Note 3. Product Revenue

Product revenue consists of revenue recorded on the sale of Kyprolis which was launched during the third quarter of 2012. The Company records revenue on the sale of Kyprolis once its distributors sell the product to the end customers. Product revenue is derived by calculating the net sales of Kyprolis by its distributors to the end customers and deducting the estimated government rebates, chargebacks, returns reserve and distribution costs.

Product revenue was $64.0 million for the three months ended March 31, 2013, compared to no product revenue for the three months ended March 31, 2012, calculated as follows:

	Three Months Ended March 31,
	2013			2012
	(In thousands)

Product revenue, gross	$	65,459		$	—
Government rebates, chargebacks and other	1,651			—
Returns reserves and distribution fees	(3,102		)	—
Product revenue, net	$	64,008		$	—

Government rebates, chargebacks and other include a credit of $5.9 million related to a change in an accounting estimate following the completion of a product replacement program, as discussed below.

Revenue is recognized when the four basic criteria of revenue recognition are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the fee is fixed or determinable; and (4) collectability is reasonably assured. Determination of criteria (3) and (4) are based on management’s judgments regarding the nature of the fee charged for products or services delivered and the collectability of those fees. Where the revenue recognition criteria are not met, we defer the recognition of revenue until such time that all criteria under the provision are met. The Company sells Kyprolis through a limited number of distributors, and title and risk of loss transfer upon receipt by these distributors. Health care providers order Kyprolis through these distributors. Since launching Kyprolis, we have deferred the recognition of revenue until the product is sold to end users such as health care providers, due to the inherent uncertainties in estimating normal channel inventory at distributor locations. During the initial launch of Kyprolis we also provided extended payment terms to distributors. As of March 31, 2013, deferred revenue related to sales of Kyprolis was $9.3 million.

Product sales are recorded net of estimated government-mandated rebates and chargebacks, distribution fees, estimated product returns and other deductions.

	Chargebacks			Rebates and Other			Distribution Fees and Returns			Total
	(In thousands)

Balance as of December 31, 2012	$	5,707		$	1,946		$	2,286		$	9,939
Provision related to current period sales	3,919			317			3,102			7,338
Credits/ Payments	(4,415		)	(51		)	(3,333		)	(7,799		)
Other	(5,087		)	(800		)	—			(5,887		)
Balance as of March 31, 2013	$	124		$	1,412		$	2,055		$	3,591

Chargebacks, Government Rebates and Other Deductions: The Company estimates reductions to product sales for qualifying federal and state government programs including discounted pricing offered to Public Health Services, or PHS, as well as government-managed Medicaid programs. The Company’s reserve for PHS is based on actual chargebacks that distributors have claimed for reduced pricing offered to such health care providers. The Company’s reserve for Medicaid is based upon statutorily-defined discounts, estimated payer mix, expected sales to qualified healthcare providers, and our expectation about future utilization. Government rebates that are invoiced directly to us are recorded in accrued liabilities on our Condensed Consolidated Balance Sheet. For qualified programs that can purchase our products through distributors at a lower contractual government price, the distributors charge back to us the difference between their acquisition cost and the lower contractual government price, which we record as allowances against accounts receivable on our Condensed Consolidated Balance Sheet. The Company also provided financial assistance to qualifying patients that are underinsured, or cannot cover the cost of commercial coinsurance amounts, through its patient assistance program, Onyx 360. Onyx 360 is available to patients in the U.S. and its territories who meet various financial need criteria.

In connection with the launch of Kyprolis, the Company offered a product replacement program under which certain sales could qualify for the shipment of a free second vial. This program was in effect for sales made through November 30, 2012, and all free replacement vials were required to be authorized by the Company prior to March 23, 2013. Based on historical program utilization rates for similar products, management estimated that this program would be utilized and adjusted its government rebate and chargeback calculations accordingly for the quarters ended September 30, 2012 and December 31, 2012. During March 2013, the product replacement program came to an end. Since no product replacement claims which met the requirements of the program were received, the Company reduced its Medicaid rebate and PHS chargeback accrual by $5.9 million, which increased product revenue by the same amount or $0.08 per share, during the quarter ended March 31, 2013.

Distribution Fees and Product Returns: The Company has written contracts with its customers that include terms for distribution-related fees. The Company records distribution fees due to its customers based on the number of units sold to health care providers. Consistent with industry practice, the Company offers its customers a limited right to return product purchased directly from the Company, which is principally based upon the product’s expiration date. The Company will accept returns for expired product during the three months prior to and after the product expiration date, on product that had been sold to the health care providers. Product returned is generally not resalable given the nature of the Company’s products and method of administration. The Company has developed estimates for Kyprolis product returns based upon historical industry information regarding product return rates of comparable products, including Nexavar, our other oncology product; inventory levels in the distribution channel; and other relevant factors. To date, actual Kyprolis product returns have been negligible.