Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended March 31, 2011

 

OR

 

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

 

For the transition period from            to            

 

Commission file number: 001-34620

 

IRONWOOD PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

04-3404176

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification Number)

 

301 Binney Street

 

 

Cambridge, Massachusetts

 

02142

(Address of Principal Executive Offices)

 

(Zip Code)

 

(617) 621-7722

(Registrant’s telephone number, including area code)

 

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

 

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

 

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

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer x

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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

 

As of May 2, 2011, there were 50,427,311 shares of Class A common stock outstanding and 49,659,761 shares of Class B common stock outstanding.

 

 

 



Table of Contents

 

IRONWOOD PHARMACEUTICALS, INC.

 

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 2011

 

TABLE OF CONTENTS

 

 

 

Page

 

 

 

PART I — FINANCIAL INFORMATION

 

 

Item 1.

Financial Statements (unaudited)

 

 

 

Condensed Consolidated Balance Sheets as of March 31, 2011 and December 31, 2010

 

3

 

Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2011 and 2010

 

4

 

Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2011 and 2010

 

5

 

Notes to Condensed Consolidated Financial Statements

 

6

Item 2.

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

 

24

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

33

Item 4.

Controls and Procedures

 

33

 

 

 

 

PART II — OTHER INFORMATION

 

 

Item 1A.

Risk Factors

 

35

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

51

Item 6.

Exhibits

 

51

 

 

 

 

 

Signatures

 

52

 

2


 


Table of Contents

 

PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Ironwood Pharmaceuticals, Inc.

 

Condensed Consolidated Balance Sheets

 

(in thousands, except share and per share amounts)

 

(unaudited)

 

 

 

March 31,
2011

 

December 31,
2010

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

46,214

 

$

44,321

 

Available-for-sale securities

 

174,355

 

203,706

 

Accounts receivable

 

207

 

19

 

Related party accounts receivable, net

 

3,977

 

2,876

 

Prepaid expenses and other assets

 

4,299

 

5,320

 

Restricted cash

 

 

2,833

 

Total current assets

 

229,052

 

259,075

 

Restricted cash

 

7,647

 

7,647

 

Property and equipment, net

 

35,074

 

34,369

 

Other assets

 

251

 

274

 

Total assets

 

$

272,024

 

$

301,365

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

2,918

 

$

4,302

 

Accrued research and development costs

 

8,052

 

8,140

 

Accrued expenses

 

6,394

 

8,938

 

Current portion of capital lease obligations

 

241

 

197

 

Current portion of deferred rent

 

2,877

 

2,799

 

Current portion of deferred revenue

 

40,050

 

40,050

 

Total current liabilities

 

60,532

 

64,426

 

Capital lease obligations, net of current portion

 

598

 

393

 

Deferred rent, net of current portion

 

13,939

 

14,612

 

Deferred revenue, net of current portion

 

52,370

 

62,383

 

Commitments and contingencies (Note 8)

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, $0.001 par value, 75,000,000 shares authorized, no shares issued and outstanding

 

 

 

Class A common stock, $0.001 par value, 500,000,000 shares authorized and 49,050,397 and 48,202,089 shares issued and outstanding at March 31, 2011 and December 31, 2010, respectively

 

49

 

48

 

Class B common stock, $0.001 par value, 100,000,000 authorized and 50,671,950 and 50,970,247 shares issued and outstanding at March 31, 2011 and December 31, 2010, respectively

 

51

 

51

 

Additional paid-in capital

 

530,374

 

526,991

 

Accumulated deficit

 

(385,941

)

(367,540

)

Accumulated other comprehensive income

 

52

 

1

 

Total stockholders’ equity

 

144,585

 

159,551

 

Total liabilities and stockholders’ equity

 

$

272,024

 

$

301,365

 

 

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

 

3



Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Condensed Consolidated Statements of Operations

 

(in thousands, except share and per share amounts)

 

(unaudited)

 

 

 

Three Months Ended
March 31,

 

 

 

2011

 

2010

 

Collaborative arrangements revenue

 

$

10,237

 

$

8,838

 

Operating expenses:

 

 

 

 

 

Research and development

 

19,555

 

17,549

 

General and administrative

 

9,224

 

5,785

 

Total operating expenses

 

28,779

 

23,334

 

Loss from operations

 

(18,542

)

(14,496

)

Other income (expense):

 

 

 

 

 

Interest expense

 

(16

)

(53

)

Interest and investment income

 

154

 

68

 

Other income

 

3

 

 

Other income (expense), net

 

141

 

15

 

Net loss from continuing operations

 

(18,401

)

(14,481

)

Net loss from discontinued operations

 

 

(1,772

)

Net loss

 

(18,401

)

(16,253

)

Net loss from discontinued operations attributable to noncontrolling interest

 

 

329

 

Net loss attributable to Ironwood Pharmaceuticals, Inc.

 

$

(18,401

)

$

(15,924

)

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

 

 

 

 

 

Continuing operations

 

$

(0.19

)

$

(0.23

)

Discontinued operations

 

 

(0.02

)

Net loss per share

 

$

(0.19

)

$

(0.25

)

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

 

99,075,187

 

63,957,966

 

 

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

 

4



Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Condensed Consolidated Statements of Cash Flows

 

(in thousands)

 

(unaudited)

 

 

 

Three Months Ended
March 31,

 

 

 

2011

 

2010

 

Cash flows from operating activities:

 

 

 

 

 

Net loss

 

$

(18,401

)

$

(16,253

)

Loss from discontinued operations

 

 

(1,772

)

Loss from continuing operations

 

(18,401

)

(14,481

)

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

 

 

 

 

 

Depreciation and amortization

 

2,133

 

1,280

 

Loss on disposal of property and equipment

 

 

1

 

Share-based compensation expense

 

2,698

 

1,588

 

Accretion of discount/premium on investment securities

 

727

 

98

 

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(1,289

)

522

 

Restricted cash

 

2,833

 

 

Prepaid expenses and other current assets

 

1,021

 

35

 

Other assets

 

23

 

(9

)

Accounts payable and accrued expenses

 

(2,962

)

(1,506

)

Accrued research and development costs

 

(88

)

(3,975

)

Deferred revenue

 

(10,013

)

(8,360

)

Deferred rent

 

(595

)

233

 

Net cash used in operating activities from continuing operations

 

(23,913

)

(24,574

)

Net cash used in operating activities from discontinued operations

 

 

(2,038

)

Total net cash used in operating activities

 

(23,913

)

(26,612

)

Cash flows from investing activities:

 

 

 

 

 

Purchases of available-for-sale securities

 

(39,436

)

(222,427

)

Sales and maturities of available-for-sale securities

 

68,111

 

 

Purchases of property and equipment

 

(3,468

)

(1,063

)

Net cash provided by (used in) investing activities from continuing operations

 

25,207

 

(223,490

)

Net cash provided by investing activities from discontinued operations

 

 

1

 

Total net cash provided by (used in) investing activities

 

25,207

 

(223,489

)

Cash flows from financing activities:

 

 

 

 

 

Proceeds from initial public offering

 

 

203,168

 

Proceeds from exercise of stock options and issuance of restricted stock

 

675

 

354

 

Payments on borrowings

 

(76

)

(324

)

Net cash provided by financing activities from continuing operations

 

599

 

203,198

 

Net cash used in financing activities from discontinued operations

 

 

(89

)

Net cash provided by financing activities

 

599

 

203,109

 

Net increase (decrease) in cash and cash equivalents

 

1,893

 

(46,992

)

Cash and cash equivalents, beginning of period

 

44,321

 

122,306

 

Cash and cash equivalents, end of period

 

$

46,214

 

$

75,314

 

Supplemental cash flow disclosures:

 

 

 

 

 

Cash paid for interest (includes cash paid by Microbia)

 

$

15

 

$

96

 

Purchases under capital leases

 

$

325

 

$

 

 

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

 

5


 


Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

1. Nature of Business

 

Ironwood Pharmaceuticals, Inc. (the “Company”) is an entrepreneurial pharmaceutical company that discovers, develops and intends to commercialize differentiated medicines that improve patients’ lives. Linaclotide, the Company’s guanylate cyclase type-C (“GC-C”) agonist being developed for the treatment of patients with irritable bowel syndrome with constipation (“IBS-C”) or chronic constipation (“CC”) is currently in Phase 3 clinical development. The Company also has a pipeline focused on both research and development of early stage product candidates and preclinical research in multiple therapeutic areas, including gastrointestinal disease, pain and inflammation, respiratory disease, allergic disease and cardiovascular disease.

 

Prior to September 2010, the Company held a majority ownership interest in Microbia, Inc. (formerly known as Microbia Precision Engineering), a subsidiary formed in September 2006. Microbia, Inc. (“Microbia”) engaged in a specialty biochemicals business based on a proprietary strain-development platform. In September 2010, the Company sold its interest in Microbia to DSM Holding Company USA, Inc. (“DSM”) (Note 2).

 

The Company was incorporated in Delaware on January 5, 1998. On April 7, 2008, the Company changed its name from Microbia, Inc. to Ironwood Pharmaceuticals, Inc.

 

The Company has generated an accumulated deficit as of March 31, 2011 of approximately $385.9 million since inception. In February 2010, the Company completed its initial public offering of Class A common stock and raised a total of approximately $203.2 million in net proceeds (Note 3).

 

2. Summary of Significant Accounting Policies

 

Unaudited Interim Financial Statements

 

The accompanying condensed consolidated financial statements and the related disclosures as of March 31, 2011 and for the three months ended March 31, 2011 and 2010 are unaudited and have been prepared in accordance with accounting principles generally accepted in the U.S. (“GAAP”) and the applicable rules and regulations of the Securities and Exchange Commission (‘‘SEC’’) for interim financial information. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements.  These interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K filed with the SEC on March 30, 2011. The December 31, 2010 condensed consolidated balance sheet included herein was derived from the audited financial statements as of that date, but does not include all disclosures including notes required by GAAP for complete financial statements.

 

The unaudited interim condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and, in the opinion of management, reflect all adjustments of a normal recurring nature considered necessary to present fairly the Company’s financial position as of March 31, 2011 and results of its operations for the three months ended March 31, 2011 and 2010, and its cash flows for the three months ended March 31, 2011 and 2010. The interim results for the three months ended March 31, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011.

 

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Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

Principles of Consolidation

 

The accompanying condensed consolidated financial statements of Ironwood Pharmaceuticals, Inc. include the revenue, expenses, and cash flows of Microbia, over which the Company exercised control until September 21, 2010, when the Company sold its 85% interest in Microbia to DSM. The Company recorded noncontrolling interest in its condensed consolidated statements of operations for the ownership interest of the minority owners of Microbia. All intercompany transactions and balances are eliminated in consolidation.

 

Sale of Subsidiary and Discontinued Operations

 

On September 21, 2010, the Company sold its interest in Microbia to DSM in exchange for cash proceeds of $9.5 million, the payment of approximately $1.1 million of Microbia debt and interest by DSM and future contingent consideration based on the sale of products incorporating Microbia’s technology. As a result of the sale of its interest in Microbia, the Company ceased to have any financial interest in Microbia. The Company maintained no further investment in Microbia and recorded a gain on the sale of Microbia in its consolidated statements of operations of approximately $12.2 million at the time of the sale.

 

Additionally, in accordance with the applicable accounting standards, the Company considered if the operations and cash flows of Microbia had been eliminated from the ongoing operations of the Company and if the Company would have any significant continuing involvement in the operations of Microbia after the sale in order to determine whether or not to present Microbia as discontinued operations in the financial statements. The Company determined that Microbia met the requirements for presentation as discontinued operations and accordingly, the Company classified the assets, liabilities, operations, and cash flows of Microbia as discontinued operations for all periods presented prior to the sale.

 

The agreement with DSM also included future contingent consideration in the form of a royalty on future sales of products incorporating Microbia’s technology through the earlier of a) 2024, b) the invalidity of any Microbia patent, or c) the maximum agreed upon amount is reached. The Company elected as its accounting policy to account for the future contingent consideration, if any, as a gain contingency as the proceeds have not been received and the receipt of royalty income is uncertain. As a result, proceeds will only be recorded in future earnings as they are earned. As of March 31, 2011, no amounts have been recorded for the contingent consideration in the Company’s condensed consolidated financial statements.

 

Use of Estimates

 

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

 

Cash and Cash Equivalents

 

The Company considers all highly liquid investment instruments with an original maturity when purchased of three months or less to be cash equivalents. Investments qualifying as cash equivalents primarily consist of money market funds and certain U.S. government sponsored securities. The carrying amount of cash equivalents approximates fair value. The amount of cash equivalents included in cash and cash equivalents was approximately $42.1 million and $39.2 million at March 31, 2011 and December 31, 2010, respectively.

 

Available-for-Sale Securities

 

The Company classifies all short-term investments with an original maturity when purchased of greater than three months as available-for-sale. Available-for-sale securities are carried at fair value, with the unrealized gains and losses reported in other

 

7



Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

comprehensive income (loss). The amortized cost of debt securities in this category is adjusted for the amortization of premiums and accretion of discounts to maturity. Such amortization is included in interest and investment income. Realized gains and losses, and declines in value judged to be other than temporary on available-for-sale securities, are included in interest and investment income.

 

The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in interest and investment income. To determine whether an other-than-temporary impairment exists, the Company considers whether it has the ability and intent to hold the investment until a market price recovery, and whether evidence indicating the recoverability of the cost of the investment outweighs evidence to the contrary. There were no other-than-temporary impairments for the three months ended March 31, 2011.

 

Concentrations of Credit Risk

 

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

 

Accounts receivable primarily consist of amounts due under the collaboration agreement with Forest Laboratories, Inc. (“Forest”) and license agreements with Almirall, S.A. (“Almirall”) and Astellas Pharma Inc. (“Astellas”) (Note 5) for which the Company does not obtain collateral. Accounts receivable from Forest and Almirall are presented as related party accounts receivable on the condensed consolidated balance sheets as both entities own common stock of the Company.

 

The percentages of revenue from continuing operations recognized from significant customers of the Company in the three months ended March 31, 2011 and 2010 are included in the following table:

 

 

 

Three Months Ended
March 31,

 

 

 

2011

 

2010

 

Collaborative Partner:

 

 

 

 

 

Forest

 

53

%

62

%

Almirall

 

37

%

33

%

Astellas

 

10

%

5

%

 

For the three months ended March 31, 2011 and 2010, no additional customers accounted for more than 10% of the Company’s revenue from continuing operations. Tate & Lyle Investments, Ltd. (“T&L”) accounted for approximately 93% of the Company’s revenue from discontinued operations for the three months ended March 31, 2010.

 

At March 31, 2011 and December 31, 2010, accounts receivable from Forest, net of any payables due Forest, accounted for approximately 95% and 89%, respectively, of the Company’s total accounts receivable. At March 31, 2011 and December 31, 2010, Almirall accounted for less than 1% and approximately 10%, respectively, of the Company’s total accounts receivable.

 

Revenue Recognition

 

The Company’s revenue is generated through collaborative research and development and licensing agreements. The terms of these agreements contain multiple deliverables which may include (i) licenses, (ii) research and development activities, and (iii) the manufacture of active pharmaceutical ingredient (“API”) and development materials for the collaborative partner. Payments to the Company under these agreements may include non-refundable license fees, payments for research and development activities, payments for the manufacture of API and development materials, payments based upon the achievement of certain milestones and royalties on product sales. In addition, prior to September 2010, the Company generated services revenue through agreements that generally provided for fees for research and development services rendered.

 

8



Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

For arrangements that include multiple deliverables, the Company follows the provisions of the Accounting Standards Codification (“ASC”) Topic 605-25, Revenue Recognition — Multiple-Element Arrangements, in accounting for these agreements. Effective January 1, 2011, the Company adopted Accounting Standards Update (“ASU”) No. 2009-13, Multiple-Deliverable Revenue Arrangements (“ASU 2009-13”), which amends ASC Topic 605-25. Refer to Note 2, Recent Accounting Pronouncements, for additional discussion of this standard and its impact on the Company’s accounting for collaboration and license agreements. In order to account for these agreements, the Company must identify the deliverables included within the agreement and evaluate which deliverables represent separate units of accounting based on if certain criteria are met, including whether the delivered element has standalone value to the collaborator. The consideration received is allocated among the separate units of accounting, and the applicable revenue recognition criteria are applied to each of the separate units. The Company recognizes revenue when there is persuasive evidence that an arrangement exists, services have been rendered or delivery has occurred, the price is fixed and determinable, and collection is reasonably assured.

 

At March 31, 2011, the Company had collaboration and license agreements with Forest, Almirall and Astellas. Refer to Note 5, Collaboration and License Agreements, for additional discussion on these agreements.

 

There are no performance, cancellation, termination or refund provisions in any of the Company’s arrangements that contain material financial consequences to the Company.

 

Collaboration and License Agreements

 

The significant deliverables under the Company’s collaboration and license agreements generally include the license to develop and commercialize linaclotide, the Company’s GC-C agonist, and may also include deliverables related to research and development activities, and the manufacture of API and development materials for the collaborative partner.

 

Generally, collaboration and license agreements contain non-refundable terms for payments and, depending on the terms of the agreement, provide that the Company will (i) provide research and development activities, including participation on a joint development committee, (ii) manufacture API and development materials which are reimbursed at a contractually determined rate, (iii) earn payments upon the achievement of certain milestones, and (iv) earn royalty payments on sales of linaclotide. In determining the separate units of accounting, management evaluates whether the license has standalone value to the partner based on the consideration of the relevant facts and circumstances for each arrangement. Factors considered in this determination include the research capabilities of the partner and the availability of peptide research expertise in the general marketplace. In addition, the Company considers whether the collaborator can use the license for its intended purpose without the receipt of the remaining deliverables, and whether the value of the license is dependent on the undelivered items and whether there are other vendors that can provide the undelivered item.

 

For all of the collaboration and licenses agreements discussed in Note 5, the license and research and development activities did not qualify as separate units of accounting since the licenses did not have standalone value without the research and development activities. Up-front payments on licenses are deferred if facts and circumstances dictate that the license does not have standalone value. The determination of the length of the period over which to defer revenue is subject to judgment and estimation and can have an impact on the amount of revenue recognized in a given period. The Company generally estimates this period as the estimated period of performance, which is typically the research and development term due to the Company’s continuing involvement in the performance of research and development, primarily through its participation on a joint development committee. Typically the research and development term begins at the inception of the collaboration or license agreement and concludes when the Company’s significant research and development obligations under the agreement have concluded. The Company believes this period of involvement is five years for the Forest collaboration, fifty months for the Almirall license agreement and 115 months for the Astellas license agreement. Quarterly, the Company reassesses its periods of substantial involvement over which the Company amortizes its up-front license fees and makes adjustments as appropriate. In the event that a license were to be terminated, the Company would recognize as revenue any portion of the up-front fee that had not previously been recorded as revenue, but was classified as deferred revenue at the date of such termination.

 

Up-front payments on licenses may be recognized upon delivery of the license if facts and circumstances dictate that the license has standalone value from the undelivered elements, which generally include research and development activities and manufacture of API and development materials.

 

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Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

At the inception of each agreement that includes milestone payments, the Company evaluates whether each milestone is substantive and at risk to both parties on the basis of the contingent nature of the milestone, specifically reviewing factors such as the scientific and other risks that must be overcome to achieve the milestone, as well as the level of effort and investment required. Milestones that are not considered substantive are accounted for as license payments and recognized on a straight-line basis over the remaining period of performance. Refer to Note 5 for details on the specific milestones in each of the Company’s agreements.

 

In those circumstances where a substantive milestone is achieved, collection of the related receivable is reasonably assured and the Company has remaining obligations to perform under the collaboration arrangement, the Company has historically recognized as revenue on the date the milestone was achieved an amount equal to the applicable percentage of the performance period that had elapsed as of the date the milestone was achieved, with the balance being deferred and recognized on a straight-line basis over the remaining period of performance. Effective January 1, 2011, the Company adopted ASU No. 2010-17, Revenue Recognition — Milestone Method (“ASU 2010-17”). Refer to Note 2, Recently Adopted Accounting Standards, for additional discussion of the adoption of this standard and its prospective impact on the Company’s accounting for collaboration and license agreements. Under ASU 2010-17, beginning January 1, 2011, in those circumstances where a substantive milestone is achieved and collection of the related receivable is reasonably assured, the Company will recognize revenue related to the milestone in its entirety in the period in which the milestone is achieved. Milestone payments received in prior periods will continue to be recognized based upon the remaining period of performance.

 

The Company produces development materials and API for its collaborators and is reimbursed for its costs to produce the material. The Company recognizes revenue on development material and API when the material has passed all quality testing required for collaborator acceptance, delivery has occurred, title and risk of loss have transferred to the collaborator, the price is fixed or determinable, and collection is reasonably assured.

 

The Company receives research and development funding under the Forest collaboration agreement and considers the factors or indicators within this arrangement to determine whether reporting such funding on a gross or net basis is appropriate. The Company records revenue transactions gross in the condensed consolidated statements of operations if it is deemed the principal in the transaction, which includes being the primary obligor and having the risks and rewards of ownership.

 

Services Revenue

 

Prior to September 2010, the Company recognized services revenue when there was persuasive evidence that an arrangement existed, services had been rendered or delivery had occurred, the price was fixed and determinable, and collection was reasonably assured. Revenue from research and development services rendered was recognized as services were performed. As a result of the sale of the Company’s interest in Microbia in September 2010, services revenue is included in net income (loss) from discontinued operations.

 

Research and Development Costs

 

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

 

Research and development expenses are comprised of costs incurred in performing research and development activities, including salaries and benefits, share-based compensation expense, laboratory supplies and other direct expenses, facilities expenses, overhead expenses, contractual services, including clinical trial and related clinical manufacturing expenses, and other outside expenses. As a result of the sale of the Company’s interest in Microbia in September 2010, costs of revenue related to the Microbia services contracts and costs associated with Microbia’s research and development activities are included in net income (loss) from discontinued operations.

 

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

 

10



Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

Share-Based Compensation

 

Share-based compensation is recognized as an expense in the financial statements based on the grant date fair value. Compensation expense recognized relates to stock awards, restricted stock and stock options granted, modified, repurchased or cancelled on or after January 1, 2006. Stock options granted to employees prior to that time continue to be accounted for using the intrinsic value method. Under the intrinsic value method, compensation associated with share-based awards to employees was determined as the difference, if any, between the fair value of the underlying common stock on the date compensation was measured, generally the grant date, and the price an employee must pay to exercise the award. For awards that vest based on service conditions, the Company uses the straight-line method to allocate compensation expense to reporting periods. The grant date fair value of options granted is calculated using the Black-Scholes option-pricing model, which requires the use of subjective assumptions including volatility, expected term and the fair value of the underlying common stock, among others.

 

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

 

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

 

Noncontrolling Interest

 

Noncontrolling interest represents the noncontrolling stockholder’s proportionate share of equity and net income or net loss of the Company’s former consolidated subsidiary, Microbia. On September 21, 2010, the Company sold its interest in Microbia, resulting in the deconsolidation of its former subsidiary bringing the noncontrolling interest balance to zero.

 

Net Loss Per Share

 

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

 

Income Taxes

 

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

 

Management of the Company has evaluated the positive and negative evidence bearing upon the realizability of its deferred tax assets. Management has considered the Company’s history of operating losses and concluded, in accordance with the applicable accounting standards, that it is more likely than not that the Company will not realize the benefit of its deferred tax assets. Accordingly, the deferred tax assets have been fully reserved at March 31, 2011 and December 31, 2010. Management reevaluates the positive and negative evidence on a quarterly basis.

 

The Company accounts for uncertain tax positions recognized in the condensed consolidated financial statements by prescribing a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. There were no income tax provisions or benefits for the three months ended March 31, 2011 and 2010 given the Company’s continued net operating loss position.

 

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Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

Impairment of Long-Lived Assets

 

The Company regularly reviews the carrying amount of its long-lived assets to determine whether indicators of impairment may exist which warrant adjustments to carrying values or estimated useful lives. If indications of impairment exist, projected future undiscounted cash flows associated with the asset are compared to the carrying amount to determine whether the asset’s value is recoverable. If the carrying value of the asset exceeds such projected undiscounted cash flows, the asset will be written down to its estimated fair value. There were no indicators of impairment at March 31, 2011.

 

Comprehensive Income (Loss)

 

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

 

 

 

Three Months Ended
March 31,

 

 

 

2011

 

2010

 

Net loss attributable to Ironwood Pharmaceuticals, Inc.

 

$

(18,401

)

$

(15,924

)

Change in unrealized gain (loss) on investments

 

51

 

(99

)

Comprehensive loss attributable to Ironwood Pharmaceuticals, Inc.

 

$

(18,350

)

$

(16,023

)

 

Segment Information

 

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

 

Prior to the sale of its interest in Microbia in September 2010, the Company had two reportable business segments: human therapeutics and biomanufacturing (Note 12). Revenue from the Company’s human therapeutics segment is presented in the condensed consolidated statements of operations as collaborative arrangements revenue. Revenue from the Company’s biomanufacturing segment is presented as a component of the net income (loss) from discontinued operations.

 

New Accounting Pronouncements

 

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

 

Recently Adopted Accounting Standards

 

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

 

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Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

2010 and allows for retrospective application. On January 1, 2011, the Company adopted ASU 2009-13 on a prospective basis. The adoption did not have a material impact on the Company’s consolidated financial position or results of operations.

 

In April 2010, the FASB issued ASU 2010-17. ASU 2010-17 provides guidance in applying the milestone method of revenue recognition to research or development arrangements. Under this guidance management may recognize revenue contingent upon the achievement of a milestone in its entirety, in the period in which the milestone is achieved, if the milestone meets all the criteria within the guidance to be considered substantive. This ASU is effective for research and development milestones achieved in fiscal years, beginning on or after June 15, 2010. On January 1, 2011, the Company adopted ASU 2010-17 to change its accounting policy to begin applying the milestone method on a prospective basis. As the Company elected prospective adoption, there was no material impact on its consolidated financial position or results of operations. However, the adoption of ASU 2010-17 is expected to impact the Company’s accounting for any milestone payments received in future periods.

 

Recently Issued Accounting Standards

 

In December 2010, the FASB issued ASU No. 2010-27, Fees Paid to the Federal Government by Pharmaceutical Manufacturers ( “ASU 2010-27”) which provides guidance on how to recognize and classify the fees mandated by the Patient Protection and Affordable Care Act as amended by the Health Care and Education Reconciliation Act (together, the “Acts”). The Acts impose an annual fee for each calendar year beginning on or after January 1, 2011 payable by branded prescription drug manufacturers and importers on branded prescription drugs. The liability for the fee should be estimated and recorded in full upon the first qualifying sale with a corresponding deferred cost that is amortized to expense using a straight-line method of allocation over the calendar year that it is payable. ASU 2010-27 is effective for calendar years beginning on or after December 31, 2010, when the fee initially becomes effective. As the Company does not currently have a commercial product, the effect of this guidance will be limited to future transactions.

 

Reclassifications

 

Amounts associated with the Company’s former subsidiary, Microbia, have been presented as discontinued operations for all periods in the condensed consolidated financial statements.

 

3. Initial Public Offering

 

In February 2010, the Company completed its initial public offering of Class A common stock pursuant to a registration statement that was declared effective on February 2, 2010. The Company sold 19,166,667 shares of its Class A common stock, which included 2,500,000 shares of the Company’s Class A common stock sold pursuant to an over-allotment option granted to the underwriters, at a price to the public of $11.25 per share. As a result of the initial public offering, the Company raised a total of $215.6 million in gross proceeds, and approximately $203.2 million in net proceeds after deducting underwriting discounts and commissions.

 

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

 

13


 


Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

4. Net Loss Per Share

 

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

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

Numerator:

 

 

 

 

 

Net loss from continuing operations

 

$

(18,401

)

$

(14,481

)

Net loss from discontinued operations

 

 

(1,772

)

Less: net loss from discontinued operations attributable to noncontrolling interest

 

 

329

 

Net loss from discontinued operations attributable to Ironwood Pharmaceuticals, Inc.

 

 

(1,443

)

Net loss attributable to Ironwood Pharmaceuticals, Inc.

 

$

(18,401

)

$

(15,924

)

Denominator:

 

 

 

 

 

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

 

99,075,187

 

63,957,966

 

Net loss per share associated with continuing operations

 

$

(0.19

)

$

(0.23

)

Net loss per share associated with discontinued operations attributable to Ironwood Pharmaceuticals, Inc.

 

$

 

$

(0.02

)

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

 

$

(0.19

)

$

(0.25

)

 

The net loss attributable to noncontrolling interest is reflected in the net loss from discontinued operations for purposes of segregating the earnings per share calculation between continuing and discontinued operations.

 

The following potentially dilutive securities have been excluded from the computation of diluted weighted average shares outstanding as of March 31, 2011 and 2010, as they would be anti-dilutive:

 

 

 

At March 31,

 

 

 

2011

 

2010

 

Options to purchase common stock

 

16,038,788

 

14,703,079

 

Shares subject to repurchase

 

252,094

 

366,229

 

 

 

16,290,882

 

15,069,308

 

 

5. Collaboration and License Agreements

 

Forest Laboratories, Inc.

 

In September 2007, the Company entered into a collaboration agreement with Forest to jointly develop and commercialize linaclotide, a drug candidate for the treatment of IBS-C, CC and other gastrointestinal conditions, in North America. Under the terms of this collaboration agreement, the Company shares equally with Forest all development costs, as well as potential future profits and losses from the development and sale of linaclotide in the U.S. The Company will receive royalties from Forest for sales in Canada and Mexico. The Company retained the rights to commercialize linaclotide outside of North America. Forest made non-refundable, up-front payments totaling $70.0 million to the Company in order to obtain rights to linaclotide in North America. Because the license to jointly develop and commercialize linaclotide did not have standalone value without the research and development activities provided by the Company, the Company is recognizing the up-front license fee as revenue on a straight-line basis over five years, which is the Company’s estimate of the period over which linaclotide will be jointly developed under the collaboration. At March 31, 2011, approximately $20.4 million of the up-front license fee remains deferred and is being recognized on a straight-line basis over the

 

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Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

remaining estimated development period. The collaboration agreement also includes contingent milestone payments, as well as a contingent equity investment based on the achievement of specific development and commercial milestones. These payments, including the up-front license fee, could total up to $330.0 million if certain development and sales milestones are achieved for linaclotide. To date, $100.0 million in license fees and milestone payments has already been received and Forest made the equity investment when it purchased $25.0 million of the Company’s capital stock. Of the remaining milestones, each of which the Company considers substantive, pre-commercial milestone payments could total up to $20.0 million upon new drug application (“NDA”) acceptance by the Food and Drug Administration (“FDA”) and up to $85.0 million upon NDA approval. The Company can also achieve up to approximately $100.0 million in a sales related milestone if certain conditions are met.

 

The collaboration agreement included a contingent equity investment, in the form of a forward purchase contract, which required Forest to purchase 2,083,333 shares of the Company’s convertible preferred stock, when a specific clinical milestone was met, at a price of $12.00 per share. The Company evaluated this financial instrument and determined that because the Company may be required to settle the instrument by transferring assets to Forest due to “deemed liquidation” provisions of the preferred stock, it should be considered an asset or liability, which is required to be carried at fair value. The Company valued the contingent equity investment at September 12, 2007 at $9.0 million, which represented the value of the premium that Forest would pay for shares of the Company’s stock should the milestone be achieved. The $9.0 million was recorded as an asset and incremental deferred revenue at the inception of the arrangement. The $9.0 million of incremental deferred revenue is being recognized as revenue on a straight-line basis over the period of the Company’s continuing involvement, which was estimated to be five years from the inception of the arrangement. At March 31, 2011, approximately $2.6 million of the incremental deferred revenue remains deferred and is being recognized on a straight-line basis over the remaining estimated development period. In July 2009, the Company achieved the clinical milestone triggering the equity investment. At that time, the Company reclassified the forward purchase contract as a reduction to convertible preferred stock. The Company issued the 2,083,333 shares to Forest on September 1, 2009.

 

Additionally, the Company has achieved two of the development milestones under this agreement, both of which the Company determined to be substantive. In September 2008, the Company achieved a clinical milestone which triggered a $10.0 million milestone payment and in July 2009, the Company achieved a second clinical milestone which triggered a $20.0 million milestone payment. At March 31, 2011, approximately $2.9 million and $5.8 million of the milestone payments, respectively, remains deferred and is being recognized on a straight-line basis over the remaining estimated development period.

 

The Company recognized revenue from the Forest collaboration agreement totaling approximately $5.4 million during both the three months ended March 31, 2011 and 2010.

 

Further, because the Company shares development costs equally with Forest, payments from Forest with respect to research and development costs incurred by the Company are recorded as a reduction to expense, and not as revenue. As a result of the cost-sharing arrangements under the collaboration, the Company offset approximately $4.4 million and $4.1 million during the three months ended March 31, 2011 and 2010, respectively, against research and development expense.

 

Almirall, S.A.

 

In April 2009, the Company entered into a license agreement with Almirall for European rights to develop and commercialize linaclotide for the treatment of IBS-C, CC and other gastrointestinal conditions. Under the terms of the license agreement, Almirall is responsible for the expenses associated with the development and commercialization of linaclotide in the European territory. The license agreement requires the Company to participate on a joint development committee over linaclotide’s development period. The Company will receive escalating royalties from the sales of linaclotide in the European territory. In May 2009, the Company received a $38.0 million payment from Almirall representing a $40.0 million non-refundable up-front payment net of foreign withholding taxes. The Company elected to record the non-refundable up-front payment on a net basis. Because the license to develop and commercialize linaclotide did not have standalone value without the research and development activities provided by the Company, the Company is recognizing the up-front license fee as revenue on a straight-line basis over fifty months, which is the Company’s estimate of the period over which linaclotide will be developed under the license agreement for the European territory. At March 31, 2011, approximately $20.5 million of the up-front license fee remains deferred. The license agreement also includes contingent milestone payments, as well as a contingent equity investment, that could total up to $55.0 million upon achievement of specific clinical and sales milestones. To date, $19.0 million, net of foreign withholding taxes, in milestone payments has already been received and Almirall made the equity investment when it purchased $15.0 million of the Company’s capital stock. Remaining pre-

 

15



Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

commercial milestone payments, each of which the Company considers substantive, consist of $4.0 million upon the first commercial launch in each of the five major E.U. countries set forth in the agreement.

 

The license agreement included a contingent equity investment, in the form of a forward purchase contract, which required Almirall to purchase 681,819 shares of the Company’s convertible preferred stock, when a specific clinical milestone was met, at a price of $22.00 per share. The Company evaluated this financial instrument and determined that because the Company may be required to settle the instrument by transferring assets to Almirall, it should be considered an asset or liability. The contingent equity investment was valued at inception at its fair value. The Company valued the contingent equity investment at April 30, 2009 at $6.0 million, which represented the value of the premium that Almirall would pay for shares of the Company’s stock should the milestone be achieved. The $6.0 million was recorded as an asset and incremental deferred revenue at the inception of the arrangement. The $6.0 million of incremental deferred revenue is being recognized as revenue on a straight-line basis over the period of the Company’s continuing involvement, which is estimated to be fifty months. At March 31, 2011, approximately $3.2 million of the incremental deferred revenue remains deferred. In November 2009, the Company achieved the clinical milestone triggering the equity investment. At that time, the Company reclassified the forward purchase contract as a reduction to convertible preferred stock. On November 13, 2009, the Company received $15.0 million from Almirall for the purchase of 681,819 shares of convertible preferred stock.

 

In November 2010, the Company achieved a second development milestone under the Almirall license agreement, that the Company determined to be substantive, which resulted in a $19.0 million payment, representing a $20.0 million milestone, net of foreign withholding taxes. The Company recognized revenue of approximately $7.2 million upon achievement of the milestone. This amount represented the portion of the milestone payment equal to the applicable percentage of the performance period that had elapsed as of the date the milestone was achieved. The remainder of the balance was deferred, and is being recognized on a straight-line basis over the remaining development period. At March 31, 2011, approximately $10.3 million of the milestone payment remains deferred.

 

The Company recognized approximately $3.8 million and $2.9 million in total revenue from the Almirall license agreement during the three months ended March 31, 2011 and 2010, respectively, including approximately $18,000 and $0.3 million, respectively, from the sale of API to Almirall.

 

Astellas Pharma Inc.

 

On November 9, 2009, the Company entered into a license agreement with Astellas. Astellas has the right to develop and commercialize linaclotide for the treatment of IBS-C, CC and other gastrointestinal conditions in Japan, South Korea, Taiwan, Thailand, Philippines, and Indonesia. Under the terms of the agreement, Astellas paid the Company an up-front licensing fee of $30.0 million on November 16, 2009. The license agreement requires the Company to participate on a joint development committee over linaclotide’s development period. The agreement includes additional development milestone payments, each of which the Company considers substantive, that could total up to $45.0 million. These milestone payments consist of $15.0 million upon initiation of a Phase 3 study for linaclotide in Japan, $15.0 million upon filing of the Japanese equivalent of an NDA with the relevant regulatory authority in Japan, and $15.0 million upon approval of such equivalent by the relevant regulatory authority. In addition, the Company will receive escalating royalties on linaclotide sales should Astellas receive approval to market and sell linaclotide in the Asian market. Astellas will be responsible for activities relating to regulatory approval and commercialization. Because the license to develop and commercialize linaclotide did not have standalone value without the research and development activities provided by the Company, the Company is recognizing the up-front license fee as revenue on a straight-line basis over 115 months, which is the Company’s estimate of the period over which linaclotide will be developed under the license agreement for the Asian market. At March 31, 2011, approximately $26.6 million of the up-front license fee remains deferred. During the three months ended March 31, 2011 and 2010, the Company recognized approximately $1.0 million and $0.5 million, respectively, in revenue from the Astellas license agreement, including approximately $0.2 million from the sale of clinical materials to Astellas in each period.

 

Protagonist Therapeutics, Inc.

 

The Company entered into a collaboration agreement with Protagonist Therapeutics, Inc. and Protagonist Pty Ltd. (collectively “Protagonist”) in January 2011. Under this agreement, Protagonist will use its proprietary technology platform to discover peptides against certain targets and the Company has the rights to develop and commercialize these peptides. In connection with entering into the agreement, the Company made an up-front payment to Protagonist of approximately $2.8 million. In accordance with the applicable accounting guidance, the Company expensed the up-front payment as research and development expense. The

 

16



Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

Company also funds full-time equivalents for Protagonist’s drug discovery activities, and will make certain milestone and royalty payments pending the achievement of certain development and commercialization milestones. The Company will expense these payments as incurred. During the three months ended March 31, 2011, the Company recorded approximately $3.2 million in research and development expense, including the up-front payment, associated with the Protagonist agreement.

 

6. Fair Value of Financial Instruments

 

The tables below present information about the Company’s assets that are measured at fair value on a recurring basis as of March 31, 2011 and December 31, 2010 and indicates the fair value hierarchy of the valuation techniques the Company utilized to determine such fair value. In general, fair values determined by Level 1 inputs utilize observable inputs such as quoted prices in active markets for identical assets or liabilities. Fair values determined by Level 2 inputs utilize data points that are either directly or indirectly observable, such as quoted prices, interest rates and yield curves. Fair values determined by Level 3 inputs utilize unobservable data points in which there is little or no market data, which require the Company to develop its own assumptions for the asset or liability.

 

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

 

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

 

 

 

 

 

Fair Value Measurements at Reporting Date Using

 

Description

 

March 31,
2011

 

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

 

Significant Other
Observable
Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Money market funds (included in cash and cash equivalents)

 

$

42,127

 

$

42,127

 

$

 

$

 

U.S. government-sponsored securities

 

46,739

 

 

46,739

 

 

U.S. Treasury securities

 

127,616

 

127,616

 

 

 

Total

 

$

216,482

 

$

169,743

 

$

46,739

 

$

 

 

 

 

 

 

Fair Value Measurements at Reporting Date Using

 

Description

 

December 31,
2010

 

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

 

Significant Other
Observable
Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Money market funds (included in cash and cash equivalents)

 

$

36,228

 

$

36,228

 

$

 

$

 

U.S. government-sponsored securities (included in cash and cash equivalents)

 

2,998

 

 

2,998

 

 

U.S. Treasury securities

 

116,219

 

116,219

 

 

 

U.S. government-sponsored securities

 

87,487

 

 

87,487

 

 

Total

 

$

242,932

 

$

152,447

 

$

90,485

 

$

 

 

Cash equivalents, accounts receivable, prepaid expenses and other current assets, accounts payable, accrued expenses and the current portion of capital lease obligations at March 31, 2011 and December 31, 2010 are carried at amounts that approximate fair value due to their short-term maturities.

 

17



Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

Capital lease obligations at March 31, 2011 and December 31, 2010 approximate fair value as they bear interest at a rate approximating a market interest rate.

 

7. Available-for-Sale Investments

 

The following tables summarize the available-for-sale securities held at March 31, 2011 and December 31, 2010 (in thousands):

 

 

 

Amortized Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair Value

 

March 31, 2011:

 

 

 

 

 

 

 

 

 

U.S. government-sponsored securities

 

$

46,729

 

$

14

 

$

(4

)

$

46,739

 

U.S. Treasury securities

 

127,575

 

42

 

(1

)

127,616

 

Total

 

$

174,304

 

$

56

 

$

(5

)

$

174,355

 

 

 

 

Amortized Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair Value

 

December 31, 2010:

 

 

 

 

 

 

 

 

 

U.S. government-sponsored securities

 

$

87,503

 

$

3

 

$

(19

)

$

87,487

 

U.S. Treasury securities

 

116,200

 

24

 

(5

)

116,219

 

Total

 

$

203,703

 

$

27

 

$

(24

)

$

203,706

 

 

The contractual maturities of all securities held at March 31, 2011 are one year or less. There were eight investments in an unrealized loss position at March 31, 2011, none of which had been in an unrealized loss position for more than twelve months. The aggregate fair value of these securities was approximately $11.4 million. The Company reviews its investments for other-than-temporary impairment whenever the fair value of an investment is less than amortized cost and evidence indicates that an investment’s carrying amount is not recoverable within a reasonable period of time. To determine whether an impairment is other-than-temporary, the Company considers whether it has the ability and intent to hold the investment until a market price recovery and considers whether evidence indicating the cost of the investment is recoverable outweighs evidence to the contrary. The Company did not hold any securities with an other-than-temporary impairment at March 31, 2011.

 

Gross realized gains and losses on the sales of investments have not been material to the Company’s consolidated results of operations.

 

8. Commitments and Contingencies

 

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

 

In January 2007, the Company entered into a lease agreement for 113,646 rentable square feet of office and lab space at 301 Binney Street, Cambridge, Massachusetts. The initial term of the lease is eight years expiring in January 2016, and the Company has the right to extend the initial term for two additional terms of five years each. The Company’s occupancy of the space occurred in four distinct phases, and rent for each phase commenced at the earlier of a contractually set date or the occupancy date. Base rent for the space ranges from $49.25 to $60.50 per rentable square foot per year. Base rent escalates in January 2012 based upon a formula that is tied to the Consumer Price Index. The space was delivered to the Company in September 2007, and rent payments for the first phase of occupancy commenced in January 2008. The rent expense, inclusive of the escalating rent payments and free rent period is recognized on a straight-line basis over the term of the lease agreement. In accordance with the terms of the lease agreement, in the second quarter of 2010 the Company increased the letter of credit securing its obligations under the lease agreement by approximately $2.3 million.

 

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Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

The Company entered into two amendments to the lease agreement in February 2010 and July 2010, respectively (together “the Amendments”). Pursuant to the Amendments, the Company leases an additional 57,033 rentable square feet of the 301 Binney Street building, comprised of (a) an initial phase of 35,444 rentable square feet (the “Initial Phase”), and (b) a second phase of 21,589 rentable square feet (the “Second Phase”). Rent for the Initial Phase commenced on July 1, 2010 and rent for the Second Phase commenced on March 1, 2011. Initial base rent for the Initial Phase is $42.00 per rentable square foot per year and the initial base rent for the Second Phase will be $42.50 per rentable square foot per year. Base rent for both the Initial Phase and the Second Phase will increase annually by $0.50 per rentable square foot. The Amendments do not change the expiration date of the lease agreement.

 

In February 2011, the Company entered into an additional amendment to the lease agreement. Pursuant to this amendment, the Company leased an additional 23,307 rentable square feet of the 301 Binney Street building. Rent for this space will commence no later than February 15, 2012. Initial base rent for this space will be $42.50 per rentable square foot per year. Base rent for this space will increase annually by $0.50 per rentable square foot. Under the terms of this amendment, the landlord will provide the Company with an allowance of $40.00 per rentable square foot for tenant improvements in this space. This amendment does not change the expiration date of the lease agreement.

 

The landlord has reimbursed the Company for its tenant improvements for the initial four phases occupied under the lease agreement at a set rate per rentable square foot. Under the terms of the Amendments, the landlord has or will provide the Company with an allowance of $55.00 per rentable square foot for tenant improvements in the Initial Phase and the Second Phase. As of March 31, 2011, approximately $14.4 million has been paid to the Company as reimbursement for tenant improvements under the lease agreement, including its amendments. The reimbursement amount is recorded as deferred rent on the condensed consolidated balance sheets and is being amortized as a reduction to rent expense over the term of the lease agreement.

 

In June 2010, the Company entered into a commercial supply agreement with a contract manufacturing organization for the purchase of a portion of the linaclotide API that will be used to obtain regulatory approval of linaclotide, and, pending any such approval, that will be incorporated into the finished product for commercialization in certain countries. The commercial supply agreement contains minimum purchase requirements that commence with the commercial launch of linaclotide and that are dependent upon forecasted commercial requirements. Since, at this time, linaclotide has not yet been approved for commercialization and future commercial demand for linaclotide is unknown, the Company cannot estimate its future minimum purchase requirements under the commercial supply agreement.

 

In March 2011, the Company, along with its collaboration partner Forest, entered into a commercial supply agreement with a second contract manufacturing organization for the purchase of a portion of the linaclotide API that will be used to support regulatory approval of linaclotide in the U.S. and/or Canada, and, pending any such approval, that will be incorporated into the finished product for commercialization in such countries. The commercial supply agreement contains a minimum purchase requirement for the Company and Forest that commences in 2012. Since, at this time, linaclotide has not yet been approved for commercialization and future commercial demand for linaclotide is unknown, the Company cannot estimate its actual future purchase requirements under the commercial supply agreement.

 

In September 2010, the Company repaid all outstanding principal and interest under its loan and security agreement with a financing company which was used to finance the purchase of laboratory and other equipment.

 

9. Restricted Stock

 

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

 

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Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

A summary of the unvested shares of restricted stock as of March 31, 2011 is presented below:

 

 

 

Shares

 

Weighted Average
Grant Date
Fair Value

 

Unvested at December 31, 2010

 

270,000

 

$

5.69

 

Granted

 

 

$

 

Vested

 

(22,500

)

$

5.69

 

Forfeited

 

 

$

 

Unvested at March 31, 2011

 

247,500

 

$

5.69

 

 

10. Stock Option Plans

 

The Company has several share-based compensation plans (1998 Amended and Restated Stock Option Plan (“1998 Plan”), Amended and Restated 2002 Stock Incentive Plan (“2002 Plan”), 2005 Plan and the Amended and Restated 2010 Employee, Director and Consultant Equity Incentive Plan, together “the Plans”) under which stock options, restricted stock, restricted stock units, and other share-based awards are available for grant to employees, directors, and consultants of the Company. At March 31, 2011 and December 31, 2010, options for 3,589,287 and 5,574,857 shares, respectively, were available for future grant under the Plans.

 

The 2010 Employee Stock Purchase Plan (“Purchase Plan”) allows eligible employees the right to purchase shares of common stock at the lower of 85% of the fair market value of a share of common stock on the first or last day of an offering period. Each offering period is six months, beginning either on January 1 or July 1. At March 31, 2011, there were 369,562 shares available for future grant under the Purchase Plan. During the three months ending March 31, 2011, approximately $0.1 million of share-based compensation expense was recognized in relation to the Purchase Plan. No share-based compensation expense was recognized in related to the Purchase Plan in the three months ended March 31, 2010.

 

Each plan, other than the Purchase Plan, provides for the granting of stock awards whereby the Company’s Class B common stock is issuable upon exercise of options granted before the closing of the Company’s initial public offering and Class A common stock is issuable upon exercise of options granted after the Company’s initial public offering. At March 31, 2011, options exercisable into 11,305,544 shares of Class B common stock and 4,733,244 shares of Class A common stock were outstanding.

 

Under the Plans, the option price at the date of grant is determined by the board of directors and, in the case of incentive stock options, may not be less than the fair market value of the common stock at the date of grant. Due to the absence of an active market for the Company’s common stock prior to the Company’s initial public offering on February 2, 2010, the board of directors was required to determine the fair value of the common stock for consideration in setting exercise prices for the options granted and in valuing the options granted.

 

The Company, from time to time, issues certain time-accelerated stock options to certain employees under the Plans. The vesting of these time-accelerated stock options accelerates upon the achievement of certain performance-based milestones. If these criteria are not met, such options will vest between six and ten years after the date of grant, and expire at the end of ten years. No shares vested as a result of milestone achievements during the three months ended March 31, 2011. During the three months ended March 31, 2010, 45,000 shares vested as a result of milestone or service period achievements. At March 31, 2011 and December 31, 2010, there were 2,279,000 shares issuable under outstanding and unvested time-accelerated options. When achievement of the milestone is not deemed probable, the Company recognizes compensation expense associated with time-accelerated stock options over the vesting period of the respective stock option. When deemed probable of achievement, the Company expenses the remaining unrecognized compensation for the respective stock option over the implicit service period. At March 31, 2011, the Company has approximately $0.5 million in unrecognized share-based compensation, net of estimated forfeitures, related to these options.

 

The Company also issues to employees options to purchase shares of common stock subject to performance-based milestone vesting. During the three months ended March 31, 2011 and 2010, the Company granted 90,000 and 45,000 options to purchase shares of common stock subject to performance-based milestone vesting, respectively. The vesting of these stock options will occur upon the achievement of certain performance-based milestones. No stock options vested as a result of milestone achievements during the three months ended March 31, 2011. At March 31, 2011, there were 1,202,500 shares issuable under outstanding and unvested performance-based milestone options. During the three months ended March 31, 2010, 5,000 stock options were vested as a result of

 

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Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

milestone achievements and the Company recorded related share-based compensation expense of approximately $31,000 for these options. As of March 31, 2011, the Company has concluded that one additional performance-based milestone is probable of achievement, and as a result, approximately $15,000 of share-based compensation expense was recorded related to options subject to this performance-based milestone during the three months ended March 31, 2011. At March 31, 2011, the unrecognized share-based compensation expense related to performance-based options was approximately $4.4 million.

 

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

 

Determining the fair value of share-based awards using the Black-Scholes option-pricing model requires the use of highly subjective assumptions, including the expected term of the award and expected stock price volatility. The weighted average assumptions used to estimate the fair value of the stock options using the Black-Scholes option-pricing model were as follows for the three months ended March 31, 2011 and 2010:

 

 

 

Three Months Ended
March 31,

 

 

 

2011

 

2010

 

Expected volatility

 

49.9

%

57.7

%

Expected term (in years)

 

6.5

 

6.5

 

Risk-free interest rate

 

2.8

%

3.1

%

Expected dividend yield

 

%

%

 

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

 

 

 

Three Months Ended
March 31,

 

 

 

2011

 

2010

 

Ironwood:

 

 

 

 

 

Employee stock options

 

$

2,484

 

$

1,458

 

Restricted stock awards

 

118

 

108

 

Non-employee stock options

 

37

 

12

 

ESPP

 

51

 

 

Stock awards

 

8

 

10

 

 

 

2,698

 

1,588

 

Microbia Stock Plan (included in discontinued operations)

 

 

20

 

 

 

$

2,698

 

$

1,608

 

 

Share-based compensation is reflected in the condensed consolidated statements of operations as follows for the three months ended March 31, 2011 and 2010 (in thousands):

 

 

 

Three Months Ended
March 31,

 

 

 

2011

 

2010

 

Research and development

 

$

1,338

 

$

722

 

General and administrative

 

1,360

 

866

 

Net loss from discontinued operations

 

 

20

 

 

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Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

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

 

 

 

Shares of
Common
Stock
Attributable
to Options

 

Weighted
Average
Exercise
Price

 

Weighted
Average
Contractual
Life

 

Aggregate
Intrinsic
Value

 

 

 

 

 

 

 

(in years)

 

(in thousands)

 

Outstanding at December 31, 2010

 

14,603,229

 

$

4.25

 

6.44

 

$

91,575

 

Granted

 

2,051,550

 

$

11.12

 

 

 

 

 

Exercised

 

(556,673

)

$

1.21

 

 

 

 

 

Cancelled

 

(59,318

)

$

8.85

 

 

 

 

 

Outstanding at March 31, 2011

 

16,038,788

 

$

5.22

 

6.75

 

$

140,541

 

Vested or expected to vest at March 31, 2011

 

14,523,067

 

$

5.12

 

6.65

 

$

128,667

 

Exercisable at March 31, 2011(1)

 

6,634,196

 

$

2.56

 

5.03

 

$

75,770

 

 


(1)                                  All stock options granted under the 1998 Plan, 2002 Plan and 2005 Plan contain provisions allowing for the early exercise of such options into restricted stock. The exercisable shares disclosed above represent those that are vested as of March 31, 2011.

 

The weighted average grant date fair value per share of options granted to employees during the three months ended March 31, 2011 and 2010 was $5.80 and $6.57, respectively. The grant date fair value of the options granted to employees during the three months ended March 31, 2011 and 2010 was approximately $11.9 million and $10.1 million, respectively. The total intrinsic value of options exercised during the three months ended March 31, 2011 and 2010 was approximately $6.2 million and $6.5 million, respectively.

 

As of March 31, 2011, there was approximately $1.2 million and $24.6 million of unrecognized share-based compensation, net of estimated forfeitures, related to restricted stock awards and unvested stock option grants with time-based vesting, respectively, which are expected to be recognized over a weighted average period of 3.32 years. The total unrecognized share-based compensation cost will be adjusted for future changes in estimated forfeitures.

 

11. Related Party Transactions

 

The Company has and currently obtains legal services from a law firm that is an investor of the Company. The Company paid approximately $39,000 and $59,000 in legal fees to this investor during the three months ended March 31, 2011 and 2010, respectively.

 

In September 2009, Forest became a related party when the Company sold to Forest 2,083,333 shares of the Company’s convertible preferred stock and in November 2009, Almirall became a related party when the Company sold to Almirall 681,819 shares of the Company’s convertible preferred stock (Note 5).

 

In September 2006, T&L became a related party when the Company sold to T&L 1,823,529 shares of common stock of Microbia at the aggregate purchase price of approximately $2,000, and sold 7,000,000 shares of convertible preferred stock of Microbia at the aggregate purchase price of $7.0 million. In June 2010, T&L and Microbia entered into an agreement to terminate their collaboration. All current and future obligations between Microbia and T&L were terminated as a result of this agreement. As a result of the sale of the Company’s interest in Microbia to DSM, T&L is no longer a related party.

 

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Table of Contents

 

Ironwood Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

 

12. Segment Reporting

 

Prior to the sale of its interest in Microbia in September 2010, the Company had two reportable business segments: human therapeutics and biomanufacturing. The Company has no inter-segment revenues.

 

The following table reports revenue and loss from operations for the Company’s reportable segments for the three months ended March 31, 2011 and 2010 (in thousands):

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

Revenue:

 

 

 

 

 

Human therapeutics

 

$

10,237

 

$

8,838

 

Biomanufacturing (included in discontinued operations)

 

 

214

 

Total

 

$

10,237

 

$

9,052

 

Loss from operations:

 

 

 

 

 

Human therapeutics

 

$

(18,542

)

$

(14,496

)

Biomanufacturing (included in discontinued operations)

 

 

(1,732

)

Total

 

$

(18,542

)

$

(16,228

)

 

 

 

March 31,
2011

 

December 31,
2010

 

Total assets:

 

 

 

 

 

Human therapeutics

 

$

272,024

 

$

301,365

 

Biomanufacturing (included in discontinued operations)

 

 

 

Total

 

$

272,024

 

$

301,365

 

 

At March 31, 2011 and December 31, 2010, all of the Company’s accounts receivable related to the human therapeutics segment.

 

13. State Grant

 

In December 2010, the Company was notified that it was awarded an approximately $1.0 million tax incentive from the Massachusetts Life Sciences Center as part of the Life Sciences Tax Incentive Program. The program was established in 2008 in order to incentivize life sciences companies to create new sustained jobs in Massachusetts. Jobs must be maintained for at least five years, during which time the credit can be recovered by the Massachusetts Department of Revenue if the Company does not meet and maintain its job creation commitments. At March 31, 2011, the Company has not recorded the credit in its condensed consolidated financial statements and plans to record the award in the second quarter of 2011.

 

14. Subsequent Events

 

In April 2011, the Company entered into a commercial supply agreement for the purchase of a portion of the linaclotide API that will be used to support international regulatory filings for approval, and pending such approval, that will be incorporated into the finished product for commercialization in certain foreign countries. The commercial supply agreement contains certain minimum purchase requirements, and aggregate purchases over the five-year term of the agreement could total up to approximately $75.0 million, depending upon demand for linaclotide.

 

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Table of Contents

 

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

 

Forward-Looking Information

 

The following discussion of our financial condition and results of operations should be read in conjunction with our financial statements and the notes to those financial statements appearing elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto and management’s discussion and analysis of financial condition and results of operations for the year ended December 31, 2010 included in our Annual Report on Form 10-K. This discussion contains forward-looking statements that involve significant risks and uncertainties. As a result of many factors, such as those set forth under “Risk Factors” in Part II, Item 1A of this Quarterly Report on Form 10-Q, which are incorporated herein by reference, our actual results may differ materially from those anticipated in these forward-looking statements.

 

Overview

 

We are an entrepreneurial pharmaceutical company that discovers, develops and intends to commercialize differentiated medicines that improve patients’ lives. To achieve this, we are building a team, a culture and processes centered on creating and marketing important new drugs. We believe that linaclotide, our guanylate cyclase type-C, or GC-C, agonist being developed for the treatment of patients with irritable bowel syndrome with constipation, or IBS-C, or chronic constipation, or CC, could present patients and healthcare practitioners with a unique therapy for a major medical need not yet met by existing therapies. Linaclotide is our only product candidate that has demonstrated clinical proof of concept. In addition to linaclotide, we have a pipeline of early stage, pre-proof of concept development candidates in multiple therapeutic areas, including gastrointestinal disease, pain and inflammation, and respiratory disease. We are also conducting early stage, preclinical research in these therapeutic areas, as well as in the area of cardiovascular disease. We have pursued a partnering strategy for commercializing linaclotide that has enabled us to retain significant control over linaclotide’s development and commercialization, share the costs with high-quality collaborators whose capabilities complement ours, and retain approximately half of linaclotide’s future long-term value in the major pharmaceutical markets, should linaclotide meet our sales expectations.

 

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

 

Prior to September 2010, we held a majority ownership interest in Microbia, Inc. (formerly known as Microbia Precision Engineering), a subsidiary formed in September 2006. Microbia, Inc., or Microbia, engaged in a specialty biochemicals business based on a proprietary strain-development platform. On September 21, 2010, we sold our interest in Microbia to DSM Holding Company USA, Inc., or DSM, in exchange for cash proceeds of $9.5 million, the payment of approximately $1.1 million of Microbia debt and interest by DSM and future contingent consideration based on the sale of products incorporating Microbia’s technology.

 

We currently operate in one reportable business segment—human therapeutics. Our human therapeutics segment consists of the development and commercialization of our product candidates, including linaclotide. Prior to the sale of our interest in Microbia, we also operated in the biomanufacturing segment. Our biomanufacturing segment, which comprised a much smaller part of our business, consisted of our majority ownership interest in Microbia. For the three months ended March 31, 2010, results of operations of our biomanufacturing segment are included in net loss from discontinued operations in our financial statements.

 

To date, we have dedicated substantially all of our activities to the research and development of our product candidates. We have not generated any revenue to date from product sales and have incurred significant operating losses since our inception in 1998. We incurred net losses attributable to Ironwood Pharmaceuticals, Inc. of approximately $18.4 million and $15.9 million in the three months ended March 31, 2011 and 2010, respectively. As of March 31, 2011, we had an accumulated deficit of approximately $385.9 million and we expect to incur losses for the foreseeable future.

 

Financial Overview

 

Revenue.  Revenue to date from our human therapeutics segment is generated primarily through our collaboration agreement with Forest Laboratories, Inc., or Forest, and our license agreements with Almirall, S.A., or Almirall, and Astellas Pharma Inc., or Astellas. The terms of these agreements include payment to us of one or more of the following: non-refundable, up-front license fees, milestone payments; payments for providing active pharmaceutical ingredient, or API; and royalties on product sales. Revenue from our human therapeutics segment is shown in our condensed consolidated statements of operations as collaborative arrangements revenue. As a result of the sale of our interest in Microbia, as discussed above, revenue from our biomanufacturing segment is

 

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Table of Contents

 

included in net loss from discontinued operations. We expect our revenue to fluctuate for the foreseeable future as our collaborative arrangements revenue is principally based on the achievement of pre-commercial and commercial milestones.

 

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

 

Our lead product candidate is linaclotide and it represents the largest portion of our research and development expense for our product candidates. Linaclotide is a first-in-class compound currently in Phase 3 clinical development for the treatment of IBS-C and CC and is our only product candidate that has demonstrated clinical proof of concept. In September and November 2010, we announced that we achieved positive results in each of our two Phase 3 IBS-C trials, and in November 2009, we announced that we achieved positive results in each of our two Phase 3 CC trials. We have a pipeline of early stage, pre-proof of concept development candidates in multiple therapeutic areas, including gastrointestinal disease, pain and inflammation, and respiratory disease. We are also conducting early stage, preclinical research in these therapeutic areas, as well as in the area of cardiovascular disease.

 

The following table sets forth our research and development expenses related to our product pipeline for the three months ended March 31, 2011 and 2010. These expenses relate primarily to external costs associated with manufacturing, preclinical studies and clinical trial costs. Costs related to facilities, depreciation, share-based compensation and research and development support services are not directly charged to programs.

 

 

 

Three Months Ended
March 31,

 

 

 

2011

 

2010

 

 

 

(in thousands)

 

Demonstrated clinical proof of concept

 

$

3,523

 

$

7,993

 

Early stage, pre-proof of concept

 

2,784

 

1,693

 

Early stage, preclinical

 

4,894

 

1,728

 

 

We began tracking program expenses for linaclotide in 2004, and research and development program expenses from inception to March 31, 2011 were approximately $126.9 million. The expenses for linaclotide include both reimbursements to us by Forest as well as our portion of costs incurred by Forest for linaclotide and invoiced to us under the cost-sharing provisions of our collaboration agreement.

 

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

 

We invest carefully in our pipeline, and the commitment of funding for each subsequent stage of our development programs is dependent upon the receipt of clear, supportive data. In addition, we are actively engaged in evaluating externally-discovered drug candidates at all stages of development. In evaluating potential assets, we apply the same criteria as those used for investments in internally-discovered assets.

 

Historically, the majority of our external costs are related to linaclotide, as costs associated with later stage clinical trials are, in most cases, more significant than those incurred in earlier stages. We expect external costs related to the linaclotide program to continue to decrease provided that no other clinical trials are necessary to obtain regulatory approval in the U.S. If our other product candidates are successful in early stage clinical trials, we would expect external costs to increase as the programs progress through later stage clinical trials. Additionally, we expect our external costs to increase as we invest in externally-discovered drug candidates through arrangements such as our collaboration with Protagonist Therapeutics, Inc. and Protagonist Pty Ltd. (collectively Protagonist).

 

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Table of Contents

 

During the three months ended March 31, 2011, we recorded approximately $3.2 million in early stage, preclinical research and development expense, including the up-front payment of $2.8 million, associated with the Protagonist agreement. The remainder of our research and development expense is not tracked by project as it consists primarily of our internal costs, and it benefits multiple projects that are in earlier stages of development and which typically share resources.

 

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

 

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

 

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

 

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

 

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

 

·                  The costs, timing and outcome of regulatory review of a product candidate may not be favorable.

 

·                  The emergence of competing technologies and products and other adverse market developments may negatively impact us.

 

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

 

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

 

General and administrative expense.  General and administrative expense consists primarily of compensation, benefits and other employee related expenses for personnel in our administrative, finance, legal, information technology, business development, commercial and human resource functions. Other costs include the legal costs of pursuing patent protection of our intellectual property, general and administrative related facility costs and professional fees for accounting and legal services. As a result of our initial public offering, or IPO, in February 2010, we have experienced increases in general and administrative expense relating to operating as a public company. These increases included legal fees, accounting fees, costs associated with implementing and complying with the requirements of the Sarbanes-Oxley Act of 2002 and the Dodd-Frank Wall Street Reform and Protection Act of 2010 and fees for investor relations services. We anticipate general and administrative expenses to continue to increase as we develop our infrastructure and organization necessary to commercialize and support linaclotide.

 

Critical Accounting Policies and Estimates

 

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements prepared in accordance with generally accepted accounting principles in the U.S., or GAAP. The preparation of these financial statements requires us to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses during the reported periods. These estimates and assumptions, including those related to revenue recognition, available-for-sale securities, impairments of long-lived assets, income taxes including the valuation allowance for deferred tax assets, research and development expenses, contingencies, and share-based compensation are monitored and analyzed by us for changes in facts and circumstances, and material changes in these estimates could occur in the future. Prior to our IPO, we

 

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also evaluated our estimates and judgments regarding the fair value assigned to our common stock. These critical estimates and assumptions are based on our historical experience, our observance of trends in the industry, and various other factors that are believed to be reasonable under the circumstances and form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from our estimates under different assumptions or conditions.

 

During the three months ended March 31, 2011, we adopted Accounting Standards Update, or ASU, No. 2009-13, Multiple-Deliverable Revenue Arrangements, or ASU 2009-13, and ASU No. 2010-17, Revenue Recognition — Milestone Method, or ASU 2010-17, as discussed in Note 2, Summary of Significant Accounting Policies, to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. Other than the adoption of these two standards, there have been no significant changes to our critical accounting policies. There were no significant changes in our critical accounting estimates, including as a result of the adoption of these standards. See Note 2 to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K filed with the Securities and Exchange Commission, or SEC, on March 30, 2011 for additional information about these critical accounting policies, as well as a description of our other significant accounting policies.

 

As a result of the sale of our interest in Microbia, we have presented the assets, liabilities, operations, and cash flows of Microbia as discontinued operations for all periods presented prior to the sale.

 

Results of Operations

 

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

 

 

 

Three Months Ended
March 31,

 

 

 

2011

 

2010

 

 

 

(in thousands)

 

Collaborative arrangements revenue

 

$

10,237

 

$

8,838

 

Operating expenses:

 

 

 

 

 

Research and development

 

19,555

 

17,549

 

General and administrative

 

9,224

 

5,785

 

Total operating expenses

 

28,779

 

23,334

 

Loss from operations

 

(18,542

)

(14,496

)

Other income (expense):

 

 

 

 

 

Interest expense

 

(16

)

(53

)

Interest and investment income

 

154

 

68

 

Other income

 

3

 

 

Other income (expense), net

 

141

 

15

 

Net loss from continuing operations

 

(18,401

)

(14,481

)

Net loss from discontinued operations

 

 

(1,772

)

Net loss

 

(18,401

)

(16,253

)

Net loss from discontinued operations attributable to noncontrolling interest

 

 

329

 

Net loss attributable to Ironwood Pharmaceuticals, Inc.

 

$

(18,401

)

$

(15,924

)

 

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Three Months Ended March 31, 2011 Compared to Three Months Ended March 31, 2010

 

Revenue

 

 

 

Three Months Ended
March 31,

 

Change

 

 

 

2011

 

2010

 

$

 

%

 

 

 

(dollars in thousands)

 

 

 

Collaborative arrangements revenue

 

$

10,237

 

$

8,838

 

$

1,399

 

15.8

%

 

Collaborative Arrangements Revenue.  The increase in revenue from collaborative arrangements for the three months ended March 31, 2011 compared to the three months ended March 31, 2010 was primarily due to the receipt of the $19.0 million milestone payment, net of foreign withholding taxes, in November 2010 related to the Almirall license agreement. In the three months ended March 31, 2011, we recognized approximately $1.1 million related to this milestone payment compared with none during the three months ended March 31, 2010. Additionally, we recognized approximately $0.5 million more in revenue from the up-front license in the Astellas agreement during the three months ended March 31, 2011 compared to the three months ended March 31, 2010. These increases were partially offset by the recognition of approximately $0.3 million less in revenue in the three months ended March 31, 2011 from shipments of clinical trial materials to Almirall and Astellas than in the corresponding period in 2010.

 

Operating Expenses

 

 

 

Three Months Ended
March 31,

 

Change

 

 

 

2011

 

2010

 

$

 

%

 

 

 

(dollars in thousands)

 

Operating Expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

$

19,555

 

$

17,549

 

$

2,006

 

11.4

%

General and administrative

 

9,224

 

5,785

 

3,439

 

59.4

%

Total operating expenses

 

$

28,779

 

$

23,334

 

$

5,445

 

23.3

%

 

Research and Development Expense.  The increase in research and development expense of approximately $2.0 million for the three months ended March 31, 2011 compared to the three months ended March 31, 2010 was primarily due to an increase of approximately $2.1 million in compensation, benefits, and employee related expenses primarily due to increased headcount, an increase of approximately $0.6 million in share-based compensation expense primarily related to our annual stock option grants, an increase of approximately $3.2 million in external research costs related to the license and research and development fees paid to Protagonist, an increase of approximately $0.8 million in research and development related facilities and other research and development support costs largely due to increased rent and depreciation expense associated with the additional space we leased and amortization of leasehold improvements related to our 301 Binney Street facility, offset by a decrease of approximately $4.6 million in support of the Phase 3 clinical trials for linaclotide, primarily resulting from lower clinical trial and collaboration expenses as our CC and IBS-C trials were completed at the end of 2010.

 

General and Administrative Expense.  The increase in general and administrative expense of approximately $3.4 million for the three months ended March 31, 2011 compared to the three months ended March 31, 2010 was due to an increase of approximately $1.6 million in compensation and benefits related expenses due to increased headcount, an increase of approximately $0.5 million in share-based compensation expense primarily related to our annual stock option grants, an increase of approximately $0.5 million in general and administrative related facilities costs primarily due to increased rent and depreciation expense associated with the additional space we leased and amortization of leasehold improvements related to our 301 Binney Street facility, and an increase in external consulting costs of approximately $0.7 million associated with developing the infrastructure to commercialize and support linaclotide.

 

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Other Income (Expense), Net

 

 

 

Three Months Ended
March 31,

 

Change

 

 

 

2011

 

2010

 

$

 

%

 

 

 

(dollars in thousands)

 

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest expense

 

$

(16

)

$

(53

)

$

37

 

69.8

%

Interest and investment income

 

154

 

68

 

86

 

126.5

%

Other income

 

3

 

 

3

 

100.0

%

Total other income (expense), net

 

$

141

 

$

15

 

$

126

 

840.0

%

 

Interest Expense.  The decrease in interest expense for the three months ended March 31, 2011 compared to the three months ended March 31, 2010 was primarily the result of the repayment of the long-term debt in September 2010, partially offset by increased interest expense resulting from the capital leases we entered into in 2010 and 2011.

 

Interest and Investment Income.  The increase in interest and investment income for the three months ended March 31, 2011 compared to the three months ended March 31, 2010 was due to the receipt of the proceeds of our IPO in February 2010 and higher average interest rates during the three months ended March 31, 2011.

 

Net Loss From Discontinued Operations. The decrease in net loss from discontinued operations for the three months ended March 31, 2011 compared to March 31, 2010 is the result of the sale of Microbia, our former subsidiary, in September 2010.

 

Net Loss From Discontinued Operations Attributable to Noncontrolling Interest. The decrease in net loss from discontinued operations attributable to noncontrolling interest for the three months ended March 31, 2011 compared to March 31, 2010 is the result of the sale of Microbia, our former subsidiary, in September 2010.

 

Liquidity and Capital Resources

 

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

 

 

 

Three Months Ended
March 31,

 

 

 

2011

 

2010

 

 

 

(in thousands)

 

Net cash (used in) provided by:

 

 

 

 

 

Operating activities

 

$

(23,913

)

$

(26,612

)

Investing activities

 

25,207

 

(223,489

)

Financing activities

 

599

 

203,109

 

Net increase (decrease) in cash and cash equivalents

 

$

1,893

 

$

(46,992

)

 

We have incurred losses since our inception on January 5, 1998 and, as of March 31, 2011, we had a cumulative deficit of approximately $385.9 million. We have financed our operations to date primarily through the sale of preferred stock and common stock, including approximately $203.2 million of net proceeds from our IPO, payments received under collaborative arrangements, including reimbursement of certain expenses, debt financings and interest earned on investments. At March 31, 2011, we had approximately $220.6 million of unrestricted cash, cash equivalents and available-for-sale securities. Our cash and cash equivalents include amounts held in money market funds, stated at cost plus accrued interest, which approximates fair market value. Our available-for-sale securities include amounts held in U.S. government-sponsored securities and U.S. Treasury securities. We invest cash in excess of immediate requirements in accordance with our investment policy which limits the amounts we may invest in any one type of investment and requires all investments held by us to be A+ rated so as to primarily achieve liquidity and capital preservation.

 

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Cash Flows From Operating Activities

 

Net cash used in operating activities totaled approximately $23.9 million for the three months ended March 31, 2011. The primary uses of cash were our net loss from continuing operations of approximately $18.4 million and a decrease of approximately $11.1 million in working capital resulting primarily from reductions in deferred revenue as revenue was recognized from our collaboration and our license agreements. These uses of cash were partially offset by non-cash items of approximately $5.6 million.

 

Net cash used in operating activities totaled approximately $26.6 million for the three months ended March 31, 2010. The primary uses of cash were our net loss from continuing operations of approximately $14.5 million, approximately $2.0 million used in operating activities from discontinued operations and a decrease of approximately $13.1 million in working capital resulting primarily from reductions in deferred revenue as revenue was recognized from our collaboration agreement and our license agreements, as well as reductions in accounts payable and accrued expenses and accrued research and development costs. These uses of cash were partially offset by non-cash items of approximately $3.0 million.

 

Cash Flows From Investing Activities

 

Cash provided by investing activities for the three months ended March 31, 2011 totaled approximately $25.2 million and resulted primarily from the sales and maturities of securities of approximately $68.1 million, partially offset by the purchase of approximately $39.4 million of securities and the purchase of approximately $3.5 million of property and equipment.

 

Cash used in investing activities for the three months ended March 31, 2010 totaled approximately $223.5 million and resulted primarily from the purchase of approximately $222.4 million of securities related to the investment of the net proceeds of our IPO and the purchase of approximately $1.1 million of property and equipment.

 

Cash Flows From Financing Activities

 

Cash provided by financing activities for the three months ended March 31, 2011 totaled approximately $0.6 million primarily resulting from approximately $0.7 million of proceeds from the exercise of stock options, partially offset by approximately $0.1 million of payments on our capital leases.

 

Cash provided by financing activities for the three months ended March 31, 2010 totaled approximately $203.1 million and resulted primarily from the net proceeds of our IPO of approximately $203.2 million.

 

Funding Requirements

 

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

 

We have generated revenue from services, up-front license fees and milestones, but have not generated any product revenue since our inception and do not expect to generate any product revenue from our collaborative arrangements or the sale of products unless we receive regulatory approval for commercial sale of linaclotide. We believe that our cash on hand as of the date of this Quarterly Report on Form 10-Q and additional cash milestone payments we may receive from our current and future collaborators give us substantial strategic optionality and will enable us to operate the company in a productive way, through at least 2014. Our forecast of the period of time through which our financial resources will be adequate to support our operations, including the underlying estimates regarding the costs to obtain regulatory approval and the costs to commercialize linaclotide, is a forward-looking statement that involves risks and uncertainties, and actual results could vary materially and negatively as a result of a number of factors, including the factors discussed in the “Risk Factors” section of this Quarterly Report on Form 10-Q. We have based these estimates on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we currently expect.

 

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

 

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

 

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

 

·                  the success of our research and development efforts;

 

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

 

·                  the revenue generated by sales of our product candidates;

 

·                  the emergence of competing or complementary technological developments;

 

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

 

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

 

·                  the acquisition of businesses, products and technologies.

 

Contractual Commitments and Obligations

 

The disclosure of our contractual obligations and commitments is set forth under the heading Management’s Discussion and Analysis of Financial Condition and Results of Operations - Contractual Commitments and Obligations in our Annual Report on Form 10-K for the year ended December 31, 2010.

 

In March 2011, we, along with our collaboration partner Forest, entered into a commercial supply agreement with a second contract manufacturing organization for the purchase of a portion of the linaclotide API that will be used to support regulatory approval of linaclotide in the U.S. and/or Canada, and, pending any such approval, that will be sold commercially in such countries. The commercial supply agreement contains a minimum purchase requirement for us and Forest that commences in 2012. Since, at this time, linaclotide has not yet been approved for commercialization and future commercial demand for linaclotide is unknown, we cannot estimate our actual future purchase requirements under the commercial supply agreement.

 

In April 2011, we entered into a commercial supply agreement for the purchase of a portion of the linaclotide API that will be used to support international regulatory filings for approval, and pending such approval, that will be incorporated into the finished product for commercialization in certain foreign countries. The commercial supply agreement contains certain minimum purchase requirements, and aggregate purchases over the five-year term of the agreement could total up to approximately $75.0 million, depending upon demand for linaclotide.

 

Related Party Transactions

 

We have and currently obtain legal services from a law firm that is an investor of ours. We paid approximately $39,000 and $59,000 in legal fees to this investor during the three months ended March 31, 2011 and 2010, respectively.

 

In September 2006, Tate & Lyle Investments, Ltd., or T&L, became a related party when we sold to them 1,823,529 shares of common stock of Microbia at the aggregate purchase price of approximately $2,000, and sold 7,000,000 shares of convertible preferred stock of Microbia at the aggregate purchase price of $7.0 million. T&L accounted for approximately 93% of our revenue from discontinued operations for the three months ended March 31, 2010. In June 2010, T&L and Microbia entered into an agreement to terminate their collaboration. All current and future obligations between Microbia and T&L were terminated as a result of this agreement. As a result of the sale of our interest in Microbia to DSM, T&L is no longer a related party.

 

In September 2009, Forest became a related party when we sold to them 2,083,333 shares of our convertible preferred stock at a price of $12.00 per share for cash proceeds of $25.0 million. Forest accounted for approximately 53% and 62% of our revenue from continuing operations for the three months ended March 31, 2011 and 2010, respectively.

 

In November 2009, Almirall became a related party when we sold to them 681,819 shares of our convertible preferred stock at a price of $22.00 per share for cash proceeds of $15.0 million. Almirall accounted for approximately 37% and 33% of our revenue from continuing operations for the three months ended March 31, 2011 and 2010, respectively.

 

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Off-Balance Sheet Arrangements

 

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

 

New Accounting Pronouncements

 

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

 

Recently Adopted Accounting Standards

 

In October 2009, the FASB issued ASU 2009-13. ASU 2009-13, amends existing revenue recognition accounting pronouncements that are currently within the scope of FASB Accounting Standards Codification Subtopic 605-25 (previously included within EITF 00-21) Revenue Arrangements with Multiple Deliverables, or EITF 00-21. The consensus to ASU 2009-13 provides accounting principles and application guidance on whether multiple deliverables exist, how the arrangement should be separated, and the consideration allocated. This guidance eliminates the requirement to establish the fair value of undelivered products and services and instead provides for separate revenue recognition based upon management’s estimate of the selling price for an undelivered item when there is no other means to determine the fair value of that undelivered item. EITF 00-21 previously required that the fair value of the undelivered item be the price of the item either sold in a separate transaction between unrelated third parties or the price charged for each item when the item is sold separately by the vendor. Under EITF 00-21, if the fair value of all of the elements in the arrangement was not determinable, then revenue was deferred until all of the items were delivered or fair value was determined. This new approach is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 and allows for retrospective application. On January 1, 2011, we adopted ASU 2009-13 on a prospective basis. The adoption did not have a material impact on our consolidated financial position or results of operations.

 

In April 2010, the FASB issued ASU 2010-17. ASU 2010-17 provides guidance in applying the milestone method of revenue recognition to research or development arrangements. Under this guidance management may recognize revenue contingent upon the achievement of a milestone in its entirety, in the period in which the milestone is achieved, only if the milestone meets all the criteria within the guidance to be considered substantive. This ASU is effective for research and development milestones achieved in fiscal years beginning on or after June 15, 2010. On January 1, 2011, we adopted ASU 2010-17 to change our accounting policy to begin applying the milestone method on a prospective basis. As we elected prospective adoption, there was no material impact on our consolidated financial position or results of operations. However, the adoption of ASU 2010-17 is expected to impact the accounting for any milestone payments we receive in future periods.

 

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Recently Issued Accounting Standards

 

In December 2010, the FASB issued ASU No. 2010-27, Fees Paid to the Federal Government by Pharmaceutical Manufacturers , or ASU 2010-27, which provides guidance on how to recognize and classify the fees mandated by the Patient Protection and Affordable Care Act as amended by the Health Care and Education Reconciliation Act (together, the Acts). The Acts impose an annual fee for each calendar year beginning on or after January 1, 2011 payable by branded prescription drug manufacturers and importers on branded prescription drugs. The liability for the fee should be estimated and recorded in full upon the first qualifying sale with a corresponding deferred cost that is amortized to expense using a straight-line method of allocation over the calendar year that it is payable. ASU 2010-27 is effective for calendar years beginning on or after December 31, 2010, when the fee initially becomes effective. As we do not currently have a commercial product, the effect of this guidance will be limited to future transactions.

 

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

 

Interest Rate Risk

 

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

 

Our primary exposure to market risk is interest income sensitivity, which is affected by changes in the general level of interest rates, particularly because our investments are in short-term marketable securities. Due to the short-term duration of our investment portfolio and the low risk profile of our investments, an immediate 100 basis point change in interest rates would not have a material effect on the fair market value of our portfolio. Accordingly, we would not expect our operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on our investment portfolio.

 

We do not believe our cash, cash equivalents and available-for-sale investments have significant risk of default or illiquidity. While we believe our cash, cash equivalents and available-for-sale securities do not contain excessive risk, we cannot provide assurance that in the future our investments will not be subject to adverse changes in market value. In addition, we maintain significant amounts of cash and cash equivalents at one or more financial institutions that are in excess of federally insured limits. Given the current instability of financial institutions, we cannot be assured that we will not experience losses on these deposits.

 

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

 

Foreign Currency Risk

 

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

 

Effects of Inflation

 

We do not believe that inflation and changing prices have had a material effect on our business over the three months ended March 31, 2011 and 2010.

 

Item 4.  Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

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

 

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including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

 

Changes in Internal Control

 

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

 

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PART II — OTHER INFORMATION

 

Item 1A.  Risk Factors

 

In addition to the other information in this Quarterly Report on Form 10-Q, any of the factors described below could significantly and negatively affect our business, financial condition, results of operations or prospects. The trading price of our Class A common stock may decline due to these risks.

 

Risks Related to Our Business and Industry

 

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

 

Our lead product candidate, linaclotide, recently completed the clinical efficacy portion of its development program. Our other drug candidates are in earlier stages of development. Our business depends entirely on the successful development and commercialization of our product candidates. We currently generate no revenue from sales, and we may never be able to develop marketable drugs. The research, testing, manufacturing, labeling, approval, sale, marketing and distribution of pharmaceutical products is subject to extensive regulation by the FDA and foreign regulatory authorities, and regulations differ from jurisdiction to jurisdiction. We are not permitted to market any of our product candidates in the U.S. until we receive approval of a new drug application, or NDA, from the FDA, or in any foreign jurisdictions until we receive the requisite approvals from such jurisdictions. We have not yet submitted an NDA or foreign equivalent in any jurisdiction. Obtaining regulatory approval is a lengthy, expensive and uncertain process. The FDA and foreign regulatory authorities also have substantial discretion in the drug approval process, including the ability to delay, limit or deny approval of a product candidate for many reasons. Potential risks include those that the regulatory authorities:

 

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

 

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

 

·                  may not approve of manufacturing processes and facilities;

 

·                  may not approve linaclotide for both IBS-C and CC indications;

 

·                  may require significant warnings or restrictions on use to the product label for linaclotide or another product candidate; or

 

·                  may change their approval policies or adopt new regulations.

 

Linaclotide is our GC-C agonist that is currently in Phase 3 clinical development for the treatment of IBS-C and CC. In September and November 2010, we announced that we achieved positive results in each of our two Phase 3 IBS-C trials, and in November 2009, we announced that we achieved positive results in each of our two Phase 3 CC trials. Even though linaclotide met all primary and secondary endpoints in each of the Phase 3 IBS-C and CC trials, it may not be approved for either or both indications or for any other indication for which we seek approval from the FDA.

 

Further, the FDA and any foreign regulatory authority may disagree with our trial design or our interpretation of data from clinical trials, or they may change the requirements for approval even after they have reviewed and commented on the design for our clinical trials. The FDA and any foreign regulatory authority might also approve linaclotide for fewer or more limited indications than we request, or may grant approval contingent on the performance of costly post-approval clinical trials. In addition, the FDA and any foreign regulatory authority may not approve the labeling claims that we believe are necessary or desirable for the successful commercialization of linaclotide. Any failure to obtain regulatory approval of linaclotide would significantly limit our ability to generate revenues, and any failure to obtain such approval for all of the indications and labeling claims we deem desirable could reduce our potential revenue.

 

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

 

Undesirable side effects caused by linaclotide could cause us or regulatory authorities to interrupt, delay or halt clinical trials and could result in the denial of regulatory approval by the FDA or other regulatory authorities and potential products liability claims. Any serious adverse events deemed to be caused by linaclotide could have a material adverse effect upon the linaclotide program and our business as a whole. The most common adverse event to date in the clinical studies evaluating the safety and efficacy of linaclotide has been diarrhea. For the most part, the diarrhea has been considered mild or moderate by the patients. In the four Phase 3 clinical trials, our results indicate that diarrhea was seen in 14% to 20% of linaclotide-treated patients, and was the most common adverse event that led to study discontinuation in 3% to 6% of linaclotide-treated patients. In our clinical development program, there have been no serious adverse events in any patients receiving linaclotide treatment that were deemed by a study investigator or us to be “definitely related” or “probably related” to linaclotide treatment, nor have there been any deaths in any patients receiving linaclotide treatment that were deemed by a study investigator or us to be related to linaclotide treatment.

 

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

 

·                  regulatory authorities may withdraw approvals of linaclotide;

 

·                  regulatory authorities may require additional warnings on the label;

 

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

 

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

 

·                  our reputation may suffer.

 

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

 

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

 

We do not currently possess internal manufacturing capacity. We currently utilize the services of contract manufacturers to manufacture our clinical supplies. With respect to the manufacturing of linaclotide, we (along with our U.S. collaboration partner, Forest) have entered into commercial supply agreements with PolyPeptide Laboratories, Inc. and Polypeptide Laboratories (SWEDEN) AB and with Roche Colorado Corporation, each for the manufacture of the linaclotide API that will be used to obtain regulatory approval of linaclotide, and, pending any such approval, that will be incorporated into the finished product for commercialization in certain countries. In addition, we have established development agreements with multiple other peptide manufacturers and continue to pursue commercial supply agreements with these manufacturers for linaclotide API. We may not be able to enter into agreements with these manufacturers on commercially reasonable terms, or at all. If we enter into a commercial supply agreement with a manufacturer but then change or add manufacturers, the regulatory authorities in each territory must approve these manufacturers’ facilities and processes prior to use, which would require new testing and compliance inspections, and the new manufacturers would have to be educated in or independently develop the processes necessary for the production of linaclotide. While we believe we will have arrangements to produce a sufficient amount of API, if we lose a manufacturer, it would take us a substantial amount of time to identify and develop a relationship with an alternative manufacturer.

 

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

 

Upon production of our API, each of our collaboration partners, Forest, Almirall and Astellas, is responsible for completing the manufacturing process of linaclotide in its respective territory, which consists of finishing and packaging linaclotide into capsules. In addition, we are pursuing arrangements with additional manufacturers to complete the manufacturing process of linaclotide in the parts of the world outside of our partnered territories, and for the purpose of introducing redundancy into our supply chain in case of a

 

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manufacturing shortage or supply interruption. We will be dependent upon the success of our partners, and these other manufacturers, provided that we are successful in developing supply arrangements with the other manufacturers, in producing drug product for commercial sale. No party has experience producing finished drug product for linaclotide at commercial scale, and such efforts may fail. Traditionally, peptide manufacturing is costly and time consuming, resulting in low yields and poor stability. We cannot give any assurances that we will overcome these issues when scaling up manufacturing for linaclotide.

 

The manufacture of pharmaceutical products requires significant expertise and capital investment, including the development of advanced manufacturing techniques and process controls. Manufacturers of pharmaceutical products often encounter difficulties in production, particularly in scaling up production. These problems include difficulties with production costs and yields, quality control, including stability of the product and quality assurance testing, shortages of qualified personnel, as well as compliance with federal, state and foreign regulations, and the challenges associated with complex supply chain management. We, together with our partners Forest and Almirall, are currently evaluating the stability of different batch sizes of linaclotide at various points in time. If we are unable to demonstrate stability in accordance with commercial requirements, or if our manufacturers were to encounter difficulties or otherwise fail to comply with their obligations to us, our ability to obtain FDA or European Medicines Agency, or EMA, approval and market linaclotide would be jeopardized.

 

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

 

Because we work with partners to develop, manufacture and promote linaclotide, we are dependent upon third parties in our efforts to obtain regulatory approval for, and to commercialize, linaclotide.

 

We co-develop and plan to co-promote linaclotide in the U.S. with Forest. Forest plays a significant role in the conduct of the clinical trials for linaclotide and the subsequent collection and analysis of data. Each of Almirall, our European partner, and Astellas, our partner in certain Asian countries, is responsible for obtaining regulatory approval of linaclotide in its respective territory. In addition, each of our partners is responsible for completing the manufacturing process of linaclotide upon production of the API, which consists of finishing and packaging linaclotide into capsules. Employees of our partners are not our employees, and we have limited ability to control the amount or timing of resources that they devote to linaclotide. If any of our partners fails to devote sufficient time and resources to linaclotide, or if its performance is substandard, it will delay the potential approval of regulatory applications for linaclotide as well as the commercialization and manufacturing of linaclotide. A material breach by any of our partners of our collaboration agreement with such partner could also delay regulatory approval and commercialization of linaclotide. In addition, the execution of our clinical development program for linaclotide, and the compilation and analysis of the data produced from the clinical trials, requires coordination among various parties. Further, each of our partners is responsible for reporting adverse event information to us. These functions may not be carried out effectively and efficiently if we fail to communicate and coordinate with our partners, and vice versa. Moreover, although we have non-compete restrictions in place with each of our partners, they may have relationships with other commercial entities, some of which may compete with us. If any of our partners assists our competitors, it could harm our competitive position.

 

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

 

We anticipate submitting an NDA for linaclotide with the FDA in the third quarter of 2011. However, even if U.S. regulatory approval is obtained, the FDA may still impose significant restrictions on a product’s indicated uses or marketing or impose ongoing requirements for potentially costly post-approval studies. Linaclotide and our other product candidates would also be subject to ongoing FDA requirements governing the labeling, packaging, storage, advertising, promotion, recordkeeping and submission of safety and other post-market information. In addition, manufacturers of drug products and their facilities are subject to continual review and periodic inspections by the FDA and other regulatory authorities for compliance with GMP regulations. If we or a

 

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regulatory agency discovers previously unknown problems with a product, such as adverse events of unanticipated severity or frequency, or problems with a facility where the product is manufactured, a regulatory agency may impose restrictions on that product or the manufacturer, including requiring withdrawal of the product from the market or suspension of manufacturing. If we, our product candidates or the manufacturing facilities for our product candidates fail to comply with applicable regulatory requirements, a regulatory agency may:

 

·                  issue warning letters or untitled letters;

 

·                  impose civil or criminal penalties;

 

·                  suspend regulatory approval;

 

·                  suspend any ongoing clinical trials;

 

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

 

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

 

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

 

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

 

We have out-licensed the European rights to develop and commercialize linaclotide to Almirall, and we have out-licensed the same rights in certain Asian countries to Astellas. In the future, we may seek to commercialize linaclotide in foreign countries outside of Europe and those Asian countries with other parties or by ourselves. In order to market any products outside of the U.S., we must establish and comply with numerous and varying regulatory requirements of other jurisdictions regarding safety and efficacy. Approval procedures vary among jurisdictions and can involve product testing and administrative review periods different from, and greater than, those in the U.S. Almirall anticipates submitting a Market Authorization Application, or MAA, with the EMA in the second half of 2011. The time required to obtain approval in other jurisdictions, including the European Union, or E.U., might differ from that required to obtain FDA approval. The regulatory approval process in other jurisdictions may include all of the risks detailed above regarding FDA approval in the U.S. as well as other risks. Regulatory approval in one jurisdiction does not ensure regulatory approval in another, but a failure or delay in obtaining regulatory approval in one jurisdiction may have a negative effect on the regulatory processes in others. Failure to obtain regulatory approvals in other jurisdictions or any delay or setback in obtaining such approvals could have the same adverse effects detailed above regarding FDA approval in the U.S. As described above, such effects include the risks that linaclotide may not be approved for all indications requested, which could limit the uses of linaclotide and have an adverse effect on its commercial potential or require costly post-marketing studies.

 

Linaclotide may not be widely adopted by patients, payors or healthcare providers, which would adversely impact our potential profitability and future business prospects.

 

The commercial success of linaclotide depends upon its level of market adoption by patients, payors and healthcare providers. If linaclotide does not achieve an adequate level of market adoption for any reason, our potential profitability and our future business prospects will be severely adversely impacted. The degree of market acceptance of linaclotide depends on a number of factors, including:

 

·                  our ability to demonstrate to the medical community, particularly general practitioners, internists and gastrointestinal specialists who may purchase or prescribe linaclotide, the clinical efficacy and safety of linaclotide as the prescription product of choice for patients who suffer from IBS-C or CC;

 

·                  the effectiveness of our sales and marketing organizations and our distribution network;

 

·                  the ability of patients or providers to be adequately reimbursed for linaclotide in a timely manner from government and private payors; and

 

·                  the actual and perceived safety profile of linaclotide, particularly if unanticipated adverse events related to linaclotide treatment arise and create safety concerns among potential patients or prescribers.

 

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

 

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

 

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

 

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

 

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

 

With linaclotide, we are developing a product candidate for large markets traditionally served by general practitioners and internists, as well as gastrointestinal specialists. Traditional pharmaceutical companies employ groups of sales representatives to call on these large generalist physician populations. In order to adequately address these physician groups, we must optimize our co-development and co-promotion relationship in the U.S., Canada and Mexico with Forest, our license and commercialization relationship in Europe with Almirall, and our license and commercialization relationship in certain Asian countries with Astellas. Likewise, we must either establish sales and marketing collaborations or co-promotion arrangements or expend significant resources to develop our own sales and marketing presence outside of North America, Europe, and those Asian countries. We currently possess limited resources and may not be successful in establishing additional collaborations or co-promotion arrangements on acceptable terms, if at all. We also face competition in our search for collaborators, co-promoters and sales force personnel.

 

If any of our partners undergoes a change in control or management, this may adversely affect our collaborative relationship.

 

We work jointly and collaboratively with Forest, Almirall and Astellas on many decisions related to the development, manufacturing and commercialization of linaclotide. In doing so, we have established relationships with several key members of our partners’ management teams in functional areas such as development, quality, regulatory and commercial. The success of our collaboration is highly dependent on the resources, efforts and skills of our partners and their key employees. If a partner undergoes a change of control or a change of management, we will need to reestablish many of these relationships and we will need to regain alignment of our development and commercialization strategy for linaclotide. Further, any change of control or management may result in a reprioritization of linaclotide within such partner’s profile, and such a change may adversely affect the timeline and likelihood of achieving regulatory approval and, ultimately, the commercialization of linaclotide, or such partner may fail to maintain the financial resources necessary to continue financing its portion of the development, manufacturing or commercialization costs.

 

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

 

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

 

We expect that private insurers will consider the efficacy, cost effectiveness and safety of linaclotide in determining whether to approve reimbursement for linaclotide and at what level. Obtaining these approvals can be a time consuming and expensive process. Our business would be materially adversely affected if we do not receive approval for reimbursement of linaclotide from private insurers on a timely or satisfactory basis. Our business could also be adversely affected if private insurers, including managed

 

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care organizations, the Medicare program or other reimbursing bodies or payors limit the indications for which linaclotide will be reimbursed to a smaller set than we believe it is effective in treating.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

·                  the federal Physician Payments Sunshine Act, and similar state laws in certain states, that require pharmaceutical and medical device companies to monitor and report payments, gifts and other remuneration made to physicians and other health care professional and health care organizations.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

·                  exposure to unknown liabilities;

 

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

 

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

 

·                  higher than expected acquisition and integration costs;

 

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

 

·                  increased amortization expenses;

 

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

 

·                  inability to motivate key employees of any acquired businesses.

 

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

 

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

 

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

 

·                  obtaining regulatory approval to commence a clinical trial;

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

·                  unforeseen safety issues; and

 

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·                  lack of adequate funding to continue the clinical trial.

 

Additionally, changes in regulatory requirements and guidance may occur, and we may need to amend clinical trial protocols to reflect these changes. Each protocol amendment requires institutional review board review and approval, which may adversely impact the costs, timing or successful completion of the associated clinical trials. If we experience delays in completion or if we terminate any of our clinical trials, the commercial prospects for our product candidate may be harmed, and our ability to generate product revenues will be delayed. In addition, many of the factors that cause, or lead to, a delay in the commencement or completion of clinical trials may also ultimately lead to the denial of regulatory approval.

 

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

 

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

 

We are highly dependent on the development, regulatory, commercial and financial expertise of our management, particularly Peter M. Hecht, Ph.D., our chief executive officer; Mark G. Currie, Ph.D., our senior vice president of research and development and our chief scientific officer; Michael J. Higgins, our senior vice president, chief operating officer and chief financial officer; and Thomas A. McCourt, our senior vice president, marketing and sales and chief commercial officer. If we lose any members of our management team in the future, we may not be able to find suitable replacements, and our business may be harmed as a result. In addition to the competition for personnel, the Boston area in particular is characterized by a high cost of living. As such, we could have difficulty attracting experienced personnel to our company and may be required to expend significant financial resources in our employee recruitment efforts.

 

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

 

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

 

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

 

·                  decreased demand for any approved product;

 

·                  impairment of our business reputation;

 

·                  withdrawal of clinical trial participants;

 

·                  initiation of investigations by regulators;

 

·                  costs of related litigation;

 

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

 

·                  substantial monetary awards to patients or other claimants;

 

·                  loss of revenues; and

 

·                  the inability to commercialize our product candidates.

 

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

 

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

 

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

 

Risks Related to Intellectual Property

 

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

 

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

 

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

 

We also rely upon unpatented trade secrets, unpatented know-how and continuing technological innovation to develop and maintain our competitive position, which we seek to protect, in part, by confidentiality agreements with our employees and our collaborators and consultants. We also have agreements with our employees and selected consultants that obligate them to assign their inventions to us. It is possible that technology relevant to our business will be independently developed by a person that is not a party to such an agreement. Furthermore, if the employees and consultants that are parties to these agreements breach or violate the terms of these agreements, we may not have adequate remedies, and we could lose our trade secrets through such breaches or violations. Further, our trade secrets could otherwise become known or be independently discovered by our competitors.

 

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

 

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

 

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

 

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patents of third parties of which we are currently unaware, that may be infringed by our product candidates. Because patent applications can take many years to issue, there may be currently pending applications which may later result in issued patents that our product candidates may infringe.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Furthermore, because of the substantial amount of discovery required in connection with intellectual property litigation, there is a risk that some of our confidential information could be compromised by disclosure during this type of litigation. In addition, there could be public announcements of the results of hearings, motions or other interim proceeding or developments.

 

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Risks Related to Our Finances and Capital Requirements

 

We have incurred significant operating losses since our inception and anticipate that we will incur continued losses for the foreseeable future.

 

In recent years, we have focused primarily on developing linaclotide, with the goal of supporting regulatory approval for this product candidate. We have financed our operations primarily through the issuance of equity and our collaboration and license arrangements, and we have incurred losses in each year since our inception in 1998. We incurred net losses attributable to Ironwood Pharmaceuticals, Inc. of approximately $18.4 million and $15.9 million in the three months ended March 31, 2011 and 2010, respectively. As of March 31, 2011, we had an accumulated deficit of approximately $385.9 million. Our prior losses, combined with expected future losses, have had and will continue to have an adverse effect on our stockholders’ equity and working capital. We expect our expenses to increase in connection with our efforts to commercialize linaclotide and our research and development of our other product candidates. As a result, we expect to continue to incur significant and increasing operating losses for the foreseeable future. Because of the numerous risks and uncertainties associated with developing pharmaceutical products, we are unable to predict the extent of any future losses or when, or if, we will become profitable.

 

We may need additional funding and may be unable to raise capital when needed, which would force us to delay, reduce or eliminate our product development programs or commercialization efforts.

 

Developing product candidates, conducting clinical trials, establishing manufacturing relationships and marketing drugs are expensive and uncertain. We believe that our cash on hand as of the date of this Quarterly Report on Form 10-Q and additional cash milestone payments we may receive from our current and future collaborators give us substantial strategic optionality and will enable us to operate the company in a productive way through at least 2014. However, circumstances, our strategic imperatives, or opportunities to create or acquire new development programs could require us to, or we may choose to, seek to raise additional funds. The amount and timing of our future funding requirements will depend on many factors, including, but not limited to:

 

·                  the rate of progress and cost of our clinical trials and other product development programs for linaclotide and our other product candidates;

 

·                  the costs associated with launching and commercializing linaclotide, should it be approved by FDA;

 

·                  if linaclotide receives regulatory approval, the level of underlying demand for that product;

 

·                  the costs and timing of in-licensing additional product candidates or acquiring other complementary companies;

 

·                  the timing of any regulatory approvals of our product candidates;

 

·                  the costs of establishing sales, marketing and distribution capabilities; and

 

·                  the status, terms and timing of any collaboration, licensing, co-promotion or other arrangements.

 

Additional funding may not be available on acceptable terms or at all. If adequate funds are not available, we may be required to delay, reduce the scope of or eliminate one or more of our development programs or our commercialization efforts.

 

Our quarterly and annual operating results may fluctuate significantly.

 

We expect our operating results to be subject to frequent fluctuations. Our net loss and other operating results will be affected by numerous factors, including:

 

·                  the achievement and timing of milestone payments under our existing collaboration and license agreements;

 

·                  our execution of any collaboration, licensing or similar arrangements, and the timing of payments we may make or receive under these arrangements;

 

·                  the costs associated with launching and commercializing linaclotide and any of our product candidates, if we receive regulatory approval of such candidate;

 

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·                  if linaclotide receives regulatory approval, the level of underlying demand for that product and wholesalers’ buying patterns;

 

·                  variations in the level of expenses related to our development programs;

 

·                  addition or termination of clinical trials;

 

·                  regulatory developments affecting our product candidates; and

 

·                  any intellectual property infringement lawsuit in which we may become involved.

 

If our operating results fall below the expectations of investors or securities analysts, the price of our Class A common stock could decline substantially. Furthermore, any quarterly or annual fluctuations in our operating results may, in turn, cause the price of our stock to fluctuate substantially.

 

Risks Relating to Securities Markets and Investment in Our Stock

 

The concentration of our capital stock ownership with our pre-IPO stockholders will limit your ability to influence certain corporate matters.

 

Each share of Class A common stock and each share of Class B common stock has one vote per share on all matters except for the following matters (for which each share of our Class B common stock has ten votes per share and each share of our Class A common stock has one vote per share):

 

·                  adoption of a merger or consolidation agreement involving Ironwood;

 

·                  a sale of all or substantially all of Ironwood’s assets;

 

·                  a dissolution or liquidation of Ironwood; and

 

·                  every matter, if and when any individual, entity or “group” (as such term is used in Regulation 13D of the Securities Exchange Act of 1934, as amended, or the Exchange Act) has, or has publicly disclosed (through a press release or a filing with the SEC) an intent to have, beneficial ownership of 30% or more of the number of outstanding shares of Class A common stock and Class B common stock, combined.

 

Because of our dual class common stock structure, the holders of our Class B common stock, who consist of our pre-IPO investors (and their affiliates), founders, directors, executives and certain of our employees, will continue to be able to control the corporate matters listed above if any such matter is submitted to our stockholders for approval even if they come to own less than 50% of the outstanding shares of our common stock. As of May 2, 2011, the holders of our Class A common stock own 50.4 % and the holders of our Class B common stock own 49.6% of the outstanding shares of Class A common stock and Class B common stock, combined. However, because of our dual class common stock structure these holders of our Class A common stock have 9.2% and holders of our Class B common stock have 90.8% of the total votes in each of the matters identified in the list above. This concentrated control with our Class B common stock holders limits the ability of the Class A common stockholders to influence those corporate matters and, as a result, we may take actions that many of our stockholders do not view as beneficial, which could adversely affect the market price of our Class A common stock.

 

Anti-takeover provisions under our charter documents and Delaware law could delay or prevent a change of control which could negatively impact the market price of our Class A common stock.

 

Provisions in our certificate of incorporation and bylaws may have the effect of delaying or preventing a change of control. These provisions include the following:

 

·                  Our certificate of incorporation provides for a dual class common stock structure. As a result of this structure, holders of our Class B common stock have significant influence over certain matters requiring stockholder approval, including significant corporate transactions, such as a merger. This concentrated control could discourage others from initiating a change of control transaction that other stockholders may view as beneficial.

 

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·                  Our board of directors is divided into three classes serving staggered three-year terms, such that not all members of the board are elected at one time. This staggered board structure prevents stockholders from replacing the entire board at a single stockholders’ meeting.

 

·                  Our board of directors has the right to elect directors to fill a vacancy created by the expansion of the board of directors or the resignation, death or removal of a director, which prevents stockholders from being able to fill vacancies on our board of directors.

 

·                  Our board of directors may issue, without stockholder approval, shares of preferred stock. The ability to authorize preferred stock makes it possible for our board of directors to issue preferred stock with voting or other rights or preferences that could impede the success of any attempt to acquire us.

 

·                  Stockholders must provide advance notice to nominate individuals for election to the board of directors or to propose matters that can be acted upon at a stockholders’ meeting. Furthermore, stockholders may only remove a member of our board of directors for cause. These provisions may discourage or deter a potential acquirer from conducting a solicitation of proxies to elect such acquirer’s own slate of directors or otherwise attempting to obtain control of our company.

 

·                  Our stockholders may not act by written consent. As a result, a holder, or holders, controlling a majority of our capital stock are not able to take certain actions outside of a stockholders’ meeting.

 

·                  Special meetings of stockholders may be called only by the chairman of our board of directors, our chief executive officer or a majority of our board of directors. As a result, a holder, or holders, controlling a majority of our capital stock are not able to call a special meeting.

 

·                  A majority of the outstanding shares of Class B common stock are required to amend our certificate of incorporation and a super-majority (80%) of the outstanding shares of Class B common stock are required to amend our by-laws, which make it more difficult to change the provisions described above.

 

In addition, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which may prohibit certain business combinations with stockholders owning 15% or more of our outstanding voting stock. These and other provisions in our certificate of incorporation and our bylaws and in the Delaware General Corporation Law could make it more difficult for stockholders or potential acquirers to obtain control of our board of directors or initiate actions that are opposed by the then-current board of directors.

 

We expect that the price of our Class A common stock will fluctuate substantially.

 

The market price of our Class A common stock may be highly volatile due to many factors, including:

 

·                  FDA or international regulatory actions, including actions on regulatory applications for any of our product candidates;

 

·                  the commercial performance of any of our product candidates that receive marketing approval;

 

·                  announcements of the introduction of new products by us or our competitors;

 

·                  market conditions in the pharmaceutical and biotechnology sectors;

 

·                  announcements concerning product development results, including clinical trial results, or intellectual property rights of others;

 

·                  litigation or public concern about the safety of our potential products;

 

·                  actual and anticipated fluctuations in our quarterly and annual operating results;

 

·                  deviations in our operating results from the estimates of securities analysts;

 

·                  sales of additional shares of our common stock;

 

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·                  additions or departures of key personnel;

 

·                  any third-party coverage and reimbursement policies for linaclotide;

 

·                  developments concerning current or future strategic collaborations; and

 

·                  discussion of us or our stock price in the financial or scientific press or in online investor communities.

 

The realization of any of the risks described in these “Risk Factors” could have a dramatic and material adverse impact on the market price of our Class A common stock. In addition, class action litigation has often been instituted against companies whose securities have experienced periods of volatility. Any such litigation brought against us could result in substantial costs and a diversion of management attention, which could hurt our business, operating results and financial condition.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q, including the sections titled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements. All statements contained in this Quarterly Report on Form 10-Q other than statements of historical fact are forward-looking statements. Forward-looking statements include statements regarding our future financial position, business strategy, budgets, projected costs, plans and objectives of management for future operations. The words “may,” “continue,” “estimate,” “intend,” “plan,” “will,” “believe,” “project,” “expect,” “seek,” “anticipate” and similar expressions may identify forward-looking statements, but the absence of these words does not necessarily mean that a statement is not forward-looking. These forward-looking statements include, among other things, statements about:

 

·                  the progress of, timing of and amount of expenses associated with our research, development and commercialization activities;

 

·                  the success of our clinical studies for our product candidates;

 

·                  our ability to obtain U.S. and foreign regulatory approval for our product candidates and the ability of our product candidates to meet existing or future regulatory standards;

 

·                  our expectations regarding federal, state and foreign regulatory requirements;

 

·                  the therapeutic benefits and effectiveness of our product candidates;

 

·                  the safety profile and related adverse events of our product candidates;

 

·                  our ability to manufacture sufficient amounts of linaclotide for commercialization activities with target characteristics;

 

·                  our plans with respect to collaborations and licenses related to the development, manufacture or sale of our product candidates;

 

·                  our expectations as to future financial performance, expense levels and liquidity sources;

 

·                  our ability to compete with other companies that are or may be developing or selling products that are competitive with our product candidates;

 

·                  anticipated trends and challenges in our potential markets;

 

·                  our ability to attract and motivate key personnel; and

 

·                  other factors discussed elsewhere in this Quarterly Report on Form 10-Q.

 

Any or all of our forward-looking statements in this Quarterly Report on Form 10-Q may turn out to be inaccurate. These forward-looking statements may be affected by inaccurate assumptions or by known or unknown risks and uncertainties, including the risks, uncertainties and assumptions identified under the heading “Risk Factors” in this Quarterly Report on Form 10-Q. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this Quarterly Report on Form 10-Q may not occur as contemplated, and actual results could differ materially from those anticipated or implied by the forward-looking statements.

 

You should not unduly rely on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. Unless required by law, we undertake no obligation to publicly update or revise any forward-looking statements to reflect new information or future events or otherwise. You should, however, review the factors and risks we describe in the reports we will file from time to time with the SEC after the date of this Quarterly Report on Form 10-Q.

 

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Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

 

The following table provides information about our repurchases of our equity securities during the quarter ended March 31, 2011:

 

 

 

Total Number of
Shares
Purchased

 

Average Price
Paid per Share

 

Period:

 

 

$

 

January 1, 2011 – January 31, 2011

 

 

$

 

February 1, 2011 – February 28, 2011

 

7,196

 

$

3.76

 

March 1, 2011 – March 31, 2011

 

 

$

 

Total

 

7,196

 

 

 

 

The foregoing repurchases were made in connection with the departure of one of our employees who had exercised options prior to their vesting, as permitted under our Amended and Restated 2005 Stock Incentive Plan.

 

Use of Proceeds

 

In February 2010, we completed our IPO of our Class A common stock pursuant to a Registration Statement on Form S-1, as amended (File No. 333-163275) that was declared effective on February 2, 2010.

 

There has been no material change in our planned use of proceeds from the IPO from that described in the final prospectus filed with the SEC pursuant to Rule 424(b) on February 4, 2010. As of March 31, 2011, approximately $33.2 million of the net proceeds remained available and were invested in highly liquid, short-term, interest-bearing funds, pending their use to fund our operations. Since our IPO, we estimate that we have used the proceeds in the following way:

 

·                  approximately $32.6 million to fund the development and commercialization of linaclotide;

·                  approximately $25.9 million to fund both research and development of early stage product candidates and preclinical research in multiple therapeutic areas, including gastrointestinal disease, pain and inflammation, respiratory disease, and cardiovascular disease; and

·                  approximately $111.5 million for general corporate purposes.

 

Item 6. Exhibits

 

See the Exhibit Index following the signature page to this Quarterly Report on Form 10-Q.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

Ironwood Pharmaceuticals, Inc.

 

 

Date: May 13, 2011

By:

/s/ PETER M. HECHT

 

 

Peter M. Hecht, Ph.D.

 

 

Chief Executive Officer and Director

 

 

(Principal Executive Officer)

 

 

 

 

 

 

Date: May 13, 2011

By:

/s/ MICHAEL J. HIGGINS

 

 

Michael J. Higgins

 

 

Senior Vice President, Chief Operating Officer and
Chief Financial Officer

 

 

(Principal Financial Officer and Principal Accounting
Officer)

 

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EXHIBIT INDEX

 

Exhibit No:

 

Description

3.1

 

Eleventh Amended and Restated Certificate of Incorporation. Incorporated by reference to Exhibit 3.1 of Ironwood Pharmaceuticals, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2009, filed with the SEC on March 30, 2010.

3.2

 

Fifth Amended and Restated Bylaws. Incorporated by reference to Exhibit 3.2 of Ironwood Pharmaceuticals, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2009, filed with the SEC on March 30, 2010.

10.1#*

 

Amended and Restated 2010 Employee, Director and Consultant Equity Incentive Plan.

10.2+*

 

Commercial Supply Agreement, dated as of March 28, 2011, by and among Roche Colorado Corporation, Ironwood Pharmaceuticals, Inc., and Forest Laboratories, Inc.

31.1*

 

Certification of Chief Executive Officer pursuant to Rules 13a-14 or 15d-14 of the Exchange Act.

31.2*

 

Certification of Chief Financial Officer pursuant to Rules 13a-14 or 15d-14 of the Exchange Act.

32.1‡

 

Certification of Chief Executive Officer pursuant to Rules 13a-14(b) or 15d-14(b) of the Exchange Act and 18 U.S.C. Section 1350.

32.2‡

 

Certification of Chief Financial Officer pursuant to Rules 13a-14(b) or 15d-14(b) of the Exchange Act and 18 U.S.C. Section 1350.

 


#                                         Management contract or compensatory plan, contract, or agreement.

 

+                                         Confidential treatment requested under 17 C.F.R. §§200.80(b)(4) and 24b-2. The confidential portions of this exhibit have been omitted and are marked accordingly. The confidential portions have been filed separately with the SEC pursuant to the confidential treatment request.

 

*                                         Filed herewith.

 

                                          Furnished herewith.

 

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Exhibit 10.1

 

IRONWOOD PHARMACEUTICALS, INC.

 

AMENDED AND RESTATED

2010 EMPLOYEE, DIRECTOR AND CONSULTANT

EQUITY INCENTIVE PLAN

 

1.                                       DEFINITIONS.

 

Unless otherwise specified or unless the context otherwise requires, the following terms, as used in this Ironwood Pharmaceuticals, Inc. 2010 Employee, Director and Consultant Equity Incentive Plan, have the following meanings:

 

Administrator means the Board of Directors, unless it has delegated power to act on its behalf to the Committee, in which case the Administrator means the Committee.

 

Affiliate means a corporation which, for purposes of Section 424 of the Code, is a parent or subsidiary of the Company, direct or indirect.

 

Agreement means an agreement between the Company and a Participant delivered pursuant to the Plan and pertaining to a Stock Right, in such form as the Administrator shall approve.

 

Board of Directors means the Board of Directors of the Company.

 

Cause means, with respect to a Participant (a) dishonesty with respect to the Company or any Affiliate, (b) insubordination, substantial malfeasance or non-feasance of duty, (c) unauthorized disclosure of confidential information, (d) breach by a Participant of any provision of any employment, consulting, advisory, nondisclosure, non-competition or similar agreement between the Participant and the Company or any Affiliate, and (e) conduct substantially prejudicial to the business of the Company or any Affiliate; provided, however, that any provision in an agreement between a Participant and the Company or an Affiliate, which contains a conflicting definition of Cause for termination and which is in effect at the time of such termination, shall supersede this definition with respect to that Participant.  The determination of the Administrator as to the existence of Cause will be conclusive on the Participant and the Company.

 

Code means the United States Internal Revenue Code of 1986, as amended including any successor statute, regulation and guidance thereto.

 

Committee means the committee of the Board of Directors to which the Board of Directors has delegated power to act under or pursuant to the provisions of the Plan, or a subcommittee thereof that consists solely of two or more “outside” directors, as required under Section 162(m) of the Code.

 

Common Stock means shares of the Company’s Class A Common Stock, $0.001 par value per share.

 



 

Company means Ironwood Pharmaceuticals, Inc., a Delaware corporation.

 

Consultant means any natural person who is an advisor or consultant that provides bona fide services to the Company or its Affiliates, provided that such services are not in connection with the offer or sale of securities in a capital raising transaction, and do not directly or indirectly promote or maintain a market for the Company’s or its Affiliates’ securities.

 

Disability or Disabled means permanent and total disability as defined in Section 22(e)(3) of the Code.

 

Employee means any employee of the Company or of an Affiliate (including, without limitation, an employee who is also serving as an officer or director of the Company or of an Affiliate), designated by the Administrator to be eligible to be granted one or more Stock Rights under the Plan.

 

Exchange Act means the Securities Exchange Act of 1934, as amended.

 

Fair Market Value of a Share of Common Stock means:

 

(1)           If the Common Stock is listed on a national securities exchange or traded in the over-the-counter market and sales prices are regularly reported for the Common Stock, the closing or, if not applicable, the last price of the Common Stock on the composite tape or other comparable reporting system for the trading day on the applicable date and if such applicable date is not a trading day, the last market trading day prior to such date;

 

(2)           If the Common Stock is not traded on a national securities exchange but is traded on the over-the-counter market, if sales prices are not regularly reported for the Common Stock for the trading day referred to in clause (1), and if bid and asked prices for the Common Stock are regularly reported, the mean between the bid and the asked price for the Common Stock at the close of trading in the over-the-counter market for the trading day on which Common Stock was traded on the applicable date and if such applicable date is not a trading day, the last market trading day prior to such date; and

 

(3)           If the Common Stock is neither listed on a national securities exchange nor traded in the over-the-counter market, such value as the Administrator, in good faith, shall determine.

 

ISO means an option meant to qualify as an incentive stock option under Section 422 of the Code.

 

Non-Qualified Option means an option which is not intended to qualify as an ISO.

 

Option means an ISO or Non-Qualified Option granted under the Plan.

 

2



 

Participant means an Employee, director or Consultant of the Company or an Affiliate to whom one or more Stock Rights are granted under the Plan. As used herein, “Participant” shall include “Participant’s Survivors” where the context requires.

 

Performance-Based Award means a Stock Right as set forth in Paragraph 9 hereof.

 

Performance Goals means performance goals based on one or more of the following criteria: achievement of research, clinical trial or other drug development objectives; achievement of regulatory objectives; achievement of manufacturing and/or supply chain objectives; sales; revenues; assets; expenses; earnings or earnings per share; earnings before interest and taxes (EBIT) or EBIT per share; earnings before interest, taxes, depreciation and amortization (EBITDA) or EBITDA per share; return on equity, investment, capital or assets; one or more operating ratios; borrowing levels, leverage ratios or credit rating; market share; capital expenditures; cash flow or cash flow per share; stock price; stockholder return; income, pre-tax income, net income, operating income, pre-tax profit, operating profit, net operating profit or economic profit; gross margin, operating margin, profit margin, return on operating revenue, return on operating assets, cash from operations, operating ratio or operating revenue; market capitalization; customer expansion or retention; acquisitions or divestitures (in whole or in part) and/or integration activities related thereto; joint ventures, collaborations, licenses and strategic alliances, and/or the management and performance of such relationships; spin-offs, split-ups or similar transactions; reorganizations; recapitalizations, restructurings, financings (issuance of debt or equity) or refinancings; achievement of litigation-related objectives and/or objectives related to litigation expenses; achievement of human resource, organizational and/or personnel objectives; achievement of information technology or information services objectives; or achievement of real estate, facilities or space-planning objectives.

 

The foregoing performance goals may be determined: (a) on an absolute basis, (b) relative to internal goals or levels attained in prior years, (c) related to other companies or indices, or (d) as ratios expressing relationships between two or more Performance Goals. Where applicable, the Performance Goals may be expressed in terms of attaining a specified level of the particular criterion or the attainment of a percentage increase or decrease in the particular criterion, and may be applied to the Company and/or an Affiliate of the Company, or a division or strategic business unit of the Company and/or an Affiliate of the Company, all as determined by the Committee. The Performance Goals may include a threshold level of performance below which no Performance-Based Award will be issued or no vesting will occur, levels of performance at which Performance-Based Awards will be issued or specified vesting will occur, and a maximum level of performance above which no additional issuances will be made or at which full vesting will occur. In the areas of drug research, development, regulatory affairs and commercialization, if a third party partner that is party to a licensing or

 

3



 

collaboration agreement with the Company accomplishes a development milestone, regulatory achievement, or commercialization or sales target with the partnered asset, then such third party partner’s accomplishment shall constitute an achievement of the Company.

 

The satisfaction of each of the foregoing Performance Goals shall be subject to certification by the Committee. The Committee has the authority to make adjustments to the Performance Goals provided that any such adjustments do not otherwise violate Section 162(m) of the Code or the terms of the Plan. In the case of Performance-Based Awards that are not intended to comply with Section 162(m) of the Code, the Committee may designate performance criteria from among the foregoing or such other performance criteria as it shall determine in its sole discretion.

 

Plan means this Ironwood Pharmaceuticals, Inc. 2010 Employee, Director and Consultant Equity Incentive Plan.

 

Securities Act means the Securities Act of 1933, as amended.

 

Shares means shares of the Common Stock as to which Stock Rights have been or may be granted under the Plan or any shares of capital stock into which the Shares are changed or for which they are exchanged within the provisions of Paragraph 3 of the Plan.  The Shares issued under the Plan may be authorized and unissued shares or shares held by the Company in its treasury, or both.

 

Stock-Based Award means a grant by the Company under the Plan of an equity award or an equity based award which is not an Option or a Stock Grant.

 

Stock Grant means a grant by the Company of Shares under the Plan.

 

Stock Right means a right to Shares or the value of Shares of the Company granted pursuant to the Plan — an ISO, a Non-Qualified Option, a Stock Grant or a Stock-Based Award.

 

Survivor means a deceased Participant’s legal representatives and/or any person or persons who acquired the Participant’s rights to a Stock Right by will or by the laws of descent and distribution.

 

2.                                       PURPOSES OF THE PLAN.

 

The Plan is intended to encourage ownership of Shares by Employees and directors of and certain Consultants to the Company and its Affiliates in order to attract and retain such people, to induce them to work for the benefit of the Company or of an Affiliate and to provide additional incentive for them to promote the success of the Company or of an Affiliate.  The Plan provides for the granting of ISOs, Non-Qualified Options, Stock Grants and Stock-Based Awards.

 

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3.                                       SHARES SUBJECT TO THE PLAN.

 

(a)           The number of Shares which may be issued from time to time pursuant to this Plan shall be the sum of: (i) 6,000,000 shares of Common Stock and (ii) any shares of common stock that are represented by awards granted under the Company’s 1998 Amended and Restated Stock Option Plan, the Amended and Restated 2002 Stock Incentive Plan, the 2002 California Stock Incentive Plan and the Amended and Restated 2005 Stock Incentive Plan that are forfeited, expire or are cancelled without delivery of shares of common stock or which result in the forfeiture of shares of common stock back to the Company on or after the effective date of this plan, or the equivalent of such number of Shares after the Administrator, in its sole discretion, has interpreted the effect of any stock split, stock dividend, combination, recapitalization or similar transaction in accordance with Paragraph 20 of this Plan; provided, however, that no more than 16,700,000 Shares shall be added to the Plan pursuant to subsection (ii).

 

(b)           Notwithstanding Subparagraph (a) above, on the first day of each fiscal year of the Company during the period beginning in fiscal year 2011, and ending on the second day of fiscal year 2019, the number of Shares that may be issued from time to time pursuant to the Plan, shall be increased by an amount equal to the lesser of (i) 6,600,000 or the equivalent of such number of Shares after the Administrator, in its sole discretion, has interpreted the effect of any stock split, stock dividend, combination, recapitalization or similar transaction in accordance with Paragraph 20 of the Plan; (ii) 4% of the number of outstanding shares of common stock on such date; and (iii) an amount determined by the Board of Directors.  The increase in the number of Shares available for issuance under this Plan set forth in this Subparagraph (b) shall be subject to the approval of the Board of Directors and shall be effective upon the first day of each applicable fiscal year; provided, however, that in the event the Board of Directors has not approved an increase on or before the first day of the applicable fiscal year, the number of Shares available for issuance under this Plan shall remain the same until such time that the Board of Directors approves an increase under this Paragraph (b).

 

(c)           If an Option ceases to be “outstanding”, in whole or in part (other than by exercise), or if the Company shall reacquire (at not more than its original issuance price) any Shares issued pursuant to a Stock Grant or Stock-Based Award, or if any Stock Right expires or is forfeited, cancelled, or otherwise terminated or results in any Shares not being issued, the unissued or reacquired Shares which were subject to such Stock Right shall again be available for issuance from time to time pursuant to this Plan.  Notwithstanding the foregoing, if a Stock Right is exercised, in whole or in part, by tender of Shares or if the Company or an Affiliate’s tax withholding obligation is satisfied by withholding Shares, the number of Shares deemed to have been issued under the Plan for purposes of the limitation set forth in Paragraph 3(a) above shall be the number of Shares that were subject to the Stock Right or portion thereof, and not the net number of Shares actually issued.  However, in the case of ISOs, the foregoing provisions shall be subject to any limitations under the Code.

 

4.                                       ADMINISTRATION OF THE PLAN.

 

The Administrator of the Plan will be the Board of Directors, except to the extent the Board of Directors delegates its authority to the Committee, in which case the Committee shall be the Administrator.

 

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Subject to the provisions of the Plan, the Administrator is authorized to:

 

(a)           Interpret the provisions of the Plan and all Stock Rights and to make all rules and determinations which it deems necessary or advisable for the administration of the Plan;

 

(b)           Determine which Employees, directors and Consultants shall be granted Stock Rights;

 

(c)           Determine the number of Shares for which a Stock Right or Stock Rights shall be granted, provided, however, that in no event shall Stock Rights with respect to more than 1,000,000 Shares be granted to any Participant in any fiscal year;

 

(d)           Specify the terms and conditions upon which a Stock Right or Stock Rights may be granted;

 

(e)           Determine Performance Goals; and

 

(f)            Adopt any sub-plans applicable to residents of any specified jurisdiction as it deems necessary or appropriate in order to comply with or take advantage of any tax or other laws applicable to the Company, any Affiliate or to Participants or to otherwise facilitate the administration of the Plan, which sub-plans may include additional restrictions or conditions applicable to Stock Rights or Shares issuable pursuant to a Stock Right; provided, however, that all such interpretations, rules, determinations, terms and conditions shall be made and prescribed in the context of: (x) not causing any adverse tax consequences under Section 409A of the Code and (y) preserving the tax status under Section 422 of the Code of those Options which are designated as ISOs.  Subject to the foregoing, the interpretation and construction by the Administrator of any provisions of the Plan or of any Stock Right granted under it shall be final, unless otherwise determined by the Board of Directors, if the Administrator is the Committee.  In addition, if the Administrator is the Committee, the Board of Directors may take any action under the Plan that would otherwise be the responsibility of the Committee.

 

To the extent permitted under applicable law, the Board of Directors or the Committee may allocate all or any portion of its responsibilities and powers to any one or more of its members and may delegate all or any portion of its responsibilities and powers to any other person selected by it.  The Board of Directors or the Committee may revoke any such allocation or delegation at any time.  Notwithstanding the foregoing, only the Board of Directors or the Committee shall be authorized to grant a Stock Right to any director of the Company or to any “officer” of the Company (as defined by Rule 16a-1 under the Exchange Act).

 

5.                                       ELIGIBILITY FOR PARTICIPATION.

 

The Administrator will, in its sole discretion, name the Participants in the Plan; provided, however, that each Participant must be an Employee, director or Consultant of the Company or of an Affiliate at the time a Stock Right is granted.  Notwithstanding the foregoing, the Administrator may authorize the grant of a Stock Right to a person not then an Employee, director or Consultant of the Company or of an Affiliate; provided, however, that the actual grant of such Stock Right shall be conditioned upon such person becoming eligible to become a Participant at or prior to the time of the execution of the Agreement evidencing such Stock

 

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Right.  ISOs may be granted only to Employees who are deemed to be residents of the United States for tax purposes.  Non-Qualified Options, Stock Grants and Stock-Based Awards may be granted to any Employee, director or Consultant of the Company or an Affiliate.  The granting of any Stock Right to any individual shall neither entitle that individual to, nor disqualify him or her from, participation in any other grant of Stock Rights or any grant under any other benefit plan established by the Company or any Affiliate for Employees, directors or Consultants.

 

6.                                       TERMS AND CONDITIONS OF OPTIONS.

 

Each Option shall be set forth in writing in an Option Agreement, duly executed by the Company and, to the extent required by law or requested by the Company, by the Participant.  The Administrator may provide that Options be granted subject to such terms and conditions, consistent with the terms and conditions specifically required under this Plan, as the Administrator may deem appropriate including, without limitation, subsequent approval by the shareholders of the Company of this Plan or any amendments thereto.  The Option Agreements shall be subject to at least the following terms and conditions:

 

(a)           Non-Qualified Options:  Each Option intended to be a Non-Qualified Option shall be subject to the terms and conditions which the Administrator determines to be appropriate and in the best interest of the Company, subject to the following minimum standards for any such Non-Qualified Option:

 

(i)                                     Exercise Price: Each Option Agreement shall state the exercise price (per share) of the Shares covered by each Option, which exercise price shall be determined by the Administrator and shall be at least equal to the Fair Market Value per share of Common Stock on the date of grant of the Option.

 

(ii)                                  Number of Shares: Each Option Agreement shall state the number of Shares to which it pertains.

 

(iii)                               Option Periods:  Each Option Agreement shall state the date or dates on which it first is exercisable and the date after which it may no longer be exercised, and may provide that the Option rights accrue or become exercisable in installments over a period of months or years, or upon the occurrence of certain conditions or the attainment of stated goals or events.

 

(iv)                              Option Conditions:  Exercise of any Option may be conditioned upon the Participant’s execution of a Share purchase agreement in form satisfactory to the Administrator providing for certain protections for the Company and its other shareholders, including requirements that:

 

A.                                   The Participant’s or the Participant’s Survivors’ right to sell or transfer the Shares may be restricted; and

 

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B.                                     The Participant or the Participant’s Survivors may be required to execute letters of investment intent and must also acknowledge that the Shares will bear legends noting any applicable restrictions.

 

(b)           ISOs:  Each Option intended to be an ISO shall be issued only to an Employee who is deemed to be a resident of the United States for tax purposes, and shall be subject to the following terms and conditions, with such additional restrictions or changes as the Administrator determines are appropriate but not in conflict with Section 422 of the Code and relevant regulations and rulings of the Internal Revenue Service:

 

(i)                                     Minimum standards:  The ISO shall meet the minimum standards required of Non-Qualified Options, as described in Paragraph 6(a) above, except clause (i) thereunder.

 

(ii)                                  Exercise Price:  Immediately before the ISO is granted, if the Participant owns, directly or by reason of the applicable attribution rules in Section 424(d) of the Code:

 

A.                                   10% or less of the total combined voting power of all classes of stock of the Company or an Affiliate, the exercise price per share of the Shares covered by each ISO shall not be less than 100% of the Fair Market Value per share of the Common Stock on the date of grant of the Option; or

 

B.                                     More than 10% of the total combined voting power of all classes of stock of the Company or an Affiliate, the exercise price per share of the Shares covered by each ISO shall not be less than 110% of the Fair Market Value per share of the Common Stock on the date of grant of the Option.

 

(iii)                               Term of Option:  For Participants who own:

 

A.                                   10% or less of the total combined voting power of all classes of stock of the Company or an Affiliate, each ISO shall terminate not more than ten years from the date of the grant or at such earlier time as the Option Agreement may provide; or

 

B.                                     More than 10% of the total combined voting power of all classes of stock of the Company or an Affiliate, each ISO shall terminate not more than five years from the date of the grant or at such earlier time as the Option Agreement may provide.

 

(iv)                              Limitation on Yearly Exercise:  The Option Agreements shall restrict the amount of ISOs which may become exercisable in any calendar year (under this or any other ISO plan of the Company or an Affiliate) so that the aggregate Fair Market Value (determined on the date each ISO is granted) of the stock with respect to which ISOs are exercisable for the

 

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first time by the Participant in any calendar year does not exceed $100,000.

 

7.                                       TERMS AND CONDITIONS OF STOCK GRANTS.

 

Each Stock Grant to a Participant shall state the principal terms in an Agreement duly executed by the Company and, to the extent required by law or requested by the Company, by the Participant.  The Agreement shall be in a form approved by the Administrator and shall contain terms and conditions which the Administrator determines to be appropriate and in the best interest of the Company, subject to the following minimum standards:

 

(a)           Each Agreement shall state the purchase price per share, if any, of the Shares covered by each Stock Grant, which purchase price shall be determined by the Administrator but shall not be less than the minimum consideration required by the Delaware General Corporation Law, if any, on the date of the grant of the Stock Grant;

 

(b)           Each Agreement shall state the number of Shares to which the Stock Grant pertains; and

 

(c)           Each Agreement shall include the terms of any right of the Company to restrict or reacquire the Shares subject to the Stock Grant, including the time or attainment of Performance Goals upon which such rights shall accrue and the purchase price therefor, if any.

 

8.                                       TERMS AND CONDITIONS OF OTHER STOCK-BASED AWARDS.

 

The Administrator shall have the right to grant other Stock-Based Awards based upon the Common Stock having such terms and conditions as the Administrator may determine, including, without limitation, the grant of Shares based upon certain conditions, the grant of securities convertible into Shares and the grant of stock appreciation rights, phantom stock awards or stock units.  The principal terms of each Stock-Based Award shall be set forth in an Agreement, duly executed by the Company and, to the extent required by law or requested by the Company, by the Participant.  The Agreement shall be in a form approved by the Administrator and shall contain terms and conditions which the Administrator determines to be appropriate and in the best interest of the Company.

 

The Company intends that the Plan and any Stock-Based Awards granted hereunder be exempt from the application of Section 409A of the Code or meet the requirements of paragraphs (2), (3) and (4) of subsection (a) of Section 409A of the Code, to the extent applicable, and be operated in accordance with Section 409A so that any compensation deferred under any Stock-Based Award (and applicable investment earnings) shall not be included in income under Section 409A of the Code.  Any ambiguities in the Plan shall be construed to effect the intent as described in this Paragraph 8.

 

9.                                       PERFORMANCE-BASED AWARDS.

 

A Participant’s Performance-Based Award shall be determined based on the attainment of written Performance Goals, which must be objective and approved by the Committee while the outcome for that performance period is substantially uncertain, and no more than ninety (90)

 

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days after the commencement of the performance period to which the Performance Goal relates or, if less, the number of days which is equal to twenty-five percent (25%) of the relevant performance period. The Committee shall determine whether, with respect to a performance period, the applicable Performance Goals have been met with respect to a given Participant and, if they have, to so certify and ascertain the amount of the applicable Performance-Based Award. No Performance-Based Awards will vest for such performance period until such certification is made by the Committee. The number of Shares issued in respect of a Performance-Based Award to a given Participant may be less than the amount determined by the applicable Performance Goal formula, at the discretion of the Committee.

 

10.                                 EXERCISE OF OPTIONS AND ISSUE OF SHARES.

 

An Option (or any part or installment thereof) shall be exercised by giving written notice to the Company or its designee (in a form acceptable to the Administrator, which may include electronic notice), together with provision for payment of the aggregate exercise price in accordance with this Paragraph 10 for the Shares as to which the Option is being exercised, and upon compliance with any other condition(s) set forth in the Option Agreement.  Such notice shall be signed by the person exercising the Option (which signature may be provided electronically in a form acceptable to the Administrator), shall state the number of Shares with respect to which the Option is being exercised and shall contain any representation required by the Plan or the Option Agreement.  Payment of the exercise price for the Shares as to which such Option is being exercised shall be made (a) in United States dollars in cash or by check, or (b) at the discretion of the Administrator, through delivery of shares of Common Stock held for at least six months (if required to avoid negative accounting treatment) having a Fair Market Value equal as of the date of the exercise to the aggregate cash exercise price for the number of Shares as to which the Option is being exercised, or (c) at the discretion of the Administrator, by having the Company retain from the Shares otherwise issuable upon exercise of the Option, a number of Shares having a Fair Market Value equal as of the date of exercise to the aggregate exercise price for the number of Shares as to which the Option is being exercised, or (d) at the discretion of the Administrator, in accordance with a cashless exercise program established with a securities brokerage firm, and approved by the Administrator, or (e) at the discretion of the Administrator, by any combination of (a), (b), (c) and (d) above or (f) at the discretion of the Administrator, by payment of such other lawful consideration as the Administrator may determine. Notwithstanding the foregoing, the Administrator shall accept only such payment on exercise of an ISO as is permitted by Section 422 of the Code.

 

The Company shall then reasonably promptly deliver the Shares as to which such Option was exercised to the Participant (or to the Participant’s Survivors, as the case may be).  In determining what constitutes “reasonably promptly,” it is expressly understood that the issuance and delivery of the Shares may be delayed by the Company in order to comply with any law or regulation (including, without limitation, state securities or “blue sky” laws) which requires the Company to take any action with respect to the Shares prior to their issuance.  The Shares shall, upon delivery, be fully paid, non-assessable Shares.

 

The Administrator shall have the right to accelerate the date of exercise of any installment of any Option; provided that the Administrator shall not accelerate the exercise date of any installment of any Option granted to an Employee as an ISO (and not previously

 

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converted into a Non-Qualified Option pursuant to Paragraph 23) without the prior approval of the Employee if such acceleration would violate the annual vesting limitation contained in Section 422(d) of the Code, as described in Paragraph 6(b)(iv).

 

The Administrator may, in its discretion, amend any term or condition of an outstanding Option provided (i) such term or condition as amended is permitted by the Plan, (ii) any such amendment shall be made only with the consent of the Participant to whom the Option was granted, or in the event of the death of the Participant, the Participant’s Survivors, if the amendment is adverse to the Participant, and (iii) any such amendment of any Option shall be made only after the Administrator determines whether such amendment would constitute a “modification” of any Option which is an ISO (as that term is defined in Section 424(h) of the Code) or would cause any adverse tax consequences for the holder of any Option including, but not limited to, pursuant to Section 409A of the Code.

 

11.                                 ACCEPTANCE OF STOCK GRANTS AND STOCK-BASED AWARDS AND ISSUE OF SHARES.

 

A Stock Grant or Stock-Based