7 billion as of September 30, 2014. We have funded our research and development operations through sales of equity securities, the issuance of convertible notes, cash received from customers, and collaborative arrangements. At September 30, 2014, we had available cash, cash equivalents and marketable securities of $532.4 million. Our cash and marketable securities balances are held in a variety of interest-bearing instruments, including money market accounts, corporate debt securities and U.S. government agency and non-agency mortgage-backed securities. Available cash is invested in accordance with our investment policy’s primary objectives of liquidity, safety of principal and diversity of investments.

 

Net cash used in operating activities was $18.5 million for the nine months ended September 30, 2014, compared to $20.9 million provided by operating activities for the nine months ended September 30, 2013.  The $39.4 million decrease was due primarily to our lower net loss and changes in accounts receivable.

 

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Our investing activities, other than purchases, sales and maturities of marketable securities, have consisted predominantly of capital expenditures.  Net cash used in investing activities was $134.9 million for the nine months ended September 30, 2014, which represented purchases of marketable securities of $113.3 million and capital expenditures of $22.0 million offset in part by maturities of marketable securities of $0.4 million.  Net cash used in investing activities was $17.5 million for the nine months ended September 30, 2013, which represented a certificate of deposit purchase of $15.0 million, capital expenditures of $2.3 million and maturities of marketable securities of $0.2 million.  In the future, net cash used by investing activities may fluctuate significantly from period to period due to the timing of capital expenditures, maturities/sales and purchases of marketable securities, strategic equity investments and acquisitions.

 

Net cash provided by financing activities was $64.0 million for the nine months ended September 30, 2014, primarily representing proceeds from the issuance of common stock under our stock plans and employee stock purchase plan. Net cash provided by financing activities was $44.6 million for the nine months ended September 30, 2013, primarily representing $55.9 million of proceeds from the issuance of common stock under our stock plans and employee stock purchase plan offset in part by $11.3 million of cash paid in connection with the conversion of $181.0 million aggregate principal amount of the 2015 Notes.

 

The following summarizes our significant contractual obligations as of September 30, 2014 and the effect those obligations are expected to have on our liquidity and cash flow in future periods (in millions):

 

 

 

Total

 

Less Than
1 Year

 

Years
1 - 3

 

Years
4 - 5

 

Over
5 Years

 

Contractual Obligations:

 

 

 

 

 

 

 

 

 

 

 

Principal on convertible senior debt

 

$

841.4

 

$

 

$

91.4

 

$

375.0

 

$

375.0

 

Interest on convertible senior debt

 

43.3

 

10.4

 

14.4

 

11.5

 

7.0

 

Non-cancelable lease obligations:

 

 

 

 

 

 

 

 

 

 

 

Related to current corporate headquarters

 

1.7

 

1.7

 

 

 

 

Related to new corporate headquarters

 

89.9

 

6.5

 

12.1

 

12.1

 

59.2

 

Total contractual obligations

 

$

976.3

 

$

18.6

 

$

117.9

 

$

398.6

 

$

441.2

 

 

In April 2013, we entered into a new facility lease agreement for approximately 190,000 square feet of laboratory and office space in Wilmington, Delaware. The lease agreement was contingent on the landlord’s ability to design the build-out of the facility based on a targeted construction budget and the landlord’s ability to secure funding for its obligations in connection with the build-out of the facility.

 

The lease agreement became effective in October 2013 upon the resolution of these contingencies and the lease commenced on October 1, 2014. The future minimum lease payments over the 15 year lease term are approximately $84.6 million, which excludes the remaining $1.3 million of build-out costs to be paid by us. We will account for the lease as a direct financing arrangement whereby over the construction period, we  recorded the full cost of the facility as a capital asset, with a corresponding liability, net of approximately $10.8 million of improvements to be paid for by us during the construction period. In addition, we have posted a $15.0 million letter of credit for the facility lease for the benefit of the landlord. This amount is recorded as restricted investments on the consolidated balance sheets and will be reduced over a period of time during the duration of the lease. The letter of credit could be subject to accelerated reductions if we meet certain pre-defined financial targets.

 

We have entered into and may in the future seek to license additional rights relating to technologies or drug development candidates in connection with our drug discovery and development programs. Under these licenses, we may be required to pay up-front fees, milestone payments, and royalties on sales of future products. The table above does not reflect any future potential payments.

 

We believe that our cash, cash equivalents and marketable securities will be adequate to satisfy our capital needs for at least the next twelve months. Our cash requirements depend on numerous factors, including our expenditures in connection with our drug discovery and development programs and commercialization operations; expenditures in connection with litigation or other legal proceedings; competing technological and market developments; the cost of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights; our receipt of any milestone or other payments under any collaborative agreements we may enter into, including the agreements with Novartis, Lilly and Pfizer; the extent to which commercialization of JAKAFI is successful; expenditures in connection with potential exchanges of our outstanding convertible senior notes; and expenditures in connection with strategic relationships and license agreements, strategic equity investments or potential acquisitions. Changes in our research and development or commercialization plans or other changes affecting our operating expenses may result in changes in the timing and amount of expenditures of our capital resources.

 

Until we can generate a sufficient amount of product revenues to finance our cash requirements, which we may never do, we expect to finance future cash needs primarily through public or private equity offerings, debt financings, borrowings or strategic collaborations.

 

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The sale of equity or additional convertible debt securities in the future may be dilutive to our stockholders, and may provide for rights, preferences or privileges senior to those of our holders of common stock. Debt financing arrangements may require us to pledge certain assets or enter into covenants that could restrict our operations or our ability to incur further indebtedness. We do not know whether additional funding will be available on acceptable terms, if at all. If we are not able to secure additional funding when needed, we may have to scale back our operations, delay or eliminate one or more of our research or development programs, or attempt to obtain funds by entering into an agreement with a collaborator or licensee that would result in terms that are not favorable to us or relinquishing our rights in certain of our proprietary technologies or drug candidates.

 

Off Balance Sheet Arrangements

 

We have no off-balance sheet arrangements other than those that are discussed above.

 

Item 3.    Quantitative and Qualitative Disclosures About Market Risk

 

Our investments in marketable securities, which are composed primarily of U.S. government agency and non-agency mortgage-backed securities and corporate debt securities, are subject to default, changes in credit rating and changes in market value. These investments are also subject to interest rate risk and will decrease in value if market rate interest rates increase. As of September 30, 2014, marketable securities were $150.4 million. Due to the nature of these investments, if market interest rates were to increase immediately and uniformly by 10% from levels as of September 30, 2014, the decline in fair value would not be material.

 

Item 4.    Controls and Procedures

 

Evaluation of disclosure controls and procedures.     We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Our disclosure controls and procedures have been designed to meet reasonable assurance standards. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

 

Based on their evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

 

Changes in internal control over financial reporting.   There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) for the three months ended September 30, 2014, that materially affected or are reasonably likely to materially affect our internal control over financial reporting.

 

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PART II:    OTHER INFORMATION

 

Item 1A.   Risk Factors

 

RISKS RELATING TO OUR LEAD PRODUCT JAKAFI

 

We depend heavily on our lead product, JAKAFI (ruxolitinib), which is marketed as JAKAVI outside the United States. If we are unable to successfully commercialize JAKAFI in its approved indication or to successfully obtain regulatory approval for and commercialize ruxolitinib for the treatment of additional indications, or if we are significantly delayed or limited in doing so, our business may be materially harmed.

 

In November 2011, we received approval from the U.S. Food and Drug Administration, or FDA, to market JAKAFI in the United States for the treatment of intermediate or high-risk myelofibrosis. JAKAFI is our first product to be approved for sale in the United States. Although we have received this regulatory approval, such approval does not guarantee future revenues. The commercial success of JAKAFI and our ability to generate and maintain revenues from the sale of JAKAFI will depend on a number of factors, including:

 

·                  the number of patients with intermediate or high-risk myelofibrosis who are diagnosed with the disease and the number of such patients that may be treated with JAKAFI;

 

·                  the acceptance of JAKAFI by patients and the healthcare community;

 

·                  whether physicians, patients and healthcare payors view JAKAFI as therapeutically effective and safe relative to cost and any alternative therapies;

 

·                  the ability to obtain and maintain sufficient coverage or reimbursement by third-party payors;

 

·                  the ability of our third-party manufacturers to manufacture JAKAFI in sufficient quantities with acceptable quality;

 

·                  the ability of our company and our third-party providers to provide marketing and distribution support for JAKAFI;

 

·                  the label and promotional claims allowed by the FDA;

 

·                  the maintenance of regulatory approval for the treatment of intermediate or high-risk myelofibrosis in the United States; and

 

·                  our ability to develop, obtain regulatory approval for and commercialize ruxolitinib in the United States for additional indications.

 

If we are not successful in commercializing JAKAFI in the United States, or are significantly delayed or limited in doing so, our business may be materially harmed and we may need to delay other drug discovery and development initiatives or even significantly curtail operations.

 

In addition, our receipt of royalties under our collaboration agreement with Novartis for sales of JAKAVI outside the United States will depend on factors similar to those listed above for jurisdictions outside the United States.

 

If we are unable to obtain, or maintain at anticipated levels, reimbursement for JAKAFI from government health administration authorities, private health insurers and other organizations, our pricing may be affected or our product sales, results of operations or financial condition could be harmed.

 

We may not be able to sell JAKAFI on a profitable basis or our profitability may be reduced if we are required to sell JAKAFI at lower than anticipated prices or reimbursement is unavailable or limited in scope or amount. JAKAFI is expensive and almost all patients will require some form of third party coverage to afford its cost. Our future revenues and profitability will be adversely affected if we cannot depend on government and other third-party payors to defray the cost of JAKAFI to the patient. In the United States, there have been, and we expect there will continue to be, efforts to control and reduce healthcare costs. Government and other third-party payors are challenging the prices charged for healthcare products and increasingly limiting and attempting to limit both coverage and level of reimbursement for prescription drugs. If these entities refuse to provide coverage and reimbursement with respect to JAKAFI, determine to provide a lower level of coverage and reimbursement than anticipated, or reduce previously approved

 

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levels of coverage and reimbursement, then our pricing or reimbursement for JAKAFI may be affected and our product sales, results of operations or financial condition could be harmed.

 

We depend upon a limited number of specialty pharmacies and group purchasing organizations for a significant portion of any revenues from JAKAFI, and the loss of, or significant reduction in sales to, any one of these specialty pharmacies or group purchasing organizations could adversely affect our operations and financial condition.

 

We sell JAKAFI primarily to specialty pharmacies and group purchasing organizations, which in turn dispense JAKAFI to patients in fulfillment of prescriptions. We do not promote JAKAFI to specialty pharmacies and group purchasing organizations, and specialty pharmacies and group purchasing organizations will not set or determine demand for JAKAFI. Our ability to successfully commercialize JAKAFI will depend, in part, on the extent to which we are able to provide adequate distribution of JAKAFI to patients. Although we have contracted with a number of specialty pharmacies and group purchasing organizations, these specialty pharmacies and group purchasing organizations are expected generally to carry a very limited inventory and may be reluctant to be part of our distribution network in the future if demand for the product does not increase. Further, it is possible that these specialty pharmacies and group purchasing organizations could decide to change their policies or fees, or both, at some time in the future. This could result in their refusal to carry smaller volume products such as JAKAFI, or cause higher product costs, lower margins or the need to find alternative methods of distributing our product. Although we believe we can find alternative channels to distribute JAKAFI on relatively short notice, our revenue during that period of time may suffer and we may incur additional costs to replace any such specialty pharmacy or group purchasing organization. The loss of any large specialty pharmacy or group purchasing organization as part of our distribution network, a significant reduction in sales we make to specialty pharmacies or group purchasing organizations, or any failure to pay for the products we have shipped to them could materially and adversely affect our results of operations and financial condition.

 

If we are unable to establish and maintain effective sales, marketing and distribution capabilities, or to enter into agreements with third parties to do so, we will not be able to successfully commercialize JAKAFI.

 

Prior to our commercialization of JAKAFI, we had no experience selling and marketing drug products and with pricing and obtaining adequate third-party reimbursement for drug products. Under our collaboration and license agreement with Novartis, we have retained commercialization rights to JAKAFI in the United States. We have established commercial capabilities in the United States, but cannot guarantee that we will be able to maintain our own capabilities or enter into and maintain any marketing, distribution or third-party logistics agreements with third-party providers on acceptable terms, if at all. We may not be able to correctly judge the size and experience of the sales and marketing force and the scale of distribution capabilities necessary to successfully market and sell JAKAFI. Establishing and maintaining sales, marketing and distribution capabilities are expensive and time-consuming. Competition for personnel with experience in sales and marketing can be high. Our expenses associated with building and maintaining the sales force and distribution capabilities may be disproportional compared to the revenues we may be able to generate on sales of JAKAFI.

 

Our reliance on other parties to manufacture JAKAFI could result in a short supply of JAKAFI, increased costs, and withdrawal of regulatory approval.

 

We do not currently operate manufacturing facilities for commercial production of JAKAFI. Accordingly, we will be subject to the risks described below under “—Other Risks Relating to Our Business—Our reliance on other parties to manufacture our drug products and drug candidates could result in a short supply of the drugs, delays in clinical trials or drug development, increased costs, and withdrawal or denial of a regulatory authority’s approval.”

 

If we fail to comply with applicable laws and regulations, we could lose our approval to market JAKAFI or be subject to other governmental enforcement activity.

 

We cannot guarantee that we will be able to maintain regulatory approval to market JAKAFI in the United States. If we do not maintain our regulatory approval to market JAKAFI, our results of operations will be materially harmed. We and our current collaborators, third-party manufacturers and suppliers are subject to rigorous and extensive regulation by the FDA and other federal and state agencies. These regulations continue to apply after product marketing approval, and cover, among other things, testing, manufacturing, quality control, labeling, advertising, promotion, risk mitigation, and adverse event reporting requirements.

 

Our commercialization of JAKAFI is subject to post-regulatory approval product surveillance, and JAKAFI may have to be withdrawn from the market or subject to restrictions if previously unknown problems occur. Regulatory agencies may also require additional clinical trials or testing for JAKAFI, and JAKAFI may be recalled or may be subject to reformulation, additional studies, changes in labeling, warnings to the public and negative publicity.

 

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Failure to comply with the laws and requirements, including statutes and regulations, administered by the FDA or other agencies could result in:

 

·                  administrative and judicial sanctions, including warning letters;

 

·                  fines and other civil penalties;

 

·                  withdrawal of regulatory approval to market JAKAFI;

 

·                  interruption of production;

 

·                  operating restrictions;

 

·                  product recall or seizure;

 

·                  injunctions; and

 

·                  criminal prosecution.

 

The occurrence of any such event may have a material adverse effect on our business.

 

If the use of JAKAFI harms patients, or is perceived to harm patients even when such harm is unrelated to JAKAFI, our regulatory approval could be revoked or otherwise negatively impacted or we could be subject to costly and damaging product liability claims.

 

The testing of JAKAFI and the manufacturing, marketing and sale of JAKAFI expose us to product liability and other risks. Side effects and other problems experienced by patients from the use of JAKAFI could:

 

·                  lessen the frequency with which physicians decide to prescribe JAKAFI;

 

·                  encourage physicians to stop prescribing JAKAFI to their patients who previously had been prescribed JAKAFI;

 

·                  cause serious harm to patients that may give rise to product liability claims against us; and

 

·                  result in our need to withdraw or recall JAKAFI from the marketplace.

 

If JAKAFI is used by a wide patient population, new risks and side effects may be discovered, the rate of known risks or side effects may increase, and risks previously viewed as less significant could be determined to be significant.

 

Previously unknown risks and adverse effects of JAKAFI may also be discovered in connection with unapproved, or off-label, uses of JAKAFI. We are prohibited by law from promoting or in any way supporting or encouraging the promotion of JAKAFI for off-label uses, but physicians are permitted to use products for off-label purposes. In addition, we are studying and expect to continue to study JAKAFI in diseases other than intermediate or high-risk myelofibrosis in controlled clinical settings, and independent investigators are doing so as well. In the event of any new risks or adverse effects discovered as new patients are treated for intermediate or high-risk myelofibrosis and as JAKAFI is studied in or used by patients for off-label indications, regulatory authorities may delay or revoke their approvals, we may be required to conduct additional clinical trials, make changes in labeling of JAKAFI, reformulate JAKAFI or make changes and obtain new approvals. We may also experience a significant drop in the sales of JAKAFI, experience harm to our reputation and the reputation of JAKAFI in the marketplace or become subject to lawsuits, including class actions. Any of these results could decrease or prevent sales of JAKAFI or substantially increase the costs and expenses of commercializing JAKAFI.

 

Patients who have been enrolled in our clinical trials or who may use JAKAFI in the future often have severe and advanced stages of disease and known as well as unknown significant pre-existing and potentially life-threatening health risks. During the course of treatment, patients may suffer adverse events, including death, for reasons that may or may not be related to JAKAFI. Such events could subject us to costly litigation, require us to pay substantial amounts of money to injured patients, delay, negatively impact or end our opportunity to receive or maintain regulatory approval to market JAKAFI, or require us to suspend or abandon our commercialization efforts. Even in a circumstance in which we do not believe that an adverse event is related to JAKAFI, the investigation into the circumstance may be time consuming or inconclusive. These investigations may interrupt our sales efforts,

 

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impact and limit the type of regulatory approvals JAKAFI receives or maintains, or delay the regulatory approval process for our collaborator Novartis in other countries.

 

Factors similar to those listed above also apply to our collaboration partner Novartis for jurisdictions outside the United States.

 

If we market JAKAFI in a manner that violates various federal and state health care related laws and regulations, we may be subject to civil or criminal penalties.

 

In addition to FDA and related regulatory requirements, we are subject to health care “fraud and abuse” laws, such as the federal False Claims Act, the anti-kickback provisions of the federal Social Security Act, and other state and federal laws and regulations. Federal and state anti-kickback laws prohibit, among other things, knowingly and willfully offering, paying, soliciting or receiving remuneration to induce, or in return for purchasing, leasing, ordering or arranging for the purchase, lease or order of any health care item or service reimbursable under Medicare, Medicaid, or other federally- or state-financed health care programs. Federal false claims laws prohibit any person from knowingly presenting, or causing to be presented, a false claim for payment to the federal government, or knowingly making, or causing to be made, a false statement to get a false claim paid. Pharmaceutical companies have been prosecuted under these laws for a variety of alleged promotional and marketing activities.

 

Although physicians are permitted, based on their medical judgment, to prescribe products for indications other than those approved by the FDA, manufacturers are prohibited from promoting their products for such off-label uses. We market JAKAFI for intermediate or high-risk myelofibrosis and provide promotional materials to physicians regarding the use of JAKAFI for this indication. Although we believe that our promotional materials for physicians do not constitute off-label promotion of JAKAFI, the FDA or other agencies may disagree. If the FDA or another agency determines that our promotional materials or other activities constitu