10-Q 1 alxn3311710q.htm 10-Q Document
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 March 31, 2017
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.)
 
100 College Street, New Haven, Connecticut 06510
(Address of Principal Executive Offices) (Zip Code)
475-230-2596
(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, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer” “smaller reporting company,” and "emerging growth 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  ¨ Emerging growth company  ¨ If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
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
224,556,542
Class
Outstanding as of April 24, 2017










 
Alexion Pharmaceuticals, Inc.
Contents

 
PART I.
FINANCIAL INFORMATION
Page
 
Item 1.
Condensed Consolidated Financial Statements (Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
Item 3.
 
Item 4.
PART II.
 
Item 1.
 
Item 1A.
 
Item 2.
 
Item 5.
 
Item 6.
SIGNATURES
 
 



Alexion Pharmaceuticals, Inc.
Condensed Consolidated Balance Sheets
(unaudited)
(amounts in millions, except per share amounts)
 
 
March 31,
 
December 31,
 
2017
 
2016
Assets
 
 
 
Current Assets:
 
 
 
Cash and cash equivalents
$
713

 
$
966

Marketable securities
749

 
327

Trade accounts receivable, net
660

 
650

Inventories
396

 
375

Prepaid expenses and other current assets
215

 
260

Total current assets
2,733

 
2,578

Property, plant and equipment, net
1,138

 
1,036

Intangible assets, net
4,223

 
4,303

Goodwill
5,037

 
5,037

Other assets
304

 
299

Total assets
$
13,435

 
$
13,253

Liabilities and Stockholders' Equity
 
 
 
Current Liabilities:
 
 
 
Accounts payable
$
61

 
$
64

Accrued expenses
546

 
508

Deferred revenue
16

 
37

Current portion of long-term debt
167

 
167

Current portion of contingent consideration
25

 
24

Other current liabilities
22

 
23

Total current liabilities
837

 
823

Long-term debt, less current portion
2,846

 
2,888

Contingent consideration
132

 
129

Facility lease obligation
270

 
233

Deferred tax liabilities
384

 
396

Other liabilities
110

 
90

Total liabilities
4,579

 
4,559

Commitments and contingencies (Note 16)

 

Stockholders' Equity:
 
 
 
Common stock, $0.0001 par value; 290 shares authorized; 233 and 232 shares issued as of March 31, 2017 and December 31, 2016, respectively

 

Additional paid-in capital
8,060

 
7,957

Treasury stock, at cost, 9 and 8 shares as of March 31, 2017 and December 31, 2016, respectively
(1,209
)
 
(1,141
)
Accumulated other comprehensive income
36

 
60

Retained earnings
1,969

 
1,818

Total stockholders' equity
8,856

 
8,694

Total liabilities and stockholders' equity
$
13,435

 
$
13,253


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 millions, except per share amounts)
 
 
Three months ended March 31,
 
2017
 
2016
Net product sales
$
869

 
$
700

Other revenue
1

 
1

Total revenues
870

 
701

Cost of sales
69

 
59

Operating expenses:
 
 
 
Research and development
219

 
176

Selling, general and administrative
262

 
233

Amortization of purchased intangible assets
80


80

Change in fair value of contingent consideration
4


(15
)
Acquisition-related costs

 
1

Restructuring expenses
24

 
1

Total operating expenses
589

 
476

Operating income
212

 
166

Other income and expense:
 
 
 
Investment income
4

 
1

Interest expense
(24
)
 
(24
)
Other income
2

 

Income before income taxes
194

 
143

Income tax expense
24

 
51

Net income
$
170

 
$
92

Earnings per common share
 
 
 
Basic
$
0.76

 
$
0.41

Diluted
$
0.75

 
$
0.41

Shares used in computing earnings per common share
 
 
 
Basic
224

 
225

Diluted
226

 
227

 
 
 
 


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 millions)

 
Three months ended March 31,
 
2017
 
2016
Net income
$
170

 
$
92

Other comprehensive income (loss), net of tax:
 
 
 
Foreign currency translation
3

 
2

Unrealized gains on marketable securities
1

 
2

Unrealized gains on pension obligation

 
2

Unrealized losses on hedging activities, net of tax of $(15), and $(36), respectively
(28
)
 
(64
)
Other comprehensive loss, net of tax
(24
)
 
(58
)
Comprehensive income
$
146

 
$
34


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 millions)
 
 
Three months ended March 31,
 
2017
 
2016
Cash flows from operating activities:
 
 
 
Net income
$
170

 
$
92

Adjustments to reconcile net income to net cash flows from operating activities:
 
 
 
Depreciation and amortization
99

 
97

Change in fair value of contingent consideration
4

 
(15
)
Share-based compensation expense
54

 
57

Deferred taxes
(1
)
 
29

Unrealized foreign currency gain
(15
)
 
(14
)
Unrealized loss on forward contracts
11

 
17

Other
2

 
1

Changes in operating assets and liabilities, excluding the effect of acquisitions:
 
 
 
Accounts receivable
(3
)
 
(37
)
Inventories
(19
)
 
(4
)
Prepaid expenses and other assets
(13
)
 
(65
)
Accounts payable, accrued expenses and other liabilities
39

 
(42
)
Deferred revenue
(20
)
 
58

Net cash provided by operating activities
308

 
174

Cash flows from investing activities:
 
 
 
Purchases of available-for-sale securities
(700
)
 
(208
)
Proceeds from maturity or sale of available-for-sale securities
282

 
269

Purchases of trading securities
(3
)
 
(3
)
Proceeds from sale of trading securities
1

 

Purchases of property, plant and equipment
(75
)
 
(64
)
Net cash used in investing activities
(495
)
 
(6
)
Cash flows from financing activities:
 
 
 
Payments on term loan
(44
)
 
(175
)
Repurchase of common stock
(68
)
 
(297
)
Net proceeds from issuance of common stock under share-based compensation arrangements
47

 
4

Other
(4
)
 
(4
)
Net cash used in financing activities
(69
)
 
(472
)
Effect of exchange rate changes on cash
3

 
4

Net change in cash and cash equivalents
(253
)
 
(300
)
Cash and cash equivalents at beginning of period
966

 
1,010

Cash and cash equivalents at end of period
$
713

 
$
710

 
 
 
 
Supplemental cash flow disclosures from investing and financing activities:
 
 
 
Capitalization of construction costs related to facility lease obligations
$
39

 
$
26

Accrued expenses for purchases of property, plant and equipment
$
30

 
$
25

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 millions, 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 devastating and rare disorders through the innovation, development and commercialization of life-transforming therapeutic products.
In our complement franchise, Soliris® is the first and only therapy approved for patients with either paroxysmal nocturnal hemoglobinuria (PNH), a life-threatening and ultra-rare genetic blood disorder, or atypical hemolytic uremic syndrome (aHUS), a life-threatening and ultra-rare genetic disease. PNH and aHUS are two disorders resulting from chronic uncontrolled activation of the complement component of the immune system.
In our metabolic franchise, we market Strensiq® for the treatment of patients with hypophosphatasia (HPP) and Kanuma® for the treatment of patients with lysosomal acid lipase deficiency (LAL-D). HPP is an ultra-rare genetic disease characterized by defective bone mineralization that can lead to deformity of bones and other skeletal abnormalities. LAL-D is a serious, life threatening ultra-rare disease in which genetic mutations result in decreased activity of the lysosomal acid lipase (LAL) enzyme leading to marked accumulation of lipids in vital organs, blood vessels and other tissues. We initiated sales of Strensiq and Kanuma in the third quarter 2015.
We are also evaluating additional potential indications for eculizumab in other severe and devastating 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 devastating and 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 the Company's Annual Report on Form 10-K for the year ended December 31, 2016. 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, 2016 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, 2016 included in our Annual Report on Form 10-K. The results of operations for the three months ended March 31, 2017 are not necessarily indicative of the results to be expected for the full year.
The financial statements of our subsidiaries with functional currencies other than the U.S. dollar are translated into U.S. dollars using period-end exchange rates for assets and liabilities, historical exchange rates for stockholders' equity and weighted average exchange rates for operating results. Translation gains and losses are included in accumulated other comprehensive income (loss), net of tax, in stockholders' equity. Foreign currency transaction gains and losses are included in the results of operations in other income and expense.
The accompanying unaudited condensed consolidated financial statements include the accounts of Alexion Pharmaceuticals, Inc. and its subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Our significant accounting policies are described in Note 1 of the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2016.
Change in Accounting Estimates
We have historically deferred revenue recognition for sales to certain international customers, mainly distributors, until the product was received by the end customer due to various factors, including our inability to estimate product returns. On a regular basis, we review revenue arrangements, including our distributor relationships, to determine whether any changes in these arrangements or historical experience with these customers have an impact on revenue recognition. In the first quarter 2017, we determined that we had sufficient sales experience with certain customers to estimate product returns from such customers. We accounted for this prospectively as a change in estimate and began to recognize revenue for these customers when title to the product and the associated risk of loss passed to the customer. Some customers may purchase larger quantities

6

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




of product less frequently, which may result in revenue fluctuations from quarter to quarter. We do not believe these buying patterns increase the risk of product returns or our ability to estimate such returns.
New Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (FASB) 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, 2017 and allows for adoption using a full retrospective method, or a modified retrospective method. Entities may elect to early adopt the standard for annual periods beginning after December 15, 2016. We currently anticipate adopting the standard using the modified retrospective method. We do not expect the implementation of this new standard to have a material impact on our financial position and results of operations.
In February 2016, the FASB issued a new standard requiring that the rights and obligations arising from leases be recognized on the balance sheet by recording a right-of-use asset and corresponding lease liability. The new standard also requires qualitative and quantitative disclosures to understand the amount, timing, and uncertainty of cash flows arising from leases, as well as significant management estimates utilized. The standard is effective for interim and annual periods beginning after December 15, 2018 and requires a modified retrospective adoption. We are currently assessing the impact of this standard on our financial condition and results of operations.
In March 2016, the FASB issued a new standard intended to simplify certain aspects of the accounting for employee share-based payments. We elected to early adopt this standard in 2016. One aspect of the standard requires an entity to recognize all excess tax benefits and deficiencies associated with stock-based compensation as a reduction or increase to tax expense in the income statement. Previously, such amounts were recognized in additional paid-in capital. The amendments also require recognition of excess tax benefits regardless of whether the benefit reduces taxes payable in the current period. Furthermore, the amendment requires that excess tax benefits be classified as an operating activity in the statement of cash flows instead of a financing activity. We have also elected to continue to estimate the impact of forfeitures when determining the amount of compensation cost to be recognized each period rather than account for forfeitures as they occur.
In October 2016, the FASB issued a new income tax standard that eliminates the exception for an intra-entity asset transfer other than inventory. Under the new standard, entities should recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. Any deferred tax asset that arises in the buyer's jurisdiction would also be recognized at the time of the transfer. We elected to early adopt this standard in the first quarter 2017. As a result of the adoption, in the first quarter of 2017, we recorded a $19 decrease in retained earnings, primarily resulting from the elimination of previously recorded prepaid tax assets.
In January 2017, the FASB issued a new standard that clarifies the definition of a business and determines when an integrated set of assets and activities is not a business. This framework requires that if substantially all of the fair value of gross assets acquired or disposed of is concentrated in a single asset or group of similar identifiable assets, the assets would not represent a business. The standard is effective for interim and annual periods beginning after December 15, 2017 with early adoption permitted. We are currently assessing the impact of this standard on our financial condition and results of operations.


7

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




3.
Inventories
Inventories are stated at the lower of cost or estimated realizable value. We determine the cost of inventory on a standard cost basis, which approximates average costs.
The components of inventory are as follows:
 
March 31,
 
December 31,
 
2017
 
2016
Raw materials
$
22

 
$
17

Work-in-process
171

 
143

Finished goods
203

 
215

 
$
396

 
$
375

 



4.
Intangible Assets and Goodwill
The following table summarizes the carrying amount of our intangible assets and goodwill, net of accumulated amortization:

 
 
 
March 31, 2017
 
December 31, 2016
 
Estimated
Life (years)
 
Cost
 
Accumulated
Amortization
 
Net
 
Cost
 
Accumulated
Amortization
 
Net
Licenses
6-8
 
$
29

 
$
(29
)
 
$

 
$
29

 
$
(29
)
 
$

Patents
7
 
11

 
(11
)
 

 
11

 
(11
)
 

Purchased technology
6-16
 
4,711

 
(519
)
 
4,192

 
4,711

 
(439
)
 
4,272

Acquired IPR&D
Indefinite
 
31

 

 
31

 
31

 

 
31

Total
 
 
$
4,782

 
$
(559
)
 
$
4,223

 
$
4,782

 
$
(479
)
 
$
4,303

Goodwill
Indefinite
 
$
5,040

 
$
(3
)
 
$
5,037

 
$
5,040

 
$
(3
)
 
$
5,037


Amortization expense was $80 for the three months ended March 31, 2017 and 2016. Assuming no changes in the gross cost basis of intangible assets, the total estimated amortization expense for finite-lived intangible assets is $240 for the nine months ending December 31, 2017, and $320 for each of the years ending December 31, 2018 through December 31, 2022.

5.
Debt
On June 22, 2015, Alexion entered into a credit agreement (Credit Agreement) with a syndicate of banks, which provides for a $3,500 term loan facility and a $500 revolving credit facility maturing in five years. Borrowings under the term loan are payable in quarterly installments equal to 1.25% of the original loan amount, beginning December 31, 2015. Final repayment of the term loan and revolving credit loans are due on June 22, 2020. In addition to borrowings in which prior notice is required, the revolving credit facility includes a sublimit of $100 in the form of letters of credit and borrowings on same-day notice, referred to as swingline loans, of up to $25. 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 in an amount that does not cause our consolidated net leverage ratio to exceed the maximum allowable amount.
In connection with entering into the Credit Agreement, we paid $45 in financing costs which are being amortized as interest expense over the life of the debt. Amortization expense associated with deferred financing costs for the three months ended March 31, 2017 and 2016 was $2 and $3, respectively.
We made principal payments of $44 during the three months ended March 31, 2017. As of March 31, 2017, we had $3,037 outstanding on the term loan. As of March 31, 2017, we had open letters of credit of $16, and our borrowing availability under the revolving facility was $484.
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.
The following table summarizes the calculation of basic and diluted EPS for the three months ended March 31, 2017 and 2016:
 
Three months ended
 
March 31,
 
2017
 
2016
Net income used for basic and diluted calculation
$
170

 
$
92

Shares used in computing earnings per common share—basic
224

 
225

Weighted-average effect of dilutive securities:
 
 
 
Stock awards
2

 
2

Shares used in computing earnings per common share—diluted
226

 
227

Earnings per common share:
 
 
 
Basic
$
0.76

 
$
0.41

Diluted
$
0.75

 
$
0.41

We exclude from EPS the weighted-average number of securities whose effect is anti-dilutive. Excluded from the calculation of EPS for the three months ended March 31, 2017 and 2016 were 6 and 4 shares of common stock, 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 as of March 31, 2017 and December 31, 2016 were as follows:
 
 
March 31, 2017
 
 
Amortized Cost
 
Gross Unrealized Holding Gains
 
Gross Unrealized Holding Losses
 
Fair Value
Commercial paper
 
$
38

 
$

 
$

 
$
38

Corporate bonds
 
387

 

 

 
387

Municipal bonds
 
15

 

 

 
15

Other government-related obligations:
 
 
 
 
 
 
 
 
U.S.
 
7

 

 

 
7

Foreign
 
331

 

 
(1
)
 
330

Bank certificates of deposit
 
11

 

 

 
11

Total available-for-sale debt securities
 
789

 

 
(1
)
 
788

Equity securities
 

 
1

 

 
1

Total available-for-sale securities
 
789

 
1

 
(1
)
 
789



8

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




 
 
December 31, 2016
 
 
Amortized Cost
 
Gross Unrealized Holding Gains
 
Gross Unrealized Holding Losses
 
Fair Value
Commercial paper
 
$
114

 
$

 
$

 
$
114

Corporate bonds
 
124

 

 
(1
)
 
123

Municipal bonds
 
91

 

 

 
91

Other government-related obligations:
 
 
 
 
 
 
 
 
U.S.
 
28

 

 

 
28

Foreign
 
73

 

 
(1
)
 
72

Bank certificates of deposit
 
5

 

 

 
5

Total available-for-sale debt securities
 
$
435

 
$

 
$
(2
)
 
$
433

Equity securities
 

 
1

 

 
1

Total available-for-sale securities
 
435

 
1

 
(2
)
 
434


The aggregate fair value of available-for-sale securities in an unrealized loss position as of March 31, 2017 and December 31, 2016 was $485 and $265, respectively. These investments have been in a continuous unrealized loss position for less than 12 months. As of March 31, 2017, 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:
 
March 31, 2017
 
December 31, 2016
Cash and cash equivalents
$
57

 
$
120

Marketable securities
732

 
314

 
$
789

 
$
434


The fair values of available-for-sale debt securities at March 31, 2017, by contractual maturity, are summarized as follows:
 
March 31, 2017
Due in one year or less
$
405

Due after one year through three years
383

 
$
788


As of March 31, 2017 and December 31, 2016, the fair value of our trading securities was $17 and $13, respectively.
We utilize the specific identification method in computing realized gains and losses. Realized gains and losses on our available-for-sale and trading securities were not material for the three months ended March 31, 2017 and 2016.

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 and Japanese Yen. We are also exposed to fluctuations in interest rates on our outstanding term loan debt. We manage these exposures within specified guidelines through the use of derivatives. All of our derivative instruments are utilized for risk management purposes, and we do not use derivatives for speculative trading purposes.
We enter into foreign exchange forward contracts, with durations of up to 60 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 these hedges is to reduce the volatility of exchange rate fluctuations on our operating results and to

9

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




increase the visibility of the foreign exchange impact on forecasted revenues. These hedges are designated as cash flow hedges upon contract inception. As of March 31, 2017, we had open foreign exchange forward contracts with notional amounts totaling $1,733 that qualified for hedge accounting.
To achieve a desired mix of floating and fixed interest rates on our term loan, we enter into interest rate swap agreements that qualify for and are designated as cash flow hedges. These contracts convert the floating interest rate on a portion of our debt to a fixed rate, plus a borrowing spread. The interest rate swap contracts executed as of March 31, 2017 are as follows:
Type of Interest Rate Swap
 
Notional Amount
 
Effective Date
 
Termination Date
 
Fixed Interest Rate
Floating to Fixed
 
$656
 
December 31, 2016
 
December 31, 2019
 
0.98%
Floating to Fixed
 
$300
 
January 31, 2017
 
December 31, 2018
 
1.29%
Floating to Fixed
 
$300
 
January 02, 2019
 
December 31, 2019
 
2.08%
Subsequent to March 31, 2017, we entered into two additional interest rate swap agreements. The first agreement has a notional amount of $200 that is effective through December 31, 2019 and converts the floating rate on a portion of our term loan to a fixed rate of 1.62%, plus a borrowing spread. The second agreement has a notional amount of $200 that is effective through December 31, 2018 and converts the floating rate on a portion of our term loan to a fixed rate of 1.40%, plus a borrowing spread.
The impact on accumulated other comprehensive income (AOCI) and earnings from foreign exchange and interest rate swap contracts that qualified as cash flow hedges, for the three months ended March 31, 2017 and 2016, were as follows:
 
Three months ended
 
March 31,
Foreign Exchange Contracts:
2017
 
2016
Gain (loss) recognized in AOCI, net of tax
$
(16
)
 
$
(49
)
Gain reclassified from AOCI to net product sales (effective portion), net of tax
$
13

 
$
15

Interest Rate Contracts:
 
 
 
Gain recognized in AOCI, net of tax
$
1

 
$

Gain reclassified from AOCI to interest expense, net of tax
$

 
$

Assuming no change in foreign exchange rates or LIBOR-based interest rates from market rates at March 31, 2017, $54 of gains recognized in AOCI will be reclassified to revenue over the next 12 months. The amount of gains recognized in AOCI that will be reclassified to interest expense over the next 12 months is $2.
We enter into foreign exchange forward contracts, with durations of approximately 90 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 March 31, 2017, the notional amount of foreign exchange contracts where hedge accounting is not applied was $634.
We recognized a loss of $9 and $13, in other income and expense, for the three months ended March 31, 2017 and 2016, respectively, associated with the foreign exchange contracts not designated as hedging instruments. These amounts were partially offset by gains or losses on monetary assets and liabilities.

10

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




The following tables summarize the fair value of outstanding derivatives as of March 31, 2017 and December 31, 2016:

 
March 31, 2017
 
Asset Derivatives
 
Liability Derivatives
 
Balance Sheet
Location
 
Fair
Value
 
Balance Sheet
Location
 
Fair
Value
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
Foreign exchange forward contracts
Prepaid expenses and other current assets
 
$
61

 
Other current liabilities
 
$
7

Foreign exchange forward contracts
Other assets
 
43

 
Other liabilities
 
9

Interest rate contracts
Prepaid expenses and other current assets
 
2

 
Other current liabilities
 

Interest rate contracts
Other assets
 
10

 
Other liabilities
 

Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
Foreign exchange forward contracts
Prepaid expenses and other current assets
 
4

 
Other current liabilities
 
7

Total fair value of derivative instruments
 
 
$
120

 
 
 
$
23



 
December 31, 2016
 
Asset Derivatives
 
Liability Derivatives
 
Balance Sheet
Location
 
Fair
Value
 
Balance Sheet
Location
 
Fair
Value
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
Foreign exchange forward contracts
Prepaid expenses and other current assets
 
$
80

 
Other current liabilities
 
$
2

Foreign exchange forward contracts
Other assets
 
59

 
Other liabilities
 
4

Interest rate contracts
Prepaid expenses and other current assets
 

 
Other current liabilities
 

Interest rate contracts
Other assets
 
10

 
Other liabilities
 

Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
Foreign exchange forward contracts
Prepaid expenses and other current assets
 
17

 
 
 
10

Total fair value of derivative instruments
 
 
$
166

 
 
 
$
16


11

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





Although we do not offset derivative assets and liabilities within our condensed consolidated balance sheets, our International Swap and Derivatives Association 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 tables summarize the potential effect on our condensed consolidated balance sheets of offsetting our foreign exchange forward contracts and interest rate contracts subject to such provisions:
 
 
March 31, 2017
 
 
 
 
 
 
 
 
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
 
Net Amounts of Assets/Liabilities Presented in the Condensed Consolidated Balance Sheet
 
Derivative Financial Instruments
 
Cash Collateral Received (Pledged)
 
Net Amount
Derivative assets
 
$
120

 
$

 
$
120

 
$
(23
)
 
$

 
$
97

Derivative liabilities
 
(23
)
 

 
(23
)
 
23

 

 

 
 
December 31, 2016
 
 
 
 
 
 
 
 
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
 
Net Amounts of Assets/Liabilities Presented in the Condensed Consolidated Balance Sheet
 
Derivative Financial Instruments
 
Cash Collateral Received (Pledged)
 
Net Amount
Derivative assets
 
$
166

 
$

 
$
166

 
$
(16
)
 
$

 
$
150

Derivative liabilities
 
(16
)
 

 
(16
)
 
16

 

 


9.
Other Investments
Other investments include our investment of $38 in the preferred stock of Moderna Therapeutics, Inc. Our investment is recorded at cost within other assets in our condensed consolidated balance sheets. The carrying value of this investment was not impaired as of March 31, 2017.

10.
Stockholders' Equity
In November 2012, our Board of Directors authorized a share repurchase program. The repurchase program does not have an expiration date, and we are not obligated to acquire a particular number of shares. The repurchase program may be discontinued at any time at the Company's discretion. In February 2017, our Board of Directors increased the authorization to acquire shares with an aggregate value of up to $1,000 for future purchases under the repurchase program, which superseded all prior repurchase programs. During the three months ended March 31, 2017 and 2016, we repurchased 1 and 2 shares of our common stock under the program at a cost of $68 and $297, respectively.
Subsequent to March 31, 2017, we repurchased common stock under our repurchase program at a cost of $32. As of April 27, 2017, there was a total of $900 remaining for repurchases under the repurchase program.


12

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




11.
Other Comprehensive Income and Accumulated Other Comprehensive Income

The following tables summarize the changes in AOCI, by component, for the three months ended March 31, 2017 and 2016:
 
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, 2016
(7
)
 
(1
)
 
92

 
(24
)
 
60

Other comprehensive income before reclassifications

 

 
(15
)
 

 
(15
)
Amounts reclassified from other comprehensive income

 
1

 
(13
)
 
3

 
(9
)
Net other comprehensive income (loss)

 
1

 
(28
)
 
3

 
(24
)
Balances, March 31, 2017
(7
)
 

 
64

 
(21
)
 
36


 
Defined Benefit Pension Plan
 
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, 2015
(10
)
 
(1
)
 
93

 
(20
)
 
62

Other comprehensive income before reclassifications
2

 
1

 
(49
)
 
2

 
(44
)
Amounts reclassified from other comprehensive income

 
1

 
(15
)
 

 
(14
)
Net other comprehensive income (loss)
2

 
2

 
(64
)
 
2

 
(58
)
Balances, March 31, 2016
(8
)
 
1

 
29

 
(18
)
 
4


The table below provides details regarding significant reclassifications from AOCI during the three months ended March 31, 2017 and 2016:
Details about Accumulated Other Comprehensive Income Components
 
Amount Reclassified From Accumulated Other Comprehensive Income during the three months ended March 31,
Affected Line Item in the Condensed Consolidated Statements of Operations
 
2017
 
2016
 
Unrealized Gains (Losses) from Hedging Activity
 
 
 
 
 
 
Effective portion of foreign exchange contracts
 
$
20

 
$
23

 
Net product sales
Effective portion of interest rate swap contracts
 
(1
)
 

 
Interest expense
 
 
19

 
23

 
 
 
 
(6
)
 
(8
)
 
Income tax expense
 
 
$
13

 
$
15

 
 

12.
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 millions, 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 March 31, 2017 and December 31, 2016, and indicate the fair value hierarchy of the valuation techniques we utilized to determine such fair value. 
 
 
Fair Value Measurement at
March 31, 2017
Balance Sheet
Classification
Type of Instrument
Total
 
Level 1
 
Level 2
 
Level 3
Cash equivalents
Money market funds
$
32

 
$

 
$
32

 
$

Cash equivalents
Commercial paper
$
17

 
$

 
$
17

 
$

Cash equivalents
Corporate bonds
$
12

 
$

 
$
12

 
$

Cash equivalents
Municipal bonds
$
14

 
$

 
$
14

 
$

Cash equivalents
Other government-related obligations
$
14

 
$

 
$
14

 
$

Marketable securities
Mutual funds
$
17

 
$
17

 
$

 
$

Marketable securities
Commercial paper
$
21

 
$

 
$
21

 
$

Marketable securities
Corporate bonds
$
375

 
$

 
$
375

 
$

Marketable securities
Municipal bonds
$
1

 
$

 
$
1

 
$

Marketable securities
Other government-related obligations
$
323

 
$

 
$
323

 
$

Marketable securities
Bank certificates of deposit
$
11

 
$

 
$
11

 
$

Marketable securities
Equity securities
$
1

 
$
1

 
$

 
$

Prepaid expenses and other current assets
Foreign exchange forward contracts
$
65

 
$

 
$
65

 
$

Other assets
Foreign exchange forward contracts
$
43

 
$

 
$
43

 
$

Other current liabilities
Foreign exchange forward contracts
$
14

 
$

 
$
14

 
$

Other liabilities
Foreign exchange forward contracts
$
9

 
$

 
$
9

 
$

Prepaid expenses and other current assets
Interest rate contracts
$
2

 
$

 
$
2

 
$

Other assets
Interest rate contracts
$
10

 
$

 
$
10

 
$

Current portion of contingent consideration
Acquisition-related contingent consideration
$
25

 
$

 
$

 
$
25

Contingent consideration
Acquisition-related contingent consideration
$
132

 
$

 
$

 
$
132

 

14

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




 
 
Fair Value Measurement at
December 31, 2016
Balance Sheet
Classification
Type of Instrument
Total
 
Level 1
 
Level 2
 
Level 3
Cash equivalents
Money market funds
$
266

 
$

 
$
266

 
$

Cash equivalents
Commercial paper
$
70

 
$

 
$
70

 
$

Cash equivalents
Corporate bonds
$
10

 
$

 
$
10

 
$

Cash equivalents
Municipal bonds
$
40

 
$

 
$
40

 
$

Marketable securities
Mutual funds
$
13

 
$
13

 
$

 
$

Marketable securities
Commercial paper
$
44

 
$

 
$
44

 
$

Marketable securities
Corporate bonds
$
113

 
$

 
$
113

 
$

Marketable securities
Municipal bonds
$
51

 
$

 
$
51

 
$

Marketable securities
Other government-related obligations
$
100

 
$

 
$
100

 
$

Marketable securities
Bank certificates of deposit
$
5

 
$

 
$
5

 
$

Marketable securities
Equity securities
$
1

 
$
1

 
$

 
$

Prepaid expenses and other current assets
Foreign exchange forward contracts
$
97

 
$

 
$
97

 
$

Other assets
Foreign exchange forward contracts
$
59

 
$

 
$
59

 
$

Other current liabilities
Foreign exchange forward contracts
$
12

 
$

 
$
12

 
$

Other liabilities
Foreign exchange forward contracts
$
4

 
$

 
$
4

 
$

Other assets
Interest rate contracts
$
10

 
$

 
$
10

 
$

Current portion of contingent consideration
Acquisition-related contingent consideration
$
24

 
$

 
$

 
$
24

Contingent consideration
Acquisition-related contingent consideration
$
129

 
$

 
$

 
$
129


There were no securities transferred between Level 1, 2 and 3 during the three months ended March 31, 2017.

Valuation Techniques
We classify mutual fund investments and equity securities, 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.
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.

15

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




As of March 31, 2017, 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 approvals 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 of 4.7% for developmental milestones and a weighted average cost of capital ranging from 10% 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.
Estimated future contingent milestone payments related to prior business combinations range from zero if no milestone events are achieved, to a maximum of $766 if all development, regulatory and sales-based milestones are reached. As of March 31, 2017, the fair value of acquisition-related contingent consideration was $157. The following table represents a roll-forward of our acquisition-related contingent consideration:
 
Three months ended March 31, 2017
Balance as of December 31, 2016
$
(153
)
Changes in fair value
(4
)
Balance as of March 31, 2017
$
(157
)
 
13.
Income Taxes
The following table provides a comparative summary of our income tax expense and effective income tax rate for the three months ended March 31, 2017 and 2016:
 
Three months ended
 
March 31,
 
2017
 
2016
Income tax expense
$
24

 
$
51

Effective income tax rate
12.4
%
 
35.8
%
The income tax expense for the three months ended March 31, 2017 and 2016 is attributable to the U.S. federal, state and foreign income taxes on our profitable operations. The decrease in the effective tax rate for the three months ended March 31, 2017 as compared to the same period in the prior year is primarily attributable to the deferred tax cost associated with the distribution of earnings from our captive foreign partnership in 2016. The absence of this non-cash deferred tax cost decreased the effective tax rate by approximately 19%.
The Internal Revenue Service (IRS) has commenced an examination of our U.S. income tax returns for 2013 and 2014. We anticipate this audit will conclude within the next twelve months. As of April 27, 2017, we had not received a Notice of Proposed Adjustment from the IRS.
We continue to maintain a valuation allowance against certain deferred tax assets where realization is not certain.

14.
Defined Benefit Plans
We maintain defined benefit plans for employees in certain countries outside the U.S., including retirement benefit plans required by applicable local law. The plans are valued by independent actuaries using the projected unit credit method. The liabilities correspond to the projected benefit obligations of which the discounted net present value is calculated based on years of employment, expected salary increases, and pension adjustments. The total net periodic benefit cost for each of the three months ended March 31, 2017 and 2016 was $2, primarily related to service costs.

16

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





15.
Facility Lease Obligations
New Haven Facility Lease Obligation
In November 2012, we entered into a lease agreement for office and laboratory space to be constructed in New Haven, Connecticut. The term of the lease commenced in 2015 and will expire in 2030, with a renewal option of ten years. Although we do not legally own the premises, we are deemed to be the owner of the building due to the substantial improvements directly funded by us during the construction period based on applicable accounting guidance for build-to-suit leases. Accordingly, the landlord's costs of constructing the facility during construction period are required to be capitalized, as a non-cash transaction, offset by a corresponding facility lease obligation in our consolidated balance sheet.
Construction of the facility was completed and the building was placed into service in the first quarter 2016. As of March 31, 2017 and December 31, 2016, our total facility lease obligation was $135 and $136, respectively, recorded within other current liabilities and facility lease obligation on our condensed consolidated balance sheets.
Lonza Facility Lease Obligation
During the third quarter 2015, we entered into a new agreement with Lonza Group AG and its affiliates (Lonza) whereby Lonza will construct a new manufacturing facility dedicated to Alexion at one of its existing facilities. The agreement requires us to make certain payments during the construction of the new manufacturing facility and annual payments for ten years thereafter. As a result of our contractual right to full capacity of the new manufacturing facility, a portion of the payments under the agreement are considered to be lease payments and a portion as payment for the supply of inventory. Although we will not legally own the premises, we are deemed to be the owner of the manufacturing facility during the construction period based on applicable accounting guidance for build-to-suit leases due to our involvement during the construction period. As of March 31, 2017 and December 31, 2016, we recorded a construction-in-process asset of $158 and $118, respectively, and an offsetting facility lease obligation of $142 and $107, respectively, associated with the manufacturing facility.
Payments to Lonza under the agreement are allocated to the purchases of inventory and the repayment of the facility lease obligation on a relative fair value basis. In 2017, we incurred $29 of payments to Lonza under this agreement, of which $4 was applied against the outstanding facility lease obligation and $25 was recognized as a prepayment of inventory. See Note 16 for minimum fixed payments due under Lonza agreements.

16.
Commitments and Contingencies
Commitments
License Agreements
We have entered into a number of license agreements in order to advance and obtain technologies and services related to our business. License agreements generally require us to pay an initial fee and certain agreements call for future payments upon the attainment of agreed upon development and/or commercial milestones. These agreements may also require minimum royalty payments based on sales of products developed from the applicable technologies, if any.
In March 2017, we entered into a license agreement with Arbutus Biopharma Corporation (Arbutus) for exclusive worldwide rights to Arbutus’ proprietary lipid nanoparticle technology for use in a single target. Due to the early stage of the assets we are licensing in connection with the collaboration, we recorded expense for the upfront payment of approximately $8 during the first quarter 2017. In addition, we could be required to make payments of up to $75 if certain development, regulatory, and commercial milestones are met over time, as well as royalties on commercial sales.

Manufacturing Agreements
We have various manufacturing development and license agreements to support our clinical and commercial product needs.
We rely on Lonza, a third party manufacturer, to produce a portion of commercial and clinical quantities of Soliris and Strensiq. We have various manufacturing and license agreements with Lonza, with remaining total non-cancellable future commitments of approximately $1,126. 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) and a payment with respect to sales of Soliris manufactured at Lonza facilities.

17

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




In addition to Lonza, we have non-cancellable commitments of $27 with other third party manufacturers.

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.
We have in the past received, and may in the future receive, notices from third parties claiming that their patents may be infringed by the development, manufacture or sale of our products. Under the guidance of ASC 450, Contingencies, we record a royalty accrual based on our best estimate of the fair value percent of net sales of our products that we could be required to pay the owners of patents for technology used in the manufacture and sale of our products. A costly license, or inability to obtain a necessary license, could have a material adverse effect on our financial results.
In May 2015, we received a subpoena in connection with an investigation by the Enforcement Division of the SEC requesting information related to our grant-making activities and compliance with the FCPA in various countries. In addition, in October 2015, we received a request from the DOJ for the voluntary production of documents and other information pertaining to Alexion’s compliance with FCPA. The SEC and DOJ also seek information related to Alexion’s recalls of specific lots of Soliris and related securities disclosures. Alexion is cooperating with these investigations.
The investigations have focused on operations in various countries, including Brazil, Colombia, Japan, Russia and Turkey, and Alexion's compliance with the FCPA and other applicable laws.
At this time, Alexion is unable to predict the duration, scope or outcome of these investigations. While it is possible that a loss related to these matters may be incurred, given the ongoing nature of these investigations, management cannot reasonably estimate the potential magnitude of any such loss or range of loss, or the cost of the ongoing investigation. Any determination that our operations or activities are not in compliance with existing laws or regulations could result in the imposition of fines, civil and criminal penalties, equitable remedies, including disgorgement, injunctive relief, and/or other sanctions against us, and remediation of any such findings could have an adverse effect on our business operations.
Alexion is committed to strengthening its compliance program and has initiated a comprehensive company-wide transformation plan to enhance and remediate its business processes, structures, controls, training, talent and systems across Alexion’s global operations. For information concerning the risks associated with the investigation, see our Risk Factor - "If we fail to comply with laws or regulations, we may be subject to investigations and civil or criminal penalties and our business could be adversely affected."
In the fourth quarter 2016, several securities class action lawsuits were filed against the Company and its former officers in federal district court alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5, promulgated thereunder, alleging that defendants made misstatements and/or omissions concerning the Company’s sales of Soliris. On April 12, 2017 the U.S. District Court for the District of Connecticut (the Court) awarded lead plaintiff status to Erste-Sparinvest KapitalanLagegesellschaft mbH (Erste) and the Public Employee Retirement System of Idaho (PERSI). Erste and PERSI filed its shareholder putative class action with the Court on December 29, 2016, alleging that defendants made misrepresentations and omissions about Soliris between February 10, 2014 and December 9, 2016. The litigation is in the early stages, and defendants have not yet responded to the complaint. Given the early stages of this litigation, management does not currently believe that 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 December 2016, we received a subpoena from the U.S. Attorney’s Office for the District of Massachusetts requesting documents relating generally to our support of 501(c)(3) organizations that provide financial assistance to Medicare patients taking drugs sold by Alexion, Alexion’s provision of free drug to Medicare patients, and Alexion compliance policies and training materials concerning the anti-kickback statute or payments to any 501(c)(3) organization that provides financial assistance to Medicare patients. Other companies have disclosed similar inquiries. We are cooperating with this inquiry.
In March 2013, we received a Warning Letter (Warning Letter) from the U.S. Food and Drug Administration (FDA) regarding compliance with current Good Manufacturing Practices (cGMP) at ARIMF. The Warning Letter followed receipt of a Form 483 Inspectional Observations by the FDA in connection with an FDA inspection that concluded in August 2012. The observations relate to commercial and clinical manufacture of Soliris at ARIMF. We responded to the Warning Letter in a letter

18

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




to the FDA dated in April 2013. As previously disclosed, the FDA issued Form 483s in August 2014 and August 2015 related to observations at ARIMF and the inspectional observations from the August 2014 and 2015 Forms 483s have since been closed out by the FDA. During July 2016, the FDA completed a routine inspection at ARIMF and have since confirmed receipt of our responses to the inspectional observations included in the Form 483 received during that inspection. The observations are inspectional and do not represent a final FDA determination of compliance. We continue to manufacture products, including Soliris, in this facility. While the resolution of the issues raised in the 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.

17.
Restructuring
In the first quarter 2017, we initiated a company-wide restructuring designed to help position the Company for sustainable, long-term growth that we believe will further allow us to fulfill our mission of serving patients and families with rare diseases. For the three months ended March 31, 2017 we recorded $24 of restructuring expenses primarily related to employee separation costs. We currently estimate incurring approximately $5 to $10 of additional restructuring related expenses in 2017. We expect to pay all accrued amounts related to this restructuring within twelve months.
The following table presents a reconciliation of the restructuring reserve recorded within accrued expenses on the Company's condensed consolidated balance sheet for the three months ended March 31, 2017:
 
Employee Separation Costs
 
Contract Termination Costs
 
Other Costs
 
Total
Liability, beginning of period
$

 
$

 
$

 
$

Restructuring expenses
21

 

 
3

 
24

Cash settlements

 

 

 

Adjustments to previous estimates

 

 

 

Asset impairments

 

 
(3
)
 
(3
)
Liability, end of period
$
21

 
$

 
$

 
$
21

The restructuring reserve of $21 is recorded in accrued expenses on the Company's condensed consolidated balance sheet as of March 31, 2017.


19

Alexion Pharmaceuticals, Inc.
(amounts in millions, 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®, Strensiq® and Kanuma® for approved indications and any expanded uses, timing and effect of sales of our products in various markets worldwide, pricing for our products, level of insurance coverage and reimbursement for our products, level of future product sales and collections, timing regarding development and regulatory approvals for additional indications or in additional territories, 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 (FDA) in the March 2013 Warning Letter and Form 483s issued by the FDA, 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 interest about our products and our product candidates in the patient, physician and payer communities, the safety and efficacy of our products and our product candidates, estimates of the potential markets and estimated commercialization dates for our products and our product candidates around the world, sales and marketing plans, any changes in the current or anticipated market demand or medical need for our products or our product candidates, status of our ongoing clinical trials for eculizumab, asfotase alfa, sebelipase 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 of our products and our product candidates, 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 our products infringes their intellectual property, estimates of the capacity of manufacturing and other service facilities to support our products 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 our products, delay of collection or reduction in reimbursement due to adverse economic conditions or changes in government and private insurer regulations and approaches to reimbursement, uncertainties surrounding legal proceedings, company investigations and government investigations, including our Securities and Exchange Commission (SEC) and U.S. Department of Justice (DOJ) investigations, the securities fraud class action litigation filed in December 2016, the investigation by our Audit and Finance Committee announced in November 2016 (the Audit Committee Investigation), and the inquiry by the U.S. Attorney's Office for the District of Massachusetts requesting documents relating generally to our support of patient assistance programs, risks related to potential disruptions to our business as a result of the leadership changes and transition announced in December 2016 and March 2017, the anticipated effects of the company-wide restructuring initiated in the first quarter 2017, 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 SEC.
Business
We are a biopharmaceutical company focused on serving patients with devastating and rare disorders through the innovation, development and commercialization of life-transforming therapeutic products.
In our complement franchise, Soliris is the first and only therapy approved for patients with either PNH or aHUS. In our metabolic franchise, we commercialize Strensiq for the treatment of patients with HPP and Kanuma for the treatment of patients with LAL-D.

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We are also evaluating additional potential indications for eculizumab in other severe and devastating 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 devastating and ultra-rare diseases.
 
Products and Development Programs
We focus our product development programs on life-transforming therapeutics for devastating and ultra-rare diseases for which current treatments are either non-existent or inadequate.
Marketed Products
Our marketed products include the following:
Product
 
Development Area
 
Indication
Soliris (eculizumab)
 
Hematology
 
Paroxysmal Nocturnal Hemoglobinuria (PNH)
 
 
Hematology/Nephrology
 
Atypical Hemolytic Uremic Syndrome (aHUS)
Strensiq (asfotase alfa)
 
Metabolic Disorders
 
Hypophosphatasia (HPP)
Kanuma (sebelipase alfa)
 
Metabolic Disorders
 
Lysosomal Acid Lipase Deficiency (LAL-D)

Soliris (eculizumab)
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, neurology and transplant rejection. 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.
Paroxysmal Nocturnal Hemoglobinuria (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). We continue to work with researchers to expand the base of knowledge in PNH and the utility of Soliris to treat patients with PNH. Soliris is approved for the treatment of PNH in the U.S., Europe, Japan and in several other territories. 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. In addition, Soliris has been granted orphan drug designation for the treatment of PNH in the U.S., Europe, Japan and several other territories.
Atypical Hemolytic Uremic Syndrome (aHUS)
aHUS is a severe and life-threatening, ultra-rare genetic 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. Soliris is approved for the treatment of pediatric and adult patients with aHUS in the U.S., Europe and Japan. We are sponsoring a multinational registry to gather information regarding the natural history of patients with aHUS and the longer-term outcomes during Soliris treatment. In addition, the FDA and European Commission (EC) have granted Soliris orphan drug designation for the treatment of patients with aHUS.
Strensiq (asfotase alfa)
Hypophosphatasia (HPP)
HPP is an ultra-rare genetic and progressive metabolic disease in which patients experience devastating effects on multiple systems of the body, leading to debilitating or life-threatening complications. HPP is characterized by defective bone mineralization that can lead to deformity of bones and other skeletal abnormalities, as well as systemic complications such as profound muscle weakness, seizures, pain, and respiratory failure leading to premature death in infants.

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

Strensiq, a targeted enzyme replacement therapy, is the first and only approved therapy for patients with HPP, and is designed to directly address underlying causes of HPP by aiming to restore the genetically defective metabolic process, thereby preventing or reversing the severe and potentially life-threatening complications in patients with HPP. In 2015, the FDA approved Strensiq for patients with perinatal-, infantile- and juvenile-onset HPP, the EC granted marketing authorization for Strensiq for the treatment of patients with pediatric-onset HPP, and Japan’s Ministry of Health Labour and Welfare (MHLW) approved Strensiq for the treatment of patients with HPP. We are sponsoring a multinational registry to gather information regarding the natural history of patients with HPP and the longer-term outcomes during Strensiq treatment.
Kanuma (sebelipase alfa)
Lysosomal Acid Lipase Deficiency (LAL Deficiency or LAL-D)
LAL-D is a serious, life-threatening ultra-rare disease associated with premature mortality and significant morbidity. LAL-D is a chronic disease in which genetic mutations result in decreased activity of the LAL enzyme that leads to marked accumulation of lipids in vital organs, blood vessels, and other tissues, resulting in progressive and systemic organ damage including hepatic fibrosis, cirrhosis, liver failure, accelerated atherosclerosis, cardiovascular disease, and other devastating consequences.
Kanuma, a recombinant form of the human LAL enzyme, is the only enzyme-replacement therapy that is approved for the treatment for patients with LAL-D. In 2015, the FDA approved Kanuma for the treatment of patients with LAL-D and the EC granted marketing authorization of Kanuma for long-term enzyme replacement therapy in patients of all ages with LAL-D. On March 28, 2016, we announced that the MHLW approved Kanuma for the treatment of patients of all ages in Japan with LAL-D. We are sponsoring a multinational registry to gather information regarding the natural history of patients with LAL-D and the longer-term outcomes during Kanuma treatment.
Clinical Development Programs
Our programs, including investigator sponsored clinical programs, include the following:
Product
 
Development Area
 
Indication
 
Development Stage
Soliris (eculizumab)
 
Neurology
 
Refractory Generalized Myasthenia Gravis (gMG)
 
Phase III
 
 
 
 
Relapsing Neuromyelitis Optica Spectrum Disorder (NMOSD)
 
Phase III
 
 
Transplant
 
Antibody Mediated Rejection (AMR) Presensitized Renal Transplant - Deceased Donor

 
Phase II
ALXN1210 (IV)
 
Next Generation Complement Inhibitor
 
Paroxysmal Nocturnal Hemoglobinuria (PNH)
 
Phase III
 
 
 
 
Atypical Hemolytic Uremic Syndrome (aHUS)
 
Phase III
ALXN1210 (Subcutaneous)
 
Next Generation Complement Inhibitor
 
 
 
Phase I
cPMP (ALXN1101)
 
Metabolic Disorders

 
Molybdenum Cofactor Deficiency (MoCD ) Type A

 
Phase II / III
SBC-103
 
Metabolic Disorders
 
Mucopolysaccharidoses IIIB
(MPS IIIB)


 
Phase I / II
Samalizumab
(ALXN6000)
 
Immuno-Oncology
 
Advanced Solid Tumors

 
Phase I
 
 
 
 
Acute Myeloid Leukemia (AML)
 
Phase I/II



22

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

Soliris (eculizumab)
Neurology
Refractory Generalized Myasthenia Gravis (gMG)
Refractory gMG is an ultra-rare segment of Myasthenia Gravis, a debilitating, complement-mediated neuromuscular disease in which patients suffer profound muscle weakness throughout the body, resulting in slurred speech, impaired swallowing and choking, double vision, upper and lower extremity weakness, disabling fatigue, shortness of breath due to respiratory muscle weakness and episodes of respiratory failure. The FDA, EC and MHLW have granted orphan drug designation for eculizumab as a treatment for patients with refractory gMG.
In June 2016, we announced topline results of the Phase III REGAIN trial of eculizumab for the treatment of refractory gMG. The primary efficacy endpoint of change from baseline in Myasthenia Gravis-Activities of Daily Living Profile (MG-ADL) total score, a patient-reported assessment, at week 26, did not reach statistical significance (p=0.0698) as measured by a worst-rank analysis. The totality of data reviewed to date, including the first three secondary endpoints and a series of prospectively defined sensitivity analyses, shows early and sustained substantial improvements over 26 weeks for patients treated with eculizumab compared to placebo. The safety of eculizumab in this study was consistent with the Soliris labels. Additional data from the Phase III study was presented in July 2016. The data showed that 18 of 22 pre-defined endpoints and pre-specified analyses in the study, based on the primary and five secondary endpoints, achieved p-values below 0.05.
In January 2017, we announced that we filed for regulatory approval for eculizumab in refractory gMG in both the U.S. and Europe. These marketing applications were based on the comprehensive data from the Phase III REGAIN trial. In January, the European submission was validated by the European Medicines Agency (EMA), marking the beginning of the review process in Europe for this potential new indication for Soliris. In March 2017, the FDA accepted for review the Company's supplemental Biologics License Application to extend the indication for Soliris as a potential treatment for patients with gMG. Additionally, in March 2017, we submitted an application to the MHLW to extend the indication for Soliris as a potential treatment for patients with gMG.
Relapsing Neuromyelitis Optica Spectrum Disorder (NMOSD)
Relapsing NMOSD is a severe and ultra-rare autoimmune disease of the central nervous system (CNS) that primarily affects the optic nerves and spinal cord. The disease leads to severe weakness, paralysis, respiratory failure, loss of bowel and bladder function, blindness and premature death. Enrollment and dosing are ongoing in a global, randomized, double-blind, placebo-controlled trial to evaluate eculizumab as a treatment for patients with relapsing NMOSD. The FDA, EC, and MHLW have each granted orphan designation for eculizumab as a treatment for patients with relapsing NMOSD.
Transplant
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-center 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 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. In May 2015, new data from the Phase II single-arm deceased-donor transplant trial of eculizumab in prevention of acute AMR was presented and was consistent with previous positive reports.

ALXN1210
ALXN1210 is a highly innovative, longer-acting anti-C5 antibody discovered and developed by Alexion that inhibits terminal complement. In early studies, ALXN1210 demonstrated rapid, complete, and sustained reduction of free C5 levels. Alexion has completed enrollment in two ongoing clinical studies of ALXN1210 in patients with PNH-a Phase I/II dose-escalating study and an open-label, multi-dose Phase II study that is also evaluating longer dosing intervals beyond eight weeks.

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

Paroxysmal Nocturnal Hemoglobinuria (PNH)
In June 2016, we announced interim data from a Phase I/II study in patients with PNH showing that once-monthly dosing of ALXN1210 achieved rapid and sustained reductions in hemolysis, as measured by mean levels of lactate dehydrogenase (LDH), in 100 percent of treated patients. 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). Researchers also reported that, at the time of analysis, 80 percent of patients who required at least 1 blood transfusion in the 12 months prior to treatment with ALXN1210 did not require transfusions while on treatment with ALXN1210. Furthermore, in December 2016, we reported new data from this same ongoing study that showed rapid and sustained reductions LDH in patients with PNH treated with once-monthly dosing. Patients also had improvements in Functional Assessment of Chronic Illness Therapy (FACIT)-Fatigue score from baseline, with patients in the higher-dose cohort achieving a two-fold greater improvement compared with the lower-dose cohort. In addition, we have completed enrollment and treatment is ongoing in an open-label, multi-dose Phase II study of ALXN1210 in patients with PNH designed to measure reductions in hemolysis and safety in several dosing cohorts and intervals evaluating monthly and longer dosing intervals. We have initiated a Phase III open-label, multinational, active-controlled study of ALXN1210 compared to eculizumab (Soliris) in adult patients with PNH who have never been treated with a complement inhibitor. The study is evaluating ALXN1210 administered intravenously every eight weeks. Patient enrollment is ongoing in this trial.
In June 2016 and January 2017, the EC and the FDA, respectively, granted orphan drug designation to ALXN1210, for the treatment of patients with PNH.
Atypical Hemolytic Uremic Syndrome (aHUS)
We initiated a Phase III open-label, single arm, multicenter study of ALXN1210 in adolescent and adult patients with aHUS who have never been treated with a complement inhibitor. In patients with aHUS, complement-mediated TMA leads to life-threatening damage to the kidney, brain, heart and other vital organs. The study will evaluate ALXN1210 administered intravenously every eight weeks. Patient enrollment is ongoing in this trial.
Subcutaneous (SC) Delivery
We have completed enrollment in a Phase I study in healthy volunteers to evaluate ALXN1210 delivered subcutaneously.

cPMP (ALXN1101)
Molybdenum Cofactor Deficiency (MoCD) Disease Type A (MoCD Type A)
MoCD Type A is an ultra-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 the function of certain enzymes and 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 recombinant cPMP replacement therapy in a small number of children with MoCD Type A, and we have completed enrollment in a natural history study in patients with MoCD Type A. cPMP has received Breakthrough Therapy Designation from the FDA for the treatment of patients with MoCD Type A. Evaluation of our synthetic form of cPMP replacement therapy in a Phase I healthy volunteer study is complete. In addition, we completed enrollment in a multi-center, multinational open-label clinical trial of synthetic cPMP in patients with MoCD Type A switched from treatment with recombinant cPMP. Enrollment is ongoing in the Phase II/III pivotal open-label, single-arm trial of ALXN1101 for treatment-naïve neonates with MoCD Type A.

SBC-103
Mucopolysaccharidosis IIIB (MPS IIIB)
MPS IIIB is an ultra-rare, devastating and life-threatening disease which typically presents in children during the first few years of life. Genetic mutations result in decreased activity of the alpha-N-acetyl-glucosaminidase (NAGLU) enzyme, which leads to a buildup of abnormal amounts of heparan sulfate (HS) in the brain and throughout the body. Over time, this unrelenting systemic accumulation of HS causes progressive and severe cognitive decline, behavioral problems, speech loss, increasing loss of mobility, and premature death. Current treatments are palliative for the behavioral problems, sleep disturbances, seizures, and other complications, and these treatments do not address the root cause of MPS IIIB or stop disease progression.
SBC-103, a recombinant form of natural human NAGLU is designed to replace the missing (or deficient) NAGLU enzyme. SBC-103 was granted orphan drug designation by the FDA and by the EC. It received Fast Track designation by the FDA. The first-in-human trial of patients with MPS IIIB is ongoing. In March 2016, researchers presented 24-week results from this study that showed a 26.2 percent mean reduction in heparan sulfate in cerebrospinal fluid at the highest dose studied (3mg/kg every other week) in a Phase I/II study at six months. In July 2016, researchers presented preliminary results on brain

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

MRI and neurocognitive assessments performed after 24 weeks of dosing suggesting preliminary evidence of potential for dose-dependent disease stabilization in patients treated with 0.3, 1, or 3mg/kg every other week of doses of SBC-103. Planned dose escalation of SBC-103 is now ongoing in this trial. This trial will not be expanded and no new patients will be added to the trial. Patients currently enrolled in the trial will continue to receive therapy. No additional studies are planned.
Samalizumab (ALXN6000)
Samalizumab is a first-in-class immunomodulatory humanized monoclonal antibody that blocks CD200 a key immune checkpoint protein expressed in both hematologic and solid malignancies. Alexion is currently enrolling patients in a Phase I trial evaluating the safety and efficacy of samalizumab in patients with advanced solid tumors.
Patients are also being dosed in The Leukemia and Lymphoma Society's BEAT AML Master Trial, a Phase I/II multi-arm clinical trial, which is evaluating samalizumab as well as other potential therapies for the treatment of previously untreated patients with AML.
Manufacturing
We currently rely on internal manufacturing facilities and third party contract manufacturers, including Lonza Group AG and its affiliates (Lonza), to supply clinical and commercial quantities of our commercial products and product candidates. Our internal manufacturing facilities include our Ireland manufacturing facilities, our Rhode Island manufacturing facility (ARIMF), and facilities in Massachusetts and Georgia. We also utilize third party contract manufacturers for other manufacturing services including purification, product filling, finishing, packaging, and labeling.
We have various agreements with Lonza through 2028, with remaining total non-cancellable commitments of approximately $1,126. If we terminate certain supply agreements with Lonza without cause, we will be required to pay for product scheduled for manufacture under our arrangements. Under an existing arrangement with Lonza, we also pay Lonza a royalty on sales of Soliris manufactured at ARIMF and a payment with respect to sales of Soliris manufactured at Lonza facilities. During 2015, we entered into a new supply agreement with Lonza whereby Lonza will construct a new manufacturing facility dedicated to Alexion manufacturing at one of its existing facilities.
In addition, we have non-cancellable commitments of approximately $27 through 2019 with other third party manufacturers.
In March 2013, we received a Warning Letter (Warning Letter) from the FDA regarding compliance with current Good Manufacturing Practices (cGMP) at ARIMF. The Warning Letter followed receipt of a Form 483 Inspectional Observations by the FDA in connection with an FDA inspection that concluded in August 2012. The observations relate to commercial and clinical manufacture of Soliris at ARIMF. We responded to the Warning Letter in a letter to the FDA dated in April 2013. As previously disclosed, the FDA issued Form 483s in August 2014 and August 2015 relating to observations at ARIMF and the inspectional observations from the August 2014 and 2015 Form 483s have since been closed out by the FDA. During July 2016, the FDA completed a routine inspection at ARIMF and have since confirmed receipt of our responses to the inspectional observations included in the Form 483 received during that inspection. We continue to manufacture products, including Soliris, at ARIMF, and we anticipate that the supply of Soliris to patients will not be interrupted as a result of the inspectional observations. While the resolution of the issues raised in the 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 April 2014, we purchased a fill/finish facility in Athlone, Ireland. Our refurbishment of the facility is substantially complete and after regulatory approvals, the facility will become our first company-owned fill/finish facility for our commercial and clinical products. In July 2016, we announced plans to construct a new biologics manufacturing facility at this site, which is expected to be completed by 2018.
In May 2015, we announced plans to construct a new biologics manufacturing facility on our existing property in Dublin, Ireland, which is expected to be completed by 2020.
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 the Consolidated Financial Statements included in our Form 10-K for the year ended December 31, 2016. 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:

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Alexion Pharmaceuticals, Inc.
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Revenue recognition;
Contingent liabilities;
Inventories;
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, 2016. 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 (FASB) 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, 2017 and allows for adoption using a full retrospective method, or a modified retrospective method. Entities may elect to early adopt the standard for annual periods beginning after December 15, 2016. We currently anticipate adopting the standard using the modified retrospective method. We do not expect the implementation of this new standard to have a material impact on our financial position and results of operations.
In February 2016, the FASB issued a new standard requiring that the rights and obligations arising from leases be recognized on the balance sheet by recording a right-of-use asset and corresponding lease liability. The new standard also requires qualitative and quantitative disclosures to understand the amount, timing, and uncertainty of cash flows arising from leases, as well as significant management estimates utilized. The standard is effective for interim and annual periods beginning after December 15, 2018 and requires a modified retrospective adoption. We are currently assessing the impact of this standard on our financial condition and results of operations.
In March 2016, the FASB issued a new standard intended to simplify certain aspects of the accounting for employee share-based payments. We elected to early adopt this standard in 2016. One aspect of the standard requires an entity to recognize all excess tax benefits and deficiencies associated with stock-based compensation as a reduction or increase to tax expense in the income statement. Previously, such amounts were recognized in additional paid-in capital. The amendments also require recognition of excess tax benefits regardless of whether the benefit reduces taxes payable in the current period. Furthermore, the amendment requires that excess tax benefits be classified as an operating activity in the statement of cash flows instead of a financing activity. We have also elected to continue to estimate the impact of forfeitures when determining the amount of compensation cost to be recognized each period rather than account for forfeitures as they occur.
In October 2016, the FASB issued a new income tax standard that eliminates the exception for an intra-entity asset transfer other than inventory. Under the new standard, entities should recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. Any deferred tax asset that arises in the buyer's jurisdiction would also be recognized at the time of the transfer. We elected to early adopt this standard in the first quarter 2017. As a result of the adoption, in the first quarter of 2017, we recorded a $19 decrease in retained earnings, primarily resulting from the elimination of previously recorded prepaid tax assets.
In January 2017, the FASB issued a new standard that clarifies the definition of a business and determines when an integrated set of assets and activities is not a business. This framework requires that if substantially all of the fair value of gross assets acquired or disposed of is concentrated in a single asset or group of similar identifiable assets, the assets would not represent a business. The standard is effective for interim and annual periods beginning after December 15, 2017 with early adoption permitted. We are currently assessing the impact of this standard on our financial condition and results of operations.

26

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

Results of Operations
Net Product Sales
Net product sales by significant geographic region for the three months ended March 31, 2017 and 2016 are as follows:

 
Three months ended March 31,
 
2017
 
2016
 
% Change
Net product sales:
 
 
 
 
 
United States
360

 
265

 
36
%
Europe
248

 
227

 
9
%
Asia Pacific
83

 
72

 
15
%
Rest of World
178

 
136

 
31
%
 
$
869

 
$
700

 
24
%

Net product sales by product are as follows:
 
Three months ended March 31,
 
2017
 
2016
 
% Change
Net product sales:
 
 
 
 
 
Soliris
$
783

 
$
665

 
18
%
Strensiq
74

 
33

 
124
%
Kanuma
12

 
2

 
500
%
 
$
869

 
$
700

 
24
%
The components of this increase in revenues are as follows:
Components of change:
 
   Price
 %
   Volume
26
 %
   Foreign exchange
(2
)%
Total change in net product sales
24
 %
The increase in net product sales for the three months ended March 31, 2017, as compared to the same period in 2016, was primarily due to an increase in unit volumes of 26%. This increase in unit volumes is due to increased global demand for Soliris therapy for patients with PNH or aHUS, as well as increased sales of Strensiq and Kanuma during 2017 as a result of our continuing efforts to identify and reach more patients with HPP and LAL-D globally. Approximately 3% of the year-over-year increase in unit volumes was due to increased unit volumes in Latin America primarily driven by large orders of Soliris in the first quarter 2017. We have historically deferred revenue recognition for sales to certain international customers, mainly distributors, until the product was received by the end customer due to various factors, including our inability to estimate product returns. On a regular basis, we review revenue arrangements, including our distributor relationships, to determine whether any changes in these arrangements or historical experience with these customers have an impact on revenue recognition. In the first quarter 2017, we determined that we had sufficient sales experience with certain customers to estimate product returns from such customers. As a result, we began to recognize revenue for these customers when title to the product and the associated risk of loss passed to the customer. Some customers may purchase larger quantities of product less frequently, which may result in revenue fluctuations from quarter to quarter.
Foreign exchange had a negative impact of 2% for the three months ended March 31, 2017, as compared to the same period in 2016. The negative impact on foreign exchange of $12 or 2%, was due to changes in foreign currency exchange rates (inclusive of hedging activity) versus the U.S. dollar for the three months ended March 31, 2017. The negative impact was primarily due to the weakening of the Euro and British Pound, offset in part by gains in the Russian Ruble. Offsetting the impact of the stronger dollar, we recorded a gain in revenue of $20 and $23 related to our foreign currency cash flow hedging program for the three months ended March 31, 2017 and 2016, respectively. We expect to maintain our current hedging program to mitigate foreign currency risk associated with our revenues in 2017.

27

Alexion Pharmaceuticals, Inc.
(amounts in millions, 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 our products.
The following table summarizes cost of sales for the three months ended March 31, 2017 and 2016:
 
Three months ended March 31,
 
 
 
2017
 
2016
 
Change
Cost of sales
$
69

 
$
59

 
$
10

Cost of sales as a percentage of net product sales
8
%
 
8
%
 
%
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, including ALXN1210. 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 our products 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 facilities, 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
 
 
 
 
 
March 31,
 
$
 
%
 
2017
 
2016
 
Change
 
Change
Clinical development
$
58

 
$
50

 
$
8

 
16
 %
Product development
54

 
30

 
24

 
80
 %
Licensing agreements
9

 
3

 
6

 
200
 %
Discovery research
12

 
13

 
(1
)
 
(8
)%
Total external direct expenses
133

 
96

 
37

 
39
 %
Payroll and benefits
74

 
71

 
3

 
4
 %
Facilities and other costs
12

 
9

 
3

 
33
 %
Total other R&D expenses
86

 
80

 
6

 
8
 %
Research and development expense
$
219

 
$
176

 
$
43

 
24
 %

For the three months ended March 31, 2017, the increase of $43 in research and development expense, as compared to the same period in the prior year, was primarily related to the following:
Increase of $24 in external product development expenses related primarily to an increase in costs associated with the manufacturing of material for ALXN1210 and ALXN6000 clinical research activities as compared to the first quarter of 2016.
Increase of $8 in external clinical development expenses related primarily to an expansion of clinical studies for ALXN 1210 (see table below).
Increase of $6 in licensing agreement expenses primarily related to upfront payments made in the first quarter 2017 related to our licensing arrangement with Arbutus Biopharma Corporation.


28

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

The following table summarizes external direct expenses related to our clinical development programs. Please refer to "Clinical Development Programs" above for a description of each of these programs:
 
Three months ended
 
 
 
March 31,
 
$
 
2017
 
2016
 
Change
External direct expenses
 
 
 
 
 
eculizumab
$
20

 
$
22

 
$
(2
)
ALXN1210
17

 
4

 
13

sebelipase alfa
7

 
5

 
2

asfotase alfa
6

 
5

 
1

cPMP
1

 
2

 
(1
)
ALXN1007
1

 
3

 
(2
)
SBC-103
2

 
1

 
1

Other programs
1

 
3

 
(2
)
Shared expenses
3

 
5

 
(2
)
 
$
58

 
$
50

 
$
8

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 our products; human resources; finance, legal, information technology and support personnel expenses; and other corporate costs such as telecommunications, insurance, audit, government affairs and our global corporate compliance program.
The table below provides information regarding selling, general and administrative expense:
 
Three months ended
 
 
 
 
 
March 31,
 
$
 
%
 
2017
 
2016
 
Change
 
Change
Salary, benefits and other labor expense
$
157

 
$
148

 
$
9

 
6
%
External selling, general and administrative expense
105

 
85

 
20

 
24
%
Total selling, general and administrative expense
$
262

 
$
233

 
$
29

 
12
%
For the three months ended March 31, 2017, the increase of $29 in selling, general and administrative expense, as compared to the same period in the prior year, was related to the following:
Increase in salary, benefits and other labor expenses of $9. The increase was a result of increased staff costs of our commercial activities to support the continued global launches of Strensiq and Kanuma.
Increase in external selling, general and administrative expenses of $20. The increase was primarily due to an increase in legal expenses from the SEC/DOJ FCPA investigation and additional charitable contributions as compared to the first quarter 2016, offset in part by decreases in advertising and promotional cost as compared to the first quarter 2016. Additionally, facilities costs increased from 2016 as a result of continuing growth of operations worldwide.
Amortization of Purchase Intangible Assets
For each of the three months ended March 31, 2017 and 2016, we recorded amortization expense of $80, primarily associated with intangible assets related to Strensiq and Kanuma, for which we received regulatory approval in the third quarter 2015.

29

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

Change in Fair Value of Contingent Consideration
For the three months ended March 31, 2017 and 2016, the change in fair value of contingent consideration expense associated with our prior business combinations was $4 and $(15), respectively. The increase in the expense associated with the change in the fair value of contingent consideration for the three months ended March 31, 2017 compared to the same period in 2016 was primarily due to decreases in the likelihood of payments for contingent consideration in 2016.
Restructuring Expenses
In the first quarter 2017, Alexion initiated a company-wide restructuring designed to help position the Company for sustainable, long-term growth and to further allow us to fulfill our mission of serving patients and families with rare diseases. For the three months ended March 31, 2017 we recorded $24 of restructuring expenses primarily related to employee separation costs. We currently estimate incurring approximately $5 to $10 of additional restructuring related expenses in 2017. We expect to pay all accrued amounts related to this restructuring within twelve months. As a result of this restructuring , we expect research and development and selling, general, and administrative expenses to grow at a slower rate than in prior periods.
Other Income and Expense
The following table provides information regarding other income and expense:
 
Three months ended
 
 
 
March 31,
 
$
 
2017
 
2016
 
Change
Investment income
$
4

 
$
1

 
$
3

Interest expense
(24
)
 
(24
)
 

Other income
2

 

 
2

Total other income (expense)
$
(18
)
 
$
(23
)
 
$
5

Income Taxes
During the three months ended March 31, 2017, we recorded an income tax expense of $24 and an effective tax rate of 12.4%, compared to an income tax expense of $51 and an effective tax rate of 35.8% for the three months ended March 31, 2016.
The income tax expense for the three months ended March 31, 2017 and 2016 is attributable to the U.S. federal, state and foreign income taxes on our profitable operations. The decrease in the effective tax rate for the three months ended March 31, 2017 as compared to the same period in the prior year is primarily attributable to the deferred tax cost associated with the distribution of earnings from our captive foreign partnership in 2016. We expect to continue to benefit from a reduced tax rate as a result of our centralized global supply chain and technical operations in Ireland.
We continue to maintain a valuation allowance against certain other deferred tax assets where realization is not certain. We periodically evaluate the likelihood of realizing deferred tax assets and reduce the carrying amount of these deferred tax assets by a valuation allowance to the extent we believe a portion will not be realized.
Financial Condition, Liquidity and Capital Resources
The following table summarizes the components of our financial condition as of March 31, 2017 and December 31, 2016:
 
March 31, 2017
 
December 31, 2016
 
$
Change
Cash and cash equivalents
$
713

 
$
966

 
$
(253
)
Marketable securities
$
749

 
$
327

 
$
422

Long-term debt (includes current portion)
$
3,037

 
$
3,081

 
$
(44
)
 
 
 
 
 
 
Current assets
$
2,733

 
$
2,578

 
$
155

Current liabilities
837

 
823

 
14

Working capital
$
1,896

 
$
1,755

 
$
141

 
The aggregate increase in cash and cash equivalents and marketable securities was primarily attributable to cash generated from operations and net proceeds from the issuance of common stock under share-based compensation arrangements.

30

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

Partially offsetting these increases in cash was cash utilized to repurchase shares, principal payments on our term loan, and purchases of property, plant, and equipment.
We expect continued growth in our expenditures and capital investment. However, we anticipate that cash generated from operations and our existing available cash, cash equivalents and marketable securities should provide us adequate resources to fund our operations as currently planned.
We have financed our operations and capital expenditures primarily through positive cash flows from operations. We expect to continue to be able to fund our operations, including principal and interest payments on our credit facility and contingent payments from our acquisitions principally through our cash flows from operations. We may, from time to time, also seek additional funding through a combination of equity or debt financings or from other sources, if necessary for future acquisitions or other strategic purposes.
Financial Instruments
Until required for use in the business, we may invest our cash reserves in money market funds, bank deposits, and high-quality marketable securities in accordance with our investment policy. The stated objectives of our investment policy is to preserve capital, provide liquidity consistent with forecasted cash flow requirements, maintain appropriate diversification and generate returns relative to these investment objectives and prevailing market conditions.
Financial instruments that potentially expose us to concentrations of credit risk are cash equivalents, marketable securities, accounts receivable and our derivative contracts. As of March 31, 2017 and December 31, 2016, three customers accounted for 47% of the accounts receivable balance, with these individual customers accounting for 14% to 19% of the accounts receivable balance. For the three months ended March 31, 2017, three customers accounted for 35% of our product sales, with these individual customers accounting for 10% to 15% of our product sales. For the three months ended March 31, 2016, three customers accounted for 39% of our product sales, with these individual customers accounting for 11% to 16% of our product sales.
We continue to monitor economic conditions, including volatility associated with international economies and the associated impacts on the financial markets and our business. A substantial portion of our accounts receivable due from these countries are due from or backed by sovereign or local governments, and the amount of non-sovereign accounts receivable is not material. Although collection of our accounts receivables from certain countries may extend beyond our credit terms, we do not expect any such delays to have a material impact on our financial condition or results of operations.
We manage our foreign currency transaction risk and interest rate 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. As of March 31, 2017, we had foreign exchange forward contracts with notional amounts totaling $2,367. These outstanding foreign exchange forward contracts had a net fair value of $85, of which $10