ALXN 9.30.13 10Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
x
Quarterly report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2013
or
¨
Transition report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934
For the transition period from              to             
Commission file number: 0-27756
 
ALEXION PHARMACEUTICALS, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware
13-3648318
(State or Other Jurisdiction of Incorporation or Organization)
(I.R.S. Employer Identification No.)
 
352 Knotter Drive, Cheshire Connecticut 06410
(Address of Principal Executive Offices) (Zip Code)
203-272-2596
(Registrant’s telephone number, including area code)
N/A
(Former name, former address, and former fiscal year, if changed since last report)

 

 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x   No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. Check One:
Large accelerated filer  x   Accelerated filer  ¨    Non-accelerated filer  ¨ (Do not check if a smaller reporting company)
Smaller reporting company  ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
Common Stock, $0.0001 par value
196,074,387
Class
Outstanding as of October 23, 2013










 
Alexion Pharmaceuticals, Inc.
Contents

 
PART I.
FINANCIAL INFORMATION
Page
 
Item 1.
Condensed Consolidated Financial Statements (Unaudited)
 
 
 
Condensed Consolidated Balance Sheets as of September 30, 2013 and December 31, 2012
2

 
 
Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2013 and 2012
3

 
 
Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2013 and 2012
4

 
 
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2013 and 2012
5

 
 
Notes to Condensed Consolidated Financial Statements
6

 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
21

 
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
34

 
Item 4.
Controls and Procedures
35

PART II.
OTHER INFORMATION
36

 
Item 1.
Legal Proceedings
36

 
Item 1A.
Risk Factors
36

 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
57

 
Item 5.
Other Information
57

 
Item 6.
Exhibits
59

SIGNATURES
 
 



Alexion Pharmaceuticals, Inc.
Condensed Consolidated Balance Sheets
(unaudited)
(amounts in thousands, except per share amounts)
 
 
September 30,
 
December 31,
 
2013
 
2012
Assets
 
 
 
Current Assets:
 
 
 
Cash and cash equivalents
$
910,411

 
$
989,501

Marketable securities
392,344

 

Trade accounts receivable, net
404,956

 
295,598

Inventories
105,196

 
94,521

Deferred tax assets
23,820

 
26,086

Prepaid expenses and other current assets
78,775

 
89,894

Total current assets
1,915,502

 
1,495,600

Property, plant and equipment, net
178,842

 
165,629

Intangible assets, net
646,138

 
646,678

Goodwill
254,073

 
253,645

Deferred tax assets
9,743

 
13,954

Other assets
45,497

 
38,054

Total assets
$
3,049,795

 
$
2,613,560

 
 
 
 
Liabilities and Stockholders' Equity
 
 
 
Current Liabilities:
 
 
 
Accounts payable
$
24,416

 
$
21,488

Accrued expenses
255,784

 
249,787

Deferred revenue
54,371

 
31,266

Current portion of long-term debt
48,000

 
48,000

Other current liabilities
12,885

 
9,548

Total current liabilities
395,456

 
360,089

Long-term debt, less current portion
77,000

 
101,000

Contingent consideration
144,621

 
139,002

Deferred tax liabilities
13,607

 
19,827

Facility lease obligation
12,251

 

Other liabilities
52,094

 
22,792

Total liabilities
695,029

 
642,710

 
 
 
 
Commitments and contingencies (Note 15)

 

 
 
 
 
Stockholders' Equity:
 
 
 
Preferred stock, $0.0001 par value; 5,000 shares authorized, no shares issued or outstanding

 

Common stock, $0.0001 par value; 290,000 shares authorized; 197,018 and 194,918 shares issued at September 30, 2013 and December 31, 2012, respectively
20

 
20

Additional paid-in capital
2,049,244

 
1,852,221

Treasury stock, at cost, 985 and 227 shares at September 30, 2013 and December 31, 2012, respectively
(80,365
)
 
(14,229
)
Accumulated other comprehensive income (loss)
(12,223
)
 
6,635

Retained earnings
398,090

 
126,203

Total stockholders' equity
2,354,766

 
1,970,850

Total liabilities and stockholders' equity
$
3,049,795

 
$
2,613,560


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

2


Alexion Pharmaceuticals, Inc.
Condensed Consolidated Statements of Operations
(unaudited)
(amounts in thousands, except per share amounts)
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
2013
 
2012
 
2013
 
2012
Net product sales
$
400,405

 
$
294,136

 
$
1,109,437

 
$
813,588

Cost of sales:
 
 
 
 
 
 
 
Cost of sales
42,177

 
33,186

 
116,823

 
93,067

Change in contingent liability from intellectual property settlements
9,181

 
(53,377
)
 
9,181

 
(53,377
)
Total cost of sales
51,358

 
(20,191
)
 
126,004

 
39,690

Operating expenses:
 
 
 
 
 
 
 
Research and development
88,209

 
54,280

 
231,308

 
159,323

Selling, general and administrative
122,886

 
89,957

 
354,901

 
272,054

Acquisition-related costs
2,573

 
967

 
6,974

 
19,447

Impairment of intangible asset

 
26,300

 

 
26,300

Amortization of purchased intangible assets
104

 
104

 
312

 
312

Total operating expenses
213,772

 
171,608

 
593,495

 
477,436

Operating income
135,275

 
142,719

 
389,938

 
296,462

Other income and expense:
 
 
 
 
 
 
 
Investment income
638

 
317

 
1,793

 
872

Interest expense
(1,078
)
 
(1,855
)
 
(3,305
)
 
(6,220
)
Foreign currency loss
(547
)
 
(416
)
 
(134
)
 
(817
)
Income before income taxes
134,288

 
140,765

 
388,292

 
290,297

Income tax provision
40,503

 
48,586

 
116,405

 
116,446

Net income
$
93,785

 
$
92,179

 
$
271,887

 
$
173,851

Earnings per common share
 
 
 
 
 
 
 
Basic
$
0.48

 
$
0.48

 
$
1.40

 
$
0.92

Diluted
$
0.47

 
$
0.46

 
$
1.37

 
$
0.88

Shares used in computing earnings per common share
 
 
 
 
 
 
 
Basic
195,662

 
193,353

 
194,520

 
189,219

Diluted
199,711

 
201,142

 
198,655

 
197,635

 
 
 
 
 
 
 
 


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

3


Alexion Pharmaceuticals, Inc.
Condensed Consolidated Statements of Comprehensive Income
(unaudited)
(amounts in thousands)

 
Three months ended September 30,
 
Nine months ended September 30,
 
2013
 
2012
 
2013
 
2012
Net income
$
93,785

 
$
92,179

 
$
271,887

 
$
173,851

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation
986

 
984

 
(543
)
 
241

Unrealized gains (losses) on marketable securities, net of tax of $136, $0, $(9) and $0, respectively
210

 

 
(17
)
 

Unrealized losses on pension obligation, net of tax of $0, $0, $(165) and $(49), respectively

 

 
(2,682
)
 
(801
)
Unrealized losses on hedging activities, net of tax of $(2,982), $(950), $(1,059) and $(46), respectively
(32,945
)
 
(15,181
)
 
(15,616
)
 
(1,274
)
Other comprehensive loss, net of tax
(31,749
)
 
(14,197
)
 
(18,858
)
 
(1,834
)
Comprehensive income
$
62,036

 
$
77,982

 
$
253,029

 
$
172,017


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


4


Alexion Pharmaceuticals, Inc.
Condensed Consolidated Statements of Cash Flows
(unaudited)
(amounts in thousands)
 
 
Nine months ended September 30,
 
2013
 
2012
Cash flows from operating activities:
 
 
 
Net income
$
271,887

 
$
173,851

Adjustments to reconcile net income to net cash flows from operating activities:
 
 
 
Depreciation and amortization
20,239

 
17,613

Impairment of intangible asset

 
26,300

Change in fair value of contingent consideration
5,951

 
4,333

Share-based compensation expense
56,409

 
40,322

Premium amortization of available-for-sale securities
579

 

Deferred taxes
17,036

 
57,674

Unrealized foreign currency gain
(3,426
)
 
(5,405
)
Gains on forward contracts
(1,571
)
 
(202
)
Other
177

 
18

Changes in operating assets and liabilities, excluding the effect of acquisitions:
 
 
 
Accounts receivable
(98,432
)
 
(65,299
)
Inventories
(4,992
)
 
(3,467
)
Prepaid expenses and other assets
(3,629
)
 
(17,065
)
Accounts payable, accrued expenses and other liabilities
3,952

 
59,945

Deferred revenue
24,288

 
17,038

Net cash provided by operating activities
288,468

 
305,656

Cash flows from investing activities:
 
 
 
Purchases of available-for-sale securities
(420,515
)
 

Proceeds from maturity or sale of available-for-sale securities
27,951

 

Purchases of trading securities
(473
)
 

Purchases of property, plant and equipment
(20,628
)
 
(14,257
)
Payments for acquisitions of businesses, net of cash acquired

 
(605,735
)
Increase in restricted cash
(205
)
 
(3
)
Net cash used in investing activities
(413,870
)
 
(619,995
)
Cash flows from financing activities:
 
 
 
Debt issuance costs

 
(6,184
)
Proceeds from revolving credit facility

 
115,000

Payments on revolving credit facility

 
(115,000
)
Proceeds from term loan

 
240,000

Payments on term loan
(24,000
)
 
(79,000
)
Excess tax benefit from stock options
95,832

 
7,582

Repurchase of common stock
(66,136
)
 

Net proceeds from issuance of common stock

 
462,212

Net proceeds from the exercise of stock options
44,560

 
54,910

Payment of contingent consideration
(3,000
)
 

Other
(133
)
 
(638
)
Net cash provided by financing activities
47,123

 
678,882

Effect of exchange rate changes on cash
(811
)
 
118

Net change in cash and cash equivalents
(79,090
)
 
364,661

Cash and cash equivalents at beginning of period
989,501

 
540,865

Cash and cash equivalents at end of period
$
910,411

 
$
905,526

 
 
 
 
Supplemental cash flow disclosures from investing and financing activities:
 
 
 
Contingent consideration issued in acquisitions
$

 
$
117,000

Construction in process related to facility lease obligation
$
12,251

 
$

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

5

Alexion Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
(amounts in thousands, except per share amounts)






1.
Business
Alexion Pharmaceuticals, Inc. (Alexion, the Company, we, our or us) is a biopharmaceutical company focused on serving patients with severe and ultra-rare disorders through the innovation, development and commercialization of life-transforming therapeutic products. Our marketed product Soliris is the first and only therapeutic approved for patients with either of two severe and ultra-rare disorders resulting from chronic uncontrolled activation of the complement component of the immune system: paroxysmal nocturnal hemoglobinuria (PNH), a life-threatening and ultra-rare genetic blood disorder, and atypical hemolytic uremic syndrome (aHUS), a life-threatening and ultra-rare genetic disease. We are also evaluating additional potential indications for Soliris in other severe and ultra-rare diseases in which uncontrolled complement activation is the underlying mechanism, and we are progressing in various stages of development with additional product candidates as potential treatments for patients with severe and life-threatening ultra-rare disorders. We were incorporated in 1992 and began commercial sale of Soliris in 2007.

2.
Basis of Presentation and Principles of Consolidation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. These accounting principles were applied on a basis consistent with those of the consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2012. In our opinion, the accompanying unaudited consolidated financial statements include all adjustments, consisting of normal recurring accruals, necessary for a fair presentation of our financial statements for interim periods in accordance with accounting principles generally accepted in the United States. The condensed consolidated balance sheet data as of December 31, 2012 was derived from audited financial statements but does not include all disclosures required by accounting principles generally accepted in the United States. These interim financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2012 included in our Annual Report on Form 10-K. The results of operations for the three and nine months ended September 30, 2013 are not necessarily indicative of the results to be expected for the full year.
The financial statements of our subsidiaries with functional currencies other than the U.S. dollar are translated into U.S. dollars using period-end exchange rates for assets and liabilities, historical exchange rates for stockholders' equity and weighted average exchange rates for operating results. Translation gains and losses are included in accumulated other comprehensive income (loss), net of tax, in stockholders' equity. Foreign currency transaction gains and losses are included in the results of operations in other income and expense.
The accompanying unaudited condensed consolidated financial statements include the accounts of Alexion Pharmaceuticals, Inc. and its subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Our significant accounting policies are described in Note 1 of the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2012.

New Accounting Pronouncements
In January 2013, the Financial Accounting Standards Board issued an update to clarify the scope of disclosures for offsetting assets and liabilities. The standard is effective for interim and annual periods beginning on or after January 1, 2013 and requires disclosure for all comparative periods. We adopted the provisions of this guidance in 2013.
In February 2013, the Financial Accounting Standards Board issued a new standard to improve the reporting of reclassifications out of accumulated other comprehensive income (AOCI). The new standard requires the disclosure of significant amounts reclassified from each component of AOCI and the income statement line items affected by the reclassification. The standard is effective prospectively for interim and annual periods beginning after December 15, 2012. We adopted the provisions of this guidance, and included the additional disclosure requirements, in the first quarter of 2013.


6

Alexion Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
(amounts in thousands, except per share amounts)





3.
Inventories
Inventories are stated at the lower of cost or estimated realizable value. We determine the cost of inventory using the weighted-average cost method.
The components of inventory are as follows:
 
September 30,
 
December 31,
 
2013
 
2012
Raw materials
$
12,970

 
$
6,485

Work-in-process
61,415

 
43,899

Finished goods
30,811

 
44,137

 
$
105,196

 
$
94,521

 


4.
Intangible Assets and Goodwill
The following table summarizes the carrying amount of our intangible assets and goodwill, net of accumulated amortization: 
 
 
September 30, 2013
 
December 31, 2012
Licenses, patents and purchased technology, net
 
$
17,888

 
$
18,428

Acquired in-process research and development
 
628,250

 
628,250

Intangible assets
 
$
646,138

 
$
646,678

Goodwill
 
$
254,073

 
$
253,645

The following table summarizes the changes in the carrying amount of goodwill: 
Balance at December 31, 2012
$
253,645

Change in goodwill associated with prior acquisition
428

Balance at September 30, 2013
$
254,073


5.
Debt
On February 7, 2012, we and our wholly-owned Swiss subsidiary, Alexion Pharma International Sàrl, entered into a credit agreement with a syndicate of banks that provides for a $240,000 senior secured term loan facility payable in equal quarterly installments of $12,000 starting June 30, 2012 and a $200,000 senior secured revolving credit facility through February 7, 2017. In addition to borrowings upon prior notice, the revolving credit facility includes borrowing capacity in the form of letters of credit up to $60,000 and borrowings on same-day notice, referred to as swingline loans, of up to $10,000. Borrowings can be used for working capital requirements, acquisitions and other general corporate purposes. With the consent of the lenders and the administrative agent and subject to satisfaction of certain conditions, we may increase the term loan facility and/or the revolving credit facility by an aggregate amount not to exceed $150,000.
As of September 30, 2013, we had $125,000 outstanding on the term loan. As of September 30, 2013, we had open letters of credit of $15,085, and our borrowing availability under the revolving facility was $184,915.
The fair value of our long term debt, which is measured using Level 2 inputs, approximates book value.

6.
Earnings Per Common Share
Basic earnings per common share (EPS) is computed by dividing net income by the weighted-average number of shares of common stock outstanding. For purposes of calculating diluted EPS, the denominator reflects the potential dilution that could occur if stock options, unvested restricted stock, unvested restricted stock units or other contracts to issue common stock were exercised or converted into common stock, using the treasury stock method.
 

7

Alexion Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
(amounts in thousands, except per share amounts)





The following table summarizes the calculation of basic and diluted EPS for the three and nine months ended September 30, 2013 and 2012:
 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Net income used for basic and diluted calculation
$
93,785

 
$
92,179

 
$
271,887

 
$
173,851

Shares used in computing earnings per common share—basic
195,662

 
193,353

 
194,520

 
189,219

Weighted-average effect of dilutive securities:
 
 
 
 

 

Shares issuable upon the assumed conversion of our 1.375% convertible senior notes

 

 

 
11

Stock awards
4,049

 
7,789

 
4,135

 
8,405

Dilutive potential common shares
4,049

 
7,789

 
4,135

 
8,416

Shares used in computing earnings per common share—diluted
199,711

 
201,142

 
198,655

 
197,635

Earnings per common share:
 
 
 
 

 

Basic
$
0.48

 
$
0.48

 
$
1.40

 
$
0.92

Diluted
$
0.47

 
$
0.46

 
$
1.37

 
$
0.88

The following table represents the potentially dilutive shares excluded from the calculation of EPS for the three and nine months ended September 30, 2013, and 2012 because their effect is anti-dilutive:
 
 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Potentially dilutive securities:
 
 
 
 
 
 
 
Options to purchase common stock
2,002

 
226

 
2,281

 
1,561

Unvested restricted stock and restricted stock units
13

 

 
19

 
44

 
2,015

 
226

 
2,300

 
1,605



7.
Marketable Securities

We invest our excess cash balances in marketable securities of highly rated financial institutions and investment-grade debt instruments. We seek to diversify our investments and limit the amount of investment concentrations for individual institutions, maturities and investment types. We classify these marketable securities as available-for-sale and, accordingly, record such securities at fair value. We classify these marketable securities as current assets as these investments are intended to be available to the Company for use in funding current operations.
We offer a nonqualified deferred compensation plan which allows participants to elect to defer income to future periods. Participants in the plan earn a return on their deferrals based on several investments options, which mirror returns on underlying mutual fund investments. We choose to invest in the underlying mutual fund investments to offset the liability associated with our nonqualified deferred compensation plan. These securities are classified as trading securities and are carried at fair value with gains and losses included in investment income. The changes in the underlying liability to the employee are recorded in operating expenses.

8

Alexion Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
(amounts in thousands, except per share amounts)





We held no marketable securities as of December 31, 2012. The amortized cost, gross unrealized holding gains, gross unrealized holding losses and estimated fair value of available-for-sale investments by type of security at September 30, 2013 were as follows:
 
 
Amortized Cost
 
Gross Unrealized Holding Gains
 
Gross Unrealized Holding Losses
 
Estimated Fair Value
Commercial paper
 
$
51,914

 
$

 
$

 
$
51,914

Corporate bonds
 
180,322

 
175

 
(162
)
 
180,335

Municipal bonds
 
17,211

 
2

 
(1
)
 
17,212

U.S. Treasury securities
 
4,999

 
1

 

 
5,000

Other government-related obligations:
 
 
 
 
 
 
 
 
U.S.
 
48,168

 
33

 
(39
)
 
48,162

Foreign
 
106,875

 
42

 
(77
)
 
106,840

Bank certificates of deposit
 
3,000

 

 

 
3,000

 
 
$
412,489

 
$
253

 
$
(279
)
 
$
412,463


Unrealized gains and losses that are deemed temporary are included in accumulated other comprehensive income (loss) as a separate component of stockholders' equity. If any adjustment to fair value reflects a significant decline in the value of the security, we evaluate the extent to which the decline is determined to be other-than-temporary and would mark the security to market through a charge to our condensed consolidated statement of operations. Credit losses are identified when we do not expect to receive cash flows sufficient to recover the amortized cost basis of a security. In the event of a credit loss, only the amount associated with the credit loss is recognized in operating results, with the amount of loss relating to other factors recorded in accumulated other comprehensive income (loss).
The aggregate fair value of available-for-sale securities in an unrealized loss position as of September 30, 2013 was $171,357. These investments have been in a continuous unrealized loss position for less than 12 months. As of September 30, 2013, we believe that the cost basis of our available-for-sale investments is recoverable.
The fair values of available-for-sale securities by classification in the condensed consolidated balance sheet were as follows:
 
September 30, 2013
Cash and cash equivalents
$
20,599

Marketable securities
391,864

 
$
412,463


The fair values of available-for-sale debt securities at September 30, 2013, by contractual maturity, are summarized as follows:
 
September 30, 2013
Due in one year or less
$
133,611

Due after one year through three years
278,852

Due after three years through five years

 
$
412,463


As of September 30, 2013, the fair value of our trading securities was $480.
We utilize the specific identification method in computing realized gains and losses. Realized gains and losses on our trading securities and available-for-sale investments were not material for the three and nine months ended September 30, 2013.

9

Alexion Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
(amounts in thousands, except per share amounts)






8.
Derivative Instruments and Hedging Activities
We operate internationally and, in the normal course of business, are exposed to fluctuations in foreign currency exchange rates. The exposures result from portions of our revenues, as well as the related receivables, and expenses that are denominated in currencies other than the U.S. dollar, primarily the Euro, Japanese Yen, British Pound and Swiss Franc. We manage our foreign currency transaction risk within specified guidelines through the use of derivatives. All of our derivative instruments are utilized for risk management purposes, and we do not use derivatives for speculative trading purposes.
We enter into foreign exchange forward contracts, with durations of up to 36 months, to hedge exposures resulting from portions of our forecasted intercompany revenues that are denominated in currencies other than the U.S. dollar. The purpose of the hedges of intercompany revenue is to reduce the volatility of exchange rate fluctuations on our operating results and to increase the visibility of the foreign exchange impact on forecasted revenues. These hedges are designated as cash flow hedges upon contract inception. At September 30, 2013, we had open contracts with notional amounts totaling $999,559 that qualified for hedge accounting.
The impact on AOCI and earnings from foreign exchange contracts that qualified as cash flow hedges, for the three and nine months ended September 30, 2013 and 2012 were as follows:
 
 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Gain (loss) recognized in AOCI, net of tax
$
(28,523
)
 
$
(11,238
)
 
$
1,011

 
$
6,321

Gain reclassified from AOCI to net product sales (effective portion), net of tax
$
5,225

 
$
4,401

 
$
16,803

 
$
8,130

Loss reclassified from AOCI to other income and expense (ineffective portion), net of tax
$
(803
)
 
$
(458
)
 
$
(176
)
 
$
(535
)
Assuming no change in foreign exchange rates from market rates at September 30, 2013, $3,901 of gains recognized in AOCI will be reclassified to revenue over the next 12 months.
We enter into foreign exchange forward contracts, with durations of approximately 30 days, designed to limit the balance sheet exposure of monetary assets and liabilities. We enter into these hedges to reduce the impact of fluctuating exchange rates on our operating results. Hedge accounting is not applied to these derivative instruments as gains and losses on these hedge transactions are designed to offset gains and losses on underlying balance sheet exposures. As of September 30, 2013, the notional amount of foreign exchange contracts where hedge accounting is not applied was $151,458.
We recognized a gain (loss) of $(2,640) and $(3,470), in other income and expense, for the three months ended September 30, 2013 and 2012, respectively, and $6,146 and $787, for the nine months ended September 30, 2013 and 2012, respectively, associated with the foreign exchange contracts not designated as hedging instruments. These amounts were largely offset by gains or losses in monetary assets and liabilities.

10

Alexion Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
(amounts in thousands, except per share amounts)





The following tables summarize the fair value of outstanding derivatives at September 30, 2013 and December 31, 2012: 

 
September 30, 2013
 
Asset Derivatives
 
Liability Derivatives
 
Balance Sheet
Location
 
Fair
Value
 
Balance Sheet
Location
 
Fair
Value
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
Foreign exchange forward contracts
Other current assets
 
$
19,164

 
Other current liabilities
 
$
12,538

Foreign exchange forward contracts
Other non-current assets
 
7,559

 
Other non-current liabilities
 
12,110

Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
Foreign exchange forward contracts
Other current assets
 

 
Other current liabilities
 

Total fair value of derivative instruments
 
 
$
26,723

 
 
 
$
24,648



 
December 31, 2012
 
Asset Derivatives
 
Liability Derivatives
 
Balance Sheet
Location
 
Fair
Value
 
Balance Sheet
Location
 
Fair
Value
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
Foreign exchange forward contracts
Other current assets
 
$
15,617

 
Other current liabilities
 
$
3,529

Foreign exchange forward contracts
Other non-current assets
 
9,378

 
Other non-current liabilities
 
4,521

Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
Foreign exchange forward contracts
Other current assets
 
2,245

 
Other current liabilities
 
2,010

Total fair value of derivative instruments
 
 
$
27,240

 
 
 
$
10,060



11

Alexion Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
(amounts in thousands, except per share amounts)





Although we do not offset derivative assets and liabilities within our condensed consolidated balance sheets, our International Swap and Derivatives Association (ISDA) agreements provide for net settlement of transactions that are due to or from the same counterparty upon early termination of the agreement due to an event of default or other termination event. The following table summarizes the potential effect on our condensed consolidated balance sheets of offsetting our foreign exchange forward contracts subject to such provisions:
September 30, 2013
 
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Condensed Consolidated Balance Sheet
 
 
Description
 
Gross Amounts of Recognized Assets/Liabilities
 
Gross Amounts Offset in the Condensed Consolidated Balance Sheet
 
Amounts of Assets/Liabilities Presented in the Condensed Consolidated Balance Sheet
 
Derivative Financial Instruments
 
Cash Collateral Received (Pledged)
 
Net Amount
Derivative assets
 
$
26,723

 
$

 
$
26,723

 
$
(19,710
)
 
$

 
$
7,013

Derivative liabilities
 
(24,648
)
 

 
(24,648
)
 
19,710

 

 
(4,938
)


December 31, 2012
 
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Condensed Consolidated Balance Sheet
 
 
Description
 
Gross Amounts of Recognized Assets/Liabilities
 
Gross Amounts Offset in the Condensed Consolidated Balance Sheet
 
Amounts of Assets/Liabilities Presented in the Condensed Consolidated Balance Sheet
 
Derivative Financial Instruments
 
Cash Collateral Received (Pledged)
 
Net Amount
Derivative assets
 
$
27,240

 
$

 
$
27,240

 
$
(10,060
)
 
$

 
$
17,180

Derivative liabilities
 
(10,060
)
 

 
(10,060
)
 
10,060

 

 



9.
Stockholders' Equity
In November 2012, our Board of Directors authorized the repurchase of up to $400,000 of our common stock. This repurchase program does not have an expiration date, and we are not obligated to acquire a particular number of shares. The program may be discontinued at any time at our discretion. Under the program, we repurchased 758 shares of our common stock at a cost of $66,136 during the nine months ended September 30, 2013. As of September 30, 2013, there is a total of $322,311 remaining for repurchases under the program.
  
10.
Other Comprehensive Income and Accumulated Other Comprehensive Income
Other comprehensive income includes changes in equity that are excluded from net income, such as changes in pension liabilities, unrealized gains and losses on marketable securities, unrealized gains and losses on hedge contracts and foreign currency translation adjustments. Certain of these changes in equity are reflected net of tax.


12

Alexion Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
(amounts in thousands, except per share amounts)





The following tables summarize the changes in AOCI, by component, for the nine months ended September 30, 2013 and 2012:

 
Defined Benefit Pension Plans
 
Unrealized Gains (Losses) from Marketable Securities
 
Unrealized Gains (Losses) from Hedging Activities
 
Foreign Currency Translation Adjustment
 
Total Accumulated Other Comprehensive Income (Loss)
Balances, December 31, 2012
$
(5,712
)
 
$

 
$
15,156

 
$
(2,809
)
 
$
6,635

Other comprehensive income before reclassifications
(2,967
)
 
(76
)
 
1,011

 
(543
)
 
(2,575
)
Amounts reclassified from other comprehensive income
285

 
59

 
(16,627
)
 

 
(16,283
)
Net other comprehensive loss
(2,682
)
 
(17
)
 
(15,616
)
 
(543
)
 
(18,858
)
Balances, September 30, 2013
$
(8,394
)
 
$
(17
)
 
$
(460
)
 
$
(3,352
)
 
$
(12,223
)

 
Defined Benefit Pension Plans
 
Unrealized Gains (Losses) from Hedging Activities
 
Foreign Currency Translation Adjustment
 
Total Accumulated Other Comprehensive Income (Loss)
Balances, December 31, 2011
$
(4,183
)
 
$
11,321

 
$
(2,959
)
 
$
4,179

Other comprehensive income before reclassifications
(1,006
)
 
6,321

 
241

 
5,556

Amounts reclassified from other comprehensive income
205

 
(7,595
)
 

 
(7,390
)
Net other comprehensive income (loss)
(801
)
 
(1,274
)
 
241

 
(1,834
)
Balances, September 30, 2012
$
(4,984
)
 
$
10,047

 
$
(2,718
)
 
$
2,345



13

Alexion Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
(amounts in thousands, except per share amounts)





The table below provides details regarding significant reclassifications from AOCI during the three and nine months ended September 30, 2013 and 2012:
Details about Accumulated Other Comprehensive Income Components
 
Amount Reclassified From Accumulated Other Comprehensive Income during the three months ended September 30,
 
Amount Reclassified From Accumulated Other Comprehensive Income during the nine months ended September 30,
 
Affected Line Item in the Condensed Consolidated Statements of Operations
 
2013
2012
 
2013
2012
 
Unrealized Gains (Losses) on Hedging Activity
 
 
 
 
 
 
 
 
Effective portion of foreign exchange contracts
 
$
5,710

$
4,810

 
$
18,364

$
8,885

 
Net product sales
Ineffective portion of foreign exchange contracts
 
(878
)
(501
)
 
(192
)
(585
)
 
Foreign currency loss
 
 
4,832

4,309

 
18,172

8,300

 
 
 
 
(410
)
(366
)
 
(1,545
)
(705
)
 
Income tax provision
 
 
$
4,422

$
3,943

 
$
16,627

$
7,595

 
 
Unrealized Gains (Losses) from Marketable Securities
 
 
 
 
 
 
 
 
Realized gains (losses) on sale of securities
 
$
(96
)
$

 
$
(94
)
$

 
Investment income
 
 
(96
)

 
(94
)

 
 
 
 
36


 
35


 
Income tax provision
 
 
$
(60
)
$

 
$
(59
)
$

 
 
Defined Benefit Pension Items
 
 
 
 
 
 
 
 
Amortization of prior service costs and actuarial losses
 
$
(104
)
$
(73
)
 
$
(311
)
$
(224
)
 
(a)
 
 
(104
)
(73
)
 
(311
)
(224
)
 
 
 
 
9

6

 
26

19

 
Income tax provision
 
 
$
(95
)
$
(67
)
 
$
(285
)
$
(205
)
 
 
(a) This AOCI component is included in the computation of net periodic pension benefit cost (see Note 13 for additional details).


11.
Fair Value Measurement
Authoritative guidance establishes a valuation hierarchy for disclosure of the inputs to the valuation used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument. Level 3 inputs are unobservable inputs based on our own assumptions used to measure assets and liabilities at fair value.

14

Alexion Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
(amounts in thousands, except per share amounts)





The following tables present information about our assets and liabilities that are measured at fair value on a recurring basis as of September 30, 2013 and December 31, 2012, and indicate the fair value hierarchy of the valuation techniques we utilized to determine such fair value. 
 
 
Fair Value Measurement at
September 30, 2013
Balance Sheet
Classification
Type of Instrument
Total
 
Level 1
 
Level 2
 
Level 3
Cash equivalents
Institutional money market funds
$
717,980

 
$

 
$
717,980

 
$

Cash equivalents
Commercial paper
$
19,999

 
$

 
$
19,999

 
$

Cash equivalents
Other government-related obligations
$
600

 
$

 
$
600

 
$

Marketable securities
Mutual funds
$
480

 
$
480

 
$

 
$

Marketable securities
Commercial paper
$
31,915

 
$

 
$
31,915

 
$

Marketable securities
Corporate bonds
$
180,335

 
$

 
$
180,335

 
$

Marketable securities
Municipal bonds
$
17,212

 
$

 
$
17,212

 
$

Marketable securities
U.S. Treasury securities
$
5,000

 
$
5,000

 
$

 
$

Marketable securities
Other government-related obligations
$
154,402

 
$

 
$
154,402

 
$

Marketable securities
Bank certificates of deposit
$
3,000

 
$

 
$
3,000

 
$

Other current assets
Foreign exchange forward contracts
$
19,164

 
$

 
$
19,164

 
$

Other assets
Foreign exchange forward contracts
$
7,559

 
$

 
$
7,559

 
$

Other current liabilities
Foreign exchange forward contracts
$
12,538

 
$

 
$
12,538

 
$

Other liabilities
Foreign exchange forward contracts
$
12,110

 
$

 
$
12,110

 
$

Contingent consideration
Acquisition-related contingent consideration
$
144,621

 
$

 
$

 
$
144,621

 

15

Alexion Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
(amounts in thousands, except per share amounts)





 
 
Fair Value Measurement at
December 31, 2012
Balance Sheet
Classification
Type of Instrument
Total
 
Level 1
 
Level 2
 
Level 3
Cash equivalents
Institutional money market funds
$
803,550

 
$

 
$
803,550

 
$

Other current assets
Foreign exchange forward contracts
$
17,862

 
$

 
$
17,862

 
$

Other assets
Foreign exchange forward contracts
$
9,378

 
$

 
$
9,378

 
$

Other current liabilities
Foreign exchange forward contracts
$
5,539

 
$

 
$
5,539

 
$

Other liabilities
Foreign exchange forward contracts
$
4,521

 
$

 
$
4,521

 
$

Other current liabilities
Acquisition-related contingent consideration
$
2,668

 
$

 
$

 
$
2,668

Contingent consideration
Acquisition-related contingent consideration
$
139,002

 
$

 
$

 
$
139,002


There were no securities transferred between Level 1, 2 and 3 during the nine months ended September 30, 2013.

Valuation Techniques
We classify U.S. Treasury securities and mutual fund investments, which are valued based on quoted market prices in active markets with no valuation adjustment, as Level 1 assets within the fair value hierarchy.
Items classified as Level 2 within the valuation hierarchy consist of institutional money market funds, commercial paper, municipal bonds, U.S. and foreign government-related debt, corporate debt securities and certificates of deposit. We estimate the fair values of these marketable securities by taking into consideration valuations obtained from third-party pricing sources. These pricing sources utilize industry standard valuation models, including both income and market-based approaches, for which all significant inputs are observable, either directly or indirectly, to estimate fair value. These inputs include market pricing based on real-time trade data for the same or similar securities, issuer credit spreads, benchmark yields, and other observable inputs.
Our derivative assets and liabilities include foreign exchange derivatives that are measured at fair value using observable market inputs such as forward rates, interest rates, our own credit risk and our counterparties’ credit risks. Based on these inputs, the derivative assets and liabilities are classified within Level 2 of the valuation hierarchy.
Items classified as Level 3 within the valuation hierarchy, consisting of contingent consideration liabilities related to acquisitions, were valued based on various estimates, including probability of success, discount rates and amount of time until the conditions of the milestone payments are met.
As of September 30, 2013, there has not been any impact to the fair value of our derivative liabilities due to our own credit risk. Similarly, there has not been any significant adverse impact to our derivative assets based on our evaluation of our counterparties’ credit risks.

Contingent Consideration
In connection with prior acquisitions, we may be required to pay future consideration that is contingent upon the achievement of specified development, regulatory approval or sales-based milestone events. We determine the fair value of these obligations on the acquisition date using various estimates that are not observable in the market and represent a Level 3 measurement within the fair value hierarchy. The resulting probability-weighted cash flows were discounted using a cost of debt ranging from 4.9% to 5.4% for developmental milestones and a weighted average cost of capital ranging from 13% to 21% for sales-based milestones.
Each reporting period, we adjust the contingent consideration to fair value with changes in fair value recognized in operating earnings. Changes in fair values reflect new information about the probability and timing of meeting the conditions of the milestone payments. In the absence of new information, changes in fair value will only reflect the interest component of

16

Alexion Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
(amounts in thousands, except per share amounts)





contingent consideration related to the passage of time as development work progresses towards the achievement of the milestones.
Estimated future contingent milestone payments related to prior business combinations range from zero if no milestone events are achieved, to a maximum of $876,000 if all development, regulatory and sales-based milestones are reached. As of September 30, 2013, the fair value of acquisition-related contingent consideration was $144,621. The following table represents a roll-forward of our acquisition-related contingent consideration, which are all Level 3 liabilities:
 
Nine months ended
 
September 30, 2013
Balance at beginning of period
$
(141,670
)
Milestone payment
3,000

Changes in fair value
(5,951
)
Balance at end of period
$
(144,621
)

12.
Income Taxes
We utilize the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement carrying amounts and tax basis of assets and liabilities using enacted tax rates in effect for years in which the temporary differences are expected to reverse. We provide a valuation allowance when it is more likely than not that deferred tax assets will not be realized. We recognize the benefit of an uncertain tax position that has been taken or we expect to take on income tax returns if such tax position is more likely than not to be sustained.
We continue to maintain a valuation allowance against certain other deferred tax assets where realization is not certain. We periodically evaluate the likelihood of the realization of deferred tax assets and reduce the carrying amount of these deferred tax assets by a valuation allowance to the extent we believe a portion will not be realized.
The following table provides a comparative summary of our income tax provision and effective tax rate for the three and nine months ended September 30, 2013 and 2012:
 
 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Provision for income taxes
$
40,503

 
$
48,586

 
$
116,405

 
$
116,446

Effective tax rate
30.2
%
 
34.5
%
 
30.0
%
 
40.1
%

The tax provision for the three and nine months ended September 30, 2013 is attributable to the U.S. federal, state and foreign income taxes on our profitable operations. Additionally, included in the nine months ended September 30, 2013 is the tax benefit of $2,854 attributable to the 2012 U.S. Federal tax credit for research and experimentation.
The U.S. Federal tax credit for research and experimentation expenses expired December 31, 2011.  In connection with this expiration, our 2012 tax expense did not include any benefit from the U.S. Federal tax credit for research and experimentation.  In January 2013, the American Taxpayer Relief Act of 2012, which retroactively extended the tax credit for research and experimentation back to January 1, 2012 through the end of 2013 was signed into law.  The effects of a change in tax law is recognized in the period that includes the date of enactment and, therefore, our tax benefit attributable to the 2012 U.S. Federal tax credit for research and experimentation was recorded in the first quarter of 2013.
The tax provision for the three and nine months ended September 30, 2012 is principally attributable to the U.S. federal, state and foreign income taxes on our profitable operations and the tax expense of $22,673 associated with the settlement and non-exclusive license agreement with a third party, which was executed in the third quarter of 2012. Additionally, included in the nine months ended September 30, 2012 is the impact of the tax expense of $21,812 associated with the structuring of the Enobia business.


17

Alexion Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
(amounts in thousands, except per share amounts)





The Internal Revenue Service (IRS) commenced an examination of our U.S. income tax returns for 2008 and 2009 during the second quarter 2011. This examination is anticipated to be completed within the next twelve months. We are not able to determine any impact to our unrecognized tax benefits based on the preliminary stage of discussions with the IRS.

13.
Employee Benefit Plans
Defined Contribution Plan
We have one qualified 401(k) plan covering all eligible employees. Under the plan, employees may contribute up to the statutory allowable amount for any calendar year. We make matching contributions equal to $1.00 for each dollar contributed up to the first 6% of an individual's base salary and incentive cash bonus. For the three months ended September 30, 2013 and 2012, we recorded matching contributions of approximately $1,362, and $798, respectively. For the nine months ended September 30, 2013 and 2012, we recorded matching contributions of approximately $4,626 and $2,853, respectively.
Deferred Compensation Plan
Effective June 15, 2013, we began sponsoring a nonqualified deferred compensation plan which allows certain highly-compensated employees to make voluntary deferrals of up to 80% of their base salary and incentive bonuses. The plan is designed to work in conjunction with the 401(k) plan and provides for a total combined employer match of up to 6% of an employee's eligible earnings, up to the IRS annual 401(k) contribution limitations. Employee deferrals and employer matching contributions under the plan began in the third quarter of 2013 and were not material for the three and nine months ended September 30, 2013.
Defined Benefit Plans
We maintain defined benefit plans for employees in certain countries outside the United States, including retirement benefit plans required by applicable local law. The plans are valued by independent actuaries using the projected unit credit method. The liabilities correspond to the projected benefit obligations of which the discounted net present value is calculated based on years of employment, expected salary increases, and pension adjustments.
The components of net periodic benefit cost were as follows: 
 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Service cost
$
1,376

 
$
1,061

 
$
4,087

 
$
3,422

Interest cost
127

 
110

 
376

 
338

Expected return on plan assets
(157
)
 
(125
)
 
(471
)
 
(385
)
Employee contributions
(358
)
 
(283
)
 
(1,071
)
 
(868
)
Amortization
104

 
73

 
311

 
224

Total net periodic benefit cost
$
1,092

 
$
836

 
$
3,232

 
$
2,731



14.
Leases

In November 2012, we entered into a lease agreement for office and laboratory space to be constructed in New Haven, Connecticut. We amended the lease in July 2013 to expand the building by two floors. Although we will not legally own the premises, we are deemed to be the owner of the building during the construction period based on applicable accounting guidance for build-to-suit leases due to our involvement during the construction period. Accordingly, the landlord's costs of constructing the facility are required to be capitalized, as a non-cash transaction, offset by a corresponding facility lease obligation in our condensed consolidated balance sheet.
Construction of the new facility began in June 2013 and is expected to be completed in 2015. As of September 30, 2013, our construction-in-process asset associated with the new facility and the offsetting facility lease obligation totaled $12,251.


18

Alexion Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
(amounts in thousands, except per share amounts)





15.
Commitments and Contingencies
Commitments
License Agreements

In January 2013, we entered into a license agreement for a technology, which provides an exclusive research license and an option for an exclusive commercial license for specific targets and products to be developed. Due to the early stage of this asset, we recorded expense for an upfront payment of $3,000 during the first quarter of 2013. We will also be required to pay annual maintenance fees during the term of the arrangement. In addition, for each target, up to a maximum of six targets we develop, we could be required to pay up to an additional $70,500 in license fees, development and sales milestones as the specific milestones are met over time.
In July 2013, we entered into a license and collaboration agreement for the identification, development and commercialization of therapeutic candidates based on specific drug targets.  Due to the early stage of these assets, we recorded expense for an upfront payment of $11,500 during the third quarter of 2013. We will also be responsible for funding research activities under the program.  In addition, for each drug target, up to a maximum of four targets, we could be required to pay up to an additional $90,750 in development milestones as the specific milestones are met over time.  The agreement also provides for royalty payments on commercial sales of each product developed under the agreement.
Lonza Agreement
We rely on Lonza Group AG and its affiliates (Lonza), a third party manufacturer, to produce a portion of commercial and clinical quantities of Soliris and for clinical quantities of asfotase alfa, and we have contracted and expect to continue contracting for product finishing, vial filling and packaging through third parties. We have various agreements with Lonza, with remaining total commitments of approximately $163,000 through 2019. Such commitments may be canceled only in limited circumstances. If we terminate certain supply agreements with Lonza without cause, we will be required to pay for product scheduled for manufacture under our arrangement. Under an existing arrangement with Lonza, we also pay Lonza a royalty on sales of Soliris manufactured at Alexion Rhode Island Manufacturing Facility (ARIMF).

Contingent Liabilities
We are currently involved in various claims and legal proceedings. On a quarterly basis, we review the status of each significant matter and assess its potential financial exposure. If the potential loss from any claim, asserted or unasserted, or legal proceeding is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. Because of uncertainties related to claims and litigation, accruals are based on our best estimates based on available information. On a periodic basis, as additional information becomes available, or based on specific events such as the outcome of litigation or settlement of claims, we may reassess the potential liability related to these matters and may revise these estimates, which could result in a material adverse adjustment to our operating results.
As previously stated, we have received, and may in the future receive, notices from third parties claiming that their patents may be infringed by the development, manufacture or sale of Soliris. Under the guidance of ASC 450, Contingencies, we record a royalty accrual based on our best estimate of the fair value percent of net sales of Soliris that we could be required to pay the owners of patents for technology used in the manufacture and sale of Soliris. A costly license, or inability to obtain a necessary license, could have a material adverse effect on our business. However, the amount of such loss or a range of loss, if any, beyond amounts currently accrued, cannot be reasonably estimated.
In January 2011, Novartis Vaccines and Diagnostics, Inc. (Novartis) filed an action against us and other biopharmaceutical companies in the U.S. District Court for the District of Delaware claiming willful infringement by us of U.S. Patent No. 5,688,688 (688 Patent). During the third quarter of 2013, the parties engaged in discussions to resolve the matter. In October 2013, we and Novartis agreed to resolve all claims asserted by Novartis in the action. In October 2013, the parties entered into a settlement agreement and dismissal pursuant to which Novartis granted Alexion a non-exclusive, fully paid license to the 688 Patent for our products and dismissed its case with prejudice. As a result, we recorded expense of $9,181 in cost of sales in the third quarter 2013 related to this litigation settlement agreement.
As previously reported, in the third quarter of 2012 we reduced our estimate for probable contingent liabilities as of September 30, 2012. The reduction was due to the execution of a settlement and non-exclusive license agreement in October 2012 with a third party related to the third party's intellectual property and reflected the actual, negotiated royalty rate set forth in the agreement. This change in estimate resulted in a positive impact in cost of sales of $53,377 during the third quarter 2012.

19

Alexion Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
(amounts in thousands, except per share amounts)





On March 27, 2013, we received a Warning Letter from the U.S. Food and Drug Administration (FDA) regarding compliance with current Good Manufacturing Practices (cGMP) at ARIMF. The Warning Letter followed an FDA inspection which concluded on August 6, 2012. At the conclusion of that inspection, the FDA issued a Form 483 Inspectional Observations, to which we responded in August 2012 and provided additional information to the FDA in September and December 2012. The observations relate to commercial and clinical manufacture of Soliris at ARIMF. We responded to the Warning Letter in a letter to the FDA dated April 15, 2013. We continue to manufacture products, including Soliris, in this facility. While the resolution of this Warning Letter is difficult to predict, we do not currently believe a loss related to this matter is probable or that the potential magnitude of such loss or range of loss, if any, can be reasonably estimated.


20

Alexion Pharmaceuticals, Inc.
(amounts in thousands, except per share amounts)

Item 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Note Regarding Forward-Looking Statements

This quarterly report on Form 10-Q contains forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based on current expectations, estimates and projections about our industry, management's beliefs, and certain assumptions made by our management, and may include, but are not limited to, statements regarding the potential benefits and commercial potential of Soliris® (eculizumab) for its approved indications and any expanded uses, timing and effect of sales of Soliris in various markets worldwide, pricing for Soliris, level of insurance coverage and reimbursement for Soliris, level of future Soliris sales and collections, timing regarding development and regulatory approvals for additional indications or in additional territories for Soliris, the medical and commercial potential of additional indications for Soliris, failure to satisfactorily address the issues raised by the FDA in the March 2013 Warning Letter, costs, expenses and capital requirements, cash outflows, cash from operations, status of reimbursement, price approval and funding processes in various countries worldwide, progress in developing commercial infrastructure and interest about Soliris and our drug candidates in the patient, physician and payer communities, the safety and efficacy of Soliris and our product candidates, estimates of the potential markets and estimated commercialization dates for Soliris and our drug candidates around the world, sales and marketing plans, any changes in the current or anticipated market demand or medical need for Soliris or our drug candidates, status of our ongoing clinical trials for eculizumab, asfotase alfa and our other product candidates, commencement dates for new clinical trials, clinical trial results, evaluation of our clinical trial results by regulatory agencies, prospects for regulatory approval, need for additional research and testing, the uncertainties involved in the drug development process and manufacturing, performance and reliance on third party service providers, our future research and development activities, plans for acquired programs, assessment of competitors and potential competitors, the outcome of challenges and opposition proceedings to our intellectual property, assertion or potential assertion by third parties that the manufacture, use or sale of Soliris infringes their intellectual property, estimates of the capacity of manufacturing and other service facilities to support Soliris and our product candidates, potential costs resulting from product liability or other third party claims, the sufficiency of our existing capital resources and projected cash needs, assessment of impact of recent accounting pronouncements, declines in sovereign credit ratings or sovereign defaults in countries where we sell Soliris, delay of collection or reduction in reimbursement due to adverse economic conditions or changes in government and private insurer regulations and approaches to reimbursement, the short and long term effects of other government healthcare measures, and the effect of shifting foreign exchange rates. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” variations of such words and similar expressions are intended to identify such forward-looking statements, although not all forward-looking statements contain these identifying words. These statements are not guarantees of future performance and are subject to certain risks, uncertainties, and assumptions that are difficult to predict; therefore, actual results may differ materially from those expressed or forecasted in any such forward-looking statements. Such risks and uncertainties include, but are not limited to, those discussed later in this report under the section entitled “Risk Factors”. Unless required by law, we undertake no obligation to update publicly any forward-looking statements, whether because of new information, future events or otherwise. However, readers should carefully review the risk factors set forth in this and other reports or documents we file from time to time with the Securities and Exchange Commission.
Business
Overview
We are a biopharmaceutical company focused on serving patients with severe and ultra-rare disorders through the innovation, development and commercialization of life-transforming therapeutic products. Our marketed product Soliris is the first and only therapeutic approved for patients with either of two severe and ultra-rare disorders resulting from chronic uncontrolled activation of the complement component of the immune system: paroxysmal nocturnal hemoglobinuria (PNH), a life-threatening and ultra-rare genetic blood disorder, and atypical hemolytic uremic syndrome (aHUS), a life-threatening and ultra-rare genetic disease. We are also evaluating additional potential indications for Soliris in severe and ultra-rare diseases in which uncontrolled complement activation is the underlying mechanism, and we are progressing in various stages of development with additional biotechnology product candidates as treatments for patients with severe and life-threatening ultra-rare disorders. We were incorporated in 1992 and began commercial sale of Soliris in 2007.
Soliris is designed to inhibit a specific aspect of the complement component of the immune system and thereby treat inflammation associated with chronic disorders in several therapeutic areas, including hematology, nephrology, transplant rejection and neurology. Soliris is a humanized monoclonal antibody that effectively blocks terminal complement activity at the doses currently prescribed. The initial indication for which we received approval for Soliris is PNH. PNH is a debilitating and life-threatening, ultra-rare genetic blood disorder defined by chronic uncontrolled complement activation leading to the

21

Alexion Pharmaceuticals, Inc.
(amounts in thousands, except per share amounts)

destruction of red blood cells (hemolysis). The chronic hemolysis in patients with PNH may be associated with life-threatening thromboses, recurrent pain, kidney disease, disabling fatigue, impaired quality of life, severe anemia, pulmonary hypertension, shortness of breath and intermittent episodes of dark-colored urine (hemoglobinuria).
Soliris was approved for the treatment of PNH by the U.S. Food and Drug Administration (FDA) and the European Commission (EC) in 2007 and by Japan’s Ministry of Health, Labour and Welfare (MHLW) in 2010, and has been approved in several other territories. Additionally, Soliris has been granted orphan drug designation for the treatment of PNH in the United States, Europe, Japan and several other territories.
In September and November 2011, Soliris was approved by the FDA and EC, respectively, for the treatment of pediatric and adult patients with aHUS in the United States and Europe. aHUS is a severe and life-threatening genetic ultra-rare disease characterized by chronic uncontrolled complement activation and thrombotic microangiopathy (TMA), the formation of blood clots in small blood vessels throughout the body, causing a reduction in platelet count (thrombocytopenia) and life-threatening damage to the kidney, brain, heart and other vital organs. In addition, the FDA and EC have granted Soliris orphan drug designation for the treatment of patients with aHUS. In September 2013, the MHLW approved Soliris for the treatment of pediatric and adult patients with aHUS in Japan.
Products and Development Programs
We focus our product development programs on life transforming therapeutics for severe and life-threatening ultra-rare diseases for which we believe current treatments are either non-existent or inadequate. Eculizumab is a humanized antibody known as a C5 terminal complement inhibitor (C5 Inhibitor), which is designed to selectively block the production of inflammation-causing proteins of the complement cascade. We believe that selective suppression of this immune response may provide a significant therapeutic advantage relative to existing therapies. In addition to PNH and aHUS, for which the use of eculizumab has been approved in the United States, Europe and Japan, we believe that C5 Inhibitors may be useful in the treatment of a variety of other serious diseases and conditions resulting from uncontrolled complement activation.
Marketed Products
Our marketed products include the following:
Product
 
Development Area
 
Indication
 
Development Stage
Soliris (eculizumab)
 
Hematology
 
Paroxysmal Nocturnal Hemoglobinuria (PNH)
 
Commercial
 
 
 
 
PNH Registry
 
Phase IV
 
 
Hematology/Nephrology
 
Atypical Hemolytic Uremic Syndrome (aHUS)
 
Commercial
 
 
 
 
aHUS Trials
 
Phase IV
 
 
 
 
aHUS Registry
 
Phase IV
Paroxysmal Nocturnal Hemoglobinuria (PNH)
Soliris is the first and only therapy approved for the treatment of patients with PNH, a debilitating and life-threatening ultra-rare blood disorder in which an acquired genetic deficiency causes uncontrolled complement activation which leads to life-threatening complications. We continue to work with researchers to expand the base of knowledge in PNH and the utility of Soliris to treat patients with PNH. The EC recently extended the Soliris label to include pediatric patients with PNH.  Additionally, we are sponsoring multinational registries to gather information regarding the natural history of patients with PNH and the longer term outcomes during Soliris treatment.
Atypical Hemolytic Uremic Syndrome (aHUS)
aHUS is a chronic and life-threatening ultra-rare genetic disease in which uncontrolled complement activation causes blood clots in small blood vessels throughout the body (thrombotic microangiopathy, or TMA) leading to kidney failure, stroke, heart attack and death. Soliris is the first and only therapy approved for the treatment of patients with aHUS. Pursuant to a post marketing requirement imposed by the FDA, we have now completed enrollment in a prospective open-label trial in adults with aHUS and, separately, enrollment has been completed in a prospective trial of pediatric patients with aHUS.

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Alexion Pharmaceuticals, Inc.
(amounts in thousands, except per share amounts)

Clinical Development Program
Our significant programs, including investigator sponsored clinical programs, include the following:
Product
 
Development Area
 
Indication
 
Development Stage
Soliris (eculizumab)
 
Nephrology
 
Presensitized Renal Transplant - Living Donor
 
Phase II
 
 
 
 
Presensitized Renal Transplant - Deceased Donor
 
Phase II
 
 
 
 
Delayed Kidney Transplant Graft Function*
 
Phase II
 
 
 
 
ABO Incompatible Renal Transplant*
 
Phase II
 
 
 
 
STEC-HUS (Shiga-toxin producing E. coli Hemolytic Uremic Syndrome)
 
Phase II
 
 
Neurology
 
Neuromyelitis Optica (NMO)*
 
Phase II
 
 
 
 
Myasthenia Gravis (MG)
 
Phase II
 
 
Hematology
 
Cold Agglutinin Disease (CAD)*
 
Phase II
Asfotase alfa
 
Metabolic Disorders

 
Hypophosphatasia (HPP)
 
Phase II
cPMP (ALXN 1101)
 
Metabolic Disorders

 
MoCD Type A
 
Phase I
ALXN 1102/1103
 
Hematology
 
PNH
 
Phase I
ALXN 1007
 
Inflammatory Disorders
 
 
 
Phase I
* Investigator Initiated Trial
 

Soliris (eculizumab)

Nephrology
Acute Humoral Rejection (AHR) in Presensitized Kidney Transplant Patients
Enrollment of the targeted number of patients is complete in a multi-national, multi-site controlled clinical trial of eculizumab in presensitized renal transplant patients at elevated risk for AHR who have received deceased donor grafts. In response to physician requests for eculizumab for their immunized patients awaiting kidney transplant and positive preliminary data, we have decided to expand the study by reopening enrollment. Enrollment is ongoing in a multi-national, multi-site controlled clinical trial of eculizumab in presensitized renal transplant patients at elevated risk for AHR who have received living donor grafts.
Delayed Kidney Transplant Graft Function
Enrollment has been completed in an investigator-initiated Phase II study of eculizumab in patients at elevated risk for delayed graft function (DGF) following kidney transplant. DGF is the term used to describe the failure of a kidney or other organs to function immediately after transplantation due to ischemia-reperfusion and immunological injury.
Shiga-toxin producing E. coli Hemolytic Uremic Syndrome (STEC-HUS)
STEC-HUS is an ultra-rare disorder, comprising only a small sub-set of the already rare population of patients with EHEC. Following an authorization by the Paul-Ehrlich-Institut, Germany's health care regulatory body for biologics, and an access program for patients initiated in May 2011, we initiated an open-label clinical trial to investigate eculizumab as a treatment for patients with STEC-HUS. Enrollment in this trial has been completed. We are obtaining and analyzing additional control clinical outcome data from an epidemiologic study in approximately 400 STEC-HUS patients who received only best supportive care. The FDA and the EC have each granted orphan designation for eculizumab as a treatment for patients with STEC-HUS.

23

Alexion Pharmaceuticals, Inc.
(amounts in thousands, except per share amounts)

Neurology
Neuromyelitis Optica (NMO)
NMO is a severe and ultra-rare autoimmune disease of the central nervous system (CNS) that primarily affects the optic nerves and spinal cord. Preliminary data from the investigator-initiated Phase II clinical trial of eculizumab in severe and relapsing NMO patients was presented to the American Neurological Association (ANA) meeting in October 2012. The study was reported to have achieved its primary efficacy endpoint with a high degree of clinical and statistical significance and several key secondary endpoints were also achieved. We are completing our discussions with regulators and plan to initiate what we expect to be a single pivotal NMO registration trial.
Myasthenia Gravis (MG)
MG is an ultra-rare autoimmune syndrome characterized by complement activation leading to the failure of neuromuscular transmission. Preliminary data from a Phase II trial evaluating the safety and efficacy of eculizumab in patients with severe, refractory MG demonstrated an encouraging disease improvement signal and was presented at the Myasthenia Gravis Foundation Annual Meeting in September 2011. We continue to work with investigators to design the next clinical trial to evaluate eculizumab as a treatment for patients with severe and refractory MG. We have completed our discussions with regulators and plan to initiate what we expect to be a single pivotal MG registration trial.
Hematology
Cold Agglutinin Disease (CAD)
We are aware that dosing is ongoing in an investigator-initiated Phase II study of eculizumab in patients for the treatment of CAD. CAD is a severe, ultra-rare complement-mediated autoimmune disease characterized by the presence of high concentrations of circulating complement-activating antibodies directed against red blood cells. As observed with PNH patients, CAD patients also suffer from the clinical consequences of severe hemolysis.

Asfotase Alfa
Hypophosphatasia (HPP)
HPP is an ultra-rare, genetic, and life-threatening metabolic disease characterized by impaired phosphate and calcium regulation, leading to progressive damage to multiple vital organs including destruction and deformity of bones, profound muscle weakness, seizures, impaired renal function, and respiratory failure.
Asfotase alfa, a targeted enzyme replacement therapy in Phase II clinical trials for patients with HPP, is designed to directly address the morbidities and mortality of HPP by targeting alkaline phosphatase directly to the deficient tissue. In this way, asfotase alfa is designed to normalize the genetically defective metabolic process and prevent or reverse the severe, crippling and life-threatening complications of dysregulated mineral metabolism in patients with HPP. Initial studies with asfotase alfa in HPP patients indicate that the treatment significantly decreases the levels of targeted metabolic substrates. We have completed enrollment in a natural history study in infants with HPP and have completed our initial analysis for the study. We are currently dosing patients in a separate global trial of severe infant HPP patients.

cPMP (ALXN 1101)
Molybdenum Cofactor Deficiency (MoCD) Disease Type A (MoCD Type A)
MoCD Type A is a rare metabolic disorder characterized by severe and rapidly progressive neurologic damage and death in newborns. MoCD Type A results from a genetic deficiency in cyclic Pyranopterin Monophosphate (cPMP), a molecule that enables production of certain enzymes, the absence of which allows neurotoxic sulfite to accumulate in the brain. To date, there is no approved therapy available for MoCD Type A. There has been some early clinical experience with the cPMP replacement therapy in a small number of children with MoCD Type A and we have initiated a natural history study in patients with MoCD Type A. We received authorization to initiate testing of our synthetic cPMP replacement therapy in healthy volunteers and began dosing healthy volunteers in the second quarter 2013.

ALXN 1102/1103
ALXN 1102/1103 is a novel alternative pathway complement inhibitor with a mechanism of action unique from Soliris. ALXN 1102 is currently being investigated in a Phase I single dose, dose escalating safety and pharmacology study. ALXN 1103 is being dosed in the same Phase I trial as a subcutaneous formulation.


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Alexion Pharmaceuticals, Inc.
(amounts in thousands, except per share amounts)

ALXN 1007
ALXN 1007 is a novel humanized antibody designed to target rare and severe inflammatory disorders and is a product of our proprietary antibody discovery technologies. We are completing enrollment in a Phase I single-dose, dose escalating safety and pharmacology study in healthy volunteers and we are currently enrolling patients in a multi-dose, dose escalating safety and pharmacology study in healthy volunteers.
Manufacturing
We currently rely on three manufacturing facilities, Alexion's Rhode Island manufacturing facility (ARIMF) and two facilities operated by Lonza Group AG and its affiliates (Lonza), to produce commercial and clinical bulk quantities of Soliris, and we rely on a facility operated by Lonza for clinical quantities of asfotase alfa. We produce our clinical and preclinical quantities of our other product candidates at ARIMF. We also depend on a limited number of third party providers for other services with respect to our clinical and commercial requirements, including product finishing, packaging, vialing and labeling.
On March 27, 2013, we received a Warning Letter from the FDA regarding compliance with current Good Manufacturing Practices (cGMP) at ARIMF. The Warning Letter followed an FDA inspection which concluded on August 6, 2012. At the conclusion of that inspection, the FDA issued a Form 483 Inspectional Observations, to which we responded in August 2012 and provided additional information to the FDA in September and December 2012. The observations relate to commercial and clinical manufacture of Soliris at ARIMF. We responded to the Warning Letter in a letter to the FDA dated April 15, 2013. We continue to manufacture products, including Soliris, in this facility. While the resolution of the issues raised in this Warning Letter is difficult to predict, we do not currently believe a loss related to this matter is probable or that the potential magnitude of such loss or range of loss, if any, can be reasonably estimated. To the extent that circumstances related to this matter change, the impact could have a material adverse effect on our financial operations. Further, the European Medicines Agency (EMA) inspected ARIMF in January 2013 and a GMP certificate was issued in May 2013.
On August 19, 2013, we initiated a voluntary recall and replacement of the remaining vials of a single lot of Soliris due to the presence of visible particles in a limited number of vials in the lot. The recall did not interrupt the supply of Soliris to patients and had no material impact on operations or financial results.
Critical Accounting Policies and the Use of Estimates
The significant accounting policies and basis of preparation of our consolidated financial statements are described in Note 1, “Business Overview and Summary of Significant Accounting Policies,” of our financial statements included in our Form 10-K for the year ended December 31, 2012. Under accounting principles generally accepted in the United States, we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and disclosure of contingent assets and liabilities in our financial statements. Actual results could differ from those estimates.
We believe the judgments, estimates and assumptions associated with the following critical accounting policies have the greatest potential impact on our consolidated financial statements:
Revenue recognition;
Contingent liabilities;
Inventories;
Research and development expenses;
Share-based compensation;
Valuation of goodwill, acquired intangible assets and in-process research and development (IPR&D);
Valuation of contingent consideration; and
Income taxes.

For a complete discussion of these critical accounting policies, refer to “Critical Accounting Policies and Use of Estimates” within “Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations” included within our Form 10-K for the year ended December 31, 2012.  We have reviewed our critical accounting policies as disclosed in our Form 10-K, and we have not noted any material changes.

New Accounting Pronouncements
In January 2013, the Financial Accounting Standards Board issued an update to clarify the scope of disclosures for offsetting assets and liabilities. The standard is effective for interim and annual periods beginning on or after January 1, 2013 and requires disclosure for all comparative periods. We adopted the provisions of this guidance in 2013.

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Alexion Pharmaceuticals, Inc.
(amounts in thousands, except per share amounts)

In February 2013, the Financial Accounting Standards Board issued a new standard to improve the reporting of reclassifications out of accumulated other comprehensive income. The new standard requires the disclosure of significant amounts reclassified from each component of accumulated other comprehensive income and the income statement line items affected by the reclassification. The standard is effective prospectively for interim and annual periods beginning after December 15, 2012. We adopted the provisions of this guidance, and included the additional disclosure requirements, in the first quarter of 2013.
Results of Operations

Net Product Sales
The following table summarizes net product sales for the three and nine months ended September 30, 2013 and 2012:
 
 
Three months ended
 
 
 
Nine months ended
 
 
 
September 30,
 
$
 
September 30,
 
$
 
2013
 
2012
 
Variance
 
2013
 
2012
 
Variance
Net product sales
$400,405
 
$294,136
 
$106,269
 
$1,109,437
 
$813,588
 
$295,849

The increase in revenue for the three and nine months ended September 30, 2013, as compared to the same period in 2012, was primarily due to an increased volume of unit shipments, partially offset by a negative impact of price and foreign exchange.
The increase in revenue of 36.1% and 36.4% for the three and nine months ended September 30, 2013, respectively, was due to an increase in unit volumes of 42.1% and 40.1%, offset by a negative price impact of 4.1% and 2.7%, and a negative impact on foreign exchange of 1.9% and 1.0%. The increase in volume was largely due to physicians globally requesting Soliris therapy for additional patients. The negative price impact of 4.1% for the three months ended September 30, 2013 was primarily due to increased rebates in certain countries in Europe. The negative price impact of 2.7% for the nine months ended September 30, 2013 was primarily due to increased rebates in certain countries in Europe, offset by a price increase in the United States.
The negative impact on foreign exchange of $5,467 and $7,809, or 1.9% and 1.0%, for the three and nine months ended September 30, 2013 was due to changes in foreign currency exchange rates (inclusive of hedging activity) versus the dollar for the three and nine months ended September 30, 2012. The negative impact was primarily due to the weakening of the Japanese Yen. We recorded a gain in revenue of $5,709 and $4,810 for the three months ended September 30, 2013 and 2012, respectively, and $18,364 and $8,885 for the nine months ended September 30, 2013 and 2012, respectively, related to our foreign currency cash flow hedging program.
Cost of Sales
In October 2013, we entered into a settlement agreement and dismissal with Novartis pursuant to which Alexion was granted a non-exclusive, fully paid license and the case was dismissed with prejudice. As a result, we recorded expense of $9,181 in cost of sales in the third quarter 2013 related to this litigation settlement agreement.
In the third quarter of 2012, we reduced our estimate for probable contingent liabilities as of September 30, 2012 due to the execution of a settlement and non-exclusive license agreement in October 2012 with a third party related to the third party's intellectual property. The adjustment reflected the actual, negotiated royalty rate set forth in the agreement. This change in estimate resulted in a positive impact in cost of sales of $53,377 during the third quarter 2012.
Exclusive of the settlements noted above, cost of sales were $42,177 and $33,186 for the three months ended September 30, 2013 and 2012, respectively, and $116,823 and $93,067 for the nine months ended September 30, 2013 and 2012, respectively. Exclusive of the settlements noted above, cost of sales as a percentage of net product sales decreased to 10.5% for the three months ended September 30, 2013 from 11.3% for the three months ended September 30, 2012 and cost of sales as a percentage of net product sales decreased to 10.5% for the nine months ended September 30, 2013 from 11.4% for the nine months ended September 30, 2012. The decreases in cost of sales as a percentage of sales primarily related to a decrease in ongoing royalty expense from the settlement and non-exclusive license agreement we entered into in October 2012.

26

Alexion Pharmaceuticals, Inc.
(amounts in thousands, except per share amounts)

Research and Development Expense
Our research and development expense includes personnel, facility and external costs associated with the research and development of our product candidates, as well as product development costs. We group our research and development expenses into two major categories: external direct expenses and all other research and development (R&D) expenses.
External direct expenses are comprised of costs paid to outside parties for clinical development, product development and discovery research. Clinical development costs are comprised of costs to conduct and manage clinical trials related to eculizumab and other product candidates. Product development costs are those incurred in performing duties related to manufacturing development and regulatory functions, including manufacturing of material for clinical and research activities. Discovery research costs are incurred in conducting laboratory studies and performing preclinical research for other uses of eculizumab and other product candidates. Clinical development costs have been accumulated and allocated to each of our programs, while product development and discovery research costs have not been allocated.
All other R&D expenses consist of costs to compensate personnel, to maintain our facility, equipment and overhead and similar costs of our research and development efforts. These costs relate to efforts on our clinical and preclinical products, our product development and our discovery research efforts. These costs have not been allocated directly to each program.
The following table provides information regarding research and development expenses: 
 
Three months ended
 
 
 
Nine months ended
 
 
 
September 30,
 
$
 
September 30,
 
$
 
2013
 
2012
 
Variance
 
2013
 
2012
 
Variance
Clinical development
$20,719
 
$10,274
 
$10,445
 
$48,715
 
$33,133
 
$15,582
Product development
12,435
 
11,292
 
1,143
 
48,951
 
40,552
 
8,399
Discovery research
11,754
 
2,174
 
9,580
 
18,732
 
5,774
 
12,958
Total external direct expenses
44,908
 
23,740
 
21,168
 
116,398
 
79,459
 
36,939
Payroll and benefits
38,504
 
25,400
 
13,104
 
101,288
 
68,972
 
32,316
Operating and occupancy
2,099
 
3,029
 
(930)
 
6,308
 
5,608
 
700
Depreciation and amortization
2,698
 
2,111
 
587
 
7,314
 
5,284
 
2,030
Total other R&D expenses
43,301
 
30,540
 
12,761
 
114,910
 
79,864
 
35,046
Research and development expense
$88,209
 
$54,280
 
$33,929
 
$231,308
 
$159,323
 
$71,985

For the three months ended September 30, 2013, the increase of $33,929 in research and development expense, as compared to the same period in the prior year, was primarily related to the following:
Increase of $10,445 in external clinical development expenses related primarily to an expansion of studies of our eculizumab, asfotase alfa and cPMP programs (see table below).
Increase of $9,580 in discovery research expenses primarily related to the upfront payment on the license agreement entered into in the third quarter of 2013.
Increase of $13,104 in R&D payroll and benefit expense related primarily to the continued global expansion of staff supporting our increasing number of clinical and development programs.
For the nine months ended September 30, 2013, the increase of $71,985 in research and development expense, as compared to the same period in the prior year, was primarily related to the following:
Increase of $15,582 in external clinical development expenses related primarily to an expansion of studies of our eculizumab, asfotase alfa and cPMP programs (see table below).
Increase of $8,399 in external product development expenses related primarily to costs associated with the preparation of regulatory filings for asfotase alfa, as well as manufacturing costs related to our other product development programs.
Increase of $12,958 in discovery research expenses primarily related to the upfront payments on the license agreements entered into in 2013.
Increase of $32,316 in R&D payroll and benefit expense related primarily to the continued global expansion of staff supporting our increasing number of clinical and development programs.


27

Alexion Pharmaceuticals, Inc.
(amounts in thousands, except per share amounts)

The following table summarizes external direct expenses related to our clinical development programs. Please refer to "Clinical Development Programs" above for a description of each of these programs:
 
 
Three months ended
 
 
 
Nine months ended
 
 
 
September 30,
 
$
 
September 30,
 
$
 
2013
 
2012
 
Variance
 
2013
 
2012
 
Variance
External direct expenses
 
 
 
 
 
 
 
 
 
 
 
Eculizumab
$14,234
 
$7,986
 
$6,248
 
$30,555
 
$26,753
 
$3,802
Asfotase alfa
2,234
 
794

 
1,440
 
8,518
 
2,249

 
6,269
cPMP
1,965
 
987
 
978
 
4,753
 
1,010
 
3,743
Other Programs
1,686
 
597

 
1,089
 
3,469
 
2,750

 
719
Unallocated
600
 
(90)
 
690
 
1,420
 
371
 
1,049
 
$20,719
 
$10,274
 
$10,445
 
$48,715
 
$33,133
 
$15,582
The successful development of our drug candidates is uncertain and subject to a number of risks. We cannot guarantee that results of clinical trials will be favorable or sufficient to support regulatory approvals for our other programs. We could decide to abandon development or be required to spend considerable resources not otherwise contemplated. For additional discussion regarding the risks and uncertainties regarding our development programs, please refer to Item 1A "Risk Factors" in this Form 10-Q.
Selling, General and Administrative Expense
Our selling, general and administrative expense includes commercial and administrative personnel, corporate facility and external costs required to support the marketing and sales of our commercialized products. These selling, general and administrative costs include: corporate facility operating expenses and depreciation; marketing and sales operations in support of Soliris; human resources; finance, legal, information technology and support personnel expenses; and other corporate costs such as telecommunications, insurance, audit and legal expenses.
The table below provides information regarding selling, general and administrative expense:
 
Three months ended
 
 
 
Nine months ended
 
 
 
September 30,
 
$
 
September 30,
 
$
 
2013
 
2012
 
Variance
 
2013
 
2012
 
Variance
Salary, benefits and other labor expense
$
75,222

 
$
52,117

 
$
23,105

 
$
216,384

 
$
161,327

 
$
55,057

External selling, general and administrative expense
47,664

 
37,840

 
9,824

 
138,517

 
110,727

 
27,790

Total selling, general and administrative expense
$
122,886

 
$
89,957

 
$
32,929

 
$
354,901

 
$
272,054

 
$
82,847

For the three months ended September 30, 2013, the increase of $32,929 in selling, general and administrative expense, as compared to the same period in the prior year, was primarily related to the following:
Increase in salary, benefits and other labor expenses of $23,105. The increase was a result of increased headcount related to commercial development activities, including increases in payroll and benefits costs of $15,500 related to our global commercial staff to support global expansion. This increase was also due to increases in payroll and benefits of $7,600 within our general and administrative functions to support our infrastructure growth as a global commercial entity.
Increase in external selling, general and administrative expenses of $9,824. The increase was primarily due to an increase in legal costs associated with the Novartis settlement, an increase in consulting fees related to our global supply chain expansion in Ireland, and an increase in marketing costs to support the continued growth in global sales.
For the nine months ended September 30, 2013, the increase of $82,847 in selling, general and administrative expense, as compared to the same period in the prior year, was primarily related to the following:
Increase in salary, benefits and other labor expenses of $55,057. The increase was a result of increased headcount related to commercial development activities, including increases in payroll and benefits costs of $40,200 related to our global commercial staff to support global expansion. This increase was also due to increases in payroll and

28

Alexion Pharmaceuticals, Inc.
(amounts in thousands, except per share amounts)

benefits of $14,800 within our general and administrative functions to support our infrastructure growth as a global commercial entity.
Increase in external selling, general and administrative expenses of $27,790. This increase was primarily due to an increase in legal costs associated with the Novartis settlement, an increase in consulting fees related to our global supply chain expansion in Ireland, an increase in marketing costs to support the continued growth in global sales, as well as an increase in general administrative expenses due to infrastructure growth.
Acquisition-related Costs
Acquisition-related costs for the three and nine months ended September 30, 2013 and 2012 associated with our business combinations included the following:
 
Three months ended

Nine months ended
 
September 30,

September 30,
 
2013

2012

2013

2012
Separately-identifiable employee costs
$

 
$
457

 
$
248

 
$
3,552

Professional fees

 
1,052

 
775

 
11,562

Changes in fair value of contingent consideration
2,573

 
(542
)
 
5,951

 
4,333

 
$
2,573

 
$
967

 
$
6,974

 
$
19,447

The following table provides information for acquisition-related costs for each business combination:
 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Enobia Pharma Corp.
$
2,210

 
$
3,441

 
$
5,920

 
$
20,558

Taligen Therapeutics, Inc.
(53
)
 
(4,224
)
 
118

 
(3,069
)
Orphatec Pharmaceuticals GmbH
416

 
1,750

 
936

 
1,958

 
$
2,573

 
$
967

 
$
6,974

 
$
19,447


Impairment of Intangible Asset
During the three months ended September 30, 2012, we reviewed for impairment the value of an early stage, preclinical indefinite-lived intangible asset related to the Taligen acquisition. We initiated such review based on our evaluation of negative scientific findings associated with our development of a different asset for the treatment of age-related macular degeneration, the likelihood of success for ophthalmic use and the value that can be obtained from a market participant in an arm's length transaction. These developments led us to deprioritize the development of this acquired asset. As a result, in the third quarter 2012, we recognized an impairment charge of $26,300 to write-down this asset to fair value, which was determined to be de minimis. We did not recognize any impairment loss for intangible assets during the three and nine months ended September 30, 2013.
Other Income and Expense
The following table provides information regarding other income and expense:
 
Three months ended
 
 
 
Nine months ended
 
 
 
September 30,
 
$
 
September 30,
 
$
 
2013
 
2012
 
Variance
 
2013
 
2012
 
Variance
Investment income
$
638