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1. Organization and Business
Halozyme Therapeutics, Inc. (referred to as “we,” “us,” “Halozyme” or the “Company”) is a biopharmaceutical company dedicated to developing and commercializing innovative products that advance patient care. Our research targets the extracellular matrix, an area outside the cell that provides structural support in tissues and orchestrates many important biological activities, including cell migration, signaling and survival. Over many years, we have developed unique scientific expertise that allows us to pursue this target-rich environment for the development of future therapies.
Our research focuses primarily on human enzymes that alter the extracellular matrix. Our lead enzyme, recombinant human hyaluronidase (“rHuPH20”), temporarily degrades hyaluronan, a matrix component in the skin, and facilitates the dispersion and absorption of drugs and fluids. We are also developing novel enzymes that may target other matrix structures for therapeutic benefit. Our EnhanzeTM technology is the platform for the delivery of proprietary small and large molecules. We apply our research products in collaboration with other companies as well as for our own proprietary pipeline in therapeutic areas with significant unmet medical need, such as diabetes, oncology and dermatology.
Our operations to date have involved: (i) organizing and staffing our operating subsidiary, Halozyme, Inc.; (ii) acquiring, developing and securing our technology; (iii) undertaking product development for our existing product and a limited number of product candidates; (iv) supporting the development of collaboration product candidates and (v) selling Hylenex ® recombinant (hyaluronidase human injection). We continue to increase our focus on our proprietary product pipeline and have expanded investments in our proprietary product candidates. We currently have multiple proprietary programs in various stages of research and development. In addition, we currently have license and collaborative agreements with F. Hoffmann-La Roche, Ltd and Hoffmann-La Roche, Inc. (“Roche”), Baxter Healthcare Corporation (“Baxter”), ViroPharma Incorporated (“ViroPharma”), and Intrexon Corporation (“Intrexon”), to apply Enhanze technology to these collaborators’ biological therapeutic compounds. Currently, we have received only limited revenue from the sales of Hylenex recombinant, in addition to other revenues from our collaborations.
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2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying interim unaudited condensed consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (“U.S. GAAP”) and with the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) related to a quarterly report on Form 10-Q. Accordingly, they do not include all of the information and disclosures required by U.S. GAAP for a complete set of financial statements. These interim unaudited condensed consolidated financial statements and notes thereto should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2011, filed with the SEC on March 12, 2012. The unaudited financial information for the interim periods presented herein reflects all adjustments which, in the opinion of management, are necessary for a fair presentation of the financial condition and results of operations for the periods presented, with such adjustments consisting only of normal recurring adjustments. Operating results for interim periods are not necessarily indicative of the operating results for an entire fiscal year.
The condensed consolidated financial statements include the accounts of Halozyme Therapeutics, Inc. and our wholly owned subsidiary, Halozyme, Inc. All intercompany accounts and transactions have been eliminated.
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. On an ongoing basis, we evaluate our estimates and judgments, which are based on historical and anticipated results and trends and on various other assumptions that management believes to be reasonable under the circumstances. By their nature, estimates are subject to an inherent degree of uncertainty and, as such, actual results may differ from management’s estimates.
Adoption of Recent Accounting Pronouncements
Effective January 1, 2012, we adopted Financial Accounting Standards Board’s (“FASB”) Accounting Standards Update (“ASU”) No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income and ASU No. 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in ASU No. 2011-5. In these updates, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU No. 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amendments in ASU No. 2011-05 do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The amendments in these updates are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of ASU Nos. 2011-05 and 2011-12 did not have a material impact on our consolidated financial position or results of operations. We have presented comprehensive income (loss) in our condensed consolidated statements of comprehensive income (loss).
Effective January 1, 2012, we prospectively adopted FASB’s ASU No. 2011-04, “Fair Value Measurement (Topic 820) — Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS”. The amendments in ASU 2011-04 result in common fair value measurement and disclosure requirements in GAAP and International Financial Reporting Standards (“IFRS”). Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. This pronouncement is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of ASU No. 2011-04 did not have a material effect on our consolidated financial position or results of operations.
Inventories
Inventories are stated at lower of cost or market. Cost is determined on a first-in, first-out basis. Inventories are reviewed periodically for potential excess, dated or obsolete status. Management evaluates the carrying value of inventories on a regular basis, taking into account such factors as historical and anticipated future sales compared to quantities on hand, the price it expects to obtain for products in their respective markets compared with historical cost and the remaining shelf life of goods on hand.
Raw materials inventories consist of raw materials used in the manufacture of our bulk drug material for Hylenex recombinant product. Work-in-process inventories consist of in-process Hylenex recombinant. Finished goods inventories consist of finished Hylenex recombinant product.
We expense costs relating to the purchase and production of pre-approval inventories for which the sole use is pre-approval products as research and development expense in the period incurred until such time as we believe future commercialization is probable and future economic benefit is expected to be realized. For products that have been approved by regulatory bodies such as the U.S. Food and Drug Administration (“FDA”), inventories used in clinical trials are expensed at the time the inventories are packaged for the clinical trials. Prior to receiving approval from the FDA or comparable regulatory agencies in foreign countries, costs related to purchases of the active pharmaceutical ingredients (“API”) and the manufacturing of the product candidate are recorded as research and development expense. All direct manufacturing costs incurred after approval are capitalized as inventory.
Revenue Recognition
We generate revenues from product sales and collaborative agreements. Payments received under collaborative agreements may include nonrefundable fees at the inception of the agreements, license fees, milestone payments for specific achievements designated in the collaborative agreements, reimbursements of research and development services and/or royalties on sales of products resulting from collaborative arrangements.
We recognize revenue in accordance with the authoritative guidance on revenue recognition. Revenue is recognized when all of the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the seller’s price to the buyer is fixed or determinable; and (4) collectibility is reasonably assured.
Product Sales – Hylenex recombinant was approved for marketing by the FDA in December 2005. From 2005 through January 7, 2011, Baxter had the worldwide market rights for Hylenex recombinant under the terms of the amended and restated development and supply agreement with Baxter (“Hylenex Collaboration”). Baxter commercially launched Hylenex recombinant in October 2009. However, Hylenex recombinant was voluntarily recalled in May 2010 because a portion of the product manufactured by Baxter was not in compliance with the requirements of the underlying collaboration. Effective January 7, 2011, we and Baxter mutually agreed to terminate the Hylenex Collaboration. During the second quarter of 2011, we submitted the data that the FDA had requested to support the reintroduction of Hylenex recombinant to the market. The FDA approved the submitted data and granted the reintroduction of Hylenex recombinant.
In December 2011, we reintroduced Hylenex recombinant to the market, shipped initial orders to our wholesaler customers and began promoting Hylenex recombinant through our sales force. We sell Hylenex recombinant in the United States to wholesale pharmaceutical distributors, who sell the product to hospitals and other end-user customers. The wholesale distributors take title to the product, bear the risk of loss of ownership and have economic substance to the inventory. Further, we have no significant obligations for future performance to generate pull-through sales; however, we do allow the wholesale distributors to return product that is damaged or received in error. In addition, we allow for product to be returned beginning six months prior to and ending twelve months following product expiration.
Given our limited history of selling Hylenex recombinant and the lengthy return period, we currently cannot reliably estimate expected returns and chargebacks of Hylenex recombinant at the time the product is received by the wholesale distributors. Therefore, we do not recognize revenue upon delivery of Hylenex recombinant to the wholesale distributor until the point at which we can reliably estimate expected product returns and chargebacks from the wholesale distributors. Shipments of Hylenex recombinant are recorded as deferred revenue until evidence exists to confirm that pull-through sales to the hospitals or other end-user customers have occurred. We recognize revenue when the product is sold through from the distributors to the distributors’ customers. In addition, the costs of manufacturing Hylenex recombinant associated with the deferred revenue are recorded as deferred costs, which are included in inventory, until such time as the related deferred revenue is recognized. We estimate sell-through revenue and certain gross to net sales adjustments based on analysis of third-party information including information obtained from certain distributors with respect to their inventory levels and sell-through to the distributors’ customers. At the time we can reliably estimate product returns and chargebacks from the wholesale distributors, we will record a one-time increase in net product sales revenue related to the recognition of product sales revenue previously deferred.
We recognize product sales allowances as a reduction of product sales in the same period the related revenue is recognized. Product sales allowances are based on amounts owed or to be claimed on the related sales. These estimates take into consideration the terms of our agreements with wholesale distributors and hospitals and the levels of inventory within the distribution channels that may result in future discounts taken. We must make significant judgments in determining these allowances. If actual results differ from our estimates, we will be required to make an adjustment to these allowances in the future, which could have an effect on product sales revenue in the period of adjustment. Our product sales allowances include:
Distribution Fees. The distribution fees, based on contractually determined rates, arise from contractual agreements we have with certain wholesale distributors for distribution services they provide with respect to Hylenex recombinant. At the time the sale is made to the respective wholesale distributors, we record an allowance for distribution fees by reducing our accounts receivable and deferred revenue associated with such product sales.
Prompt Payment Discounts. We offer cash discounts to certain wholesale distributors as an incentive to meet certain payment terms. We expect our customers will take advantage of this discount; therefore, at the time the sale is made to the respective wholesale distributors, we accrue the entire prompt payment discount, based on the gross amount of each invoice, by reducing our accounts receivable and deferred revenue associated with such product sales.
Chargebacks. We provide discounts to end-user members of certain group purchasing organizations (“GPO”) under collective purchasing contracts between us and the GPOs. We also provide discounts to certain hospitals who are members of the GPOs with which we do not have contracts. The end-user members purchase products from the wholesale distributors at a contracted discounted price, and the wholesale distributors then charge back to us the difference between the current retail price and the price the end users paid for the product. Given our lack of historical sales data, we recognize chargebacks in the same period the related product sales revenue is recognized and reduce our accounts receivable accordingly. A GPO fee we incur for these transactions is also recorded in the same period the related product sales revenue is recognized and is included in accrued expenses.
Product Returns. The product returns reserve is based on management’s best estimate of the product sales recognized as revenue during the period that are anticipated to be returned. The product returns reserve is recorded as a reduction of product sales revenue in the same period the related product sales revenue is recognized and is included in accrued expenses.
Revenues under Collaborative Agreements – We have entered into license and collaboration agreements under which the collaborators obtained worldwide exclusive rights for the use of our proprietary rHuPH20 enzyme in the development and commercialization of the collaborators’ biologic compounds. The collaborative agreements contain multiple elements, including nonrefundable payments at the inception of the arrangements, license fees, exclusivity fees, payments based on achievement of specified milestones designated in the collaborative agreements, reimbursements of research and development services, payments for supply of rHuPH20 API for the collaborator and/or royalties on sales of products resulting from collaborative agreements. We analyze each element of the collaborative agreements and consider a variety of factors in determining the appropriate method of revenue recognition of each element.
Prior to the adoption of ASU No. 2009-13, Multiple-Deliverable Revenue Arrangements, on January 1, 2011, in order for a delivered item to be accounted for separately from other deliverables in a multiple-element arrangement, the following three criteria had to be met: (i) the delivered item had standalone value to the customer, (ii) there was objective and reliable evidence of fair value of the undelivered items, and (iii) if the arrangement included a general right of return relative to the delivered item, delivery or performance of the undelivered items was considered probable and substantially in the control of the vendor. For the collaborative agreements entered into prior to January 1, 2011, there was no objective and reliable evidence of fair value of the undelivered items. Thus, the delivered licenses did not meet all of the required criteria to be accounted for separately from undelivered items. Therefore, we recognized revenue on nonrefundable upfront payments and license fees from these collaborative agreements over the period of significant involvement under the related agreements.
For new collaborative agreements or material modifications of existing collaborative agreements entered into after December 31, 2010, we follow the provisions of ASU No. 2009-13. In order to account for the multiple-element arrangements, we identify the deliverables included within the agreement and evaluate which deliverables represent units of accounting. Analyzing the arrangement to identify deliverables requires the use of judgment, and each deliverable may be an obligation to deliver services, a right or license to use an asset, or another performance obligation. The deliverables under our collaborative agreements include (i) the license to rHuPH20 technology, (ii) at the collaborator’s request, research and development services which are reimbursed at contractually determined rates, and (iii) at the collaborator’s request, supply of rHuPH20 API which is reimbursed at our cost plus a margin. A delivered item is considered a separate unit of accounting when the delivered item has value to the collaborator on a standalone basis based on the consideration of the relevant facts and circumstances for each arrangement. Factors considered in this determination include the research capabilities of the collaborator and the availability of research expertise in this field in the general marketplace.
Arrangement consideration is allocated at the inception of the agreement to all identified units of accounting based on their relative selling price. The relative selling price for each deliverable is determined using vendor specific objective evidence (“VSOE”) of selling price or third-party evidence of selling price if VSOE does not exist. If neither VSOE nor third-party evidence of selling price exists, we use our best estimate of the selling price for the deliverable. The amount of allocable arrangement consideration is limited to amounts that are fixed or determinable. The consideration received is allocated among the separate units of accounting, and the applicable revenue recognition criteria are applied to each of the separate units. Changes in the allocation of the sales price between delivered and undelivered elements can impact revenue recognition but do not change the total revenue recognized under any agreement.
Nonrefundable upfront license fee payments are recognized upon delivery of the license if facts and circumstances dictate that the license has standalone value from the undelivered items, which generally include research and development services and the manufacture of rHuPH20 API, the relative selling price allocation of the license is equal to or exceeds the upfront license fee, persuasive evidence of an arrangement exists, our price to the collaborator is fixed or determinable and collectability is reasonably assured. Upfront license fee payments are deferred if facts and circumstances dictate that the license does not have standalone value. The determination of the length of the period over which to defer revenue is subject to judgment and estimation and can have an impact on the amount of revenue recognized in a given period.
The terms of our collaborative agreements provide for milestone payments upon achievement of certain development and regulatory events and/or specified sales volumes of commercialized products by the collaborator. Effective January 1, 2011, we adopted on a prospective basis the Milestone Method. Under the Milestone Method, we recognize consideration that is contingent upon the achievement of a milestone in its entirety as revenue in the period in which the milestone is achieved only if the milestone is substantive in its entirety. A milestone is considered substantive when it meets all of the following criteria:
1. | The consideration is commensurate with either the entity’s performance to achieve the milestone or the enhancement of the value of the delivered item(s) as a result of a specific outcome resulting from the entity’s performance to achieve the milestone, |
2. | The consideration relates solely to past performance, and |
3. | The consideration is reasonable relative to all of the deliverables and payment terms within the arrangement. |
A milestone is defined as an event (i) that can only be achieved based in whole or in part on either the entity’s performance or on the occurrence of a specific outcome resulting from the vendor’s performance, (ii) for which there is substantive uncertainty at the date the arrangement is entered into that the event will be achieved, and (iii) that would result in additional payments being due to the vendor.
Reimbursements of research and development services are recognized as revenue during the period in which the services are performed as long as there is persuasive evidence of an arrangement, the fee is fixed or determinable and collection of the related receivable is probable. Revenue from the manufacture of rHuPH20 API is recognized when the API has met all specifications required for the collaborator’s acceptance and title and risk of loss have transferred to the collaborator. We do not directly control when any collaborator will request research and development services or supply of rHuPH20 API; therefore, we cannot predict when we will recognize revenues in connection with research and development services and supply of rHuPH20 API. Royalties to be received based on sales of licensed products by our collaborators incorporating rHuPH20 will be recognized as earned.
The collaborative agreements typically provide the collaborators the right to terminate such agreements in whole or on a product-by-product or target-by-target basis at any time upon 90 days prior written notice to us. There are no performance, cancellation, termination or refund provisions in any of our collaborative agreements that contain material financial consequences to us.
Cost of Product Sales
Cost of product sales consists primarily of raw materials, third-party manufacturing costs, fill and finish costs, freight costs, internal costs and manufacturing overhead associated with the production of Hylenex recombinant. Cost of product sales also consists of the write-down of excess, dated and obsolete inventories.
Research and Development Expenses
Research and development expenses include salaries and benefits, facilities and other overhead expenses, external clinical trial expenses, research related manufacturing services, contract services and other outside expenses. Research and development expenses are charged to operations as incurred when these expenditures relate to our research and development efforts and have no alternative future uses.
Advance payments, including nonrefundable amounts, for goods or services that will be used or rendered for future research and development activities are deferred and capitalized. Such amounts will be recognized as an expense as the related goods are delivered or the related services are performed or at such time when we do not expect the goods to be delivered or services to be performed.
Milestone payments that we make in connection with in-licensed technology or product candidates are expensed as incurred when there is uncertainty in receiving future economic benefits from the licensed technology or product candidates. We consider the future economic benefits from the licensed technology or product candidates to be uncertain until such licensed technology or product candidates are approved for marketing by regulatory bodies such as the FDA or when other significant risk factors are abated. Management has viewed future economic benefits for all of our licensed technology or product candidates to be uncertain and has expensed these amounts as incurred.
Clinical Trial Expenses
Expenses related to clinical trials are accrued based on our estimates and/or representations from service providers regarding work performed, including actual level of patient enrollment, completion of patient studies and progress of clinical trials. Other incidental costs related to patient enrollment or treatment are accrued when reasonably certain. If the contracted amounts are modified (for instance, as a result of changes in the clinical trial protocol or scope of work to be performed), we modify our accruals accordingly on a prospective basis. Revisions in the scope of a contract are charged to expense in the period in which the facts that give rise to the revision become reasonably certain.
Share-Based Compensation
Total share-based compensation expense related to all of our share-based awards was allocated as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2012 | 2011 | 2012 | 2011 | |||||||||||||
Research and development |
$ | 913,946 | $ | 890,276 | $ | 3,279,940 | $ | 1,944,552 | ||||||||
Selling, general and administrative |
1,008,447 | 867,083 | 3,082,432 | 1,971,777 | ||||||||||||
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Share-based compensation expense |
$ | 1,922,393 | $ | 1,757,359 | $ | 6,362,372 | $ | 3,916,329 | ||||||||
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Share-based compensation expense per basic and diluted share |
$ | 0.02 | $ | 0.02 | $ | 0.06 | $ | 0.04 | ||||||||
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Share-based compensation expense from: |
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Stock options |
$ | 1,164,973 | $ | 806,078 | $ | 3,491,220 | $ | 2,318,728 | ||||||||
Restricted stock awards and restricted stock units |
757,420 | 951,281 | 2,871,152 | 1,597,601 | ||||||||||||
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$ | 1,922,393 | $ | 1,757,359 | $ | 6,362,372 | $ | 3,916,329 | |||||||||
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Since we have a net operating loss carryforward as of September 30, 2012, no excess tax benefits for the tax deductions related to share-based awards were recognized in the interim unaudited condensed consolidated statements of comprehensive loss for the three and nine months ended September 30, 2012. For the three months ended September 30, 2012 and 2011, employees exercised stock options to purchase 7,055 and 38,511 shares of common stock, respectively, for aggregate proceeds of approximately $39,000 and $79,000, respectively. For the nine months ended September 30, 2012 and 2011, employees exercised stock options to purchase 426,277 and 2,713,573 shares of common stock, respectively, for aggregate proceeds of approximately $1.9 million and $4.1 million, respectively. In addition, for the nine months ended September 30, 2012, upon vesting of 128,000 restricted stock units (“RSUs”), the RSU holders received net settlement of 81,070 shares of common stock and surrendered 46,930 RSUs to pay for the minimum withholding taxes totaling approximately $347,000. There were no RSUs vested for the three months ended September 30, 2012 or the three and nine months ended September 30, 2011.
As of September 30, 2012, total unrecognized estimated compensation cost related to non-vested stock options and non-vested restricted stock awards and restricted stock units granted prior to that date was approximately $9.6 million and $7.0 million, respectively, which is expected to be recognized over a weighted-average period of approximately 2.7 years and 3.6 years, respectively.
Fair Value of Financial Instruments
We follow the authoritative guidance for fair value measurements and disclosures which, among other things, defines fair value, establishes a consistent framework for measuring fair value and expands disclosure for each major asset and liability category measured at fair value on either a recurring or nonrecurring basis. Fair value is defined as an exit price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability.
The framework for measuring fair value provides a hierarchy that prioritizes the inputs to valuation techniques used in measuring fair value as follows:
Level 1 | Quoted prices (unadjusted) in active markets for identical assets or liabilities, | |
Level 2 | Inputs other than quoted prices included within Level 1 that are either directly or indirectly observable, and | |
Level 3 | Unobservable inputs in which little or no market activity exists, therefore requiring an entity to develop its own assumptions about the assumptions that market participants would use in pricing. |
Our financial instruments include cash and cash equivalents, accounts receivable, prepaid expenses, accounts payable and accrued expenses. The carrying amounts of financial instruments approximate their fair values due to their short maturities. Cash equivalents of approximately $85.0 million and $51.8 million at September 30, 2012 and December 31, 2011, respectively, are carried at fair value and are classified within Level 1 of the fair value hierarchy because they are valued based on quoted market prices for identical securities. We have no instruments that are classified within Level 2 and Level 3.
Segment Information
We operate our business in one segment, which includes all activities related to the research, development and commercialization of human enzymes that either transiently modify tissue to facilitate injection of other therapies or correct diseased tissue structures for clinical benefit. This segment also includes revenues and expenses related to (i) research and development activities conducted under our collaborative agreements with third parties and (ii) product sales of Hylenex recombinant. The chief operating decision-maker reviews the operating results on an aggregate basis and manages the operations as a single operating segment.
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3. Collaborative Agreements
Roche Collaboration
In December 2006, we and Roche entered into a license and collaborative agreement under which Roche obtained a worldwide, exclusive license to develop and commercialize product combinations of rHuPH20 and up to thirteen Roche target compounds (the “Roche Collaboration”). As of September 30, 2012, Roche has elected a total of five exclusive targets and retains the option to develop and commercialize rHuPH20 with three additional targets, provided that Roche continues to pay annual maintenance fees to us. As of September 30, 2012, we have received $57 million from Roche, including the $20 million upfront license fee payment for the application of rHuPH20 to the initial three Roche exclusive targets, $20 million in connection with Roche’s election of two additional exclusive targets and annual license maintenance fees for the right to designate the remaining targets as exclusive targets, $13 million in clinical development milestone payments and a $4 million regulatory milestone payment. If Roche successfully develops all five exclusive targets and achieves pre-agreed sales targets, we could receive additional milestone payments of up to $178 million, including up to $17 million for the achievement of clinical development milestones, up to $16 million for the achievement of regulatory milestones and up to $145 million for the achievement of sales-based milestones.
Under the terms of the Roche Collaboration, Roche will also pay us a royalty on each product commercialized under the agreement consisting of a mid-single digit percent of the net sales of such product. Unless terminated earlier in accordance with its terms, the Roche Collaboration continues in effect until the expiration of Roche’s obligation to pay royalties. Roche has the obligation to pay royalties with respect to each product in each country, during the period equal to the longer of: (a) the duration of any valid claim of our patents covering rHuPH20 or other specified patents developed under the collaboration which valid claim covers the product in such country or (b) ten years following the date of the first commercial sale of such product in such country. For products developed for each of the additional targets, Roche may pay us upfront and milestone payments of up to $47 million per target, as well as royalties on product sales for each of the additional targets consisting of a mid-single digit percent of the net sales of such products. Additionally, Roche will obtain access to our expertise in developing and applying rHuPH20 to Roche targets. Under the terms of the Roche Collaboration, we were obligated to scale up the production of rHuPH20 and to identify a second source manufacturer that would help meet anticipated production obligations arising from the Roche Collaboration.
Due to our continuing involvement obligations (for example, support activities associated with rHuPH20), revenues from the upfront payment, exclusive designation fees and annual license maintenance fees were deferred and are being recognized over the term of the Roche Collaboration. We have determined that the clinical and regulatory milestones are substantive; therefore, we expect to recognize such clinical and regulatory milestone payments as revenue upon achievement of the milestones. In addition, we have determined that the sales-based milestone payments are similar to royalty payments and are not considered milestone payments under the Milestone Method of revenue recognition; therefore, we will recognize such sales-based milestone payments as revenue upon achievement of the milestones.
There were no milestone payments recognized as revenues under collaborative agreements under the Roche Collaboration for the three months ended September 30, 2012 and 2011. For the nine months ended September 30, 2012 and 2011, we recognized $4 million and $5 million, respectively, as revenues under collaborative agreements in accordance with the Milestone Method related to the achievement of certain regulatory and clinical milestones pursuant to the terms of the Roche Collaboration.
Gammagard Collaboration
In September 2007, we entered into a license and collaborative agreement with Baxter, under which Baxter obtained a worldwide, exclusive license to develop and commercialize a product candidate (currently named HyQ) consisting of rHuPH20 combined with a current Baxter product, GAMMAGARD LIQUID® (the “Gammagard Collaboration”). As of September 30, 2012, we have received $13 million under the Gammagard Collaboration, including the $10 million upfront license fee payment and a $3 million regulatory milestone payment. If Baxter successfully receives marketing approval for the licensed product candidate and achieves pre-agreed sales targets, we could receive additional milestone payments of up to $34 million for the achievement of sales-based milestones. In addition, Baxter will pay us a royalty on each product commercialized under the agreement consisting of a mid-single digit percent of the net sales of such product. The Gammagard Collaboration is applicable to both kit and formulation combinations. Baxter assumes all development, manufacturing, clinical, regulatory, sales and marketing costs under the Gammagard Collaboration, while we are responsible for the supply of rHuPH20 enzyme. We perform research and development activities at the request of Baxter, which are reimbursed by Baxter under the terms of the Gammagard Collaboration. In addition, Baxter has certain product development and commercialization obligations in major markets identified in the Gammagard Collaboration. Unless terminated earlier in accordance with its terms, the Gammagard Collaboration continues in effect until the expiration of Baxter’s obligation to pay royalties. Baxter has the obligation to pay royalties, with respect to each product in each country, during the period equal to the longer of: (a) the duration of any valid claim of our patents covering rHuPH20 or other specified patents developed under the collaboration which valid claim covers the product in such country or (b) ten years following the date of the first commercial sale of such product in such country.
Due to our continuing involvement obligations (for example, support activities associated with rHuPH20 enzyme), the upfront payment was deferred and is being recognized over the term of the Gammagard Collaboration.
We have determined that sales-based milestone payments are similar to royalty payments and are not considered milestone payments under the Milestone Method of revenue recognition; therefore, such payments will be recognized as revenue upon achievement of the milestones. There were no milestone payments recognized as revenues under collaborative agreements under the Gammagard Collaboration for the three and nine months ended September 30, 2012. For the three and nine months ended September 30, 2011, we recognized zero and $3 million, respectively, as revenues under collaborative agreements under the Gammagard Collaboration in accordance with the Milestone Method.
ViroPharma and Intrexon Collaborations
Effective May 10, 2011, we and ViroPharma entered into a collaboration and license agreement, under which ViroPharma obtained a worldwide exclusive license for the use of rHuPH20 enzyme in the development of a subcutaneous injectable formulation of ViroPharma’s commercialized product, Cinryze ® (C1 esterase inhibitor [human]) (the “ViroPharma Collaboration”). In addition, the license provides ViroPharma with exclusivity to C1 esterase inhibitor and to the hereditary angioedema indication, along with three additional orphan indications. As of September 30, 2012, we have received $13 million from ViroPharma, including the $9 million nonrefundable upfront license fee payment, a $3 million clinical development milestone payment and a $1 million annual exclusivity fee. If ViroPharma successfully develops the licensed product candidate, we could receive additional milestone payments of up to $41 million for the achievement of development and regulatory milestones. In addition, so long as the agreement is in effect, we are entitled to receive a nonrefundable annual exclusivity fee of $1 million which commenced on May 10, 2012 and on each anniversary of the effective date of the agreement thereafter until a certain development event occurs. ViroPharma is solely responsible for the development, manufacturing and marketing of any products resulting from this collaboration. We are entitled to receive payments for research and development services and supply of rHuPH20 API if requested by ViroPharma. In addition, we are entitled to receive additional cash payments potentially totaling $10 million upon achievement of certain development and regulatory milestones for each product targeting the treatment of any of the three additional orphan indications. We are also entitled to receive a royalty on each product commercialized under the agreement consisting of ten percent of the net sales of such product.
Unless terminated earlier in accordance with its terms, the ViroPharma Collaboration continues in effect until the later of (i) expiration of the last to expire of the valid claims of our patents covering rHuPH20 or other specified patents developed under the collaboration which valid claim covers a product developed under the collaboration, and (ii) expiration of the last to expire royalty term for a product developed under the collaboration. The royalty term of a product developed under the ViroPharma Collaboration, with respect to each country, consists of the period equal to the longer of: (a) the duration of any valid claim of our patents covering rHuPH20 or other specified patents developed under the collaboration which valid claim covers the product in such country or (b) ten years following the date of the first commercial sale of such product in such country. ViroPharma may terminate the agreement prior to expiration for any reason on a product-by-product basis upon 90 days prior written notice to us. Upon any such termination, the license granted to ViroPharma (in total or with respect to the terminated product, as applicable) will terminate.
Effective June 6, 2011, we and Intrexon entered into a collaboration and license agreement, under which Intrexon obtained a worldwide exclusive license for the use of rHuPH20 enzyme in the development of a subcutaneous injectable formulation of Intrexon’s recombinant human alpha 1-antitrypsin (rHuA1AT) (the “Intrexon Collaboration”). In addition, the license provides Intrexon with exclusivity for a defined indication (“Exclusive Field”). As of September 30, 2012, we have received $10 million from Intrexon, including a nonrefundable upfront license fee payment of $9 million and a $1 million annual exclusivity fee. If Intrexon successfully develops the licensed product candidate and achieves the pre-agreed sales target, we could receive additional milestone payments of up to $54 million, including $44 million for the achievement of development and regulatory milestones and $10 million for the achievement of a sales-based milestone. In addition, so long as the agreement is in effect, we are entitled to receive a nonrefundable annual exclusivity fee of $1 million which commenced on June 6, 2012 and on each anniversary of the effective date of the agreement thereafter until a certain development event occurs. Intrexon is solely responsible for the development, manufacturing and marketing of any products resulting from this collaboration. We are entitled to receive payments for research and development services and supply of rHuPH20 API if requested by Intrexon. In addition, we are entitled to receive additional cash payments potentially totaling $10 million for each product for use outside the Exclusive Field upon achievement of development and regulatory milestones. We are also entitled to receive a royalty on each product commercialized under the agreement consisting of a percentage of the net sales of such product ranging from mid-single digits up to low double-digit percent.
Unless terminated earlier in accordance with its terms, the Intrexon Collaboration continues in effect until the later of (i) expiration of the last to expire of the valid claims of our patents covering rHuPH20 or other specified patents developed under the collaboration which valid claim covers a product developed under the collaboration, and (ii) expiration of the last to expire royalty term for a product developed under the collaboration. The royalty term of a product developed under the Intrexon Collaboration, with respect to each country, consists of the period equal to the longer of: (a) the duration of any valid claim of our patents covering rHuPH20 or other specified patents developed under the collaboration which valid claim covers the product in such country or (b) ten years following the date of the first commercial sale of such product in such country. Intrexon may terminate the agreement prior to expiration for any reason on a product-by-product basis upon 90 days prior written notice to us. Upon any such termination, the license granted to Intrexon (in total or with respect to the terminated product, as applicable) will terminate. Intrexon’s chief executive officer, chairman of its board of directors and major shareholder is also a member of our board of directors.
We identified the deliverables at the inception of the ViroPharma and Intrexon agreements which are the license, research and development services and API supply. We have determined that the license, research and development services and API supply individually represent separate units of accounting, because each deliverable has standalone value. The estimated selling prices for these units of accounting were determined based on market conditions, the terms of comparable collaborative arrangements for similar technology in the pharmaceutical and biotech industry and entity-specific factors such as the terms of our previous collaborative agreements, our pricing practices and pricing objectives and the nature of the research and development services to be performed for the collaborators. The arrangement consideration was allocated to the deliverables based on the relative selling price method.
The amount allocable to the delivered unit or units of accounting is limited to the amount that is not contingent upon the delivery of additional items or meeting other specified performance conditions (the noncontingent amount). As such, we excluded from the allocable arrangement consideration the milestone payments, annual exclusivity fees and royalties regardless of the probability of receipt. Based on the results of our analysis, we allocated the $9 million upfront license fee received from ViroPharma to the license fee deliverable under the ViroPharma arrangement and the $9 million upfront fee received from Intrexon to the license fee deliverable under the Intrexon arrangement. We determined that the upfront payment was earned upon the granting of the worldwide, exclusive right to our technology to the collaborator in both the ViroPharma Collaboration and Intrexon Collaboration. As a result, we recognized the $9 million upfront license fee received under the ViroPharma Collaboration and the $9 million upfront license fee received under the Intrexon Collaboration as revenues under collaborative agreements upon receipt of the upfront license fees.
We recognize the annual exclusivity fees as revenues under collaborative agreements when they are due and payable on each anniversary of the effective date and such amounts are included in the allocable arrangement consideration and recognized based on the relative selling price allocation. We recognize amounts allocated to research and development services as revenues under collaborative agreements as the related services are performed. We recognize amounts allocated to the sales of API as revenues under collaborative agreements when such API has met all required specifications by the collaborators and the related title and risk of loss and damages have passed to the collaborators. We cannot predict the timing of delivery of research and development services and API as they are at the collaborators’ requests.
We are eligible to receive additional cash payments upon the achievement by the collaborators of specified development, regulatory and sales-based milestones. We have determined that each of the development and regulatory milestones is substantive; therefore, we expect to recognize such development and regulatory milestone payments as revenues under collaborative agreements upon achievement in accordance with the Milestone Method. In addition, we have determined that the sales-based milestone payment is similar to a royalty payment and is not considered a milestone payment under the Milestone Method of revenue recognition; therefore, we will recognize the sales-based milestone payment as revenue upon achievement of the milestone because we have no future performance obligations associated with the milestone.
For the three and nine months ended September 30, 2011, we recognized a $3 million milestone payment as revenues under collaborative agreements in accordance with the Milestone Method related to the achievement of a development milestone pursuant to the terms of the ViroPharma Collaboration. There were no milestone payments recognized as revenues under collaborative agreements associated with the ViroPharma Collaboration for the three and nine months ended September 30, 2012. There were no milestone payments recognized as revenues under collaborative agreements associated with the Intrexon Collaboration for the three and nine months ended September 30, 2012 and 2011. We recognized the annual exclusivity fee of zero and $1 million as revenues under collaborative agreements associated with each the ViroPharma and Intrexon Collaborations for the three and nine months ended September 30, 2012, respectively.
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4. Inventories
Inventories consist of the following:
September 30, | December 31, | |||||||
2012 | 2011 | |||||||
Raw materials |
$ | 962,751 | $ | 201,822 | ||||
Work-in-process |
715,241 | 290,647 | ||||||
Finished goods |
508,071 | 74,794 | ||||||
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$ | 2,186,063 | $ | 567,263 | |||||
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5. Property and Equipment, Net
Property and equipment, net consist of the following:
September 30, | December 31, | |||||||
2012 | 2011 | |||||||
Research equipment |
$ | 6,207,401 | $ | 5,231,763 | ||||
Computer and office equipment |
1,524,340 | 1,266,041 | ||||||
Leasehold improvements |
1,137,187 | 1,019,147 | ||||||
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8,868,928 | 7,516,951 | |||||||
Accumulated depreciation and amortization |
(6,505,278 | ) | (5,745,903 | ) | ||||
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$ | 2,363,650 | $ | 1,771,048 | |||||
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Depreciation and amortization expense totaled approximately $286,000 and $239,000 for the three months ended September 30, 2012 and 2011, respectively, and approximately $796,000 and $852,000 for the nine months ended September 30, 2012 and 2011, respectively.
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6. Accrued Expenses
Accrued expenses consist of the following:
September 30, | December 31, | |||||||
2012 | 2011 | |||||||
Accrued outsourced research and development expenses |
$ | 3,735,396 | $ | 1,910,273 | ||||
Accrued compensation and payroll taxes |
3,339,791 | 3,223,936 | ||||||
Other accrued expenses |
966,486 | 481,365 | ||||||
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$ | 8,041,673 | $ | 5,615,574 | |||||
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7. Deferred Revenue
Deferred revenue consists of the following:
September 30, | December 31, | |||||||
2012 | 2011 | |||||||
Collaborative agreements |
$ | 44,034,015 | $ | 40,716,806 | ||||
Product sales |
319,367 | 167,184 | ||||||
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Total deferred revenue |
44,353,382 | 40,883,990 | ||||||
Less current portion |
9,470,247 | 4,129,407 | ||||||
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Deferred revenue, net of current portion |
$ | 34,883,135 | $ | 36,754,583 | ||||
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Roche Collaboration. Under the terms of the Roche Collaboration, Roche paid $20 million to us in December 2006 as an initial upfront payment for the application of rHuPH20 to three pre-defined Roche biologic targets. As of September 30, 2012, Roche has paid an aggregate of $20 million in connection with Roche’s election of two additional exclusive targets and annual license maintenance fees for the right to designate the remaining targets as exclusive targets. Roche currently retains the option to develop and commercialize rHuPH20 with three additional targets, provided that Roche continues to pay annual license maintenance fees to us.
Due to our continuing involvement obligations (for example, support activities associated with rHuPH20 enzyme), revenues from the upfront payment, exclusive designation fees and annual license maintenance fees were deferred and are being recognized over the term of the Roche Collaboration. We recognized revenue from the upfront payment, exclusive designation fees and annual license maintenance fees under the Roche Collaboration in the amounts of approximately $503,000 and $491,000 for the three months ended September 30, 2012 and 2011, respectively, and approximately $1.5 million for the nine months ended September 30, 2012 and 2011. Deferred revenue relating to the upfront payment, exclusive designation fees and annual license maintenance fees under the Roche Collaboration was $30.1 million and $31.7 million as of September 30, 2012 and December 31, 2011, respectively.
During the nine months ended September 30, 2012, we received approximately $7.0 million in deferred revenue relating to the manufacture of rHuPH20 API for Roche. We recognized approximately $334,000 as revenues under collaborative agreements from deferred revenue relating to the manufacture of rHuPH20 API for the three and nine months ended September 30, 2012. Deferred revenue relating to the manufacture of rHuPH20 API under the Roche Collaboration was $6.7 million and zero as of September 30, 2012 and December 31, 2011, respectively.
Gammagard Collaboration. Under the terms of the Gammagard Collaboration, Baxter paid us a nonrefundable upfront payment of $10 million. Due to our continuing involvement obligations (for example, support activities associated with rHuPH20 enzyme), the $10 million upfront payment was deferred and is being recognized over the term of the Gammagard Collaboration. We recognized revenue from the upfront payment under the Gammagard Collaboration in the amounts of approximately $121,000 for each of the three months ended September 30, 2012 and 2011 and approximately $362,000 for the nine months ended September 30, 2012 and 2011. Deferred revenue relating to the upfront payment under the Gammagard Collaboration was $7.2 million and $7.6 million as of September 30, 2012 and December 31, 2011, respectively.
Hylenex Collaboration. In February 2007, we and Baxter amended certain existing agreements for Hylenex recombinant and entered into the Hylenex Collaboration for kits and formulations with rHuPH20. Effective January 7, 2011, we and Baxter mutually agreed to terminate the Hylenex Collaboration and the associated agreements. On July 18, 2011, we and Baxter entered into an agreement (the “Transition Agreement”) setting forth certain rights, data and assets to be transferred by Baxter to us during a transition period. Effective July 18, 2011, we had no future performance obligations to Baxter in connection with the Hylenex Collaboration. Therefore, we recognized the unamortized deferred revenue of approximately $9.3 million relating to the prepaid product-based payments and the unamortized deferred revenue of approximately $7.6 million relating to deferred upfront payment from the Hylenex Collaboration as revenues under collaborative agreements for the three months ended September 30, 2011. For the nine months ended September 30, 2011, we recognized revenues under the Hylenex Collaboration from the upfront payment of approximately $7.8 million and from the product-based payments of approximately $9.3 million. There were no deferred revenues relating to the Hylenex Collaboration at September 30, 2012 and 2011.
In addition, pursuant to the terms of the Transition Agreement, Baxter no longer had the right to return the Hylenex recombinant API previously delivered to Baxter. Accordingly, we recognized approximately $991,000 of deferred revenue related to such Hylenex recombinant API as product sales revenue during the three and nine months ended September 30, 2011.
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9. Stockholders’ Equity
During the nine months ended September 30, 2012 and 2011, we issued an aggregate of 426,277 and 2,713,573 shares of common stock, respectively, in connection with the exercises of stock options at a weighted average exercise price of $4.56 and $1.70 per share, respectively, for net proceeds of approximately $1.9 million and $4.1 million, respectively. In addition, for the nine months ended September 30, 2012, we issued 81,070 shares of common stock upon vesting of certain RSUs. The RSU holders surrendered 46,930 RSUs to pay for minimum withholding taxes totaling approximately $347,000. Options and RSUs to purchase approximately 6.9 million and 6.0 million shares of our common stock were outstanding as of September 30, 2012 and December 31, 2011, respectively. In addition, we issued 375,908 shares of common stock, net of RSAs canceled, in connection with the grants of RSAs during the nine months ended September 30, 2012.
On February 15, 2012, we completed an underwritten public offering and issued 7,820,000 shares of common stock, including 1,020,000 shares sold pursuant to the full exercise of an over-allotment option granted to the underwriter. All of the shares were offered at a public offering price of $10.61 per share, generating approximately $81.5 million in net proceeds. Randal J. Kirk, a member of our board of directors, through his affiliates, purchased 1,360,000 shares of common stock in this offering at the public offering price of $10.61 per share for a total of approximately $14.4 million.
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10. Commitments and Contingencies
From time to time, we may be involved in disputes, including litigation, relating to claims arising out of operations in the normal course of our business. Any of these claims could subject us to costly legal expenses and, while we generally believe that we have adequate insurance to cover many different types of liabilities, our insurance carriers may deny coverage or our policy limits may be inadequate to fully satisfy any damage awards or settlements. If this were to happen, the payment of any such awards could have a material adverse effect on our consolidated results of operations and financial position. Additionally, any such claims, whether or not successful, could damage our reputation and business. We currently are not a party to any legal proceedings, the adverse outcome of which, in management’s opinion, individually or in the aggregate, would have a material adverse effect on our consolidated results of operations or financial position.
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Basis of Presentation
The accompanying interim unaudited condensed consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (“U.S. GAAP”) and with the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) related to a quarterly report on Form 10-Q. Accordingly, they do not include all of the information and disclosures required by U.S. GAAP for a complete set of financial statements. These interim unaudited condensed consolidated financial statements and notes thereto should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2011, filed with the SEC on March 12, 2012. The unaudited financial information for the interim periods presented herein reflects all adjustments which, in the opinion of management, are necessary for a fair presentation of the financial condition and results of operations for the periods presented, with such adjustments consisting only of normal recurring adjustments. Operating results for interim periods are not necessarily indicative of the operating results for an entire fiscal year.
The condensed consolidated financial statements include the accounts of Halozyme Therapeutics, Inc. and our wholly owned subsidiary, Halozyme, Inc. All intercompany accounts and transactions have been eliminated.
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. On an ongoing basis, we evaluate our estimates and judgments, which are based on historical and anticipated results and trends and on various other assumptions that management believes to be reasonable under the circumstances. By their nature, estimates are subject to an inherent degree of uncertainty and, as such, actual results may differ from management’s estimates.
Adoption of Recent Accounting Pronouncements
Effective January 1, 2012, we adopted Financial Accounting Standards Board’s (“FASB”) Accounting Standards Update (“ASU”) No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income and ASU No. 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in ASU No. 2011-5. In these updates, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU No. 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amendments in ASU No. 2011-05 do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The amendments in these updates are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of ASU Nos. 2011-05 and 2011-12 did not have a material impact on our consolidated financial position or results of operations. We have presented comprehensive income (loss) in our condensed consolidated statements of comprehensive income (loss).
Effective January 1, 2012, we prospectively adopted FASB’s ASU No. 2011-04, “Fair Value Measurement (Topic 820) — Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS”. The amendments in ASU 2011-04 result in common fair value measurement and disclosure requirements in GAAP and International Financial Reporting Standards (“IFRS”). Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. This pronouncement is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of ASU No. 2011-04 did not have a material effect on our consolidated financial position or results of operations.
Inventories
Inventories are stated at lower of cost or market. Cost is determined on a first-in, first-out basis. Inventories are reviewed periodically for potential excess, dated or obsolete status. Management evaluates the carrying value of inventories on a regular basis, taking into account such factors as historical and anticipated future sales compared to quantities on hand, the price it expects to obtain for products in their respective markets compared with historical cost and the remaining shelf life of goods on hand.
Raw materials inventories consist of raw materials used in the manufacture of our bulk drug material for Hylenex recombinant product. Work-in-process inventories consist of in-process Hylenex recombinant. Finished goods inventories consist of finished Hylenex recombinant product.
We expense costs relating to the purchase and production of pre-approval inventories for which the sole use is pre-approval products as research and development expense in the period incurred until such time as we believe future commercialization is probable and future economic benefit is expected to be realized. For products that have been approved by regulatory bodies such as the U.S. Food and Drug Administration (“FDA”), inventories used in clinical trials are expensed at the time the inventories are packaged for the clinical trials. Prior to receiving approval from the FDA or comparable regulatory agencies in foreign countries, costs related to purchases of the active pharmaceutical ingredients (“API”) and the manufacturing of the product candidate are recorded as research and development expense. All direct manufacturing costs incurred after approval are capitalized as inventory.
Revenue Recognition
We generate revenues from product sales and collaborative agreements. Payments received under collaborative agreements may include nonrefundable fees at the inception of the agreements, license fees, milestone payments for specific achievements designated in the collaborative agreements, reimbursements of research and development services and/or royalties on sales of products resulting from collaborative arrangements.
We recognize revenue in accordance with the authoritative guidance on revenue recognition. Revenue is recognized when all of the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the seller’s price to the buyer is fixed or determinable; and (4) collectibility is reasonably assured.
Cost of Product Sales
Cost of product sales consists primarily of raw materials, third-party manufacturing costs, fill and finish costs, freight costs, internal costs and manufacturing overhead associated with the production of Hylenex recombinant. Cost of product sales also consists of the write-down of excess, dated and obsolete inventories.
Research and Development Expenses
Research and development expenses include salaries and benefits, facilities and other overhead expenses, external clinical trial expenses, research related manufacturing services, contract services and other outside expenses. Research and development expenses are charged to operations as incurred when these expenditures relate to our research and development efforts and have no alternative future uses.
Advance payments, including nonrefundable amounts, for goods or services that will be used or rendered for future research and development activities are deferred and capitalized. Such amounts will be recognized as an expense as the related goods are delivered or the related services are performed or at such time when we do not expect the goods to be delivered or services to be performed.
Milestone payments that we make in connection with in-licensed technology or product candidates are expensed as incurred when there is uncertainty in receiving future economic benefits from the licensed technology or product candidates. We consider the future economic benefits from the licensed technology or product candidates to be uncertain until such licensed technology or product candidates are approved for marketing by regulatory bodies such as the FDA or when other significant risk factors are abated. Management has viewed future economic benefits for all of our licensed technology or product candidates to be uncertain and has expensed these amounts as incurred.
Clinical Trial Expenses
Expenses related to clinical trials are accrued based on our estimates and/or representations from service providers regarding work performed, including actual level of patient enrollment, completion of patient studies and progress of clinical trials. Other incidental costs related to patient enrollment or treatment are accrued when reasonably certain. If the contracted amounts are modified (for instance, as a result of changes in the clinical trial protocol or scope of work to be performed), we modify our accruals accordingly on a prospective basis. Revisions in the scope of a contract are charged to expense in the period in which the facts that give rise to the revision become reasonably certain.
Share-Based Compensation
Total share-based compensation expense related to all of our share-based awards was allocated as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2012 | 2011 | 2012 | 2011 | |||||||||||||
Research and development |
$ | 913,946 | $ | 890,276 | $ | 3,279,940 | $ | 1,944,552 | ||||||||
Selling, general and administrative |
1,008,447 | 867,083 | 3,082,432 | 1,971,777 | ||||||||||||
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Share-based compensation expense |
$ | 1,922,393 | $ | 1,757,359 | $ | 6,362,372 | $ | 3,916,329 | ||||||||
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Share-based compensation expense per basic and diluted share |
$ | 0.02 | $ | 0.02 | $ | 0.06 | $ | 0.04 | ||||||||
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Share-based compensation expense from: |
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Stock options |
$ | 1,164,973 | $ | 806,078 | $ | 3,491,220 | $ | 2,318,728 | ||||||||
Restricted stock awards and restricted stock units |
757,420 | 951,281 | 2,871,152 | 1,597,601 | ||||||||||||
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$ | 1,922,393 | $ | 1,757,359 | $ | 6,362,372 | $ | 3,916,329 | |||||||||
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Since we have a net operating loss carryforward as of September 30, 2012, no excess tax benefits for the tax deductions related to share-based awards were recognized in the interim unaudited condensed consolidated statements of comprehensive loss for the three and nine months ended September 30, 2012. For the three months ended September 30, 2012 and 2011, employees exercised stock options to purchase 7,055 and 38,511 shares of common stock, respectively, for aggregate proceeds of approximately $39,000 and $79,000, respectively. For the nine months ended September 30, 2012 and 2011, employees exercised stock options to purchase 426,277 and 2,713,573 shares of common stock, respectively, for aggregate proceeds of approximately $1.9 million and $4.1 million, respectively. In addition, for the nine months ended September 30, 2012, upon vesting of 128,000 restricted stock units (“RSUs”), the RSU holders received net settlement of 81,070 shares of common stock and surrendered 46,930 RSUs to pay for the minimum withholding taxes totaling approximately $347,000. There were no RSUs vested for the three months ended September 30, 2012 or the three and nine months ended September 30, 2011.
As of September 30, 2012, total unrecognized estimated compensation cost related to non-vested stock options and non-vested restricted stock awards and restricted stock units granted prior to that date was approximately $9.6 million and $7.0 million, respectively, which is expected to be recognized over a weighted-average period of approximately 2.7 years and 3.6 years, respectively.
Fair Value of Financial Instruments
We follow the authoritative guidance for fair value measurements and disclosures which, among other things, defines fair value, establishes a consistent framework for measuring fair value and expands disclosure for each major asset and liability category measured at fair value on either a recurring or nonrecurring basis. Fair value is defined as an exit price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability.
The framework for measuring fair value provides a hierarchy that prioritizes the inputs to valuation techniques used in measuring fair value as follows:
Level 1 | Quoted prices (unadjusted) in active markets for identical assets or liabilities, | |
Level 2 | Inputs other than quoted prices included within Level 1 that are either directly or indirectly observable, and | |
Level 3 | Unobservable inputs in which little or no market activity exists, therefore requiring an entity to develop its own assumptions about the assumptions that market participants would use in pricing. |
Our financial instruments include cash and cash equivalents, accounts receivable, prepaid expenses, accounts payable and accrued expenses. The carrying amounts of financial instruments approximate their fair values due to their short maturities. Cash equivalents of approximately $85.0 million and $51.8 million at September 30, 2012 and December 31, 2011, respectively, are carried at fair value and are classified within Level 1 of the fair value hierarchy because they are valued based on quoted market prices for identical securities. We have no instruments that are classified within Level 2 and Level 3.
Segment Information
We operate our business in one segment, which includes all activities related to the research, development and commercialization of human enzymes that either transiently modify tissue to facilitate injection of other therapies or correct diseased tissue structures for clinical benefit. This segment also includes revenues and expenses related to (i) research and development activities conducted under our collaborative agreements with third parties and (ii) product sales of Hylenex recombinant. The chief operating decision-maker reviews the operating results on an aggregate basis and manages the operations as a single operating segment.
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Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2012 | 2011 | 2012 | 2011 | |||||||||||||
Research and development |
$ | 913,946 | $ | 890,276 | $ | 3,279,940 | $ | 1,944,552 | ||||||||
Selling, general and administrative |
1,008,447 | 867,083 | 3,082,432 | 1,971,777 | ||||||||||||
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Share-based compensation expense |
$ | 1,922,393 | $ | 1,757,359 | $ | 6,362,372 | $ | 3,916,329 | ||||||||
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Share-based compensation expense per basic and diluted share |
$ | 0.02 | $ | 0.02 | $ | 0.06 | $ | 0.04 | ||||||||
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Share-based compensation expense from: |
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Stock options |
$ | 1,164,973 | $ | 806,078 | $ | 3,491,220 | $ | 2,318,728 | ||||||||
Restricted stock awards and restricted stock units |
757,420 | 951,281 | 2,871,152 | 1,597,601 | ||||||||||||
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$ | 1,922,393 | $ | 1,757,359 | $ | 6,362,372 | $ | 3,916,329 | |||||||||
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September 30, | December 31, | |||||||
2012 | 2011 | |||||||
Raw materials |
$ | 962,751 | $ | 201,822 | ||||
Work-in-process |
715,241 | 290,647 | ||||||
Finished goods |
508,071 | 74,794 | ||||||
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$ | 2,186,063 | $ | 567,263 | |||||
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|
|
|
September 30, | December 31, | |||||||
2012 | 2011 | |||||||
Research equipment |
$ | 6,207,401 | $ | 5,231,763 | ||||
Computer and office equipment |
1,524,340 | 1,266,041 | ||||||
Leasehold improvements |
1,137,187 | 1,019,147 | ||||||
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|
|
|
|||||
8,868,928 | 7,516,951 | |||||||
Accumulated depreciation and amortization |
(6,505,278 | ) | (5,745,903 | ) | ||||
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|
|
|
|||||
$ | 2,363,650 | $ | 1,771,048 | |||||
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|
|
|
September 30, | December 31, | |||||||
2012 | 2011 | |||||||
Accrued outsourced research and development expenses |
$ | 3,735,396 | $ | 1,910,273 | ||||
Accrued compensation and payroll taxes |
3,339,791 | 3,223,936 | ||||||
Other accrued expenses |
966,486 | 481,365 | ||||||
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|
|
|
|||||
$ | 8,041,673 | $ | 5,615,574 | |||||
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|
|
September 30, | December 31, | |||||||
2012 | 2011 | |||||||
Collaborative agreements |
$ | 44,034,015 | $ | 40,716,806 | ||||
Product sales |
319,367 | 167,184 | ||||||
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|
|
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Total deferred revenue |
44,353,382 | 40,883,990 | ||||||
Less current portion |
9,470,247 | 4,129,407 | ||||||
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|
|
|||||
Deferred revenue, net of current portion |
$ | 34,883,135 | $ | 36,754,583 | ||||
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