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 March 31, 2007

OR

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

For the transition period from                to

Commission file number 0-26301

United Therapeutics Corporation

(Exact Name of Registrant as Specified in Its Charter)

 

(301) 608-9292

(Registrant’s Telephone Number, Including Area Code)

(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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check One):

Large accelerated filer x      Accelerated filer o      Non-accelerated filer o

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

The number of shares outstanding of the issuer’s common stock, par value $.01 per share, as of April 27, 2007 was 20,782,575.

INDEX

 

PART I.   FINANCIAL INFORMATION

Item 1.                        Consolidated Financial Statements

UNITED THERAPEUTICS CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)

 

See accompanying notes to consolidated financial statements.

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UNITED THERAPEUTICS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)

 

See accompanying notes to consolidated financial statements.

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UNITED THERAPEUTICS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

 

See accompanying notes to consolidated financial statements.

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UNITED THERAPEUTICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2007
(UNAUDITED)

1. ORGANIZATION AND BUSINESS DESCRIPTION

United Therapeutics Corporation (United Therapeutics) is a biotechnology company focused on the development and commercialization of innovative therapeutic products for patients with chronic and life-threatening cardiovascular, cancer and infectious diseases. We were incorporated on June 26, 1996, under the laws of the State of Delaware and we have the following wholly-owned subsidiaries: Lung Rx, Inc. (Lung Rx), Unither Pharmaceuticals, Inc. (UPI), Unither Telmed, Ltd. (Unither Telmed and formerly Unither Telemedicine Services Corporation), Unither.com, Inc., United Therapeutics Europe, Ltd., Unither Pharma, Inc., Medicomp, Inc., Unither Nutriceuticals, Inc., Lung Rx, Ltd. and Unither Biotech Inc.

Our lead product is Remodulin® (treprostinil sodium). Remodulin was first approved for use on May 21, 2002, by the United States Food and Drug Administration (FDA) as a continuous subcutaneous infusion for the treatment of pulmonary arterial hypertension (PAH) in patients with NYHA class II-IV symptoms to diminish symptoms associated with exercise. On November 24, 2004, the FDA approved intravenous infusion of Remodulin, based on data establishing intravenous bioequivalence with subcutaneous Remodulin, for patients who are not able to tolerate a subcutaneous infusion. On March 21, 2006, the FDA expanded its approval of Remodulin to include patients requiring transition from Flolan®, the only other FDA-approved intravenous prostacyclin. In addition to the United States, Remodulin is approved for subcutaneous infusion in most of Europe, Canada, Israel, Australia and several countries in South America. It is approved for intravenous infusion in Canada, Israel, Mexico, Argentina and Peru. Other international applications for the approval of Remodulin are pending.

We have generated pharmaceutical revenues from sales of Remodulin and arginine products in the United States, Canada, Europe, South America and Asia. In addition, we have generated non-pharmaceutical revenues from telemedicine products and services in the United States.

2. BASIS OF PRESENTATION

The consolidated financial statements included herein have been prepared, without audit, pursuant to Regulation S-X of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. These consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2006, as filed with the Securities and Exchange Commission.

In the opinion of our management, any adjustments contained in the accompanying unaudited consolidated financial statements are of a normal recurring nature, necessary to present fairly the financial position as of March 31, 2007, and results of operations and cash flows for the three-month periods ended March 31, 2007 and 2006. Interim results are not necessarily indicative of results for an entire year.

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3. INVENTORIES

We manufacture certain compounds, such as the treprostinil-based compounds, and purchase medical supplies, for use in our product sales and ongoing clinical trials. We subcontract the manufacture of cardiac monitoring equipment. We contract with a third-party manufacturer to make arginine products and for the formulation of Remodulin and for clinical trial materials for the inhaled and oral treprostinil clinical trials. Clinical trial materials are expensed as incurred as research and development expense. These inventories are accounted for under the first-in, first-out method and are carried at the lower of cost or market. Inventories consisted of the following, net of reserves of approximately $486,000 and $440,000 at March 31, 2007 and December 31, 2006, respectively (in thousands):

 

4. GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill and other intangible assets were comprised as follows (in thousands):

 

The HeartBar product was discontinued in January 2006 and is no longer sold. As a result, an impairment related to the HeartBar product tradename totaling approximately $2.0 million was recorded during the three months ended March 31, 2006.

Total amortization expense for the three-month periods ended March 31, 2007 and 2006 was approximately $155,000 and $81,000, respectively. The aggregate amortization expense related to these intangible assets for each of the five succeeding years is estimated as follows (in thousands):

 

5. SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN

In May 2006, the Compensation Committee of our Board of Directors approved the United Therapeutics Corporation Supplemental Executive Retirement Plan (the SERP). The SERP is administered by the Compensation Committee. Only a member of a “select group of management or

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highly compensated employees” within the meaning of ERISA section 201(2) may be eligible to participate in the SERP. During the three months ending March 31, 2007, a normal revaluation of the SERP was performed as a result of finalization of the 2007 salary levels for the SERP participants. The revaluation process includes updating any assumptions and inputs into the actuarial calculations. During the revaluation process, the discount rate changed to 5.7% from 6.2% used in 2006. For the three months ending March 31, 2007, we recognized approximately $612,200 and $37,000, respectively, in service and interest costs for the SERP.

In accordance with SFAS 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, we record as part of the projected benefit obligation the unfunded actuarial loss and unamortized prior period service costs. These amounts are recorded net of tax in other comprehensive income (loss). See footnote No. 8 Comprehensive Income (loss) for the details.

The reconciliation of the beginning and ending balances in benefit obligations and fair value of plan assets, as well as the funded status of our plans, is as follows (in thousands):

 

6. STOCKHOLDERS’ EQUITY

Earnings (Loss) per Common Share

Basic earnings (loss) per common share are computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the respective periods. Diluted earnings per common share are computed by dividing net income by the weighted average number of shares of common stock outstanding during the period plus the number of shares issuable upon the exercise of outstanding stock options and warrants using the treasury stock method. The effects of outstanding stock options and other potential stock issuances were not included in the computation of diluted loss per share for the three months ended March 31, 2007, because to do so would have been antidilutive for the period presented.

At March 31, 2007, the holders of the components of basic and dilutive earnings (loss) per share were as follows (in thousands, except per share amounts):

 

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Stock options and warrants to purchase approximately 5.3 million weighted-average shares of our common stock were also outstanding during the three-month period ended March 31, 2007, but were not included in the computation of earnings (loss) per share because the exercise prices of these options and warrants were greater than the average market price of our common stock during this period; therefore their effect was antidilutive. Due to our net loss for the three month period ended March 31, 2007, outstanding options to purchase approximately 1.1 million weighted-average shares of our common stock were not included in the computation of diluted net loss per share because their inclusion would have been antidilutive.

Stock Option Plan

Effective January 1, 2006, we adopted the provisions of FASB Statement No. 123 (revised 2004), Share-Based Payment, (SFAS 123(R)) and interpretative literature within SEC Staff Accounting Bulletin No. 107, Share-Based Payment, (SAB 107). We utilize the Black-Scholes-Merton valuation model for estimating the fair value of stock options granted. Option valuation models, including Black-Scholes-Merton, require the input of highly subjective assumptions. Changes in the assumptions used can materially affect the grant date fair value of an award. These assumptions include the risk-free rate of interest, expected dividend yield, expected volatility, and the expected life of the award.

The following are the weighted-average assumptions used in valuing the stock options granted to employees during the three-month periods ended March 31, 2007 and 2006:

 

A summary of the status of our employee stock options as of March 31, 2007, and changes during the three months ended is presented below:

 

The weighted-average grant-date fair value of options granted during the three months ended March 31, 2007 and 2006, was $25.77 and $33.33, respectively.

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Total employee share-based compensation expense recognized for the three months ended March 31, 2007 and 2006, is as follows (in thousands):

 

Equity-based compensation costs capitalized as part of inventory during the three months ended March 31, 2007 and 2006, were approximately $78,000 and $158,000, respectively.

A summary of option exercises under all share-based payment is as follows (dollars in thousands):

 

Stock Repurchases

On October 17, 2006, our Board of Directors approved a stock repurchase program to repurchase up to 4.0 million shares of our common stock over a two-year period. As of December 31, 2006, a total of approximately 1.9 million shares had been repurchased at a cost of approximately $115.5 million in the stock repurchase program. Approximately 1.2 million shares of our common stock were repurchased at cost of approximately $67.1 million during the three months ended March 31, 2007. As of March 31, 2007, 911,669 shares remained eligible for repurchase under this program.

7. NOTES PAYABLE

Convertible Senior Notes

On October 30, 2006, we issued $250.0 million of 0.50% Convertible Senior Notes due October 2011 (the Convertible Senior Notes). In connection with the issuance of the Convertible Senior Notes, we also entered into a call spread option. The Convertible Senior Notes were issued at par value and pay interest in cash semi-annually in arrears on April 15 and October 15 of each year, beginning on April 15, 2007. The Convertible Senior Notes are unsecured unsubordinated obligations and rank equally with all other unsecured and unsubordinated indebtedness. The Convertible Senior Notes have an initial conversion price of $75.2257 per share. The Convertible Senior Notes may only be converted: (i) anytime after July 15, 2011; (ii) during any calendar quarter commencing after the date of original issuance of the notes, if the closing sale price of our common stock for at least 20 trading days in the period of 30 consecutive trading days ending on the last trading day of the calendar quarter preceding the quarter in which the conversion occurs is more than 120% of the conversion price of the notes in effect on that last trading day; (iii) during the ten consecutive trading-day period following any five consecutive trading-day period in which the trading price for the notes for each such trading day was less than 95% of the closing sale price of our common stock on such date multiplied by the then current conversion rate; or (iv) if specified significant distributions to holders of our common stock are made, specified corporate transactions occur, or our

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common stock ceases to be approved for listing on The NASDAQ Global Select Market and is not listed for trading on another U.S. national or regional securities exchange. Upon conversion, a holder will receive: (i) cash equal to the lesser of the principal amount of the note or the conversion value; and (ii) to the extent the conversion value exceeds the principal amount of the note, shares of our common stock. In addition, upon a change in control, as defined in the indenture under which the Convertible Senior Notes have been issued, the holders may require us to purchase all or a portion of their Convertible Senior Notes for 100% of the principal amount plus accrued and unpaid interest, if any, plus a number of additional shares of our common stock  As of March 31, 2007, the fair value of the $250.0 million Convertible Senior Notes outstanding was approximately $242.6 million, based on the quoted market price.

8. COMPREHENSIVE INCOME (LOSS)

SFAS No. 130, Reporting Comprehensive Income, establishes standards for the reporting and display of comprehensive income and its components. SFAS No. 130 requires, among other things, that unrealized gains and losses on available-for-sale securities, certain unrecognized and unfunded pension costs and foreign currency translation adjustments be included in other comprehensive income (loss). The following statement presents comprehensive income (loss) for the three months ended March 31, 2007 and 2006 (in thousands):

 

9. INCOME TAXES

Significant components of the provision for income taxes attributable to operations consist of the following (in thousands):

 

We recognized a benefit for income taxes as a result of incurring a loss for the three months ended March 31, 2007.

The income tax provision (benefit) for the three months ended March 31, 2007 and 2006, respectively, is based on the estimated annual effective tax rate for the entire year. The estimated effective tax rate is

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subject to adjustment in subsequent quarterly periods as the estimates of pretax income for the year are increased or decreased. The effective tax rate for the three months ended March 31, 2007 and 2006, was approximately 34 percent and 44 percent, respectively. Until legislation to retroactively reinstate federal tax credits for qualified research expenditures was enacted in October 2006, no benefit from the federal research credit generated during the three months ended March 31, 2006, was included in estimating the 2006 effective tax rate.

As of March 31, 2007, we had available approximately $48.3 million in net operating loss carryforwards and approximately $48.3 million in business tax credit carryforwards for federal income tax purposes, which expire at various dates through 2024. We have conducted a study to determine whether any limitations under Section 382 of the Internal Revenue Code have been triggered through December 31, 2006. Results of this study indicate that multiple limitations occurred through November 2004. As a result, portions of these carryforward items that were generated prior to November 2004 will be subject to certain limitations on their use. We do not believe that these potential limitations will cause the net operating loss and general business credit carryforwards to expire unused.

In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement 109 (FIN 48). This statement clarifies the criteria that an individual tax position must satisfy for some or all of the benefits of that position to be recognized in a company’s financial statements. FIN 48 prescribes a recognition threshold of more-likely-than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those tax positions to be recognized in the financial statements. Effective January 1, 2007, we adopted the provisions of FIN 48 and there was no material effect on the financial statements. As a result, there was no cumulative effect related to adopting FIN 48.

We file income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. All of our U.S. federal tax returns remain open for examination since we have not utilized any of our business credits. State jurisdictions that remain subject to examination range from 2001 to 2005. We do not believe there will be any material changes in our unrecognized tax positions over the next 12 months.

Our policy is that we recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. As of the date of adoption of FIN 48, we did not have any accrued interest or penalties associated with any unrecognized tax benefits, nor was any interest expense recognized during the quarter.

10. LICENSE AGREEMENT

In March 2007, Lung Rx entered into an agreement with Toray Industries, Inc. (Toray) to assume and amend the rights and obligations of the agreement entered into between Toray and us in June 2000 concerning the commercialization of modified release formulations of beraprost (beraprost-MR). Under our original agreement with Toray, we had exclusive North American rights to commercialize beraprost-MR in the United States for cardiovascular disease. Under the amended agreement, we received additional exclusive rights to commercialize beraprost-MR in Europe, broadens the indication to vascular disease (excluding renal disease) and includes other revisions. While an earlier clinical trial of an immediate release form of beraprost in PAH demonstrated efficacy at 12 weeks but not at 36 weeks, a number of patients did respond positively to the drug. We feel that the development of beraprost-MR as combination therapy with drugs featuring different mechanisms of action presents a desirable clinical opportunity given what we understand about how the human body interacts with beraprost and how beraprost, in turn, affects the body. Since there is considerable variability in how PAH patients respond to the same class of molecules, we believe it is beneficial to offer a variety of treatments within that family of molecules. In addition, we are in the early stages of exploring the development of beraprost-MR for the treatment of congestive heart failure.

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In accordance with the terms of the agreement, in March 2007, we issued 200,000 shares of our common stock to Toray in exchange for the cancellation of Toray’s existing right to receive an option grant to purchase 500,000 shares of our common stock (the Option Grant). Under the June 2000 Agreement, Toray’s right to receive the Option Grant was conditioned on Toray’s delivery to us of adequate documentation of beraprost-MR in humans and its transfer of clinical trial material to us, neither of which has yet to occur. Had the Option Grant been made, the exercise price of the options would have been set at the average closing price of our common stock for the period one month prior to the delivery date. Under the terms of the assumed and amended agreement, Toray has the right to request that we repurchase the newly-issued 200,000 shares of common stock upon 30 days prior written notice at the price of $54.41 per share, which was the average closing price of our stock between January 11, 2007, and February 23, 2007. Based on the average closing price of our stock for the two trading days prior to and the two trading days after March 16, 2007, we recognized a research and development expense of approximately $11.0 million in March relating to the issuance of the 200,000 shares, since beraprost-MR has not yet obtained regulatory approval for commercial sales. In accordance with the provision of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock, and EITF Topic No. D-98, Classification and Measurement of Redeemable Securities, these shares of stock are reflected in mezzanine equity as common stock subject to repurchase valued at the repurchase price. If Toray requests that we repurchase these shares, then the value of these shares will be transferred to a liability account until the repurchase is completed.

The amended license agreement also specifies that we make certain milestone payments to Toray during the development period and upon U.S. or European Union approval. Upon execution of the amended agreement, we made a $3.0 million payment to Toray in addition to the issuance of the 200,000 shares of our common stock discussed above. Additional annual milestone payments are specified in the agreement of $2.0 million commencing in 2008 and increasing by $1.0 million per year through 2011. These payments will be expensed when incurred. These payments are contingent upon the receipt of clinical trial material and commercial drug from Toray that meet all of the regulatory standards and requirements, including those relating to chemistry, manufacturing and controls, and are characterized and documented to the satisfaction of the U.S. and European Union regulatory authorities. In addition, if Toray elects to terminate production of beraprost-MR, no further payments would be due under the amended agreement. Conversely, if we elect to terminate development of beraprost-MR, then all remaining milestone payments would be due to Toray, unless certain regulatory standards and requirements have not been met, or material problems have been identified with respect to manufacture and regulatory compliance.

11. SEGMENT INFORMATION

We have two reportable business segments, pharmaceutical and telemedicine. The pharmaceutical segment includes all activities associated with the research, development, manufacture and commercialization of therapeutic products. The telemedicine segment includes all activities associated with the development and manufacture of patient monitoring products and the delivery of patient monitoring services. The telemedicine segment is managed separately because diagnostic services require different technology, manufacturing and marketing strategies than therapeutic products require.

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Segment information as of and for the three months ended March 31, 2007 and 2006, was as follows (in thousands):

 

The segment information shown above equals the consolidated totals. These consolidated totals equal the amounts reported in the consolidated financial statements without further reconciliation for those categories that are reported in the consolidated financial statements. There are no inter-segment transactions.

For the three-month periods ended March 31, 2007 and 2006, approximately 85 percent and 87 percent, respectively, of our revenues were earned from customers located in the United States.

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

The following discussion should be read in conjunction with the consolidated financial statements and related notes appearing in our Annual Report on Form 10-K for the year ended December 31, 2006. The following discussion contains forward-looking statements made pursuant to the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995 including the statements listed under the section entitled “Part II, Item 1A—Risk Factors” below. These statements are based on our beliefs and expectations as to future outcomes and are subject to risks and uncertainties that could cause our results to differ materially from anticipated results. Factors that could cause or contribute to such differences include those discussed below and as described in our Annual Report on Form 10-K for the year ended December 31, 2006, under the section entitled “Part II, Item 1A—Risk Factors—Forward-Looking Statements”, and the other cautionary statements, cautionary language and risk factors set forth in other reports and documents filed with the Securities and Exchange Commission. We undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise.

Overview

We are a biotechnology company focused on the development and commercialization of innovative therapeutic products for patients with chronic and life-threatening cardiovascular, cancer and infectious diseases. We commenced operations in June 1996 and, since our inception, have devoted substantially all of our resources to acquisitions and research and development programs.

United Therapeutics Products and Services

Our lead product is Remodulin, a prostacyclin analog. Our prostacyclin analog acts as a stable synthetic form of prostacyclin, an important molecule produced by the body that has powerful effects on blood-vessel health and function. On May 21, 2002, the United States Food and Drug Administration (FDA) approved subcutaneous (injection under the skin) use of Remodulin (treprostinil sodium) for the treatment of PAH in patients with NYHA class II-IV symptoms to diminish symptoms associated with exercise. PAH is a life-threatening condition characterized by elevated blood pressures between the heart and lungs. In November 2004, the FDA approved intravenous (through a vein or artery) infusion of Remodulin for patients who are not able to tolerate subcutaneous infusion. This approval was based on data establishing the bioequivalence of intravenous with subcutaneous Remodulin. On March 21, 2006, the FDA expanded its approval of Remodulin to include patients requiring transition from Flolan.

Remodulin is approved for subcutaneous use in 33 countries throughout the world. The mutual recognition process to obtain approvals from European Union member countries for subcutaneous use of Remodulin was completed in August 2005, with positive decisions received from most European Union countries. We withdrew applications in Ireland, Spain and the United Kingdom. We anticipate resubmitting these applications following intravenous Remodulin approval in Europe. Licenses and pricing approvals have been received in most European Union countries, with the remainder expected during 2007. We have filed a variation to our license for approval of intravenous Remodulin through the mutual recognition process. Currently, our application is under review in France, our reference member state in the mutual recognition process. Remodulin has been approved for intravenous use in Canada, Israel, Mexico, Argentina and Peru. Marketing authorization applications are currently under review in other countries.

We have generated revenues from sales of Remodulin and arginine royalties and products (which deliver an amino acid that is necessary for maintaining cardiovascular function) in the United States and other countries. In addition, we have generated revenues from telemedicine products and services, primarily designed for patients in the United States with abnormal heart rhythms, called cardiac

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arrhythmias, and ischemic heart disease, a condition that causes poor blood flow to the heart. We currently fund our operations from revenues generated from the sales of our products and services.

Remodulin Marketing and Sales

Remodulin is currently marketed by our own staff of approximately 24 employees who market directly to physicians specialized in treating PAH, comprised mainly of cardiologists and pulmonologists. Our staff is augmented by the marketing resources of our distributors. We face stiff competition from several other companies that market and sell competing therapies and expect the competition to continue growing.

Remodulin is sold to patients in the United States by Accredo Therapeutics, Inc. (a wholly-owned subsidiary of Medco Health Solutions, Inc.), CuraScript, Inc. (a wholly owned subsidiary of Express Scripts, Inc.), and Caremark, Inc., (a wholly-owned subsidiary of CVS Corp.), and outside of the United States by various international distributors. We sell Remodulin in bulk shipments to our distributors. Our U.S.-based distributors typically place one order per month, usually in the first half of the month. The timing and magnitude of our sales of Remodulin are impacted by the timing and volume of these bulk orders from distributors. Bulk orders placed by our distributors are based on their estimates of the amount of drug required for existing and newly starting patients, as well as maintaining an inventory that can meet approximately thirty days’ demand as a contingent supply. Effective January 1, 2007, Curascript’s minimum inventory requirement was reduced from 60 days to 30 days to make their agreement consistent with our two other U.S. distributors. This inventory reduction resulted in a decrease in our first quarter 2007 revenues of approximately $2 million. Because discontinuation of therapy can be life-threatening to patients, we require our distributors to maintain inventory levels as specified in our distribution agreements. Due to these contractual requirements, sales of Remodulin to distributors in any given quarter may not be indicative of patient demand during that quarter. In addition, inventory levels reported by distributors are impacted by the timing of their sales around the end of each reporting period. Sales of Remodulin and associated pumps and supplies are recognized as revenue when delivered to our distributors.

On March 27, 2007, we entered into an exclusive agreement with Mochida Pharmaceutical Co., Ltd. (Mochida), for subcutaneous and intravenous Remodulin distribution in Japan. Mochida will be responsible for obtaining Japanese marketing authorization for Remodulin with our assistance, including conducting necessary bridging studies. We will supply study drug at no charge to Mochida. Due to these bridging studies and required Japanese regulatory reviews, commercial activities in Japan are not expected to commence until 2010 or later. Upon receipt of marketing authorization and pricing approval, Mochida will purchase Remodulin from us for at an agreed-upon transfer price. In addition, Mochida has agreed to pay us certain exclusive distribution rights payments. The first payment of $4.0 million will be paid within fifteen days following their receipt of a tax certificate from the U.S. Treasury Department, which is expected during the 2nd quarter of 2007. Certain other distribution rights payments are due as follows:  (1) upon Remodulin receiving orphan drug status in Japan or February 1, 2008, whichever first occurs, $4.0 million; (2) upon filing a New Drug Application (NDA) in Japan, $2.0 million; and (3) upon marketing approval in Japan, $2.0 million. Payments for distribution rights received through the filing of the NDA will be recognized ratably over a three-year period representing the estimated period of time until marketing authorization is received.

Effective July 1, 2006, we increased the selling price of Remodulin to our U.S.-based distributors. The price was increased approximately 3.5% to $67.25 per milligram, and applies to sales of Remodulin made on or after July 1, 2006.

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Future Prospects

We believe it is likely that many patients now being treated with non-prostacyclin therapies for PAH will require prostacyclin therapy in the near future due to disease progression. As they do, we believe our subcutaneous and intravenous formulations of Remodulin will capture a significant number of these patients. We have two Phase III trials, VIVETA and OvaRex, the results of which should be known during the later half of 2007. If either or both of these trials are successful, we will be working on obtaining regulatory approvals for these products and developing our commercial strategy and foundation. Future profitability will depend on many factors, including the price, level of sales, level of reimbursement by public and private insurance payers, the impact of competitive products, and the number of patients using Remodulin and other currently commercialized products and services, as well as the results and costs of research and development projects, as discussed in the section entitled “Actual consolidated revenues and net income may be different from published securities analyst projections. In addition, we have a history of losses and may not continue to be profitable” under Part II—Items 1.A. “Risk Factors” below.

Major Research and Development Projects

Our major research and development projects are focused on the use of Remodulin to treat cardiovascular diseases, immunotherapeutic monoclonal antibodies (antibodies that activate a patient’s immune response) to treat a variety of cancers and glycobiology antiviral agents (a novel class of small molecules that may be effective as oral therapies) to treat infectious diseases, such as the hepatitis C virus.

Cardiovascular Disease Projects

Subcutaneous use of Remodulin was approved by the FDA in May 2002. Material net cash inflows from the sales of Remodulin for PAH commenced in May 2002 after FDA approval was received. In November 2004, the FDA approved intravenous (through a vein or artery) infusion of Remodulin for patients who are not able to tolerate subcutaneous infusion. This approval was based on data establishing the bioequivalence of intravenous with subcutaneous Remodulin.

TRIUMPH-1, Treprostinil Inhalation Used in the Management of Pulmonary Hypertension, a clinical trial, is currently being conducted at approximately 42 centers in the United States and Europe. In May 2006, the FDA agreed to permit the inclusion of patients with PAH who are also being treated with Revatio, to expand the trial size to at least 200 patients, and to permit the assessment of efficacy after 150 patients have completed the trial. We did not conduct this interim efficacy assessment. As a result, the TRIUMPH-1 trial is expected to conclude when 200 evaluable patients have completed the study, when approximately 215 patients have been enrolled. As of March 31, 2007, approximately 175 patients had been enrolled in this trial. As of April 30, 2007, approximately 190 patients have been enrolled in this trial.

We are developing an oral formulation of treprostinil, treprostinil diethanolamine. Two multi-national placebo-controlled clinical trials of oral treprostinil in patients with PAH commenced in October 2006. These trials are a combination of Phase II and Phase III trials, in which both dosing and efficacy are being studied. One trial, FREEDOM-C, is a 16-week study of up to 300 patients, with an interim assessment at 150 patients, currently on background therapy using a PDE5-inhibitor, such as Revatio®, or an endothelin antagonist, such as Tracleer®, or a combination of both. The second trial, FREEDOM-M, is a 12-week study of up to 150 patients, who are not on any background therapy, with an interim assessment at 90 patients. Both trials will be conducted at approximately 50 centers in the United States and the rest of the world. As of March 31, 2007, there were 70 and 35 patients enrolled in FREEDOM-C and FREEDOM-M, respectively. As of April 30, 2007, there were 85 and 40 patients enrolled in FREEDOM-C and FREEDOM-M, respectively.

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We are also developing beraprost-MR for PAH. Beraprost-MR is an oral analog of prostacyclin. In March 2007, Lung Rx entered into an agreement with Toray Industries, Inc. (Toray) to assume and amend the rights and obligations of the agreement entered into between Toray and us in June 2000 concerning the commercialization of a modified release formulation of beraprost. This agreement is discussed in greater detail in the section entitled “License Agreement” below. In accordance with the terms of the agreement, we paid Toray $3.0 million in cash and issued 200,000 shares of our stock in March 2007. As a result, we recognized a $14.0 million expense during the first quarter of 2007 for these transactions. We are currently awaiting delivery of beraprost-MR clinical trial material from Toray.

We incurred expenses of approximately $6.8 million and $8.9 million during the three months ended March 31, 2007 and 2006, respectively, on Remodulin development. Approximately $200.7 million from inception to date has been incurred on Remodulin development.

Cancer Disease Projects

We licensed our monoclonal antibody immunotherapies in April 2002 from AltaRex Medical Corp. OvaRex® is our lead product and is currently being studied in two identical Phase III clinical trials in advanced ovarian cancer (Stage III and IV) patients. In January 2003, we initiated these Phase III pivotal clinical trials of OvaRex called IMPACT I and II. Patients enrolled in these studies have successfully completed front-line therapy, consisting of surgery and chemotherapy. We are conducting these studies at approximately 60 centers throughout the United States. In June 2006, these trials were fully enrolled with 367 patients. The primary endpoint for these trials is the difference in time to disease relapse between patients treated with OvaRex and patients receiving a placebo. The trials will be analyzed when each study has reached at least 118 relapse events. Following relapse, patients will also be followed to assess survival rate. As of March 31, 2007, the reported number of relapse events was 127 and 104, respectively, in each of the trials. We are also developing the manufacturing processes to manufacture OvaRex ourselves. OvaRex had previously been supplied by a contract manufacturer. We incurred expenses of approximately $2.9 million and $2.1 million during the three months ended March 31, 2007 and 2006, respectively, on OvaRex development. Approximately $45.8 million from inception to date has been incurred on OvaRex development.

Infectious Disease Projects

Our infectious disease program includes glycobiology antiviral drug candidates in the preclinical and clinical stages of testing. The drugs in this program are being developed for a wide variety of viruses. We completed acute and chronic Phase I clinical dosing studies using UT-231B, for the treatment of hepatitis C, to assess safety in healthy volunteers in early 2003. We initiated Phase II clinical studies in patients infected with hepatitis C and completed those studies in October 2004. In that trial, UT-231B did not demonstrate efficacy against hepatitis C in a population of patients that had previously failed conventional treatments. We are now conducting preclinical testing of new glycobiology drug candidates. We incurred expenses of approximately $145,000 and $200,000 during the three months ended March 31, 2007 and 2006, respectively, for our infectious disease programs. Approximately $35.9 million from inception to date has been incurred for infectious disease programs.

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Project Risks

Due to the inherent uncertainties involved in the drug development, regulatory review and approval processes, the anticipated completion dates, the cost of completing the research and development and the period in which material net cash inflows from these projects are expected to commence are not known or estimable. There are many risks and uncertainties associated with completing the development of the unapproved products discussed above, including the following:

·       Products may fail in clinical studies;

·       Hospitals, physicians and patients may not be willing to participate in clinical studies;

·       Hospitals, physicians and patients may not properly adhere to clinical study procedures;

·       The drugs may not be safe and effective or may not be perceived as safe and effective;

·       Other approved or investigational therapies may be viewed as safer, more effective or more convenient;

·       Patients may experience severe side effects during treatment;

·       Patients may die during the clinical study because their disease is too advanced or because they experience medical problems that are not related to the drug being studied;

·       Other ongoing or new clinical trials sponsored by other drug companies or ourselves may reduce the number of patients available for our studies;

·       Patients may not enroll in the studies at the rate we expect;

·       The FDA, international regulatory authorities or local internal review boards may delay or withhold approvals to commence clinical trials or to manufacture drugs;

·       The FDA or international regulatory authorities may request that additional studies be performed;

·       Higher than anticipated costs may be incurred due to the high cost of contractors for drug manufacture, research and clinical trials;

·       Drug supplies may not be sufficient to treat the patients in the studies; and

·       The results of preclinical testing may cause delays in clinical trials.

If these projects are not completed in a timely manner, regulatory approvals could be delayed and our operations, liquidity and financial position could suffer. Without regulatory approvals, we cannot commercialize and sell these products and, therefore, potential revenues and profits from these products could be delayed or impossible to achieve.

License Agreement

In March 2007, Lung Rx entered into an agreement with Toray to assume and amend the rights and obligations of the agreement entered into between Toray and us in June 2000 concerning the commercialization of modified release formulation of beraprost (beraprost-MR). Under our original agreement with Toray, we had exclusive North American rights to commercialize beraprost-MR in the United States for all cardiovascular disease. The amended agreement provides, among other things, that we also have the exclusive rights to commercialize beraprost-MR in Europe, broadens the indication to vascular disease (excluding renal disease) and includes other revisions. While an earlier clinical trial of an immediate release form of beraprost as monotherapy in PAH demonstrated efficacy at 12 weeks but not at 36 weeks, a number of patients did respond positively to the drug. We feel that the development of beraprost-MR as combination therapy with drugs featuring different mechanisms of action presents a

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desirable clinical opportunity given what we understand about how the human body interacts with beraprost and how beraprost, in turn, affects the body. Since there is considerable variability in how PAH patients respond to the same class of molecules, we believe it is beneficial to offer a variety of treatments within that family of molecules. In addition, we are in the early stages of exploring the development of beraprost-MR for the treatment of congestive heart failure.

In accordance with the terms of the amended license agreement, in March 2007, we issued 200,000 shares of our common stock to Toray in exchange for the cancellation of Toray’s existing right to receive an option grant to purchase 500,000 shares of our common stock (the Option Grant). Under the June 2000 Agreement, Toray’s right to receive the Option Grant was conditioned on Toray’s delivery to us of adequate documentation of beraprost-MR in humans and its transfer of clinical trial material to us, neither which had yet to occur. Had the Option Grant been made, the exercise price of the options would have been set at the average closing price of our common stock for the period one month prior to the delivery date. Under the terms of the assumed and amended agreement, Toray has the right to request that we repurchase the newly-issued 200,000 shares of common stock upon 30 days’ prior written notice at the price of $54.41 per share, which is the average closing price of our stock between January 11, 2007, and February 23, 2007. Based on the average closing price of our stock for the two trading days prior to and the two trading days after March 16, 2007, we recognized a research and development expense of approximately $11.0 million in March relating to the issuance of the 200,000 shares, since beraprost-MR has not yet obtained regulatory approval for commercial sales. In accordance with the provision of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and EITF Topic No. D-98, Classification and Measurement of Redeemable Securities, these shares of stock are reflected in mezzanine equity as common stock subject to repurchase valued at the repurchase price. If Toray requests that we repurchase these shares, then the value of these shares will be transferred to a liability account until the repurchase is completed.

The new amended license agreement also specifies that we make certain milestone payments to Toray during the development period and upon U.S. or European Union approval. Upon execution of the amended agreement, we made a $3.0 million milestone payment to Toray in addition to the issuance of the 200,000 shares of our common stock discussed above. The amended license agreement  provides for additional milestone payments of $2.0 million commencing in 2008 and increasing by $1.0 million per year through 2011. These payments will be expensed when incurred. These payments are contingent upon the receipt of clinical trial material and commercial drug from Toray that meets all the regulatory standards and requirements, including chemistry, manufacturing and controls, and that are characterized and documented to the satisfaction of the U.S. and European Union regulatory authorities. In addition, if Toray elects to terminate production of beraprost-MR, no further payments will become be due under the amended license agreement. Conversely, if we elect to terminate development of beraprost-MR, then all remaining milestone payments would be due to Toray, unless certain regulatory standards and requirements have not been met, and material problems have been identified with respect to manufacture and regulatory compliance. In addition to these milestone payments, the amended agreement provides that we will become obligated to make additional payments to Toray if certain specified events occur. Please see the section entitled “Certain license and assignment agreements relating to our products may restrict our ability to develop products in certain countries and/or for particular diseases and impose other restrictions on our freedom to develop and market our products” under Part II—Item 1.A. “Risk Factors” below for more information about the license agreement with Toray.

Financial Position

Cash, cash equivalents and marketable investments (including all unrestricted and restricted amounts) at March 31, 2007, were approximately $252.4 million, as compared to approximately $303.2 million at December 31, 2006. The decrease of approximately $50.8 million is due primarily to the repurchase of

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approximately $67.1 million worth of our common stock which was offset by cash provided by operating activities and investing activities of approximately $13.1 million and $20.4 million, respectively. Restricted cash and marketable investments pledged to secure our obligations under the synthetic operating lease discussed in the section entitled “Off Balance Sheet Arrangement” at March 31, 2007, totaled approximately $38.2 million, as compared with approximately $39.0 million at December 31, 2006.

Property, plant and equipment at March 31, 2007, were approximately $42.1 million, as compared to approximately $34.7 million at December 31, 2006. The increase was primarily due the acquisition of an office building adjacent to our legal and governmental affairs office that we lease in Washington, DC for $5.7 million.

Investments in affiliates at March 31, 2007, were approximately $5.1 million, as compared to approximately $4.7 million at December 31, 2006. The increase was due primarily to an increase in the fair value of our investment in ViRexx Medical Corp., based on quoted market prices.

Accounts payable at March 31, 2007, were approximately $5.0 million, as compared to approximately $2.8 million at December 31, 2006. The increase was due generally to the timing of payments to vendors.

Accrued expenses at March 31, 2007, was approximately $13.8 million, as compared to approximately $15.3 million at December 31, 2006. The decrease was due primarily to the payout of employee year-end bonuses in March of 2007.

Total stockholders’ equity at March 31, 2007, were approximately $162.4 million, as compared to approximately $204.6 million at December 31, 2006. For the three-month period ended March 31, 2007, we repurchased approximately 1.2 million shares of our common stock for $67.1 million which was offset by $8.0 million from the proceeds from stock option exercises, $5.5 million from the recognition of stock option expense and $3.4 million in tax benefits recognized.

Results Of Operations

Three months ended March 31, 2007 and 2006

Revenues for the three months ended March 31, 2007, were approximately $40.2 million, as compared to approximately $33.2 million for the three months ended March 31, 2006.

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The following sets forth our revenues by source for the periods presented (in thousands).

 

Effective January 1, 2007, CuraScript’s minimum inventory requirement was reduced from 60 days to 30 days to make their agreement consistent with our other two U.S. distributors. This inventory reduction resulted in a reduction in our first quarter 2007 revenues of approximately $2 million.

For the three months ended March 31, 2007 and, 2006, approximately 85 percent and 87 percent of our revenues, respectively, were earned from our three distributors located in the United States.

Total revenues are reported net of estimated government rebates, prompt pay discounts and fees due to distributors for services. We pay government rebates to state Medicaid agencies that pay for Remodulin. We estimate our liability for such rebates based on the historical level of government rebates invoiced by state Medicaid agencies relative to U.S. sales of Remodulin. Prompt pay discounts are offered on sales of Remodulin if the related invoices are paid in full generally within 60 days from the date of sale. We estimated our liability for prompt pay discounts based on historical payment patterns. Fees paid to distributors for services are estimated based on contractual rates for specific services applied to estimated units of service provided by the distributors for the period.

A roll forward of the liability accounts associated with estimated government rebates, prompt pay discounts, and fees paid to distributors as well as the net amount of reductions to revenues for these items are presented as follows (in thousands):

 

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Research and development expenses consist primarily of salaries and related expenses, costs to acquire pharmaceutical products and product rights for development, and amounts paid to contract research organizations, hospitals and laboratories for the provision of services and materials for drug development and clinical trials. The table below summarizes research and development by major project and non-project components (dollars in thousands):

 

The increase in cardiovascular expenses was primarily due to expensing a $3.0 million milestone payment to Toray in connection with the amended beraprost-MR license, offset by a reduction in spending in the oral treprostinil program. During the first quarter of 2006, we purchased and expensed advanced chemical intermediates for the manufacture of oral treprostinil. There were no such purchases in the first quarter of 2007. The increase in expenses for the cancer program is related to the development of our OvaRex manufacturing processes.

The research and development expense from issuance of common stock pertains to the 200,000 shares of our common stock issued to Toray in connection with the amended beraprost-MR license.

Selling, general and administrative expenses consist primarily of salaries, travel, office expenses, insurance, professional fees, provision for doubtful accounts receivable, depreciation and amortization. The table below summarizes selling, general and administrative expenses by major categories (dollars in thousands):

 

The increase in general and administrative expenses was due primarily to increased expenses of approximately (1) $817,000 of salaries and related expenses from headcount growth to support expanding operations; (2) $432,400 of rent expense due to rent on our laboratory facility in Silver Spring, Maryland, which began operations in May 2006; and (3) $458,300 of other operating expenses supporting the growth in our operations. The increase in sales and marketing related expenses is the result of an increase in salaries and related expenses of $1.3 million due to an increase in headcount and travel expenses of approximately $382,000.

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A write down of intangible assets related to the HeartBar product tradename totaling approximately $2.0 million was recorded during the three months ended March 31, 2006. This write down was required since the HeartBar product was discontinued in January 2006 and is no longer sold.

Cost of sales consists of the cost to manufacture or acquire products that are sold to customers. Cost of service sales consists of the salaries and related overhead necessary to provide telemedicine services to customers. Cost of product sales was approximately 10% of net product sales for the three months ended March 31, 2007, which is consistent with approximately 11% for the three months ended March 31, 2006. Cost of service sales was approximately 33% of service sales for the three months ended March 31, 2007, which is consistent with approximately 34% for the three months ended March 31, 2006.

Interest income for the three months ended March 31, 2007, was approximately $4.1 million, as compared to interest income of approximately $1.9 million for the three months ended March 31, 2006. The increase was due primarily to an increase in cash invested during 2007 and increased market interest rates.

Equity loss in affiliate represents our share of Northern Therapeutics, Inc.’s losses. The equity loss in affiliate was approximately $114,000 for the three months ended March 31, 2007, as compared to approximately $207,000 for the three months ended March 31, 2006. Northern Therapeutics, Inc.’s loss was due primarily to expenditures for its autologous (non-viral vector) gene therapy research for PAH.

An income tax benefit of approximately $1.4 million was recognized for the three months ended March 31, 2007, as compared to an expense of approximately $1.9 million recognized for the three months ended March 31, 2006. We recognized a benefit for income taxes as a result of incurring a loss for the three months ended March 31, 2007.

The income tax provision (benefit) is based on the estimated annual effective tax rate for the entire year. The estimated effective tax rate is subject to adjustment in subsequent quarterly periods as the estimates of pre-tax income for the year are increased or decreased. The effective tax rate for the three months ended March 31, 2007 and 2006, was approximately 34 percent and 44 percent, respectively. Until legislation to retroactively reinstate federal tax credits for qualified research expenditures was enacted in October 2006, no benefit from the federal research credit generated during the three months ended March 31, 2006, was included in estimating the 2006 effective tax rate. The cumulative effect of the legislation was recorded in the fourth quarter 2006.

Liquidity and Capital Resources

Until June 1999, we financed our operations principally through private placements of common stock. On June 17, 1999, we completed our initial public offering. Our net proceeds from the initial public offering and sale of the over-allotment shares, after deducting underwriting commissions and offering expenses, were approximately $56.4 million. In 2000, we issued common stock in two private placements and received aggregate net proceeds of approximately $209.0 million. Until 2002, we funded the majority of our operations from such net proceeds of equity. Since 2004, we funded the majority of our operations from revenues, mainly Remodulin-related, and this is expected to continue.

Our working capital at March 31, 2007 was approximately $199.7 million, as compared to approximately $258.1 million at December 31, 2006. The decrease is primarily due to our purchase of approximately $67.1 million worth of our common stock during the three months ended March 31, 2007.

At March 31, 2007, restricted cash and marketable investments pledged to secure our obligations under the synthetic operating lease (discussed below under Off Balance Sheet Arrangement) totaled approximately $38.2 million, as compared with approximately $39.0 million at December 31, 2006.

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Net cash provided by operating activities was approximately $13.1 million for the three months ended March 31, 2007, as compared to approximately $16.5 million for the three months ended March 31, 2006. The decrease in cash provided by operating activities is due primarily to the $3.0 million milestone payment to Toray under the amended license agreement. During the three months ended March 31, 2007, we paid approximately $2.0 million for year-end 2006 incentive bonus payments and recognized an excess tax benefit on stock-based compensation of approximately $2.4 million which were not present during the three-month period ending March 31, 2006. For the three months ended March 31, 2007, we invested approximately $8.0 million in cash for property, plant and equipment, as compared to approximately $1.1 million in the three months ended March 31, 2006. In January 2007, we purchased an office building adjacent to our legal and governmental affairs office which we lease in Washington, DC for $5.7 million. For the three months ended March 31, 2007, we also received approximately $8.0 million in stock option exercise proceeds as compared to $3.5 million in the three months ended March 31, 2006. In addition, during the three months ended March 31, 2007, we repurchased approximately 1.2 million shares of our common stock for $67.1 million, as compared to no shares for the three months ended March 31, 2006.

We are currently in the planning phase for building an approximately 200,000 square foot facility in Research Triangle Park, North Carolina, which will consist of a manufacturing operation and offices. The manufacturing operation will primarily be for oral treprostinil, although it is expected to support other programs, and the offices will be used by our clinical development and sales and marketing staff, which currently occupy a leased facility in the area. Construction of this facility is expected to begin during the second quarter of 2007 and may take up to two years to complete. The project may cost up to $100 million, and we expect to fund the construction of this facility from our working capital or other financing arrangements.

Effective March 9, 2007, we entered into a construction management agreement with DPR Construction, Inc. (DPR) based in Falls Church, Virginia. DPR will manage the construction of our manufacturing and office facility in Research Triangle Park, North Carolina. The agreement has a guaranteed maximum price clause in which DPR agrees that the construction cost of the facility will not exceed approximately $78.0 million, which amount is subject to change based on agreed-upon changes to the scope of work. DPR will be responsible for covering any costs in excess of the guaranteed maximum price. If the ultimate cost of the project is less than the guaranteed maximum, we will share a portion of these savings with DPR. In addition, DPR must pay us penalties if the construction is not completed by February 2009, which date is subject to change based on agreed-upon changes to the scope of work. DPR has no material relationship with us or any of our affiliates.

In addition, we are in the planning phase for a new office and laboratory building which will connect to our current laboratory facility in Silver Spring, Maryland. The building of this facility is anticipated to begin in the latter half of 2007. The costs are still being estimated due to continuing design and related estimation work. We anticipate that the construction of this facility will be financed though a synthetic operating lease.

We made milestone payments totaling $20,000 pursuant to existing license agreements during each of the three months ended March 31, 2007 and 2006. We are obligated to make royalty payments on sales of Remodulin that exceed annual net sales of $25.0 million and on all arginine products. Royalties on sales of all products currently marketed range up to 10 percent of sales of those products.

We believe that our existing revenues, together with existing capital resources (comprised primarily of unrestricted cash, cash equivalents and marketable investments), will be adequate to fund our operations. However, any projections of future cash needs and cash flows are subject to substantial uncertainty. See the section entitled “Part II, Item 1A—Risk Factors—Actual consolidated revenues and net income may be different from published securities analyst projections. In addition, we have a history of losses and may not continue to be profitable” below.

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At March 31, 2007, we had, for federal income tax purposes, net operating loss carryforwards of approximately $48.3 million and business tax credit carryforwards of approximately $48.3 million which expire at various dates from 2012 through 2025. The remaining net operating loss carryforwards are attributable to exercised stock options, the benefit of which, when realized, directly increases additional paid-in-capital. Business tax credits can offset future tax liabilities and arise from qualified research expenditures. We have been and may continue to be subject to federal alternative minimum tax and state income taxes, even though we have significant net operating loss and credit carryforwards.

Section 382 of the Internal Revenue Code limits the utilization of net operating losses when ownership changes occur as defined by that section. We have reviewed our ownership change position pursuant to Section 382 through December 31, 2006 and have determined that ownership changes occurred in December 1997, June 1999, and November 2004 and, as a result, the utilization of certain of our net operating loss carryforwards may be limited. However, we do not expect any significant portion of our net operating loss carryforwards or business tax credits will expire unused. A portion of the net operating loss carryforwards continues to be reserved through a valuation allowance as of March 31, 2007.

Convertible Senior Notes

On October 30, 2006, we issued $250.0 million of 0.50% Convertible Senior Notes due October 2011 (the Convertible Senior Notes). Proceeds from the offering, after deducting the initial purchaser’s, Deutsche Bank Securities Inc. (Deutsche Bank), discount and commission and estimated expenses were approximately $242.0 million. The Convertible Senior Notes were issued at par value and pay interest in cash semi-annually in arrears on April 15 and October 15 of each year, beginning on April 15, 2007. The Convertible Senior Notes are unsecured unsubordinated obligations and rank equally with all other unsecured and unsubordinated indebtedness. The Convertible Senior Notes have an initial conversion price of $75.2257 per share. The Convertible Senior Notes may only be converted: (i) anytime after July 15, 2011; (ii) during any calendar quarter commencing after the date of original issuance of the notes, if the closing sale price of our common stock for at least 20 trading days in the period of 30 consecutive trading days ending on the last trading day of the calendar quarter preceding the quarter in which the conversion occurs is more than 120% of the conversion price of the notes in effect on that last trading day; (iii) during the ten consecutive trading-day period following any five consecutive trading-day period in which the trading price for the notes for each such trading day was less than 95% of the closing sale price of our common stock on such date multiplied by the then current conversion rate; or (iv) if specified significant distributions to holders of our common stock are made, specified corporate transactions occur, or our common stock ceases to be approved for listing on The NASDAQ Global Select Market and is not listed for trading on another U.S. national or regional securities exchange. Upon conversion, a holder will receive: (i) cash equal to the lesser of the principal amount of the note or the conversion value; and (ii) to the extent the conversion value exceeds the principal amount of the note, shares of our common stock. In addition, upon a change in control, as defined in the indenture under which the Convertible Senior Notes have been issued, the holders may require us to purchase all or a portion of their Convertible Senior Notes for 100% of the principal amount plus accrued and unpaid interest, if any, plus a number of additional shares of our common stock, as set forth in the related indenture. The indenture under which the Convertible Senior Notes were issued contains customary covenants.

Concurrent with the issuance of the Convertible Senior Notes, we purchased call options on our common stock in a private transaction. The call options allow us to receive up to approximately 3.3 million shares of our common stock from counterparties, equal to the amount of common stock related to the excess conversion value that we would pay to the holders of the Convertible Senior Notes upon conversion. These call options will terminate upon the earlier of the maturity dates of the related Convertible Senior Notes or the first day all of the related Convertible Senior Notes are no longer outstanding due to conversion or otherwise. The call options, which cost approximately $80.8 million, were recorded as a

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reduction of shareholders’ equity. The cost of call options for tax purposes creates a tax deduction since it is classified as an Original Issue Discount (OID). The deduction is considered a permanent difference and, as such, does not create a deferred tax asset. The benefit of the deduction is recorded as an increase to additional paid-in-capital.

In a separate transaction, we sold warrants to issue shares of our common stock at an exercise price of $105.689 per share. Pursuant to this transaction, warrants for approximately 3.3 million shares of our common stock were issued. If the average price of our common stock during a defined period, ending on or about the respective settlement dates, exceeds the exercise price of the warrants, the warrants will be settled in shares of our common stock. Proceeds received from the issuance of the warrants totaled approximately $45.4 million and were recorded as an increase to additional paid-in-capital.

We also used approximately $112.4 million of the proceeds from the issuance of the Convertible Senior Notes to repurchase approximately 1.8 million outstanding shares of our common stock as part of this transaction. We intend to use the remainder of the net proceeds for working capital or other general corporate purposes, which may include acquisitions, strategic investments or joint venture arrangements. Including the shares of common stock repurchased as part of the Convertible Senior Note transaction, we have repurchased a total of approximately 3.1 million shares of our common stock for approximately $182.5 million through March 31, 2007.

Off Balance Sheet Arrangement

In June 2004, we entered into a synthetic operating lease and related agreements with Wachovia Development Corporation and its affiliates (Wachovia) to fund the construction of a laboratory facility in Silver Spring, Maryland. Under these agreements, Wachovia funded $32.0 million towards the construction of the laboratory facility on land owned by us. The construction phase commenced in 2004 and was completed in May 2006. Following construction, Wachovia leased the laboratory facility to us with a term ending in May 2011. Under the 99-year ground lease, Wachovia will pay fair value rent to us for use of the land both during the construction phase and after the laboratory lease is terminated. During the term of the laboratory lease, Wachovia will pay $1 per year to us for use of the land.

Wachovia receives rent from us, generally based on applying the 30-day LIBOR rate plus approximately 55 basis points to the amount funded by Wachovia towards the construction of the laboratory. This monthly rent commenced when the laboratory construction was completed and will continue until the termination of the lease in May 2011. Upon termination of the lease, we will generally have the option of renewing the lease (subject to approval of both parties), purchasing the laboratory at a price approximately equal to the funded construction cost, or selling it and repaying Wachovia the cost of its construction. We have guaranteed that if the laboratory is sold, Wachovia will receive at least 86% of the amount it funded towards the construction.

We pledged a portion of our marketable investments as collateral to secure our lease obligations. At March 31, 2007, approximately $38.2 million of marketable investments and cash were pledged as collateral and are reported as restricted marketable investments and cash in our consolidated balance sheet.

This arrangement enabled us to construct our laboratory facility without using our own working capital. There will not be any depreciation expense associated with the laboratory facility, since these improvements are owned by Wachovia. The amount of rent to be paid to Wachovia during the term of the laboratory lease will vary as it is tied to the then current 30-day LIBOR rate plus approximately 55 basis points. As this rate increases, so will the rent to be paid. Similarly, if this rate decreases, so will the amount of rent to be paid to Wachovia.

Rent payments under the laboratory lease commenced in May 2006 and will continue through termination of the lease in May 2011. Upon the completion of the building in May 2006, Wachovia

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advanced to us approximately $5.2 million, which constituted the remaining funds available for construction due to the lengthy process involved in finalizing construction costs. At March 31, 2007, the remaining construction advance totaled approximately $436,000 and is classified as other current liability in our balance sheet. When the final construction costs have been agreed upon, any remaining funds that were advanced will be returned to Wachovia. Upon the return of unspent funds, the remaining rent payments will be based on the actual funded costs of the building.

Based on construction costs of approximately $32.0 million and the current effective rate of approximately 5.9% (equivalent to the current 30-day LIBOR rate plus approximately 55 basis points at March 31, 2007), the rents to be paid are approximately $1.9 million annually. In addition, Wachovia paid us ground rent of approximately $307,000 in June 2004 covering the period through May 2011. This amount is being recognized as income ratably through May 2011.

We guaranteed a minimum residual value of the laboratory facility. This guaranteed residual is generally equal to 86% of the amount funded by Wachovia towards construction. If, at the end of the lease term, we do not renew the lease or purchase the improvements, then the building will be sold to a third party. In that event, we have guaranteed that Wachovia will receive at least this residual value amount. The maximum potential amount of this guarantee is approximately $27.5 million, equivalent to 86% of total expected construction costs of $32.0 million. We have reported this guarantee as a non-current asset (prepaid rent) and non-current liability (other liability). We have estimated the fair value of this guarantee liability and the corresponding asset at approximately $692,000, net of accumulated amortization at March 31, 2007.

The laboratory lease and other agreements require, among other things, that we maintain a consolidated net worth of at least $70.0 million. The agreements contain other covenants and conditions with which we must comply throughout the lease periods and upon termination of the lease. If we were unable to comply with these covenants and conditions, if the noncompliance went uncured, and if the parties could not agree otherwise, the agreements could terminate. A termination of these agreements could result in our acquisition of the improvements from Wachovia or the loss of our liquid collateral.

Contractual Obligations

At March 31, 2007, we had contractual obligations coming due approximately as follows (in thousands):

(1)          In October 2006, we issued $250.0 million aggregate principal amount of Convertible Senior Notes. The principal balance of the notes is repaid in cash with any increase of our stock price above $75.22 paid in our stock. While the notes can be redeemed by the bondholder once our stock price exceeds $75.22, we have assumed that the bondholders will hold the bonds until maturity.

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(2)          Upon the completion of our laboratory in May 2006, Wachovia advanced to us the remaining funds available for construction due to the lengthy process involved in finalizing construction costs. When the final construction costs have been agreed upon, any remaining funds that were advanced will be returned to Wachovia. At March 31, 2007, the remaining construction advance totaled approximately $436,000 and is classified as other current liability in our balance sheet.

(3)          Includes specified payments to Toray for clinical trial material.

(4)          Upon termination of the lease with Wachovia for the laboratory facility, we will generally have the option of renewing the lease, purchasing the laboratory or selling it and repaying Wachovia the cost of its construction. We guaranteed that if the laboratory is sold, Wachovia will receive at least 86% of the amount it funded towards the construction. We estimate that the laboratory will cost approximately $32.0 million to construct and the guarantee is estimated at approximately $27.5 million. The estimated fair value of the guarantee is included in other long-term liabilities reflected in the statement of financial position. See the section entitled “Off Balance Sheet Arrangement” above for additional information.

(5)          We licensed certain products from other companies under certain license agreements. These agreements generally include milestone payments to be paid in cash by us upon the achievement of certain product development and commercialization goals set forth in each license agreement. Total milestone payments under these license agreements have been estimated based on the assumption that the products will be successfully developed and on the estimated timing of these development and commercialization goals.

Summary of Critical Accounting Policies

The preparation of our consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. On an ongoing basis, we evaluate our estimates and judgments, which are based on historical and anticipated results and trends and on various other assumptions that we believe are reasonable under the circumstances, including assumption as to future events. By their nature, estimates are subject to an inherent degree of uncertainty and, as such, actual results may differ from our estimates. We discuss accounting policies and assumptions that involve a higher degree of judgment and complexity than others in our Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report to shareholders on Form 10-K for the year ended December 31, 2006.

Recent Accounting Pronouncements

Fair Value Measurements

In September 2006, the FASB issued SFAS 157, Fair Value Measurements. SFAS 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are currently evaluating the impact the adoption of this statement could have on our financial condition, results of operations or cash flows.

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