UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

Form 10-Q

 

 

Commission File Number: 0-29801

 

InterMune, Inc.

(Exact name of Registrant as specified in its charter)

 

 

3280 Bayshore Blvd., Brisbane, California 94005

(Address of principal executive offices, including zip code)

 

(415) 466-2200

(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 þ     No o

 

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

Large accelerated filer o     Accelerated filer þ     Non-accelerated filer o

 

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

 

As of April 28, 2006, there were 33,728,506 outstanding shares of common stock, par value $0.001 per share, of InterMune, Inc.

 

 

INTERMUNE, INC.

QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006

INDEX

 

 

INTERMUNE, INC.

 

CONDENSED CONSOLIDATED BALANCE SHEETS

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

INTERMUNE, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

INTERMUNE, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

INTERMUNE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

 

Overview

 

InterMune, Inc. (“InterMune,” “the Company,” “we,” “our,” or “us”) is an independent biopharmaceutical company focused on developing and commercializing innovative therapies in pulmonology and hepatology. Our revenue is provided solely from sales of Actimmune^®. We also have preclinical and advanced stage clinical programs addressing a range of unmet medical needs with attractive potential commercial markets. As part of our efforts to refocus our corporate strategy, we completed the sale of the Infergenproduct, including related intellectual property rights and inventory, in December 2005. As a result of this transaction, Infergen^® related activities are reflected as discontinued operations.

 

 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information. The financial statements include all adjustments (consisting only of normal recurring adjustments) that we believe are necessary for a fair presentation of the periods presented. These interim financial results are not necessarily indicative of results to be expected for the full fiscal year.

 

Principles of consolidation

 

The consolidated financial statements include the accounts of InterMune and its wholly-owned subsidiaries, InterMune Canada Inc. and InterMune Ltd. (U.K.). All inter-company accounts and transactions have been eliminated. To date, the operations of InterMune Canada Inc. and InterMune Ltd. (U.K.) have been immaterial.

 

Use of estimates

 

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates and assumptions.

 

Inventory reserves and non-cancelable purchase obligations for inventory

 

Because of the long lead times required to manufacture our products, we enter into non-cancelable obligations to purchase our inventory. We evaluate the need to provide reserves for contractually committed future purchases of inventory that may be in excess of forecasted future demand. In making these assessments, we are required to make judgments as to the future demand for current or committed inventory levels. We are also required to make judgments as to the expiration dates of our products, since our products can no longer be used after their respective expiration dates. As part of our excess inventory assessment for all of our products, we also consider the expiration dates of our products to be manufactured in the future under non-cancelable purchase obligations.

 

Significant differences between our current estimates and judgments and future commercial and clinical estimated demand for Actimmune^® and the useful life of our inventories may result in significant charges for excess inventory or purchase commitments in the future. These differences could have a material adverse effect on our financial condition and results of operations during the period in which we recognize an inventory reserve. For example, during the year ended December 31, 2005, we charged $9.1 million to cost of goods sold for excess inventory and non-cancelable purchase obligations for inventory in excess of forecasted needs.

 

INTERMUNE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Foreign currency and derivative instruments

 

From time to time, we use derivatives to manage our market exposure to fluctuations in foreign currencies. We record all derivatives on the balance sheet at fair value. For derivative instruments that are designated and qualify as a fair value hedge (i.e., hedging the exposure to changes in the fair value of an asset or a liability or an identified portion thereof that is attributable to a particular risk), the gain or loss on the derivative instrument, as well as the offsetting loss or gain on the hedged item attributable to the hedged risk, is recognized in current earnings during the period of the change in fair values. For derivative instruments that are designated and qualify as a cash flow hedge (i.e., hedging the exposure to variability in expected future cash flows that is attributable to a particular risk), the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. The gain or loss on the derivative instruments in excess of the cumulative change in the present value of future cash flows of the hedged transaction, if any, is recognized in current earnings during the period of change. We do not use derivative instruments for speculative purposes.

 

We purchase commercial and clinical products from Boehringer Ingelheim (“BI”) in a foreign currency. This exposes us to foreign currency exchange rate risk. To protect against currency exchange risks on forecasted foreign currency cash payments for the purchases of Actimmune^® from BI over the next year, we have considered instituting a foreign currency cash flow hedging program. We have in the past hedged portions of our forecasted foreign currency cash payments with forward contracts. When the dollar strengthens significantly against the foreign currencies, the decline in the value of future foreign currency expenses is offset by losses in the value of the option or forward contracts designated as hedges. Conversely, when the dollar weakens, the increase in the value of future foreign currency expenses is offset by gains in the value of the forward contracts. In accordance with FAS 133, hedges related to anticipated transactions are designated and documented at the hedge’s inception as cash flow hedges and evaluated for hedge effectiveness at least quarterly.

 

At March 31, 2006, net gains on derivative instruments expected to be reclassified from accumulated other comprehensive income to earnings ratably with sales of Actimmune^® were $0.5 million. Such amount will be recognized as a reduction of cost of goods sold ratably as the related units of Actimmune^® are sold. At March 31, 2006, there were no outstanding derivative instruments.

 

Inventories

 

Inventories consist principally of finished-good products and are stated at the lower of cost or market value. Cost is determined by the first-in, first-out (FIFO) method.

 

Acquired product rights

 

Initial payments for the acquisition of products that, at the time of acquisition, are already marketed or are approved by the U.S. Food and Drug Administration (“FDA”) for marketing are capitalized and amortized ratably over the estimated life of the products, typically ten years. At the time of acquisition, the product life is estimated based upon the term of the agreement, the patent life of the product and our assessment of future sales and profitability of the product. We assess this estimate regularly during the amortization period and adjust the asset value or useful life when appropriate. Initial payments for the acquisition of products that, at the time of acquisition, are under development or are not approved by the FDA for marketing, have not reached technical feasibility and have no foreseeable alternative uses are expensed as research and development costs. Acquired product rights consist of payments made for the acquisition of rights to interferon gamma. Accumulated amortization of this intangible asset was $2.0 million and $1.8 million at March 31, 2006 and December 31, 2005, respectively. Amortization expense for acquired product rights for each of the next four years until fully amortized is as follows: 2006 — $0.3 million; 2007 — $0.5 million; 2008 — $0.5 million; 2009 — $0.2 million.

 

INTERMUNE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Impairment of long-lived assets

 

In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” if indicators of impairment exist, we assess the recoverability of the affected long-lived assets by determining whether the carrying value of such assets can be recovered through undiscounted future operating cash flows. If impairment is indicated, we will measure the amount of such impairment by comparing the carrying value of the asset to the present value of the expected future cash flows associated with the use of the asset.

 

Revenue recognition and revenue reserves

 

We recognize revenue generally upon delivery when title passes to a credit-worthy customer and record reserves for estimated returns, rebates, chargebacks and cash discounts against accounts receivable. We are obligated to accept from customers the return of pharmaceuticals that have reached their expiration date. We believe that we are able to make reasonable and reliable estimates of product returns, rebates, chargebacks and cash discounts based on historical experience. We review all sales transactions for potential rebates, chargebacks and discounts each month and believe that our reserves are adequate. We include shipping and handling costs in cost of goods sold.

 

On March 26, 2004, we entered into an agreement with Baxter under which we co-promoted Baxter’s product Aralast^® in the United States for the treatment of patients with hereditary emphysema. Under this agreement, we were compensated by Baxter based upon a percentage of Aralast sales. We recognized Aralast co-promotion revenue upon receipt of the co-promotion funds from Baxter. The co-promotion revenue calculation was dependent upon national sales data which lagged one quarter for reporting purposes, therefore estimates were not used. Co-promotion revenue was based on a percentage of Baxter’s sales of Aralast to pulmonologists. We terminated this agreement with Baxter in December 2005 in connection with the decision to significantly reduce our field-based pulmonary disease awareness activities.

 

Research and development expenses

 

Research and development (“R&D”) expenses include salaries, contractor and consultant fees, external clinical trial expenses performed by contract research organizations (“CRO”), in-licensing fees and facility and administrative expense allocations. In addition, we fund R&D at research institutions under agreements that are generally cancelable at our option. Research costs typically consist of applied and basic research and preclinical and toxicology work. Pharmaceutical manufacturing development costs consist of product formulation, chemical analysis and the transfer and scale-up of manufacturing at our contract manufacturers. Clinical development costs include the costs of Phase I, II and III clinical trials. These costs, along with the manufacturing scale-up costs, are a significant component of research and development expenses.

 

We accrue costs for clinical trial activities performed by contract research organizations and other third parties based upon the estimated amount of work completed on each study as provided by the CRO. These estimates may or may not match the actual services performed by the organizations as determined by patient enrollment levels and related activities. We monitor patient enrollment levels and related activities using available information; however, if we underestimate activity levels associated with various studies at a given point in time, we could record significant R&D expenses in future periods when the actual activity level becomes known. We charge all such costs to R&D expenses.

 

Net loss per share

 

We compute basic net loss per share by dividing the net loss for the period by the weighted average number of common shares outstanding during the period. We deduct shares subject to repurchase by us from the outstanding shares to arrive at the weighted average shares outstanding. We compute diluted net loss per share by dividing the net loss for the period by the weighted average number of common and common equivalent shares outstanding

 

INTERMUNE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

during the period. We exclude potentially dilutive securities, composed of incremental common shares issuable upon the exercise of stock options and common shares issuable upon conversion of our convertible notes, from diluted net loss per share because of their anti-dilutive effect.

 

The securities excluded were as follows (in thousands):

 

 

The calculation of basic and diluted net loss per share is as follows (in thousands, except per share data):

 

 

Stock-Based Compensation

 

On January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including employee stock options, restricted stock and employee stock purchases related to the Employee Stock Purchase Plan (“ESPP”) based on estimated fair values. SFAS 123(R) supersedes the Company’s previous accounting under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) for periods beginning in fiscal 2006. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 (“SAB 107”) relating to SFAS 123(R). The Company has applied the provisions of SAB 107 in its adoption of SFAS 123(R).

 

The Company adopted SFAS 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of the Company’s fiscal year 2006. The Company’s Condensed Consolidated Financial Statements as of and for the three months ended March 31, 2006 reflect the impact of SFAS 123(R). In accordance with the modified prospective transition method, the Company’s Condensed Consolidated Financial Statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). Stock-based compensation expense recognized under SFAS 123(R) for the three months ended March 31, 2006 was $4.7 million which consisted of stock-based compensation expense related to employee stock options, restricted stock and the ESPP. Stock-based compensation expense of $0.5 million for the three months ended March 31, 2005 was related to restricted stock which the Company had been recognizing under previous accounting standards. There was no stock-based compensation expense related to employee stock options and the ESPP recognized during the three months ended March 31, 2005. See Note 9 for additional information.

 

SFAS 123(R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s Consolidated Statement of Operations. Prior to the

 

INTERMUNE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

adoption of SFAS 123(R), the Company accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB 25 as allowed under Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). Under the intrinsic value method, no stock-based compensation expense had been recognized in the Company’s Consolidated Statement of Operations, other than for restricted stock, because the exercise price of the Company’s stock options granted to employees and directors equaled the fair market value of the underlying stock at the date of grant.

 

Stock-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period. Stock-based compensation expense recognized in the Company’s Condensed Consolidated Statement of Operations for the first quarter of fiscal 2006 included compensation expense for share-based payment awards granted prior to, but not yet vested as of December 31, 2005 based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123 and compensation expense for the share-based payment awards granted subsequent to December 31, 2005 based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R). In conjunction with the adoption of SFAS 123(R), the Company changed its method of attributing the value of stock-based compensation to expense from the accelerated multiple-option approach to the straight-line single option method. Compensation expense for all share-based payment awards granted on or prior to December 31, 2005 will continue to be recognized using the accelerated multiple-option approach while compensation expense for all share-based payment awards granted subsequent to December 31, 2005 is recognized using the straight-line single option method. As stock-based compensation expense recognized in the Condensed Consolidated Statement of Operations for the first quarter of fiscal 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company intends to review its forfeiture estimates on at least an annual basis. In the Company’s pro forma information required under SFAS 123 for the periods prior to fiscal 2006, the Company accounted for forfeitures as they occurred.

 

Upon adoption of SFAS 123(R), the Company retained its method of valuation for share-based awards granted beginning in fiscal 2006 with the use of the Black-Scholes option-pricing model (“Black-Scholes model”) which was previously used for the Company’s pro forma information required under SFAS 123. For additional information, see Note 9. The Company’s determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to the Company’s expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors. Option-pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions and are fully transferable. Because the Company’s employee stock options have certain characteristics that are significantly different from traded options, and because changes in the subjective assumptions can materially affect the estimated value, in management’s opinion, the existing valuation models may not provide an accurate measure of the fair value of the Company’s employee stock options. Although the fair value of employee stock options is determined in accordance with SFAS 123(R) and SAB 107 using an option-pricing model, that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.

 

 

In the fourth quarter of 2005, our Board of Directors approved a restructuring plan that was designed to help streamline our operations and reduce our operating expenses in 2006. The plan, which consisted of a significant reduction in our investment in field-based pulmonary disease awareness activities, was implemented concurrently with the divestiture of Infergen^® in December 2005. These combined actions led to a significant headcount reduction of approximately 160 employees and resulting termination costs of approximately $9.2 million. Restructuring charges comprised approximately $5.5 million of this amount which were recorded in the fourth quarter of 2005 as a separate component of operating expenses in the statement of operations, with the remainder

 

INTERMUNE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

allocated to discontinued operations. The majority of the 160 employees left InterMune at the end of the fourth quarter of 2005 with the remainder having left during the first quarter of 2006.

 

The $5.5 million restructuring charge is comprised of approximately $4.7 million for cash severance and related benefits and approximately $0.8 million for non-cash stock compensation, consisting of an allocation of option acceleration costs for approximately 400,000 shares of our common stock.

 

The activity in the accrued restructuring balance, included within accrued compensation on the balance sheet, was as follows for the three months ended March 31, 2006 (in thousands):

 

 

 

Inventories consist of the following (in thousands):

 

 

 

Comprehensive loss is comprised of net loss and other comprehensive income (loss). We include in other comprehensive income (loss) changes in the fair value of derivatives designated as effective foreign currency cash flow hedges and unrealized gains and losses on our available-for-sale securities. Comprehensive loss is as follows (in thousands):

 

 

Accumulated other comprehensive income consists of the following (in thousands):

 

 

 

In February 2004, we issued 0.25% convertible senior notes due March 1, 2011 in an aggregate principal amount of $170.0 million (the “Senior Notes”). The Senior Notes are convertible into our common stock at the option of the holder at a conversion price of approximately $21.63 per share, subject to adjustment in certain

 

INTERMUNE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

circumstances. Interest on the Senior Notes is payable semiannually in arrears on March 1 and September 1 of each year. The Senior Notes are unsecured and rank on parity with all existing and future senior unsecured debt and prior to all subordinated indebtedness. In addition, the Senior Notes are effectively subordinated to any existing and future secured debt to the extent of the value of the collateral securing such debt. As of March 31, 2006, we had no secured debt and no senior obligations. Offering expenses of $5.8 million related to the sale of the Senior Notes were recorded in other assets and are being amortized to interest expense over the term of the Senior Notes, which is seven years from the date of issuance. Accumulated amortization at March 31, 2006 and December 31, 2005 was $1.8 million and $1.6 million, respectively.

 

 

Purchase Commitments

 

We have purchase commitments with BI for the manufacture and supply of Actimmune^®. In 2000, we entered into an agreement with BI for the clinical and commercial supply of Actimmune^®. The agreement with BI generally provides for the exclusive supply by BI and exclusive purchase by us of Actimmune^®. We are required to purchase a minimum amount of Actimmune^® per year, and BI is required to supply Actimmune^® to us, subject to certain limits. In July 2005, we amended the supply agreement with BI pursuant to which BI agreed to waive certain of our minimum purchase commitments for Actimmune^® for 2005, and to reduce certain other minimum Actimmune^® purchase requirements for 2006. With regard to certain minimum purchase requirements for 2007 and thereafter, BI granted us the option of either taking delivery of Actimmune^® or paying for the difference between the amount of product actually purchased and the minimum purchase requirement. At March 31, 2006, our minimum purchase obligations totaled $99.1 million and are committed through the year 2012. Of these commitments, we have $6.5 million and $16.1 million of outstanding fixed purchase order commitments that become due and payable in 2006 and 2007, respectively. Our contractual obligation to BI is denominated in euros.

 

Contingent Payments

 

We will be required to make contingent milestone payments to the owners of our licensed products or the suppliers of our drug compounds in accordance with our license, commercialization and collaboration agreements in the aggregate amount of $136.4 million if all of the milestones per the agreements are achieved. These milestones include development, regulatory approval, commercialization and sales milestones.

 

Other Contingency

 

On November 9, 2004, we received a subpoena from the U.S. Department of Justice requiring us to provide the Department of Justice with certain information relating to Actimmune^®, including information regarding the promotion and marketing of Actimmune^®. We are cooperating with the Department of Justice in this inquiry. Although we cannot predict whether the outcome of this inquiry will have a material adverse effect on our business, it is possible that we will be required to pay a substantial civil fine in connection with the settlement of this matter. At this time we cannot predict the magnitude of such a fine or the impact the payment of such a fine may have on our future business operations.

 

 

We have determined that, in accordance with SFAS No. 131, we operate in one segment, because operating results are reported only on an aggregate basis to our chief operating decision makers. We currently market Actimmune^® in the United States for the treatment of chronic granulomatous disease and severe, malignant osteopetrosis. Prior to its divestiture in December 2005, we also marketed Infergen^® in the United States and Canada for chronic hepatitis C virus infections; and prior to its divestiture in May 2005, we also marketed Amphotec worldwide for invasive aspergillosis. Revenue for the three months ended March 31, 2005 has been adjusted to reflect the reclassification of Infergen^® revenue into discontinued operations.

 

INTERMUNE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Our net revenue by product for the three months ended March 31, were as follows (in thousands):

 

 

Our net revenue by region for the three months ended March 31, were as follows (in thousands):

 

 

Our revenue and trade receivables are concentrated with a few customers. We perform credit evaluations on our customers’ financial condition and limit the amount of credit extended. However, we generally do not require collateral on accounts receivable. Concentrations of credit risk, with respect to accounts receivable, exist to the extent of amounts presented in the financial statements. Two customers represented 67% and 18%, respectively, of total accounts receivable at March 31, 2006, and three customers represented 46%, 12% and 11%, respectively, of total accounts receivable at December 31, 2005. No other customer represented more than 10% of accounts receivable at March 31, 2006 or December 31, 2005.

 

Revenue from customers representing 10% or more of total revenue during the three months ended March 31, 2006 and March 31, 2005, was as follows:

 

 

 

Employee Stock Purchase Plan

 

To provide employees with an opportunity to purchase our common stock through payroll deductions, our board of directors adopted the 2000 Employee Stock Purchase Plan (the “ESPP”). Under the ESPP, employees, subject to certain restrictions, may purchase shares of common stock at 85% of the fair market value at either the date of eligibility for enrollment or the date of purchase, whichever is less. Purchases are limited to the lesser of 15% of each employee’s eligible annual compensation or $25,000. During the three months ended March 31, 2006, we did not issue any shares under the ESPP and 1,121,490 shares remained available for future issuance at March 31, 2006.

 

Restricted Stock Awards

 

During the three months ended March 31, 2006, we granted employees restricted stock awards for 404,450 shares of our common stock with a weighted-average fair value of $19.30 per share that vest in January 2008. The vesting may accelerate depending on the Company’s achievement of certain performance criteria over the two-year period, twenty-five percent each for four different milestones. Grants made in 2004 and prior (none were granted in 2005) vest annually over a four-year period, thirty percent in each of the first three years and ten

 

INTERMUNE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

percent in the final year. Restricted stock awards are shares of common stock which are forfeited if the employee leaves the Company prior to vesting. As a result of these 2006 restricted stock awards and awards granted in 2004 and prior, we recognized $1.7 million in compensation expense during the three months ended March 31, 2006 compared to $0.5 million in the three months ended March 31, 2005. As all of the restricted stock awards vest through 2008, we will continue to recognize stock based compensation expenses related to the grants of these restricted awards. These stock awards offer employees the opportunity to earn shares of our stock over time, rather than options that give the employee the right to purchase stock at a set price. If all of the remaining restricted stock awards that were granted in 2003, 2004 and 2006 vest, we would recognize approximately $8.0 million in compensation expense over a weighted average remaining period of 1.6 years. However, no compensation expense will be recognized for stock awards that do not vest.

 

A summary of our restricted stock activity during the three months ended March 31, 2006 is presented in the following table:

 

 

Stock Compensation Plans

 

We have three share-based compensation plans for employees and non-employee directors, which authorize the granting of stock options, restricted stock, and other types of awards consistent with the purpose of the plans. The number of shares authorized for issuance under our plans as of March 31, 2006 totals approximately 7.1 million shares, of which approximately 2.1 million shares were available for future issuance. Stock options granted under these plans are granted with an exercise price equal to the market price of our stock at the date of grant; those option awards generally vest at a cumulative rate of 25% per year beginning on the first anniversary of the grant date and expire ten years from the date of grant.

 

General Option Information

 

The stock option and related activity during the three months ended March 31, 2006 under all of our stock compensation plans is summarized as follows:

 

 

INTERMUNE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

At March 31, 2006, the weighted average remaining contractual term for the outstanding options is 7.9 years and the aggregate intrinsic value is approximately $17.6 million. The total intrinsic value of options exercised during the three months ended March 31, 2006 was approximately $3.0 million. Intrinsic value for stock options is defined as the difference between the current market value and the grant price.

 

The following table summarizes information about options outstanding and exercisable at March 31, 2006:

 

 

At March 31, 2006, the weighted average remaining contractual term for options exercisable is 7.1 years and the aggregate intrinsic value is approximately $4.9 million.

 

Valuation and Expense Information under SFAS 123(R)

 

We adopted SFAS 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of the Company’s fiscal year 2006. The Company’s Condensed Consolidated Financial Statements as of and for the three months ended March 31, 2006 reflect the impact of SFAS 123(R). In accordance with the modified prospective transition method, the Company’s Condensed Consolidated Financial Statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). Stock-based compensation expense recognized under SFAS 123(R) for the three months ended March 31, 2006 was $4.7 million, which consisted of stock-based compensation expense related to employee stock options, restricted stock and the ESPP. Of this amount, approximately $2.1 million has been recorded in research and development expense and the remaining $2.6 million has been recorded in selling, general and administrative expense. Stock-based compensation expense of $0.5 million for the three months ended March 31, 2005 was related to restricted stock which the Company had been recognizing under previous accounting standards. There was no stock-based compensation expense related to employee stock options and the ESPP recognized during the three months ended March 31, 2005.

 

Upon adoption of SFAS 123(R), we retained our method of valuation for share-based awards granted beginning in fiscal 2006 with the use of the Black-Scholes model which was previously used for the Company’s pro forma information required under SFAS 123. The Company’s determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to the Company’s expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors. A description of the assumptions follows:

 

 

INTERMUNE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

We estimated the fair value of each option grant on the date of grant using the Black-Scholes model with the following weighted-average assumptions:

 

 

The weighted-average fair value per share of options granted for the three month period ended March 31, 2006 was $10.54.

 

We estimated the fair value of the employees’ stock purchase rights using the Black-Scholes model with the following weighted-average assumptions:

 

 

The weighted-average fair value for purchase rights granted under the employee stock purchase plan for the three month period ended March 31, 2006 was $6.99.

 

As stock-based compensation expense recognized in the Condensed Consolidated Statement of Operations for the first quarter of fiscal 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

 

INTERMUNE, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Pro Forma Information under SFAS 123 for Periods Prior to January 1, 2006

 

Had we used the fair value based accounting method for stock-based compensation expense prescribed by SFAS No. 123 for the first quarter ended March 31, 2005, our net loss and net loss per share would have increased to the following pro-forma amounts (in thousands, except per share data):

 

 

Prior to the adoption of SFAS No. 123(R), pro forma disclosures reflected the fair value of each option grant estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:

 

 

The weighted-average fair value per share of options granted for the three month period ended March 31, 2005 was $8.28.

 

We estimated the fair value of the employees’ stock purchase rights using the Black-Scholes option-pricing model with the following weighted-average assumptions:

 

 

The weighted-average fair value for purchase rights granted under the employee stock purchase plan for the three month period ended March 31, 2005 was $9.57.

 

Forward-Looking Statements

 

This Quarterly Report on Form 10-Q (the “Report”) contains certain information regarding our financial projections, plans and strategies that are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements involve substantial risks and uncertainty. You can identify these statements by forward-looking words such as “may,” “will,” “expect,” “intend,” “anticipate,” “believe,” “estimate,” “plan,” “could,” “should,” “continue” or the negative of such terms or similar words or expressions. These forward-looking statements may also use different phrases.

 

We have based these forward-looking statements on our current expectations and projections about future events. These forward-looking statements, which are subject to risks, uncertainties and assumptions about us, may include, among other things, statements which address our strategy and operating performance and events or developments that we expect or anticipate will occur in the future, including, but not limited to, statements in the discussions about:

 

 

You should also consider carefully the statements under the heading “Risk Factors” below, which address additional factors that could cause our results to differ from those set forth in the forward-looking statements. Any forward-looking statements are qualified in their entirety by reference to the factors discussed in this Report, including those discussed in this Report under the heading “Risk Factors” below. Because of the factors referred to above, as well as the factors discussed in this Report under the heading “Risk Factors” below, could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements made by us or on our behalf, you should not place undue reliance on any forward-looking statement. Further, any forward-looking statement speaks only as of the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for us to predict which factors will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. When used in the Report, unless otherwise indicated, “InterMune,” “we,” “our” and “us” refers to InterMune, Inc.

 

Critical Accounting Policies

 

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe are reasonable. These estimates are the basis for our judgments about the carrying values of assets and liabilities, which in turn may impact our reported revenue and expenses. Actual results may differ from these estimates under different assumptions or conditions.

 

An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimate that are reasonably likely to occur

periodically, could materially change the financial statements. We believe there have been no significant changes during the three-month period ended March 31, 2006 to the items that we disclosed as our critical accounting policies and estimates under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report on Form 10-K for the year ended December 31, 2005, with the exception of our estimates related to the recording of expenses for stock-based compensation.

 

Beginning January 1, 2006, we account for stock-based compensation in accordance with SFAS No. 123(R), Share-Based Payment. Under the fair value recognition provisions of this statement, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the vesting period. In order to estimate the value of share-based awards, we use the Black-Scholes model, which requires the use of certain subjective assumptions. The most significant assumptions are our estimates of the expected volatility and the expected term of the award. In addition, judgment is also required in estimating the amount of share-based awards that are expected to be forfeited. If actual results differ significantly from any of these estimates, stock-based compensation expense and our results of operations could be materially impacted.

 

The Company adopted SFAS 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of the Company’s fiscal year 2006. SFAS 123(R)supersedes the Company’s previous accounting under APB 25. The Company’s Condensed Consolidated Financial Statements as of and for the three months ended March 31, 2006 reflect the impact of SFAS 123(R). In accordance with the modified prospective transition method, the Company’s Condensed Consolidated Financial Statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). Stock-based compensation expense recognized under SFAS 123(R) for the three months ended March 31, 2006 was $4.7 million which consisted of stock-based compensation expense related to employee stock options, restricted stock and the ESPP. Stock-based compensation expense of $0.5 million for the three months ended March 31, 2005 was related to restricted stock which the Company had been recognizing under previous accounting standards. There was no stock-based compensation expense related to employee stock options and the ESPP recognized during the three months ended March 31, 2005.

 

If all of the remaining restricted stock awards that were granted in 2003, 2004 and 2006 vest, we would recognize approximately $8.0 million in compensation expense over a weighted average remaining period of 1.6 years. If all of the remaining nonvested and outstanding stock option awards that have been granted vest, we would recognize approximately $14.2 million in compensation expense over a weighted average remaining period of 1.3 years. However, no compensation expense will be recognized for any stock awards that do not vest.

 

Executive Overview

 

We are an independent biopharmaceutical company focused on developing and commercializing innovative therapies in pulmonology and hepatology. Pulmonology is the field of medicine concerned with the diagnosis and treatment of lung conditions. Hepatology is the field of medicine concerned with the diagnosis and treatment of disorders of the liver. We were incorporated in California in 1998 and reincorporated in Delaware in 2000 upon becoming a public company. On April 26, 2001, we changed our name from InterMune Pharmaceuticals, Inc. to InterMune, Inc. During the past several years, we have reorganized our business by curtailing new investment in non-core areas and focusing our development and commercial efforts in pulmonology and hepatology. Until December 2005, our revenue base was provided primarily from the sales of two products, Actimmune^® (interferon gamma-1b) and Infergen^® (consensus interferon alfacon-1). As part of our efforts to refocus our corporate strategy, we completed the sale of the Infergen^® product, including related intellectual property rights and inventory, to a wholly-owned subsidiary of Valeant Pharmaceuticals International (“Valeant”) in December 2005, for approximately $120.0 million in cash, of which $6.5 million was attributed to the purchase of finished product inventory. As part of this transaction, we received a $2.1 million promissory note from Valeant due in 2007 and may also receive up to approximately $20.0 million in clinical related contingent milestone payments beginning in 2007. Concurrent with the above transaction, we made the decision to significantly reduce our investment in field-based idiopathic pulmonary fibrosis (“IPF”) disease awareness activities, which, when combined with the sale of our Infergen^® assets, led to a significant headcount reduction of approximately 160 full time equivalent employees and resulting termination costs of approximately $9.2 million. We also made the strategic decision to continue to advance the development of our chronic hepatitis C virus (“HCV”) protease inhibitor at least through Phase Ib development

without a partner. As a result of these decisions made during the latter part of 2005, we currently have three key development programs: Actimmune^® for IPF, pirfenidone for IPF and the HCV protease inhibitor. During 2005, we divested the Amphotec^® (amphotericin B cholesteryl sulfate complex for injection) product as well as the oritavancin compound. We have sustained losses in every year since inception and, as of March 31, 2006, we had an accumulated deficit of $473.7 million.

 

Approved Product

 

Our sole approved product is Actimmune^® (interferon gamma-1b), approved for the treatment of patients with severe, malignant osteopetrosis and chronic granulomatous disease (“CGD”). For the three months ended March 31, 2006, Actimmune^® accounted for all of our product revenue, and substantially all of this revenue was derived from physicians’ prescriptions for the off-label use of Actimmune^® in the treatment of IPF.

 

Research Programs

 

• Hepatology

 

We have a preclinical research program in the hepatology area. In September 2002, we entered into a drug discovery collaboration agreement with Array BioPharma, Inc. (“Array”) to discover novel small molecule protease inhibitors for the treatment of hepatitis C. In late 2004, we amended the Array agreement to provide for the acquisition of certain intellectual property rights from Array. In April 2005, we initiated a second research collaboration with Array with respect to a new hepatology target.

 

Results from scientific studies presented at the Digestive Disease Weekly medical conference in May 2005 have identified protease inhibitors as a promising therapeutic class. In 2005, we presented several abstracts demonstrating high potency, favorable pharmacokinetics, including uptake into the liver, and encouraging tolerability for our two lead oral HCV protease inhibitor compounds. In the third quarter of 2005, we chose “ITMN 191” (formerly known as ITMN B) as our lead compound and are currently advancing this compound through toxicology and other clinical trial authorisation-enabling studies. We expect to submit a Clinical Trial Authorisation (“CTA”) with European regulatory authorities for this lead compound in the third quarter of 2006. In addition, we are pursuing research related to other small molecules for follow-on compounds to ITMN 191 as well as second-generation protease inhibitors.

 

• Pulmonology

 

We have a preclinical research program in pulmonology focused on the discovery of small molecule therapeutics.

 

Development Programs

 

We have a late-stage development pipeline in the pulmonology area and an early-stage pipeline in the hepatology area.

 

• Hepatology

 

In hepatology, we are working to provide expanded treatment options for patients suffering from HCV infections. Prior to the end of 2005, we were focusing our hepatology efforts on those HCV patients that do not show a sufficient and sustained virologic response to pegylated interferons plus ribavirin. These patients are referred to as HCV “PEG non-responders.” Because we anticipate a shift in HCV treatment paradigm from non-specific immunomodulator drugs toward direct targeted therapies such as protease and polymerase inhibitors, we decided to divest our Infergen^® product in 2005. In connection with the sale of the Infergen^® product to Valeant, we are no longer limiting our hepatology efforts to the PEG non-responder patient population. We have now decided to focus our hepatology program on the development of small molecules for the treatment of HCV, the first of which is our protease inhibitor program which we believe may have a broad application in the overall HCV patient population. In this regard, we have transferred the Phase III trial of once-daily treatment with Infergen^® in combination with ribavirin therapy for HCV PEG non-responder patients (the “DIRECT trial”) to Valeant. We have

also decided not to proceed with the expansion phase of the Phase IIb clinical trial for once-daily Infergen^® in combination with Actimmune^®, with and without ribavirin for the treatment of HCV PEG non-responders which effectively terminates our further investment in this program. We are also no longer investing in or actively seeking a partner for the PEG-Alfacon-1 program due to limited interest by potential partners, long development timelines and high costs.

 

• Pulmonology

 

In pulmonology, we are developing two therapies for the treatment of IPF. IPF is a fatal disease characterized by progressive scarring, or fibrosis, of the lungs, which leads to the deterioration and destruction of lung function. There is no FDA approved therapy for IPF. Based on data developed by Policy Analysis Inc. from a claims database, we believe that approximately 83,000 people suffer from IPF in the United States. We are developing two clinically advanced compounds for the treatment of IPF, Actimmune^® and pirfenidone.

 

We initiated a second Phase III clinical trial of Actimmune^® for the treatment of patients with mild to moderate IPF (the “INSPIRE” trial) in December 2003. The INSPIRE trial required the enrollment of approximately 600 patients, all of which were enrolled by the end of 2005. According to the protocol, when we neared the enrollment of the 600^th patient, we conducted a prespecified sample size re-evaluation. The results of the re-evaluation determined that the overall mortality rate observed at that early point in the trial was somewhat lower than forecast in the study protocol. Consequently, as provided in the protocol, we made the decision in October 2005 to increase the pre-specified sample size of the trial by approximately 200 patients to increase the likelihood that the protocol-specified number of events will have occurred by the time the trial is scheduled to conclude in late 2007. On April 13, 2006, we completed enrollment of the INSPIRE trial by enrolling a total of 826 patients. The INSPIRE trial is scheduled to conclude near the end of 2007, and we expect to disclose top-line data from the trial in early 2008.

 

We have rights to develop and commercialize Actimmune^® for a broad range of diseases in the United States, Canada and Japan. We are collaborating with Boehringer Ingelheim GmbH (“BI”), which has similar rights in Europe and the rest of the world, to develop and commercialize interferon gamma-1b under the trade name Imukin^®.

 

We are also developing pirfenidone for the treatment of IPF. In 2005 we finalized the design of a Phase III clinical program for pirfenidone (the “CAPACITY” program) after receiving input from the FDA and the European Medicines Agency (“EMEA”). This program is designed to enroll approximately 580 patients with mild to moderate forms of IPF in two separate, concurrent multi-national Phase III trials. The primary endpoint of these trials will be lung function, as measured by change in forced vital capacity (“FVC”), which is believed to be an important measure of disease progression. Phase II studies of pirfenidone suggest that pirfenidone may be effective in preventing a decline in lung function and disease progression. On April 27, 2006 we initiated the CAPACITY program by enrolling the first patient in the program.

 

• Ovarian Cancer

 

We also were evaluating Actimmune^® in patients with ovarian cancer in a Phase III trial (the “GRACES” trial). On February 2, 2006, we announced our decision to discontinue the GRACES trial evaluating the safety and efficacy of Actimmune^® in combination with standard of care chemotherapy in patients with advanced ovarian cancer. After reviewing the results of an analysis of progression free survival time and an interim analysis of overall survival time, an independent Data Safety Monitoring Board recommended the discontinuation of the ongoing post-treatment follow-up of patients in the study. This recommendation was based on a shorter overall survival time in patients who received Actimmune^® plus standard of care chemotherapy compared to patients who received standard of care chemotherapy alone.

Product Development Status

 

The following chart shows the status of our product development programs as of March 31, 2006:

 

 

We have stopped development of PEG-Alfacon-1. Under the terms of our agreement with Valeant for the purchase of Infergen^®, Valeant has the option to acquire our rights to PEG Alfacon-1 at any time prior to the commencement of a Phase III clinical trial for PEG Alfacon-1, provided that we have incurred documented expenses by that time of at least $7.0 million in the development of PEG Alfacon-1. If Valeant chooses to exercise this option, Valeant will be obligated to pay us an amount equal to 150% of our documented expenses directly incurred by us in connection with the development of PEG Alfacon-1. In addition, if we decide to accept an offer from a third party to acquire the rights to PEG Alfacon-1, we are required to deliver written notice to Valeant of such offer and Valeant has the option to acquire the rights to PEG Alfacon-1 on substantially the same terms and conditions as those offered to us by such third party.

 

Results of Operations

 

The following discussion of our results of operations for the comparative periods excludes Infergen^® revenue and related expenses. These amounts are reflected in discontinued operations as a result of the sale of the Infergen^® product to Valeant in December 2005.

 

Revenue

 

Total product revenue was $24.4 million and $28.3 million for the three-month periods ended March 31, 2006 and 2005, respectively, representing a decrease of 14%. This decrease was primarily attributable to decreases in sales of Actimmune^®, Amphotec, a product line we divested in May 2005, and Aralast^®, a product we ceased co-promoting in December 2005. For the three-month period ended March 31, 2006, Actimmune^® accounted for all of our net product revenue compared to 98% of our total product revenue in the three months ended March 31, 2005. Substantially all of these revenues were derived from physicians’ prescriptions for the off-label use of Actimmune^® in the treatment of IPF.

 

There are a number of variables that impact Actimmune^® revenue including, but not limited to, the level of U.S. enrollment in our IPF clinical trials or those of other companies, new patients started on therapy, average duration of therapy, new data on Actimmune^® or other products presented at medical conferences and publications in medical journals, reimbursement and patient referrals from physicians. In the first quarter of 2006, Actimmune^® revenues declined 12% to $24.4 million from $27.7 million during the same period in 2005.

 

Cost of goods sold

 

Cost of goods sold included product manufacturing costs, royalties and distribution costs. Cost of goods sold were $6.2 million and $6.6 million for the three-month periods ended March 31, 2006 and 2005, respectively. The gross margin percentage for our products was 74% and 77% for these periods in 2006 and 2005, respectively. The decrease in gross margin for the first quarter of 2006, when compared to the same period in 2005, was primarily the result of a change in the mix of product revenues, as there was no Aralast^® or Amphotec^® revenue in the first quarter of 2006.

Exchange rate fluctuations between the U.S. dollar and the Euro may adversely affect cost of goods sold on Actimmune^® purchased from BI. We have, in the past, utilized forward exchange contracts to partially offset the effect of exchange rate fluctuations on purchases. However, no forward exchange contracts had been established in 2005 or to date in 2006.

 

Amortization of acquired product rights

 

We recorded amortization of acquired product rights of $0.1 million for the three-month period ended March 31, 2006 and $0.8 million for the three-month period ended March 31, 2005. The amortization and impairment of product rights for the quarter ended March 31, 2005 includes $0.6 million in respect of the impairment of Amphotec^® recorded in anticipation of the divestiture of this product in 2005.

 

Research and development expenses

 

Research and development expenses were $21.6 million and $16.9 million for the three-month periods ended March 31, 2006 and 2005, respectively, representing an increase of $4.6 million or 27%. The increase in spending for the three-month period ended March 31, 2006 compared with the same period in 2005 was primarily due to increased spending in our two late-stage clinical development programs in IPF and the advancement of our pre-clinical HCV protease inhibitor program, as well as $2.1 million of stock-based compensation expense.

 

The following table lists our current product development programs and the research and development expenses recognized in connection with each program during the indicated periods. The category title “Programs-Non specific” is comprised of facilities and personnel costs that are not allocated to a specific development program or discontinued programs. Our management reviews each of these program categories in evaluating our business. For a discussion of the risks and uncertainties associated with developing our products, as well as the risks and uncertainties associated with potential commercialization of our product candidates, see the Risk Factors below including those under the headings “Risks Related to the Development of Our Products and Product Candidates” and “Risks Related to Manufacturing and Our Dependence on Third Parties.”

 

Our development program expenses for the three-months ended March 31, were as follows (in thousands):

 

 

 

 

A significant component of our total operating expenses is our ongoing investments in research and development and, in particular, the clinical development of our product pipeline. The process of conducting the clinical research necessary to obtain FDA approval is costly, time consuming, and variable with respect to the timing of expense recognition. Current FDA requirements for a new human drug to be marketed in the United States include:

 

 

Based on our existing budgeted programs and including the impact of SFAS 123(R), we expect research and development expenses to be in a range of $90.0 million to $105.0 million in 2006.

 

Selling, general and administrative expenses

 

Selling, general and administrative expenses were $10.7 million and $15.7 million for the three-month periods ended March 31, 2006 and 2005, respectively, representing a decrease of $5.0 million or 32%. The decreased spending for the three-month period ended March 31, 2006 compared with the same period in 2005 was largely the result of the headcount reductions announced last November in field-based IPF disease awareness activities and a decrease in the number of personnel in the home office. This decrease was partially offset by stock-based compensation expense of $2.6 million. In 2006, including the impact of SFAS 123(R), we expect selling, general and administrative expenses to be in a range of $30.0 million to $45.0 million.

 

Interest income

 

Interest income increased to $2.1 million for the three-month period ended March 31, 2006, compared to $1.0 million for the three-month period ended March 31, 2005. The increase in interest income in the three-month period ended March 31, 2006 reflects increasing investment yields on our cash and short-term investments resulting from higher market interest rates and the increased cash position as a result of the $120.0 million in proceeds received in December 2005 from the sale of Infergen^®.

 

Interest expense

 

Interest expense remained flat at $0.3 million for each of the three-month periods ended March 31, 2006 and March 31, 2005. Interest expense for each of the reported periods is a result of our outstanding $170.0 million 0.25% convertible senior notes due in March 2011 and includes amortization of debt issuance costs.

 

Other income (expense)

 

Other income (expense) was $0.1 million expense for the three-month period ended March 31, 2006 compared to other income of $0.7 million for the three-month period ended March 31, 2005. Other income of $0.7 million for the three-month period ended March 31, 2005 represented a foreign currency transaction gain.

 

Loss from Discontinued Operations

 

The loss from discontinued operations reflects the divestiture of our Infergen^® product line to Valeant which was completed in December 2005. The loss from discontinued operations of $0.3 million in the three months ended March 31, 2006 compares to a loss of $7.2 million in the three months ended March 31, 2005. The components of the loss from discontinued operations for the three months ended March 31, 2005 included net revenue of Infergen^®, the related cost of goods sold and amortization of acquired product rights, as well as certain allocated research and development and selling general and administrative expenses specific to Infergen^®.

 

Liquidity and Capital Resources

 

At March 31, 2006, we had available cash, cash equivalents and available-for-sale securities of $194.6 million. The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we invest our excess cash in debt instruments of the U.S. federal and state governments and their agencies and high-quality corporate issuers, and, by policy, restrict our exposure to any single corporate issuer by imposing concentration limits.

 

Operating Activities

 

Cash used in operating activities was $30.0 million during the three-month period ended March 31, 2006, comprised primarily of a net loss of $12.8 million and a significant decrease in accounts payable and accrued compensation of approximately $26.0 million. This use of cash was partially offset by a decrease in accounts receivable of $6.1 million. The decrease in accounts payable and accrued compensation was the result of

approximately $4.5 million in severance payments made in connection with the headcount reduction at the end of 2005 as a result of our decision to concurrently sell our Infergen^® assets and reduce our investment in field-based IPF disease awareness activities. In addition, we reduced the days outstanding in our trade payables, thus reducing our accounts payable balance by approximately $17.0 million. The decrease in accounts receivable is primarily due to the decline in Actimmune^® sales and the elimination of Infergen^® sales. Details concerning the loss from operations can be found above in this Report under the heading “Results of Operations.”

 

Investing Activities

 

Cash used in investing activities was $77.1 million in during the three-month period ended March 31, 2006, comprised primarily of purchases of short-term investments totaling $87.0 million, offset by approximately $10.0 million of short-term investment maturities. A portion of the $120.0 million in proceeds received from the sale of our Infergen^® assets at the end of 2005 was invested during the quarter in accordance with our investment objectives.

 

Financing Activities

 

Cash provided by financing activities of $9.8 million for the three-month period ended March 31, 2006 was primarily due to the receipt of proceeds from issuance of common stock. A significant number of in-the-money stock options were exercised as a result of the headcount reduction at the end of 2005.

 

We do not have any “special purpose” entities that are not consolidated in our financial statements. We have no commercial commitments with related parties. We have no loans with related parties, except for executive loans to Dr. Marianne Armstrong, our Chief Medical Affairs and Regulatory Officer in the amount of $0.2 million (due April 2007), and Dr. Lawrence Blatt, our Chief Scientific Officer, in the amount of $0.1 million (due May 2007). Both of these loans were in place prior to the enactment of the Sarbanes-Oxley Act in 2002.

 

We believe that we will continue to require substantial additional funding in order to complete the research and development activities currently contemplated and to commercialize our product candidates. We believe our existing cash, cash equivalents and available-for-sale securities, together with anticipated cash flows from our operations, will be sufficient to fund our operating expenses, debt obligations and capital requirements under our current business plan through at least the end of 2007. However, this forward-looking statement is based upon the risks identified in this report; our current plans and assumptions, which may change; and our capital requirements, which may increase in future periods. Our future capital requirements will depend on many factors, including, but not limited to:

 

 

 

As a result, we may require additional funds and may attempt to raise additional funds through equity or debt financings, collaborative arrangements with corporate partners or from other sources. We have no commitments for such fund raising activities at this time. Additional funding may not be available to finance our operations when needed or, if available, the terms for obtaining such funds may not be favorable or may result in dilution to our stockholders.

 

The securities in our investment portfolio are not leveraged, are classified as available-for-sale and are, due to their short-term nature, subject to minimal interest rate risk. We currently do not hedge interest rate exposure. Because of the short-term maturities of our investments, we do not believe that a change in market rates would have a significant negative impact on the value of our investment portfolio.

 

The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we invest our excess cash in debt instruments of the U.S. federal and state governments and its agencies and high-quality corporate issuers, and, by policy, restrict our exposure to any single corporate issuer by imposing concentration limits. To minimize the exposure due to adverse shifts in interest rates we maintain investments of shorter effective maturities.

 

The table below presents the principal amounts and weighted-average interest rates by year of maturity for our investment portfolio as of March 31, 2006 by effective maturity (in millions, except percentages):

 

 

Foreign Currency Market Risk

 

We have obligations denominated in euros for the purchase of Actimmune^® inventory. In 2004, we used foreign currency forward contracts to partially mitigate this exposure, but did not enter into any new foreign currency forward contracts in 2005 or 2006 to date. We regularly evaluate the cost-benefit of entering into such arrangements, and presently have no foreign currency hedge agreements outstanding.

 

Evaluation of Disclosure Controls and Procedures.

 

As of the end of the period covered by this quarterly report on Form 10-Q, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures, or “disclosure controls.” This controls evaluation was performed under the supervision and with the participation of management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”). Disclosure controls are controls and procedures designed to reasonably assure that information required to be disclosed in our reports filed under the Exchange Act, such as this Report, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls are also designed to reasonably ensure that such information is accumulated and communicated to our management, including the CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure. Based upon the controls evaluation, our CEO and CFO have concluded that, as a result of the matters discussed below with respect to our internal control over financial reporting, our disclosure controls were effective as of the end of the period covered by this Report.

 

Internal Control Over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Our internal control system was designed to provide reasonable assurance to management and our board of directors regarding the reliability of financial reporting and preparation of published financial statements in accordance with generally accepted accounting principles.

 

Management assessed our internal control over financial reporting as of December 31, 2005, the end of our fiscal year, and concluded that our internal control over financial reporting was effective as of December 31, 2005. Management assessed our internal control over financial reporting as of March 31, 2006, the end of the period covered by this report. As a result of this assessment, management has concluded that our internal control over financial reporting was effective as of March 31, 2006. In making our assessment of internal control over financial reporting, we used the criteria issued in the report Internal Control-Integrated Framework by the Committee of Sponsoring Organizations of the Treadway Commission.

 

Changes in Internal Control Over Financial Reporting

 

There have been no changes to our internal controls over financial reporting during the three months ended March 31, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

CEO and CFO Certifications

 

Attached as exhibits to this Report, there are “Certifications” of the CEO and the CFO required by Rule 13a-14(a) of the Securities Exchange Act of 1934, or the Rule 13a-14(a) Certifications. This Controls and Procedures section of the Report includes the information concerning the controls evaluation referred to in the Rule 13a-14(a) Certifications and it should be read in conjunction with the Rule 13a-14(a) Certifications for a more complete understanding of the topics presented.

 

Limitations on the effectiveness of controls.

 

Our management, including our CEO and CFO, does not expect that our control systems will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within InterMune have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. Accordingly, our disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the objectives of our disclosure control system are met and, as set forth above, our CEO and CFO have concluded, based on their evaluation as of the end of the period covered by this Report, that our disclosure controls and procedures were effective to provide reasonable assurance that the objectives of our disclosure control system were met.

 

On November 9, 2004, we received a subpoena from the U.S. Department of Justice requiring us to provide the Department of Justice with certain information relating to Actimmune^®, including information regarding the promotion and marketing of Actimmune^®. We are cooperating with the Department of Justice in this inquiry. Although we cannot predict whether the outcome of this inquiry will have a material adverse effect on our business, it is possible that we will be required to pay a substantial civil fine in connection with the settlement of this matter. At this time we cannot predict the magnitude of such a fine or the impact the payment of such a fine may have on our future business operations.

 

An investment in our common stock is risky. Stockholders and potential investors in shares of our stock should carefully consider the following risk factors, which hereby update those risks contained in the “Risk Factors” section of our Annual Report on Form 10-K for the period ended December 31, 2005, in addition to other information and risk factors in this Report. We are identifying these risk factors as important factors that could cause our actual results to differ materially from those contained in any written or oral forward-looking statements made by or on behalf of InterMune. We are relying upon the safe harbor for all forward-looking statements in this Report, and any such statements made by or on behalf of InterMune are qualified by reference to the following cautionary statements, as well as to those set forth elsewhere in this Report.

 

Risks Related to the Development of Our Products and Product Candidates

 

We may not succeed in our development efforts or in growing product revenue.

 

We commenced operations in 1998 and have incurred significant losses to date. Our revenue has been limited primarily to sales of Actimmune^® derived from physicians’ prescriptions for the off-label use of Actimmune^® in the treatment of IPF. Although we are developing Actimmune^® for the treatment of IPF, Actimmune^® may not be marketed for IPF before 2008, if at all. We are developing pirfenidone for the treatment of IPF, but pirfenidone will not be marketed for any diseases before 2010, if at all.

 

We may fail to develop our products on schedule, or at all, for the reasons stated in this “Risks Related to the Development of Our Products and Product Candidates” section of this Report. If this were to occur, our costs would increase and our ability to generate revenue could be impaired. In addition, we may need to raise capital in amounts greater than we anticipate in order to continue our development activities as planned. If additional capital is not available, we may be forced to curtail our development activities or cease operations.

 

Clinical development is a long, expensive and uncertain process, and delay or failure can occur at any stage of any of our clinical trials.

 

To gain approval to market a product for treatment of a specific disease, we must provide the FDA and foreign regulatory authorities with clinical data that demonstrate the safety and statistically significant efficacy of that product for the treatment of the disease. Clinical development is a long, expensive and uncertain process, and delay or failure can occur at any stage of any of our clinical trials. A number of companies in the pharmaceutical industry, including biotechnology companies, have suffered significant setbacks in advanced clinical trials, even after promising results in earlier trials. Success in preclinical testing and early clinical trials does not ensure that later clinical trials will be successful. For example, we have decided to end our investment in Actimmune^® for patients with ovarian cancer as a result of our decision to discontinue the GRACES trial on the recommendation of an independent Data Safety Monitoring Board. As a result, we do not intend to conduct further development of Actimmune^® for the treatment of ovarian cancer.

 

We are conducting the INSPIRE trial, a second Phase III clinical trial of Actimmune^® as a treatment for IPF. However, Actimmune^® may not demonstrate safety or statistically significant efficacy with respect to the primary or secondary endpoints of the protocol of that clinical trial or any additional clinical trial. If the Phase III clinical

trial were to fail to demonstrate statistically significant efficacy, we would likely abandon the development of Actimmune^® for the treatment of IPF, which would seriously harm our business and would result in a significant decline in our expected Actimmune^® revenue.

 

We do not know whether our planned clinical trials will begin on time, or at all, or will be completed on schedule, or at all.

 

The commencement or completion of any of our clinical trials may be delayed or halted for numerous reasons, including, but not limited to, the following:

 

 

Our development costs will increase if we have material delays in our clinical trials or if we need to perform more or larger clinical trials than planned. For example, our development costs related to Actimmune^® as a treatment for IPF increased due to our need to conduct an additional Phase III clinical trial, as our first Phase III clinical trial of Actimmune^® for the treatment of IPF failed to show a significant effect on the primary endpoint of progression-free survival or on secondary endpoints of lung function and quality of life. In addition, we conducted a blinded pre-specified sample size re-evaluation in the INSPIRE trial that was a part of the original study protocol to determine if the observed aggregate mortality rate to date was consistent with the mortality assumptions underlying the trial design. At this early stage of the trial, the aggregate mortality rate observed was somewhat lower than the projections used in designing the trial. To increase the likelihood of reaching the total number of deaths upon which the trial is powered by the time the trial is scheduled to conclude in late 2007, we decided to increase the trial size by approximately 200 patients. However, there is no guarantee that this increase in patient numbers will in fact result in an aggregate mortality rate necessary to reach the mortality projections. In this event, the scheduled completion of this trial could extend past late 2007. If there are any significant delays for this or any of our other current or planned clinical trials, our financial results and the commercial prospects for our products and product candidates will be harmed, and our prospects for profitability will be impaired.

 

Preclinical development is a long, expensive and uncertain process, and we may terminate one or more of our current preclinical development programs.

 

We may determine that certain preclinical product candidates or programs do not have sufficient potential to warrant the allocation of resources toward them. Accordingly, we may elect to terminate our programs for and, in certain cases, our licenses to, such product candidates or programs. If we terminate a preclinical program in which we have invested significant resources, we will have expended resources on a program that will not provide a full return on our investment and missed the opportunity to have allocated those resources to potentially more productive uses.

Risks Related to Government Regulation and Approval of our Products and Product Candidates

 

If we fail to comply or have failed in the past to comply with FDA or other government regulations prohibiting the promotion of off-label uses and the promotion of products for which marketing approval has not been obtained, it could result in regulatory enforcement action by the FDA or other governmental authorities, including a substantial fine, either of which could harm our business.

 

Physicians may prescribe commercially available drugs for uses that are not described in the product’s labeling and that differ from those uses tested by us and approved by the FDA. Such off-label uses are common across medical specialties. For example, even though the FDA has not approved the use of Actimmune^® for the treatment of IPF, we are aware that physicians are, and have in the past, prescribing Actimmune^® for the treatment of IPF. Substantially all of our Actimmune^® revenue is derived from physicians’ prescriptions for off-label use for IPF. The FDA does not regulate the behavior of physicians in their choice of treatments. The FDA and other governmental agencies do, however, restrict manufacturers’ communications on the subject of off-label use. Companies may not promote FDA approved drugs or investigational drugs for off-label or unapproved uses. Accordingly, we may not promote Actimmune^® for the treatment of IPF. The FDA and other governmental authorities actively enforce regulations prohibiting promotion of off-label uses and the promotion of products for which marketing approval has not been obtained. The federal government has levied large civil and criminal fines against manufacturers for alleged improper promotion, and the FDA has enjoined several companies from engaging in off-label promotion. The FDA has also requested that companies enter into consent decrees or permanent injunctions under which certain promotional conduct is changed or curtailed. We are aware of at least one instance in which the Office of the Inspector General of the FDA has sought and secured criminal penalties and a corporate integrity agreement against a pharmaceutical manufacturer requiring that company to pay substantial fines and to monitor certain promotional activities to ensure compliance with FDA regulations. We engage in medical education activities that are subject to scrutiny under the FDA’s regulations relating to off-label promotion. While we believe we are currently in compliance with these regulations, the regulations are subject to varying interpretations, which are evolving.

 

If the FDA or any other governmental agency initiates an enforcement action against us and it is determined that we violated prohibitions relating to off-label promotion in connection with past or future activities, we could be subject to civil and/or criminal fines and sanctions such as those noted above in this risk factor, any of which would have an adverse effect on our revenue, business and financial prospects. On November 9, 2004, we received a subpoena from the U.S. Department of Justice requiring us to provide the Department of Justice with certain information relating to Actimmune^®, including information regarding the promotion and marketing of Actimmune^®. We are cooperating with the Department of Justice in this inquiry. Although we cannot predict whether the outcome of this inquiry will have a material adverse effect on our business, it is possible that we will be required to pay a substantial civil fine in connection with the settlement of this matter. At this time we cannot predict the magnitude of such a fine or the impact the payment of such a fine may have on our future business operations.

 

In addition, some of the agreements pursuant to which we license our products, including our license agreement relating to Actimmune^®, contain provisions requiring us to comply with applicable laws and regulations, including the FDA’s restriction on the promotion of FDA approved drugs for off-label uses. As a result, if it were determined that we violated the FDA’s rules relating to off-label promotion in connection with our marketing of Actimmune^®, we may be in material breach of our license agreement for Actimmune^®. If we failed to cure a material breach of this license agreement, we could lose our rights to certain therapeutic uses for Actimmune^® under the agreement.

 

If the FDA imposes significant restrictions or requirements related to our products for any disease or withdraws its approval of any of our products for any disease for which they have been approved, our revenues would decline.

 

The FDA and foreign regulatory authorities may impose significant restrictions on the use or marketing of Actimmune^® or our other products or impose additional requirements for post-approval studies. Later discovery of previously unknown problems with any of our products or their manufacture may result in further restrictions, including withdrawal of the product from the market. In this regard, the FDA has conducted routine inspections of our manufacturing contractors, and some were issued a standard “notice of observations.” While we believe that all

of these observations are being appropriately corrected, failure to correct any deficiency could result in manufacturing delays. Our existing approvals for diseases, and any new approval for any other disease that we target, if granted, could be withdrawn for failure to comply with regulatory requirements or to meet our post-approval commitments. For example, we have ongoing Phase IV post-marketing commitments to the FDA relating to Actimmune^® for the treatment of osteopetrosis. Our failure to adequately address these ongoing Phase IV commitments could result in a regulatory action or restriction, such as withdrawal of the relevant product’s approval by the FDA. If approval for a disease is withdrawn, we could no longer market the affected product for that disease. In addition, governmental authorities could seize our inventory of such product, or force us to recall any product already in the market, if we fail to comply with FDA or other governmental regulations.

 

For a description of restrictions relating to the off-label promotion of our products, please see the risk factor titled, “If we fail to comply or have in the past failed to comply with FDA or other government regulations prohibiting the promotion of off-label uses and the promotion of products for which marketing approval has not been obtained, it could result in regulatory enforcement action by the FDA or other governmental authorities, including a substantial fine, either of which could harm our business.” above.

 

If our clinical trials fail to demonstrate to the FDA and foreign regulatory authorities that any of our products or product candidates are safe and effective for the treatment of particular diseases, the FDA and foreign regulatory authorities may require us to conduct additional clinical trials or may not grant us marketing approval for such products or product candidates for those diseases.

 

Our failure to adequately demonstrate the safety and effectiveness of any of our products or product candidates for the treatment of particular diseases will delay or prevent our receipt of the FDA’s and foreign regulatory authorities’ approval and, ultimately, may prevent commercialization of our products and product candidates for those diseases. The FDA and foreign regulatory authorities have substantial discretion in deciding whether, based on the benefits and risks in a particular disease, any of our products or product candidates should be granted approval for the treatment of that particular disease. Even if we believe that a clinical trial has demonstrated the safety and statistically significant efficacy of any of our products or product candidates for the treatment of a disease, the results may not be satisfactory to the FDA or foreign regulatory authorities. Preclinical and clinical data can be interpreted by the FDA and foreign regulatory authorities in different ways, which could delay, limit or prevent regulatory approval. If regulatory delays are significant or regulatory approval is limited or denied altogether, our financial results and the commercial prospects for those of our products or product candidates involved will be harmed, and our prospects for profitability will be impaired.

 

The pricing and profitability of our products may be subject to control by the government and other third-party payors.

 

The continuing efforts of governmental and other third-party payors to contain or reduce the cost of healthcare through various means may adversely affect our ability to successfully commercialize our products. For example, in most foreign markets, the pricing and/or profitability of prescription pharmaceuticals are subject to governmental control. In the United States, we expect that there will continue to be federal and state proposals to implement similar governmental controls. For example, the federal Medicare Prescription Drug Improvement and Modernization Act of 2003 provides a new Medicare prescription drug benefit which began in 2006 and which mandates other reforms. Although we cannot predict the full effects on our business of the implementation of this program, it is possible that the new Medicare benefit, which will be managed by private health insurers, pharmacy benefit managers and other managed care organizations, will result in decreased reimbursement for prescription drugs, which may further exacerbate industry-wide pressure to reduce the prices charged for prescription drugs. In addition, increasing emphasis on managed care in the United States will continue to put pressure on the pricing of pharmaceutical products. These new and any future cost-control initiatives could decrease the price that we would receive for Actimmune^® or any other products that we may develop in the future, which would reduce our revenue and potential profitability.

Our failure or alleged failure to comply with anti-kickback and false claims laws could result in civil and/or criminal sanctions and/or harm our business.

 

We are subject to various federal and state laws pertaining to health care “fraud and abuse,” including anti-kickback laws and false claims laws. Subject to certain exceptions, the anti-kickback laws make it illegal for a prescription drug manufacturer to knowingly and willfully solicit, offer, receive or pay any remuneration in exchange for, or to induce, the referral of business, including the purchase or prescription of a particular drug. The federal government has published regulations that identify “safe harbors” or exemptions for certain payment arrangements that do not violate the anti-kickback statutes. Due to the breadth of the statutory provisions and the absence of guidance in the form of regulations or court decisions addressing some of our practices, it is possible that our practices might be challenged under anti-kickback or similar laws. False claims laws prohibit anyone from knowingly presenting, or causing to be presented, for payment to third party payors (including Medicare and Medicaid) claims for reimbursed drugs or services that are false or fraudulent, claims for items or services not provided as claimed or claims for medically unnecessary items or services. Our activities relating to the reporting of wholesaler or estimated retail prices for our products, the reporting of Medicaid rebate information and other information affecting federal and state and third-party payment for our products, and the sale and marketing of our products, could become subject to scrutiny under these laws.

 

In addition, pharmaceutical companies have been prosecuted under the False Claims Act in connection with their “off-label” promotion of drugs. For information regarding allegations with respect to “off-label” promotion by us, please see the risk factor titled “If we fail to comply or have in the past failed to comply with FDA or other government regulations prohibiting the promotion of off-label uses and the promotion of products for which marketing approval has not been obtained, it could result in regulatory enforcement action by the FDA or other governmental authorities, including a substantial fine, either of which could harm our business” above.

 

If the government were to allege that we were, or convict us of, violating these laws, there could be a material adverse effect on us, including a substantial fine, decline in our stock price, or both. Our activities could be subject to challenge for the reasons discussed above and due to the broad scope of these laws and the increasing attention being given to them by law enforcement authorities.

 

Risks Related to Manufacturing and Our Dependence on Third Parties

 

The manufacturing and manufacturing development of our products and product candidates present technological, logistical and regulatory risks, each of which may adversely affect our potential revenues.

 

The manufacturing and manufacturing development of pharmaceuticals, and, in particular, biologicals, are technologically and logistically complex and heavily regulated by the FDA and other governmental authorities. The manufacturing and manufacturing development of our products and product candidates present many risks, including, but not limited to, the following:

 

 

Any of these factors could delay clinical trials, regulatory submissions and/or commercialization of our products for particular diseases, interfere with current sales, entail higher costs and result in our being unable to effectively sell our products.

Our manufacturing strategy, which relies on third-party manufacturers, exposes us to additional risks as a result of which we may lose potential revenues.

 

We do not have the resources, facilities or experience to manufacture any of our products or product candidates ourselves. Completion of our clinical trials and commercialization of our products requires access to, or development of, manufacturing facilities that meet FDA standards to manufacture a sufficient supply of our products. The FDA must approve facilities that manufacture our products for commercial purposes, as well as the manufacturing processes and specifications for the product. We depend on third parties for the manufacture of our products and product candidates for preclinical, clinical and commercial purposes, and we rely on third parties with FDA approved manufacturing facilities for the manufacture of Actimmune^® for commercial purposes. These third parties include BI and Cardinal Health, Inc. (“Cardinal”). We have a long-term supply contract with BI for Actimmune^® and an agreement with Cardinal for the manufacture of the drug product for pirfenidone. However, if we do not perform our obligations under these agreements, these agreements may be terminated.

 

Our manufacturing strategy for our products and product candidates presents many risks, including, but not limited to, the following:

 

 

Any of these factors could delay clinical trials, regulatory submissions or commercialization of our products for particular diseases, interfere with current sales, entail higher costs and result in our being unable to effectively sell our products.

We rely on third parties to conduct clinical trials for our products and product candidates, and those third parties may not perform satisfactorily.

 

If our third-party contractors do not successfully carry out their contractual duties or meet expected deadlines, we may be delayed in or prevented from obtaining regulatory approvals for our products and product candidates, and may not be able to successfully commercialize our products and product candidates for targeted diseases. We do not have the ability to independently conduct clinical trials for all of our products and product candidates, and we rely on third parties such as contract research organizations, medical institutions and clinical investigators to perform this function. Our ability to monitor and audit the performance of these third parties is limited. If these third parties do not perform satisfactorily, our clinical trials may be extended or delayed, resulting in potentially substantial cost increases to us and other adverse impacts on our product development efforts. We may not be able to locate any necessary acceptable replacements or enter into favorable agreements with them, if at all.

 

Risks Related to the Commercialization of Our Products and Product Candidates

 

We rely on one customer for approximately 60% of our total revenue. If this customer does not continue to sell Actimmune^® at its current levels, our business will be harmed.

 

During the three months ended March 31, 2006, CuraScript, Inc. (formerly Priority Healthcare, Inc.) accounted for approximately 62% of our total product sales and 67% of our outstanding receivables. If this customer or any other customer that sells a significant portion of Actimmune^® were to experience financial difficulties, or otherwise became unable or unwilling to sell Actimmune^®, our business would be harmed. Additionally, any reduction, delay or loss of orders from our key customers could harm our revenue in any period or harm our business generally.

 

If the specialty pharmacies and distributors that we rely upon to sell our products fail to perform, our business may be adversely affected.

 

Our success depends on the continued customer support efforts of our network of specialty pharmacies and distributors. A specialty pharmacy is a pharmacy that specializes in the dispensing of injectable or infused medications for complex or chronic conditions, which often require a high level of patient education and ongoing management. The use of specialty pharmacies and distributors involves certain risks, including, but not limited to, risks that these specialty pharmacies and distributors will:

 

 

Any such failure may result in decreased Actimmune^® revenues, which would harm our business.

 

Even if regulatory authorities approve our products or product candidates for the treatment of the diseases we are targeting, our products may not be marketed or be commercially successful.

 

Our products and product candidates are expensive, and we anticipate that the annual cost for treatment for each of the diseases for which we are seeking approval will be significant. These costs will vary for different diseases based on the dosage and method of administration. Accordingly, we may decide not to market any of our products or product candidates for an approved disease because we believe that it may not be commercially

successful. Market acceptance of and demand for our products and product candidates will depend on many factors, including, but not limited to:

 

 

If third-party payors do not provide coverage or reimburse patients for our products, our revenue and prospects for profitability will suffer.

 

Our ability to commercialize our products or product candidates for particular diseases is highly dependent on the extent to which coverage and reimbursement for our products is available from:

 

 

Significant uncertainty exists as to the coverage and reimbursement status of pharmaceutical products, particularly with respect to products that are prescribed by physicians for off-label use. If governmental and other third-party payors do not provide adequate coverage and reimbursement levels for our products, market acceptance of our products will be reduced, and our sales will suffer. Many third-party payors provide coverage or reimbursement only for FDA approved indications. If any large or many third-party payors decide to deny reimbursement for Actimmune^® used to treat IPF, sales of Actimmune^® would decline, and our revenue would suffer.

 

Often, third-party payors make the decision to reimburse an off-label prescription based on whether that product has a compendia listing. A drug compendia is produced by a compendia body, such as the United States Pharmacopoeia Drug Information, that lists approved indications that a product has received from the FDA. The compendia bodies also evaluate all of the clinical evidence to determine whether an off-label use of a product should be listed in the compendia as medically appropriate. A compendia listing of an off-label use is a requirement of third-party payors, such as Medicare and private payors, to cover that use. Applications for a compendia listing are often based upon the publication of certain data in peer reviewed journals whose publication is often outside the applicant’s control. If we are unable to achieve acceptance by a compendia body for Actimmune^® for the treatment of IPF, additional third-party payors may decide to deny reimbursement for Actimmune^® for the treatment of IPF, and fewer physicians may prescribe Actimmune^® for such treatment. If either of these were to occur, sales of Actimmune^® would decline and our revenue would suffer.

 

Some third-party payors have denied coverage for Actimmune^® for the treatment of IPF for a variety of reasons, including the cost of Actimmune^®, the fact that IPF is not an FDA approved indication for Actimmune^® or a third-party payor’s assessment that a particular patient’s case of IPF has advanced to a stage at which treatment with Actimmune^® would not have a significant effect. We believe that approximately 60-70% of the patients who seek coverage for Actimmune^® for the treatment of IPF from private third-party payors are able to obtain coverage. While coverage trends have not changed significantly in the last two years, major health plans could further restrict coverage or adopt a policy of no coverage.

Medicare generally does not provide coverage for drugs, like Actimmune^®, that are administered by injection in the home. However, in connection with the Medicare Prescription Drug Improvement and Modernization Act of 2003, Medicare has recently discussed the possibility of refusing to provide coverage for products for a specific indication unless the product has been approved by the FDA for that indication. If Medicare were to make a formal decision not to cover the off-label use of products, it may have a negative impact on the willingness of private third-party payors to provide coverage for the off-label use of products such as Actimmune^®.

 

Our supply agreement with BI may restrict our ability to establish alternative sources of Actimmune^® in a timely manner or at an acceptable cost, which may cause us to be unable to meet demand for Actimmune^® and to lose potential revenue.

 

Our supply agreement with BI provides that BI is our exclusive source of supply for Actimmune^®, except under certain circumstances. Under our agreement with BI, we cannot seek a secondary source to manufacture Actimmune^® until BI has indicated to us its inability or unwillingness to meet our requirements. If we are delayed in establishing a secondary supply source for Actimmune^®, or cannot do so at an acceptable cost, we may suffer a shortage of commercial supply of Actimmune^® or a higher cost of product, either of which would have a material and adverse effect on our revenue, business and financial prospects.

 

Competitive activities of other drug companies may limit our products’ revenue potential or render them obsolete.

 

Our commercial opportunities will be reduced or eliminated if our competitors develop or market products that, compared to our products or product candidates:

 

 

Even if we are successful in developing effective drugs, our products may not compete effectively with our competitors’ current or future products. Our competitors include larger, more established, fully integrated pharmaceutical companies and biotechnology companies that have substantially greater capital resources, existing competitive products, larger research and development staffs and facilities, greater experience in drug development and in obtaining regulatory approvals and greater marketing capabilities than we do.

 

Risks Related to Our Intellectual Property Rights

 

We may not be able to obtain, maintain and protect certain proprietary rights necessary for the development and commercialization of our products or product candidates.

 

Our commercial success will depend in part on obtaining and maintaining patent protection on our products and product candidates and successfully defending these patents against third-party challenges. Our ability to commercialize our products will also depend in part on the patent positions of third parties, including those of our competitors. The patent positions of pharmaceutical and biotechnology companies can be highly uncertain and involve complex legal and factual questions. No consistent policy regarding the breadth of claims allowed in

biotechnology patents has emerged to date. Accordingly, we cannot predict with certainty the scope and breadth of patent claims that may be afforded to other companies’ patents. We could incur substantial costs in litigation if we are required to defend against patent suits brought by third parties, or if we initiate suits to protect our patent rights.

 

The degree of future protection for our proprietary rights is uncertain, and we cannot ensure that:

 

 

Others have filed and in the future may file patent applications covering uses and formulations of interferon gamma-1b, a pegylated version of this product, and other products in our development program. If a third party has been or is in the future issued a patent that blocked our ability to commercialize any of our products, alone or in combination, for any or all of the diseases that we are targeting, we would be prevented from commercializing that product or combination of products for that disease or diseases unless we obtained a license from the patent holder. We may not be able to obtain such a license to a blocking patent on commercially reasonable terms, if at all. If we cannot obtain, maintain and protect the necessary proprietary rights for the development and commercialization of our products or product candidates, our business and financial prospects will be impaired.

 

Since the pirfenidone molecule is in the public domain and the patent we licensed from Marnac is limited to specific methods of use of pirfenidone, we may be subject to competition from third party products with the same active pharmaceutical ingredients as our product candidate.

 

Composition of matter patent protection for pirfenidone molecule has expired in the United States and elsewhere. Marnac, Inc. (“Marnac”) and others have obtained patents in the United States and elsewhere relating to methods of use of pirfenidone for the treatment of certain diseases. We have licensed from Marnac and KDL GmbH (“KDL”) rights to a U.S. patent related to the use of pirfenidone for the treatment of fibrotic disorders, including the use of pirfenidone for the treatment of IPF. Marnac has retained rights under other U.S. and foreign patents for the use of pirfenidone to treat diseases other than fibrotic disorders. It is possible that Marnac will license these patent rights to third parties to develop, market, sell and distribute pirfenidone for these indications in the United States and elsewhere. It is also possible that a third party may develop pirfenidone for the treatment of certain diseases that are not covered by patents held by Marnac or those we licensed from Marnac. If Marnac or others were to license their method of use patents for non anti-fibrotic indications to a third party, or if a third party were to develop pirfenidone for a use that is not covered by any patents and such third parties successfully developed pirfenidone for non-fibrotic indications, we could face competition from third party products with the same active pharmaceutical ingredient as our product candidate. If a third party were to obtain FDA approval for the use of pirfenidone for an indication before we did, such third party would be first to market and could establish the price for pirfenidone. This could adversely impact our ability to implement our pricing strategy for the product and may limit our ability to maximize the commercial potential of pirfenidone. The presence of a lower priced competitive product with the same active pharmaceutical ingredients as our product could lead to use of the competitive product for our anti-fibrotic indications. This could lead to pricing pressure for pirfenidone, which would adversely affect our ability to generate revenue from the sale of pirfenidone for anti-fibrotic indications.

If we breach our license agreements, we may lose our ability to develop and sell our products.

 

We license certain patents and trade secrets relating to Actimmune^® from Genentech, Inc. (“Genentech”) and relating to pirfenidone from Marnac and KDL. If we breach any of our agreements with Genentech or with Marnac and KDL, any of these licensors may be able to terminate the respective license, and we would have no further rights to utilize the licensed patents or trade secrets to develop and market the corresponding products, which could adversely affect our revenue and financial prospects.

 

Over time, we will lose our ability to rely upon the intellectual property we currently own to prevent competing products, which may impair our ability to generate revenue.

 

We have licensed certain patents relating to interferon gamma-1b, the active ingredient in Actimmune^®, from Genentech. A U.S. patent relating to the composition of interferon gamma-1b expires in 2014. Other material U.S. patents relating to interferon gamma-1b expire between 2009 and 2013. We also previously purchased certain patents relating to interferon gamma analogs from Amgen, Inc. (“Amgen”) in 2002 including two U.S. patents that issued August 30, 2005 which will expire on August 30, 2022. When these various patents expire, we will be unable to use these patents to try to block others from marketing interferon gamma-1b in the United States.

 

We have licensed from Marnac and KDL rights to a U.S. patent related to the use of pirfenidone for the treatment of fibrotic disorders, including the use of pirfenidone for the treatment of IPF. After the U.S. patent expires in 2011, we will not be able to use this patent to block others from marketing pirfenidone for fibrotic disorders, including IPF although we may be able to extend our U.S. exclusivity for IPF if we gain FDA approval for IPF under orphan drug designation, which we may not be able to do. The pirfenidone molecule itself has no composition of matter patent protection in the United States or elsewhere. Therefore, we have no ability to prevent others from commercializing pirfenidone for (i) uses covered by the other patents held by Marnac and third parties, or (ii) other uses in the public domain for which there is no patent protection. We are relying on exclusivity granted from orphan drug designation in IPF to protect pirfenidone from competitors in this indication. The exclusivity period in the United States begins on first NDA approval for this product in IPF and ends seven years thereafter. In addition, a third party could develop pirfenidone for another non-fibrotic disease that also qualifies for orphan drug designation and could be granted seven years exclusivity in that indication. Additionally, in the European Union we have been granted orphan drug designation for pirfenidone for the treatment of IPF by the EMEA, which provides for ten years of market exclusivity in the European Union following first marketing approval in the European Union. We cannot provide any assurance that we will be able to maintain this orphan drug designation.

 

Once our patents expire, we will be subject to competition from third parties who will be able to use the intellectual property covered by these patents, which could impair our ability to generate revenue.

 

Litigation or third-party claims of intellectual property infringement could require us to spend substantial time and money and could adversely affect our ability to develop and commercialize products.

 

Our commercial success depends in part on our ability and the ability of our collaborators to avoid infringing patents and proprietary rights of third parties. As noted in the immediately preceding risk factor, third parties may accuse us or our collaborators of employing their proprietary technology in our products, or in the materials or processes used to research or develop our products, without authorization. Any legal action against our collaborators or us claiming damages and/or seeking to stop our commercial activities relating to the affected products, materials and processes could, in addition to subjecting us to potential liability for damages, require our collaborators or us to obtain a license to continue to utilize the affected materials or processes or to manufacture or market the affected products. We cannot predict whether we, or our collaborators, would prevail in any of these actions or whether any license required under any of these patents would be made available on commercially reasonable terms, if at all. If we are unable to obtain such a license, we, or our collaborators, may be unable to continue to utilize the affected materials or processes or manufacture or market the affected products or we may be obligated by a court to pay substantial royalties and/or other damages to the patent holder. Even if we are able to obtain such a license, the terms of such a license could substantially reduce the commercial value of the affected product or products and impair our prospects for profitability. Accordingly, we cannot predict whether or to what extent the commercial value of the affected product or products or our prospects for profitability may be harmed as a

result of any of the liabilities discussed above. Furthermore, infringement and other intellectual property claims, with or without merit, can be expensive and time-consuming to litigate and can divert management’s attention from our core business.

 

If the owners of the intellectual property we license fail to maintain the intellectual property, we may lose our rights to develop our products or product candidates.

 

We generally do not control the patent prosecution of technology that we license from others. Accordingly, we are unable to exercise the same degree of control over this intellectual property as we would exercise over technology that we own. For example, if Genentech fails to maintain the intellectual property licensed to us, we may lose our rights to develop and market certain therapeutic uses for Actimmune^® and may be forced to incur substantial additional costs to maintain or protect the intellectual property or to compel Genentech to do so.

 

If our employees, consultants and vendors do not comply with their confidentiality agreements or our trade secrets otherwise become known, our ability to generate revenue and profits may be impaired.

 

We rely on trade secrets to protect technology where it is possible that patent protection is not appropriate or obtainable. However, trade secrets are difficult to protect. We protect these rights mainly through confidentiality agreements with our corporate partners, employees, consultants and vendors. These agreements generally provide that all confidential information developed or made known to an individual or company during the course of their relationship with us will be kept confidential and will not be used or disclosed to third parties except in specified circumstances. In the case of employees and consultants, our agreements generally provide that all inventions made by the individual while engaged by us will be our exclusive property. We cannot be certain that these parties will comply with these confidentiality agreements, that we will have adequate remedies for any breach, or that our trade secrets will not otherwise become known or be independently discovered by our competitors. If our trade secrets become known, we may lose a competitive advantage and our ability to generate revenue may therefore be impaired.

 

By working with corporate partners, research collaborators and scientific advisors, we are subject to disputes over intellectual property, and our ability to obtain patent protection or protect proprietary information may be impaired.

 

Under some of our research and development agreements, inventions discovered in certain cases become jointly owned by our corporate partner and us and in other cases become the exclusive property of one of us. It can be difficult to determine who owns a particular invention, and disputes could arise regarding those inventions. These disputes could be costly and could divert management’s attention from our business. Our research collaborators and scientific advisors have some rights to publish our data and proprietary information in which we have rights. Such publications may impair our ability to obtain patent protection or protect our proprietary information, which could impair our ability to generate revenue.

 

Risks Related to Our Financial Results and Other Risks Related to Our Business

 

If physicians do not prescribe Actimmune^® or prescribe it less often for the treatment of IPF, our revenue will decline.

 

Physicians may choose not to prescribe Actimmune^® or provide fewer patient referrals for Actimmune^® for the treatment of IPF because:

 

 

 

Net sales of Actimmune^® for the three months ended March 31, 2006 were $24.4 million, compared to $27.7 million for the three months ended March 31, 2005, a decline of 12%. If physicians do not prescribe Actimmune^® for the treatment of IPF for the above reasons or any other reasons, our Actimmune^® revenue will continue to decline. Revenue for Actimmune^® may have been adversely affected by the publication of an article and a related editorial in the January 8, 2004 issue of the New England Journal of Medicine regarding the results of our initial Phase III trial of Actimmune^® or the treatment of IPF. The article concluded that “(i)n a well-defined population of patients with idiopathic pulmonary fibrosis, (Actimmune^®) did not affect progression-free survival, pulmonary function, or the quality of life. Owing to the size of and duration of the trial, a clinically significant survival benefit could not be ruled out.” The related editorial that appeared in the January 8, 2004 New England Journal of Medicine, among other things, cast doubt on our study’s indication of “increased survival among patients who were compliant with interferon gamma-1b treatment” by stating, “(i)t should be emphasized that survival data based on one year of observation in a disease with an unknown date of onset and a life expectancy of two to five years after diagnosis may be very misleading.” The editorial concluded by stating, “(s)tudies of other promising agents ... are indicated, since interferon gamma-1b has not proved to be the answer.”

 

If we fail to obtain the capital necessary to fund our operations, we will be unable to successfully execute our business plan.

 

We believe our existing cash, cash equivalents and available-for-sale securities, together with anticipated cash flows from our operations, will be sufficient to fund our operating expenses, debt obligations and capital requirements under our current business plan through at least the end of 2007. However, our current plans and assumptions may change, and our capital requirements may increase in future periods. We have no committed sources of capital and do not know whether additional financing will be available when needed, or, if available, that the terms will be favorable to our stockholders or us. If additional funds are not available, we may be forced to delay or terminate clinical trials, curtail operations or obtain funds through collaborative and licensing arrangements that may require us to relinquish commercial rights or potential markets, or grant licenses on terms that are not favorable to us. If adequate funds are not available, we will not be able to successfully execute our business plan.

 

If we continue to incur net losses for a period longer than we anticipate, we may be unable to continue our business.

 

We have incurred net losses since inception, and our accumulated deficit was approximately $473.7 million at March 31, 2006. We expect to incur substantial additional net losses prior to achieving profitability, if ever. The extent of our future net losses and the timing of our profitability are highly uncertain, and we may never achieve profitable operations. We are planning to expand the number of diseases for which our products may be marketed, and this expansion will require significant expenditures. To date, we have generated revenue primarily through the sale of Actimmune^®. However, Actimmune^® sales have decreased in recent periods and Actimmune^® is currently our sole marketed product. We have not generated operating profits to date from our products. If the time required for us to achieve profitability is longer than we anticipate, we may not be able to continue our business.

Failure to accurately forecast our revenue could result in additional charges for excess inventories or non-cancelable purchase obligations.

 

We base many of our operating decisions on anticipated revenue trends and competitive market conditions, which are difficult to predict. Based on projected revenue trends, we acquired inventories and entered into non-cancelable purchase obligations in order to meet anticipated increases in demand for our products. However, more recent projected revenue trends resulted in us recording charges of $9.1 million during 2005 for excess inventory and non-cancelable purchase obligations for inventory in excess of forecasted needs. If revenue levels experienced in future quarters are substantially below our expectations, especially revenue from sales of Actimmune^®, we could be required to record additional charges for excess inventories and/or non-cancelable purchase obligations. For additional information relating to difficulties we have experienced forecasting revenue, see the risk factor titled, “We may fail to meet our publicly announced revenue and/or expense projections and/or other financial guidance, which would cause our stock to decline in value” below.

 

If product liability lawsuits are brought against us, we may incur substantial liabilities.

 

The testing, marketing and sale of medical products entail an inherent risk of product liability. If product liability costs exceed our liability insurance coverage, we may incur substantial liabilities. Whether or not we were ultimately successful in product liability litigation, such litigation would consume substantial amounts of our financial and managerial resources, and might result in adverse publicity, all of which would impair our business. While we believe that our clinical trial and product liability insurance currently provides adequate protection to our business, we may not be able to maintain our clinical trial insurance or product liability insurance at an acceptable cost, if at all, and this insurance may not provide adequate coverage against potential claims or losses.

 

Our use of hazardous materials, chemicals, viruses and radioactive compounds exposes us to potential liabilities.

 

Our research and development activities involve the controlled use and disposal of hazardous materials, chemicals, infectious disease agents and various radioactive compounds. Although we believe that our safety procedures for handling and disposing of such materials comply with the standards prescribed by state and federal regulations, we cannot completely eliminate the risk of accidental contamination or injury from these materials. In the event of such an accident, we could be held liable for significant damages or fines, which may not be covered by or may exceed our insurance coverage.

 

We face certain litigation risks that could harm our business.

 

On November 9, 2004, we received a subpoena from the U.S. Department of Justice requiring us to provide the Department of Justice with certain information relating to Actimmune^®, including information regarding the promotion and marketing of Actimmune^®. We are cooperating with the Department of Justice in this inquiry. Although we cannot predict whether the outcome of this inquiry will have a material adverse effect on our business, it is possible that we will be required to pay a substantial civil fine in connection with the settlement of this matter. At this time we cannot predict the magnitude of such a fine or the impact the payment of such a fine may have on our future business operations.

 

Insurance coverage is increasingly difficult to obtain or maintain.

 

While we currently maintain clinical trial and product liability insurance, directors’ and officers’ liability insurance, general liability insurance, property insurance and warehouse and transit insurance, first- and third-party insurance is increasingly more costly and narrower in scope, and we may be required to assume more risk in the future. If we are subject to third-party claims or suffer a loss or damage in excess of our insurance coverage, we may be required to share that risk in excess of our insurance limits. Furthermore, any first- or third-party claims made on our insurance policies may impact our future ability to obtain or maintain insurance coverage at reasonable costs, if at all.

Budget or cash constraints may force us to delay our efforts to develop certain products in favor of developing others, which may prevent us from meeting our stated timetables and commercializing those products as quickly as possible.

 

Because we are an emerging company with limited resources, and because research and development is an expensive process, we must regularly assess the most efficient allocation of our research and development resources. Accordingly, we may choose to delay our research and development efforts for a promising product candidate to allocate those resources to another program, which could cause us to fall behind our initial timetables for development. As a result, we may not be able to fully realize the value of some of our product candidates in a timely manner, since they will be delayed in reaching the market, or may not reach the market at all.

 

Failure to attract, retain and motivate skilled personnel and cultivate key academic collaborations will delay our product development programs and our business development efforts.

 

We had 183 full-time employees as of April 28, 2006, and our success depends on our continued ability to attract, retain and motivate highly qualified management and scientific personnel and on our ability to develop relationships with leading academic scientists. Competition for personnel and academic collaborations is intense. We are highly dependent on our current management and key scientific and technical personnel, including Daniel G. Welch, our Chief Executive Officer and President, as well as the other principal members of our management. None of our employees, including members of our management team, has a long-term employment contract, and any of our employees can leave at any time. Our success will depend in part on retaining the services of our existing management and key personnel and attracting and retaining new highly qualified personnel. In addition, we may need to hire additional personnel and develop additional academic collaborations as we continue to expand our research and development activities. We do not know if we will be able to attract, retain or motivate personnel or cultivate academic collaborations. Our inability to hire, retain or motivate qualified personnel or cultivate academic collaborations would harm our business.

 

Risks Related to our Outstanding Notes

 

Our indebtedness and debt service obligations may adversely affect our cash flow.

 

As of March 31, 2006, our annual debt service obligation on the $170.0 million in aggregate principal amount of our 0.25% convertible senior notes due March 1, 2011 was $0.4 million. We intend to fulfill our current debt service obligations, including repayment of the principal, both from cash generated by our operations and from our existing cash and investments. If we are unable to generate sufficient cash to meet these obligations and need to use existing cash or liquidate investments in order to fund our current debt service obligations, including repayment of the principal, we may have to delay or curtail research and development programs.

 

We may add additional lease lines to finance capital expenditures and may obtain additional long-term debt and lines of credit. If we issue other debt securities in the future, our debt service obligations will increase further.

 

Our indebtedness could have significant additional negative consequences, including, but not limited to:

 

 

We may not have the ability to raise the funds necessary to finance any required redemptions of our outstanding convertible notes, which might constitute a default by us.

 

If a designated event, such as the termination of trading of our common stock on the NASDAQ National Market or a specified change of control transaction, occurs prior to maturity, we may be required to redeem all or part of our 0.25% convertible senior notes due 2011. We may not have enough funds to pay the redemption price for all tendered notes. Although the indenture governing the 0.25% convertible senior notes due 2011 allows us in certain circumstances to pay the applicable redemption prices in shares of our common stock, if a designated event were to occur, we may not have sufficient funds to pay the redemption prices for all the notes tendered.

 

We have not established a sinking fund for payment of our outstanding notes, nor do we anticipate doing so. In addition, any future credit agreements or other agreements relating to our indebtedness may contain provisions prohibiting redemption of our outstanding notes under certain circumstances, or expressly prohibit our redemption of our outstanding notes upon a designated event or may provide that a designated event constitutes an event of default under that agreement. If a designated event occurs at a time when we are prohibited from purchasing or redeeming our outstanding notes, we could seek the consent of our lenders to redeem our outstanding notes or attempt to refinance this debt. If we do not obtain consent, we would not be permitted to purchase or redeem our outstanding notes. Our failure to redeem tendered notes would constitute an event of default under the indenture for the notes, which might constitute a default under the terms of our other indebtedness.

 

On January 16, 2006, the Company granted a total of 202,500 shares of restricted stock to the Company’s following executive officers:

 

 

The shares of restricted stock vest in January 2008 and may accelerate depending on the Company’s achievement of certain performance criteria over the two-year period, twenty-five percent each for four different milestones.

 

 

 

 

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.

 

InterMune, Inc.

 

Chief Financial Officer and Senior Vice President,

Finance (Principal Financial and Accounting Officer and Duly Authorized Officer)

 

Date: May 9, 2006

INDEX TO EXHIBITS