UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

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

 

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2013

 

OR

 

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

 

Commission file number:  0-21379

 

CUBIST PHARMACEUTICALS, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

65 Hayden Avenue, Lexington, MA 02421

(Address of Principal Executive Offices and Zip Code)

 

(781) 860-8660

(Registrant’s Telephone Number, Including Area Code)

 

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

 

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

 

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

 

 

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

 

Number of shares of the registrant’s Common Stock, $0.001 par value, outstanding on April 22, 2013: 65,206,393.

 

 

 

Cubist Pharmaceuticals, Inc.

Form 10-Q

For the Quarter Ended March 31, 2013

 

Table of Contents

 

Item			Page
PART I. Financial information
1.	Condensed Consolidated Financial Statements (Unaudited)		3
	Condensed Consolidated Balance Sheets at March 31, 2013 and December 31, 2012		3
	Condensed Consolidated Statements of Comprehensive Income for the three months ended March 31, 2013 and 2012		4
	Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2013 and 2012		5
	Notes to Condensed Consolidated Financial Statements		6
2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		19
3.	Quantitative and Qualitative Disclosures About Market Risk		27
4.	Controls and Procedures		28
PART II. Other Information
1.	Legal Proceedings		28
1A.	Risk Factors		28
2.	Unregistered Sales of Equity Securities and Use of Proceeds		44
3.	Defaults Upon Senior Securities		44
4.	Mine Safety Disclosures		44
5.	Other Information		44
6.	Exhibits		44
	Signatures		46

 

2

 

PART I. FINANCIAL INFORMATION

 

Item 1. Condensed Consolidated Financial Statements

 

CUBIST PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

UNAUDITED

(in thousands, except share data)

 

		March 31,			December 31,
		2013			2012
ASSETS
Current assets:
Cash and cash equivalents		$	63,009		$	104,041
Short-term investments		789,502			872,188
Accounts receivable, net		92,659			93,467
Inventory		43,286			41,947
Deferred tax assets, net		17,935			14,190
Prepaid expenses and other current assets		45,550			31,217
Total current assets		1,051,941			1,157,050
Property and equipment, net		166,272			166,465
In-process research and development		272,700			272,700
Goodwill		114,130			114,130
Other intangible assets, net		147,776			152,830
Long-term investments		88,156			3,167
Other assets		64,496			66,043
Total assets		$	1,905,471		$	1,932,385
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	32,227		$	45,603
Accrued liabilities		123,443			163,633
Short-term deferred revenue		5,885			6,784
Short-term contingent consideration		38,987			38,998
Other current liabilities		3,500			3,500
Total current liabilities		204,042			258,518
Long-term deferred revenue		33,579			34,091
Long-term deferred tax liabilities, net		99,562			103,081
Long-term contingent consideration		152,279			150,215
Long-term debt, net		371,418			367,811
Other long-term liabilities		29,808			27,921
Total liabilities		890,688			941,637
Commitments and contingencies (Notes D, G, L and M)
Stockholders’ equity:
Preferred stock, non-cumulative; convertible, $.001 par value; authorized 5,000,000 shares; no shares issued and outstanding		—			—
Common stock, $.001 par value; authorized 150,000,000 shares; 65,163,806 and 64,713,695 shares issued and outstanding as of March 31, 2013 and December 31, 2012, respectively		65			65
Additional paid-in capital		958,892			940,969
Accumulated other comprehensive loss		(35		)	(59		)
Retained earnings		55,861			49,773
Total stockholders’ equity		1,014,783			990,748
Total liabilities and stockholders’ equity		$	1,905,471		$	1,932,385

 

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

 

3

 

CUBIST PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

UNAUDITED

(in thousands, except share and per share data)

 

		Three Months Ended
		March 31,
		2013			2012
Revenues:
U.S. product revenues, net		$	213,248		$	194,149
International product revenues		12,403			12,654
Service revenues		3,624			3,664
Other revenues		654			1,225
Total revenues, net		229,929			211,692
Costs and expenses:
Cost of product revenues		55,675			53,952
Research and development		114,209			51,172
Contingent consideration		2,053			2,829
Selling, general and administrative		48,201			43,780
Total costs and expenses		220,138			151,733
Operating income		9,791			59,959
Other income (expense):
Interest income		742			674
Interest expense		(7,184		)	(9,007		)
Other income (expense)		240			(180		)
Total other income (expense), net		(6,202		)	(8,513		)
Income before income taxes		3,589			51,446
(Benefit) provision for income taxes		(2,499		)	18,652
Net income		$	6,088		$	32,794
Basic net income per common share		$	0.09		$	0.52
Diluted net income per common share		$	0.09		$	0.45
Shares used in calculating:
Basic net income per common share		64,935,601			63,001,379
Diluted net income per common share		67,034,457			84,386,002
Total comprehensive income		$	6,112		$	32,825

 

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

 

4

 

CUBIST PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

UNAUDITED

(in thousands)

 

		Three Months Ended March 31,
		2013			2012
Cash flows from operating activities:
Net income		$	6,088		$	32,794
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Depreciation and amortization		8,472			8,218
Amortization and accretion of investments		3,224			1,309
Amortization of debt discount and debt issuance costs		3,979			5,284
Deferred income taxes		(7,264		)	(139		)
Stock-based compensation		7,729			5,767
Contingent consideration		2,053			2,829
Payment of contingent consideration		—			(17,408		)
Other non-cash		2,299			1,828
Changes in assets and liabilities:
Accounts receivable		808			2,183
Inventory		(365		)	(685		)
Prepaid expenses and other current assets		5,667			8,766
Other assets		196			4,751
Accounts payable and accrued liabilities		(52,962		)	(58,673		)
Deferred revenue and other liabilities		256			4,340
Total adjustments		(25,908		)	(31,630		)
Net cash (used in) provided by operating activities		(19,820		)	1,164
Cash flows from investing activities:
Purchases of property and equipment		(3,864		)	(8,090		)
Purchases of investments		(405,155		)	(391,384		)
Proceeds from maturities of investments		399,650			365,588
Payment for purchase option		(20,000		)	—
Net cash used in investing activities		(29,369		)	(33,886		)
Cash flows from financing activities:
Payment of contingent consideration		—			(12,592		)
Issuance of common stock, net		5,574			11,964
Excess tax benefit on stock-based awards		2,583			3,033
Net cash provided by financing activities		8,157			2,405
Net decrease in cash and cash equivalents		(41,032		)	(30,317		)
Effect of changes in foreign exchange rates on cash balances		—			(180		)
Cash and cash equivalents at beginning of period		104,041			197,618
Cash and cash equivalents at end of period		$	63,009		$	167,121

 

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

 

5

 

CUBIST PHARMACEUTICALS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED

 

A.            BASIS OF PRESENTATION AND ACCOUNTING POLICIES

 

Basis of Presentation and Consolidation

 

The accompanying condensed consolidated financial statements are unaudited and have been prepared by Cubist Pharmaceuticals, Inc. (“Cubist” or the “Company”) in accordance with accounting principles generally accepted in the United States of America, or GAAP, and pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X. The year-end condensed consolidated financial statements were derived from audited financial statements, but certain information and footnote disclosures required by GAAP normally included in the Company’s annual consolidated financial statements have been condensed or omitted. These interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2012, which are contained in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission, or SEC, on February 27, 2013. The condensed consolidated financial statements, in the opinion of management, reflect all normal and recurring adjustments necessary for a fair statement of the Company’s financial position and results of operations. Certain reclassifications have been made to prior year amounts to conform to the current year presentation.

 

The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for any future period or the entire fiscal year.

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires the extensive use of estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. The most significant assumptions are employed in estimates used in determining values of: inventories; investments; acquisition-date fair value and subsequent fair value estimates used to assess impairment of long-lived assets, including goodwill, in-process research and development, or IPR&D, and other intangible assets; accrued clinical research costs; contingent consideration; income taxes; accounting for stock-based compensation; product rebate, chargeback and return accruals; restructuring charges; as well as in estimates used in accounting for contingencies and revenue recognition. Actual results could differ from these estimates.

 

Fair Value Measurements

 

The accounting standard for fair value measurements defines fair value, establishes a framework for measuring fair value in accordance with GAAP, and requires detailed disclosures about fair value measurements. Under this standard, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The valuation techniques are based on observable and unobservable inputs. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect certain market assumptions. This standard classifies these inputs into the following hierarchy:

 

Level 1 Inputs—Quoted prices for identical instruments in active markets.

 

Level 2 Inputs—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

 

Level 3 Inputs—Instruments with primarily unobservable value drivers.

 

The fair value hierarchy level is determined by asset class based on the lowest level of significant input. In periods of market inactivity, the observability of prices and inputs may be reduced for certain instruments. This condition could cause an instrument to be reclassified between Level 1 and Level 2 or between Level 2 and Level 3. During the three months ended March 31, 2013, there were no transfers between Level 1, Level 2 or Level 3.

 

The carrying amounts of Cubist’s cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximate their fair value due to the short-term nature of these amounts. Short-term and long-term investments primarily consist of available-for-sale securities as of March 31, 2013 and December 31, 2012, and are carried at fair value.

 

6

 

Concentration of Risk

 

Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of cash and cash equivalents, investments and accounts receivable. The Company’s cash and cash equivalents are held with several major financial institutions in the United States, or U.S. The Company’s investments are restricted, in accordance with its investment policy, to a concentration limit per institution.

 

Cubist’s accounts receivable at March 31, 2013 and December 31, 2012, primarily represent amounts due to the Company from wholesalers, including AmerisourceBergen Drug Corporation, Cardinal Health, Inc. and McKesson Corporation. Cubist performs ongoing credit evaluations of its key wholesalers, distributors and other customers and generally does not require collateral. For the three months ended March 31, 2013 and 2012, Cubist did not have any significant write-offs of accounts receivable, and its days sales outstanding has not significantly changed since December 31, 2012.

 

		Percentage of Total Accounts Receivable Balance as of
		March 31, 2013		December 31, 2012
AmerisourceBergen Drug Corporation		21	%	22	%
Cardinal Health, Inc.		18	%	18	%
McKesson Corporation		21	%	20	%

 

		Percentage of Total Net Revenues for the Three Months Ended March 31,
		2013		2012
AmerisourceBergen Drug Corporation		20	%	20	%
Cardinal Health, Inc.		17	%	19	%
McKesson Corporation		18	%	18	%

 

IPR&D

 

IPR&D acquired in a business combination is capitalized on the Company’s condensed consolidated balance sheets at its acquisition-date fair value. Until the underlying project is completed, these assets are accounted for as indefinite-lived intangible assets, subject to impairment testing. Once the project is completed, the carrying value of the IPR&D is amortized over the estimated useful life of the asset. Post-acquisition research and development expenses related to the acquired IPR&D are expensed as incurred.

 

IPR&D is tested for impairment on an annual basis, or more frequently if impairment indicators are present. If IPR&D becomes impaired or is abandoned, the carrying value of the IPR&D is written down to its revised fair value with the related impairment charge recognized in the period in which the impairment occurs. If the fair value of the asset becomes impaired as the result of unfavorable data from any ongoing or future clinical trial, changes in assumptions that negatively impact projected cash flows, or because of any other information regarding the prospects of successfully developing or commercializing the Company’s programs, Cubist could incur significant charges in the period in which the impairment occurs. The valuation techniques utilized in performing impairment tests incorporate significant assumptions and judgments to estimate the fair value. The use of different valuation techniques or different assumptions could result in materially different fair value estimates.

 

Revenue Recognition

 

Principal sources of revenue are (i) sales of CUBICIN® (daptomycin for injection)  and ENTEREG® (alvimopan)  in the U.S.; (ii) revenues derived from sales of CUBICIN by Cubist’s international distribution partners; (iii) license fees and milestone payments that are derived from collaboration, license and commercialization agreements with other biopharmaceutical companies; and (iv) service revenues derived from Cubist’s agreement with Optimer Pharmaceuticals, Inc. for the promotion and support of DIFICID® (fidaxomicin)  in the U.S. In all instances, revenue is recognized only when the price is fixed or determinable, persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, and collectibility of the resulting receivable is reasonably assured.

 

7

 

U.S. Product Revenues, net

 

All revenues from product sales are recorded net of applicable provisions for returns, chargebacks, Medicaid program rebates, Medicare coverage gap discount program rebates, wholesaler management fees, volume-based rebates and discounts in the same period the related sales are recorded.

 

Gross U.S. product revenues were offset by provisions for the three months ended March 31, 2013 and 2012, as follows:

 

		Three Months Ended March 31,
		2013			2012
		(in thousands)
Gross U.S. product revenues		$	245,947		$	224,125
Provisions offsetting U.S. product revenues:
Contractual adjustments		(14,018		)	(12,896		)
Governmental rebates		(18,681		)	(17,080		)
Total provisions offsetting product revenues		(32,699		)	(29,976		)
U.S. product revenues, net		$	213,248		$	194,149

 

Certain product sales qualify for rebates or discounts from standard list pricing due to government sponsored programs or other contractual agreements. Contractual adjustments in the table above include pricing and early payment discounts extended to the Company’s external customers, as well as returns, wholesaler distribution fees and volume-based rebates. Governmental rebates in the table above represent estimated amounts for Medicaid program rebates, Medicare coverage gap discount program rebates and chargebacks related to 340B/Public Health Service and Federal Supply Schedule drug pricing programs. Estimates and assumptions for reserves are analyzed quarterly.

 

Basic and Diluted Net Income Per Share

 

Basic net income per common share has been computed by dividing net income by the weighted average number of shares outstanding during the period. Diluted net income per share has been computed by dividing diluted net income by the diluted number of shares outstanding during the period. Except where the result would be antidilutive to income from continuing operations, diluted net income per share has been computed assuming the conversion of convertible obligations and the elimination of the interest expense related to the Company’s 2.25% convertible subordinated notes which were due June 2013, or 2.25% Notes, and 2.50% convertible senior notes due 2017, or 2.50% Notes, the exercise of stock options and the vesting of restricted stock units, or RSUs, as well as their related income tax effects. In 2012, Cubist retired its 2.25% Notes, in privately-negotiated transactions. This reduced Cubist’s fully-diluted shares of common stock outstanding by 3,549,377 shares for the three months ended March 31, 2013, compared to the three months ended March 31, 2012.

 

The following table sets forth the computation of basic and diluted net income per common share:

 

8

 

		Three Months Ended March 31,
		2013			2012
		(in thousands, expect share and per share amounts)
Net income, basic		$	6,088		$	32,794
Effect of dilutive securities:
Interest on 2.50% Notes, net of tax		—			1,802
Debt issuance costs related to 2.50% Notes, net of tax		—			238
Debt discount amortization related to 2.50% Notes, net of tax		—			2,157
Interest on 2.25% Notes, net of tax		—			394
Debt issuance costs related to 2.25% Notes, net of tax		—			55
Debt discount amortization related to 2.25% Notes, net of tax		—			937
Net income, diluted		$	6,088		$	38,377
Shares used in calculating basic net income per common share		64,935,601			63,001,379
Effect of dilutive securities:
Options to purchase shares of common stock and RSUs		2,098,856			2,411,091
2.50% Notes convertible into shares of common stock		—			15,424,155
2.25% Notes convertible into shares of common stock		—			3,549,377
Shares used in calculating diluted net income per common share		67,034,457			84,386,002
Net income per share, basic		$	0.09		$	0.52
Net income per share, diluted		$	0.09		$	0.45

 

Potential common shares excluded from the calculation of diluted net income per share, as their inclusion would have been antidilutive, were:

 

		Three Months Ended March 31,
		2013		2012
Options to purchase shares of common stock and RSUs		2,501,854		2,460,408
2.50% Notes convertible into shares of common stock		15,424,152		—

 

 

Accumulated Other Comprehensive Income

 

In February 2013, the Financial Accounting Standards Board issued amended accounting guidance for reporting accumulated other comprehensive income. The amendments require a company to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, a company is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income. The Company adopted this guidance on January 1, 2013. The Company did not recognize any realized gains or losses from sales of its available-for-sale securities during the three months ended March 31, 2013, and as a result, did not reclassify any amount out of accumulated other comprehensive income for the same period.

 

Subsequent Events

 

Cubist considers events or transactions that have occurred after the balance sheet date of March 31, 2013, but prior to the filing of the financial statements with the SEC on this Form 10-Q to provide additional evidence relative to certain estimates or to identify matters that require additional recognition or disclosure. Subsequent events have been evaluated through the date of the filing with the SEC of this Quarterly Report on Form 10-Q. There were no subsequent events that occurred after March 31, 2013, that required disclosure in this filing.

 

Recent Accounting Pronouncements

 

None.

 

B.            INVESTMENTS

 

The following table summarizes the amortized cost and estimated fair value of the Company’s marketable securities, which are considered to be available-for-sale investments:

 

9

 

		Amortized Cost			Unrealized Gains			Unrealized Losses			Fair Value
		(in thousands)
Balance at March 31, 2013
Bank deposits		$	136,910		$	—		$	—		$	136,910
U.S. Treasury securities		110,103			8			(1		)	110,110
Corporate and municipal notes		628,681			126			(169		)	628,638
Total		$	875,694		$	134		$	(170	)	$	875,658
Balance at December 31, 2012:
Bank deposits		$	61,000		$	—		$	—		$	61,000
U.S. Treasury securities		114,041			4			(3		)	114,042
Corporate and municipal notes		640,234			158			(215		)	640,177
Total		$	815,275		$	162		$	(218	)	$	815,219

 

The following table contains information regarding the range of contractual maturities of the Company’s marketable securities:

 

		March 31, 2013						December 31, 2012
		Amortized Cost			Fair Value			Amortized Cost			Fair Value
		(in thousands)
Within 1 year		$	787,428		$	787,502		$	812,104		$	812,052
1-2 years		88,266			88,156			3,171			3,167
Total		$	875,694		$	875,658		$	815,275		$	815,219

 

Certain short-term debt securities with original maturities of less than 90 days are included in cash and cash equivalents on the condensed consolidated balance sheets and are not included in the tables above. In addition, certificates of deposit of $2.0 million and $60.1 million as of March 31, 2013 and December 31, 2012, respectively, were included within short-term investments in the condensed consolidated balance sheets but are excluded from the tables above as they were not deemed to be securities.

 

Adynxx Option Agreement

 

In February 2013, Cubist entered into an option agreement with Adynxx, Inc., or Adynxx. Under the agreement, Cubist made a $20.0 million payment to Adynxx, which is non-refundable except in limited circumstances, and obtained an exclusive option to acquire 100% of the outstanding shares of Adynxx. The option is exercisable any time prior to sixty days following Cubist’s receipt of the data from a Phase 2 clinical trial for Adynxx’s lead product candidate, AYX1, subject to extension in certain limited circumstances. Adynxx is studying AYX1 as a potential treatment for the reduction of acute pain and prevention of persistent and chronic pain following surgery. If Cubist exercises the option, Cubist would make an additional payment of $40.0 million to acquire Adynxx, net of any cash acquired and liabilities assumed, and would be obligated to make certain additional payments to the stockholders of Adynxx that are contingent upon the achievement of certain development, regulatory and sales milestones.

 

The Company has concluded that Adynxx is a variable interest entity, or VIE, in which Cubist is not the primary beneficiary. Cubist does not have power, through its variable interest, to direct the activities that most significantly impact the economic performance of Adynxx. Specifically, Cubist does not have any voting rights or other decision-making authority over Adynxx’s operational or financial activities, and it does not participate on any joint steering or oversight committees of Adynxx. Accordingly, the Company did not consolidate Adynxx as of March 31, 2013. Cubist accounted for the $20.0 million payment, which represents the maximum exposure to any potential losses associated with this VIE, at cost, subject to impairment testing. The $20.0 million was included in prepaid expenses and other current assets within the condensed consolidated balance sheet at March 31, 2013.

 

10

 

C.    BUSINESS AGREEMENTS

 

In connection with the Company’s acquisition of Calixa Therapeutics Inc., or Calixa, in December 2009, Cubist acquired the rights to ceftolozane (formerly known as CXA-101), which Calixa had licensed from Astellas Pharma Inc., or Astellas. In March 2013, the license agreement with Astellas was amended to expand the territory in which Cubist holds the rights to manufacture, market and sell any eventual products that incorporate ceftolozane, including ceftolozane/tazobactam (formerly known as CXA-201), to include the Asia-Pacific and Middle East territories that Astellas had retained under the original agreement. With this amendment, Cubist now owns all worldwide rights to ceftolozane/tazobactam, subject to ongoing milestone and royalty obligations to Astellas. As consideration for these rights, Cubist made a one-time payment of $25.0 million to Astellas in March 2013, which was recorded within research and development expense in the condensed consolidated statement of comprehensive income for the three months ended March 31, 2013, as these rights relate to an unapproved product.

 

D.            FAIR VALUE MEASUREMENTS

 

The following tables set forth the Company’s assets and liabilities that are measured at fair value on a recurring basis as of March 31, 2013:

 

		March 31, 2013
		Fair Value Measurements Using
		Level 1			Level 2			Level 3			Total
		(in thousands)
Assets
Cash and cash equivalents: (1)
Corporate and municipal notes		$	—		$	6,517		$	—		$	6,517
Short-term and long-term investments: (2)
Bank deposits		—			136,910			—			136,910
U.S. Treasury securities		110,110			—			—			110,110
Corporate and municipal notes		—			628,638			—			628,638
Total assets		$	110,110		$	772,065		$	—		$	882,175
Liabilities
Contingent consideration		$	—		$	—		$	191,266		$	191,266
Total liabilities		$	—		$	—		$	191,266		$	191,266

 

(1)         Excludes $56.5 million of cash at March 31, 2013.

(2)         Excludes certificates of deposit of $2.0 million recorded at cost at March 31, 2013.

 

Marketable Securities

 

The Company classifies its bank deposits and corporate and municipal notes as a Level 2 input under the fair value hierarchy. These assets have been valued using information obtained through a third-party pricing service at each balance sheet date, using observable market inputs that may include trade information, broker or dealer quotes, bids, offers, or a combination of these data sources.

 

Contingent Consideration

 

In connection with the acquisitions of Adolor Corporation, or Adolor, and Calixa, Cubist recorded contingent consideration pertaining to the amounts potentially payable to Adolor’s former stockholders pursuant to Cubist’s agreement to acquire Adolor and to Calixa’s former stockholders pursuant to Cubist’s agreement to acquire Calixa. Contingent consideration is measured at fair value and is based on significant inputs not observable in the market, which represents a Level 3 measurement within the fair value hierarchy. The valuation of contingent consideration uses assumptions the Company believes would be made by a market participant. The Company assesses these estimates on an on-going basis as additional data impacting the assumptions is obtained. Changes in the fair value of contingent consideration related to updated assumptions and estimates are recognized within the condensed consolidated statements of comprehensive income.

 

Contingent consideration may change significantly as development progresses and additional data is obtained, impacting the Company’s assumptions regarding probabilities of successful achievement of related milestones used to estimate the fair value of the liability and the timing in which they are expected to be achieved. In evaluating the fair value information, considerable judgment is

 

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required to interpret the market data used to develop the estimates. The estimates of fair value may not be indicative of the amounts that could be realized in a current market exchange. Accordingly, the use of different market assumptions and/or different valuation techniques could result in materially different fair value estimates.

 

Level 3 Disclosures

 

The following table provides quantitative information associated with the fair value measurement of the Company’s Level 3 inputs:

 

		Fair Value as of March 31, 2013			Valuation Technique		Unobservable Input		Range (Weighted Average)
		(in thousands)
Adolor
Contingent Consideration		$	78,114		Probability-adjusted discounted cash flow		Probabilities of success		29% - 54% (43%)
							Periods in which milestones are expected to be achieved		2016 - 2020
							Discount rates		5.3% / 16%
Calixa
Contingent Consideration		$	113,152		Probability-adjusted discounted cash flow		Probabilities of success		29% - 100% (57%)
							Periods in which milestones are expected to be achieved		2013 - 2018
							Discount rate		5.3%

 

The significant unobservable inputs used in the fair value measurement of Cubist’s contingent consideration are the probabilities of successful achievement of development, regulatory and sales milestones, the period in which these milestones are expected to be achieved and a discount rate. Significant increases or decreases in any of the probabilities of success would result in a significantly higher or lower fair value measurement, respectively. Significant increases or decreases in the discount rate and/or the period in which milestones will be achieved would result in a significantly lower or higher fair value measurement, respectively.

 

The table below provides a roll-forward of fair value balances that used Level 3 inputs:

 

		Contingent Consideration
		(in thousands)
Beginning balance at December 31, 2012		$	189,213
Contingent consideration expense		2,053
Ending balance at March 31, 2013		$	191,266

 

Adolor

 

The fair value of contingent consideration relating to amounts payable by the Company to the former stockholders of Adolor upon the achievement of certain regulatory milestones, sales milestones or a combination of both, with respect to bevenopran (formerly known as CB-5945), was estimated to be $78.1 million and $77.0 million as of March 31, 2013 and December 31, 2012, respectively. The change in the fair value of the contingent consideration liability during the three months ended March 31, 2013, is due to the time value of money. The aggregate remaining, undiscounted amount of contingent consideration that Cubist could pay to the former stockholders of Adolor under the merger agreement ranges from zero to $233.8 million. Bevenopran is an oral, peripherally-acting mu opioid receptor antagonist in development for the treatment of opioid-induced constipation in patients with chronic, non-cancer pain.

 

Calixa

 

The fair value of contingent consideration relating to amounts payable by the Company to the former stockholders of Calixa, upon the achievement of certain development, regulatory and sales milestones with respect to ceftolozane/tazobactam

 

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was estimated to be $113.2 million and $112.2 million as of March 31, 2013 and December 31, 2012, respectively. The change in fair value for the three months ended March 31, 2013, is due to the time value of money. The aggregate remaining, undiscounted amount of contingent consideration that Cubist could pay to the former stockholders of Calixa under the merger agreement is $220.0 million. Ceftolozane/tazobactam is being developed as a potential treatment for complicated urinary tract infections, or cUTI, complicated intra-abdominal infections, or cIAI, hospital-acquired bacterial pneumonia, or HABP, and ventilator-associated bacterial pneumonia, or VABP.

 

Other Fair Value Measurements

 

Debt

 

The Company estimates the fair value of its 2.50% Notes by using a quoted market rate in an inactive market, which is classified as a Level 2 input. The estimated fair value and carrying value of the $450.0 million aggregate principal amount of the outstanding 2.50% Notes was $769.2 million and $371.4 million, respectively, as of March 31, 2013. See Note G., “Debt,” for additional information.

 

Payable to Glaxo

 

In connection with the acquisition of Adolor in December 2011, Cubist assumed the obligation to pay Glaxo Group Limited, or Glaxo, six annual payments aggregating to $22.5 million as a result of Adolor’s termination of its collaboration agreement with Glaxo in September 2011. The amount payable to Glaxo was recorded at its estimated fair value at the time of acquisition and is allocated between current and non-current liabilities within the condensed consolidated balance sheets based on the contractual payment dates. The fair value estimate utilizes a discount rate, which is classified as a Level 3 input. As of March 31, 2013, the carrying value of the remaining annual payments to Glaxo of $17.1 million approximates its fair value. Imputed interest on the amount payable to Glaxo is recorded as interest expense within the condensed consolidated statements of comprehensive income.

 

E.            PROPERTY AND EQUIPMENT, NET

 

Property and equipment, net consisted of the following at:

 

		March 31, 2013			December 31, 2012
		(in thousands)
Land and buildings		$	168,511		$	166,659
Laboratory equipment		37,372			35,961
Furniture and fixtures		3,381			3,351
Computer hardware and software		22,003			20,903
Construction-in-progress		1,950			3,120
		233,217			229,994
Less: accumulated depreciation		(66,945		)	(63,529		)
Property and equipment, net		$	166,272		$	166,465

 

Depreciation expense was $3.4 million and $3.0 million for the three months ended March 31, 2013 and 2012, respectively.

 

F.             GOODWILL AND OTHER INTANGIBLE ASSETS, NET

 

IPR&D

 

As of March 31, 2013, the Company’s IPR&D consisted of: (i) $78.7 million related to the development and potential commercialization of bevenopran as a result of the acquisition of Adolor and (ii) $194.0 million related to the development and potential commercialization of ceftolozane/tazobactam indications, which are currently expected to be cUTI, cIAI, HABP and VABP, as a result of the acquisition of Calixa. Ceftolozane/tazobactam for HABP and VABP had an estimated fair value of $174.0 million and ceftolozane/tazobactam for cUTI and cIAI had an estimated fair value of $20.0 million as of the acquisition date.

 

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Goodwill

 

The Company’s goodwill balance as of March 31, 2013, remained unchanged from the goodwill balance as of December 31, 2012. As of March 31, 2013, there were no accumulated impairment losses. Goodwill has been assigned to the Company’s single reporting unit, which is the single operating segment by which the chief decision maker manages the Company. See Note K., “Segment Information,” for additional information.

 

Other Intangible Assets

 

Other intangible assets, net consisted of the following at:

 

			March 31,			December 31,
			2013			2012
			(in thousands)
Patents			$	2,627		$	2,627
Acquired technology rights			191,800			191,800
			194,427			194,427
Less:	accumulated amortization — patents		(2,446		)	(2,431		)
	accumulated amortization — acquired technology rights		(44,205		)	(39,166		)
Intangible assets, net			$	147,776		$	152,830

 

Amortization expense was $5.1 million and $5.2 million for the three months ended March 31, 2013 and 2012, respectively.

 

The estimated aggregate amortization of intangible assets as of March 31, 2013, for each of the five succeeding years and thereafter is as follows:

 

		(in thousands)
Remainder of 2013		$	15,547
2014		20,729
2015		20,729
2016		19,449
2017		18,210
2018 and thereafter		53,112
Total		$	147,776

 

G.           DEBT

 

In October 2010, Cubist issued $450.0 million aggregate principal amount of the 2.50% Notes, resulting in net proceeds to Cubist, after debt issuance costs, of $436.0 million. The 2.50% Notes are convertible into common stock at an initial conversion rate of 34.2759 shares of common stock per $1,000 principal amount of convertible notes, subject to adjustment upon certain events, which is equivalent to an initial conversion price of approximately $29.18 per share of common stock. Holders of the 2.50% Notes may convert the 2.50% Notes at any time prior to the close of business on the business day immediately preceding May 1, 2017, only under the following circumstances: (i) during any calendar quarter (and only during such calendar quarter), if the last reported sale price of the common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day; (ii) during the five business day period after any five consecutive trading day period, or the measurement period, in which the trading price per $1,000 principal amount of notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of Cubist’s common stock and the conversion rate on each such trading day; or (iii) upon the occurrence of specified corporate events. Upon conversion, Cubist may deliver cash, common stock or a combination of cash and common stock, at Cubist’s option, to the note holders that requested the conversion. Interest is payable to the note holders on each May 1st and November 1st. As of March 31, 2013, the “if-converted value” exceeded the principal amount of the 2.50% Notes by $272.2 million.

 

In accordance with accounting guidance for debt with conversion and other options, Cubist separately accounted for the liability and equity components of the 2.50% Notes in a manner that reflected its non-convertible debt borrowing rate of similar debt. The equity component of the 2.50% Notes was recognized as a debt discount and represents the difference between the proceeds from the issuance of the convertible notes and the fair value of the liability of the 2.50% Notes at the date of issuance. The debt

 

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discount is amortized to interest expense using the effective interest method over the expected life of a similar liability without an equity component. The Company determined this expected life to be equal to the original seven-year term of each of the 2.50% Notes, resulting in an amortization period ending November 1, 2017.

 

Credit Facility

 

In November 2012, Cubist entered into a $150.0 million three-year senior secured, syndicated revolving credit facility with a group of lenders, including Royal Bank of Canada, as administrative agent. The credit facility, which includes a sublimit for letters of credit, will be used for general corporate purposes. There were no outstanding borrowings under the credit facility as of March 31, 2013 or December 31, 2012.

 

H.           ACCRUED LIABILITIES

 

Accrued liabilities consisted of the following at:

 

		March 31,			December 31,
		2013			2012
		(in thousands)
Accrued royalty		$	33,873		$	72,103
Accrued clinical trials		32,182			29,143
Accrued Medicaid and Medicare rebates		20,795			20,565
Accrued benefits and incentive compensation		8,026			8,603
Accrued bonus		4,653			13,971
Other accrued costs		23,914			19,248
Accrued liabilities		$	123,443		$	163,633

 

Accrued royalties are primarily comprised of royalties owed on net sales of CUBICIN under Cubist’s license agreement with Eli Lilly & Co., or Eli Lilly. Accrued royalties decreased at March 31, 2013, as compared to December 31, 2012, due to the semi-annual royalty payment made to Eli Lilly in February 2013. Accrued bonus decreased at March 31, 2013, as compared to December 31, 2012, due to the payment of the 2012 annual performance-based bonuses during the three months ended March 31, 2013.

 

I.               INVENTORY

 

Inventory consisted of the following at:

 

		March 31,			December 31,
		2013			2012
		(in thousands)
Raw materials		$	7,269		$	9,132
Work-in-process		6,159			8,485
Finished goods		29,858			24,330
Inventory		43,286			41,947
Included in other assets:
Raw materials		32,524			34,091
Work-in-process		1,733			1,733
Finished goods		2,257			1,669
Total		$	79,800		$	79,440

 

Inventory included in other assets within the condensed consolidated balance sheets as of March 31, 2013 and December 31, 2012, represents the amount of ENTEREG inventory held that is in excess of the amount expected to be sold within one year. In connection with the acquisition of Adolor in December 2011, Cubist recorded the acquired ENTEREG inventory at its fair value, which required a step-up adjustment to recognize the inventory at its expected net realizable value.

 

ENTEREG finished goods have a shelf-life of three years from the date of manufacture. The Company expects to sell the ENTEREG finished goods prior to expiration, with the corresponding inventory step-up recorded to cost of product revenues within

 

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the consolidated statements of income in the period in which the inventory is sold. The ENTEREG Active Pharmaceutical Ingredient, or API, which is classified as raw materials, has a shelf-life of 60 months from the date of manufacture, but can be reprocessed at an immaterial cost to the Company with no expected reduction in potency, thereby extending its shelf-life as needed. The Company expects to consume substantially all of the ENTEREG API over a remaining period of approximately eight years based on the Company’s long-range sales projections of ENTEREG.

 

J.              EMPLOYEE STOCK BENEFIT PLANS

 

Summary of Stock-Based Compensation Plans

 

The 2012 Equity Incentive Plan, or 2012 EIP, is the only existing equity compensation plan from which the Company may make equity-based awards to employees, directors and consultants. Under the 2012 EIP, the Company has reserved 5,000,000 shares of common stock for grant to employees, officers, directors and consultants in the form of stock options, restricted stock, RSUs, performance-based restricted stock units, or PRSUs, stock grants and stock appreciation rights. In addition, the number of shares of common stock available for grant includes the number of shares of common stock subject to stock options and RSUs granted and outstanding under the 2010 Equity Incentive Plan, the Directors’ Equity Incentive Plan and the Amended and Restated 2000 Equity Incentive Plan as of June 7, 2012, which become available for grant upon the forfeiture, cancellation, expiration or termination of those awards after June 7, 2012. At March 31, 2013, there were 3,379,011 shares remaining available for grant under the 2012 EIP.

 

Summary of Stock-Based Compensation Expense

 

Stock-based compensation expense recorded in the condensed consolidated statements of comprehensive income for the three months ended March 31, 2013 and 2012, is as follows:

 

		Three Months Ended March 31,
		2013			2012
		(in thousands)
Stock-based compensation expense allocation:
Cost of product revenues		$	125		$	86
Research and development		2,789			1,962
Selling, general and administrative		4,815			3,719
Total stock-based compensation		7,729			5,767
Income tax effect		(2,517		)	(2,071		)
After-tax effect of stock-based compensation expense		$	5,212		$	3,696

 

General Option Information

 

A summary of option activity for the three months ended March 31, 2013, is as follows:

 

		Number of shares			Weighted Average Exercise Price
Outstanding at December 31, 2012		8,025,194			$	27.31
Granted		888,993			$	41.66
Exercised		(334,604		)	$	16.66
Forfeited		(25,403		)	$	34.86
Outstanding at March 31, 2013		8,554,180			$	29.20
Vested and exercisable at March 31, 2013		4,810,186			$	22.85
Weighted average grant-date fair value of options granted during the period		$	13.47

 

RSU Information

 

A summary of RSU activity, including PRSUs, for the three months ended March 31, 2013, is as follows:

 

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		Number of Shares		Weighted Average Grant Date Fair Value
Nonvested at December 31, 2012		735,939		$	35.33
Granted		359,549		$	41.64
Vested		(71,888	)	$	42.04
Forfeited		(5,170	)	$	35.25
Nonvested at March 31, 2013		1,018,430		$	37.09

 

K.           SEGMENT INFORMATION

 

Cubist has one operating segment, the research, development and commercialization of pharmaceutical products that address unmet medical needs in the acute care environment. The Company’s entire business is managed by a single management team, which reports to the Chief Executive Officer. For the three months ended March 31, 2013 and 2012, the Company generated approximately 94% and 93% of revenues, respectively, within the U.S., and substantially all of the Company’s long-lived assets were held within the U.S.

 

L.            INCOME TAXES

 

Cubist’s federal statutory tax rate for the three months ended March 31, 2013 and 2012, was 35.0%. The following table reconciles the federal statutory tax rate to the effective tax rates and the related impact to the (benefit) provision for income taxes for the periods presented:

 

		Three Months Ended March 31,
		2013					2012
		Amount			Tax Rate		Amount			Tax Rate
		(in thousands, except percentages)
Federal statutory tax rate applied to income before taxes		$	1,256		35.0	%	$	18,006		35.0	%
Differential arising from:
State		78			2.1	%	966			1.9	%
Domestic manufacturing deduction		(119		)	-3.3	%	(1,453		)	-2.8	%
Contingent consideration		42			1.2	%	671			1.3	%
2013 Federal research credit		(119		)	-3.3	%	—			0.0	%
2012 Federal research credit		(4,041		)	-112.6	%	—			0.0	%
Increase in reserve for uncertain tax positions		395			11.0	%	72			0.1	%
Other		9			0.3	%	390			0.8	%
Total		$	(2,499	)	-69.6	%	$	18,652		36.3	%

 

The decrease in the effective tax rate for the three months ended March 31, 2013, as compared to the three months ended March 31, 2012, is primarily due to the impact of the 2012 Federal research tax credit, which was extended retroactively back to January 1, 2012, by the American Taxpayer Relief Act of 2012, enacted on January 2, 2013.

 

The Company’s total uncertain tax positions were $37.6 million and $36.1 million as of March 31, 2013 and December 31, 2012, respectively. Of the total uncertain tax positions as of March 31, 2013, $15.4 million were included in other long-term liabilities within the condensed consolidated balance sheet and $22.2 million were offset against deferred tax assets.

 

M.         LEGAL PROCEEDINGS

 

In February 2012, the Company received a Paragraph IV Certification Notice Letter from Hospira, Inc., or Hospira, notifying Cubist that it had submitted an Abbreviated New Drug Application, or ANDA, to the U.S. Food and Drug Administration, or FDA, seeking approval to market a generic version of CUBICIN. Hospira’s notice letter advised that it is seeking FDA approval to market daptomycin for injection, 500 mg/vial, prior to the expiration of U.S. Patent Nos. 6,468,967 and 6,852,689, which expire on September 24, 2019, U.S. Patent No. RE39,071, which expires on June 15, 2016, U.S. Patent No. 8,058,238, which expires on November 28, 2020, and U.S. Patent No. 8,003,673, which expires on September 4, 2028. In May 2012, the Company received a second Paragraph IV Certification Notice Letter from Hospira notifying Cubist that it had submitted to the FDA an amendment to its ANDA. Hospira’s second notice letter advised that it is seeking FDA approval to market daptomycin for injection, 500 mg/vial, prior

 

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