Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended June 30, 2010

 

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: 001-34620

 

IRONWOOD PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

04-3404176

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification Number)

 

 

 

301 Binney Street

 

 

Cambridge, Massachusetts

 

02142

(Address of Principal Executive Offices)

 

(Zip Code)

 

(617) 621-7722

(Registrant’s telephone number, including area code)

 

320 Bent Street

Cambridge, Massachusetts, 02141

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

 

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

 

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

 

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

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer x

 

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

 

As of July 30, 2010, there were 19,180,562 shares of Class A common stock outstanding and 78,850,764 shares of Class B common stock outstanding.

 

 

 



Table of Contents

 

IRONWOOD PHARMACEUTICALS, INC.

 

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 2010

 

TABLE OF CONTENTS

 

 

 

Page

 

 

PART I — FINANCIAL INFORMATION

 

Item 1.

Financial Statements (unaudited)

 

 

Condensed Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009

3

 

Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2010 and 2009

4

 

Condensed Consolidated Statements of Cash Flows for the Three and Six Months Ended June 30, 2010 and 2009

5

 

Notes to Condensed Consolidated Financial Statements

6

Item 2.

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

24

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

33

Item 4.

Controls and Procedures

34

 

 

 

PART II — OTHER INFORMATION

 

Item 1A.

Risk Factors

35

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

54

Item 6.

Exhibits

54

 

 

 

 

Signatures

55

 

2



Table of Contents

 

PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Ironwood Pharmaceuticals, Inc.

 

Condensed Consolidated Balance Sheets

 

(in thousands, except share and per share amounts)

 

(unaudited)

 

 

 

June 30,
2010

 

December 31,
2009

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

35,384

 

$

123,145

 

Available-for-sale securities

 

236,221

 

 

Accounts receivable

 

196

 

12

 

Related party accounts receivable, net

 

6,156

 

5,222

 

Prepaid expenses and other assets

 

4,202

 

3,069

 

Total current assets

 

282,159

 

131,448

 

Restricted cash

 

10,510

 

8,431

 

Property and equipment, net

 

29,117

 

22,551

 

Other assets

 

298

 

21

 

Total assets

 

$

322,084

 

$

162,451

 

Liabilities and Stockholders’ Equity (Deficit)

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

5,202

 

$

4,944

 

Accrued research and development costs

 

8,573

 

12,401

 

Accrued expenses

 

5,523

 

4,899

 

Current portion of long-term debt

 

1,017

 

1,310

 

Current portion of capital lease obligations

 

246

 

143

 

Current portion of deferred rent

 

1,150

 

180

 

Current portion of deferred revenue

 

35,490

 

32,560

 

Total current liabilities

 

57,201

 

56,437

 

Long-term debt, net of current portion

 

1,288

 

1,764

 

Capital lease obligations, net of current portion

 

427

 

112

 

Deferred rent, net of current portion

 

16,330

 

10,486

 

Deferred revenue, net of current portion

 

73,288

 

93,642

 

Commitments and contingencies (Note 8)

 

 

 

 

 

Convertible preferred stock, $0.001 par value, no shares authorized at June 30, 2010 and 74,942,226 shares authorized at December 31, 2009, no shares issued and outstanding at June 30, 2010 and 69,904,843 shares issued and outstanding at December 31, 2009 (Note 3 and Note 9)

 

 

298,350

 

Stockholders’ equity (deficit):

 

 

 

 

 

Preferred stock, $0.001 par value, 75,000,000 shares authorized, no shares issued and outstanding at June 30, 2010 and no shares authorized, issued or outstanding at December 31, 2009

 

 

 

Class A common stock, $0.001 par value, 500,000,000 and 98,530,700 shares authorized at June 30, 2010 and December 31, 2009, respectively, and 19,180,562 shares issued and outstanding at June 30, 2010 and no shares issued and outstanding at December 31, 2009

 

19

 

 

Class B common stock, $0.001 par value, 100,000,000 and 98,530,700 shares authorized at June 30, 2010 and December 31, 2009, respectively, 78,850,764 and 7,854,602 shares issued and outstanding at June 30, 2010 and December 31, 2009, respectively

 

79

 

8

 

Additional paid-in capital

 

518,217

 

12,999

 

Accumulated deficit

 

(347,619

)

(314,559

)

Accumulated other comprehensive income

 

44

 

 

Total Ironwood Pharmaceuticals, Inc. stockholders’ equity (deficit)

 

170,740

 

(301,552

)

Noncontrolling interest

 

2,810

 

3,212

 

Total stockholders’ equity (deficit)

 

173,550

 

(298,340

)

Total liabilities and stockholders’ equity (deficit)

 

$

322,084

 

$

162,451

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Condensed Consolidated Statements of Operations

 

(in thousands, except share and per share amounts)

 

(unaudited)

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Revenue:

 

 

 

 

 

 

 

 

 

Collaborative arrangements

 

$

9,188

 

$

6,210

 

$

18,026

 

$

10,660

 

Services

 

1,771

 

400

 

1,985

 

1,181

 

Total revenue

 

10,959

 

6,610

 

20,011

 

11,841

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

20,953

 

19,397

 

39,590

 

38,004

 

General and administrative

 

7,325

 

5,790

 

13,968

 

10,984

 

Total operating expenses

 

28,278

 

25,187

 

53,558

 

48,988

 

Loss from operations

 

(17,319

)

(18,577

)

(33,547

)

(37,147

)

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest expense

 

(79

)

(122

)

(172

)

(256

)

Interest and investment income

 

189

 

82

 

257

 

186

 

Remeasurement of forward purchase contracts

 

 

(300

)

 

(100

)

Other income (expense), net

 

110

 

(340

)

85

 

(170

)

Net loss

 

(17,209

)

(18,917

)

(33,462

)

(37,317

)

Net loss attributable to noncontrolling interest

 

73

 

532

 

402

 

964

 

Net loss attributable to Ironwood Pharmaceuticals, Inc.

 

$

(17,136

)

$

(18,385

)

$

(33,060

)

$

(36,353

)

Net loss per share attributable to Ironwood Pharmaceuticals, Inc.—basic and diluted

 

$

(0.18

)

$

(2.61

)

$

(0.41

)

$

(5.18

)

Weighted average number of common shares used in net loss per share attributable to Ironwood Pharmaceuticals, Inc.—basic and diluted

 

97,642,330

 

7,035,871

 

80,893,200

 

7,021,733

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Condensed Consolidated Statements of Cash Flows

 

(in thousands)

 

(unaudited)

 

 

 

Six Months Ended June 30,

 

 

 

2010

 

2009

 

Cash flows from operating activities:

 

 

 

 

 

Net loss

 

$

(33,462

)

$

(37,317

)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

Depreciation and amortization

 

2,805

 

2,574

 

Loss on disposal of property and equipment

 

227

 

69

 

Remeasurement of forward purchase contracts

 

 

100

 

Share-based compensation expense

 

3,298

 

1,927

 

Accretion of discount/premium on investment securities

 

487

 

148

 

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(1,118

)

2,717

 

Restricted cash

 

(2,079

)

(446

)

Prepaid expenses and other current assets

 

(1,133

)

(1,851

)

Other assets

 

(277

)

25

 

Accounts payable and accrued expenses

 

401

 

(1,873

)

Accrued research and development costs

 

(3,828

)

(2,663

)

Deferred revenue

 

(17,424

)

27,505

 

Deferred rent

 

6,814

 

1,240

 

Net cash used in operating activities

 

(45,289

)

(7,845

)

Cash flows from investing activities:

 

 

 

 

 

Purchases of available-for-sale securities

 

(274,131

)

(8,981

)

Sales and maturities of available-for-sale securities

 

37,467

 

23,300

 

Purchases of property and equipment

 

(8,604

)

(2,279

)

Proceeds from the sale of property and equipment

 

1

 

10

 

Net cash (used in) provided by investing activities

 

(245,267

)

12,050

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from initial public offering

 

203,167

 

 

Proceeds from exercise of stock options and issuance of restricted stock

 

466

 

11

 

Proceeds from borrowings

 

 

2,597

 

Payments on borrowings

 

(838

)

(694

)

Net cash provided by financing activities

 

202,795

 

1,914

 

Net (decrease) increase in cash and cash equivalents

 

(87,761

)

6,119

 

Cash and cash equivalents, beginning of period

 

123,145

 

67,722

 

Cash and cash equivalents, end of period

 

$

35,384

 

$

73,841

 

Supplemental cash flow disclosures:

 

 

 

 

 

Cash paid for interest

 

$

180

 

$

233

 

Fair value of forward purchase contract

 

$

 

$

6,000

 

Purchases under capital leases

 

$

487

 

$

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

1. Nature of Business

 

Ironwood Pharmaceuticals, Inc. (the “Company”) is an entrepreneurial pharmaceutical company that discovers, develops and intends to commercialize innovative medicines targeting important therapeutic needs. The Company is focused on a portfolio of internally discovered drug candidates that currently includes one Phase 3 drug candidate (linaclotide), one Phase 1/Phase 2 pain drug candidate, and multiple preclinical candidates.

 

The Company holds a majority ownership interest in Microbia, Inc. (formerly known as Microbia Precision Engineering), a subsidiary formed in September 2006. Microbia, Inc. (“Microbia”) engages in a specialty biochemicals business based on a proprietary strain-development platform.

 

The Company was incorporated in Delaware on January 5, 1998. On April 7, 2008, the Company changed its name from Microbia, Inc. to Ironwood Pharmaceuticals, Inc. The Company operates in two reportable business segments: human therapeutics and biomanufacturing (Note 12).

 

The Company has generated an accumulated deficit as of June 30, 2010 of approximately $347.6 million since inception.  In February 2010, the Company completed its initial public offering of Class A common stock and raised a total of approximately $203.2 million in net proceeds (Note 3). At June 30, 2010, the Company believes that based on its current business plan, its unrestricted cash, cash equivalents and available-for-sale securities totaling approximately $271.6 million are sufficient to fund operations through the anticipated commercialization of linaclotide in the U.S.

 

2. Summary of Significant Accounting Policies

 

Unaudited Interim Financial Statements

 

The accompanying condensed consolidated financial statements and the related disclosures as of June 30, 2010 and for the three and six months ended June 30, 2010 and 2009 are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and the applicable rules and regulations of the Securities and Exchange Commission (‘‘SEC’’) for interim financial information. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements.  These interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K filed with the SEC on March 30, 2010.  The December 31, 2009 condensed consolidated balance sheet included herein was derived from the audited financial statements as of that date, but does not include all disclosures including notes required by GAAP for complete financial statements.

 

The unaudited interim condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and, in the opinion of management, reflect all adjustments of a normal recurring nature considered necessary to present fairly the Company’s financial position as of June 30, 2010 and results of its operations for the three and six months ended June 30, 2010 and 2009, and its cash flows for the six months ended June 30, 2010 and 2009. The interim results for the three and six months ended June 30, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010.

 

Basis of Presentation

 

In June 2009, the Financial Accounting Standards Board (“FASB”) issued the FASB Accounting Standards Codification (“Codification”). The Codification became the single source for all authoritative GAAP recognized by the FASB and is required to be applied to financial statements issued for interim and annual periods ending after September 15, 2009. The Codification does not change GAAP and did not impact the Company’s financial position or results of operations.

 

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Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

Principles of Consolidation

 

During 2006, the Company formed Microbia as a 100% wholly owned subsidiary of the Company. In September 2006, Microbia sold additional equity interests to a third party, which reduced the Company’s ownership interest in Microbia to 85% (Note 13). The accompanying condensed consolidated financial statements of Ironwood Pharmaceuticals, Inc. include the assets, liabilities, revenue, and expenses of Microbia, over which the Company exercises control. The Company records noncontrolling interest in its condensed consolidated statements of operations for the ownership interest of the minority owners of Microbia. All intercompany transactions and balances are eliminated in consolidation.

 

Use of Estimates

 

The preparation of consolidated financial statements in accordance with GAAP requires the Company’s management to make estimates and judgments that may affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company’s management evaluates its estimates, including those related to revenue recognition, available-for-sale securities, impairment of long-lived assets, income taxes including the valuation allowance for deferred tax assets, valuation of forward purchase contracts, research and development, contingencies, and share-based compensation. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. Changes in estimates are reflected in reported results in the period in which they become known.

 

Cash and Cash Equivalents

 

The Company considers all highly liquid investment instruments with an original maturity when purchased of three months or less to be cash equivalents. Investments qualifying as cash equivalents primarily consist of money market funds and U.S. Treasury securities. The carrying amount of cash equivalents approximates fair value. The amount of cash equivalents included in cash and cash equivalents was approximately $28.0 million and $120.6 million at June 30, 2010 and December 31, 2009, respectively.

 

Available-for-Sale Securities

 

The Company classifies all short-term investments with an original maturity when purchased of greater than three months as available-for-sale. Available-for-sale securities are carried at fair value, with the unrealized gains and losses reported in other comprehensive income (loss). The amortized cost of debt securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in interest and investment income. Realized gains and losses, and declines in value judged to be other than temporary on available-for-sale securities, are included in interest and investment income.

 

The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in interest and investment income. To determine whether an other-than-temporary impairment exists, the Company considers whether it has the ability and intent to hold the investment until a market price recovery, and whether evidence indicating the recoverability of the cost of the investment outweighs evidence to the contrary. There were no other-than-temporary impairments for the three and six months ended June 30, 2010.

 

Concentrations of Credit Risk

 

Financial instruments that subject the Company to credit risk primarily consist of cash and cash equivalents, restricted cash, available-for-sale securities, and accounts receivable. The Company maintains its cash and cash equivalent balances with high-quality financial institutions and, consequently, the Company believes that such funds are subject to minimal credit risk. The Company’s available-for-sale investments potentially subject the Company to concentrations of credit risk. The Company has adopted an investment policy which limits the amounts the Company may invest in any one type of investment, and requires all investments held by the Company to be A+ rated, thereby reducing credit risk concentration.

 

Accounts receivable primarily consist of amounts due under the collaboration agreement with Forest Laboratories, Inc. (“Forest”) and license agreements with Almirall, S.A. (“Almirall”) and Astellas Pharma Inc. (“Astellas”) (Note 5) and from Tate &

 

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Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

Lyle Investments, Ltd. (“T&L”) (Note 13) for which the Company does not obtain collateral. Effective September 1, 2009, Forest became a related party when the Company sold to Forest 2,083,333 shares of the Company’s Series G convertible preferred stock and effective November 2, 2009, Almirall became a related party when the Company sold to them 681,819 shares of its Series I convertible preferred stock.

 

Forest accounted for approximately 50% and 54% of the Company’s revenue for the three and six months ended June 30, 2010, respectively, and approximately 67% and 75% for the three and six months ended June 30, 2009, respectively. Almirall accounted for approximately 25% and 29% of the Company’s revenue for the three and six months ended June 30, 2010, respectively, and approximately 27% and 15% for the three and six months ended June 30, 2009, respectively. T&L accounted for approximately 16% and 10% of the Company’s revenue for the three and six months ended June 30, 2010, respectively and approximately 6% and 10% for the three and six months ended June 30, 2009, respectively. For the three and six months ended June 30, 2010 and 2009, no additional customers accounted for more than 10% of the Company’s revenue.

 

At June 30, 2010 and December 31, 2009, accounts receivable from Forest, net of any payables due Forest, accounted for approximately 67% and 94%, respectively, of the Company’s total accounts receivable. At June 30, 2010 and December 31, 2009, Almirall accounted for approximately 2% and 6%, respectively, of the Company’s total accounts receivable.  At June 30, 2010 and December 31, 2009, accounts receivable from T&L, accounted for approximately 28% and 0%, respectively, of the Company’s total accounts receivable.

 

Revenue Recognition

 

The Company’s revenue is generated primarily through collaborative research and development and licensing agreements. The terms of these agreements typically include payment to the Company of one or more of the following: nonrefundable, up-front license fees; milestone payments; sale of drug substance to its collaborators; and royalties on product sales. In addition, the Company generates services revenue through agreements that generally provide for fees for research and development services rendered, and may include additional payments at the conclusion of the research period upon achieving specified events. These service agreements also contemplate royalty payments to the Company on future sales of its customers’ products. To date the Company has earned no royalty revenue as a result of product sales.

 

The Company recognizes revenue when there is persuasive evidence that an arrangement exists, services have been rendered or delivery has occurred, the price is fixed and determinable, and collection is reasonably assured. The Company evaluates revenue from agreements that have multiple elements and accounts for the components as separate elements when the following criteria are met:

 

·                  the delivered items have value to the customer on a stand-alone basis;

 

·                  there is objective and reliable evidence of fair value of the undelivered items; and

 

·                  if there is a general right of return relative to the delivered items, delivery or performance of the undelivered items is considered probable and within the Company’s control.

 

Collaborative Arrangements Revenue

 

Up-front License Fees

 

The Company recognizes revenues from nonrefundable, up-front license fees for which the separation criteria were not met due to continuing involvement in the performance of research and development services on a straight-line basis over the contracted or estimated period of performance, which is typically the research or development term.

 

Milestones

 

At the inception of each agreement that includes milestone payments, the Company evaluates whether each milestone is substantive and at risk to both parties on the basis of the contingent nature of the milestone, specifically reviewing factors such as the scientific and other risks that must be overcome to achieve the milestone, as well as the level of effort and investment required.

 

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Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

Milestones that are not considered substantive are accounted for as license payments and recognized on a straight-line basis over the remaining period of performance.

 

In those circumstances where a substantive milestone is achieved, collection of the related receivable is reasonably assured and the Company has remaining obligations to perform under the collaboration arrangement, the Company recognizes as revenue on the date the milestone is achieved an amount equal to the applicable percentage of the performance period that has elapsed as of the date the milestone is achieved, with the balance being deferred and recognized on a straight-line basis over the remaining period of performance.

 

Payments received or reasonably assured after performance obligations are fully satisfied are recognized as earned.

 

Services Revenue

 

The Company recognizes services revenue when there is persuasive evidence that an arrangement exists, services have been rendered or delivery has occurred, the price is fixed and determinable, and collection is reasonably assured. Revenue from research and development services rendered is recognized as services are performed. Bonus payments are recognized as revenue when achieved and the bonus payments are due and collectible. Royalty revenue related to research and development services is recognized in the period the sales occur.

 

The Company receives research and development funding under the Forest collaboration agreement and considers the factors or indicators within this arrangement to determine whether reporting such funding on a gross or net basis is appropriate. The Company records revenue transactions gross in the condensed consolidated statements of operations if it is deemed the principal in the transaction, which includes being the primary obligor and having the risks and rewards of ownership. The Company produces clinical materials for its collaborators and is reimbursed for its costs to produce such clinical materials. The Company recognizes revenue on clinical materials when the materials have passed all quality testing required for collaborator acceptance and title and risk of loss have transferred to the collaborator.

 

For certain of the Company’s arrangements, particularly the Company’s license agreement with Almirall, it is required that taxes be withheld on payments made to the Company. The Company has adopted a policy to recognize revenue net of these tax withholdings.

 

Research and Development Costs

 

The Company expenses research and development costs to operations as incurred. The Company defers and capitalizes nonrefundable advance payments made by the Company for research and development activities until the related goods are received or the related services are performed.

 

Research and development expenses comprise costs incurred in performing research and development activities, including salaries and benefits, share-based compensation expense, laboratory supplies and other direct expenses, facilities expenses, overhead expenses, contractual services, including clinical trial and related clinical manufacturing expenses, and other outside expenses. Also included in research and development expenses are the costs of revenue related to the Microbia services contracts.

 

The Company has entered into a collaboration agreement in which it shares research and development expenses with a collaborator. The Company records the expenses for such work as research and development expense. Because the collaboration arrangement is a cost-sharing arrangement, the Company concluded that when there is a period during the collaboration arrangement during which the Company receives payments from the collaborator, the Company records the payments by the collaborator for their share of the development effort as a reduction of research and development expense.

 

Share-Based Compensation

 

Share-based compensation is recognized as an expense in the financial statements based on the grant date fair value. Compensation expense recognized relates to stock awards, restricted stock and stock options granted, modified, repurchased or cancelled on or after January 1, 2006. Stock options granted to employees prior to that time continue to be accounted for using the intrinsic value method. Under the intrinsic value method, compensation associated with share-based awards to employees was

 

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Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

determined as the difference, if any, between the fair value of the underlying common stock on the date compensation was measured, generally the grant date, and the price an employee must pay to exercise the award. For awards that vest based on service conditions, the Company uses the straight-line method to allocate compensation expense to reporting periods. The grant date fair value of options granted is calculated using the Black-Scholes option-pricing model, which requires the use of subjective assumptions including volatility, expected term and the fair value of the underlying common stock, among others.

 

The Company records the expense for stock option grants subject to performance-based milestone vesting over the remaining service period when management determines that achievement of the milestone is probable. Management evaluates when the achievement of a performance-based milestone is probable based on the relative satisfaction of the performance conditions as of the reporting date.

 

The Company records the expense of services rendered by non-employees based on the estimated fair value of the stock option using the Black-Scholes option-pricing model. The fair value of unvested non-employee awards are remeasured at each reporting period and expensed over the vesting term of the underlying stock options.

 

Noncontrolling Interest

 

Effective January 1, 2009, the Company adopted a newly issued accounting standard for noncontrolling interests. In accordance with the accounting standard, the Company changed the accounting and reporting for its noncontrolling interest in its condensed consolidated financial statements.

 

Noncontrolling interest represents the noncontrolling stockholder’s proportionate share of equity and net income or net loss of the Company’s consolidated subsidiary, Microbia. The noncontrolling stockholder’s proportionate share of the equity in Microbia, of approximately $2.8 million and $3.2 million as of June 30, 2010 and December 31, 2009, respectively, is reflected as noncontrolling interest in the Company’s condensed consolidated balance sheets as a component of stockholders’ equity (deficit).

 

The proportionate share of the net loss attributable to noncontrolling interest is reflected in the accompanying condensed consolidated statements of operations. The following table is a roll-forward of the noncontrolling interest (in thousands):

 

Balance at December 31, 2009

 

$

3,212

 

Net loss attributable to noncontrolling interest

 

(402

)

Balance at June 30, 2010

 

$

2,810

 

 

Net Loss Per Share

 

The Company calculates basic and diluted net loss per common share by dividing the net loss by the weighted average number of common shares outstanding during the period. The Company has excluded all shares that are subject to repurchase by the Company from the weighted average number of common shares outstanding. The Company’s potentially dilutive shares, which include convertible preferred stock, outstanding common stock options and unvested shares of restricted stock, have not been included in the computation of diluted net loss per share for all periods as the result would be antidilutive.

 

Income Taxes

 

The Company provides for income taxes under the liability method. Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates in effect when the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance to reflect the uncertainty associated with their ultimate realization.

 

Management of the Company has evaluated the positive and negative evidence bearing upon the realizability of its deferred tax assets. Management has considered the Company’s history of operating losses and concluded, in accordance with the applicable accounting standards, that it is more likely than not that the Company may not realize the benefit of its deferred tax assets. Accordingly, the deferred tax assets have been fully reserved at June 30, 2010 and December 31, 2009. Management reevaluates the positive and negative evidence on a quarterly basis.

 

10



Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

The Company accounts for uncertain tax positions recognized in the condensed consolidated financial statements by prescribing a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  There were no income tax provisions or benefits for the three and six months ended June 30, 2010 and 2009 given the Company’s continued net operating loss position.

 

The statute of limitations for assessment by the Internal Revenue Service (“IRS”) and state tax authorities is open for tax years ending December 31, 2006, 2007 and 2008, although carryforward attributes that were generated prior to tax year 2006 may still be adjusted upon examination by the IRS or state tax authorities if they either have been or will be used in a future period. The Company is aware of no federal or state audits currently in progress.

 

Impairment of Long-Lived Assets

 

The Company regularly reviews the carrying amount of its long-lived assets to determine whether indicators of impairment may exist which warrant adjustments to carrying values or estimated useful lives. If indications of impairment exist, projected future undiscounted cash flows associated with the asset are compared to the carrying amount to determine whether the asset’s value is recoverable. If the carrying value of the asset exceeds such projected undiscounted cash flows, the asset will be written down to its estimated fair value. There were no indicators of impairment at June 30, 2010.

 

Comprehensive Income (Loss)

 

All components of comprehensive income (loss) are required to be disclosed in the condensed consolidated financial statements. Comprehensive income (loss) is defined as the change in equity of a business enterprise during a period from transactions, and other events and circumstances from non-owner sources and currently consists of net loss and changes in unrealized gains and losses on available-for-sale securities.  Comprehensive loss from operations was calculated as follows (in thousands):

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Net loss attributable to Ironwood Pharmaceuticals, Inc.

 

$

(17,136

)

$

(18,385

)

$

(33,060

)

$

(36,353

)

Unrealized gain (loss) on investments

 

143

 

(15

)

44

 

(21

)

Comprehensive loss attributable to Ironwood Pharmaceuticals, Inc.

 

$

(16,993

)

$

(18,400

)

$

(33,016

)

$

(36,374

)

 

Segment Information

 

Operating segments are components of an enterprise for which separate financial information is available and is evaluated regularly by the Company’s chief operating decision-maker in deciding how to allocate resources and in assessing performance.

 

The Company has two reportable business segments: human therapeutics and biomanufacturing (Note 12). Revenue from the Company’s human therapeutics segment is presented in the condensed consolidated statements of operations as collaborative arrangements revenue. Revenue from the Company’s biomanufacturing segment is presented as services revenue.

 

New Accounting Pronouncements

 

From time to time, new accounting pronouncements are issued by the FASB or other standard setting bodies that are adopted by the Company as of the specified effective date. Unless otherwise discussed, the Company believes that the impact of recently issued standards that are not yet effective will not have a material impact on its consolidated financial position or results of operations upon adoption.

 

11



Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

Recently Issued Accounting Standards

 

In April 2010, the FASB issued Accounting Standards Update “ASU” No. 2010-17, Revenue Recognition — Milestone Method (“ASU 2010-017”). ASU 2010-017 provides guidance in applying the milestone method of revenue recognition to research or development arrangements. Under this guidance management may recognize revenue contingent upon the achievement of a milestone in its entirety, in the period in which the milestone is achieved, only if the milestone meets all the criteria within the guidance to be considered substantive. This ASU is effective on a prospective basis for research and development milestones achieved in fiscal years, beginning on or after June 15, 2010. Early adoption is permitted; however, adoption of this guidance as of a date other than January 1, 2011 will require the Company to apply this guidance retrospectively effective as of January 1, 2010 and will require disclosure of the effect of this guidance as applied to all previously reported interim periods in the fiscal year of adoption. As the Company plans to implement ASU No. 2010-17 prospectively, the effect of this guidance will be limited to future transactions.

 

In October 2009, the FASB issued ASU No. 2009-13, Multiple- Deliverable Revenue Arrangements (“ASU 2009-13”). ASU 2009-13, amends existing revenue recognition accounting pronouncements that are currently within the scope of FASB Accounting Standards Codification Subtopic 605-25 (previously included within EITF 00-21, Revenue Arrangements with Multiple Deliverables (“EITF 00-21”). The consensus to ASU 2009-13 provides accounting principles and application guidance on whether multiple deliverables exist, how the arrangement should be separated, and the consideration allocated. This guidance eliminates the requirement to establish the fair value of undelivered products and services and instead provides for separate revenue recognition based upon management’s estimate of the selling price for an undelivered item when there is no other means to determine the fair value of that undelivered item. EITF 00-21 previously required that the fair value of the undelivered item be the price of the item either sold in a separate transaction between unrelated third parties or the price charged for each item when the item is sold separately by the vendor. Under EITF 00-21, if the fair value of all of the elements in the arrangement was not determinable, then revenue was deferred until all of the items were delivered or fair value was determined. This new approach is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 and allows for retrospective application. The Company is currently evaluating the potential impact of this standard on its financial position and results of operations.

 

3. Initial Public Offering

 

In February 2010, the Company completed its initial public offering of Class A common stock pursuant to a registration statement that was declared effective on February 2, 2010. The Company sold 19,166,667 shares of its Class A common stock, which included 2,500,000 shares of the Company’s Class A common stock sold pursuant to an over-allotment option granted to the underwriters, at a price to the public of $11.25 per share. As a result of the initial public offering, the Company raised a total of $215.6 million in gross proceeds, and approximately $203.2 million in net proceeds after deducting underwriting discounts and commissions of $10.5 million and estimated offering expenses of $1.9 million. Costs directly associated with the Company’s initial public offering were capitalized and recorded as deferred offering costs prior to the closing of the initial public offering. These costs have been recorded as a reduction of the proceeds received in arriving at the amount to be recorded in additional paid-in capital.

 

Upon the closing of the initial public offering, 69,904,843 shares outstanding of the Company’s convertible preferred stock automatically converted into 70,391,620 shares of its Class B common stock.

 

12



Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

4. Net Loss Per Share

 

Basic and diluted net loss per share is calculated as follows (in thousands, except share and per share amounts):

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Numerator:

 

 

 

 

 

 

 

 

 

Net loss attributable to Ironwood Pharmaceuticals, Inc.

 

$

(17,136

)

$

(18,385

)

$

(33,060

)

$

(36,353

)

Denominator:

 

 

 

 

 

 

 

 

 

Weighted average number of common shares used in net loss per share attributable to Ironwood Pharmaceuticals, Inc.—basic and diluted

 

97,642,330

 

7,035,871

 

80,893,200

 

7,021,733

 

Net loss per share attributable to Ironwood Pharmaceuticals, Inc.—basic and diluted

 

$

(0.18

)

$

(2.61

)

$

(0.41

)

$

(5.18

)

 

The following potentially dilutive securities have been excluded from the computation of diluted weighted average shares outstanding as of June 30, 2010 and 2009, as they would be anti-dilutive:

 

 

 

At June 30,

 

 

 

2010

 

2009

 

Convertible preferred stock

 

 

67,118,858

 

Options to purchase common stock

 

14,888,833

 

12,890,489

 

Shares subject to repurchase

 

338,556

 

44,146

 

 

 

15,227,389

 

80,053,493

 

 

5. Collaboration and License Agreements

 

Forest Laboratories, Inc.

 

In September 2007, the Company entered into a collaboration agreement with Forest to jointly develop and commercialize linaclotide, a drug candidate for the treatment of irritable bowel syndrome with constipation (“IBS-C”), chronic constipation (“CC”) and other lower gastrointestinal conditions, in North America. Under the terms of this collaboration agreement, the Company shares equally with Forest all development costs, as well as potential future profits and losses from the development and sale of linaclotide in the United States. The Company will receive royalties from Forest for sales in Canada and Mexico. The Company retained the rights to commercialize linaclotide outside of North America. Forest made non-refundable, up-front payments totaling $70.0 million to the Company in order to obtain rights to linaclotide in North America. Because of the Company’s continuing involvement in the development program, the Company is recognizing the up-front license fee as revenue on a straight-line basis over five years, which is the Company’s estimate of the period over which linaclotide will be jointly developed under the collaboration. The collaboration agreement also includes contingent milestone payments, as well as a contingent equity investment based on the achievement of specific clinical and commercial milestones. These payments, including the up-front license fee, could total up to $330.0 million, of which $125.0 million has already been received, if certain development and sales milestones are achieved for linaclotide. In September 2008, the Company achieved a clinical milestone which triggered a $10.0 million milestone payment from Forest. At June 30, 2010, approximately $30.9 million and $4.4 million of the up-front license fee and milestone payment, respectively, remain deferred and are being recognized on a straight-line basis over the remaining estimated development period.

 

The collaboration agreement included a contingent equity investment, in the form of a forward purchase contract, which required Forest to purchase 2,083,333 shares of the Company’s convertible preferred stock, when a specific clinical milestone was met, at a price of $12.00 per share. The Company evaluated this financial instrument and determined that because the Company may be required to settle the instrument by transferring assets to Forest due to “deemed liquidation” provisions of the preferred stock, it should be considered an asset or liability, which is required to be carried at fair value.  The changes in fair value are recorded as other income or expense.

 

13



Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

The Company valued the contingent equity investment at September 12, 2007 at $9.0 million, which represented the value of the premium that Forest would pay for shares of the Company’s stock should the milestone be achieved. The $9.0 million was recorded as an asset and incremental deferred revenue at the inception of the arrangement. The $9.0 million of incremental deferred revenue is being recognized as revenue on a straight-line basis over the period of the Company’s continuing involvement, which was estimated to be five years from the inception of the arrangement. At June 30, 2010, approximately $4.0 million of the incremental deferred revenue remains deferred and is being recognized on a straight-line basis over the remaining estimated development period.

 

At June 30, 2009, the Company remeasured the fair value of the contingent equity investment using current assumptions resulting in a fair value of $8.4 million. For the three and six months ended June 30, 2009, the Company recorded a decrease of approximately $0.5 million and $0.3 million, respectively, in the fair value of the forward purchase contract related to this remeasurement.

 

On July 22, 2009, the Company achieved the clinical milestone under the Forest collaboration agreement, triggering the equity investment. As a result, the Company remeasured the fair value of the contingent equity investment as of July 22, 2009 using assumptions as of that date. The resulting final fair value of the contingent equity investment was $8.8 million. The increase in the fair value of the contingent equity investment was recorded to other income (expense) at that time and the Company reclassified the forward purchase contract as a reduction to convertible preferred stock. The Company issued the 2,083,333 shares to Forest on September 1, 2009. Additionally, the achievement of the clinical milestone triggered a $20.0 million milestone payment from Forest that was received on August 20, 2009, of which approximately $8.8 million remains deferred at June 30, 2010 and is being recognized on a straight-line basis over the remaining estimated development period.

 

The Company recognized in revenue from the Forest collaboration agreement approximately $5.5 million and $10.9 million during the three and six months ended June 30, 2010, respectively, and approximately $4.5 million and $8.9 million during the three and six months ended June 30, 2009, respectively.

 

Further, because the Company shares development costs equally with Forest, payments from Forest with respect to research and development costs incurred by the Company are recorded as a reduction to expense, and not as revenue.  As a result of the cost-sharing arrangements under the collaboration, the Company offset approximately $4.3 million and $8.1 million during the three and six months ended June 30, 2010 and approximately $1.8 million and $4.8 million during the three and six months ended June 30, 2009, respectively against research and development expense.

 

Almirall, S.A.

 

In April 2009, the Company entered into a license agreement with Almirall for European rights to develop and commercialize linaclotide for the treatment of IBS-C, CC and other lower gastrointestinal conditions. Under the terms of the license agreement, Almirall is responsible for the expenses associated with the development and commercialization of linaclotide in the European territory. The license agreement requires the Company to participate on a joint development committee over linaclotide’s development period. The Company will receive escalating royalties from the sales of linaclotide in the European territory. In May 2009, the Company received a $38.0 million payment from Almirall representing a $40.0 million non-refundable up-front payment net of foreign withholding taxes. The Company elected to record the non-refundable up-front payment on a net basis. Because of the Company’s continuing involvement in the development program, the Company is recognizing the up-front license fee as revenue on a straight-line basis over fifty months, which is the Company’s estimate of the period over which linaclotide will be developed under the license agreement for the European territory. At June 30, 2010, approximately $27.4 million of the up-front license fee remains deferred.  The license agreement also includes contingent milestone payments, as well as a contingent equity investment based on the achievement of specific clinical and sales milestones. These payments could total up to $55.0 million, including the contingent equity investment discussed below, of which $15.0 million has already been received, if certain development and sales milestones are achieved for linaclotide.

 

The license agreement included a contingent equity investment, in the form of a forward purchase contract, which required Almirall to purchase 681,819 shares of the Company’s convertible preferred stock, when a specific clinical milestone was met, at a price of $22.00 per share. The Company evaluated this financial instrument and determined that because the Company may be required to settle the instrument by transferring assets to Almirall, it should be considered an asset or liability. The contingent equity investment was valued at inception at its fair value. The Company valued the contingent equity investment at April 30, 2009 at $6.0 million, which represented the value of the premium that Almirall would pay for shares of the Company’s stock should the milestone

 

14



Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

be achieved. The $6.0 million was recorded as an asset and incremental deferred revenue at the inception of the arrangement. The $6.0 million of incremental deferred revenue is being recognized as revenue on a straight-line basis over the period of the Company’s continuing involvement, which is estimated to be fifty months. At June 30, 2010, approximately $4.3 million of the incremental deferred revenue remains deferred.

 

At June 30, 2009, the Company remeasured the fair value of the contingent equity investment using current assumptions resulting in a fair value of $6.2 million. For both the three and six months ended June 30, 2009, the Company recorded an increase of approximately $0.2 million in the fair value of the forward purchase contract related to this remeasurement.

 

On November 2, 2009, the Company achieved the clinical milestone under the Almirall license agreement, triggering the equity investment. As a result, the Company remeasured the fair value of the contingent equity investment as of November 2, 2009 using assumptions as of that date. The resulting final fair value of the contingent equity investment was $6.5 million. The increase in the fair value of the contingent equity investment was recorded to other income (expense) at that time, and the Company reclassified the forward purchase contract as a reduction to convertible preferred stock. On November 13, 2009, the Company received $15.0 million from Almirall for the purchase of 681,819 shares of convertible preferred stock.

 

The Company recognized approximately $2.8 million and $5.7 million in revenue from the Almirall license agreement during the three and six months ended June 30, 2010, respectively, including approximately $0.1 million and $0.4 million from the sale of clinical materials to Almirall. During both the three and six months ended June 30, 2009 the Company recognized approximately $1.8 million in revenue from the Almirall license agreement.

 

Astellas Pharma Inc.

 

On November 9, 2009, the Company entered into a license agreement with Astellas. Astellas has the right to develop and commercialize linaclotide for the treatment of IBS-C and other gastrointestinal conditions in Japan, South Korea, Taiwan, Thailand, Philippines, and Indonesia. Under the terms of the agreement, Astellas paid the Company an up-front licensing fee of $30.0 million on November 16, 2009. The license agreement requires the Company to participate on a joint development committee over linaclotide’s development period. The agreement includes additional development milestone payments that could total up to $45.0 million. In addition, the Company will receive escalating royalties on linaclotide sales should Astellas receive approval to market and sell linaclotide in the Asian market. Astellas will be responsible for activities relating to regulatory approval and commercialization.  Because of the Company’s continuing involvement in the development program, the Company is recognizing the up-front license fee as revenue on a straight-line basis over 115 months, which is the Company’s estimate of the period over which linaclotide will be developed under the license agreement for the Asian market. At June 30, 2010, approximately $29.0 million of the up-front license fee remains deferred.  During the three and six months ended June 30, 2010, the Company recognized approximately $1.0 million and $1.4 million, respectively, in revenue from the Astellas license agreement, including approximately $0.2 million and $0.4 million, respectively, from the sale of clinical materials to Astellas.

 

6. Fair Value of Financial Instruments

 

The table below presents information about the Company’s assets that are measured at fair value on a recurring basis as of June 30, 2010 and indicates the fair value hierarchy of the valuation techniques the Company utilized to determine such fair value. In general, fair values determined by Level 1 inputs utilize observable inputs such as quoted prices in active markets for identical assets or liabilities. Fair values determined by Level 2 inputs utilize data points that are either directly or indirectly observable, such as quoted prices, interest rates and yield curves. Fair values determined by Level 3 inputs utilize unobservable data points in which there is little or no market data, which require the Company to develop its own assumptions for the asset or liability.

 

The Company’s investment portfolio includes many fixed income securities that do not always trade on a daily basis. As a result, the pricing services used by the Company applied other available information as applicable through processes such as benchmark yields, benchmarking of like securities, sector groupings and matrix pricing to prepare evaluations. In addition, model processes were used to assess interest rate impact and develop prepayment scenarios. These models take into consideration relevant credit information, perceived market movements, sector news and economic events. The inputs into these models may include benchmark yields, reported trades, broker-dealer quotes, issuer spreads and other relevant data.

 

15



Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

The Company has classified assets measured at fair value on a recurring basis as follows (in thousands):

 

 

 

 

 

Fair Value Measurements at Reporting Date Using

 

Description

 

June 30,
2010

 

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

 

Significant Other
Observable
Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Money market funds (included in cash and cash equivalents)

 

$

18,013

 

$

18,013

 

$

 

$

 

U.S. Treasury securities (included in cash and cash equivalents)

 

9,999

 

9,999

 

 

 

U.S. government-sponsored entities

 

144,276

 

 

144,276

 

 

U.S. Treasury securities

 

91,945

 

91,945

 

 

 

Total

 

$

264,233

 

$

119,957

 

$

144,276

 

$

 

 

Cash, cash equivalents, accounts receivable, prepaid expenses and other current assets, restricted cash, accounts payable, accrued expenses, current portion of capital lease obligations and the current portion of long-term debt are carried at amounts that approximate fair value at June 30, 2010 and December 31, 2009 due to their short-term maturities.

 

Capital lease obligations and long-term debt approximate fair value at June 30, 2010 and December 31, 2009, as they bear interest at a rate approximating a market interest rate.

 

7. Available-for-Sale Investments

 

The following is a summary of available-for-sale securities at June 30, 2010 (in thousands):

 

 

 

Amortized Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair Value

 

June 30, 2010:

 

 

 

 

 

 

 

 

 

U.S. government-sponsored entities

 

$

144,260

 

$

33

 

$

(17

)

$

144,276

 

U.S. Treasury securities

 

91,917

 

28

 

 

91,945

 

Total

 

$

236,177

 

$

61

 

$

(17

)

$

236,221

 

 

The Company did not have any available-for-sale securities at December 31, 2009.

 

The contractual maturities of all securities held at June 30, 2010 are one year or less. There were seven investments in an unrealized loss position having an aggregate fair value of approximately $32.8 million at June 30, 2010.  The Company reviews its investments for other-than-temporary impairment whenever the fair value of an investment is less than amortized cost and evidence indicates that an investment’s carrying amount is not recoverable within a reasonable period of time. To determine whether an impairment is other-than-temporary, the Company considers whether it has the ability and intent to hold the investment until a market price recovery and considers whether evidence indicating the cost of the investment is recoverable outweighs evidence to the contrary.

 

The cost of securities sold is determined based on the specific identification method for purposes of recording realized gains and losses. Gross realized gains and losses on the sales of investments have not been material to the Company’s consolidated results of operations.

 

16



Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

8. Commitments and Contingencies

 

The Company leases various facilities and equipment under leases that expire at varying dates through 2016. Certain of these leases contain renewal options, and require the Company to pay operating costs, including property taxes, insurance, and maintenance.

 

On February 9, 2010, the Company entered into a Second Lease Amendment for its 301 Binney Street facility. Under the amended lease, the Company, effective as of February 9, 2010, leased an additional 50,000-60,000 square feet of the 301 Binney Street facility, comprised of (a) an initial phase of at least 30,000 square feet (the “Initial Phase”), with rent for such space in the Initial Phase commencing no later than July 1, 2010, and (b) a second phase of up to an additional 30,000 square feet (for total additional space of no less than 50,000 square feet and no more than 60,000 square feet) (the “Second Phase”), with rent for such space in the Second Phase commencing no later than July 1, 2011.  The final square footage will be mutually agreed upon based on actual constructed space. The rent for the space in the Initial Phase will be $42.00 per rentable square foot per year, and the rent for the space in the Second Phase will be $42.50 per rentable square foot per year. The base rent for the additional space in each of the Initial Phase and the Second Phase will increase annually by $0.50 per rentable square foot. Under the terms of the Second Lease Amendment, the landlord will provide the Company with a finish work allowance of $55.00 per rentable square foot of additional space rented in the Initial Phase and the Second Phase. The Amendment does not change the January 31, 2016 expiration date of the original lease. As a result of this amendment, the Company increased their letter of credit by approximately $2.1 million and disposed of leasehold improvements resulting in a loss of approximately $0.2 million. In conjunction with the 301 Binney Street amendment, the Company elected not to renew its lease of approximately 39,000 square feet of space at its 320 Bent Street facility when the lease expires in December 2010.

 

On November 3, 2009, Microbia amended its facility lease to include an early termination option. In consideration for an up-front payment of approximately $0.3 million, the landlord gave Microbia an option to terminate the lease, which was exercised on January 18, 2010.  As a result, the lease will terminate on September 30, 2010. Under the terms of the amended lease, the landlord has agreed to defer the monthly base rent for the seven months beginning March 2010 and ending September 2010. Additionally, Microbia may be required to issue a warrant to the landlord, which is exercisable into shares of Microbia common stock. The number of shares issuable will be determined at the time of issuance in accordance with the terms of the warrant and the price per share will be the fair value of Microbia’s common stock at that time. The Company calculated the fair value of the warrant at June 30, 2010 and at December 31, 2009, which was de minimus. The Company will continue to remeasure the fair value of the warrant at each reporting period and will record the resulting changes in its fair value as other income or expense.

 

In connection with Microbia’s November 2009 restructuring, Microbia may incur approximately $0.8 million of additional costs if Microbia implements an additional reduction in force prior to the earlier of November 5, 2010 or the date that Microbia closes on a new round of financing.

 

9. Stockholders’ Equity (Deficit)

 

Common Stock

 

At June 30, 2010, the Company is authorized to issue 675,000,000 shares of stock, of which 600,000,000 shares have been authorized for the issuance of common stock, with a par value of $0.001 per share, which consist of Class A common stock and Class B common stock, and 75,000,000 shares have been authorized for the issuance of preferred stock, with a par value of $0.001 per share.

 

All shares of common stock that were outstanding immediately prior to the initial public offering were shares of Class B common stock and all shares of common stock sold in the initial public offering were shares of Class A common stock.  Prior to the closing of the Company’s initial public offering, the Company had outstanding nine series of convertible preferred stock with various rights and preferences.  In conjunction with the closing of the Company’s initial public offering, all of the Company’s 69,904,843 outstanding convertible preferred shares automatically converted on a one-for-one basis, except for Series C convertible preferred stock, which converted on a one-for-1.076 basis, into 70,391,620 shares of Class B common stock.  At June 30, 2010, the Company had no preferred shares outstanding.

 

17



Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

Restricted Stock

 

In 2009, the Company sold an aggregate of 515,549 shares of common stock to independent members of the Board of Directors under restricted stock agreements in accordance with the terms of the Company’s 2005 Stock Incentive Plan (“2005 Plan”) and the Company’s director compensation program. 115,549 shares of restricted common stock sold in 2009 vested on December 31, 2009 and the remainder vest ratably over four years beginning in January 2010. In the event that a member of the Board of Directors ceases to serve on the Company’s Board prior to December 31, 2013, the member shall forfeit all unvested shares in accordance with the terms of the restricted stock agreement.

 

A summary of the unvested shares of restricted stock as of June 30, 2010 is presented below:

 

 

 

Shares

 

Weighted Average
Grant Date
Fair Value

 

Unvested at December 31, 2009

 

400,000

 

$

5.67

 

Granted

 

 

$

 

Vested

 

(45,000

)

$

5.69

 

Forfeited

 

(40,000

)

$

5.48

 

Unvested at June 30, 2010

 

315,000

 

$

5.69

 

 

10. Stock Option Plans

 

The Company has several share-based compensation plans. Under the 1998 Amended and Restated Stock Option Plan (“1998 Plan”), options to purchase 3,405,000 shares of common stock were available for grant to employees, directors, and consultants of the Company. The options were granted under the 1998 Plan at fair market value on the grant date, generally vest over a period of four years, and expire ten years from the grant date. There are no shares available for future grant under this plan, as it expired in accordance with its terms in 2008. At June 30, 2010 and December 31, 2009, options for 498,883 and 550,633 shares, respectively, were outstanding under the 1998 Plan.

 

Under the Company’s 2002 Stock Incentive Plan (“2002 Plan”) and 2005 Plan, stock awards may be granted to employees, officers, directors, consultants, or advisors of the Company. The 2002 Plan and 2005 Plan provide for the granting of stock options, restricted stock, restricted stock units, and other share-based awards. At June 30, 2010, 4,700,000 shares of common stock are reserved for issuance under the 2002 Plan and 12,200,000 shares are reserved under the 2005 Plan. The 2002 Plan allows for the transfer of unused shares from the 1998 Plan.  At June 30, 2010, there were 61,831 shares available for future grant under the 2002 Plan and 284,157 shares available for future grant under the 2005 Plan.

 

On January 21, 2010, the Company’s stockholders approved the 2010 Employee, Director and Consultant Equity Incentive Plan (“2010 Plan”) (together with the 2002 Plan and 2005 Plan, the “Plans”) which became effective upon the closing of the Company’s initial public offering. Under the 2010 Plan, stock awards may be granted to employees, officers, directors, or consultants of the Company. There were 6,000,000 shares of common stock initially reserved for issuance under the 2010 Plan. The number of shares available for future grant under the 2010 Plan may be increased on the first day of each fiscal year by an amount equal to the lesser of (i) 6,600,000; (ii) 4% of the number of outstanding shares of common stock on the first day of each fiscal year; and (iii) an amount determined by the Board of Directors. Awards that are returned to the Company’s 1998 Plan, 2002 Plan and 2005 Plan as a result of their expiration, cancellation, termination or repurchase are automatically made available for issuance under the 2010 Plan.  At June 30, 2010, there were 6,040,781 shares available for future grant under the 2010 Plan.

 

On January 21, 2010, the Company’s stockholders approved the 2010 Employee Stock Purchase Plan (“Purchase Plan”) which became effective upon the closing of the Company’s initial public offering. The Purchase Plan allows eligible employees the right to purchase shares of common stock at the lower of 85% of the fair market value of a share of common stock on the first or last day of an offering period. Each offering period is six months. There were 400,000 shares of common stock initially reserved for issuance pursuant to the Purchase Plan. The number of shares available for future grant under the Purchase Plan may be increased on the first day of each fiscal year by an amount equal to the lesser of (i) 1,000,000 shares, (ii) 1% of the shares of common stock outstanding on the last day of the immediately preceding fiscal year, or (iii) such lesser number of shares as is determined by the

 

18



Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

Board.  At June 30, 2010, there were 400,000 shares available for future grant under the Purchase Plan.  The initial offering period began on July 1, 2010 and runs through December 31, 2010.

 

Each plan, other than the Purchase Plan, provides for the granting of stock awards whereby the Company’s Class B common stock is issuable upon exercise of options granted before the closing of the Company’s initial public offering and Class A common stock is issuable upon exercise of options granted after the Company’s initial public offering. At June 30, 2010, options exercisable into 12,998,652 shares of Class B common stock and 1,890,181 shares of Class A common stock were outstanding.

 

The option price at the date of grant is determined by the Board of Directors and, in the case of incentive stock options, may not be less than the fair market value of the common stock at the date of grant. Due to the absence of an active market for the Company’s common stock, prior to the pricing of the Company’s initial public offering on February 2, 2010, the Board of Directors was required to determine the fair value of the common stock for consideration in setting exercise prices for the options granted and in valuing the options granted. In determining the fair value, the Board of Directors considered both quantitative and qualitative factors including prices at which the Company sold shares of its convertible preferred stock, the rights, preferences and liquidity of the Company’s convertible preferred and common stock, the Company’s historical operating and financial performance and the status of its research and product development efforts, achievement of enterprise milestones, including the Company entering into collaboration agreements where third parties agree to purchase shares of the Company’s convertible preferred stock at fixed prices sometime in the future, external market conditions affecting the biotechnology industry sector, and financial market conditions and, commencing in 2006, contemporaneous valuations provided by management.

 

The option exercise period may not extend beyond ten years from the date of grant. The 2002 Plan and 2005 Plan provide that, subject to approval by the Board of Directors, option grantees may have the right to exercise an option prior to vesting. Shares purchased upon the exercise of unvested options will be subject to the same vesting schedule as the underlying options, and are subject to repurchase at the original exercise price by the Company should the employee be terminated or leave the Company prior to becoming fully vested in such shares. At June 30, 2010 and December 31, 2009, there were 23,556 and 34,156 shares, respectively, that had been issued pursuant to the exercise of unvested options that remain unvested and subject to repurchase by the Company. Upon stock option exercise, the Company issues restricted shares and delivers them to the participant. The number of these early-exercised shares is not substantive.  The cash paid for the exercise prices is recorded as a liability and was not material to the consolidated financial statements at June 30, 2010 and December 31, 2009.  At June 30, 2010, the Company does not hold any treasury shares.

 

The Company, from time to time, issues certain time-accelerated stock options to certain employees under the Plans. The vesting of these time-accelerated stock options accelerates upon the achievement of certain performance-based milestones, such as the filing of a New Drug Application (“NDA”) with the Food and Drug Administration (“FDA”), the first commercial sale of a Company product, the successful completion of an initial public offering, or achieving a specified market capitalization target, among others. If these criteria are not met, such options will vest between six and ten years after the date of grant, and expire at the end of ten years. During the six months ended June 30, 2010, 45,000 shares vested as a result of milestone achievements, and the Company recorded related share-based compensation of approximately $0.1 million for these options. In the three months ended June 30, 2010, no shares vested as a result of milestone achievements. At June 30, 2010 and December 31, 2009, there were 2,286,500 and 2,481,500 shares, respectively, issuable under outstanding and unvested time-accelerated options. When achievement of the milestone is not deemed probable, the Company recognizes compensation expense associated with time-accelerated stock options initially over the vesting period of the respective stock option. When deemed probable of achievement, the Company expenses the remaining unrecognized compensation for the respective stock option over the implicit service period.

 

During 2005, the Company granted to employees options to purchase 97,500 shares of common stock at an exercise price of $0.60 per share, which represented the fair value of the stock at that time. These options are subject to performance-based milestone vesting and expire ten years from the date of grant. The options were deemed to be variable upon grant because the number of shares that will vest were not fixed on the date of grant. The options are therefore remeasured at each reporting period until settlement of the option. During the year ended December 31, 2006, 37,500 shares vested as a result of milestone achievements. In the year ended December 31, 2008, it became probable that the remaining 60,000 unvested options would vest and ultimately vested in February 2009.  In April 2010, 30,000 shares were exercised and therefore will no longer be remeasured.  For the three and six months ended June 30, 2010, the Company recorded related share-based compensation expense of approximately $(0.1) million and $0.1 million, respectively, for these options and none for the three and six months ending June 30, 2009.

 

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Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

During 2009, the Company granted to employees options to purchase a total of 1,060,000 shares of common stock subject to performance-based milestone vesting. During the three and six months ended June 30, 2010, the Company granted additional options to purchase a total of 12,500 shares and 57,500 shares, respectively of common stock subject to performance-based milestone vesting. The vesting of these stock options will occur upon the achievement of certain performance-based milestones, such as the filing of a second NDA with the FDA, the first commercial sale of a Company product, or achieving a specified sales target. During the six months ended June 30, 2010, 5,000 shares vested as a result of milestone achievements and the Company recorded related share-based compensation expense of approximately $31,000 for these options.  During the three months ended June 30, 2010, no shares vested as a result of milestone achievements. The Company has concluded that for the remaining shares of common stock subject to performance-based milestone vesting the performance-based milestones are not probable of achievement; as such, no compensation expense has been recorded related to these options. At June 30, 2010, the unrecognized share-based compensation expense related to these options was approximately $3.9 million.

 

The Company also grants options to external consultants. 25,000 options were granted to external consultants during the three and six months ended June 30, 2010. The weighted average grant date fair value per share of these options was $7.22. During the three and six months ended June 30, 2009, the Company granted options for the purchase of 5,000 shares and 37,000 shares, respectively to external consultants. The weighted average grant date fair value per share of options granted to external consultants during the three and six months ended June 30, 2009 was $3.06 and $2.97, respectively. Most grants made to external consultants vest over a period of one year, and the expense related to these options is charged to share-based compensation expense over the vesting period of the options. The amount of share-based compensation expense that may be recognized for outstanding, unvested options as of June 30, 2010 was approximately $0.3 million. The amount of share-based compensation expense that will ultimately be recorded will depend on the remeasurement of the outstanding awards through their vesting date. This remaining compensation expense will be recognized over a weighted average amortization period of 1.63 years at June 30, 2010.

 

In calculating share-based compensation costs, the Company estimated the fair value of stock options using the Black-Scholes option-pricing model. The Black-Scholes option-pricing model was developed for use in estimating the fair value of short-lived, exchange-traded options that have no vesting restrictions and are fully transferable. The Company estimates the number of awards that will be forfeited in calculating compensation costs. Such costs are then recognized over the requisite service period of the awards on a straight-line basis.

 

Determining the fair value of share-based awards using the Black-Scholes option-pricing model requires the use of highly subjective assumptions, including the expected term of the award and expected stock price volatility. The weighted average assumptions used to estimate the fair value of the stock options using the Black-Scholes option-pricing model were as follows for the three and six months ended June 30, 2010 and 2009:

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Expected volatility

 

57.3

%

62.5

%

57.7

%

62.6

%

Expected term (in years)

 

6.5

 

6.5

 

6.5

 

6.5

 

Risk-free interest rate

 

3.1

%

2.7

%

3.1

%

2.2

%

Expected dividend yield

 

%

%

%

%

 

20



Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

The following table summarizes the expense recognized for these share-based compensation arrangements in the condensed consolidated statements of operations (in thousands):

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Ironwood:

 

 

 

 

 

 

 

 

 

Employee stock options

 

$

1,407

 

$

850

 

$

2,865

 

$

1,708

 

Restricted stock awards

 

119

 

 

227

 

 

Non-employee stock options

 

46

 

3

 

58

 

110

 

Stock awards

 

93

 

 

103

 

 

 

 

1,665

 

853

 

3,253

 

1,818

 

Microbia Stock Plan

 

25

 

57

 

45

 

109

 

 

 

$

 1,690

 

$

910

 

$

3,298

 

$

1,927

 

 

Share-based compensation is reflected in the condensed consolidated statements of operations as follows for the three and six months ended June 30, 2010 and 2009 (in thousands):

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Research and development

 

$

1,040

 

$

558

 

$

1,769

 

$

1,287

 

General and administrative

 

650

 

352

 

1,529

 

640

 

 

At June 30, 2010, there were 6,386,769 shares, available for future grant under the Plans.

 

The following table summarizes stock option activity under the share-based compensation plans, including performance-based options:

 

 

 

Shares of
Common
Stock
Attributable
to Options

 

Weighted
Average
Exercise
Price

 

Weighted
Average
Contractual
Life

 

Aggregate
Intrinsic
Value

 

 

 

 

 

 

 

(in years)

 

(in thousands)

 

Outstanding at December 31, 2009

 

13,691,579

 

$

2.45

 

6.24

 

$

131,459

 

Granted

 

1,894,000

 

$

11.49

 

 

 

 

 

Exercised

 

(650,200

)

$

0.72

 

 

 

 

 

Cancelled

 

(46,546

)

$

4.62

 

 

 

 

 

Outstanding at June 30, 2010

 

14,888,833

 

$

3.67

 

 

 

$

123,103

 

Vested or expected to vest at June 30, 2010

 

13,531,458

 

$

3.55

 

6.37

 

$

113,411

 

Exercisable at June 30, 2010(1)

 

7,149,576

 

$

1.75

 

4.91

 

$

72,694

 

 


(1)                                  All stock options granted under the 1998 Plan, 2002 Plan and 2005 Plan contain provisions allowing for the early exercise of such options into restricted stock. The exercisable shares disclosed above represent those that are vested as of June 30, 2010.

 

The weighted average grant date fair value per share of options granted to employees during the three and six months ended June 30, 2010 was $7.26 and $6.69, respectively, and $3.06 and $2.95 during the three and six months ended June 30, 2009, respectively. The total intrinsic value of options exercised during the three and six months ended June 30, 2010 was approximately $2.0 million and $8.4 million, respectively, and approximately $0.1 million and $0.2 million during the three and six months ended June 30, 2009, respectively. Prior to the closing of the Company’s initial public offering, the intrinsic value was calculated as the difference between the estimated fair value of the Company’s common stock and the exercise price of the option.

 

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Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

The grant date fair value of the options granted to employees during the three and six months ended June 30, 2010 was approximately $2.4 million and $12.5 million, respectively, and approximately $0.1 million and $4.4 million, respectively during the three and six months ended June 30, 2009.

 

As of June 30, 2010, there was approximately $1.6 million and $15.8 million of unrecognized share-based compensation, net of estimated forfeitures, related to restricted stock awards and unvested stock option grants with time-based vesting, respectively, which are expected to be recognized over a weighted average period of 3.57 years. The total unrecognized share-based compensation cost will be adjusted for future changes in estimated forfeitures.

 

11. Related Party Transactions

 

The Company has and currently obtains legal services from a law firm that is an investor of the Company. The Company paid approximately $41,000 and $100,000 in legal fees to this investor during the three and six months ended June 30, 2010 and approximately $3,000 and $5,000 in legal fees to this investor during the three and six months ended June 30, 2009, respectively.

 

In September 2009, Forest became a related party when the Company sold to Forest 2,083,333 shares of the Company’s convertible preferred stock and in November 2009, Almirall became a related party when the Company sold to Almirall 681,819 shares of the Company’s convertible preferred stock (Note 5). Additional related party disclosure related to Microbia and T&L is included in Note 13.

 

12. Segment Reporting

 

The Company has two reportable business segments: human therapeutics and biomanufacturing. The Company has no inter-segment revenues.

 

The following table reports revenue and loss from operations for the Company’s reportable segments for the three and six months ended June 30, 2010 and 2009 (in thousands):

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Revenue:

 

 

 

 

 

 

 

 

 

Human therapeutics

 

$

9,188

 

$

6,210

 

$

18,026

 

$

10,660

 

Biomanufacturing

 

1,771

 

400

 

1,985

 

1,181

 

Total

 

$

10,959

 

$

6,610

 

$

20,011

 

$

11,841

 

Loss from operations:

 

 

 

 

 

 

 

 

 

Human therapeutics

 

$

(17,310

)

$

(15,285

)

$

(31,806

)

$

(31,162

)

Biomanufacturing

 

(9

)

(3,292

)

(1,741

)

(5,985

)

Total

 

$

(17,319

)

$

(18,577

)

$

(33,547

)

$

(37,147

)

 

 

 

June 30,
2010

 

December 31,
2009

 

Total assets:

 

 

 

 

 

Human therapeutics

 

$

319,290

 

$

160,105

 

Biomanufacturing

 

2,794

 

2,346

 

Total

 

$

322,084

 

$

162,451

 

 

At June 30, 2010 and December 31, 2009, approximately $1.8 million and $15,000, respectively, of the Company’s accounts receivable related to the Company’s biomanufacturing segment and approximately $4.6 million and $5.2 million, respectively, of the Company’s accounts receivable related to the human therapeutics segment.

 

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Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

13. Microbia, Inc.

 

Tate & Lyle Investments, Ltd.

 

In September 2006, the Company entered into a collaboration agreement with T&L. The collaboration agreement has a five-year term with a one-year notice of termination. In connection with the execution of the collaboration agreement, the Company also issued T&L 1,823,529 shares of common stock of Microbia, at the aggregate purchase price of approximately $2,000, and issued 7,000,000 shares of convertible preferred stock of Microbia at the aggregate purchase price of $7.0 million. After the sale of stock to T&L, the Company retained an 85% majority ownership interest, and T&L had a 15% noncontrolling interest in Microbia. The Company’s ownership interest in Microbia is comprised entirely of convertible preferred stock with the same preferences to that held by T&L. The ownership of the convertible preferred and common stock by T&L is recorded as noncontrolling interest in the consolidated financial statements.

 

On June 15, 2010, T&L and Microbia entered into an agreement to terminate their collaboration.  The terms and conditions of the agreement include an exchange of intellectual property and a one-time payment to Microbia of approximately $1.8 million.  All current and future obligations between Microbia and T&L are terminated as a result of this agreement.

 

Revenue earned from the T&L collaboration agreement totaled approximately $1.8 million and $1.9 million during the three and six months ended June 30, 2010 and approximately $0.4 million and $1.2 million during the three and six months ended June 30, 2009, respectively. Accounts receivable from T&L was approximately $1.8 million and $10,000 at June 30, 2010 and December 31, 2009, respectively.

 

Strategic Restructuring Plan

 

In November 2009, Microbia implemented a strategic restructuring plan that included an immediate reduction of Microbia’s workforce by approximately 40% of its existing workforce, and a reduced workweek for an additional 12% of its existing workforce. Microbia took this action to focus on its proprietary strain-development platform and existing service agreements.

 

In connection with the strategic restructuring plan, Microbia recorded restructuring charges of $1.2 million in the year ended December 31, 2009, relating primarily to one-time termination benefits and asset impairment charges, which were included in operating expenses.  As of June 30, 2010, Microbia had paid in cash all remaining termination benefits. Additionally, Microbia may incur approximately $0.8 million of additional restructuring costs if Microbia implements an additional reduction in force prior to the earlier of November 5, 2010 or the date that Microbia closes on a new round of financing.

 

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Table of Contents

 

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

 

Forward-Looking Information

 

The following discussion of our financial condition and results of operations should be read in conjunction with our financial statements and the notes to those financial statements appearing elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto and management’s discussion and analysis of financial condition and results of operations for the year ended December 31, 2009 included in our Annual Report on Form 10-K. This discussion contains forward-looking statements that involve significant risks and uncertainties. As a result of many factors, such as those set forth under “Risk Factors” in Part II, Item 1A of this Quarterly Report on Form 10-Q, which are incorporated herein by reference, our actual results may differ materially from those anticipated in these forward-looking statements.

 

Overview

 

We are an entrepreneurial pharmaceutical company that discovers, develops and intends to commercialize innovative medicines targeting important therapeutic needs. To achieve this, we are building a sustainable culture centered on creating and marketing important new drugs. Our experienced team of researchers is focused on a portfolio of internally discovered drug candidates that includes one Phase 3 drug candidate (linaclotide), one Phase 1/Phase 2 pain drug candidate, and multiple preclinical programs. We have pursued a partnering strategy for the commercialization of linaclotide that has enabled us to retain significant control over linaclotide’s development and commercialization, share the costs of drug development and commercialization with collaborators whose capabilities complement ours, and retain approximately half of the future long-term value of linaclotide in the major pharmaceutical markets, should linaclotide meet our sales expectations.

 

We were incorporated in Delaware as Microbia, Inc., or Microbia (which is now the name of our majority-owned subsidiary), on January 5, 1998. On April 7, 2008, we changed our name to Ironwood Pharmaceuticals, Inc.

 

We operate in two reportable business segments—human therapeutics and biomanufacturing. Our human therapeutics segment comprises the vast majority of our business, and it consists of the development and commercialization of our product candidates, including linaclotide. Our biomanufacturing segment, which comprises a much smaller part of our business, consists of our majority ownership interest in Microbia, which focuses on building a specialty biochemicals business based on a proprietary strain-development platform. Our human therapeutics segment represented approximately 99% and our biomanufacturing segment represented approximately 1% of our total assets at June 30, 2010 and December 31, 2009. Our human therapeutics segment represented approximately 100% and 95%, and our biomanufacturing segment represented approximately 0% and 5%, of our loss from operations for the three and six months ended June 30, 2010, respectively.  Our human therapeutics segment represented approximately 82% and 84% and our biomanufacturing segment represented approximately 18% and 16% of our loss from operations for the three and six months ended June 30, 2009, respectively.  We expect our human therapeutics segment to continue to represent substantially all of our total assets and our consolidated operating loss.

 

To date we have dedicated substantially all of our activities to the research and development of our product candidates. We have not generated any revenue to date from product sales and have incurred significant operating losses since our inception in 1998. We incurred net losses attributable to Ironwood Pharmaceuticals, Inc. of approximately $17.1 million and $33.1 million in the three and six months ended June 30, 2010, respectively, and approximately $18.4 million and $36.4 million in the three and six months ended June 30, 2009, respectively. As of June 30, 2010, we had an accumulated deficit of approximately $347.6 million and we expect to incur losses for the foreseeable future.

 

Financial Overview

 

Revenue.  Revenue to date from our human therapeutics segment is generated primarily through our collaboration agreement with Forest Laboratories, Inc., or Forest, and our license agreements with Almirall, S.A., or Almirall, and Astellas Pharma Inc., or Astellas. The terms of these agreements typically include payment to us of one or more of the following: nonrefundable, up-front license fees; milestone payments; and royalties on product sales. Revenue from our human therapeutics segment is shown in our consolidated statements of operations as collaborative arrangements revenue. Revenue from our biomanufacturing segment is generated by our subsidiary, Microbia, which has entered into research and development service agreements with various third parties. These agreements generally provide for fees for research and development services rendered, and may include additional payments at the conclusion of the research period upon achieving specified events. These service agreements also contemplate royalty payments to us on future sales of Microbia’s customers’ products. Revenue from our biomanufacturing segment is shown as services revenue. We expect our revenue to fluctuate for the foreseeable future as our collaborative arrangements revenue is principally based on the

 

24



Table of Contents

 

achievement of clinical and commercial milestones. Additionally, we expect our services revenue to decline as existing Microbia customer contracts are completed and no new services contracts are anticipated.

 

Research and development expense.  Research and development expense consists of expenses incurred in connection with the discovery and development of our product candidates. These expenses consist primarily of compensation, benefits and other employee related expenses, facility costs and third-party contract costs relating to research, formulation, manufacturing, preclinical study and clinical trial activities. Also included in research and development expenses are the costs of revenue related to the Microbia services contracts. We charge all research and development expenses to operations as incurred. Under our Forest collaboration agreement we are reimbursed for certain research and development expenses and we net these reimbursements against our research and development expenses as incurred.

 

Our lead product candidate is linaclotide and it represents the largest portion of our research and development expense for our product candidates. Linaclotide is a first-in-class compound currently in confirmatory Phase 3 trials evaluating its safety and efficacy for the treatment of patients with irritable bowel syndrome with constipation, or IBS-C, or chronic constipation, or CC. Our other clinical stage program is IW-6118, an inhibitor of Fatty Acid Amide Hydrolase, or FAAH, being evaluated for the treatment of pain and inflammation. IW-6118 is a novel small molecule inhibitor of FAAH, that decreased inflammation and pain and elevated fatty acid amides in preclinical models. We have an active investigational new drug application, or IND, for IW-6118 and are currently investigating the safety, tolerability, and pharmacokinetic properties of this molecule in Phase 1/Phase 2 studies.

 

The following table sets forth our research and development expenses related to linaclotide and IW-6118 for the three and six months ended June 30, 2010 and 2009. We began tracking program expenses for linaclotide in 2004, and program expenses from inception to June 30, 2010 were approximately $111.9 million. We began tracking program expenses for IW-6118 in 2008, and program expenses from inception to June 30, 2010 were approximately $10.5 million. These expenses relate primarily to external costs associated with manufacturing, preclinical studies and clinical trial costs. The expenses for linaclotide include both reimbursements to us by Forest as well as our portion of costs incurred by Forest for linaclotide and invoiced to us under the cost-sharing provisions of our collaboration agreement. Costs related to facilities, depreciation, share-based compensation and research and development support services are not directly charged to programs.

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

(in thousands)

 

(in thousands)

 

Linaclotide

 

$

7,216

 

$

8,427

 

$

15,209

 

$

15,307

 

IW-6118

 

1,696

 

$

1,440

 

2,560

 

$

3,393

 

 

The lengthy process of securing Food and Drug Administration, or FDA, approvals for new drugs requires the expenditure of substantial resources. Any failure by us to obtain, or any delay in obtaining, regulatory approvals would materially adversely affect our product development efforts and our business overall. Accordingly, we cannot currently estimate with any degree of certainty the amount of time or money that we will be required to expend in the future on linaclotide or IW-6118 prior to their regulatory approval, if such approval is ever granted. As a result of these uncertainties surrounding the timing and outcome of any approvals, we are currently unable to estimate precisely when, if ever, linaclotide, IW-6118 or any of our other product candidates will generate revenues and cash flows.

 

We have multiple product candidates in earlier stages of development, and are pursuing various therapeutic opportunities. We invest carefully in our pipeline, and the commitment of funding for each subsequent stage of our development programs is typically dependent upon the receipt of clear, positive data. In addition, we are actively engaged in identifying externally-discovered drug candidates at various stages of clinical development and accessing them through in-licensing or acquisition. In evaluating potential assets, we apply the same criteria as those used for investments in internally-discovered assets. To date, we have not in-licensed any drug candidates, but we do expect to do so from time to time.

 

The majority of our external costs are spent on linaclotide, as costs associated with later stage clinical trials are, in most cases, more significant than those incurred in earlier stages of our pipeline. We expect external costs related to the linaclotide program to begin decreasing if its current Phase 3 clinical trials yield positive data and no other clinical trials are necessary to obtain regulatory approval in the U.S. If IW-6118 is successful in early stage clinical trials, we would expect the program’s external costs to increase as it progresses through later stage clinical trials. The remainder of our research and development expense is not tracked by project as it consists primarily of our internal costs, and it benefits multiple projects that are in earlier stages of development and which typically share resources.

 

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The successful development of our product candidates is highly uncertain and subject to a number of risks including, but not limited to:

 

·                  The duration of clinical trials may vary substantially according to the type, complexity and novelty of the product candidate.

 

·                  The FDA and comparable agencies in foreign countries impose substantial requirements on the introduction of therapeutic pharmaceutical products, typically requiring lengthy and detailed laboratory and clinical testing procedures, sampling activities and other costly and time-consuming procedures.

 

·                  Data obtained from nonclinical and clinical activities at any step in the testing process may be adverse and lead to discontinuation or redirection of development activity. Data obtained from these activities also are susceptible to varying interpretations, which could delay, limit or prevent regulatory approval.

 

·                  The duration and cost of discovery, nonclinical studies and clinical trials may vary significantly over the life of a product candidate and are difficult to predict.

 

·                  The costs, timing and outcome of regulatory review of a product candidate.

 

·                  The emergence of competing technologies and products and other adverse market developments.

 

As a result of the uncertainties discussed above, we are unable to determine the duration and costs to complete current or future clinical stages of our product candidates or when, or to what extent, we will generate revenues from the commercialization and sale of any of our product candidates. Development timelines, probability of success and development costs vary widely. We anticipate that we will make determinations as to which additional programs to pursue and how much funding to direct to each program on an ongoing basis in response to the scientific and clinical data of each product candidate, as well as ongoing assessments of such product candidate’s commercial potential.

 

We expect our research and development costs to continue to be substantial for the foreseeable future and to increase with respect to our product candidates other than linaclotide as we advance those product candidates through preclinical studies and clinical trials.

 

General and administrative expense.  General and administrative expense consists primarily of compensation, benefits and other employee related expenses for personnel in our administrative, finance, legal, information technology, business development, commercial and human resource functions. Other costs include the legal costs of pursuing patent protection of our intellectual property, facility costs and professional fees for accounting and legal services. As a result of our initial public offering, or IPO, in February 2010, we anticipate increases in general and administrative expense relating to operating as a public company. These increases will likely include legal fees, accounting fees, costs associated with implementing and complying with the requirements of the Sarbanes-Oxley Act of 2002, and directors’ and officers’ insurance premiums, as well as fees for investor relations services. We also anticipate substantial expenses related to developing the organization necessary to commercialize linaclotide.

 

Critical Accounting Policies and Estimates

 

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States, or GAAP. The preparation of these financial statements requires us to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses during the reported periods. These estimates and assumptions, including those related to revenue recognition, available-for-sale securities, impairments of long-lived assets, income taxes including the valuation allowance for deferred tax assets, research and development expenses, contingencies, and share-based compensation are monitored and analyzed by us for changes in facts and circumstances, and material changes in these estimates could occur in the future. Prior to our IPO, we also evaluated our estimates and judgments regarding the fair value assigned to our common stock. These critical estimates and assumptions are based on our historical experience, our observance of trends in the industry, and various other factors that are believed to be reasonable under the circumstances and form the 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 our estimates under different assumptions or conditions.

 

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During the six months ended June 30, 2010, there were no significant changes in our critical accounting policies or estimates. See Note 2 to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K filed with the Securities and Exchange Commission, or SEC, on March 30, 2010 for additional information about these critical accounting policies, as well as a description of our other significant accounting policies.

 

Results of Operations

 

The following discussion summarizes the key factors our management believes are necessary for an understanding of our condensed consolidated financial statements.

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

(in thousands)

 

(in thousands)

 

Revenue:

 

 

 

 

 

 

 

 

 

Collaborative arrangements

 

$

9,188

 

$

6,210

 

$

18,026

 

$

10,660

 

Services

 

1,771

 

400

 

1,985

 

1,181

 

Total revenue

 

10,959

 

6,610

 

20,011

 

11,841

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

20,953

 

19,397

 

39,590

 

38,004

 

General and administrative

 

7,325

 

5,790

 

13,968

 

10,984

 

Total operating expenses

 

28,278

 

25,187

 

53,558

 

48,988

 

Loss from operations

 

(17,319

)

(18,577

)

(33,547

)

(37,147

)

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest expense

 

(79

)

(122

)

(172

)

(256

)

Interest and investment income

 

189

 

82

 

257

 

186

 

Remeasurement of forward purchase contracts

 

 

(300

)

 

(100

)

Other income (expense), net

 

110

 

(340

)

85

 

(170

)

Net loss

 

(17,209

)

(18,917

)

(33,462

)

(37,317

)

Net loss attributable to noncontrolling interest

 

73

 

532

 

402

 

964

 

Net loss attributable to Ironwood Pharmaceuticals, Inc.

 

$

(17,136

)

$

(18,385

)

$

(33,060

)

$

(36,353

)

 

Three Months and Six Months Ended June 30, 2010 Compared to Three Months and Six Months Ended June 30, 2009

 

Revenue

 

 

 

Three Months Ended
June 30,

 

Change

 

Six Months Ended
June 30,

 

Change

 

 

 

2010

 

2009

 

$

 

%

 

2010

 

2009

 

$

 

%

 

 

 

(dollars in thousands)

 

 

 

(dollars in thousands)

 

 

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Collaborative arrangements

 

$

9,188

 

$

6,210

 

$

2,978

 

48.0

%

$

18,026

 

$

10,660

 

$

7,366

 

69.1

%

Services

 

1,771

 

400

 

1,371

 

342.8

%

1,985

 

1,181

 

804

 

68.1

%

Total revenue

 

$

10,959

 

$

6,610

 

$

4,349

 

65.8

%

$

20,011

 

$

11,841

 

$

8,170

 

69.0

%

 

Collaborative Arrangements.  The increase in revenue from collaborative arrangements for the three months ended June 30, 2010 compared to the three months ended June 30, 2009 was primarily due to an increase in revenue from the Forest collaboration, an increase in revenue related to the Almirall license agreement and an increase in revenue associated with the Astellas license agreement. During the three months ended June 30, 2010, we recognized approximately $1.0 million of revenue related to a $20.0 million Forest milestone payment we received in July 2009, approximately $0.8 million of revenue related to the $30.0 million up-front license payment received from Astellas in November 2009, as well as approximately $0.3 million from shipments of clinical trial materials to both Almirall and Astellas.  We recognized approximately $0.8 million more in revenue during the three months ended

 

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June 30, 2010 compared to the three months ended June 30, 2009, related to the $38.0 million up-front license payment received from Almirall in May 2009.

 

The increase in revenue from collaborative arrangements for the six months ended June 30, 2010 compared to the six months ended June 30, 2009 was primarily due to an increase in revenue from the Forest collaboration, an increase in revenue related to the Almirall license agreement and an increase in revenue associated with the Astellas license agreement. During the six months ended June 30, 2010, we recognized approximately $2.0 million of revenue related to the $20.0 million Forest milestone payment, approximately $1.1 million of revenue related to the $30.0 million up-front license payment from Astellas, as well as approximately $0.8 million from shipments of clinical trial materials to both Almirall and Astellas.  We recognized approximately $3.5 million more in revenue during the six months ended June 30, 2010 compared to the six months ended June 30, 2009, related to the $38.0 million up-front license payment received from Almirall and the amortization of the deferred revenue resulting from recording the initial $6.0 million valuation of the Almirall forward purchase contract, approximately $5.3 million compared to $1.8 million.

 

Services.  Services revenue increased during both the three and six months ended June 30, 2010 compared to the three and six months ended June 30, 2009 due to the one-time payment of approximately $1.8 million associated with the Tate & Lyle Investments, Ltd. (T&L) termination agreement.

 

Operating Expenses

 

 

 

Three Months Ended
June 30,

 

Change

 

Six Months Ended
June 30,

 

Change

 

 

 

2010

 

2009

 

$

 

%

 

2010

 

2009

 

$

 

%

 

 

 

(dollars in thousands)

 

 

 

(dollars in thousands)

 

 

 

Operating Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

$

20,953

 

$

19,397

 

$

1,556

 

8.0

%

$

39,590

 

$

38,004

 

$

1,586

 

4.2

%

General and administrative

 

7,325

 

5,790

 

1,535

 

26.5

%

13,968

 

10,984

 

2,984

 

27.2

%

Total operating expenses

 

$

28,278

 

$

25,187

 

$

3,091

 

12.3

%

$

53,558

 

$

48,988

 

$

4,570

 

9.3

%

 

Research and Development Expense.  The increase in research and development expense for the three months ended June 30, 2010 compared to the three months ended June 30, 2009 was primarily due to an increase of approximately $0.7 million in compensation and benefits related expenses primarily due to a newly implemented employee incentive plan, an approximately $0.5 million increase in stock compensation expense primarily related to our annual stock option grant made in February 2010, an approximately $0.8 million increase in allocated facilities costs primarily due to increased rent expense associated with the newly acquired space at our 301 Binney Street facility, offset by a decrease of approximately $0.4 million in the Phase 3 clinical trials for linaclotide, primarily resulting from lower collaboration expenses.

 

The increase in research and development expense for the six months ended June 30, 2010 compared to the six months ended June 30, 2009 was primarily due to an increase of approximately $0.7 million in compensation and benefits related expenses primarily due to a newly implemented employee incentive plan, an approximately $0.5 million increase in stock compensation expense primarily related to our annual stock option grant made in February 2010, an approximately $0.2 million increase in allocated facilities costs primarily due to increased rent expense associated with the newly acquired space at our 301 Binney Street facility, an approximately $0.3 million increase in internal research and development costs, offset by a decrease of approximately $0.1 million in the Phase 3 clinical trials for linaclotide, primarily resulting from lower collaboration expenses.

 

General and Administrative Expense.  The increase in general and administrative expense for the three months ended June 30, 2010 compared to the three months ended June 30, 2009 was due to an approximately $0.5 million increase in compensation and benefits related expenses due to increased headcount, an approximately $0.3 million increase in stock compensation expense primarily related to our annual stock option grant made in February 2010, an approximately $0.3 million increase in allocated facilities costs primarily due to increased rent expense associated with the newly acquired space at our 301 Binney Street facility, and an increase in external consulting costs of approximately $0.4 million associated with marketing and business development.

 

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The increase in general and administrative expense for the six months ended June 30, 2010 compared to the six months ended June 30, 2009 was due to an approximately $1.0 million increase in compensation and benefits related expenses as a result of increased headcount, an approximately $0.9 million increase in stock compensation expense primarily related to our annual stock option grant made in February 2010, an approximately $0.4 million increase in allocated facilities costs primarily due to increased rent expense associated with the newly acquired space at our 301 Binney Street facility, and an increase in consulting costs of approximately $0.7 million associated with marketing and business development, as well as compliance with the Sarbanes-Oxley Act of 2002 and stock administration.

 

Other Income (Expense), Net

 

 

 

Three Months Ended
June 30,

 

Change

 

Six Months Ended
June 30,

 

Change

 

 

 

2010

 

2009

 

$

 

%

 

2010

 

2009

 

$

 

%

 

 

 

(dollars in thousands)

 

 

 

(dollars in thousands)

 

 

 

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

$

(79

)

$

(122

)

$

43

 

35.2

%

$

(172

)

$

(256

)

$

84

 

32.8

%

Interest and investment income

 

189

 

82

 

107

 

130.5

%

257

 

186

 

71

 

38.2

%

Remeasurement of forward purchase contracts

 

 

(300

)

300

 

100.0

%

 

(100

)

100

 

100.0

%

Total other income (expense), net

 

$

110

 

$

(340

)

$

450

 

132.4

%

$

85

 

$

(170

)

$

255

 

150.0

%

 

Interest Expense.  The decrease in interest expense for both the three and six months ended June 30, 2010 compared to the three and six months ended June 30, 2009 was the result of a reduction in long-term debt.

 

Interest and Investment Income.  The increase in interest and investment income for the three and six months ended June 30, 2010 compared to the three and six months ended June 30, 2009 was due to higher average investment balances, partially offset by lower prevailing interest rates during the period.

 

Remeasurement of Forward Purchase Contracts.  The increase in the remeasurement of forward purchase contracts for the three and six months ended June 30, 2010 compared to the three and six months ended June 30, 2009 resulted from the final settlement of the Forest forward purchase contract in July 2009 and the Almirall forward purchase contract in November 2009.  Both forward purchase contracts were remeasured at June 30, 2009, resulting in an overall remeasurement loss of $0.3 million and $0.1 million over the three and six months ended June 30, 2009, respectively.  As a result of the final settlements, there was not a corresponding remeasurement at June 30, 2010.

 

Net Loss Attributable to Noncontrolling Interest.  The approximately $0.5 million and $0.6 million decrease in net loss attributable to noncontrolling interest, was due to a smaller net loss for Microbia during the three and six months ended June 30, 2010 compared to the three and six months ended June 30, 2009, respectively.  The smaller net loss for Microbia was primarily associated with lower expenses resulting from reduced headcount and approximately $1.8 million in revenue recorded in the three months ended June 30, 2010 associated with the termination of the T&L agreement.

 

Liquidity and Capital Resources

 

The following table sets forth the major sources and uses of cash for each of the periods set forth below:

 

 

 

Six Months Ended
June 30,

 

 

 

2010

 

2009

 

 

 

(in thousands)

 

Net cash (used in) provided by:

 

 

 

 

 

Operating activities

 

$

(45,289

)

$

(7,845

)

Investing activities

 

(245,267

)

12,050

 

Financing activities

 

202,795

 

1,914

 

Net (decrease) increase in cash and cash equivalents

 

$

(87,761

)

$

6,119

 

 

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We have incurred losses since our inception on January 5, 1998 and, as of June 30, 2010, we had a cumulative deficit of approximately $347.6 million. We have financed our operations to date primarily through the sale of preferred stock and common stock, including approximately $203.2 million of net proceeds from our IPO, payments received under collaborative arrangements, including reimbursement of certain expenses, debt financings and interest earned on investments. At June 30, 2010, we had approximately $271.6 million of cash, cash equivalents and available-for-sale securities. Our cash and cash equivalents include amounts held in money market funds, stated at cost plus accrued interest, which approximates fair market value and U.S. Treasury securities. Our available-for-sale securities include amounts held in U.S. government-sponsored entities and U.S. Treasury securities. We invest cash in excess of immediate requirements in accordance with our investment policy which limits the amounts we may invest in any one type of investment and requires all investments held by us to be A+ rated so as to primarily achieve liquidity and capital preservation.

 

Cash Flows From Operating Activities

 

Cash flows from operating activities represent the cash receipts and disbursements related to all our activities other than investing and financing activities.  Our operating cash flow is derived by adjusting our net loss for:

 

·                  Non-cash items such as depreciation, share-based compensation expense, remeasurement of forward purchase contracts and accretion of discount/premium on investment securities;

 

·                  Changes in operating assets and liabilities which reflect timing differences between the receipt and payment of cash associated with transactions and when they are recognized in results of operations.

 

Net cash used in operating activities totaled approximately $45.3 million for the six months ended June 30, 2010.  The primary uses of cash were our net loss of approximately $33.5 million, a decrease of approximately $18.6 million in working capital resulting primarily from reductions in deferred revenue as revenue was recognized from our Forest collaboration agreement and our Almirall and Astellas license agreements. These uses of cash were partially offset by approximately $6.8 million of non-cash items.

 

Net cash used in operating activities totaled approximately $7.8 million for the six months ended June 30, 2009.  The primary uses of cash were our net loss of approximately $37.3 million, offset by approximately $4.8 million in non-cash items and approximately $24.7 million increase in working capital.  The increase in working capital was due primarily to an increase in deferred revenue resulting from the up-front cash payment associated with the Almirall license agreement of $38.0 million, partially offset by reductions in deferred revenue as revenue was recognized on our Forest and Almirall collaborations.

 

Cash Flows From Investing Activities

 

Cash used in investing activities for the six months ended June 30, 2010 totaled approximately $245.3 million and resulted primarily from the purchase of approximately $274.1 million of securities related to the investment of the net proceeds of our IPO and the purchase of approximately $8.6 million of property and equipment resulting from the expansion of our 301 Binney Street facility.  These uses of cash were partially offset by the sale and maturity of approximately $37.5 million in investments.

 

Cash provided by investing activities for the six months ended June 30, 2009 totaled approximately $12.1 million and resulted primarily from the sales and maturities of securities of approximately $23.3 million, partially offset by the purchase of approximately $9.0 million of securities and the purchase of approximately $2.3 million of property and equipment.

 

Cash Flows From Financing Activities

 

Cash provided by financing activities for the six months ended June 30, 2010 totaled approximately $202.8 million and resulted primarily from the net proceeds of our IPO of approximately $203.2 million.

 

Cash provided by financing activities for the six months ended June 30, 2009 totaled approximately $1.9 million and primarily resulted from the net borrowings under our debt facility and capital leases.

 

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Funding Requirements

 

To date, we have not commercialized any products and have not achieved profitability. We anticipate that we will continue to incur substantial net losses for the next several years as we further develop and prepare for the potential commercial launch of linaclotide, continue to invest in our pipeline, develop the organization required to sell our product candidates and operate as a publicly traded company.

 

We have generated revenue from services, up-front license fees and milestones, but have not generated any product revenue since our inception and do not expect to generate any product revenue from our collaborative arrangements or the sale of products unless we receive regulatory approval for commercial sale of linaclotide. We believe that our existing cash, cash equivalents and available-for-sale securities balances, interest income we earn on these balances, and amounts we expect to receive from our collaborators under existing contractual obligations will be sufficient to meet our anticipated cash requirements to complete development and commercialize linaclotide with our partner Forest for the U.S. market, and to fund our currently contemplated research and development efforts for at least the next five years, based on our current business plan. Our forecast of the period of time through which our financial resources will be adequate to support our operations, the costs to obtain regulatory approval, and the costs to commercialize our product candidates are forward-looking statements and involve risks and uncertainties, and actual results could vary materially and negatively as a result of a number of factors, including the factors discussed in the “Risk Factors” section of this Quarterly Report on Form 10-Q. We have based these estimates on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we currently expect.

 

Due to the numerous risks and uncertainties associated with the development of our product candidates, we are unable to estimate precisely the amounts of capital outlays and operating expenditures necessary to complete the development of, and to obtain regulatory approval for, linaclotide and our other product candidates for all of the indications for which we believe each product candidate is suited. Our funding requirements will depend on many factors, including, but not limited to, the following:

 

·                  the time and costs involved in obtaining regulatory approvals for our product candidates;

 

·                  the rate of progress and cost of our commercialization activities;

 

·                  the success of our research and development efforts;

 

·                  the expenses we incur in marketing and selling our product candidates;

 

·                  the revenue generated by sales of our product candidates;

 

·                  the emergence of competing or complementary technological developments;

 

·                  the costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights;

 

·                  the terms and timing of any additional collaborative, licensing or other arrangements that we may establish; and

 

·                  the acquisition of businesses, products and technologies.

 

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Table of Contents

 

Contractual Commitments and Obligations

 

The disclosure of our contractual obligations and commitments is set forth under the heading Management’s Discussion and Analysis of Financial Condition and Results of Operations - Contractual Commitments and Obligations in our Annual Report on Form 10-K for the year ended December 31, 2009. As of June 30, 2010, in connection with Microbia’s November 2009 restructuring, Microbia may incur approximately $0.8 million of additional restructuring costs if Microbia implements an additional reduction in force prior to the earlier of November 5, 2010 or the date that Microbia closes on a new round of financing.

 

In June 2010, we entered into a commercial supply agreement with PolyPeptide Laboratories, Inc. and Polypeptide Laboratories (SWEDEN) AB for the purchase of a portion of the linaclotide active pharmaceutical ingredient, or API, that will be used to obtain regulatory approval of linaclotide in the United States, Canada and/or Mexico, and, pending any such approval, that will be commercialized in such country. The commercial supply agreement contains minimum purchase requirements that commence with the commercial launch of linaclotide and that are dependent upon forecasted commercial requirements. Since, at this time, linaclotide has not yet been approved for commercialization and future commercial demand for linaclotide is unknown, we cannot estimate our future minimum purchase requirements under the commercial supply agreement.

 

Related Party Transactions

 

We have and currently obtain legal services from a law firm that is an investor of ours. We paid approximately $41,000 and $100,000 in legal fees to this investor during the three and six months ended June 30, 2010, respectively and approximately $3,000 and $5,000 during the three and six months ended June 30, 2009, respectively.

 

In September 2006, T&L became a related party when we sold to them 1,823,529 shares of common stock of Microbia at the aggregate purchase price of approximately $2,000, and sold 7,000,000 shares of convertible preferred stock of Microbia at the aggregate purchase price of $7.0 million. T&L accounted for approximately 16% and 10% of our revenue for the three and six months ended June 30, 2010, respectively, and approximately 6% and 10% of our revenue for the three and six months ended June 30, 2009, respectively.  On June 15, 2010, T&L and Microbia entered into an agreement to terminate their collaboration.  The terms and conditions of the termination agreement include an exchange of intellectual property and a one-time payment to Microbia of approximately $1.8 million.  All current and future obligations between Microbia and T&L are terminated as a result of this agreement.

 

In September 2009, Forest became a related party when we sold to them 2,083,333 shares of our convertible preferred stock at a price of $12.00 per share for cash proceeds of $25.0 million. Forest accounted for approximately 50% and 54% of our revenue for the three and six months ended June 30, 2010, respectively, and approximately 67% and 75% of our revenue for the three and six months ended June 30, 2009, respectively.

 

In November 2009, Almirall became a related party when we sold to them 681,819 shares of our convertible preferred stock at a price of $22.00 per share for cash proceeds of $15.0 million. Almirall accounted for approximately 25% and 29% of our revenue for the three and six months ended June 30, 2010, respectively, and approximately 27% and 15% of our revenue for the three and six months ended June 30, 2009, respectively.

 

Off-Balance Sheet Arrangements

 

We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, that would have been established for the purpose of facilitating off-balance sheet arrangements (as that term is defined in Item 303(a)(4)(ii) of Regulation S-K) or other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in those types of relationships. We enter into guarantees in the ordinary course of business related to the guarantee of our own performance and the performance of our subsidiaries.

 

New Accounting Pronouncements

 

From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board, or FASB, or other standard setting bodies that are adopted by us as of the specified effective date. Unless otherwise discussed, we believe that the impact of recently issued standards that are not yet effective will not have a material impact on our consolidated financial position or results of operations upon adoption.

 

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Recently Issued Accounting Standards

 

In April 2010, the FASB issued Accounting Standards Update, or ASU, No. 2010-17, Revenue Recognition — Milestone Method, or ASU 2010-017. ASU 2010-017 provides guidance in applying the milestone method of revenue recognition to research or development arrangements. Under this guidance management may recognize revenue contingent upon the achievement of a milestone in its entirety, in the period in which the milestone is achieved, only if the milestone meets all the criteria within the guidance to be considered substantive. This ASU is effective on a prospective basis for research and development milestones achieved in fiscal years, beginning on or after June 15, 2010. Early adoption is permitted; however, adoption of this guidance as of a date other than January 1, 2011 will require us to apply this guidance retrospectively effective as of January 1, 2010 and will require disclosure of the effect of this guidance as applied to all previously reported interim periods in the fiscal year of adoption. As we plan to implement ASU No. 2010-17 prospectively, the effect of this guidance will be limited to future transactions.

 

In October 2009, the FASB issued ASU No. 2009-13, Multiple-Deliverable Revenue Arrangements, or ASU 2009-13. ASU 2009-13, amends existing revenue recognition accounting pronouncements that are currently within the scope of FASB Accounting Standards Codification, or ASC, Subtopic 605-25 (previously included within EITF 00-21, Revenue Arrangements with Multiple Deliverables, or EITF 00-21). The consensus to ASU 2009-13 provides accounting principles and application guidance on whether multiple deliverables exist, how the arrangement should be separated, and the consideration allocated. This guidance eliminates the requirement to establish the fair value of undelivered products and services and instead provides for separate revenue recognition based upon management’s estimate of the selling price for an undelivered item when there is no other means to determine the fair value of that undelivered item. EITF 00-21 previously required that the fair value of the undelivered item be the price of the item either sold in a separate transaction between unrelated third parties or the price charged for each item when the item is sold separately by the vendor. This was difficult to determine when the product was not individually sold because of its unique features. Under EITF 00-21, if the fair value of all of the elements in the arrangement was not determinable, then revenue was deferred until all of the items were delivered or fair value was determined. This new approach is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 and allows for retrospective application. We are currently evaluating the potential impact of this standard on our financial position and results of operations.

 

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

 

Interest Rate Risk

 

We are exposed to market risk related to changes in interest rates. We invest our cash in a variety of financial instruments, principally deposits, securities issued by the U.S. government and its agencies and money market instruments. The goals of our investment policy are preservation of capital, fulfillment of liquidity needs and fiduciary control of cash and investments. We also seek to maximize income from our investments without assuming significant risk.

 

Our primary exposure to market risk is interest income sensitivity, which is affected by changes in the general level of interest rates, particularly because our investments are in short-term marketable securities. Due to the short-term duration of our investment portfolio and the low risk profile of our investments, an immediate 1% change in interest rates would not have a material effect on the fair market value of our portfolio. Accordingly, we would not expect our operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on our investment portfolio.

 

Recently, there has been concern in the credit markets regarding the value of a variety of mortgage-backed and auction rate securities and the resulting effect on various securities markets. We do not currently have any auction rate securities. We do not believe our cash, cash equivalents and available-for-sale investments have significant risk of default or illiquidity. While we believe our cash, cash equivalents and available-for-sale securities do not contain excessive risk, we cannot provide absolute assurance that in the future our investments will not be subject to adverse changes in market value. In addition, we maintain significant amounts of cash and cash equivalents at one or more financial institutions that are in excess of federally insured limits. Given the current instability of financial institutions, we cannot be assured that we will not experience losses on these deposits.

 

Our long-term debt and capital lease obligations bear interest at a fixed rate and therefore have minimal exposure to changes in interest rates.

 

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Foreign Currency Risk

 

We have no operations outside the U.S. and do not have any foreign currency or other derivative financial instruments.

 

Effects of Inflation

 

We do not believe that inflation and changing prices have had a material effect on our business over the three and six months ended June 30, 2010 and 2009.

 

Item 4.  Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

As required by Rule 13a-15(b) of the Securities Exchange Act of 1934, or the Exchange Act, our management, including our principal executive officer and our principal financial officer, conducted an evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective at the reasonable assurance level in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports we file under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

 

Changes in Internal Control

 

As required by Rule 13a-15(d) of the Exchange Act, our management, including our principal executive officer and our principal financial officer, conducted an evaluation of the internal control over financial reporting to determine whether any changes occurred during the period covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based on that evaluation, our principal executive officer and principal financial officer concluded no such changes during the period covered by this Quarterly Report on Form 10-Q materially affected, or were reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II — OTHER INFORMATION

 

Item 1A.  Risk Factors

 

Our future operating results could differ materially from the results described in this report due to the risks and uncertainties related to our business, including those discussed below.  Furthermore, these factors represent risks and uncertainties that could cause actual results to differ materially from those implied by forward-looking statements.  We refer you to our “Special Note Regarding Forward-Looking Statements” which identifies the forward-looking statements in this report.

 

Risks Related to Our Business and Industry

 

We are largely dependent on the success of linaclotide, which may never receive regulatory approval or be successfully commercialized.

 

We currently have one product candidate, linaclotide, in Phase 3 clinical development. Our other drug candidates are in earlier stages of development. Our business depends entirely on the successful development and commercialization of our product candidates. We currently generate no revenue from sales, and we may never be able to develop marketable drugs. The research, testing, manufacturing, labeling, approval, sale, marketing and distribution of pharmaceutical products is subject to extensive regulation by the FDA, and foreign regulatory authorities, and regulations differ from jurisdiction to jurisdiction. We are not permitted to market any of our product candidates in the U.S. until we receive approval of a New Drug Application, or NDA, from the FDA, or in any foreign jurisdictions until we receive the requisite approvals from such jurisdictions. We have neither submitted an NDA nor received marketing approval for linaclotide in any jurisdiction. Obtaining approval of an NDA is a lengthy, expensive and uncertain process. The FDA also has substantial discretion in the drug approval process, including the ability to delay, limit or deny approval of a product candidate for many reasons. Potential risks include:

 

·                  the FDA may not deem linaclotide or another product candidate safe and effective;

 

·                  the FDA may not find the data from preclinical studies and clinical trials sufficient to support approval;

 

·                  the FDA may not approve of manufacturing processes and facilities; or

 

·                  the FDA may change its approval policies or adopt new regulations.

 

Linaclotide is a first-in-class compound that is currently in Phase 3 clinical development for the treatment of IBS-C and CC and will require the successful completion of at least two Phase 3 clinical trials for each indication before submission of an NDA to the FDA for potential approval in such indication. In November 2009 and May 2010, we announced that we achieved favorable results in our CC trials. Even though linaclotide met the endpoints of the CC trial, it may not be approved for the CC indication or for any other indication for which we seek approval from the FDA. We are amending both Phase 3 IBS-C clinical trial protocols to include a fourth primary endpoint, based on (a) our interactions with the FDA and their recently-issued draft guidance with respect to the design of clinical trials for IBS-C, (b) our view that the likely higher responder rate with respect to the new endpoint will more accurately demonstrate the applicability of linaclotide to the general IBS-C population and (c) our desire to ensure that we are not disadvantaged in comparison to subsequent competitors who may be held to a less stringent responder analysis if they comply with the FDA’s draft guidance. While meeting one or more of the primary endpoints may result in a positive outcome to the clinical trials, there remains the risk that the results based on these endpoints may not support product approval. Further, the FDA may disagree with our trial design or our interpretation of data from clinical trials, or may change the requirements for approval even after it has reviewed and commented on the design for our clinical trials. The FDA might also approve linaclotide for fewer or more limited indications than we request, or may grant approval contingent on the performance of costly post-approval clinical trials. In addition, the FDA may not approve the labeling claims that we believe are necessary or desirable for the successful commercialization of linaclotide. Any failure to obtain regulatory approval of linaclotide would significantly limit our ability to generate revenues, and any failure to obtain such approval for all of the indications and labeling claims we deem desirable could reduce our potential revenue.

 

Our clinical trials may fail to demonstrate acceptable levels of safety and efficacy of linaclotide, which could prevent or significantly delay regulatory approval.

 

Our product candidates are prone to the risks of failure inherent in drug development—most pharmaceutical product candidates fail. Before obtaining regulatory approvals for the commercial sale of linaclotide or any other product candidate for a specific indication, we must demonstrate with substantial evidence gathered in well-controlled clinical trials and to the satisfaction of the FDA, with respect to approval in the U.S., and to the satisfaction of similar regulatory authorities in other jurisdictions, with respect to approval in those jurisdictions, that the product candidate is safe and effective for use for the target indication.

 

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The results from the preclinical and clinical trials that we have completed for linaclotide may not be replicated in future trials, or we may be unable to demonstrate sufficient safety and efficacy to obtain the requisite regulatory approvals for linaclotide. A number of companies in the biotechnology and pharmaceutical industries have suffered significant setbacks in advanced clinical trials, even after promising results in earlier trials. If linaclotide is not shown to be safe and effective, our clinical development programs could be delayed or terminated. Our failure to adequately demonstrate the efficacy and safety of linaclotide or any other product candidates that we may develop, in-license or acquire would prevent receipt of regulatory approval and, ultimately, the commercialization of that product candidate.

 

The positive top-line results from our two Phase 3 clinical trials assessing the safety and efficacy of linaclotide in patients with CC may not be indicative of our two Phase 3 clinical trials assessing the safety and efficacy of linaclotide in patients with IBS-C.

 

In November 2009 and May 2010, we announced that the primary endpoint was achieved in each of our two Phase 3 clinical trials assessing the safety and efficacy of linaclotide in patients with CC. The primary efficacy endpoint in each of these two clinical trials is only one of the four primary efficacy endpoints in each of our two Phase 3 clinical trials assessing the safety and efficacy of linaclotide in patients with IBS-C. Positive results in the CC trial or from earlier clinical trials are not necessarily indicative of future success in the IBS-C trials, even with respect to similar endpoints. While meeting one or more of the primary endpoints may result in a positive outcome to the clinical trials, there remains the risk that the results based on these endpoints may not support product approval. Finally, our partners Almirall and Astellas intend to seek approval from regulatory authorities in each of their respective territories solely for the IBS-C indication. The European Medicines Agency, or the EMA, has indicated that Almirall can use the U.S. IBS-C clinical trial data as a basis for a Market Authorisation Application, the EMA’s counterpart to an NDA. Accordingly, if we are unable to establish safety and efficacy of linaclotide in our U.S. IBS-C trials, our partners may be unable to utilize our data in the U.S. in their regulatory filings, and may be hindered from obtaining approval for linaclotide in their respective territories.

 

Linaclotide may cause undesirable side effects or have other properties that could delay or prevent its regulatory approval or limit its commercial potential.

 

Undesirable side effects caused by linaclotide could cause us or regulatory authorities to interrupt, delay or halt clinical trials and could result in the denial of regulatory approval by the FDA or other regulatory authorities and potential products liability claims. Earlier this year, we completed our evaluation of the data from our CC studies and are currently conducting two Phase 3 IBS-C trials as well as a long-term safety study in patients dosed with linaclotide over a 78-week period. Serious adverse events deemed to be caused by linaclotide could have a material adverse effect upon the linaclotide program and our business as a whole. The most common adverse event to date in the clinical studies evaluating the safety and efficacy of linaclotide has been diarrhea. For the most part, the diarrhea has been considered mild or moderate by the patients, but in a small percentage of patients, it has been severe enough for patients to discontinue participation in a study. There have been no serious adverse events in patients treated with linaclotide that were deemed by a study investigator to be “definitively related” or “probably related” to linaclotide treatment. There have been a small number of serious adverse events in patients treated with linaclotide that were deemed by an independent study investigator to be “possibly related” to linaclotide treatment, involving cases of abdominal pain, aplastic anemia, atrial fibrillation, bronchitis, gall stones, ileus, pericarditis, stroke and thombrosed hemorrhoids. At the end of the linaclotide development program, the incidence of these events in linaclotide recipients will be compared to the population at-large to assess whether linaclotide increases the risks of such events. Finally, there have been no deaths in our trials that were considered by a study investigator to be related to linaclotide treatment.

 

If linaclotide receives marketing approval, and we or others later identify undesirable side effects caused by the product, a number of potentially significant negative consequences could result, including:

 

·                  regulatory authorities may withdraw approvals of linaclotide;

 

·                  regulatory authorities may require additional warnings on the label;

 

·                  we may be required to create a medication guide outlining the risks of such side effects for distribution to patients;

 

·                  we could be sued and held liable for harm caused to patients; and

 

·                  our reputation may suffer.

 

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Any of these events could prevent us from achieving or maintaining market acceptance of linaclotide and could substantially increase commercialization costs.

 

Delays in the completion of clinical testing could result in increased costs and delay or limit our ability to generate revenues.

 

Delays in the completion of clinical testing could significantly affect our product development costs. We do not know whether planned clinical trials will be completed on schedule, if at all. The commencement and completion of clinical trials can be delayed for a number of reasons, including delays related to:

 

·                  obtaining regulatory approval to commence a clinical trial;

 

·                  reaching agreement on acceptable terms with prospective clinical research organizations, or CROs, and trial sites, the terms of which can be subject to extensive negotiation and may vary significantly among different CROs and trial sites;

 

·                  manufacturing sufficient quantities of a product candidate for use in clinical trials;

 

·                  obtaining institutional review board approval to conduct a clinical trial at a prospective site;

 

·                  recruiting and enrolling patients to participate in clinical trials for a variety of reasons, including competition from other clinical trial programs for the treatment of similar conditions; and

 

·                  signing-up patients who have initiated a clinical trial but may be prone to withdraw due to side effects from the therapy, lack of efficacy or personal issues, or who are lost to further follow-up.

 

Clinical trials may also be delayed as a result of ambiguous or negative interim results. In addition, a clinical trial may be suspended or terminated by us, an institutional review board overseeing the clinical trial at a clinical trial site (with respect to that site), the FDA, or other regulatory authorities due to a number of factors, including:

 

·                  failure to conduct the clinical trial in accordance with regulatory requirements or the study protocols;

 

·                  inspection of the clinical trial operations or trial sites by the FDA or other regulatory authorities resulting in the imposition of a clinical hold;

 

·                  unforeseen safety issues; and

 

·                  lack of adequate funding to continue the clinical trial.

 

Additionally, changes in regulatory requirements and guidance may occur, and we may need to amend clinical trial protocols to reflect these changes. The FDA recently issued draft guidance on the design of clinical trials for IBS-C, and based on this draft guidance, we are amending both Phase 3 IBS-C clinical trial protocols to include a fourth primary endpoint.    These amendments will, as any protocol amendment would, require institutional review board review and approval, which may adversely impact the costs, timing or successful completion of the clinical trials. If we experience delays in completion or if we terminate any of our clinical trials, the commercial prospects for linaclotide may be harmed, and our ability to generate product revenues will be delayed. In addition, many of the factors that cause, or lead to, a delay in the commencement or completion of clinical trials may also ultimately lead to the denial of regulatory approval of linaclotide.

 

Because we work with Forest Laboratories, Inc. to develop, promote and manufacture linaclotide in North America, we are dependent upon a third party in our efforts to obtain regulatory approval for, and to commercialize, linaclotide within our expected timeframes.

 

We co-develop and plan to co-promote linaclotide in the U.S. with Forest. Forest plays a significant role in the conduct of the clinical trials for linaclotide and the subsequent collection and analysis of data. In addition, Forest is responsible for completing the manufacturing process of linaclotide upon production of the API, which consists of finishing and packaging linaclotide into capsules. Employees of Forest are not our employees, and we have limited ability to control the amount or timing of resources that they devote to linaclotide. If Forest fails to devote sufficient time and resources to linaclotide, or if its performance is substandard, it will delay the potential approval of our regulatory applications as well as the commercialization and manufacturing of linaclotide. A material breach by Forest of our collaboration agreement could also delay regulatory approval and commercialization of linaclotide. In addition, the

 

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execution of clinical trials, and the subsequent compilation and analysis of the data produced, requires coordination among various parties. These functions may not be carried out effectively and efficiently if these parties fail to communicate and coordinate with one another. Moreover, although we have non-compete restrictions in place with Forest, Forest may have relationships with other commercial entities, some of which may compete with us. If Forest assists our competitors, it could harm our competitive position.

 

We may face competition in the IBS-C and CC marketplace for linaclotide, and new products may emerge that provide different or better alternatives for treatment of gastrointestinal conditions.

 

If approved and commercialized, linaclotide will compete globally with certain prescription therapies and over the counter products for the treatment of IBS-C and CC, or certain associated symptoms. The availability of prescription competitors and over the counter products for gastrointestinal conditions could limit the demand, and the price we are able to charge, for linaclotide unless we are able to differentiate linaclotide on the basis of its clinical benefits in our clinical trials. New developments, including the development of other drug technologies and methods of preventing the incidence of disease, occur in the pharmaceutical and medical technology industries at a rapid pace. These developments may render linaclotide obsolete or noncompetitive.

 

We believe certain companies are developing other products which could compete with linaclotide should they be approved by the FDA. Currently, there are compounds in late stage development for the treatment of patients with either IBS-C or CC.  To our knowledge, other potential competitors also are in earlier stages of development. If our potential competitors are successful in completing drug development for their drug candidates and obtain approval from the FDA, they could limit the demand for linaclotide.

 

Many of our competitors have substantially greater financial, technical and human resources than us. Mergers and acquisitions in the pharmaceutical industry may result in even more resources being concentrated in our competitors. Competition may increase further as a result of advances made in the commercial applicability of technologies and greater availability of capital for investment in these fields.

 

We have limited sales and marketing experience and resources, and we may not be able to effectively market and sell linaclotide.

 

With linaclotide, we are developing a product candidate for large markets traditionally served by general practitioners and internists, as well as gastrointestinal specialists. Traditional pharmaceutical companies employ groups of sales representatives to call on these large generalist physician populations. In order to adequately address these physician groups, we must optimize our co-development and co-promotion relationship in the U.S., Canada and Mexico with Forest, our license and commercialization relationship in Europe with Almirall, and our license and commercialization relationship in certain Asian countries with Astellas. Likewise, we must either establish sales and marketing collaborations or co-promotion arrangements or expend significant resources to develop our own sales and marketing presence outside of North America, Europe, and those Asian countries. We currently possess limited resources and may not be successful in establishing additional collaborations or co-promotion arrangements on acceptable terms, if at all. We also face competition in our search for collaborators, co-promoters and sales force personnel. By entering into strategic collaborations or similar arrangements, we rely on third parties for financial resources and for development, commercialization, sales and marketing and regulatory expertise. Our collaborators may fail to develop or effectively commercialize linaclotide because they cannot obtain the necessary regulatory approvals, lack adequate financial or other resources or decide to focus on other initiatives.

 

Even if linaclotide receives regulatory approval, it may still face future development and regulatory difficulties.

 

Even if U.S. regulatory approval is obtained, the FDA may still impose significant restrictions on a product’s indicated uses or marketing or impose ongoing requirements for potentially costly post-approval studies. Linaclotide and our other product candidates would also be subject to ongoing FDA requirements governing the labeling, packaging, storage, advertising, promotion, recordkeeping and submission of safety and other post-market information. In addition, manufacturers of drug products and their facilities are subject to continual review and periodic inspections by the FDA and other regulatory authorities for compliance with current good manufacturing practices, or GMP, regulations. If we or a regulatory agency discovers previously unknown problems with a product, such as adverse events of unanticipated severity or frequency, or problems with the facility where the product is manufactured, a regulatory agency may impose restrictions on that product or the manufacturer, including requiring withdrawal of the product from the market or suspension of manufacturing. If we, our product candidates or the manufacturing facilities for our product candidates fail to comply with applicable regulatory requirements, a regulatory agency may:

 

·                  issue warning letters or untitled letters;

 

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·                  impose civil or criminal penalties;

 

·                  suspend regulatory approval;

 

·                  suspend any ongoing clinical trials;

 

·                  refuse to approve pending applications or supplements to applications filed by us;

 

·                  impose restrictions on operations, including costly new manufacturing requirements; or

 

·                  seize or detain products or require us to initiate a product recall.

 

Even if linaclotide receives regulatory approval in the U.S., we or our collaborators may never receive approval to commercialize linaclotide outside of the U.S.

 

In April 2009, we entered into an out-license agreement with Almirall for European rights to develop and commercialize linaclotide. In November 2009, we entered into an out-license agreement with Astellas for rights to develop and commercialize linaclotide in certain Asian countries. In the future, we may seek to commercialize linaclotide in foreign countries outside of Europe and those Asian countries with other parties or by ourselves. In order to market any products outside of the U.S., we must establish and comply with numerous and varying regulatory requirements of other jurisdictions regarding safety and efficacy. Approval procedures vary among jurisdictions and can involve product testing and administrative review periods different from, and greater than, those in the U.S. The time required to obtain approval in other jurisdictions might differ from that required to obtain FDA approval. The regulatory approval process in other jurisdictions may include all of the risks detailed above regarding FDA approval in the U.S. as well as other risks. Regulatory approval in one jurisdiction does not ensure regulatory approval in another, but a failure or delay in obtaining regulatory approval in one jurisdiction may have a negative effect on the regulatory processes in others. Failure to obtain regulatory approvals in other jurisdictions or any delay or setback in obtaining such approvals could have the same adverse effects detailed above regarding FDA approval in the U.S. As described above, such effects include the risks that linaclotide may not be approved for all indications requested, which could limit the uses of linaclotide and have an adverse effect on its commercial potential or require costly post-marketing studies.

 

If we or our collaboration partners and other third parties upon whom we rely to produce linaclotide are unable to satisfy FDA quality standards and related regulatory requirements, experience manufacturing difficulties, or are unable to manufacture sufficient quantities of our product candidates, our development and commercialization efforts may be materially harmed.

 

We do not currently possess internal manufacturing capacity. We currently utilize the services of contract manufacturers to manufacture our clinical supplies. With respect to the manufacturing of linaclotide, we (along with our U.S. collaboration partner, Forest) entered into a commercial supply agreement with PolyPeptide Laboratories, Inc. and Polypeptide Laboratories (SWEDEN) AB in June 2010 for the manufacture of the linaclotide API that will be used to obtain regulatory approval of linaclotide in the United States, Canada and/or Mexico, and, pending any such approval, that will be incorporated into finished product for commercialization in such country.  In addition, we continue to pursue long-term commercial supply agreements with other manufacturers for the linaclotide API. We may not be able to enter into long-term agreements with such manufacturers on commercially reasonable terms, or at all. If we enter into a long-term commercial supply agreement with another manufacturer but then change or add manufacturers, the FDA and comparable foreign regulators must approve these manufacturers’ facilities and processes prior to use, which would require new testing and compliance inspections, and the new manufacturers would have to be educated in or independently develop the processes necessary for the production of our product candidates. While we believe we will have long term arrangements with a sufficient number of API manufacturers, if we lose a manufacturer, it would take us a substantial amount of time to identify and develop a relationship with an alternative manufacturer.

 

Peptide manufacturing is a highly specialized manufacturing business.  These third party manufacturers acquire the raw materials for the API from a limited number of sources. Any curtailment in the availability of these raw materials could result in production or other delays with consequent adverse effects on us. In addition, because regulatory authorities must generally approve raw material sources for pharmaceutical products, changes in raw material suppliers may result in production delays or higher raw material costs.

 

Upon production of our API, each of our collaboration partners, Forest, Almirall and Astellas, is responsible for completing the manufacturing process of linaclotide which consists of finishing and packaging linaclotide into capsules, and we will be dependent upon those parties’ success in producing drug product for commercial sale. No party has experience producing the API or finished

 

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drug product for linaclotide at commercial scale, and such efforts may fail. Traditionally, peptide manufacturing is costly and time consuming, resulting in low yields and poor stability. We cannot give any assurances that we will overcome these issues when scaling up manufacturing for linaclotide.

 

The manufacture of pharmaceutical products requires significant expertise and capital investment, including the development of advanced manufacturing techniques and process controls. Manufacturers of pharmaceutical products often encounter difficulties in production, particularly in scaling up production. These problems include difficulties with production costs and yields, quality control, including stability of the product and quality assurance testing, shortages of qualified personnel, as well as compliance with federal, state and foreign regulations. We are currently evaluating the stability of different batch sizes of linaclotide at various points in time. If we are unable to demonstrate stability in accordance with commercial requirements, or if our manufacturers were to encounter difficulties or otherwise fail to comply with their obligations to us, our ability to obtain FDA approval and market linaclotide would be jeopardized. In addition, any delay or interruption in the supply of clinical trial supplies could delay the completion of our clinical trials, increase the costs associated with conducting our clinical trials and, depending upon the period of delay, require us to commence new trials at significant additional expense or to terminate a trial.

 

Each of the linaclotide manufacturers would need to comply with GMP requirements enforced by the FDA through its facilities inspection program. These requirements include, among other things, quality control, quality assurance and the maintenance of records and documentation. Manufacturers of linaclotide may be unable to comply with these GMP requirements and with other FDA and foreign regulatory requirements. We have little control over our manufacturers’ or collaboration partners’ compliance with these regulations and standards. A failure to comply with these requirements may result in fines and civil penalties, suspension of production, suspension or delay in product approval, product seizure or recall, or withdrawal of product approval. If the safety of linaclotide is compromised due to a manufacturers’ or collaboration partners’ failure to adhere to applicable laws or for other reasons, we may not be able to obtain regulatory approval for or successfully commercialize linaclotide, and we may be held liable for any injuries sustained as a result. Any of these factors could cause a delay of clinical trials, regulatory submissions, approvals or commercialization of linaclotide or our other product candidates, entail higher costs or result in our being unable to effectively commercialize linaclotide or our other product candidates. Furthermore, if our manufacturers or collaboration partners fail to deliver the required commercial quantities on a timely basis and at commercially reasonable prices, we may be unable to meet demand for any approved products and would lose potential revenues.

 

Guidelines and recommendations published by various organizations can reduce the use of our products.

 

Government agencies promulgate regulations and guidelines directly applicable to us and to our products. In addition, professional societies, practice management groups, private health and science foundations and organizations involved in various diseases from time to time may also publish guidelines or recommendations to the health care and patient communities. Recommendations of government agencies or these other groups or organizations may relate to such matters as usage, dosage, route of administration and use of concomitant therapies. Recommendations or guidelines suggesting the reduced use of our products or the use of competitive or alternative products that are followed by patients and health care providers could result in decreased use of our products.

 

We are subject to uncertainty relating to reimbursement policies which, if not favorable for linaclotide, could hinder or prevent linaclotide’s commercial success.

 

Our ability to commercialize linaclotide successfully will depend in part on the coverage and reimbursement levels set by governmental authorities, private health insurers and other third-party payors. As a threshold for coverage and reimbursement, third-party payors generally require that drug products have been approved for marketing by the FDA. Third-party payors also are increasingly challenging the effectiveness of and prices charged for medical products and services. We may not obtain adequate third-party coverage or reimbursement for linaclotide or we may be required to sell linaclotide at a discount.

 

We expect that private insurers will consider the efficacy, cost effectiveness and safety of linaclotide in determining whether to approve reimbursement for linaclotide and at what level. Obtaining these approvals can be a time consuming and expensive process. Our business would be materially adversely affected if we do not receive approval for reimbursement of linaclotide from private insurers on a timely or satisfactory basis. Our business could also be adversely affected if private insurers, including managed care organizations, the Medicare program or other reimbursing bodies or payors limit the indications for which linaclotide will be reimbursed to a smaller set than we believe it is effective in treating.

 

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In some foreign countries, particularly Canada and the countries of Europe, the pricing of prescription pharmaceuticals is subject to strict governmental control. In these countries, pricing negotiations with governmental authorities can take six to 12 months or longer after the receipt of regulatory approval and product launch. To obtain favorable reimbursement for the indications sought or pricing approval in some countries, we may be required to conduct a clinical trial that compares the cost-effectiveness of our products, including linaclotide, to other available therapies.  Further, several European countries have recently implemented government measures to either freeze or reduce pricing of pharmaceutical products, and it is expected that other countries will do so, as well. If reimbursement for our products is unavailable in any country in which reimbursement is sought, limited in scope or amount, or if pricing is set at unsatisfactory levels, our business could be materially harmed.

 

We expect to experience pricing pressures in connection with the sale of linaclotide and our future products due to the potential healthcare reforms discussed below, as well as the trend toward programs aimed at reducing health care costs, the increasing influence of health maintenance organizations and additional legislative proposals.

 

We face potential product liability exposure, and, if successful claims are brought against us, we may incur substantial liabilities.

 

The use of our product candidates in clinical trials and the sale of any products for which we obtain marketing approval expose us to the risk of product liability claims. If we cannot successfully defend ourselves against product liability claims, we could incur substantial liabilities. In addition, regardless of merit or eventual outcome, product liability claims may result in:

 

·                  decreased demand for any approved product;

 

·                  impairment of our business reputation;

 

·                  withdrawal of clinical trial participants;

 

·                  initiation of investigations by regulators;

 

·                  costs of related litigation;

 

·                  distraction of management’s attention from our primary business;

 

·                  substantial monetary awards to patients or other claimants;

 

·                  loss of revenues; and

 

·                  the inability to commercialize our product candidates.

 

We have obtained product liability insurance coverage for our clinical trials. Our insurance coverage is limited to $5 million per occurrence, and $10 million in the aggregate, and covers bodily injury and property damage arising from our clinical trials, subject to industry-standard terms, conditions and exclusions. Our insurance coverage may not be sufficient to reimburse us for any expenses or losses we may suffer. Moreover, insurance coverage is becoming increasingly expensive, and, in the future, we may not be able to maintain insurance coverage at a reasonable cost or in sufficient amounts to protect us against losses. If and when we obtain marketing approval for any of our product candidates, we intend to expand our insurance coverage to include the sale of commercial products; however, we may be unable to obtain this product liability insurance on commercially reasonable terms. On occasion, large judgments have been awarded in class action lawsuits based on drugs that had unanticipated side effects. A successful product liability claim or series of claims brought against us could cause our stock price to decline and, if judgments exceed our insurance coverage, could decrease our cash and adversely affect our business.

 

In pursuing our growth strategy, we will incur a variety of costs and may devote resources to potential opportunities that are never completed or for which we never receive the benefit. Our failure to successfully discover, acquire, develop and market additional product candidates or approved products would impair our ability to grow.

 

As part of our growth strategy, we intend to develop and market additional products and product candidates. We are pursuing various therapeutic opportunities through our pipeline. We may spend several years completing our development of any particular current or future internal product candidate, and failure can occur at any stage. The product candidates to which we allocate our resources may not end up being successful. In addition, because our internal research capabilities are limited, we may be dependent upon pharmaceutical and biotechnology companies, academic scientists and other researchers to sell or license products or technology

 

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to us. The success of this strategy depends partly upon our ability to identify, select, discover and acquire promising pharmaceutical product candidates and products.

 

The process of proposing, negotiating and implementing a license or acquisition of a product candidate or approved product is lengthy and complex. Other companies, including some with substantially greater financial, marketing and sales resources, may compete with us for the license or acquisition of product candidates and approved products. We have limited resources to identify and execute the acquisition or in-licensing of third-party products, businesses and technologies and integrate them into our current infrastructure. Moreover, we may devote resources to potential acquisitions or in-licensing opportunities that are never completed, or we may fail to realize the anticipated benefits of such efforts. We may not be able to acquire the rights to additional product candidates on terms that we find acceptable, or at all.

 

In addition, future acquisitions may entail numerous operational and financial risks, including:

 

·                  exposure to unknown liabilities;

 

·                  disruption of our business and diversion of our management’s time and attention to develop acquired products or technologies;

 

·                  incurrence of substantial debt, dilutive issuances of securities or depletion of cash to pay for acquisitions;

 

·                  higher than expected acquisition and integration costs;

 

·                  difficulty in combining the operations and personnel of any acquired businesses with our operations and personnel;

 

·                  increased amortization expenses;

 

·                  impairment of relationships with key suppliers or customers of any acquired businesses due to changes in management and ownership; and

 

·                  inability to motivate key employees of any acquired businesses.

 

Further, any product candidate that we acquire may require additional development efforts prior to commercial sale, including extensive clinical testing and approval by the FDA and applicable foreign regulatory authorities. All product candidates are prone to risks of failure typical of pharmaceutical product development, including the possibility that a product candidate will not be shown to be sufficiently safe and effective for approval by regulatory authorities.

 

Healthcare reform measures could hinder or prevent our product candidates’ commercial success.

 

The U.S. government and other governments have shown significant interest in pursuing healthcare reform, as evidenced by the recent passing of the Patient Protection and Affordable Healthcare Act and the Health Care and Education Reconciliation Act. This healthcare reform law will increase the number of individuals who receive health insurance coverage and will close a gap in drug coverage under Medicare Part D as established under the Medicare Prescription Drug Improvement Act of 2003; each of these reforms could potentially increase our future revenue from linaclotide or any other product candidates that are approved for sale.  The newly-enacted law, however, also implements cost containment measures that could adversely affect our future revenue.  These measures include increased drug rebates under Medicaid for brand name prescription drugs and extension of these rebates to Medicaid managed care.  The legislation also extends 340B discounted pricing on outpatient drugs to children’s hospitals, critical access hospitals, and rural health centers; this expansion reduces the amount of reimbursement received for drugs purchased by these new 340B-covered entities.

 

Additional provisions of the health care reform law, which become effective in 2011, may negatively affect our future revenue and prospects for profitability.  Along with other pharmaceutical manufacturers and importers of brand name prescription drugs, we would be assessed a fee based on our proportionate share of sales of brand name prescription drugs to certain government programs, including Medicare and Medicaid.  As part of the health care reform law’s provisions closing a funding gap that currently exists in the Medicare Part D prescription drug program (commonly known as the “donut hole”), we will also be required to provide a 50% discount on brand name prescription drugs sold to beneficiaries who fall within the donut hole.

 

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In the aftermath of the healthcare reform law, private health insurers and managed care plans are likely to continue challenging the prices charged for medical products and services.  These cost-control initiatives could decrease the price we might establish for linaclotide, which would result in lower product revenue or royalties payable to us.

 

In addition, in some foreign jurisdictions, there have been a number of legislative and regulatory proposals to change the health care system in ways that could affect our ability to sell our products profitably. The recent U.S. legislation and these proposed reforms could result in reduced reimbursement rates for linaclotide and our other potential products, which would adversely affect our business strategy, operations and financial results.

 

In September 2007, the Food and Drug Administration Amendments Act of 2007 was enacted, giving the FDA enhanced post-marketing authority, including the authority to require post-marketing studies and clinical trials, labeling changes based on new safety information, and compliance with risk evaluations and mitigation strategies approved by the FDA. The FDA’s exercise of this authority could result in delays or increased costs during product development, clinical trials and regulatory review, increased costs to assure compliance with post-approval regulatory requirements, and potential restrictions on the sale and/or distribution of approved products.

 

If our strategic alliances are unsuccessful, our operating results will be negatively impacted.

 

Our three primary strategic alliances are with Forest, Almirall and Astellas. The success of these arrangements is largely dependent on the resources, efforts and skills of these partners. Disputes and difficulties in such relationships are common, often due to conflicting priorities or conflicts of interest. Merger and acquisition activity may exacerbate these conflicts. The benefits of these alliances are reduced or eliminated when strategic partners:

 

·                  terminate the agreements covering the strategic alliance;

 

·                  fail to devote financial or other resources to the alliances and thereby hinder or delay development, manufacturing or commercialization activities; or

 

·                  fail to maintain the financial resources necessary to continue financing their portion of the development, manufacturing or commercialization costs, or become insolvent or declare bankruptcy.

 

We will need to increase the size of our organization, and we may experience difficulties in managing growth.

 

We will need to expand our managerial, operational, financial and other resources in order to manage our operations and clinical trials, continue our development activities and commercialize our product candidates. Our personnel, systems and facilities currently in place may not be adequate to support this future growth. Our need to effectively execute our growth strategy requires that we:

 

·                  manage our clinical trials effectively, including our Phase 3 clinical trials for linaclotide;

 

·                  manage our internal development efforts effectively while complying with our contractual obligations to licensors, licensees, contractors, collaborators and other third parties;

 

·                  improve our operational, financial and management controls, reporting systems and procedures; and

 

·                  attract and motivate sufficient numbers of talented employees.

 

We may not be able to manage our business effectively if we lose any of our current management team or if we are unable to attract and motivate key personnel.

 

We may not be able to attract or motivate qualified management and scientific and clinical personnel in the future due to the intense competition for qualified personnel among biotechnology, pharmaceutical and other businesses, particularly in the greater-Boston area. Our industry has experienced a high rate of turnover of management personnel in recent years. If we are not able to attract and motivate necessary personnel to accomplish our business objectives, we may experience constraints that will significantly impede the achievement of our objectives.

 

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We are highly dependent on the development, regulatory, commercial and financial expertise of our management, particularly Peter M. Hecht, Ph.D., our Chief Executive Officer; Mark G. Currie, Ph.D., our Senior Vice President of Research and Development and our Chief Scientific Officer; Michael J. Higgins, our Senior Vice President, Chief Operating Officer and Chief Financial Officer; and Thomas A. McCourt, our Senior Vice President, Marketing and Sales and Chief Commercial Officer. Although no member of our management team has informed us to date that he or she intends to resign or retire, if we lose any members of our management team in the future, we may not be able to find suitable replacements, and our business may be harmed as a result. In addition to the competition for personnel, the Boston area in particular is characterized by a high cost of living. As such, we could have difficulty attracting experienced personnel to our company and may be required to expend significant financial resources in our employee recruitment efforts.

 

We also have scientific and clinical advisors who assist us in formulating our product development and clinical strategies. These advisors are not our employees and may have commitments to, or consulting or advisory contracts with, other entities that may limit their availability to us, or may have arrangements with other companies to assist in the development of products that may compete with ours.

 

We will need to obtain FDA approval of any proposed product names, and any failure or delay associated with such approval may adversely impact our business.

 

Any name we intend to use for our product candidates will require approval from the FDA regardless of whether we have secured a formal trademark registration from the U.S. Patent and Trademark Office. The FDA typically conducts a review of proposed product names, including an evaluation of potential for confusion with other product names. The FDA may also object to a product name if it believes the name inappropriately implies medical claims. If the FDA objects to any of our proposed product names, we may be required to adopt an alternative name for our product candidates. If we adopt an alternative name, we would lose the benefit of our existing trademark applications for such product candidate, such as linaclotide, and may be required to expend significant additional resources in an effort to identify a suitable product name that would qualify under applicable trademark laws, not infringe the existing rights of third parties and be acceptable to the FDA. We may be unable to build a successful brand identity for a new trademark in a timely manner or at all, which would limit our ability to commercialize our product candidates.

 

If we fail to comply with healthcare regulations, we could face substantial penalties and our business, operations and financial condition could be adversely affected.

 

As a manufacturer of pharmaceuticals, even though we do not and will not control referrals of healthcare services or bill directly to Medicare, Medicaid or other third-party payors, certain federal and state healthcare laws and regulations pertaining to fraud and abuse and patients’ rights are and will be applicable to our business. We could be subject to healthcare fraud and abuse and patient privacy regulation by both the federal government and the states in which we conduct our business. The regulations include:

 

·                  federal healthcare program anti-kickback laws, which prohibits, among other things, persons from soliciting, receiving or providing remuneration, directly or indirectly, to induce either the referral of an individual, for an item or service or the purchasing or ordering of a good or service, for which payment may be made under federal healthcare programs such as the Medicare and Medicaid programs;

 

·                  federal false claims laws which prohibit, among other things, individuals or entities from knowingly presenting, or causing to be presented, claims for payment from Medicare, Medicaid, or other third-party payors that are false or fraudulent, and which may apply to entities like us which provide coding and billing advice to customers;

 

·                  the federal Health Insurance Portability and Accountability Act of 1996, which prohibits executing a scheme to defraud any healthcare benefit program or making false statements relating to healthcare matters and which also imposes certain requirements relating to the privacy, security and transmission of individually identifiable health information;

 

·                  the Federal Food, Drug, and Cosmetic Act, which among other things, strictly regulates drug product marketing, prohibits manufacturers from marketing drug products for off-label use and regulates the distribution of drug samples; and

 

·                  state law equivalents of each of the above federal laws, such as anti-kickback and false claims laws which may apply to items or services reimbursed by any third-party payor, including commercial insurers, and state laws governing the privacy and security of health information in certain circumstances, many of which differ from each other in significant ways and often are not preempted by federal laws, thus complicating compliance efforts.

 

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If our operations are found to be in violation of any of the laws described above or any governmental regulations that apply to us, we may be subject to penalties, including civil and criminal penalties, damages, fines and the curtailment or restructuring of our operations. Any penalties, damages, fines, curtailment or restructuring of our operations could adversely affect our ability to operate our business and our financial results. Although compliance programs can mitigate the risk of investigation and prosecution for violations of these laws, the risks cannot be entirely eliminated. Any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal expenses and divert our management’s attention from the operation of our business. Moreover, achieving and sustaining compliance with applicable federal and state privacy, security and fraud laws may prove costly.

 

Our business involves the use of hazardous materials, and we must comply with environmental laws and regulations, which can be expensive and restrict how we do business.

 

Our activities involve the controlled storage, use and disposal of hazardous materials. We are subject to federal, state, city and local laws and regulations governing the use, manufacture, storage, handling and disposal of these hazardous materials. Although we believe that the safety procedures we use for handling and disposing of these materials comply with the standards prescribed by these laws and regulations, we cannot eliminate the risk of accidental contamination or injury from these materials. In the event of an accident, local, city, state or federal authorities may curtail the use of these materials and interrupt our business operations. We do not currently maintain hazardous materials insurance coverage.

 

Our business and operations would suffer in the event of system failures.

 

Despite the implementation of security measures, our internal computer systems and those of our contractors and consultants are vulnerable to damage from computer viruses, unauthorized access, natural disasters, terrorism, war and telecommunication and electrical failures. Such an event could cause interruption of our operations. The loss of clinical trial data from completed or ongoing clinical trials for linaclotide could result in delays in our regulatory approval efforts and significantly increase our costs. To the extent that any disruption or security breach were to result in a loss of or damage to our data, or inappropriate disclosure of confidential or proprietary information, we could incur liability and the development of our product candidates could be delayed.

 

If the proprietary strain-development platform of our biomanufacturing segment does not succeed, we may lose our investment in Microbia, Inc.

 

Our biomanufacturing segment consists of our majority ownership interest in Microbia. Microbia focuses on building a specialty biochemicals business based on a proprietary strain-development platform. The success of this segment is dependent on Microbia successfully developing, scaling up manufacturing and establishing commercial partnerships for biochemicals produced using its industrial biotechnology platform. If Microbia is not successful in developing products from its strain-development platform or partnering its platform, we may lose some or all of the value of our equity investment in Microbia.

 

Risks Related to Intellectual Property

 

Limitations on our patent rights relating to our product candidates may limit our ability to prevent third parties from competing against us.

 

Our success will depend on our ability to obtain and maintain patent protection for our product candidates, preserve our trade secrets, prevent third parties from infringing upon our proprietary rights and operate without infringing upon the proprietary rights of others.

 

The strength of patents in the pharmaceutical industry involves complex legal and scientific questions and can be uncertain. Patent applications in the U.S. and most other countries are confidential for a period of time until they are published, and publication of discoveries in scientific or patent literature typically lags actual discoveries by several months or more. As a result, we cannot be certain that we were the first to conceive inventions covered by our patents and pending patent applications or that we were the first to file patent applications for such inventions. In addition, we cannot be certain that our patent applications will be granted, that any issued patents will adequately protect our intellectual property or that such patents will not be challenged, narrowed, invalidated or circumvented.

 

We also rely upon unpatented trade secrets, unpatented know-how and continuing technological innovation to develop and maintain our competitive position, which we seek to protect, in part, by confidentiality agreements with our employees and our collaborators and consultants. We also have agreements with our employees and selected consultants that obligate them to assign their

 

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inventions to us. It is possible that technology relevant to our business will be independently developed by a person that is not a party to such an agreement. Furthermore, if the employees and consultants that are parties to these agreements breach or violate the terms of these agreements, we may not have adequate remedies, and we could lose our trade secrets through such breaches or violations. Further, our trade secrets could otherwise become known or be independently discovered by our competitors.

 

In addition, the laws of certain foreign countries do not protect proprietary rights to the same extent or in the same manner as the U.S., and therefore, we may encounter problems in protecting and defending our intellectual property in certain foreign jurisdictions.

 

If we are sued for infringing intellectual property rights of third parties, it will be costly and time consuming, and an unfavorable outcome in that litigation would have a material adverse effect on our business.

 

Our commercial success depends upon our ability and the ability of our collaborators to develop, manufacture, market and sell our product candidates and use our proprietary technologies without infringing the proprietary rights of third parties. Numerous U.S. and foreign issued patents and pending patent applications, which are owned by third parties, exist in the fields in which we and our collaborators are developing products. As the biotechnology and pharmaceutical industry expands and more patents are issued, the risk increases that our potential products may give rise to claims of infringement of the patent rights of others. There may be issued patents of third parties of which we are currently unaware, that may be infringed by our product candidates. Because patent applications can take many years to issue, there may be currently pending applications which may later result in issued patents that our product candidates may infringe.

 

We may be exposed to, or threatened with, future litigation by third parties alleging that our product candidates infringe their intellectual property rights. If one of our product candidates is found to infringe the intellectual property rights of a third party, we or our collaborators could be enjoined by a court and required to pay damages and could be unable to commercialize the applicable product candidate unless we obtain a license to the patent. A license may not be available to us on acceptable terms, if at all. In addition, during litigation, the patent holder could obtain a preliminary injunction or other equitable relief which could prohibit us from making, using or selling our products, pending a trial on the merits, which may not occur for several years.

 

There is a substantial amount of litigation involving patent and other intellectual property rights in the biotechnology and pharmaceutical industries generally. If a third party claims that we or our collaborators infringe its intellectual property rights, we may face a number of issues, including, but not limited to:

 

·                  infringement and other intellectual property claims which, regardless of merit, may be expensive and time-consuming to litigate and may divert our management’s attention from our core business;

 

·                  substantial damages for infringement, which we may have to pay if a court decides that the product at issue infringes on or violates the third party’s rights, and, if the court finds that the infringement was willful, we could be ordered to pay treble damages and the patent owner’s attorneys’ fees;

 

·                  a court prohibiting us from selling our product unless the third party licenses its rights to us, which it is not required to do;

 

·                  if a license is available from a third party, we may have to pay substantial royalties, fees or grant cross-licenses to our intellectual property rights; and

 

·                  redesigning our products so they do not infringe, which may not be possible or may require substantial monetary expenditures and time.

 

We may become involved in lawsuits to protect or enforce our patents, which could be expensive, time consuming and unsuccessful.

 

Competitors may infringe our patents. To counter infringement or unauthorized use, we may be required to file infringement claims, which can be expensive and time consuming. In addition, in an infringement proceeding, a court may decide that a patent of ours is not valid or is unenforceable, or may refuse to stop the other party from using the technology at issue on the grounds that our patents do not cover the technology in question. An adverse result in any litigation or defense proceedings could put one or more of our patents at risk of being invalidated or interpreted narrowly and could put our patent application at risk of not issuing.

 

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Interference proceedings brought by the U.S. Patent and Trademark Office may be necessary to determine the priority of inventions with respect to our patents and patent applications or those of our collaborators. An unfavorable outcome could require us to cease using the technology or to attempt to license rights to it from the prevailing party. Our business could be harmed if a prevailing party does not offer us a license on terms that are acceptable to us. Litigation or interference proceedings may fail and, even if successful, may result in substantial costs and distraction of our management and other employees. We may not be able to prevent, alone or with our collaborators, misappropriation of our proprietary rights, particularly in countries where the laws may not protect those rights as fully as in the U.S.