Note 8—Commitments and Contingencies

Commitments

In July 2012, the Company implemented to a plan of reorganization pursuant to which it intends to reduce annual operating expenses by reducing non-workforce related operating expenses across all functional areas and by reducing its salary, bonus and benefit related operating costs. Severance costs related to this reorganization plan were approximately $0.7 million and substantially paid by December 31, 2012.

The Company has committed to cash retention payments to certain key employees during 2013. The Company’s potential commitment, if all recipients are employed at the time of payment, would be approximately $1.1 million during the second quarter of 2013.

On January 23, 2012, the Company entered into a lease agreement for office space consisting of approximately 48,000 rentable square feet in Bridgewater, NJ, for the Company’s principal offices and corporate headquarters. The Company relocated all of its operations to the new facility in September 2012. The term of the lease is 123 months, and the Company has rights to extend the term for two additional five-year terms at fair market value subject to specified terms and conditions. The aggregate minimum lease commitment over the 123-month term of the new lease is approximately $15.2 million. The Company has arranged for a bank to provide the landlord a letter of credit of $1.6 million, to secure the Company’s obligations under the lease.

The lease agreement includes fixed escalations of minimum annual lease payments and accordingly, the Company records rent expense on a straight-line basis over the lease-term. Additionally, in connection with the lease, the property owner provided a lease inducement to the Company in the form of a $2.0 million tenant improvement allowance. The leasehold improvement asset and the lease incentive liability are being amortized on a straight-line basis over the term of the lease to depreciation expense and as an offset to rent expense, respectively.

The Company’s former corporate headquarters are located in East Brunswick, New Jersey, where it currently leases approximately 53,000 square feet of office space. The lease has a base average annual rental expense of approximately $1.9 million and expires in March 2013.

The Company’s future annual minimum lease payments, which include payments related to the Company’s former corporate headquarters located in East Brunswick, New Jersey, that will expire in March of 2013, for each of the following calendar years are as follows:


December 31, 2012	(In thousands)
2013		1,855
2014		1,408
2015		1,431
2016		1,456
2017		1,480
Thereafter		7,228

Total minimum payments	$	14,858

Rent expense charged to operations was approximately $2.6 million, $2.0 million, and $1.9 million for each of the years ended December 31, 2012, 2011 and 2010, respectively. Rent expense is presented within research and development and selling, general and administrative expense in the consolidated statements of operations.

At December 31, 2012, the Company had employment agreements with eight senior officers. Under these agreements, the Company has committed to total aggregate base compensation per year of approximately $3.1 million plus other benefits and bonuses. These employment agreements generally have an initial-term of three years and are automatically renewed thereafter for successive one-year periods unless either party gives the other notice of non-renewal. In addition, in order to secure the retention of the Company’s executives and prevent any disruption to the strategic development of the Company, the Company granted executive cash and stock retention awards which vest as to 50% of the award on specific dates over a two-year period to these executives. The Company’s potential commitment, if all of the executives are employed at the time of vesting, is $0.8 million during the first quarter of 2013 and would be $0.8 million during the first quarter of 2014. In addition, the Company recorded approximately $0.8 million related to the stock retention awards during 2012. The expense related to these awards is expected to be approximately $0.9 million in 2013. The expense represents the grant date fair value of the awards as computed in accordance with the Financial Accounting Standards Board, or FASB, Accounting Standards Codification (ASC), Topic 718, Stock-Based Compensation . The assumptions used in the calculations of these amounts are included in footnote 11.

In 2007, the Company entered into commercial supply and development agreements with Bio-Technology General (Israel) Ltd, (“BTG”), pursuant to which BTG serves as the manufacturer and commercial supplier of the pegloticase drug substance for KRYSTEXXA and provides development, manufacturing and other services in relation to the product. Under the agreements, BTG also provided support with respect to the Company’s biologics license application (“BLA”) for KRYSTEXXA. Pursuant to its terms, the development agreement automatically expired upon the FDA’s approval for marketing of KRYSTEXXA in the United States. Under the commercial supply agreement with BTG, as amended, BTG is obligated to manufacture the Company’s firmly forecasted commercial supply of KRYSTEXXA and the Company is obligated to purchase from BTG at least 80% of its worldwide requirements of pegloticase drug substance. However, if BTG produces specified numbers of failed batches of pegloticase drug substance within one or more calendar quarters, then the Company may purchase all of its KRYSTEXXA requirements from other suppliers until BTG demonstrates to the Company’s reasonable satisfaction that it has remedied its supply failure. In addition, if the Company’s product forecasts are reasonably anticipated to exceed BTG’s processing capacity, then the Company may purchase from other suppliers the KRYSTEXXA requirements that exceed BTG’s capacity. The Company is obligated to provide BTG with a rolling forecast on a monthly basis setting forth the total quantity of pegloticase drug substance it expects to require for commercial supply in the following 18 months. The first six months of each forecast represent a rolling firm irrevocable order, and the Company may only increase or decrease its forecast for the next 12 months within specified limits. Beginning in December 2015, which is the seventh anniversary of BTG’s first delivery of pegloticase drug substance under the commercial supply agreement, either the Company or BTG may provide three years advance notice to terminate the commercial supply agreement, effective not earlier than December 2018. The commercial supply agreement may also be terminated in the event of insolvency or uncured material breach by either party. Based on the current rolling forecast, the Company does not have a minimum purchase commitment at December 31, 2012.

In 2007, the Company entered into a services agreement with Fujifilm Diosynth Biotechnologies USA LLC (“Fujifilm”), pursuant to which Fujifilm is preparing to serve as the Company’s secondary source supplier in the United States of pegloticase drug substance for KRYSTEXXA. Under the agreement, the Company is obligated to make specified milestone payments related to the technology transfer, and subsequent performance, of the manufacturing and supply process, which was initiated in August 2007 with BTG’s cooperation. In November 2009, the Company entered into a revised services agreement with Fujifilm, pursuant to which the Company delayed the 2009 conformance batch production campaign until 2010. During the first quarter of 2010, the conformance batch production campaign at Fujifilm commenced. As a result of batch failures at Fujifilm based on one manufacturing specification, the 2010 conformance batch production campaign was terminated in December 2010. The Company and Fujifilm renegotiated the agreement in June 2011. Either the Company or Fujifilm may terminate the services agreement in the event of an uncured material breach by the other party. In addition, the Company may terminate the agreement at any time upon 45 days advance notice. If the Company terminates the agreement other than for Fujifilm’s breach, or if Fujifilm terminates the agreement for our breach, the Company must pay Fujifilm a termination fee based on the value of the remaining unbilled activities under the agreement. Either party may also terminate the agreement within 30 days after any written notice from Fujifilm that, in its reasonable judgment and based on a change in the assumptions or objectives for the project, it cannot continue to perform its obligations without a change in the scope, price or payment schedule for the project. We are continuing our re-evaluation of whether to continue our efforts to validate Fujifilm Diosynth Biotechnologies USA LLC, or Fujifilm, as a potential secondary source supplier of the pegloticase drug substance used in the manufacture of KRYSTEXXA.

In 2007, the Company entered into a supply agreement with NOF Corporation of Japan (“NOF”), pursuant to which NOF serves as the Company’s exclusive supplier of mPEG-NPC, which is used in the PEGylation process to produce the pegloticase drug substance for KRYSTEXXA. The Company must purchase its entire supply of mPEG-NPC from NOF unless NOF fails to supply at least 75% of the Company’s firm orders, in which case the Company may obtain mPEG-NPC from a third party until NOF’s supply failure is remedied to the Company’s reasonable satisfaction. Under the agreement, the Company is obligated to make specified minimum purchases of mPEG-NPC from NOF. The Company must provide NOF with a rolling forecast on a quarterly basis setting forth the total quantity of mPEG-NPC that it expects to require in the following 18 months. The first six months of each forecast represent a rolling firm irrevocable order, and the Company may only increase or decrease its forecast for the next 12 months within specified limits. For any given year, upon three months advance notice, the Company may terminate its minimum purchase obligation for the entire year or the remainder of that year by paying NOF 50% of the minimum purchase obligation for that year or the remainder of that year. NOF is obligated under the supply agreement to use commercially reasonable efforts to submit a Type II Drug Master File, or its equivalent, to the appropriate regulatory agency in one country outside of the United States or in the EU. The Company’s agreement with NOF has an initial term ending in May 2017 and may be extended for an additional 10 years by mutual agreement of the parties at least 12 months before the expiration of the initial term. Prior to the expiration of the term, either the Company or NOF may terminate the agreement for convenience upon 24 months advance notice. Either the Company or NOF may terminate the agreement in the event of the other party’s insolvency or uncured material breach. In the event that NOF terminates the agreement for convenience or if the Company terminates the agreement for NOF’s breach or bankruptcy, the Company may require NOF to continue to supply mPEG-NPC for up to two years following the termination date. If the Company terminates the agreement for convenience or if NOF terminates the agreement for the Company’s breach, the Company must pay NOF 50% of the minimum purchase obligation for the period from the termination date until the date on which the agreement would have expired. In January 2013, the Company re-negotiated its supply agreement with NOF. Pursuant to the amended agreement, the Company prepaid its 50% minimum purchase obligation for 2013 in January 2013 and in return, its 2014 minimum purchase obligation was forgiven by NOF. The Company’s minimum purchase obligation with NOF through 2017 is approximately $4.8 million and is fully accrued as of December 31, 2013.

In 2008, the Company entered into a non-exclusive commercial supply agreement with Sigma-Tau PharmaSource, Inc. (“Sigma-Tau”) (formerly known as Enzon Pharmaceuticals, Inc., which was acquired by Sigma-Tau in January 2010). Under the terms of the commercial supply agreement, Sigma-Tau has agreed to fill, label, package, test and provide specified product support services for the final KRYSTEXXA product. In return, the Company agreed that once KRYSTEXXA received FDA marketing approval, the Company would purchase product support services from Sigma-Tau. These purchase obligations are based on a rolling forecast that the Company has agreed to provide to Sigma-Tau on a quarterly basis setting forth the total amount of final product that it expects to require in the following 24 months. The first six months of each forecast will represent a rolling firm irrevocable order, and the Company may only increase or decrease its forecast for the next 18 months within specified limits. If the Company cancels batches subject to a firm order, it must pay Sigma-Tau a fee. Under the agreement, the Company is also obligated to pay Sigma-Tau a rolling, non-refundable capacity reservation fee, which may be credited against the fees for Sigma-Tau’s production of the final product. Either the Company or Sigma-Tau may terminate the agreement upon 24 months advance notice given 30 days before each year’s anniversary date of the agreement. If the Company terminates the agreement, it would be obligated to pay Sigma-Tau a fee based on the previously submitted rolling forecasts. Either the Company or Sigma-Tau may also terminate the agreement in the event of insolvency or uncured material default in performance by either party. Based on the current rolling forecast, the Company does not have a minimum purchase commitment at December 31, 2012.

The Company believes that its current arrangements for the supply of clinical and commercial quantities of pegloticase drug substance and finished form KRYSTEXXA will be adequate to satisfy its currently forecasted commercial requirements of KRYSTEXXA and any currently planned future clinical studies.

The Company is a party to an exclusive royalty bearing license agreement with Mountain View Pharmaceuticals (“MVP”) and Duke University (“Duke”), originally entered into in 1997 and amended in 2001, granting the Company rights under technology relating to mammalian and non-mammalian uricases, and MVP’s technology relating to mPEG conjugates of these uricases, as well as patents and pending patent applications covering this technology, to make, use and sell, for human treatment, products that use this technology. These patents and pending patent applications constitute the fundamental composition of matter and underlying manufacturing patents for KRYSTEXXA.

The agreement requires the Company to pay to MVP and Duke quarterly royalty payments within 60 days after the end of each quarter based on KRYSTEXXA net sales made in that quarter by us. The royalty rate for a particular quarter ranges between 8% and 12% of net sales based on the amount of cumulative net sales made by us. In addition, and pursuant to the agreement, the Company is required to make potential separate milestone payments to MVP and Duke if the Company successfully commercializes KRYSTEXXA and attains specified KRYSTEXXA sales targets. The Company also achieved the final sales-based milestone in 2012, which required the Company to pay MVP and Duke $1.0 million in the first quarter of 2013. Also under the agreement, for sales made by sub-licensees and not by the Company, the Company is required to pay royalties of 20% on any revenues or other consideration we receive from sub-licensees during any quarter. The Company records the royalty and sales-based milestone payments pursuant to the MVP and Duke agreement as a component of cost of goods sold in its consolidated statements of operations.

The Company previously received financial support of research and development from the Office of the Chief Scientist of the State of Israel (“OCS”), and the Israel-United States Bi-national Industrial Research and Development Foundation (“BIRD”), of approximately $2.6 million for the development of KRYSTEXXA. In addition, under the Israeli Law of Encouragement of Research and Development in Industry, as amended, as a result of the funding received from OCS, if the Company does not manufacture 100% of its annual worldwide bulk product requirements in Israel, the Company may be subject to total payments, based upon the percentage of manufacturing that does not occur in Israel. As of December 31, 2012 the Company’s $0.6 million obligation to BIRD has been met and therefore, the Company will not be required to make any future royalty payments to BIRD.

Contingencies

On April 30, 2012, a creditor derivative action complaint was filed by one of the holders of our 2018 Convertible Notes, Tang Capital Partners, LP, against the Company and certain of its current directors and three former directors in the Court of Chancery of the State of Delaware. On May 21, 2012, Tang Capital amended its complaint to add new claims against the Company and its current and former directors and also to add additional note-holders as plaintiffs. On June 29, 2012, the plaintiffs amended their complaint for a second time to add claims against the Company relating to an alleged event of default under the 2018 Indenture. As with the April 30 and May 21 complaints, the June 29 complaint also alleges, among other things, that the Company is insolvent, and seeks the appointment of a receiver. The Company filed a motion to dismiss the receiver claim in the June 29 complaint on the grounds that the note-holders did not have standing to bring that claim and a motion for summary judgment that an event of default has not occurred under the Company’s convertible notes. On July 23, 2012, the Delaware Court of Chancery issued a memorandum opinion granting both of the Company’s motions. Specifically, the Court determined that the note-holders do not have standing to bring an action to appoint a receiver for the Company and that an event of default has not occurred under the Company’s convertible notes. The Company has moved to dismiss the remaining claims in the June 29 complaint, but that motion has not yet been decided. On June 8, 2012, the Company filed a cross-complaint against Tang Capital, which was subsequently amended on August 31, 2012. The amended complaint alleges a claim for breach of a non-disclosure agreement between the Company and Tang and for tortious interference with the Company’s business and contractual relations. The Company’s amended complaint remains outstanding.

From time to time, the Company is subject to other legal proceedings and claims in the ordinary course of business. Such claims, even if without merit, could result in significant expenditure of the Company’s financial and managerial resources. The Company is not aware of any legal proceedings or claims that it believes will, individually or in the aggregate, materially harm its business, results of operations, financial condition, liquidity or cash flows.