ALXN 6.30.14 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 June 30, 2014
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
197,814,997
Class
Outstanding as of July 23, 2014










 
Alexion Pharmaceuticals, Inc.
Contents

 
PART I.
FINANCIAL INFORMATION
Page
 
Item 1.
Condensed Consolidated Financial Statements (Unaudited)
 
 
 
Condensed Consolidated Balance Sheets as of June 30, 2014 and December 31, 2013
2

 
 
Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2014 and 2013
3

 
 
Condensed Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2014 and 2013
4

 
 
Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2014 and 2013
5

 
 
Notes to Condensed Consolidated Financial Statements
6

 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
20

 
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
58

SIGNATURES
 
 



Alexion Pharmaceuticals, Inc.
Condensed Consolidated Balance Sheets
(unaudited)
(amounts in thousands, except per share amounts)
 
 
June 30,
 
December 31,
 
2014
 
2013
Assets
 
 
 
Current Assets:
 
 
 
Cash and cash equivalents
$
612,045

 
$
529,857

Marketable securities
982,317

 
984,994

Trade accounts receivable, net
440,699

 
421,752

Inventories
144,859

 
102,602

Deferred tax assets
50,281

 
41,432

Prepaid expenses and other current assets
111,105

 
106,220

Total current assets
2,341,306

 
2,186,857

Property, plant and equipment, net
273,326

 
201,109

Intangible assets, net
599,786

 
609,719

Goodwill
254,073

 
254,073

Deferred tax assets
7,417

 
3,394

Other assets
77,902

 
62,544

Total assets
$
3,553,810

 
$
3,317,696

Liabilities and Stockholders' Equity
 
 
 
Current Liabilities:
 
 
 
Accounts payable
$
36,066

 
$
21,596

Accrued expenses
204,743

 
402,344

Deferred revenue
72,271

 
53,801

Current portion of long-term debt
48,000

 
48,000

Other current liabilities
56,621

 
56,688

Total current liabilities
417,701

 
582,429

Long-term debt, less current portion
33,500

 
65,000

Contingent consideration
108,232

 
106,744

Facility lease obligation
59,515

 
32,230

Deferred tax liabilities
96

 
101,241

Other liabilities
53,184

 
47,973

Total liabilities
672,228

 
935,617

Commitments and contingencies (Note 16)

 

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; 200,035 and 197,941 shares issued at June 30, 2014 and December 31, 2013, respectively
20

 
20

Additional paid-in capital
2,467,945

 
2,106,183

Treasury stock, at cost, 2,134 and 985 shares at June 30, 2014 and December 31, 2013, respectively
(258,880
)
 
(80,365
)
Accumulated other comprehensive loss
(32,450
)
 
(22,857
)
Retained earnings
704,947

 
379,098

Total stockholders' equity
2,881,582

 
2,382,079

Total liabilities and stockholders' equity
$
3,553,810

 
$
3,317,696


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 June 30,
 
Six months ended June 30,
 
2014
 
2013
 
2014
 
2013
Net product sales
$
512,495

 
$
370,091

 
$
1,079,111

 
$
709,032

Cost of sales
39,626

 
39,377

 
72,565

 
74,646

Operating expenses:
 
 
 
 
 
 
 
Research and development
92,554

 
68,563

 
284,011

 
143,099

Selling, general and administrative
159,477

 
123,189

 
288,768

 
232,015

Impairment of intangible asset

 

 
3,464

 

Acquisition-related costs
1,989

 
1,167

 
1,951

 
4,401

Amortization of purchased intangible assets

 
104

 

 
208

Total operating expenses
254,020

 
193,023

 
578,194

 
379,723

Operating income
218,849

 
137,691

 
428,352

 
254,663

Other income and expense:
 
 
 
 
 
 
 
Investment income
1,714

 
718

 
3,927

 
1,155

Interest expense
(715
)
 
(1,056
)
 
(1,778
)
 
(2,227
)
Foreign currency gain (loss)
(1,202
)
 
(90
)
 
56

 
413

Income before income taxes
218,646

 
137,263

 
430,557

 
254,004

Income tax provision
52,151

 
41,378

 
104,708

 
75,902

Net income
$
166,495

 
$
95,885

 
$
325,849

 
$
178,102

Earnings per common share
 
 
 
 
 
 
 
Basic
$
0.84

 
$
0.49

 
$
1.65

 
$
0.92

Diluted
$
0.83

 
$
0.48

 
$
1.62

 
$
0.90

Shares used in computing earnings per common share
 
 
 
 
 
 
 
Basic
197,880

 
195,247

 
197,838

 
193,944

Diluted
201,524

 
199,299

 
201,715

 
198,096

 
 
 
 
 
 
 
 

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 June 30,
 
Six months ended June 30,
 
2014
 
2013
 
2014
 
2013
Net income
$
166,495

 
$
95,885

 
$
325,849

 
$
178,102

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation
46

 
(77
)
 
552

 
(1,529
)
Unrealized gains (losses) on marketable securities
299

 
(226
)
 
1,110

 
(226
)
Unrealized losses on pension obligation
(2,685
)
 
(2,684
)
 
(2,685
)
 
(2,684
)
Unrealized (losses) gains on hedging activities, net of tax of $(526), $(587), $(1,771) and $1,923, respectively
(3,675
)
 
(8,448
)
 
(8,570
)
 
17,330

Other comprehensive loss, net of tax
(6,015
)
 
(11,435
)
 
(9,593
)
 
12,891

Comprehensive income
$
160,480

 
$
84,450

 
$
316,256

 
$
190,993


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)
 
 
Six months ended June 30,
 
2014
 
2013
Cash flows from operating activities:
 
 
 
Net income
$
325,849

 
$
178,102

Adjustments to reconcile net income to net cash flows from operating activities:
 
 
 
Depreciation and amortization
19,042

 
13,014

Impairment of intangible asset
3,464

 

Change in fair value of contingent consideration
1,951

 
3,378

Share-based compensation expense
52,254

 
34,812

Premium amortization of available-for-sale securities
8,163

 
25

Deferred taxes
(112,425
)
 
25,985

Unrealized foreign currency gain
(4,046
)
 
(457
)
Unrealized loss (gain) on forward contracts
161

 
(561
)
Excess tax benefit from stock options
(254,547
)
 
(57,317
)
Other
148

 
23

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(9,179
)
 
(55,178
)
Inventories
(34,972
)
 
(14,391
)
Prepaid expenses and other assets
(17,815
)
 
10,160

Accounts payable, accrued expenses and other liabilities
78,298

 
4,246

Deferred revenue
18,749

 
2,352

Net cash provided by operating activities
75,095

 
144,193

Cash flows from investing activities:
 
 
 
Purchases of available-for-sale securities
(278,134
)
 
(185,322
)
Proceeds from maturity or sale of available-for-sale securities
275,946

 
2,002

Purchases of trading securities
(1,765
)
 

Purchases of other investments
(25,000
)
 

Purchases of property, plant and equipment
(61,189
)
 
(14,012
)
Other
26

 
(207
)
Net cash used in investing activities
(90,116
)
 
(197,539
)
Cash flows from financing activities:
 
 
 
Payments on term loan
(31,500
)
 
(12,000
)
Excess tax benefit from stock options
254,547

 
57,317

Repurchase of common stock
(178,515
)
 
(66,136
)
Net proceeds from the exercise of stock options
52,181

 
23,577

Other
(81
)
 
(99
)
Net cash provided by financing activities
96,632

 
2,659

Effect of exchange rate changes on cash
577

 
(2,350
)
Net change in cash and cash equivalents
82,188

 
(53,037
)
Cash and cash equivalents at beginning of period
529,857

 
989,501

Cash and cash equivalents at end of period
$
612,045

 
$
936,464

 
 
 
 
Supplemental cash flow disclosures from investing and financing activities:
 
 
 
Construction in process related to facility lease obligation
$
27,284

 
$
6,854

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.

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, 2013. 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, 2013 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, 2013 included in our Annual Report on Form 10-K. The results of operations for the three and six months ended June 30, 2014 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 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, 2013.

New Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board issued a comprehensive new standard which amends revenue recognition principles and provides a single set of criteria for revenue recognition among all industries. The new standard provides a five step framework whereby revenue is recognized when promised goods or services are transferred to a customer at an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard also requires enhanced disclosures pertaining to revenue recognition in both interim and annual periods. The standard is effective for interim and annual periods beginning after December 15, 2016 and allows for adoption using a full retrospective method, or a modified retrospective method. We are currently assessing the method of adoption and the expected impact the new standard has on our financial position and results of operations.


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:
 
June 30,
 
December 31,
 
2014
 
2013
Raw materials
$
16,693

 
$
12,170

Work-in-process
56,783

 
62,192

Finished goods
71,383

 
28,240

 
$
144,859

 
$
102,602


As of June 30, 2014, we had capitalized $9,627 of inventory produced for commercial sale for products awaiting regulatory approval. At December 31, 2013, we did not have any inventory capitalized associated with such products.


4.
Intangible Assets and Goodwill
The following table summarizes the carrying amount of our intangible assets and goodwill, net of accumulated amortization: 
 
 
June 30, 2014
 
December 31, 2013
Licenses, patents and purchased technology, net
 
$
4,736

 
$
11,205

Acquired in-process research and development
 
595,050

 
598,514

Intangible assets
 
$
599,786

 
$
609,719

Goodwill
 
$
254,073

 
$
254,073

During first quarter of 2014, we reviewed for impairment the value of an early stage, Phase I indefinite-lived intangible asset related to the Taligen acquisition. We initiated such review based on a reassessment of scientific findings associated with this acquired asset. As a result, during the six months ended June 30, 2014, we recognized an impairment of $3,464 to adjust this asset to fair value, which was determined to be de minimis.

5.
Debt
On February 7, 2012, we 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 June 30, 2014, we had $81,500 outstanding on the term loan. As of June 30, 2014, we had open letters of credit of $12,445, and our borrowing availability under the revolving facility was $187,555.
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 six months ended June 30, 2014 and 2013:
 
Three months ended
 
Six months ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Net income used for basic and diluted calculation
$
166,495

 
$
95,885

 
$
325,849

 
$
178,102

Shares used in computing earnings per common share—basic
197,880

 
195,247

 
197,838

 
193,944

Weighted-average effect of dilutive securities:
 
 
 
 
 
 
 
Stock awards
3,644

 
4,052

 
3,877

 
4,152

Dilutive potential common shares
3,644

 
4,052

 
3,877

 
4,152

Shares used in computing earnings per common share—diluted
201,524

 
199,299

 
201,715

 
198,096

Earnings per common share:
 
 
 
 

 

Basic
$
0.84

 
$
0.49

 
$
1.65

 
$
0.92

Diluted
$
0.83

 
$
0.48

 
$
1.62

 
$
0.90

We exclude from EPS the weighted-average number of securities whose effect is anti-dilutive. Excluded from the calculation of EPS for the three and six months ended June 30, 2014 were 1,698 and 1,151 shares of common stock, respectively, because their effect is anti-dilutive. Similarly, we excluded 2,265 and 3,037 shares from the calculation of EPS for the three and six months ended June 30, 2013, respectively, because their effect was anti-dilutive.
 
7.
Marketable Securities

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 June 30, 2014 and December 31, 2013 were as follows:
 
 
June 30, 2014
 
 
Amortized Cost
 
Gross Unrealized Holding Gains
 
Gross Unrealized Holding Losses
 
Estimated Fair Value
Commercial paper
 
$
66,448

 
$

 
$

 
$
66,448

Corporate bonds
 
484,588

 
916

 
(120
)
 
485,384

Municipal bonds
 
207,643

 
251

 

 
207,894

Other government-related obligations:
 
 
 
 
 
 
 
 
U.S.
 
51,969

 
37

 
(21
)
 
51,985

Foreign
 
149,573

 
208

 
(41
)
 
149,740

Bank certificates of deposit
 
18,004

 
5

 

 
18,009

 
 
$
978,225

 
$
1,417

 
$
(182
)
 
$
979,460


8

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






 
 
December 31, 2013
 
 
Amortized Cost Basis
 
Gross Unrealized Holding Gains
 
Gross Unrealized Holding Losses
 
Aggregate Fair Value
Commercial paper
 
$
112,679

 
$

 
$

 
$
112,679

Corporate bonds
 
476,459

 
487

 
(588
)
 
476,358

Municipal bonds
 
202,396

 
47

 
(40
)
 
202,403

Other government-related obligations:
 
 
 
 
 
 
 
 
U.S.
 
46,466

 
30

 
(7
)
 
46,489

Foreign
 
156,974

 
54

 
(204
)
 
156,824

Bank certificates of deposit
 
33,004

 

 

 
33,004

 
 
$
1,027,978

 
$
618

 
$
(839
)
 
$
1,027,757


The aggregate fair value of available-for-sale securities in an unrealized loss position as of June 30, 2014 and December 31, 2013 was $210,079 and $461,634, respectively. Investments that have been in a continuous unrealized loss position for more than 12 months are not material. As of June 30, 2014, 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:
 
June 30, 2014
December 31, 2013
Cash and cash equivalents
$

$
43,780

Marketable securities
979,460

983,977

 
$
979,460

$
1,027,757


The fair values of available-for-sale debt securities at June 30, 2014, by contractual maturity, are summarized as follows:
 
June 30, 2014
Due in one year or less
$
417,471

Due after one year through three years
561,989

Due after three years through five years

 
$
979,460


As of June 30, 2014 and December 31, 2013, the fair value of our trading securities was $2,857 and $1,017, respectively.
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 six months ended June 30, 2014 and 2013.

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, and British Pound. 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.

9

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





We enter into foreign exchange forward contracts, with durations of up to 36 months, to hedge exposures resulting from portions of our forecasted revenues, including intercompany revenues, that are denominated in currencies other than the U.S. dollar. The purpose of the hedges of 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 June 30, 2014, we had open contracts with notional amounts totaling $1,410,389 that qualified for hedge accounting.
The impact on accumulated other comprehensive income (AOCI) and earnings from foreign exchange contracts that qualified as cash flow hedges, for the three and six months ended June 30, 2014 and 2013 were as follows:
 
Three months ended
 
Six months ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Gain (loss) recognized in AOCI, net of tax
$
(4,119
)
 
$
(1,388
)
 
$
(8,063
)
 
$
29,537

Gain (loss) reclassified from AOCI to net product sales (effective portion), net of tax
$
(608
)
 
$
6,864

 
$
500

 
$
11,579

Gain reclassified from AOCI to other income and expense (ineffective portion), net of tax
$
164

 
$
196

 
$
7

 
$
628

Assuming no change in foreign exchange rates from market rates at June 30, 2014, $7,000 of losses 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 June 30, 2014, the notional amount of foreign exchange contracts where hedge accounting is not applied was $239,318.
We recognized a gain (loss) of $(1,640) and $1,837, in other income and expense, for the three months ended June 30, 2014 and 2013, respectively, and $649 and $8,787, for the six months ended June 30, 2014 and 2013, 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.
The following tables summarize the fair value of outstanding derivatives at June 30, 2014 and December 31, 2013: 

 
June 30, 2014
 
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
 
$
13,018

 
Other current liabilities
 
$
19,729

Foreign exchange forward contracts
Other non-current assets
 
4,115

 
Other non-current liabilities
 
11,285

Total fair value of derivative instruments
 
 
$
17,133

 
 
 
$
31,014



10

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






 
December 31, 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
 
$
21,815

 
Other current liabilities
 
$
20,228

Foreign exchange forward contracts
Other non-current assets
 
9,839

 
Other non-current liabilities
 
14,864

Total fair value of derivative instruments
 
 
$
31,654

 
 
 
$
35,092


The fair value of our foreign exchange forward contracts that are not designated as hedging instruments was zero as of June 30, 2014 and December 31, 2013.

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:
 
 
June 30, 2014
 
 
 
 
 
 
 
 
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
 
$
17,133

 
$

 
$
17,133

 
$
(15,934
)
 
$

 
$
1,199

Derivative liabilities
 
(31,014
)
 

 
(31,014
)
 
15,934

 

 
(15,080
)


 
 
December 31, 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
 
$
31,654

 
$

 
$
31,654

 
$
(27,256
)
 
$

 
$
4,398

Derivative liabilities
 
(35,092
)
 

 
(35,092
)
 
27,256

 

 
(7,836
)


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 the Company's discretion. Under the program, we repurchased 1,012 and 353 shares of our common stock at a cost of $156,458 and $31,029 during the three months ended June 30, 2014 and 2013,

11

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





respectively, and 1,149 and 758 shares of our common stock at a cost of $178,515 and $66,136 during the six months ended June 30, 2014 and 2013, respectively. As of June 30, 2014, there is a total of $143,796 remaining for repurchases under the program.
Subsequent to June 30, 2014, we repurchased 180 shares of our common stock under our repurchase program at a cost of $28,968.
  
10.
Other Comprehensive Income and Accumulated Other Comprehensive Income

The following tables summarize the changes in AOCI, by component, for the six months ended June 30, 2014 and 2013:

 
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, 2013
$
(11,502
)
 
$
(146
)
 
$
(3,827
)
 
$
(7,382
)
 
$
(22,857
)
Other comprehensive income before reclassifications
(3,086
)
 
1,111

 
(8,063
)
 
552

 
(9,486
)
Amounts reclassified from other comprehensive income
401

 
(1
)
 
(507
)
 

 
(107
)
Net other comprehensive income (loss)
(2,685
)
 
1,110

 
(8,570
)
 
552

 
(9,593
)
Balances, June 30, 2014
$
(14,187
)
 
$
964

 
$
(12,397
)
 
$
(6,830
)
 
$
(32,450
)

 
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
(2,873
)
 
(225
)
 
29,537

 
(1,529
)
 
24,910

Amounts reclassified from other comprehensive income
189

 
(1
)
 
(12,207
)
 

 
(12,019
)
Net other comprehensive income (loss)
(2,684
)
 
(226
)
 
17,330

 
(1,529
)
 
12,891

Balances, June 30, 2013
$
(8,396
)
 
$
(226
)
 
$
32,486

 
$
(4,338
)
 
$
19,526



12

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 six months ended June 30, 2014 and 2013:
Details about Accumulated Other Comprehensive Income Components
 
Amount Reclassified From Accumulated Other Comprehensive Income during the three months ended June 30,
 
Amount Reclassified From Accumulated Other Comprehensive Income during the six months ended June 30,
 
Affected Line Item in the Condensed Consolidated Statements of Operations
 
2014
2013
 
2014
2013
 
Unrealized Gains (Losses) from Hedging Activity
 
 
 
 
 
 
 
 
Effective portion of foreign exchange contracts
 
$
(695
)
$
7,502

 
$
571

$
12,655

 
Net product sales
Ineffective portion of foreign exchange contracts
 
187

214

 
8

686

 
Foreign currency gain (loss)
 
 
(508
)
7,716

 
579

13,341

 
 
 
 
64

(656
)
 
(72
)
(1,134
)
 
Income tax provision
 
 
$
(444
)
$
7,060

 
$
507

$
12,207

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

$
2

 
$
2

$
2

 
Investment income
 
 

2

 
2

2

 
 
 
 

(1
)
 
(1
)
(1
)
 
Income tax provision
 
 
$

$
1

 
$
1

$
1

 
 
Defined Benefit Pension Plans
 
 
 
 
 
 
 
 
Amortization of prior service costs and actuarial losses
 
$
(359
)
$
(131
)
 
$
(438
)
$
(207
)
 
(a)
 
 
(359
)
(131
)
 
(438
)
(207
)
 
 
 
 
31

11

 
37

18

 
Income tax provision
 
 
$
(328
)
$
(120
)
 
$
(401
)
$
(189
)
 
 
(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.

13

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 June 30, 2014 and December 31, 2013, and indicate the fair value hierarchy of the valuation techniques we utilized to determine such fair value. 
 
 
Fair Value Measurement at
June 30, 2014
Balance Sheet
Classification
Type of Instrument
Total
 
Level 1
 
Level 2
 
Level 3
Cash equivalents
Institutional money market funds
$
256,300

 
$

 
$
256,300

 
$

Marketable securities
Mutual funds
$
2,857

 
$
2,857

 
$

 
$

Marketable securities
Commercial paper
$
66,448

 
$

 
$
66,448

 
$

Marketable securities
Corporate bonds
$
485,384

 
$

 
$
485,384

 
$

Marketable securities
Municipal bonds
$
207,894

 
$

 
$
207,894

 
$

Marketable securities
Other government-related obligations
$
201,725

 
$

 
$
201,725

 
$

Marketable securities
Bank certificates of deposit
$
18,009

 
$

 
$
18,009

 
$

Other current assets
Foreign exchange forward contracts
$
13,018

 
$

 
$
13,018

 
$

Other assets
Foreign exchange forward contracts
$
4,115

 
$

 
$
4,115

 
$

Other current liabilities
Foreign exchange forward contracts
$
19,729

 
$

 
$
19,729

 
$

Other liabilities
Foreign exchange forward contracts
$
11,285

 
$

 
$
11,285

 
$

Other current liabilities
Acquisition-related contingent consideration
$
36,395

 
$

 
$

 
$
36,395

Contingent consideration
Acquisition-related contingent consideration
$
108,232

 
$

 
$

 
$
108,232

 

14

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





 
 
Fair Value Measurement at
December 31, 2013
Balance Sheet
Classification
Type of Instrument
Total
 
Level 1
 
Level 2
 
Level 3
Cash equivalents
Institutional money market funds
$
234,212

 
$

 
$
234,212

 
$

Cash equivalents
Commercial paper
$
6,298

 
$

 
$
6,298

 
$

Cash equivalents
Corporate bonds
$
15,255

 
$

 
$
15,255

 
$

Cash equivalents
Municipal bonds
$
2,225

 
$

 
$
2,225

 
$

Cash equivalents
Bank certificates of deposit
$
20,003

 
$

 
$
20,003

 
$

Marketable securities
Mutual funds
$
1,017

 
$
1,017

 
$

 
$

Marketable securities
Commercial paper
$
106,381

 
$

 
$
106,381

 
$

Marketable securities
Corporate bonds
$
461,103

 
$

 
$
461,103

 
$

Marketable securities
Municipal bonds
$
200,178

 
$

 
$
200,178

 
$

Marketable securities
Other government-related obligations
$
203,313

 
$

 
$
203,313

 
$

Marketable securities
Bank certificates of deposit
$
13,001

 
$

 
$
13,001

 
$

Other current assets
Foreign exchange forward contracts
$
21,815

 
$

 
$
21,815

 
$

Other assets
Foreign exchange forward contracts
$
9,839

 
$

 
$
9,839

 
$

Other current liabilities
Foreign exchange forward contracts
$
20,228

 
$

 
$
20,228

 
$

Other liabilities
Foreign exchange forward contracts
$
14,864

 
$

 
$
14,864

 
$

Other current liabilities
Acquisition-related contingent consideration
$
35,932

 
$

 
$

 
$
35,932

Contingent consideration
Acquisition-related contingent consideration
$
106,744

 
$

 
$

 
$
106,744


There were no securities transferred between Level 1, 2 and 3 during the six months ended June 30, 2014.

Valuation Techniques
We classify 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.
Cash equivalents and marketable securities 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. We validate the prices provided by our third-party pricing sources by understanding the models used, obtaining market values from other pricing sources and analyzing pricing data in certain instances.

15

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






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, as well as an evaluation of our counterparties’ credit risks. Based on these inputs, the derivative assets and liabilities are classified within Level 2 of the valuation hierarchy.
Contingent consideration liabilities related to acquisitions are classified as Level 3 within the valuation hierarchy and are 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 June 30, 2014, 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 5.3% to 6.2% for developmental milestones and a weighted average cost of capital ranging from 14% 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 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 June 30, 2014, the fair value of acquisition-related contingent consideration was $144,627. The following table represents a roll-forward of our acquisition-related contingent consideration:
 
Six months ended
 
June 30, 2014
Balance at beginning of period
$
(142,676
)
Changes in fair value
(1,951
)
Balance at end of period
$
(144,627
)

12.
Income Taxes
The following table provides a comparative summary of our income tax provision and effective tax rate for the three and six months ended June 30, 2014 and 2013:
 
 
Three months ended
 
Six months ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Provision for income taxes
$
52,151

 
$
41,378

 
$
104,708

 
$
75,902

Effective tax rate
23.9
%
 
30.1
%
 
24.3
%
 
29.9
%

The tax provision for the three and six months ended June 30, 2014 is attributable to the U.S. federal, state and foreign income taxes on our operations. Additionally, included in the six months ended June 30, 2014 is $2,128 of tax attributable to our agreement with the French government that provided reimbursement for shipments of Soliris made prior to January 1, 2014. The tax provision for the three and six months ended June 30, 2013 is attributable to the U.S. federal, state and foreign income taxes on our operations. Additionally, included in the six months ended June 30, 2013 is a benefit of $3,033 attributable to the 2012 U.S. Federal tax credit for research and experimentation. The reduction in the effective tax rate for the

16

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





three and six months ended June 30, 2014 as compared to the same periods in the prior year is primarily attributable to the centralization of our global supply chain and technical operations in Ireland.
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 U.S. Federal tax credit for research and experimentation expenses expired again on December 31, 2013. In connection with this expiration, our 2014 tax provision does not include any benefit from the U.S. Federal tax credit for research and experimentation.
We continue to maintain a valuation allowance against certain other deferred tax assets where realization is not certain.

13.
Employee Benefit Plans
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. Matching contributions were not material for the three and six months ended June 30, 2014. As of June 30, 2014 and December 31, 2013, we recorded a liability of $2,857 and $1,097 associated with our nonqualified deferred compensation plan. We invest employee deferrals and employer matching contributions in mutual fund investments. These investments, which are recorded at the same value as the liability, are classified as trading securities and are included in marketable securities in our condensed consolidated balance sheet.
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 June 30, 2014 and 2013, we recorded matching contributions of approximately $2,279, and $1,497, respectively. For the six months ended June 30, 2014 and 2013, we recorded matching contributions of approximately $4,936 and $3,264, respectively.
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.

17

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





The components of net periodic benefit cost were as follows: 
 
Three months ended
 
Six months ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Service cost
$
2,622

 
$
1,326

 
$
4,185

 
$
2,711

Interest cost
200

 
123

 
400

 
249

Expected return on plan assets
(232
)
 
(156
)
 
(463
)
 
(314
)
Employee contributions
(482
)
 
(358
)
 
(877
)
 
(713
)
Amortization
359

 
131

 
438

 
207

Total net periodic benefit cost
$
2,467

 
$
1,066

 
$
3,683

 
$
2,140



14.
Leases

In November 2012, we entered into a lease agreement for office and laboratory space to be constructed in New Haven, Connecticut. 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 June 30, 2014, we recorded a construction-in-process asset of $62,157, inclusive of the landlord's costs as well as costs incurred by Alexion, and an offsetting facility lease obligation of $59,515 associated with the new facility.

15.
License Agreements
In January 2014, we entered into an agreement with Moderna Therapeutics, Inc. (Moderna) that allows us to purchase ten product options to develop and commercialize treatments for rare diseases with Moderna's messenger RNA (mRNA) therapeutics platform. Alexion will lead the discovery, development and commercialization of the treatments produced through this broad, long-term strategic agreement, while Moderna will retain responsibility for the design and manufacture of the messenger RNA against selected targets. Due to the early stage of these assets, we recorded expense for an upfront payment of $100,000.  We will also be responsible for funding research activities under the program.  In addition, for each drug target, up to a maximum of ten targets, we could be required to make an option exercise payment of $15,000 and to pay up to an additional $120,000 with respect to a rare disease product and $400,000 with respect to a non-rare disease product in development and sales milestones if the specific milestones are met over time as well as royalties on commercial sales. 
In addition to the option agreement, we purchased $25,000 of non-voting preferred equity of Moderna LLC, Moderna's non-public parent company. We recorded this investment at cost within other assets in our condensed consolidated balance sheets. We regularly monitor the investment to evaluate whether there has been an other-than-temporary decline in its fair value, based on the implied value of recent company financings, public market prices of comparable companies, and general market conditions. The carrying value of this investment was not impaired as of June 30, 2014.


16.
Commitments and Contingencies
Commitments
Lonza Agreement
We have supply agreements with Lonza Group AG and its affiliates (Lonza), a third party manufacturer, relating to the manufacture of Soliris and asfotase alfa. We have various agreements with Lonza, with remaining total commitments of approximately $146,000 through 2018. 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).


18

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





Contingent Liabilities
We are currently involved in various claims, lawsuits 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.
In March 2013, we received a Warning Letter from the U.S. Food and Drug Administration (FDA) regarding compliance with current Good Manufacturing Practices at ARIMF. The Warning Letter followed an FDA inspection which concluded in August 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 in April 2013. We continue to manufacture products, including Soliris, in this facility. In the first quarter of 2014, we submitted our request for inspection to the FDA, and we are currently awaiting this re-inspection of ARIMF. 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.
In 2013 and 2014, we initiated voluntary recalls and replacements of certain lots of Soliris due to the presence of visible particles detected in a limited number of vials in these lots. These recalls did not interrupt the supply of Soliris to patients. Following investigation, we believe that we have identified the filling process step that resulted in the presence of the visible particles and we have implemented the changes necessary to modify the process step. During the fourth quarter of 2013, we recorded expense of $14,277 in cost of sales resulting from the expected disposal of inventory in 2014, and we do not expect a material impact from these recalls in 2014.


19

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 U.S. Food and Drug Administration 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, the adequacy of our pharmacovigilance and drug safety reporting processes, 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, our ability to develop and commercialize products with our collaborators, 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, the possibility that expected tax benefits will not be realized, 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 (the SEC).
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 we believe that 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.
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

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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 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 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. In September 2013, the MHLW approved Soliris for the treatment of pediatric and adult patients with aHUS in Japan. 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.
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.
Marketed Product/Indications
Our marketed product/indications 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 Long-term Follow-up
 
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. .  Additionally, we are sponsoring a multinational registry 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 (TMA) leading to kidney failure, stroke, heart attack and death. Soliris is the first and only therapy approved for the treatment of adult and pediatric patients with aHUS. Pursuant to a post marketing requirement imposed by the FDA, we have now completed both a prospective open-label trial in adults with aHUS, as well as, a prospective trial of pediatric patients with aHUS. In May 2014, based on data from these trials, the FDA approved conversion of Soliris accelerated approval in aHUS to regular approval for the treatment of adult and pediatric patients with aHUS to inhibit complement-mediated TMA.

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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)
 
Transplant
  
Antibody Mediated Rejection (AMR) Presensitized Renal Transplant - Living Donor
  
Phase II
 
 
 
 
Antibody Mediated Rejection (AMR) Presensitized Renal Transplant - Deceased Donor
 
Phase II
 
 
 
 
Treatment of Antibody Mediated Rejection (AMR) Following Renal Transplantation*
 
Phase II
 
 
 
 
Delayed Kidney Transplant Graft Function*
 
Phase II
 
 
Nephrology
  
STEC-HUS (Shiga-toxin producing E. Coli Hemolytic Uremic Syndrome)*
  
Phase II
 
 
Neurology
  
Neuromyelitis Optica (NMO)
  
Phase III
 
 
 
  
Myasthenia Gravis (MG)
  
Phase III
Asfotase alfa
 
Metabolic Disorders

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

 
MoCD Type A
 
Phase II
ALXN 1007
 
Inflammatory Disorders
 
Anti-phospholipid Syndrome
 
Phase II
* Investigator Initiated Trial

Soliris (eculizumab)

Transplant
Acute Antibody Mediated Rejection (AMR) in Presensitized Kidney Transplant Patients
AMR is the term used to describe a type of transplant rejection that occurs when the recipient has antibodies to the donor organ. Enrollment in a multi-national, multi-site controlled clinical trial of eculizumab in presensitized kidney transplant patients at elevated risk for AMR who received kidneys from deceased organ donors was completed in March 2013. The study was re-opened in October 2013 to enroll additional patients at the request of participating investigators. Enrollment in this expanded trial has been completed and patient follow-up in the trial is continuing. In September 2013, researchers presented positive preliminary data from the eculizumab deceased-donor AMR kidney transplant study at the European Society of Organ Transplant in Vienna, Austria.
Enrollment in a multi-national, multi-site randomized controlled clinical trial of eculizumab in presensitized kidney transplant patients at elevated risk for AMR who received kidneys from living donors has been completed and patient follow-up in the trial is ongoing. Enrollment in a U.S., multi-site, open-label, randomized, controlled, investigator-initiated trial of eculizumab to treat kidney transplant patients who are diagnosed with biopsy proven acute AMR has been initiated.  
In April 2014, the EC granted orphan drug designation to eculizumab for the prevention of graft rejection following solid organ transplantation.
Delayed Kidney Transplant Graft Function
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. 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. Eculizumab has been granted orphan drug designation for DGF by the FDA and, in the first quarter of 2014, the EC granted orphan drug designation to eculizumab for prevention of DGF after solid organ transplantation. Following positive discussions with regulators in the U.S. and EU, we plan to initiate a single multinational DGF registration trial in the third quarter of 2014.

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

Nephrology
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 enterohemorrhagic Escherichia coli (EHEC). We are aware that independent investigators are examining the role of eculizumab for the treatment of patients with STEC-HUS.
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. In an investigator-initiated Phase II clinical trial of eculizumab in severe and relapsing NMO, eculizumab reduced the median number of NMO attacks at 12 months with a high degree of statistical significance. In the first half of 2014, a single pivotal trial in patients with relapsing NMO commenced patient enrollment. The FDA and the EC have each granted orphan designation for eculizumab as a treatment for patients with NMO.
Myasthenia Gravis (MG)
MG is an ultra-rare autoimmune syndrome characterized by complement activation leading to the failure of neuromuscular transmission. Data from a Phase II trial evaluating the safety and efficacy of eculizumab in patients with refractory generalized MG indicated improvement in clinical measures. In the second quarter of 2014, we commenced a Phase III pivotal trial to evaluate eculizumab as a treatment for patients with refractory generalized MG. In addition, the FDA has granted orphan designation for eculizumab as a treatment for patients with MG.

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 its severe, crippling and life-threatening complications in patients with HPP. Initial studies with asfotase alfa in HPP patients indicate that the treatment significantly decreases the levels of targeted metabolic substrates. In 2013, asfotase alfa received Breakthrough Therapy Designation from the FDA.
We continue to enroll and dose patients in a separate multinational Phase II open-label study of infants and children with HPP. Interim results of this trial were presented at the European Society of Pediatric Endocrinology meeting held in September 2013. Results of 15 enrolled and treated patients representing a range of HPP characteristics were summarized, showing that the primary efficacy endpoint was achieved with a high degree of clinical and statistical significance and several key secondary endpoints were also achieved. 
We have completed enrollment in a natural history study in infantile-onset patients with HPP and have completed our initial analysis for the study. The natural history study in juveniles with HPP is ongoing and is expected to be completed in the fall. We have commenced a rolling submission of our U.S. Biologics License Application (BLA) for asfotase alfa, which allows completed portions of the application to be submitted and reviewed by the FDA on an ongoing basis.  We submitted certain portions of the BLA to the FDA during the second quarter and expect to complete the submission of the remaining sections in the fall of 2014. In July 2014, we announced that the European Medicines Agency (EMA) informed us that it had validated, and granted accelerated assessment to, our Marketing Authorization Application (MAA) for asfotase alfa for the treatment of HPP.  We believe the analysis of our clinical data is supportive of our regulatory filings in the U.S. and EU and anticipated regulatory filing in Japan.

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

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with MoCD Type A. In October 2013, cPMP received Breakthrough Therapy Designation from the FDA for the treatment of patients with MoCD Type A. Evaluation of our synthetic cPMP replacement therapy in a Phase I healthy volunteer study is complete. As a result, we have initiated a multi-center, multinational, open-label clinical trial of synthetic cPMP in patients with MoCD Type A being treated with recombinant Escherichia coli-derived cPMP.

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 have completed enrollment in both a Phase I single-dose, dose escalating safety and pharmacology study in healthy volunteers, as well as in a multi-dose, dose escalating safety and pharmacology study in healthy volunteers. As a result of meetings with the FDA, we commenced screening in a Phase II proof-of-concept study in patients with anti-phospholipid syndrome, a severe life-threatening and ultra-rare disorder, in the second quarter of 2014. A second proof-of-concept study in another severe life-threatening and ultra-rate disorder is expected to start in the second half of 2014.
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 manufacturing services, product finishing, packaging, filling and labeling.
In March 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 in August 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 in April 2013. We continue to manufacture products, including Soliris, in this facility. In the first quarter of 2014, we submitted our request for inspection to the FDA, and we are currently awaiting this re-inspection of ARIMF. 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.
The EMA inspected ARIMF in January 2013, and a good manufacturing practices certificate was issued in May 2013.
In 2013 and 2014, we initiated voluntary recalls and replacements of certain lots of Soliris due to the presence of visible particles detected in a limited number of vials in these lots. These recalls did not interrupt the supply of Soliris to patients. Following investigation, we believe that we have identified the filling process step that resulted in the presence of the visible particles and we have implemented the changes necessary to modify the process step. During the fourth quarter of 2013, we recorded expense of $14,277 in cost of sales resulting from the expected disposal of inventory in 2014, and we do not expect a material impact from these recalls in 2014.
In April 2014, we purchased a filling facility in Athlone, Ireland.  Following refurbishment of the facility, and after successful completion of the appropriate validation processes and regulatory approvals, the facility will become our first company-owned filling and packaging facility for Soliris and other clinical and commercial products. Our plans for future expansion in Ireland also include the purchase of property in Dublin, Ireland, in April 2014, for the construction of office and laboratory facilities.
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, 2013. 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;

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

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, 2013.  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 May 2014, the Financial Accounting Standards Board issued a comprehensive new standard which amends revenue recognition principles and provides a single set of criteria for revenue recognition among all industries. The new standard provides a five step framework whereby revenue is recognized when promised goods or services are transferred to a customer at an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard also requires enhanced disclosures pertaining to revenue recognition in both interim and annual periods. The standard is effective for interim and annual periods beginning after December 15, 2016 and allows for adoption using a full retrospective method, or a modified retrospective method. We are currently assessing the method of adoption and the expected impact the new standard has on our financial position and results of operations.
Results of Operations
Net Product Sales
The following table summarizes net product sales for the three and six months ended June 30, 2014 and 2013:
 
 
Three months ended
 
 
 
Six months ended
 
 
 
June 30,
 
$
 
June 30,
 
$
 
2014
 
2013
 
Variance
 
2014
 
2013
 
Variance
Net product sales
$512,495
 
$370,091
 
$142,404
 
$1,079,111
 
$709,032
 
$370,079
In March 2014, we entered into an agreement with the French government which positively impacts prospective reimbursement of Soliris and also provides for reimbursement for shipments made in years prior to January 1, 2014. As a result of the agreement, in the first quarter of 2014, we recognized $87,830 of net product sales from Soliris in France relating to years prior to January 1, 2014.
Exclusive of the $87,830 recognized related to prior years, the increase of 38% and 40% in revenue for the three and six months ended June 30, 2014, as compared to the same periods in 2013, was primarily due to an increased volume of unit shipments and increased price, partially offset by a negative impact of foreign exchange. The increase in revenue of 38.5% and 40% for the three and six months ended June 30, 2014, respectively, was due to an increase in unit volumes of 34.4% and 35.6% and a positive price impact of 5.4% and 5.9%, offset by a negative impact on foreign exchange of 1.3% and 1.7%. The increase in volume was largely due to physicians globally requesting Soliris therapy for additional patients. The positive price impact of 5.4% and 5.9% for the three and six months ended June 30, 2014, respectively, was primarily due to the agreement with the French government and a reduction in estimated rebates in Germany, offset by an increase in rebates in certain countries in Europe.
The negative impact on foreign exchange of $4,885 and $11,747, or 1.3% and 1.7%, for the three and six months ended June 30, 2014 was due to changes in foreign currency exchange rates (inclusive of hedging activity) versus the U.S. dollar for the three and six months ended June 30, 2013. The negative impact was primarily due to changes in the Japanese Yen and the Russian Ruble. We recorded a (loss) gain in revenue of $(695) and $7,502 for the three months ended June 30, 2014 and 2013, respectively, and $571 and $12,655 for the six months ended June 30, 2014 and 2013, respectively, related to our foreign currency cash flow hedging program.

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

Cost of Sales
Cost of sales includes manufacturing costs as well as actual and estimated royalty expenses associated with sales of Soliris.
In the first quarter of 2014, we entered into a settlement agreement with a third party related to the calculation of royalties payable to such third party under a pre-existing license agreement. Based on this settlement agreement, the Company recorded a reversal of accrued royalties of $5,124 as a reduction of cost of sales.
In the first quarter of 2014, we also recorded an incremental impact in cost of sales of $2,055 for additional royalties related to the $87,830 of net product sales from prior year shipments.
Exclusive of the royalty items noted above, cost of sales were $39,626 and $39,377 for the three months ended June 30, 2014 and 2013, respectively, and $75,634 and $74,646 for the six months ended June 30, 2014 and 2013, respectively. Exclusive of the royalty items noted above, cost of sales as a percentage of product revenue (exclusive of the $87,830 recognized related to prior years), was 7.7% and 10.6% for the three months ended June 30, 2014 and 2013, respectively, and 7.6% and 10.5% for the six months ended June 30, 2014 and 2013, respectively. The decrease in cost of sales as a percentage of sales resulted from a decrease in royalties on sales of Soliris.
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, as well as costs associated with strategic licensing agreements we have entered into with third parties. 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. Licensing agreement costs include upfront and milestone payments made in connection with strategic licensing arrangements we have entered into with third parties. 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
 
 
 
Six months ended
 
 
 
June 30,
 
$
 
June 30,
 
$
 
2014
 
2013
 
Variance
 
2014
 
2013
 
Variance
Clinical development
$26,382
 
$16,501
 
$9,881
 
$50,299
 
$27,996
 
$22,303
Product development
12,142
 
12,921
 
(779)
 
25,181
 
36,516
 
(11,335)
Licensing agreements

 

 

 
101,925

 
3,000

 
98,925

Discovery research
2,349
 
2,648
 
(299)
 
4,930
 
3,978
 
952
Total external direct expenses
40,873
 
32,070
 
8,803
 
182,335
 
71,490
 
110,845
Payroll and benefits
44,480
 
32,066
 
12,414
 
88,499
 
62,784
 
25,715
Operating and occupancy
3,765
 
1,973
 
1,792
 
6,641
 
4,209
 
2,432
Depreciation and amortization
3,436
 
2,454
 
982
 
6,536
 
4,616
 
1,920
Total other R&D expenses
51,681
 
36,493
 
15,188
 
101,676
 
71,609
 
30,067
Research and development expense
$92,554
 
$68,563
 
$23,991
 
$284,011
 
$143,099
 
$140,912

For the three months ended June 30, 2014, the increase of $23,991 in research and development expense, as compared to the same period in the prior year, was primarily related to the following:
Increase of $9,881 in external clinical development expenses related primarily to an expansion of studies within our eculizumab programs (see table below).

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

Increase of $12,414 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 six months ended June 30, 2014, the increase of $140,912 in research and development expense, as compared to the same period in the prior year, was primarily related to the following:
Increase of $22,303 in external clinical development expenses related primarily to an expansion of studies within our eculizumab programs and additional clinical costs associated with our asfotase alfa program (see table below).
Decrease of $11,335 in external product development expenses related primarily to a decrease in costs associated with the production of asfotase alfa for clinical trials.
Increase of $98,925 in licensing agreements primarily related to the upfront payment of $100,000 on the license agreement entered into with Moderna Therapeutics, Inc. in the first quarter of 2014.
Increase of $25,715 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.

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
 
 
 
Six months ended
 
 
 
June 30,
 
$
 
June 30,
 
$
 
2014
 
2013
 
Variance
 
2014
 
2013
 
Variance
External direct expenses
 
 
 
 
 
 
 
 
 
 
 
Eculizumab
$17,235
 
$9,578
 
$7,657
 
$32,731
 
$16,321
 
$16,410
Asfotase alfa
5,105
 
4,019

 
1,086
 
9,347
 
6,284

 
3,063
cPMP
1,855
 
1,468
 
387
 
3,408
 
2,788
 
620
Other programs
1,212
 
975

 
237
 
2,813
 
1,783

 
1,030
Unallocated
975
 
461
 
514
 
2,000
 
820
 
1,180
 
$26,382
 
$16,501
 
$9,881
 
$50,299
 
$27,996
 
$22,303
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, government affairs and legal expenses.
The table below provides information regarding selling, general and administrative expense:
 
Three months ended
 
 
 
Six months ended
 
 
 
June 30,
 
$
 
June 30,
 
$
 
2014
 
2013
 
Variance
 
2014
 
2013
 
Variance
Salary, benefits and other labor expense
$
95,338

 
$
73,233

 
$
22,105

 
$
177,756

 
$
141,162

 
$
36,594

External selling, general and administrative expense
64,139

 
49,956

 
14,183

 
111,012

 
90,853

 
20,159

Total selling, general and administrative expense
$
159,477

 
$
123,189

 
$
36,288

 
$
288,768

 
$
232,015

 
$
56,753


27

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

For the three months ended June 30, 2014, the increase of $36,288 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 $22,105. The increase was a result of increased headcount related to commercial development activities, including increases in payroll and benefits costs of $13,200 related to our global commercial staff to support global expansion. This increase was also due to increases in payroll and benefits of $8,900 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 $14,183. The increase was primarily due to an increase in marketing costs to support the continued growth in global sales of Soliris, as well as an increase in other administrative functions to support our infrastructure growth.
For the six months ended June 30, 2014, the increase of $56,753 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 $36,594. The increase was a result of increased headcount related to commercial development activities, including increases in payroll and benefits costs of $22,100 related to our global commercial staff to support global expansion. This increase was also due to increases in payroll and benefits of $14,500 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 $20,159. This increase was primarily due to an increase in marketing costs to support the continued growth in global sales of Soliris, as well as an increase in other administrative functions to support our infrastructure growth.
Impairment of Intangible Asset
During the first quarter of 2014, we reviewed for impairment the value of an early stage, Phase I indefinite-lived intangible asset related to the Taligen acquisition. We initiated such review based on a reassessment of scientific findings associated with this acquired asset. As a result, in the first quarter of 2014, we recognized an impairment of $3,464 to adjust 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 six months ended June 30, 2013.
Acquisition-related Costs
For the three and six months ended June 30, 2014 and 2013, acquisition-related costs associated with our business combinations included the following:
 
Three months ended

Six months ended
 
June 30,

June 30,
 
2014

2013

2014

2013
Separately-identifiable employee costs
$

 
$

 
$

 
$
248

Professional fees

 

 

 
775

Changes in fair value of contingent consideration
1,989

 
1,167

 
1,951

 
3,378

 
$
1,989

 
$
1,167

 
$
1,951

 
$
4,401

The following table provides information for acquisition-related costs for each business combination:
 
Three months ended
 
Six months ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Enobia Pharma Corp.
$
2,087

 
$
719

 
$
4,537

 
$
3,710

Taligen Therapeutics, Inc.
23

 
56

 
(2,435
)
 
171

Orphatec Pharmaceuticals GmbH
(121
)
 
392

 
(151
)
 
520

 
$
1,989