Novartis Relationship

9 Months Ended

Sep. 30, 2012

Novartis Relationship [Abstract]

NOVARTIS RELATIONSHIP

4. NOVARTIS RELATIONSHIP

Collaboration with Novartis

We entered into the development and commercialization agreement with Novartis related to the worldwide development and commercialization of our drug candidates in May 2003. In July 2012, we and Novartis materially modified our collaboration by executing the termination agreement and the second amended and restated stockholders’ agreement.

The collaboration entered into in May 2003 included the following agreements and transactions which together constituted our arrangement with Novartis which was treated as a single unit of accounting for revenue recognition purposes:

• the development and commercialization agreement, under which we collaborated with Novartis to develop, manufacture and commercialize drug candidates which Novartis licensed from us;

• the manufacturing and supply agreement, under which Novartis manufactured for us the active pharmaceutical ingredient for the clinical development and, under certain circumstances, commercial supply of drug candidates Novartis licensed from us and for the finishing and packaging of licensed products;

• the stock purchase agreement, under which Novartis purchased approximately 54% of our then outstanding capital stock from certain stockholders for $255.0 million in cash, with an additional aggregate amount of up to $357.0 million contingently payable to these stockholders if we achieved predetermined milestones with respect to the development of specific HCV drug candidates, including valopicitabine, which we ceased developing in July 2007;

• the stockholders’ agreement, which was subsequently amended and restated in July 2004 and amended in April 2011, which provided Novartis with, among other things, registration rights, certain corporate governance rights including board representation and participation rights in future issuances of our securities; and

• a letter agreement, which was subsequently amended in January 2009 and April 2011. We refer to the letter agreement, as amended, as the letter agreement. The letter agreement provided Novartis with rights regarding the appointment and removal of our chief financial officer and other matters.

Termination Agreement

Termination of Novartis’ Option to License our Development Stage Drug Candidates

Under the development and commercialization agreement, Novartis had an option to license any of our development-stage drug candidates after demonstration of activity and safety in a proof-of-concept clinical trial so long as Novartis maintained at least 30% ownership of our voting stock. If Novartis licensed a drug candidate, it was obligated to fund a portion of the development expenses that we incurred in accordance with development plans agreed upon by the parties. Under the development and commercialization agreement, we granted Novartis an exclusive worldwide license to market and sell drug candidates that Novartis chose to license from us. The commercialization rights under the development and commercialization agreement also included our right to co-promote and co-market all licensed products in the United States, United Kingdom, France, Germany, Italy and Spain. In other countries, we would receive a royalty payment from Novartis based on net product sales.

Under the development and commercialization agreement, we granted Novartis an exclusive worldwide license to develop, market and sell Tyzeka ^®/Sebivo^®, valtorcitabine and valopicitabine. Under this agreement, we have received $117.2 million of non-refundable payments from Novartis related to these drug candidates that have been recorded as deferred revenue. Through July 2012, the $117.2 million of deferred payments were being recognized over the development period of the licensed drug candidates, which represented the period of our continuing obligations, in accordance with revenue recognition guidance that was applicable at the time the collaboration was entered into. We estimated this period to be through May 2021 based on judgments related to the product development timeline of our licensed drug candidates. Significant judgments and estimates were involved in determining the estimated development period and different assumptions could have yielded materially different results. Related to the deferred revenue under the development and commercialization agreement, we recognized $0.3 million and $0.8 million as revenue during the three months ended September 30, 2012 and 2011, respectively, and we recognized $1.9 million and $2.3 million as revenue during the nine months ended September 30, 2012 and 2011, respectively. These amounts were impacted by Novartis’ stock subscription rights described below.

Pursuant to the termination agreement, Novartis’ option right to license our current and future development-stage drug candidates in any therapeutic area has terminated. In exchange, we have agreed to pay Novartis a royalty based on worldwide product sales of our HCV drug products, unless such drug products are prescribed in combination with Novartis’ HCV drug products. The royalty percentage will vary based on our commercialized HCV drug product, but range from the high single digits to the low double digit percentages. Royalties are payable until the later to occur of: a) expiration of the last-to-expire of specified patent rights in a country; or b) ten years after the first commercial sale of a product in such country, provided that if royalties are payable on a product after the expiration of the patent rights in a country, each of the respective royalty rates for such product in such country would be reduced by one-half.

Novartis’ Non-Exclusive License to Conduct Combination Trials

Pursuant to the termination agreement, we granted Novartis a non-exclusive license to conduct clinical trials evaluating a combination of any of our and Novartis’ HCV drug candidates after the HCV drug candidates have completed dose-ranging studies, subject to meeting certain criteria. Under certain circumstances Novartis may conduct a dose ranging study with respect to our HCV drug candidates. With respect to any combination trial, certain criteria must first be met prior to the commencement of such combination clinical trial, including, but not limited to: a) the Novartis HCV drug candidate at issue cannot be subject to any clinical hold imposed by a regulatory authority; and b) a drug-drug interaction study between the Novartis HCV drug candidate and our HCV drug candidate must be conducted by either Novartis or us. If the parties cannot agree to the initiation of a combination trial, an independent data safety monitoring board will determine whether or not the combination trial should be initiated based on the safety profile of each HCV drug candidate. We have agreed to supply Novartis with our HCV drug candidates for use in such combination trials. We and Novartis have agreed to use commercially reasonable efforts to, in good faith, enter into a supply agreement and other relevant agreements in connection with any such combination trial. Novartis’ ability to initiate combination trials expires on the seven year anniversary of the execution of the termination agreement, or July 2019, although any then existing combination study commenced prior to such expiration date may continue after the expiration date.

As previously noted, since neither VSOE nor TPE for the non-exclusive license deliverable was available, the selling price for this non-exclusive license was established using the BESP. Prior to the execution of the termination agreement, the balance of deferred revenue, related party was $24.7 million. We determined the BESP of the non-exclusive license at July 31, 2012 to be $5.0 million and recognized the excess deferred revenue over the BESP, or $19.7 million, as collaborative revenue – related party in the three months ended September 30, 2012. The remaining deferred revenue of $5.0 million will be recognized as revenue on a straight-line basis over the term of the non-exclusive license, or seven years. During the three months ended September 30, 2012, we recognized $0.1 million of collaboration revenue related to the non-exclusive license and as of September 30, 2012, we had a balance of $4.9 million of deferred revenue, related party in our condensed consolidated balance sheet.

Product Sales of Tyzeka ^®/Sebivo^® for the Treatment of the Hepatitis B Virus

In 2003 under the development and commercialization agreement, Novartis licensed Tyzeka^®/Sebivo ^® from us for the treatment of the hepatitis B virus, or HBV. In September 2007, we and Novartis entered into an amendment to the development and commercialization agreement pursuant to which we transferred to Novartis worldwide development, commercialization and manufacturing rights and obligations pertaining to Tyzeka ^®/Sebivo^®. Subsequently, we received royalty payments equal to a percentage of net sales of Tyzeka^®/Sebivo ^® through July 31, 2012, the date of the termination agreement. We recognized $0.4 million and $1.2 million as royalty revenue from Novartis’ sales of Tyzeka^®/Sebivo ^® during the three months ended September 30, 2012 and 2011, respectively, and we recognized $2.9 million and $3.4 million as royalty revenue from Novartis’ sales of Tyzeka^®/Sebivo ^® during the nine months ended September 30, 2012 and 2011, respectively. Royalty revenues for the three and nine months ended September 30, 2012 included royalty payments through July 31, 2012, the date of the termination agreement. The receivables from related party balance of $7.8 million at September 30, 2012 consisted of $0.4 million of royalties associated with product sales of Tyzeka^®/Sebivo ^® from Novartis and $7.4 million for the reimbursement by Novartis of the contractual payments to a third-party which have been recorded as collaboration revenue – related party in our condensed consolidated statement of operations for the three months ended September 30, 2012. The receivables from related party balance of $1.2 million at December 31, 2011 consisted solely of royalties associated with product sales of Tyzeka^®/Sebivo ^® from Novartis.

Under the termination agreement executed in July 2012, we will no longer receive royalty or milestone payments from Novartis based upon worldwide product sales of Tyzeka ^®/Sebivo^® for the treatment of HBV. Novartis is committed to reimburse us for contractual payments to third-parties in connection with intellectual property related to Tyzeka ^®/Sebivo^®. We will otherwise be responsible for any payments to third-parties in connection with intellectual property necessary to sell Tyzeka^®/Sebivo ^®. Contractual payments to third-parties are described more fully in Note 9.

Termination or Breach by Either Party

If either we or Novartis materially breaches the termination agreement and does not cure such breach within 30 days, the non-breaching party may terminate this agreement in its entirety. Either party may also terminate this agreement, effective immediately, if the other party files for bankruptcy, is dissolved, or has a receiver appointed for substantially all of its property. Novartis may also terminate this agreement for convenience. If Novartis terminates this agreement either because of a material breach by us that has not been cured or because we have filed for bankruptcy, Novartis may, at its election, retain the licenses granted to it by us under the termination agreement to conduct clinical trials evaluating a combination of any of our HCV drug candidates and any of Novartis’ HCV drug candidates and we would remain obligated to make royalty payments to Novartis on sales of our HCV drug products. If we terminate this agreement either because of a material breach by Novartis that has not been cured or because Novartis has filed for bankruptcy, or if Novartis terminates this agreement for convenience, the licenses granted to Novartis to conduct combination trials terminate and we would remain obligated to make royalty payments to Novartis on sales of our HCV drug products.

Indemnification

We have agreed to indemnify Novartis and its affiliates against losses suffered as a result of our development, manufacture and commercialization of our HCV products. We have also agreed to indemnify Novartis and its affiliates against losses suffered as a result of any breach of representations and warranties in the termination agreement, the development and commercialization agreement and the stock purchase agreement. Under these agreements with Novartis, we made numerous representations and warranties to Novartis regarding our drug candidates for the treatment of HBV and HCV, including representations regarding ownership of related inventions and discoveries. In the event of a breach of any such representation or warranty by us, Novartis has the right to seek indemnification from us and, under certain circumstances, our stockholders who sold shares to Novartis in 2003, which includes certain of our directors and officers, for damages suffered by Novartis as a result of such breach. The amounts for which we and our stockholders could be liable to Novartis could be substantial.

Future Agreements and Possible Competition with Novartis

Under the termination agreement, following the receipt of certain data related to a combination trial and upon Novartis’ request, we and Novartis are obligated to use, in good faith, commercially reasonable efforts to negotiate a future agreement for the development, manufacture and commercialization of such combination therapy for the treatment of HCV. Any future arrangement may set forth any co-promotion and co-marketing rights we may retain and any net benefit to us and Novartis attributable to such rights. Neither party is obligated to negotiate for a period longer than 180 days. Also under the termination agreement, Novartis has a non-exclusive license to conduct clinical trials evaluating a combination of any of our HCV drug candidates and any of Novartis’ HCV drug candidates after certain criteria have been met. If Novartis obtains regulatory approval to co-label a Novartis HCV drug product with one or more of our HCV drug products, Novartis could market and sell a combination that may compete with our drug candidates and/or combination products that we market and sell in the future.

Stock Purchase Agreement

In May 2003, Novartis purchased approximately 54% of our then outstanding capital stock from our stockholders. In connection with Novartis’ purchase of stock from our stockholders, we, Novartis and substantially all of our stockholders at that time entered into the stockholders’ agreement which was amended and restated in 2004 and amended in April 2011 in connection with an underwritten offering of our common stock. The stockholders received $255.0 million in cash from Novartis with an additional aggregate amount of up to $357.0 million contingently payable to these stockholders if we achieve predetermined development milestones relating to specific HCV drug candidates. The stock purchase agreement remains unchanged and Novartis is still obligated to make such contingent payments.

Second Amended and Restated Stockholders’ Agreement

In July 2012, we, Novartis and certain other stockholders entered into a second amended and restated stockholders’ agreement which includes the terms as described below.

Novartis’ Registration Rights

Under the second amended and restated stockholders’ agreement, Novartis maintains its rights to cause us to register for resale, under the Securities Act of 1933, as amended, shares held by Novartis and/or its affiliates.

Corporate Governance Rights

Under the stockholders’ agreement, we had agreed to use our reasonable best efforts to nominate for election as directors at least two designees of Novartis for so long as Novartis and its affiliates owned at least 30% of our voting stock and at least one designee of Novartis for so long as Novartis and its affiliates owned at least 19.4% of our voting stock. Furthermore, Novartis had approval rights over a number of corporate actions that we or our subsidiaries may take, including the authorization or issuance of additional shares of capital stock and significant acquisitions and dispositions, as long as Novartis and its affiliates continued to own at least 19.4% of our voting stock. Under the second amended and restated stockholders’ agreement executed in July 2012, we have agreed to use our reasonable best efforts to nominate for election one designee of Novartis for so long as Novartis and its affiliates own at least 15% of our voting stock. Novartis maintains its rights to appoint a non-voting observer to any committee of our board of directors. All of Novartis’ other corporate governance rights, including its rights under the letter agreement, were terminated pursuant to the second amended and restated stockholders’ agreement.

Novartis’ Stock Subscription Rights

Under the stockholders’ agreement, Novartis had the right to purchase, at par value of $0.001 per share, such number of shares as was required to maintain its percentage ownership of our voting stock if we issued shares of capital stock in connection with the acquisition or in-licensing of technology through the issuance of up to 5% of our stock in any 24-month period. These purchase rights have been terminated under the second amended and restated stockholders’ agreement.

In addition to the right to purchase shares of our stock at par value as described above under the stockholders’ agreement, if we issued any shares of capital stock, other than in certain situations, Novartis had the right to purchase such number of shares required to maintain its percentage ownership of our voting stock for the same consideration per share paid by others acquiring our stock. Under the second amended and restated stockholders’ agreement, if we issue any shares of our capital stock, other than in limited situations, Novartis continues to have the right to purchase such number of shares required to maintain its percentage ownership of our voting stock for either the same consideration per share paid by others acquiring our stock or, in specified situations, for a 10% premium to the consideration per share paid by others acquiring our stock.

Through July 2012, upon the grant of options and stock awards under our stock incentive plans, with the exception of the 1998 plan, the fair value of our common stock that would be issuable to Novartis, less the exercise price, was recorded as a reduction of the non-refundable payments associated with the Novartis collaboration. The amount was attributed proportionately between cumulative revenue recognized through the current date and the remaining amount of deferred revenue. Novartis retains these rights under the second amended and restated stockholders’ agreement that was executed in July 2012. As of July 31, 2012, the aggregate impact of Novartis’ stock subscription rights reduced the non-refundable payments by $26.3 million, which was recorded as additional paid-in capital. Of this amount, $6.3 million was recorded as a reduction of deferred revenue with the remaining amount of $20.0 million recorded as a reduction of license fee revenue. For the month of July 2012, the impact of Novartis’ stock subscription rights reduced additional paid-in capital by $0.4 million, increased deferred revenue by $0.1 million and increased license fee revenue by $0.3 million.

Commencing in August 2012, the change in fair value of Novartis’ stock subscription rights under the second amended and restated stockholders’ agreement is accounted for solely as an adjustment to the cumulative revenue recognized from the grant of the non-exclusive license to conduct combination trials to Novartis under the termination agreement and the stock subscription rights no longer impact deferred revenue. The fair value of the stock subscription rights is estimated using a trinomial lattice valuation model which includes inputs of our per share common stock price, exercise prices of outstanding options, expected term of our options and exercise rates as well as assumptions regarding expected volatility and exercise multiples. For August 2012 through September 2012, using the trinomial lattice model, the impact of Novartis’s stock subscription rights decreased additional paid-in capital by $4.0 million and increased license fee revenue by $4.0 million.

For the nine months ended September 30, 2012, the impact of Novartis’ stock subscription rights has reduced additional paid-in capital by $0.4 million, decreased deferred revenue by $0.9 million and increased license fee revenue by $1.3 million. For the three and nine months ended September 30, 2011, there was no cumulative significant impact of Novartis’ stock subscription rights to additional paid-in capital, deferred revenue or license fee revenue as the value of Novartis’ stock subscription rights at September 30, 2011 was comparable with the values at June 30, 2011 and December 31, 2010, respectively.

In connection with the closing of our initial public offering in July 2004, Novartis terminated a common stock subscription right with respect to approximately 1.4 million shares of common stock issuable by us as a result of the exercise of stock options granted after May 8, 2003 pursuant to the 1998 plan. In exchange for Novartis’ termination of such right, we issued 1.1 million shares of common stock to Novartis for a purchase price of $0.001 per share. The fair value of these shares was determined to be $15.4 million at the time of issuance. As a result of the issuance of these shares, Novartis’ rights to purchase additional shares as a result of future option grants and stock issuances under the 1998 plan were terminated and no additional adjustments to revenue and deferred revenue are required. As we granted options that were subject to this stock subscription right, the fair value of our common stock that would be issuable to Novartis, less par value, was recorded as an adjustment of the non-refundable payments received from Novartis. We remain subject to potential revenue adjustments with respect to grants of options and stock awards under our stock incentive plans other than the 1998 plan.

Prior to July 2012, any financing requiring the issuance of additional shares of capital stock had to first be approved by Novartis so long as Novartis owned at least 19.4% of our voting stock. This right was terminated in July 2012 under the second amended and restated stockholders’ agreement with Novartis and therefore Novartis’ approval was not required for the underwritten offering in August 2012. We received Novartis’ approval for the following offerings in 2011:

• in April 2011, we received approval from Novartis to issue capital shares so long as the issuance of shares did not reduce Novartis’ interest in Idenix below 30%. In April 2011, we issued approximately 21.1 million shares of our common stock pursuant to a September 2008 shelf registration statement and approximately 1.8 million shares of our common stock to Novartis pursuant to a private placement agreement. The net proceeds of both transactions were $60.2 million. Upon completion of this offering, we fully utilized the shelf registration statement and Novartis owned approximately 35% of our outstanding common stock. In conjunction with the issuance of common stock in April 2011, we amended the collaboration with Novartis to provide that: a) Novartis retained the exclusive option to obtain rights to drug candidates developed by us so long as Novartis maintained ownership of at least 30% of our common stock, rather than ownership of at least 40% as was the case prior to the amendment; b) we would use reasonable best efforts to nominate for election as directors at least two designees of Novartis so long as Novartis maintained ownership of at least 30% of our common stock, rather than ownership of at least 35% as was the case prior to the amendment; and c) Novartis’ consent was required for the selection and appointment of our chief financial officer so long as Novartis owned at least 30% of our common stock, rather than ownership of at least 40% as was the case prior to the amendment; and

• in November 2011, we received approval from Novartis to issue capital shares so long as the issuance of shares did not reduce Novartis’ interest in Idenix below 31%. In October 2011, we filed a universal shelf registration statement with the SEC which allowed us to offer and sell from time to time up to a maximum of $150.0 million of shares of common stock, at prices and terms to be determined at the time of sale. Pursuant to this shelf registration statement, in November 2011, we issued approximately 10.8 million shares of our common stock pursuant to an underwritten offering and received $65.8 million in net proceeds. Novartis did not participate in this offering.