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OPTR > SEC Filings for OPTR > Form 10-K on 18-Mar-2013All Recent SEC Filings

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Form 10-K for OPTIMER PHARMACEUTICALS INC


18-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation

The following discussion and analysis should be read in conjunction with our "Selected Consolidated Financial Data" and consolidated financial statements and accompanying notes appearing elsewhere in this report. This discussion and other parts of this report may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of several factors, including those set forth under "Risk Factors" and elsewhere in this report.

Overview

We are a global biopharmaceutical company currently focused on commercializing our antibiotic product DIFICIDŽ (fidaxomicin) in the United States and Canada, and on developing other fidaxomicin products in the United States and worldwide, both independently and with our partners and licensees. DIFICID is a macrolide antibacterial drug indicated in adults 18 years of age or older for the treatment of CDAD and is the first antibacterial drug to be approved in the United States for the treatment of CDAD in more than 25 years. We currently are marketing DIFICID in the United States through our own sales force and through our co-promotion agreement with Cubist Pharmaceuticals, Inc., or Cubist.

We continue to pursue regulatory approval for, and commercialization of, fidaxomicin in other geographies outside the United States and Canada through various collaboration partners. In December 2011, the European Medicines Agency, or EMA, approved the Marketing Authorization Application, or MAA, for DIFICLIR (fidaxomicin) for the treatment of adults suffering from CDI in Europe. In June 2012, our collaboration partner, Astellas Pharma Europe Ltd., or APEL, achieved the first sales of DIFICLIR tablets in its European territories. In addition, in June 2012, our subsidiary Optimer Pharmaceuticals Canada, Inc., or Optimer Canada, began marketing DIFICID in Canada. We have entered into agreements with Astellas Pharma Inc., or Astellas Japan, and with Specialised Therapeutics Australia Pty. Ltd, or STA, for the development and commercialization of fidaxomicin in Japan and in Australia and New Zealand, respectively. In November 2012 we entered an exclusive agreement with AstraZeneca UK Limited, or AstraZeneca, to commercialize fidaxomicin tablets for the treatment of CDI in Latin America, including Brazil, Central America, Mexico and the Caribbean.

We were incorporated in November 1998 and have incurred significant net losses since our inception. At December 31, 2012, we had an accumulated deficit of $252.0 million. These losses have resulted principally from costs incurred in connection with research and development activities, including the costs of clinical trial activities, license fees and general and administrative expenses and, more recently, expenses incurred in connection with our commercial efforts with respect to DIFICID in the United States and Canada. We expect to incur operating losses for at least the next two years as we commercialize DIFICID and pursue further development of DIFICID, including conducting post-marketing studies for label expansion and continuing further development, regulatory approval and commercialization of fidaxomicin worldwide. For example, in October 2012, we initiated a Phase 3b clinical trial of DIFICID for the prevention of CDAD in patients undergoing HSCT. We may acquire or in-license additional products or product candidates, technologies or businesses that are complementary.

Recent Developments

On February 26, 2013, the Board of Directors appointed Henry A. McKinnell, Ph.D., the Chairman of our Board of Directors, as our Chief Executive Officer. Dr. McKinnell replaced Pedro Lichtinger, who served as our President and Chief Executive Officer beginning in May 2010. The Board of Directors also appointed Meredith Schaum to replace Kurt Hartman as our General Counsel and Chief Compliance Officer. The independent members of the Board of Directors recommended to the Board of Directors that the foregoing management changes were appropriate following their review of prior compliance, record keeping and conflict-of-interest issues observed during the review, including issues arising from the conduct of our personnel who were the subject of the changes in management and leadership announced in April 2012. The previously disclosed investigations of these issues by the relevant U.S. authorities are ongoing and we are continuing to cooperate with those authorities (see "Legal Proceedings").

In connection with Mr. Lichtinger's resignation, we expect to enter into a separation agreement, pursuant to which he will receive the following benefits:
(i) an amount equal to 24 months of his base salary and a cash bonus based on 2012 performance, in each case less applicable tax withholdings; (ii) 24 months of continued group health benefits; and (iii) acceleration of 30,500 unvested restricted stock units and 230,292 unvested stock options with a weighted average exercise price of $12.53.

In connection with Mr. Hartman's resignation, we entered into a separation agreement with Mr. Hartman, executed on March 2, 2013, pursuant to which he will receive the following benefits: (i) an amount equal to 15 months of his base salary and a cash bonus based on 2012 performance, in each case, less applicable tax withholdings; (ii) 15 months of continued group health benefits; and
(iii) acceleration of 1,167 unvested restricted stock units and 37,109 unvested stock options with a weighted average exercise price of $10.18.

On February 27, 2013, our Board of Directors announced that it had commenced a process to explore a full range of strategic alternatives, including a possible sale of the Company. In connection with this process, we have engaged J.P. Morgan and Centerview Partners as our financial advisers. There can be no assurance that this process will result in the pursuit or consummation of any strategic transaction or that there will be a formal cessation of the process. In addition, we may incur significant expenses pursuing one or more transactions unsuccessfully (see "Risk Factors - The results and impact of our announcement that we are exploring strategic alternatives cannot be determined."). In conjunction with this process, our Board of Directors adopted a stockholder rights plan to protect our stockholders while the strategic review is being conducted.

Financial Operations Overview

Revenues

DIFICID is available in the United States and Canada through three major wholesalers - AmerisourceBergen Corporation, Cardinal Health, Inc. and McKesson Corporation - and through regional wholesalers and specialty pharmacies that provide DIFICID to purchasing customers, such as hospitals, retail pharmacies, long-term care facilities and other purchasing outlets that may dispense DIFICID. We recognize revenue from product sales when persuasive evidence of an arrangement exists, delivery has occurred, title has passed to the customer, the price is fixed and determinable, the buyer is obligated to pay us, the obligation to pay is not contingent on resale of the product, the buyer has economic substance apart from us, we have no obligation to bring about the sale of the product, the amount of returns can be reasonably estimated and collectability is reasonably assured. We recognize product sales of DIFICID upon delivery of product to the wholesalers, specialty pharmacies and certain direct purchasers.

Contract revenue is generated from collaboration partners and includes up-front and milestone payments, product sales and royalties.

Prior to the launch of DIFICID, we generated revenues primarily as a result of various collaborations with pharmaceutical and biotechnology companies and grants from government agencies. Revenues from license and collaboration agreements are recognized based on the performance requirements of the underlying agreements. Revenue is deferred for fees received before they are earned. Non-refundable, up-front payments and license fees, where we have an ongoing involvement or performance obligation, are recorded as deferred revenue and recognized as revenue over the contract or development period. Milestone payments generally are recognized as revenue upon the achievement of the milestones as specified in the underlying agreement, assuming we meet certain criteria. Royalty revenues from the sale of fidaxomicin are recognized upon the sale of product.

Cost and Expenses

Cost of Product Sales. Cost of product sales consists of the costs to manufacture and ship DIFICID in support of U.S. and Canadian sales, as well as royalties due on such sales.

Cost of Contract Revenue. Cost of contract revenue consists of the cost of pharmaceutical product sales to our collaborators, as well as royalties due on contract revenue recognized.


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Research and Development Expense. Research and development expense consists of expenses incurred in connection with developing our drug candidates. Our research and development expenses consist primarily of salaries and related employee benefits and costs associated with clinical trials. Research and development expense also includes the costs associated with our medical affairs and health outcomes and economic research efforts. We charge all research and development expenses to operations as they are incurred because the underlying technology associated with these expenditures relates to our research and development efforts and has no alternative future uses. From inception through December 31, 2012, we incurred total research and development expenses of approximately $268.2 million.

Selling, General and Administrative Expense. Selling, general and administrative expense consists primarily of compensation, including stock-based compensation, related to our commercial operations and administrative employees and other expenses related to an allocated portion of facility costs, legal fees and other professional services expenses and insurance costs.

Co-promotion Expenses with Cubist. Co-promotion expenses with Cubist consist of co-promotion fees and any bonus and profit-share earned by Cubist.

Interest Income (Expense) and Other, Net. Interest income (expense) and other, net consists of interest earned on our cash, cash equivalents and short-term investments and other-than-temporary declines in the market value of available-for-sale securities and cash and non-cash interest charges related to bridge financings.

Net Operating Losses and Tax Credit Carryforwards. At December 31, 2012, we had federal, state and foreign net operating loss carryforwards of approximately $184.0 million, $195.1 million, and $7.3 million, respectively. If not utilized, the net operating loss carryforwards will begin expiring in 2020 for federal purposes and in 2015 for state purposes. The foreign net loss carryforwards will begin expiring in 2019. At December 31, 2012, we had both federal and state research and development tax credit carryforwards of approximately $7.0 million and $4.7 million, respectively. The federal tax credits will begin expiring in 2020 unless previously utilized and the state tax credits carry forward indefinitely. At December 31, 2012, we had a state manufacturer's investment tax credit carryforward of approximately $47,000 that began expiring in 2012. Under Section 382 of the Internal Revenue Code of 1986, as amended, substantial changes in our ownership may limit the amount of net operating loss and tax credit carryforwards that could be utilized annually to offset taxable income. Any such annual limitation may significantly reduce the utilization of the net operating losses and tax credits before they expire.

In 2012, we completed a Section 382/383 analysis regarding the limitation of the net operating losses and credit carryovers and determined that the entire amount of U.S. federal and state net operating losses and credit carryovers are available for utilization, subject to an annual limitation. Any carryforwards that will expire, prior to utilization and as a result of future limitation, will be removed from deferred tax assets with a corresponding reduction of the valuation allowance. Due to the existence of the valuation allowance, future changes in the unrecognized tax benefits will not impact the effective tax rate.

The American Taxpayer Relief Act of 2012, which reinstated the U.S. Federal Research and Development Tax Credit retroactively from January 1, 2012 through December 31, 2013, was not enacted into law until the first quarter of 2013. Therefore, the expected tax benefit resulting from such reinstatement for 2012 will not be reflected in the Company's estimated annual effective tax rate until 2013.

Critical Accounting Policies and Estimates

Our Management's Discussion and Analysis of our Financial Condition and Results of Operations is based on our consolidated financial statements, which have been prepared in conformity with generally accepted accounting principles in the United States. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, expenses and related disclosures. Actual results could differ from those estimates. While our significant accounting policies are described in more detail in Note 1 of the Notes to Consolidated Financial Statements appearing elsewhere in this report, we believe the following accounting policies to be critical to the judgments and estimates used in the preparation of our consolidated financial statements.

Product Sales

During the year ended December 31, 2012, the $62.4 million in net product sales to wholesalers reflected a total of 26,628 DIFICID treatments shipped to wholesalers and specialty pharmacies. Wholesalers and specialty pharmacies shipped approximately 25,700 DIFICID treatments to hospitals, retail pharmacies, long-term care facilities and other purchasing outlets that may dispense DIFICID in the United States and Canada. Our sales representatives primarily target approximately 1,200 hospitals, although approximately 2,800 hospitals have ordered DIFICID.

Our net product sales represent total gross product sales in the United States and Canada less allowances for customer credits, including estimated rebates, chargebacks, discounts and returns. These allowances are established by management as its best estimate, based on available information, and are adjusted to reflect known changes in the factors that impact such allowances. Allowances for rebates, chargebacks, discounts and returns are established based on the contractual terms with customers, communications with customers, as well as expectations about the market for the product and anticipated introduction of competitive products. Product shipping and handling costs are included in cost of sales.


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Product Sales Allowances. We establish reserves for prompt-payment discounts, fee-for-service arrangements, government and commercial rebates, product returns and other applicable allowances, such as our hospital discount. Allowances relate to prompt-payment discounts and fee-for-service arrangement with our contracted wholesalers and direct purchase discounts, and are recorded at the time of sale, resulting in a reduction in product sales revenue. Accruals related to government and commercial rebates, product returns and other applicable allowances are recognized at the time of sale, resulting in a reduction in product sales and an increase in accrued expenses.

Prompt-payment Discounts. We offer a prompt-payment discount to our customers. Since we expect our customers will take advantage of this discount, we accrue 100% of the prompt-payment discount that is based on the gross amount of each invoice, at the time of sale. The accrual is adjusted quarterly to reflect actual earned discounts.

Government and Commercial Rebates and Chargebacks. We estimate commercial rebates as well as government-mandated rebates and discounts relating to federal and state programs such as Medicaid, the Veterans' Administration, or VA, and Department of Defense programs, the Medicare Part D Coverage Discount Program and certain other qualifying federal and state government programs. We estimate the amount of these rebates and chargebacks based on historical trends for DIFICID. These allowances are adjusted each period based on actual experience.

Medicaid rebate reserves relate to our estimated obligations to states under statutory "best price" obligations which also may include supplemental rebate agreements with certain states. Rebate accruals are recorded during the same period in which the related product sales are recognized. Actual rebate amounts are determined at the time of claim by the state, and we generally will make cash payments for such amounts after receiving billings from the state.

VA rebates or chargeback reserves represent our estimated obligations resulting from contractual commitments to sell DIFICID to qualified healthcare providers at a price lower than the list price charged to our distributors. A distributor will charge us for the difference between what the distributor pays for the product and the ultimate selling price to the qualified healthcare provider. Rebate and chargeback accruals are established during the same period in which the related product sales are recognized. Actual chargeback amounts for Public Health Service are determined at the time of resale to the qualified healthcare provider from the distributor, and we generally will issue credits for such amounts after receiving notification from the distributor.

Although allowances and accruals are recorded at the time of product sale, certain rebates generally will be paid, on average, in six months or longer after the sale. Reserve estimates are evaluated quarterly and, if necessary, adjusted to reflect actual results. Any such adjustments will be reflected in our operating results in the period of the adjustment. For the year ended December 31, 2012, there were no material adjustments.

Product Returns. Our policy in the United States is to accept returns of DIFICID for six months prior to, and twelve months after, the product expiration date. Our policy in Canada is to accept returns of DIFICID for three months prior to, and twelve months after, the product expiration date. We permit returns if the product is damaged or defective when received by our customers. We will provide a credit for such returns to customers with whom we have a direct relationship. Once product is dispensed it cannot be returned, but we allow partial returns in states where such returns are mandated. We do not exchange product from inventory for the returned product.

Allowances for product returns are recorded during the period in which the related product sales are recognized, resulting in a reduction to product revenue. We estimate product returns based upon the sales pattern of DIFICID, management's experience with similar products, historical trends in the pharmaceutical industry and trends for similar products sold by others.

During the years ended December 31, 2012 and 2011, the provisions for product sales allowances reduced gross product sales as follows:

                                                          2012             2011
Total gross product sales                            $   74,890,803    $  24,357,200

Returns reserve and allowance                            (1,583,723 )       (365,358 )
Government and commercial rebates and chargebacks        (4,947,295 )       (476,116 )
Prompt-pay discounts and fees                            (5,942,630 )     (2,004,689 )
Product sales allowance                              $  (12,473,648 )  $  (2,846,163 )
Total product sales, net                             $   62,417,155    $  21,511,037
Total product sales allowances as a percent of
gross product sales                                            16.7 %           11.7 %


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An analysis of the amount of, and change in, reserves for the years ended December 31, 2012 and 2011 is as follows:

                                                     Government
                                                        and
                                      Returns        Commercial     Prompt-pay
                                    Reserve and     Rebates and      Discounts
                                     Allowances     Chargebacks      and Fees         Total
Balance at January 1, 2011          $          -    $          -    $         -    $         -
Provisions related to sales in
the current year                         365,358         476,116      2,004,689      2,846,163
Returns and payments                           -        (106,218 )     (429,403 )     (535,621 )
Balance at December 31, 2011             365,358         369,898      1,575,286      2,310,542
Provisions related to sales in
the current year                       1,583,723       4,988,805      5,953,674     12,526,202
Provisions related to sales made
in prior year                                  -         (41,510 )      (11,044 )      (52,554 )
Returns and payments                    (473,957 )    (3,674,344 )   (5,629,393 )   (9,777,694 )
Balance at December 31, 2012        $  1,475,124    $  1,642,849    $ 1,888,523    $ 5,006,496

Contract Revenue

Under certain of our licensing and collaboration agreements, we are entitled to receive payments upon the achievement of contingent milestone events. In order to determine the revenue recognition for contingent milestone-based payments, we evaluate the contingent milestones using the criteria as provided by the Financial Accounting Standards Boards, or FASB, guidance on the milestone method of revenue recognition at the inception of a collaboration agreement.

Accounting Standard Codification (ASC) Topic 605-28, Revenue Recognition - Milestone Method (ASC 605-28), established the milestone method as an acceptable method of revenue recognition for certain contingent, event-based payments under research and development arrangements. Under the milestone method, a payment that is contingent upon the achievement of a substantive milestone is recognized in its entirety in the period in which the milestone is achieved. A milestone is an event (i) that can be achieved based in whole or in part on either our performance or on the occurrence of a specific outcome resulting from our performance, (ii) for which there is substantive uncertainty at the date the arrangement is entered into that the event will be achieved and (iii) that would result in additional payments being due to us. The determination that a milestone is substantive is judgmental and is made at the inception of the arrangement. Milestones are considered substantive when the consideration earned from the achievement of the milestone is (i) commensurate with either our performance to achieve the milestone or the enhancement of value of the item delivered as a result of a specific outcome resulting from our performance to achieve the milestone, (ii) relates solely to past performance and (iii) is reasonable relative to all deliverables and payment terms in the arrangement.

Other contingent, event-based payments received for which payment is either contingent solely upon the passage of time or the results of a collaborative partner's performance are not considered milestones under ASC 605-28. In accordance with ASC Topic 605-25, Revenue Recognition - Multiple-Element Arrangements (ASC 605-25), such payments will be recognized as revenue when all of the following criteria are met: persuasive evidence of an arrangement exists; delivery has occurred or services have been rendered; the price is fixed or determinable; and collectability is reasonably assured.

Revenues recognized for royalty payments are recognized as earned in accordance with the terms of various research and collaboration agreements.

For collaboration agreements with multiple deliverables, we recognize collaboration revenues and expenses by analyzing each element of the agreement to determine if it is to be accounted for as a separate element or single unit of accounting. If an element is to be treated separately for revenue recognition purposes, the revenue recognition principles most appropriate for that element are applied to determine when revenue is to be recognized. If an element is not to be treated separately for revenue recognition purposes, the revenue recognition principles most appropriate for the bundled group of elements are applied to determine when revenue is to be recognized.


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Cash received in advance of services being performed is recorded as deferred revenue and recognized as revenue as services are performed over the applicable term of the agreement. In connection with certain research collaboration agreements, revenues are recognized from non-refundable up-front fees, that we do not believe are specifically tied to a separate earnings process, ratably over the term of the agreement. Research fees are recognized as revenue as the related research activities are performed.

With respect to revenues derived from reimbursement of direct out-of-pocket expenses for research costs associated with grants, where we act as a principal, with discretion to choose suppliers, bear credit risk and perform part of the services required in the transaction, we record revenue for the gross amount of the reimbursement. The costs associated with these reimbursements are reflected as a component of research and development expense in the consolidated statements of operations.

None of the payments we have received from collaborators to date, whether recognized as revenue or deferred, is refundable even if the related program is not successful.

Inventory

Inventory is stated at the lower of cost or market. Cost is determined using the first-in, first-out (FIFO) method. We reserve for potentially excess, dated or obsolete inventory based on an analysis of inventory on hand compared to forecasts of future sales. At December 31, 2012, inventory consisted of $9.1 million in raw materials, $3.6 million in work-in-process and $2.9 million in finished goods.

Research and Development

We expense costs related to research and development as incurred. Our research and development expenses consist primarily of license fees, salaries and related employee benefits, costs associated with clinical trials managed by contract research organizations and costs associated with non-clinical activities and regulatory approvals. We use external service providers and vendors to conduct clinical trials, to manufacture supplies of product candidates to be used in clinical trials and to provide various other research and development-related products and services.

When non-refundable payments for goods or services to be received in the future for use in research and development activities are made, we defer and capitalize these types of payments. The capitalized amounts are expensed when the related goods are delivered or the services are performed.

Stock-based Compensation

The FASB authoritative guidance requires that share-based payment transactions with employees be recognized in the financial statements based on their fair value and recognized as compensation expense over the vesting period. Total consolidated stock-based compensation expense of $13.0 million, $11.8 million and $6.4 million was recognized in the years ended December 31, 2012, 2011 and 2010, respectively. The stock-based compensation expense recognized included expense from performance-based stock options and restricted stock units.

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