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Gilead Sciences 10-Q 2010
Form 10-Q
Table of Contents

 

 

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 September 30, 2010

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 No. 0-19731

 

 

GILEAD SCIENCES, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Delaware   94-3047598

(State or Other Jurisdiction of

Incorporation or Organization)

 

(IRS Employer

Identification No.)

333 Lakeside Drive, Foster City, California   94404
(Address of principal executive offices)   (Zip Code)

650-574-3000

Registrant’s Telephone Number, Including Area Code

 

 

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 Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer x    Accelerated filer   ¨    Non-accelerated filer  ¨    Smaller reporting company  ¨

                                                               (Do  not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Number of shares outstanding of the issuer’s common stock, par value $0.001 per share, as of October 29, 2010: 811,867,667

 

 

 


Table of Contents

 

GILEAD SCIENCES, INC.

INDEX

 

PART I.

   FINANCIAL INFORMATION    3
   Item 1.   

Condensed Consolidated Financial Statements

   3
     

Condensed Consolidated Balance Sheets at September 30, 2010 and December 31, 2009

   3
     

Condensed Consolidated Statements of Income for the Three and Nine Months Ended September  30, 2010 and 2009

   4
     

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September  30, 2010 and 2009

   5
     

Notes to Condensed Consolidated Financial Statements

   6
   Item 2.   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   26
   Item 3.   

Quantitative and Qualitative Disclosures About Market Risk

   37
   Item 4.   

Controls and Procedures

   37

PART II.

   OTHER INFORMATION    38
   Item 1.   

Legal Proceedings

   38
   Item 1A.   

Risk Factors

   39
   Item 2.   

Unregistered Sales of Equity Securities and Use of Proceeds

   57
   Item 3.   

Defaults Upon Senior Securities

   57
   Item 4.   

Removed and Reserved

   57
   Item 5.   

Other Information

   57
   Item 6.   

Exhibits

   58

SIGNATURES

   67

We own or have rights to various trademarks, copyrights and trade names used in our business, including the following: GILEAD®, GILEAD SCIENCES®, TRUVADA®, VIREAD®, HEPSERA®, AMBISOME®, EMTRIVA®, VISTIDE®, LETAIRIS®, VOLIBRIS®, RANEXA® and CAYSTON®. ATRIPLA® is a registered trademark belonging to Bristol-Myers Squibb & Gilead Sciences, LLC. LEXISCAN® is a registered trademark belonging to Astellas U.S. LLC. MACUGEN® is a registered trademark belonging to Eyetech Inc. SUSTIVA® is a registered trademark of Bristol-Myers Squibb Pharma Company. TAMIFLU® is a registered trademark belonging to Hoffmann-La Roche Inc. This report also includes other trademarks, service marks and trade names of other companies.

 

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Table of Contents

 

PART I. FINANCIAL INFORMATION

 

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

GILEAD SCIENCES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except per share amounts)

 

    September 30,
2010
    December 31,
2009
 
    (unaudited)        

Assets

   

Current assets:

   

Cash and cash equivalents

  $ 1,022,993      $ 1,272,958   

Short-term marketable securities

    1,284,538        384,017   

Accounts receivable, net

    1,670,405        1,389,534   

Inventories

    1,273,389        1,051,771   

Deferred tax assets

    310,316        295,080   

Prepaid taxes

    279,956        274,196   

Prepaid expenses

    78,699        78,111   

Other current assets

    111,651        66,891   
               

Total current assets

    6,031,947        4,812,558   

Property, plant and equipment, net

    692,032        699,970   

Noncurrent portion of prepaid royalties

    203,649        226,250   

Noncurrent deferred tax assets

    95,291        101,498   

Long-term marketable securities

    2,744,150        2,247,871   

Intangible assets

    1,576,573        1,524,777   

Other noncurrent assets

    111,949        85,635   
               

Total assets

  $ 11,455,591      $ 9,698,559   
               

Liabilities and Stockholders’ Equity

   

Current liabilities:

   

Accounts payable

  $ 950,813      $ 810,544   

Accrued government rebates

    296,597        248,660   

Accrued compensation and employee benefits

    132,045        132,481   

Income taxes payable

    38,710        167,623   

Other accrued liabilities

    443,763        384,015   

Deferred revenues

    95,794        122,721   

Current portion of convertible senior notes, net and other long-term obligations

    632,386        5,587   
               

Total current liabilities

    2,590,108        1,871,631   

Long-term deferred revenues

    39,446        43,026   

Convertible senior notes, net

    2,818,708        1,155,443   

Long-term income taxes payable

    80,797        87,383   

Other long-term obligations

    47,760        35,918   

Commitments and contingencies (Note 11)

   

Stockholders’ equity:

   

Preferred stock, par value $0.001 per share; 5,000 shares authorized; none outstanding

    —          —     

Common stock, par value $0.001 per share; 2,800,000 shares authorized; 815,474 and 899,753 shares issued and outstanding at September 30, 2010 and December 31, 2009, respectively

    815        900   

Additional paid-in capital

    4,575,984        4,376,651   

Accumulated other comprehensive income (loss)

    7,485        (5,758

Retained earnings

    1,122,030        1,995,272   
               

Total Gilead stockholders’ equity

    5,706,314        6,367,065   

Noncontrolling interest

    172,458        138,093   
               

Total stockholders’ equity

    5,878,772        6,505,158   
               

Total liabilities and stockholders’ equity

  $ 11,455,591      $ 9,698,559   
               

See accompanying notes.

 

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Table of Contents

 

GILEAD SCIENCES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

(in thousands, except per share amounts)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010     2009  

Revenues:

        

Product sales

   $ 1,865,559      $ 1,648,955      $ 5,459,683      $ 4,664,913   

Royalty revenues

     69,358        142,133        480,829        269,070   

Contract and other revenues

     2,739        10,301        10,221        45,021   
                                

Total revenues

     1,937,656        1,801,389        5,950,733        4,979,004   
                                

Costs and expenses:

        

Cost of goods sold

     477,584        409,700        1,373,539        1,122,159   

Research and development

     230,440        269,856        680,170        700,273   

Selling, general and administrative

     250,559        227,427        764,183        692,789   
                                

Total costs and expenses

     958,583        906,983        2,817,892        2,515,221   
                                

Income from operations

     979,073        894,406        3,132,841        2,463,783   

Interest and other income, net

     15,593        14,017        49,523        31,098   

Interest expense

     (33,620     (17,217     (68,339     (52,372
                                

Income before provision for income taxes

     961,046        891,206        3,114,025        2,442,509   

Provision for income taxes

     258,883        220,728        850,641        616,310   
                                

Net income

     702,163        670,478        2,263,384        1,826,199   

Net loss attributable to noncontrolling interest

     2,713        2,555        8,454        7,344   
                                

Net income attributable to Gilead

   $ 704,876      $ 673,033      $ 2,271,838      $ 1,833,543   
                                

Net income per share attributable to Gilead common stockholders—basic

   $ 0.85      $ 0.75      $ 2.61      $ 2.02   
                                

Shares used in per share calculation—basic

     833,006        903,319        871,887        906,213   
                                

Net income per share attributable to Gilead common stockholders—diluted

   $ 0.83      $ 0.72      $ 2.55      $ 1.96   
                                

Shares used in per share calculation—diluted

     847,228        932,424        890,216        936,530   
                                

See accompanying notes.

 

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Table of Contents

 

GILEAD SCIENCES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)

 

     Nine Months Ended
September 30,
 
     2010     2009  

Operating Activities:

    

Net income

   $ 2,263,384      $ 1,826,199   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation expense

     49,375        44,312   

Amortization expense

     138,585        104,522   

Stock-based compensation expenses

     146,690        138,860   

Excess tax benefits from stock-based compensation

     (68,642     (59,268

Tax benefits from employee stock plans

     69,940        66,243   

Deferred income taxes

     42,720        11,339   

Other non-cash transactions

     (19,621     46,015   

Changes in operating assets and liabilities:

    

Accounts receivable, net

     (352,081     (290,013

Inventories

     (228,263     (40,020

Prepaid expenses and other assets

     (5,818     (33,356

Accounts payable

     141,692        135,212   

Income taxes payable

     (135,499     118,621   

Accrued liabilities

     97,115        79,327   

Deferred revenues

     (30,507     (23,215
                

Net cash provided by operating activities

     2,109,070        2,124,778   
                

Investing Activities:

    

Purchases of marketable securities

     (3,800,280     (1,916,498

Proceeds from sales of marketable securities

     1,808,222        1,186,319   

Proceeds from maturities of marketable securities

     591,646        362,849   

Acquisitions, net of cash acquired

     (91,000     (1,247,816

Capital expenditures and other

     (38,523     (203,070
                

Net cash used in investing activities

     (1,529,935     (1,818,216
                

Financing Activities:

    

Proceeds from issuances of convertible notes, net of issuance costs

     2,462,500        —     

Proceeds from sale of warrants

     155,425        —     

Purchases of convertible note hedges

     (362,622     —     

Proceeds from issuances of common stock

     166,826        160,924   

Proceeds from credit facility

     500,000        400,000   

Repayments of credit facility

     (500,000     (200,000

Repurchases of common stock

     (3,407,055     (756,491

Extinguishment of long-term debt

     —          (305,406

Repayments of other long-term obligations

     (5,589     (5,607

Excess tax benefits from stock-based compensation

     68,642        59,268   

Distributions from (to) noncontrolling interest

     42,819        (80,047
                

Net cash used in financing activities

     (879,054     (727,359
                

Effect of exchange rate changes on cash

     49,954        (13,906
                

Net change in cash and cash equivalents

     (249,965     (434,703

Cash and cash equivalents at beginning of period

     1,272,958        1,459,302   
                

Cash and cash equivalents at end of period

   $ 1,022,993      $ 1,024,599   
                

See accompanying notes.

 

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Table of Contents

 

GILEAD SCIENCES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information. The financial statements include all adjustments (consisting only of normal recurring adjustments) that the management of Gilead Sciences, Inc. (Gilead, we or us) believes are necessary for a fair presentation of the periods presented. These interim financial results are not necessarily indicative of results expected for the full fiscal year or for any subsequent interim period.

The preparation of these Condensed Consolidated Financial Statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosures. On an ongoing basis, management evaluates its estimates, including critical accounting policies or estimates related to revenue recognition, intangible assets, allowance for doubtful accounts, prepaid royalties, clinical trial accruals, its tax provision and stock-based compensation. We base our estimates on historical experience and on various other market specific and other relevant assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ significantly from these estimates.

The accompanying Condensed Consolidated Financial Statements include the accounts of Gilead, our wholly-owned subsidiaries and our joint ventures with Bristol-Myers Squibb Company (BMS), for which we are the primary beneficiary. We record a noncontrolling interest in our Condensed Consolidated Financial Statements to reflect BMS’ interest in the joint ventures. Significant intercompany transactions have been eliminated. The Condensed Consolidated Financial Statements include the operating results of companies acquired by us from the date of each acquisition for the applicable reporting periods.

The accompanying Condensed Consolidated Financial Statements and related financial information should be read in conjunction with the audited Consolidated Financial Statements and the related notes thereto for the year ended December 31, 2009, included in our Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission (SEC).

Consolidation of Variable Interest Entities

On January 1, 2010, we adopted amended guidance for the consolidation of variable interest entities. The amended guidance eliminates a mandatory quantitative approach to determine whether a variable interest gives the entity a controlling financial interest in a variable interest entity in favor of a qualitatively focused analysis. Additionally, the amended guidance requires an ongoing reassessment of whether the entity is a primary beneficiary. We adopted the provisions of this guidance on a prospective basis for our joint ventures with BMS, which we consolidate because we are the primary beneficiary. The adoption of this guidance did not have any impact on our Condensed Consolidated Financial Statements.

Net Income Per Share Attributable to Gilead Common Stockholders

Basic net income per share attributable to Gilead common stockholders is calculated based on the weighted-average number of shares of our common stock outstanding during the period. Diluted net income per share attributable to Gilead common stockholders is calculated based on the weighted-average number of shares of our common stock outstanding and other dilutive securities outstanding during the period. The potential dilutive

 

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shares of our common stock resulting from the assumed exercise of outstanding stock options, restricted stock units and performance shares and the assumed exercise of warrants relating to the convertible senior notes due in 2011 (2011 Notes), 2013 (2013 Notes), 2014 (2014 Notes) and 2016 (2016 Notes) (collectively, the Notes) are determined under the treasury stock method.

Because the principal amount of the Notes will be settled in cash, only the conversion spread relating to the Notes is included in our calculation of diluted net income per share attributable to Gilead common stockholders. Our common stock resulting from the assumed settlement of the conversion spread of the Notes has a dilutive effect when the average market price of our common stock during the period exceeds the conversion prices of $38.75, $38.10, $45.08 and $45.41 for the 2011 Notes, 2013 Notes, 2014 Notes and 2016 Notes, respectively. During the nine months ended September 30, 2010 and the three and nine months ended September 30, 2009, the average market prices of our common stock exceeded the conversion prices of the 2011 Notes and the 2013 Notes and the dilutive effects are included in the accompanying table.

Warrants relating to the 2011 Notes, 2013 Notes, 2014 Notes and 2016 Notes have a dilutive effect when the average market price of our common stock during the period exceeds the warrants’ exercise prices of $50.80, $53.90, $56.76 and $60.10, respectively. The average market prices of our common stock during each of the three and nine months ended September 30, 2010 and 2009 did not exceed the warrants’ exercise prices relating to any of the Notes; therefore, these warrants did not have a dilutive effect on our net income per share for those periods.

Stock options to purchase approximately 27.1 million and 22.6 million weighted-average shares of our common stock were outstanding during the three and nine months ended September 30, 2010, respectively, but were not included in the computation of diluted net income per share attributable to Gilead common stockholders because the options’ exercise prices were greater than the average market price of our common stock during these periods; therefore, their effect was antidilutive. Stock options to purchase approximately 16.9 million and 17.1 million weighted-average shares of our common stock were outstanding during the three and nine months ended September 30, 2009, respectively, but were not included in the computation of diluted net income per share attributable to Gilead common stockholders because the options’ exercise prices were greater than the average market price of our common stock during these periods; therefore, their effect was antidilutive.

The following table is a reconciliation of the numerator and denominator used in the calculation of basic and diluted net income per share attributable to Gilead common stockholders (in thousands):

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2010      2009      2010      2009  

Numerator:

           

Net income attributable to Gilead

   $ 704,876       $ 673,033       $ 2,271,838       $ 1,833,543   
                                   

Denominator:

           

Weighted-average shares of common stock outstanding used in the calculation of basic net income per share attributable to Gilead common stockholders

     833,006         903,319         871,887         906,213   

Effect of dilutive securities:

           

Stock options and equivalents

     14,222         23,288         17,120         24,482   

Conversion spread related to the 2011 Notes

     —           2,765         461         2,774   

Conversion spread related to the 2013 Notes

     —           3,052         748         3,061   
                                   

Weighted-average shares of common stock outstanding used in the calculation of diluted net income per share attributable to Gilead common stockholders

     847,228         932,424         890,216         936,530   
                                   

 

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Concentrations of Risk

We are subject to credit risk from our portfolio of cash equivalents and marketable securities. Under our investment policy, we limit amounts invested in such securities by credit rating, maturity, industry group, investment type and issuer, except for securities issued by the U.S. government. We are not exposed to any significant concentrations of credit risk from these financial instruments. The goals of our investment policy, in order of priority, are as follows: safety and preservation of principal and diversification of risk; liquidity of investments sufficient to meet cash flow requirements; and a competitive after-tax rate of return.

We are also subject to credit risk from our accounts receivable related to our product sales. The majority of our trade accounts receivable arises from product sales in the United States and Europe. To date, we have not experienced significant losses with respect to the collection of our accounts receivable. We believe that our allowance for doubtful accounts was adequate at September 30, 2010.

Recent Accounting Pronouncements

In October 2009, the Financial Accounting Standards Board issued new standards for revenue recognition for agreements with multiple deliverables. These new standards impact the determination of when the individual deliverables included in a multiple element arrangement may be treated as separate units of accounting. Additionally, these new standards modify the manner in which the transaction consideration is allocated across the separately identified deliverables by no longer permitting the residual method of allocating arrangement consideration. These new standards are effective for us beginning in the first quarter of 2011; however, early adoption is permitted. The adoption of these standards is not expected to have a material impact on our Condensed Consolidated Financial Statements.

2. FAIR VALUE MEASUREMENTS

Our financial instruments consist principally of cash and cash equivalents, marketable securities, accounts receivable, foreign currency exchange forward and option contracts, accounts payable, short-term and long-term debt. Cash and cash equivalents, marketable securities and foreign currency exchange contracts that hedge accounts receivable and forecasted sales are reported at their respective fair values on our Condensed Consolidated Balance Sheets. The carrying value and fair value of the Notes were $3.45 billion and $3.94 billion, respectively, as of September 30, 2010. The carrying value and fair value of the 2011 and 2013 Notes were $1.16 billion and $1.58 billion, respectively, as of December 31, 2009. The fair value of the Notes was based on their quoted market values. The remaining financial instruments are reported on our Condensed Consolidated Balance Sheets at amounts that approximate current fair values. Certain amounts within debt securities have been re-categorized in the accompanying tables to conform to the current presentation.

We determine the fair value of financial and non-financial assets and liabilities using the following fair value hierarchy, which establishes three levels of inputs that may be used to measure fair value, as follows:

Level 1 inputs which include quoted prices in active markets for identical assets or liabilities;

Level 2 inputs which include observable inputs other than Level 1 inputs, such as quoted prices for similar assets or liabilities; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability; and

Level 3 inputs which include unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the underlying asset or liability. Level 3 assets and liabilities include those whose fair value measurements are determined using pricing models, discounted cash flow methodologies or similar valuation techniques, as well as significant management judgment or estimation.

 

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The following table summarizes, for assets or liabilities recorded at fair value, the respective fair value and classification by level of input within the fair value hierarchy defined above (in thousands):

 

    September 30, 2010     December 31, 2009  
    Level 1     Level 2     Level 3     Total     Level 1     Level 2     Level 3     Total  

Assets:

               

Debt securities:

               

U.S. treasury securities

  $ 1,557,870      $ —        $ —        $ 1,557,870      $ 289,790      $ —  `      $ —        $ 289,790   

U.S. government agencies and FDIC guaranteed securities

    —          1,430,945        —          1,430,945        —          1,086,082        —          1,086,082   

Municipal debt securities

    —          12,998        —          12,998        —          433,474        —          433,474   

Non-U.S. government securities

    —          251,260        —          251,260        —          75,524        —          75,524   

Corporate debt securities

    —          802,141        —          802,141        —          566,176        —          566,176   

Residential mortgage and asset-backed securities

    —          108,256        —          108,256        —          120,407        839        121,246   

Student loan-backed securities

    —          —          88,311        88,311        —          —          104,823        104,823   
                                                               

Total debt securities

    1,557,870        2,605,600        88,311        4,251,781        289,790        2,281,663        105,662        2,677,115   

Equity securities

    3,370        —          —          3,370        3,470        —          —          3,470   

Derivatives

    —          51,873        —          51,873        —          26,198        —          26,198   
                                                               
  $ 1,561,240      $ 2,657,473      $ 88,311      $ 4,307,024      $ 293,260      $ 2,307,861      $ 105,662      $ 2,706,783   
                                                               

Liabilities:

               

Contingent consideration

  $ —        $ —        $ 11,100      $ 11,100      $ —        $ —        $ —        $ —     

Derivatives

    —          58,780        —          58,780        —          47,688        —          47,688   
                                                               
  $ —        $ 58,780      $ 11,100      $ 69,880      $ —        $ 47,688      $ —        $ 47,688   
                                                               

Marketable securities, measured at fair value using Level 2 inputs, are primarily comprised of U.S. government sponsored entity and corporate debt securities. We review trading activity and pricing for these investments as of the measurement date. When sufficient quoted pricing for identical securities is not available, we use market pricing and other observable market inputs for similar securities obtained from various third party data providers. These inputs represent quoted prices for similar assets in active markets or these inputs have been derived from observable market data. This approach results in the classification of these securities as Level 2 of the fair value hierarchy.

The following table is a reconciliation of marketable securities measured at fair value using significant unobservable inputs (Level 3) (in thousands):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010     2009  

Balance, beginning of period

   $ 94,062      $ 102,898      $ 105,662      $ 102,633   

Total realized and unrealized gains (losses) included in:

        

Interest and other income, net

     —          —          115        (29

Other comprehensive income, net

     2,299        1,894        4,066        7,661   

Sales of marketable securities

     (8,050     (582     (21,532     (6,055

Transfers into Level 3

     —          —          —          —     
                                

Balance, end of period

   $ 88,311      $ 104,210      $ 88,311      $ 104,210   
                                

Total losses included in interest and other income, net attributable to the change in unrealized losses relating to assets still held at the reporting date

   $ —        $ —        $ —        $ (29
                                

 

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Our policy is to recognize transfers into or out of Level 3 classification as of the actual date of the event or change in circumstances that caused the transfer. Marketable securities, measured at fair value using Level 3 inputs, are substantially comprised of auction rate securities within our available-for-sale investment portfolio. The underlying assets of our auction rate securities consist of student loans. Although auction rate securities would typically be measured using Level 2 inputs, the failure of auctions and the lack of market activity and liquidity experienced since the beginning of 2008 required that these securities be measured using Level 3 inputs. The fair value of our auction rate securities was determined using a discounted cash flow model that considered projected cash flows for the issuing trusts, underlying collateral and expected yields. Projected cash flows were estimated based on the underlying loan principal, bonds outstanding and payout formulas. The weighted-average life over which the cash flows were projected considered the collateral composition of the securities and related historical and projected prepayments. The underlying student loans have a weighted-average expected life of four to eight years. The discount rates used in our discounted cash flow model were based on market conditions for comparable or similar term asset-backed and other fixed income securities, adjusted for an illiquidity discount. This resulted in an annual discount rate of 2.01%. Our auction rate securities reset every seven to 14 days with maturity dates ranging from 2023 through 2040 and have annual interest rates ranging from 0.44% to 1.19%. As of September 30, 2010, our auction rate securities continued to earn interest.

Our auction rate securities were recorded in long-term marketable securities on our Condensed Consolidated Balance Sheets at September 30, 2010 and December 31, 2009. Although there continued to be failed auctions as well as lack of market activity and liquidity in 2010, we believe we had no other-than-temporary impairments on these securities as of September 30, 2010 because we do not intend to sell these securities and it is not more likely than not that we will be required to sell these securities before the recovery of their amortized cost basis.

 

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3. AVAILABLE-FOR-SALE SECURITIES

The following table is a summary of available-for-sale debt and equity securities recorded in cash equivalents or marketable securities in our Condensed Consolidated Balance Sheets. Estimated fair values of available-for-sale securities are generally based on prices obtained from commercial pricing services (in thousands):

 

     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Estimated
Fair Value
 

September 30, 2010

          

Debt securities:

          

U.S. treasury securities

   $ 1,547,252       $ 10,623       $ (5   $ 1,557,870   

U.S. government agencies and FDIC guaranteed securities

     1,414,099         16,851         (5     1,430,945   

Municipal debt securities

     12,845         153         —          12,998   

Non-U.S. government securities

     248,865         2,497         (102     251,260   

Corporate debt securities

     791,688         10,536         (83     802,141   

Residential mortgage and asset-backed securities

     107,552         1,196         (492     108,256   

Student loan-backed securities

     94,400         —           (6,089     88,311   
                                  

Total debt securities

     4,216,701         41,856         (6,776     4,251,781   

Equity securities

     1,451         1,919         —          3,370   
                                  

Total

   $ 4,218,152       $ 43,775       $ (6,776   $ 4,255,151   
                                  

December 31, 2009

          

Debt securities:

          

U.S. treasury securities

   $ 289,055       $ 844       $ (109   $ 289,790   

U.S. government agencies and FDIC guaranteed securities

     1,077,910         9,116         (944     1,086,082   

Municipal debt securities

     429,583         3,986         (95     433,474   

Non-U.S. government securities

     74,756         874         (106     75,524   

Corporate debt securities

     557,116         9,563         (503     566,176   

Residential mortgage and asset-backed securities

     119,308         2,048         (110     121,246   

Student loan-backed securities

     115,400         —           (10,577     104,823   
                                  

Total debt securities

     2,663,128         26,431         (12,444     2,677,115   

Equity securities

     1,451         2,019         —          3,470   
                                  

Total

   $ 2,664,579       $ 28,450       $ (12,444   $ 2,680,585   
                                  

The following table summarizes the classification of the available-for-sale debt and equity securities on our Condensed Consolidated Balance Sheets (in thousands):

 

     September 30,
2010
     December 31,
2009
 

Cash and cash equivalents

   $ 226,463       $ 48,697   

Short-term marketable securities

     1,284,538         384,017   

Long-term marketable securities

     2,744,150         2,247,871   
                 

Total

   $ 4,255,151       $ 2,680,585   
                 

 

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The following table summarizes our portfolio of available-for-sale debt securities by contractual maturity (in thousands):

 

     September 30, 2010      December 31, 2009  
     Amortized Cost      Fair Value      Amortized Cost      Fair Value  

Less than one year

   $ 1,406,891       $ 1,410,301       $ 429,980       $ 432,714   

Greater than one year but less than five years

     2,623,016         2,660,083         1,878,589         1,898,183   

Greater than five years but less than ten years

     25,806         26,489         56,895         57,585   

Greater than ten years

     160,988         154,908         297,664         288,633   
                                   

Total

   $ 4,216,701       $ 4,251,781       $ 2,663,128       $ 2,677,115   
                                   

The following table summarizes the gross realized gains and losses related to sales of marketable securities (in thousands):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010     2009  

Gross realized gains on sales

   $ 1,290      $ 1,734      $ 10,588      $ 9,108   

Gross realized losses on sales

   $ (260   $ (212   $ (2,434   $ (1,169

The cost of securities sold was determined based on the specific identification method.

The following table summarizes our available-for-sale debt securities that were in a continuous unrealized loss position, but were not deemed to be other-than-temporarily impaired (in thousands):

 

     Less Than 12 Months      12 Months or Greater      Total  
     Gross
Unrealized
Losses
    Estimated
Fair Value
     Gross
Unrealized
Losses
    Estimated
Fair Value
     Gross
Unrealized
Losses
    Estimated
Fair Value
 

September 30, 2010

              

Debt securities:

              

U.S. treasury securities

   $ (5   $ 240,430       $ —        $ —         $ (5   $ 240,430   

U.S. government agencies and FDIC guaranteed securities

     (5     41,994         —          —           (5     41,994   

Municipal debt securities

     —          —           —          —           —          —     

Non-U.S. government securities

     (102     72,518         —          —           (102     72,518   

Corporate debt securities

     (83     134,831         —          —           (83     134,831   

Residential mortgage and asset-backed securities

     (492     33,855         —          —           (492     33,855   

Student loan-backed securities

     —          —           (6,089     88,311         (6,089     88,311   
                                                  

Total

   $ (687   $ 523,628       $ (6,089   $ 88,311       $ (6,776   $ 611,939   
                                                  

December 31, 2009

              

Debt securities:

              

U.S. treasury securities

   $ (109   $ 97,871       $ —        $ —         $ (109   $ 97,871   

U.S. government agencies and FDIC guaranteed securities

     (944     223,901         —          —           (944     223,901   

Municipal debt securities

     (95     65,377         —          —           (95     65,377   

Non-U.S. government securities

     (106     30,924         —          —           (106     30,924   

Corporate debt securities

     (503     126,410         —          —           (503     126,410   

Residential mortgage and asset-backed securities

     (110     36,446         —          —           (110     36,446   

Student loan-backed securities

     —          —           (10,577     104,823         (10,577     104,823   
                                                  

Total

   $ (1,867   $ 580,929       $ (10,577   $ 104,823       $ (12,444   $ 685,752   
                                                  

 

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As of September 30, 2010 and December 31, 2009, approximately 12% and 32%, respectively, of the total number of securities were in an unrealized loss position. The gross unrealized losses for auction rate securities were caused by a higher discount rate used in the valuation of these securities as compared to the coupon rates of these securities. The gross unrealized losses for the other securities were primarily the result of an increase in the yield-to-maturity of the underlying securities. No significant facts or circumstances have arisen to indicate that there has been any deterioration in the creditworthiness of the issuers of these securities. Based on our review of these securities, we believe we had no other-than-temporary impairments on these securities as of September 30, 2010 and December 31, 2009 because we do not intend to sell these securities and it is not more likely than not that we will be required to sell these securities before the recovery of their amortized cost basis.

During the three and nine months ended September 30, 2010, we recorded net unrealized gains on available-for-sale securities of $9.7 million and $18.4 million, respectively, in accumulated other comprehensive income (OCI) . During the three and nine months ended September 30, 2010, gains of $1.0 million and $5.0 million, respectively, were reclassified out of accumulated OCI into interest and other income, net. Comparatively, during the three and nine months ended September 30, 2009, we recorded net unrealized gains on available-for-sale securities of $8.3 million and $21.7 million, respectively, in accumulated OCI. During the three and nine months ended September 30, 2009, gains of $1.0 million and $5.1 million, respectively, were reclassified out of accumulated OCI into interest and other income, net.

4. DERIVATIVE FINANCIAL INSTRUMENTS

We operate in foreign countries, which exposes us to market risk associated with foreign currency exchange rate fluctuations between the U.S. dollar and various foreign currencies, the most significant of which is the Euro. In order to manage the risk related to changes in foreign currency exchange rates, we hedge a portion of our foreign currency exposures related to outstanding monetary assets and liabilities and forecasted product sales with foreign currency exchange forward contracts and foreign currency exchange option contracts. In general, the market risks of our foreign currency exchange contracts are offset by corresponding gains and losses on the transactions being hedged. Our exposure to credit risk from these contracts is a function of changes in interest and currency exchange rates and, therefore, varies over time. We limit the risk that counterparties to these contracts may be unable to perform by transacting only with major banks, all of which we monitor closely in the context of current market conditions. We also limit risk of loss by entering into contracts that provide for net settlement at maturity. Therefore, our overall risk of loss in the event of a counterparty default is limited to the amount of any unrecognized gains on outstanding contracts (i.e., those contracts that have a positive fair value) at the date of default. We do not enter into derivative financial contracts for trading purposes. We do not hedge our net investment in any of our foreign subsidiaries.

We enter into foreign currency exchange contracts to hedge our market risk exposure associated with foreign currency exchange rate fluctuations for certain monetary assets and liabilities of our foreign subsidiaries that are denominated in a non-functional currency. As these derivative instruments are not designated as hedges, we record the changes in the fair value of such instruments in interest and other income, net on our Condensed Consolidated Statements of Income.

Foreign currency exchange contracts used to hedge forecasted product sales are designated as cash flow hedges. These derivative instruments are employed to eliminate or minimize certain foreign currency exposures that can be confidently identified and quantified, all with maturities of 18 months or less. At the inception of a hedging relationship and on a quarterly basis, we assess hedge effectiveness on a prospective basis by performing a regression analysis taking the change in cash flow of the underlying contract and regressing it against the change in cash flow of the hedge instrument. We assess hedge effectiveness on a retrospective basis using a dollar offset approach monthly. We exclude time value from our effectiveness testing and recognize changes in the time value of the hedge in interest and other income, net. The effective component of the hedge is recorded in accumulated OCI or loss within stockholders’ equity as an unrealized gain or loss on the hedging instrument. When the hedged forecasted transactions occur, the hedges are de-designated and the unrealized gains and losses

 

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are reclassified into product sales. The majority of gains and losses related to the hedged forecasted transactions reported in accumulated OCI at September 30, 2010 will be reclassified to product sales within 12 months.

We had notional amounts on foreign currency exchange forward contracts outstanding of $3.55 billion and $3.45 billion at September 30, 2010 and December 31, 2009, respectively.

The following table summarizes information about the fair values of derivative instruments on our Condensed Consolidated Balance Sheets (in thousands):

 

   

September 30, 2010

 
   

Asset Derivatives

   

Liability Derivatives

 
   

Location

  Fair Value    

Location

  Fair Value  

Derivatives designated as hedges:

       

Foreign currency exchange contracts

  Other current assets   $ 51,746      Other accrued liabilities   $ 38,579   

Foreign currency exchange contracts

  Other noncurrent assets     —        Other long-term obligations     20,178   
                   

Total derivatives designated as hedges

      51,746          58,757   
                   

Derivatives not designated as hedges:

       

Foreign currency exchange contracts

  Other current assets     127      Other accrued liabilities     23   
                   

Total derivatives not designated as hedges

      127          23   
                   

Total derivatives

    $ 51,873        $ 58,780   
                   
   

December 31, 2009

 
   

Asset Derivatives

   

Liability Derivatives

 
   

Location

  Fair Value    

Location

  Fair Value  

Derivatives designated as hedges:

       

Foreign currency exchange contracts

  Other current assets   $ 16,183      Other accrued liabilities   $ 45,482   

Foreign currency exchange contracts

  Other noncurrent assets     10,010      Other long-term obligations     2,180   
                   

Total derivatives designated as hedges

      26,193          47,662   
                   

Derivatives not designated as hedges:

       

Foreign currency exchange contracts

  Other current assets     5      Other accrued liabilities     26   
                   

Total derivatives not designated as hedges

      5          26   
                   

Total derivatives

    $ 26,198        $ 47,688   
                   

The following table summarizes the effect of our foreign currency exchange contracts on our Condensed Consolidated Statements of Income (in thousands):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010      2009  

Derivatives designated as hedges:

         

Net gains (losses) recognized in OCI (effective portion)

   $ (174,321   $ (55,640   $ 76,023       $ (17,003

Net gains reclassified from accumulated OCI into product sales (effective portion)

   $ 31,526      $ 16,714      $ 69,080       $ 89,771   

Net gains (losses) recognized in interest and other income, net (ineffective portion and amounts excluded from effectiveness testing)

   $ 5,158      $ 806      $ 3,493       $ (14,726

Derivatives not designated as hedges:

         

Net gains (losses) recognized in interest and other income, net

   $ (106,918   $ (37,519   $ 31,916       $ (28,479

 

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The net unrealized gains related to our cash flow hedges included in accumulated OCI, net of taxes, were $12.9 million at September 30, 2010. Net unrealized losses related to our cash flow hedges included in accumulated OCI, net of taxes, were $16.5 million at December 31, 2009.

5. ACQUISITION OF CGI PHARMACEUTICALS, INC.

In June 2010, we signed an agreement to acquire CGI Pharmaceuticals, Inc. (CGI) for up to $120.0 million in cash, consisting of $91.0 million as an upfront payment and up to $29.0 million of contingent consideration payable based on the achievement of clinical development milestones. This transaction closed on July 8, 2010, at which time CGI became a wholly-owned subsidiary of Gilead. CGI was a privately-held development stage pharmaceutical company based in Branford, Connecticut, primarily focused on small molecule chemistry and protein kinase biology. The lead preclinical compound from CGI’s library of proprietary small molecule kinase inhibitors targets spleen tyrosine kinase (Syk) and could have unique applications for the treatment of serious inflammatory diseases, including rheumatoid arthritis. We believe the acquisition will provide us with an opportunity to expand our research efforts in an interesting and promising area of drug discovery.

The CGI acquisition was accounted for as a business combination. The results of operations of CGI since July 8, 2010 have been included in our Condensed Consolidated Statements of Income and were not significant.

The acquisition-date fair value of the total consideration transferred to acquire CGI was $102.1 million, and consisted of cash paid at or prior to closing of $91.0 million and contingent consideration of $11.1 million.

The following table summarizes the fair values of the assets acquired and liabilities assumed at July 8, 2010 (in thousands):

 

Intangible assets—IPR&D

   $ 26,630   

Goodwill

     70,111   

Deferred tax assets

     12,656   

Deferred tax liabilities

     (6,313

Other net liabilities assumed

     (984
        

Total consideration transferred

   $ 102,100   
        

Intangible assets associated with in-process research and development (IPR&D) projects relate to the preclinical Syk product candidate. Management determined that the estimated acquisition-date fair value of intangible assets related to IPR&D was $26.6 million. The estimated fair value was determined using the income approach, which discounts expected future cash flows to present value. We estimated the fair value using a present value discount rate of 18%, which is based on the estimated weighted-average cost of capital for companies with profiles substantially similar to that of CGI. This is comparable to the estimated internal rate of return for CGI’s operations and represents the rate that market participants would use to value the intangible assets. The projected cash flows from the IPR&D project was based on key assumptions such as: estimates of revenues and operating profits related to the project considering its stage of development; the time and resources needed to complete the development and approval of the product candidate; the life of the potential commercialized product and associated risks, including the inherent difficulties and uncertainties in developing a drug compound such as obtaining marketing approval from the FDA and other regulatory agencies; and risks related to the viability of and potential alternative treatments in any future target markets. Intangible assets related to IPR&D projects are considered to be indefinite-lived until the completion or abandonment of the associated R&D efforts. During the period the assets are considered indefinite-lived, they will not be amortized but will be tested for impairment on an annual basis as well as between annual tests if we become aware of any events occurring or changes in circumstances that would indicate a reduction in the fair value of the IPR&D projects below their respective carrying amounts. If and when development is complete, which generally occurs if and when regulatory approval to market a product is obtained, the associated assets would be deemed finite-lived and would then be amortized based on their respective estimated useful lives at that point in time.

 

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The excess of the consideration transferred over the fair values assigned to the assets acquired and liabilities assumed is $70.1 million, which represents the goodwill amount resulting from the CGI acquisition. Management believes that the goodwill mainly represents the synergies expected from combining our research and development operations as well as acquiring CGI’s assembled workforce and other intangible assets that do not qualify for separate recognition. We recorded the goodwill as an intangible asset in our Condensed Consolidated Balance Sheet as of the acquisition date. Goodwill is tested for impairment on an annual basis as well as between annual tests if we become aware of any events occurring or changes in circumstances that would indicate a reduction in the fair value of the goodwill below its carrying amount. As we have elected to treat the CGI acquisition as an asset acquisition for California state tax purposes, the goodwill resulting from the acquisition is deductible for California state income tax purposes, although such amounts are not deductible for federal income tax purposes.

We do not consider the CGI acquisition to be a material business combination and therefore have not disclosed the pro forma results of operations as required for material business combinations.

6. RESTRUCTURING

In April 2009, we completed the acquisition of CV Therapeutics, Inc. (CV Therapeutics), a publicly-held biopharmaceutical company based in Palo Alto, California, primarily focused on the discovery, development and commercialization of small molecule drugs for the treatment of cardiovascular, metabolic and pulmonary diseases. CV Therapeutics had two marketed products as well as several product candidates in clinical development for the treatment of cardiovascular, metabolic and pulmonary diseases.

During the second quarter of 2009, we approved a plan to realize certain synergies between CV Therapeutics and us, re-align our cardiovascular operations and eliminate certain redundancies. The restructuring plan included consolidation and re-alignment of the cardiovascular research and development (R&D) organization, our exit from certain facilities and the termination of certain contractual obligations. During the three months ended September 30, 2010, we recorded $0.4 million in R&D expenses, related to relocation and employee severance costs. During the nine months ended September 30, 2010, we recorded $13.2 million and $3.2 million of restructuring expenses in selling, general and administrative (SG&A) expenses and R&D expenses, respectively, related to lease termination costs, other facilities-related expenses, relocation and employee severance costs. As of September 30, 2010, we recorded approximately $39.4 million and $28.9 million in SG&A expenses and R&D expenses, respectively, related to employee severance, relocation, lease termination costs and other facilities-related expenses. We expect to incur an additional $0.4 million in the fourth quarter of 2010 bringing the total amount to be incurred in connection with our restructuring plan to approximately $36.3 million for employee severance and relocation and $32.4 million for facilities-related expenses.

 

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The following table summarizes the restructuring liabilities accrued for and changes in those amounts during the period for the restructuring plan discussed above (in thousands):

 

     Employee
Severance and
Termination
Benefits
    Facilities-
Related Costs
 

Balance at December 31, 2008

   $ —        $ —     

Costs incurred during the period

     33,797        9,880   

Costs paid or settled during the period

     (24,108     (545
                

Balance at December 31, 2009

     9,689        9,335   

Costs incurred during the period

     829        12,243   

Costs paid or settled during the period

     (8,513     (1,431
                

Balance at March 31, 2010

     2,005        20,147   

Costs incurred during the period

     815        —     

Costs paid or settled during the period

     (1,916     (1,405
                

Balance at June 30, 2010

     904        18,742   

Costs incurred during the period

     438        —     

Costs paid or settled during the period

     (677     (91
                

Balance at September 30, 2010

   $ 665      $ 18,651   
                

During the second quarter of 2010, we implemented a plan to close our operations in Durham, North Carolina and consolidate our liver disease work in Foster City, California. The restructuring plan includes consolidation of the liver disease R&D organization and our exit from certain facilities. We expect to complete this plan by the end of December 2010. During the three months ended September 30, 2010, we recorded $1.1 million and $5.6 million in SG&A expenses and R&D expenses, respectively, related to employee severance and facilities-related expenses. During the nine months ended September 30, 2010, we recorded $1.4 million and $7.0 million of restructuring expenses in SG&A expenses and R&D expenses, respectively, related to employee severance and facilities-related expenses. We expect to incur an additional $13.5 million in the fourth quarter of 2010, bringing the total amount to be incurred in connection with this restructuring plan to approximately $11.6 million for employee severance and $10.3 million for facilities-related expenses.

7. INVENTORIES

Inventories are summarized as follows (in thousands):

 

     September 30,
2010
     December 31,
2009
 

Raw materials

   $ 441,525       $ 333,582   

Work in process

     392,541         392,042   

Finished goods

     439,323         326,147   
                 

Total

   $ 1,273,389       $ 1,051,771   
                 

As of September 30, 2010 and December 31, 2009, the joint ventures formed by Gilead and BMS, which are included in our Condensed Consolidated Financial Statements, held $891.3 million and $667.8 million in inventory, respectively, of efavirenz active pharmaceutical ingredient purchased from BMS at BMS’ estimated net selling price of efavirenz.

 

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8. INTANGIBLE ASSETS

The following table summarizes the carrying amount of our intangible assets (in thousands):

 

     September 30,
2010
     December 31,
2009
 

Goodwill

   $ 532,669       $ 462,558   

Finite lived intangible assets

     878,374         923,319   

Indefinite lived intangible assets

     165,530         138,900   
                 

Total

   $ 1,576,573       $ 1,524,777   
                 

The following table summarizes the changes in the carrying amount of goodwill (in thousands):

 

Balance at December 31, 2009

   $  462,558   

Goodwill resulting from the acquisition of CGI

     70,111   
        

Balance at September 30, 2010

   $ 532,669   
        

The following table summarizes our finite-lived intangible assets (in thousands):

 

     September 30, 2010      December 31, 2009  
     Gross Carrying
Amount
     Accumulated
Amortization
     Gross Carrying
Amount
     Accumulated
Amortization
 

Intangible asset—Ranexa

   $ 688,400       $ 46,570       $ 688,400       $ 21,889   

Intangible asset—Lexiscan

     262,800         37,543         262,800         18,235   

Other

     22,095         10,808         22,095         9,852   
                                   

Total

   $ 973,295       $ 94,921       $ 973,295       $ 49,976   
                                   

Amortization expense related to intangible assets was $14.9 million and $44.9 million for the three and nine months ended September 30, 2010, respectively, and was recorded in cost of goods sold in our Condensed Consolidated Statements of Income. Comparatively, amortization expense related to intangible assets was $15.2 million and $28.7 million for the three and nine months ended September 30, 2009, respectively, and was recorded primarily in cost of goods sold in our Condensed Consolidated Statements of Income.

As of September 30, 2010, the estimated future amortization expense associated with our intangible assets for the remaining three months of 2010 and each of the five succeeding fiscal years are as follows (in thousands):

 

Fiscal Year

   Amount  

2010 (remaining three months)

   $ 14,981   

2011

     73,707   

2012

     86,627   

2013

     95,302   

2014

     99,790   

2015

     104,216   
        

Total

   $ 474,623   
        

As of September 30, 2010, we had indefinite-lived intangible assets of $165.5 million, which consisted of $26.6 million and $138.9 million of purchased IPR&D from our acquisitions of CGI and CV Therapeutics, respectively. As of December 31, 2009, we had indefinite-lived intangible assets of $138.9 million related to purchased IPR&D from our acquisition of CV Therapeutics.

 

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9. COLLABORATIVE ARRANGEMENTS

As a result of entering into strategic collaborations from time to time, we may hold investments in non-public companies. We review our interests in our investee companies for consolidation and/or appropriate disclosure based on applicable guidance. As of September 30, 2010, we determined that certain of our investee companies are variable interest entities; however, other than with respect to our joint ventures with BMS, we are not the primary beneficiary and therefore do not consolidate these investees.

Bristol-Myers Squibb Company

North America

In December 2004, we entered into a collaboration arrangement with BMS in the United States to develop and commercialize a single tablet regimen containing our Truvada and BMS’ Sustiva (efavirenz), which we sell as Atripla. The collaboration is structured as a joint venture and operates as a limited liability company named Bristol-Myers Squibb & Gilead Sciences, LLC, which we consolidate. The ownership interests of the joint venture and thus the sharing of product revenue and costs reflect the respective economic interests of BMS and us and are based on the proportions of the net selling price of Atripla attributable to efavirenz and Truvada. Since the net selling price for Truvada may change over time relative to the net selling price of efavirenz, both BMS’ and our respective economic interests in the joint venture may vary annually.

We share marketing and sales efforts with BMS and both parties are obligated to provide equivalent sales force efforts for a minimum number of years. We are responsible for accounting, financial reporting, tax reporting, manufacturing and product distribution for the joint venture. Both parties provide their respective bulk active pharmaceutical ingredients to the joint venture at their approximate market values. In July 2006, the joint venture received approval from the FDA to sell Atripla in the United States. In September 2006, we and BMS amended the joint venture’s collaboration agreement to allow the joint venture to sell Atripla into Canada and in October 2007, the joint venture received approval from Health Canada to sell Atripla in Canada. As of September 30, 2010 and December 31, 2009, the joint venture held efavirenz active pharmaceutical ingredient which it purchased from BMS at BMS’ estimated net selling price of efavirenz in the U.S. market. These amounts are included in inventories on our Condensed Consolidated Balance Sheets. As of September 30, 2010 and December 31, 2009, total assets of the joint venture were $1.57 billion and $1.40 billion, respectively, and consisted primarily of cash and cash equivalents, accounts receivable (including intercompany receivables with Gilead) and inventories. As of September 30, 2010 and December 31, 2009, total liabilities of the joint venture were $1.10 billion and $1.03 billion, respectively and consisted primarily of accounts payable (including intercompany payables with Gilead) and other accrued expenses. These asset and liability amounts do not reflect the impact of intercompany eliminations that are included in our Condensed Consolidated Balance Sheets. Although we are the primary beneficiary of the joint venture, the legal structure of the joint venture limits the recourse that its creditors will have over our general credit or assets.

Europe

In December 2007, Gilead Sciences Limited (GSL), one of our wholly-owned subsidiaries in Ireland, and BMS entered into a collaboration arrangement to commercialize and distribute Atripla in the European Union, Iceland, Liechtenstein, Norway and Switzerland (collectively, the European Territory). The parties formed a limited liability company which we consolidate, to manufacture Atripla for distribution in the European Territory using efavirenz that it purchases from BMS at BMS’ estimated net selling price of efavirenz in the European Territory. We are responsible for product distribution, inventory management and warehousing. Through our local subsidiaries, we have primary responsibility for order fulfillment, collection of receivables, customer relations and handling of sales returns in all the territories where we co-promote Atripla with BMS. We are also responsible for accounting, financial reporting and tax reporting for the collaboration. In December 2007, the European Commission approved Atripla for sale in the European Union. As of September 30, 2010 and December 31, 2009, efavirenz purchased from BMS at BMS’ estimated net selling price of efavirenz in the European Territory is included in inventories on our Condensed Consolidated Balance Sheets.

 

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The parties also formed a limited liability company to hold the marketing authorization for Atripla in Europe. We have primary responsibility for regulatory activities and we share marketing and sales efforts with BMS. In the major market countries, both parties have agreed to provide equivalent sales force efforts. Revenue and cost sharing is based on the relative ratio of the respective net selling prices of Truvada and efavirenz.

10. LONG TERM OBLIGATIONS

2014 and 2016 Convertible Senior Notes

In July 2010, we issued $1.25 billion of convertible senior notes due in 2014 and $1.25 billion of convertible senior notes due in 2016 in a private placement pursuant to Rule 144A of the Securities Act of 1933, as amended. The 2014 Notes and the 2016 Notes were issued at par and bear interest rates of 1.00% and 1.625%, respectively. Debt issuance costs are primarily comprised of $37.5 million in bankers’ fees, the majority of which was recorded in other noncurrent assets and is being amortized to interest expense over the contractual terms of the Notes. The aggregate principal amount of the 2014 and 2016 Notes sold reflects the full exercise by the initial purchasers of their option to purchase additional Notes to cover over-allotments. The initial conversion rate for the 2014 Notes is 22.1845 shares per $1,000 principal amount of 2014 Notes (which represents an initial conversion price of approximately $45.08 per share), and the initial conversion rate for the 2016 Notes is 22.0214 shares per $1,000 principal amount of 2016 Notes (which represents an initial conversion price of approximately $45.41 per share). The conversion rates are subject to customary anti-dilution adjustments.

The 2014 and 2016 Notes may be converted prior to April 1, 2014 and April 1, 2016, respectively, only under the following circumstances: 1) during any calendar quarter commencing after September 30, 2010, if the closing price of the common stock for at least 20 trading days (whether or not consecutive) during the period of 30 consecutive trading days ending on the last trading day of the preceding calendar quarter is greater than 130% of the applicable conversion price on each applicable trading day, or, 2) during the five business day period after any measurement period of ten consecutive trading days in which, for each trading day of such period, the trading price per $1,000 principal amount of notes was less than 98% of the product of the last reported sale price of Gilead common stock and the applicable conversion rate on such trading day, or 3) upon the occurrence of specified corporate transactions, such as the distribution of certain stock rights, cash amounts, or other assets to all Gilead shareholders or the occurrence of a change in control. On and after April 1, 2014, in the case of the 2014 Notes, and April 1, 2016, in the case of the 2016 Notes, holders may convert their Notes at any time, regardless of the foregoing circumstances. Generally, upon conversion, a holder would receive an amount in cash equal to the lesser of (i) the principal amount of the note or (ii) the conversion value for such note, as measured under the indenture governing the relevant notes. If the conversion value exceeds the principal amount, we may also deliver, at our option, cash or common stock or a combination of cash and common stock for the conversion value in excess of the principal amount. If the 2014 and 2016 Notes are converted in connection with a change in control, we may be required to provide a make whole premium in the form of an increase in the conversion rate, subject to a stated maximum amount. In addition, in the event of a change in control, the holders may require us to purchase all or a portion of their notes at a purchase price equal to 100% of their principal amount, plus accrued and unpaid interest, if any.

Concurrent with the issuance of the 2014 and 2016 Notes, we purchased convertible note hedges in private transactions at a cost of $362.6 million, which is tax deductible over the life of the notes. We also sold warrants in private transactions and received net proceeds of $155.4 million from the sale of the warrants. The convertible note hedges and warrants are intended to reduce the potential economic dilution upon future conversions of the 2014 and 2016 Notes by effectively increasing our conversion price to $56.76 per share for the 2014 Notes and $60.10 per share for the 2016 Notes. The net cost of $207.2 million of the convertible note hedge and warrant transactions was recorded in stockholders’ equity.

The convertible note hedges cover, subject to customary anti-dilution adjustments, 55.3 million shares of our common stock at strike prices that initially correspond to the initial conversion prices of the 2014 and 2016

 

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Notes and are subject to adjustments similar to those applicable to the conversion price of the related notes. If the market value per share of our common stock at the time of conversion of the 2014 and 2016 Notes is above the strike price of the applicable convertible note hedges, we will be entitled to receive from the counterparties in the transactions shares of our common stock or, to the extent we have made a corresponding election with respect to the related convertible notes, cash or a combination of cash and shares of our common stock, at our option, for the excess of the market value of the common stock over the strike price of the convertible note hedges. The convertible note hedges will terminate upon the maturity of the 2014 and 2016 Notes or when none of the 2014 and 2016 Notes remain outstanding due to conversion or otherwise. There are 55.3 million shares of our common stock underlying the warrants, subject to customary anti-dilution adjustments. The warrants have strike prices of $56.76 per share (for the warrants expiring in 2014) and $60.10 per share (for the warrants expiring in 2016) and are exercisable only on their respective expiration dates. If the market value of our common stock at the time of the exercise of the applicable warrants exceeds their respective strike prices, we will be required to net settle in cash or shares of our common stock, at our option, with the respective counterparties for the value of the warrants in excess of the warrant strike prices.

As of September 30, 2010, we have used a portion of the net proceeds from the issuance of the convertible notes to repurchase $1.18 billion of our common stock and repay the $500.0 million borrowed under our credit facility. The remaining proceeds will be used to fund additional repurchases of our common stock and repay existing indebtedness.

Credit Facility

Under our amended and restated credit agreement, we, along with our wholly-owned subsidiary, Gilead Biopharmaceutics Ireland Corporation, may borrow up to an aggregate of $1.25 billion in revolving credit loans. The credit agreement also includes a sub-facility for swing-line loans and letters of credit. Loans under the credit agreement bear interest at an interest rate of either LIBOR plus a margin ranging from 20 basis points to 32 basis points or the base rate, as described in the credit agreement. We may reduce the commitments and may prepay loans under the credit agreement in whole or in part at any time without penalty, subject to certain conditions. The credit agreement will terminate in December 2012 and all unpaid borrowings thereunder shall be due and payable at that time. In May 2010, we borrowed $500.0 million under the credit agreement to fund our stock repurchases. In August 2010, we repaid the $500.0 million borrowed under this credit agreement using proceeds from our convertible senior notes issued in July 2010. As of September 30, 2010, we had $4.5 million in letters of credit outstanding under the $1.25 billion credit agreement. We are required to comply with certain covenants under the credit agreement and as of September 30, 2010, we were in compliance with all such covenants.

11. COMMITMENTS AND CONTINGENCIES

Legal Proceedings

Since November 2003, we have been defending a class action securities lawsuit purportedly brought on behalf of a class made up of all purchasers of our stock between July 14 and October 28, 2003. The lawsuit names Gilead and six current and former executives of Gilead as defendants. The lawsuit alleges that the defendants violated federal securities laws, specifically Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated by the SEC, by making certain alleged false and misleading statements. On May 12, 2006, the United States District Court for the Northern District of California (the District Court) executed orders dismissing in its entirety and with prejudice the fourth consolidated amended complaint. The plaintiffs appealed the dismissal. On August 11, 2008, the United States Court of Appeals for the Ninth Circuit reversed the District Court’s decision and remanded the case to the District Court. On February 6, 2009, we filed a petition for a writ of certiorari with the Supreme Court of the United States, requesting that the court review the judgment of the court of appeals. In April 2009, the Supreme Court denied the petition. On February 13, 2009, we filed a further motion to dismiss the fourth consolidated amended complaint on alternative grounds. On June 3, 2009, the District Court granted in part and denied in part our motion to dismiss and gave

 

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plaintiffs leave to amend the complaint. On July 10, 2009, plaintiffs filed a fifth consolidated amended complaint. We filed a motion to dismiss the fifth consolidated amended complaint, which the District Court heard on October 9, 2009. In an order dated October 13, 2009, the Court granted in part and denied in part our motion to dismiss. On November 16, 2009, we filed an answer to the fifth consolidated amended complaint. In March 2010, we agreed to settle the dispute. Under the terms of the proposed settlement, the plaintiffs will dismiss the action and release all claims against Gilead and each of the individual defendants. In exchange, we agreed to pay $8.25 million to the class members. The proposed settlement amount will be paid in full by our insurance carriers. Further, Gilead and the individual defendants continue to deny that they committed any act or omission giving rise to any liability and/or violation of law. On July 7, 2010, the District Court issued an order granting preliminary approval to the settlement. On November 5, 2010, the District Court granted final approval of the settlement.

On August 12, 2009, we received a subpoena from the Office of the Inspector General of the U.S. Department of Health and Human Services requesting documents regarding the development, marketing and sales of Ranexa. We have been cooperating and will continue to cooperate with any related governmental inquiry. It is not possible to predict the outcome of this inquiry.

We are also a party to various other legal actions that arose in the ordinary course of our business. We do not believe that any of these other legal actions will have a material adverse impact on our consolidated business, financial position or results of operations.

12. STOCK-BASED COMPENSATION EXPENSES

The following table summarizes the stock-based compensation expenses included in our Condensed Consolidated Statements of Income (in thousands):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010     2009  

Cost of goods sold

   $ 2,728      $ 2,461      $ 8,548      $ 8,486   

Research and development expenses

     20,946        21,916        62,536        63,192   

Selling, general and administrative expenses

     28,128        24,230        75,606        72,255   
                                

Stock-based compensation expenses included in total costs and expenses

     51,802        48,607        146,690        143,933   

Income tax effect

     (13,990     (12,389     (40,070     (37,466
                                

Stock-based compensation expenses included in net income

   $ 37,812      $ 36,218      $ 106,620      $ 106,467   
                                

13. STOCKHOLDERS’ EQUITY

Stock Repurchase Programs

Under our current three-year, $5.0 billion stock repurchase program authorized by our Board of Directors in May 2010, we repurchased $2.41 billion of our common stock through September 30, 2010. As of September 30, 2010, the remaining authorized amount of stock repurchases that may be made under our $5.0 billion repurchase program was $2.59 billion. During the three and nine months ended September 30, 2010, we utilized $1.55 billion and $3.41 billion of cash to repurchase and retire 45.8 million and 93.6 million shares of our common stock, respectively, at average purchase prices of $33.90 and $36.40 per share.

We use the par value method of accounting for our stock repurchases. Under the par value method, common stock is first charged with the par value of the shares involved. The excess of the cost of shares acquired over the par value is allocated to additional paid-in capital (APIC) based on an estimated average sales price per issued

 

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share with the excess amounts charged to retained earnings. As a result of our stock repurchases during the nine months ended September 30, 2010, we reduced common stock and APIC by an aggregate of $271.3 million and charged $3.15 billion to retained earnings.

Comprehensive Income

The components of comprehensive income were as follows (in thousands):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010     2009  

Net income

   $ 702,163      $ 670,478      $ 2,263,384      $ 1,826,199   

Other comprehensive income (loss):

        

Net foreign currency translation gain (loss)

     8,025        2,520        (3,729     9,735   

Net unrealized gain on available-for-sale securities, net of related tax effects

     8,813        7,343        13,441        16,601   

Net unrealized gain (loss) on cash flow hedges, net of related tax effects

     (198,977     (72,355     3,531        (106,775
                                

Total other comprehensive income (loss)

     (182,139     (62,492     13,243        (80,439
                                

Comprehensive income

     520,024        607,986        2,276,627        1,745,760   

Comprehensive loss attributable to noncontrolling interest

     2,713        2,555        8,454        7,344   
                                

Comprehensive income attributable to Gilead

   $ 522,737      $ 610,541      $ 2,285,081      $ 1,753,104   
                                

14. SEGMENT INFORMATION

We operate in one business segment, which primarily focuses on the development and commercialization of human therapeutics for life threatening diseases. All products are included in one segment because our major products, Atripla, Truvada and Viread, which together accounted for substantially all of our total product sales for the three and nine months ended September 30, 2010 and 2009, have similar economic and other characteristics, including the nature of the products and production processes, type of customers, distribution methods and regulatory environment.

Product sales consisted of the following (in thousands):

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2010      2009      2010      2009  

Antiviral products:

           

Atripla

   $ 742,692       $ 605,299       $ 2,151,368       $ 1,684,324   

Truvada

     668,741         620,564         1,968,222         1,818,996   

Viread

     184,263         169,711         541,121         489,241   

Hepsera

     47,519         67,928         156,977         207,716   

Emtriva

     6,696         6,729         20,597         21,001   
                                   

Total antiviral products

     1,649,911         1,470,231         4,838,285         4,221,278   

AmBisome

     75,132         77,064         230,355         214,645   

Letairis

     60,446         48,073         176,293         131,781   

Ranexa

     60,312         49,005         172,015         85,070   

Other products

     19,758         4,582         42,735         12,139   
                                   

Total product sales

   $ 1,865,559       $ 1,648,955       $ 5,459,683       $ 4,664,913   
                                   

 

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The following table summarizes total revenues from external customers and collaboration partners by geographic region (in thousands). Product sales and product related contract revenues are attributed to countries based on ship-to location. Royalty and non-product related contract revenues are attributed to countries based on the location of the collaboration partner.

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2010      2009      2010      2009  

United States

   $ 1,071,770       $ 918,477       $ 3,124,137       $ 2,592,910   

Outside of the United States:

           

Switzerland

     53,535         127,763         414,618         237,354   

France

     126,485         121,393         376,564         326,692   

Spain

     101,421         111,305         338,706         318,917   

United Kingdom

     105,186         99,663         322,885         283,893   

Italy

     78,395         79,235         261,519         239,434   

Germany

     70,077         70,092         195,084         207,249   

Other European countries

     177,356         137,004         509,050         416,469   

Other countries

     153,431         136,457         408,170         356,086   
                                   

Total revenues outside the United States

     865,886         882,912         2,826,596         2,386,094   
                                   

Total revenues

   $ 1,937,656       $ 1,801,389       $ 5,950,733       $ 4,979,004   
                                   

The following table summarizes revenues from each of our customers who individually accounted for 10% or more of our total revenues (as a % of total revenues):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010     2009  

Cardinal Health, Inc.

     17     19     17     19

McKesson Corp.

     14     15     14     14

AmerisourceBergen Corp.

     13     12     12     12

15. INCOME TAXES

Our income tax rate of 26.9% and 27.3% for the three and nine months ended September 30, 2010, respectively, differed from the U.S. federal statutory rate of 35% due primarily to certain operating earnings from non-U.S subsidiaries that are considered indefinitely invested outside the United States, partially offset by state taxes. We do not provide for U.S. income taxes on undistributed earnings of our foreign operations that are intended to be permanently reinvested.

We file federal, state and foreign income tax returns in many jurisdictions in the United States and abroad. For federal income tax purposes, the statute of limitations is open for 2003 and onwards. For certain acquired entities, the statute of limitations is open for all years from inception due to our utilization of their net operating losses and credits carried over from prior years. For California income tax purposes, the statute of limitations is open for 2002 and onwards.

Our income tax returns are audited by federal, state and foreign tax authorities. We are currently under examination by the Internal Revenue Service for the 2005, 2006 and 2007 tax years and by various state and foreign jurisdictions. There are differing interpretations of tax laws and regulations, and as a result, significant disputes may arise with these tax authorities involving issues of the timing and amount of deductions and allocations of income among various tax jurisdictions. We periodically evaluate our exposures associated with our tax filing positions.

 

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As of September 30, 2010, we believe it is reasonably possible that our unrecognized tax benefits will decrease by approximately $4.0 million in the next 12 months as we expect to have clarification from the IRS and other tax authorities around some of our uncertain tax positions. With respect to the remaining unrecognized tax benefits, we are currently unable to make a reasonable estimate as to the period of cash settlement, if any, with the respective tax authorities.

We record liabilities related to uncertain tax positions in accordance with the income tax guidance which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements by prescribing a minimum recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. We do not believe any such uncertain tax positions currently pending will have a material adverse effect on our Condensed Consolidated Financial Statements, although an adverse resolution of one or more of these uncertain tax positions in any period could have a material impact on the results of operations for that period.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Quarterly Report on Form 10-Q contains forward-looking statements regarding future events and our future results that are subject to the safe harbors created under the Securities Act of 1933, as amended (the Securities Act), and the Securities Exchange Act of 1934, as amended (the Exchange Act). The forward-looking statements are contained principally in this section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors.” Words such as “expect,” “anticipate,” “target,” “goal,” “project,” “intend,” “plan,” “believe,” “seek,” “estimate,” “continue,” “may,” “could,” “should,” “might,” variations of such words and similar expressions are intended to identify such forward-looking statements. In addition, any statements other than statements of historical fact are forward-looking statements, including statements regarding overall trends, operating cost and revenue trends, liquidity and capital needs and other statements of expectations, beliefs, future plans and strategies, anticipated events or trends and similar expressions. We have based these forward-looking statements on our current expectations about future events. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Our actual results may differ materially from those suggested by these forward-looking statements for various reasons, including those identified below under “Risk Factors.” Given these risks and uncertainties, you are cautioned not to place undue reliance on forward-looking statements. The forward-looking statements included in this report are made only as of the date hereof. Except as required under federal securities laws and the rules and regulations of the Securities and Exchange Commission, we do not undertake, and specifically decline, any obligation to update any of these statements or to publicly announce the results of any revisions to any forward-looking statements after the distribution of this report, whether as a result of new information, future events, changes in assumptions or otherwise. In evaluating our business, you should carefully consider the risks described in the section entitled “Risk Factors” under Part II, Item 1A below, in addition to the other information in this Quarterly Report on Form 10-Q. Any of the risks contained herein could materially and adversely affect our business, results of operations and financial condition.

You should read the following management’s discussion and analysis of our financial condition and results of operations in conjunction with our audited Consolidated Financial Statements and related notes thereto included as part of our Annual Report on Form 10-K for the year ended December 31, 2009 and our unaudited Condensed Consolidated Financial Statements for the three and nine months ended September 30, 2010 and other disclosures (including the disclosures under “Part II. Item 1A. Risk Factors”) included in this Quarterly Report on Form 10-Q. Our Condensed Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) and are presented in U.S. dollars.

Management Overview

We are a biopharmaceutical company that discovers, develops and commercializes innovative therapeutics in areas of unmet medical need. Our mission is to advance the care of patients suffering from life threatening diseases worldwide. Headquartered in Foster City, California, we have operations in North America, Europe and Asia Pacific. We market products in the HIV/AIDS, liver disease, respiratory and cardiovascular/metabolic therapeutic areas. Our product portfolio is comprised of Truvada® (emtricitabine and tenofovir disoproxil fumarate), Atripla® (efavirenz 600 mg/emtricitabine 200 mg/tenofovir disoproxil fumarate 300 mg), Viread® (tenofovir disoproxil fumarate) and Emtriva® (emtricitabine) for the treatment of human immunodeficiency virus (HIV) infection; Hepsera® (adefovir dipivoxil) and Viread for the treatment of chronic hepatitis B; AmBisome®(amphotericin B liposome for injection) for the treatment of severe fungal infections; Letairis® (ambrisentan) for the treatment of pulmonary arterial hypertension (PAH); Ranexa® (ranolazine) for the treatment of chronic angina; Vistide® (cidofovir injection) for the treatment of cytomegalovirus infection and Cayston® (aztreonam for inhalation solution) as a treatment to improve respiratory symptoms in cystic fibrosis (CF) patients with Pseudomonas aeruginosa (P. aeruginosa). In addition, we also sell and distribute certain products through our corporate partners under royalty-paying collaborative agreements. For example, F. Hoffmann-La Roche Ltd (together with Hoffmann-La Roche Inc., Roche) markets Tamiflu® (oseltamivir

 

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phosphate) for the treatment and prevention of influenza; GlaxoSmithKline Inc. (GSK) markets Hepsera for the treatment of chronic hepatitis B in certain territories outside of the United States; GSK also markets Volibris® (ambrisentan) outside of the United States for the treatment of PAH; Astellas Pharma US, Inc. markets AmBisome for the treatment of severe fungal infections in the United States and Canada; Astellas US LLC markets Lexiscan® (regadenoson) injection in the United States for use as a pharmacologic stress agent in radionuclide myocardial perfusion imaging; Rapidscan Pharma Solutions, Inc. markets regadenoson in certain territories outside of the United States for the inducement of pharmacological stress and/or vasodilation of the coronary vasculature strictly for purposes of diagnosing cardiovascular disease; Menarini International Operations Luxembourg SA markets Ranexa in certain territories outside of the United States for the treatment of chronic angina; and Japan Tobacco Inc. markets Truvada, Viread and Emtriva in Japan.

Business Highlights

In the HIV area, in September 2010, we announced that we had submitted a Marketing Authorization Application to the European Medicines Agency for marketing approval of the fixed-dose combination of Truvada and Tibotec Pharmaceuticals’ (Tibotec) investigational non-nucleoside reverse transcriptase inhibitor, TMC278 (rilpivirine), for the treatment of HIV-1 infection in adults. We anticipate submitting a New Drug Application to the U.S. Food and Drug Administration for the fixed-dose combination of Truvada and TMC278 in the fourth quarter of this year.

Also in the HIV area, in September 2010, we released positive 48-week results from two of our ongoing Phase 2 clinical studies in HIV-infected patients. The first were from the study of our investigational fixed-dose, single-tablet “Quad” regimen of elvitegravir, cobicistat and Truvada versus Atripla. The second were from the study of cobicistat-boosted atazanavir plus Truvada compared to ritonavir-boosted atazanavir plus Truvada. Results from both studies were presented at the 50th Annual Interscience Conference on Antimicrobial Agents and Chemotherapy in Boston.

In the liver disease area, in October 2010, we announced data from a Phase 2a study showing that our investigational compounds GS 9190 and GS 9256, used in conjunction with current standard of care therapies, produced substantial suppression of the hepatitis C virus (HCV) within 28 days of treatment. The findings were presented at the 61st annual meeting of the American Association for the Study of Liver Diseases in Boston. Our HCV pipeline now includes seven unique molecules spanning six therapeutic classes with different mechanisms of action. Five of these compounds are currently in clinical trials, and two are slated to enter human clinical studies early next year.

Also in the liver disease area, in October 2010, we announced new data from the open-label phase of two pivotal Phase 3 clinical trials (Studies 102 and 103) evaluating the four-year efficacy of Viread for the treatment of chronic hepatitis B virus (HBV) infection, which show that Viread maintains antiviral suppression with no development of resistance through four years of treatment. Data also show significant “s” antigen loss, a marker of the resolution of chronic HBV infection, in HBeAg-positive patients. These findings were also presented at the 61st annual meeting of the American Association for the Study of Liver Diseases in Boston.

In the respiratory area, in October 2010, we announced that our head-to-head Phase 3 clinical trial of Cayston versus tobramycin inhalation solution (TIS) in CF patients with P. aeruginosa achieved its co-primary endpoint of superiority of Cayston to TIS for mean actual change in forced expiratory volume in one second (FEV1, a measure of lung function) percent predicted across three treatment cycles (six months). These data were presented at the 24th Annual North American Cystic Fibrosis Conference in Baltimore.

Financial Highlights

Our operating results for the three months ended September 30, 2010 were led by total product sales of $1.87 billion, an increase of 13% over total product sales of $1.65 billion for the three months ended

 

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September 30, 2009. The increase in product sales was driven primarily by our antiviral franchise (Atripla, Truvada, Viread, Hepsera and Emtriva), due mainly to the strong growth in Atripla sales. Atripla contributed $742.7 million, or 45%, to our third quarter 2010 antiviral product sales. Atripla product sales for the three months ended September 30, 2010 increased 23% from the same period in 2009 primarily due to sales volume growth in the United States and Europe. The growth of Atripla product sales and its increased proportion to overall product sales caused total product gross margin to decrease to 74% in the three months ended September 30, 2010 from 75% in the same period of 2009, due primarily to the efavirenz component of Atripla which has a gross margin of zero. Truvada product sales for the three months ended September 30, 2010 comprised $668.7 million, or 41% of our third quarter 2010 antiviral product sales. Truvada product sales for the three months ended September 30, 2010 increased 8% from the three months ended September 30, 2009 primarily due to sales volume growth in the United States and Europe. Foreign currency exchange had an unfavorable impact of $44.2 million and $37.4 million on our third quarter 2010 revenues and pre-tax earnings, respectively, compared to the third quarter of 2009.

Product sales in the United States were driven primarily by our antiviral franchise but also reflected growth from our cardiovascular franchise. Antiviral product sales in the United States increased 15% in the third quarter of 2010 compared to the same quarter in 2009, resulting from the continued strong growth of patient and market share in the United States. Compared to the second quarter of 2010, antiviral product sales in the United States grew 4% in the third quarter due to strong demand for our antiviral products, despite the added impact of rebates to AIDS Drug Assistance Programs (ADAPs) and Public Health Service (PHS) entities as mandated by healthcare reform legislation adopted in the United States. With respect to our cardiovascular franchise, Ranexa sales in the United States were $57.7 million in the third quarter of 2010, reflecting a continued growth in demand as Ranexa prescriptions have increased by 61% since our acquisition of CV Therapeutics in April 2009. Ranexa sales increased 28% from the third quarter of 2009 and were relatively flat compared to the second quarter of 2010. Furthermore, Letairis sales contributed $60.4 million to our third quarter 2010 product sales in the United States, reflecting a 26% increase from the third quarter of 2009 and remaining relatively flat compared to the second quarter of 2010. Our newest product, Cayston, also contributed $14.7 million in its second full quarter of sales, the majority of which was in the United States.

Product sales in Europe were driven by antiviral product sales, which increased 5% in the third quarter of 2010 compared to the same quarter in 2009, due to a strong continued growth in demand. Compared to the second quarter of 2010, antiviral product sales in Europe increased 2% in the third quarter of 2010. While we saw demand growth for our products in Europe, the effect was partially offset by recent mandatory price reductions in certain European countries and foreign currency exchange impact from a strengthening U.S. dollar relative to European currencies.

Royalty revenues recognized from our collaborations with corporate partners were $69.4 million for the three months ended September 30, 2010, a decrease of $72.8 million from royalty revenues of $142.1 million for the three months ended September 30, 2009. The change in royalty revenues resulted primarily from decreased Tamiflu sales by Roche related to influenza pandemic planning initiatives worldwide. Compared to the second quarter of 2010, Tamiflu royalties in the third quarter of 2010 decreased significantly due to the fulfillment of many of the existing pandemic orders from governments and corporations. Based on Roche’s reported sales of Tamiflu for the three months ended September 30, 2010, we expect Tamiflu royalties to further decrease to approximately $21 million in the fourth quarter of 2010.

Our research and development (R&D) and selling, general and administrative (SG&A) expenses decreased by $16.3 million, or 3%, for the three months ended September 30, 2010 compared to the same period in 2009. The decrease was due primarily to lower R&D expense reimbursement related to our collaboration with Tibotec. Also, in the second half of 2010, we experienced lower R&D expense due to delays in clinical trial expenditures which we expect to incur in future periods.

During the second quarter of 2010, we approved and communicated a plan to close our operations in Durham, North Carolina and consolidate our liver disease work in Foster City, California. We believe that this

 

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plan will allow our employees across R&D to collaborate more effectively and further advance our programs in the liver disease area. For the three months ended September 30, 2010, we incurred $6.7 million of restructuring expenses related to employee severance and facilities-related expenses. We expect to close our operations in Durham by the end of December 2010 and incur an additional $13.5 million in pre-tax restructuring expenses during the fourth quarter of 2010, bringing the total restructuring cost to approximately $21.9 million comprised of employee severance and facilities-related expenses.

Cash, cash equivalents and marketable securities increased by $1.15 billion during the nine months ended September 30, 2010, driven primarily by our operating cash flows of $2.11 billion and proceeds of $2.46 billion from the issuance of convertible senior notes, net of issuance costs, partially offset by repurchases of our common stock under our stock repurchase programs. Under our current three-year, $5.0 billion stock repurchase program, we repurchased $2.41 billion of our common stock through September 30, 2010. During the nine months ended September 30, 2010, we utilized $3.41 billion of cash to repurchase and retire 93.6 million shares of our common stock at an average purchase price of $36.40 per share.

In July 2010, we issued $2.50 billion of convertible senior notes in a private placement and purchased convertible note hedges as well as sold warrants for a net cost of $207.2 million. The cost of the convertible note hedges will be tax deductible over the life of the notes. The convertible note hedges and warrants are intended to reduce the potential economic dilution upon future conversions of the notes by effectively increasing our conversion prices for the notes. Our interest expense for the three months ended September 30, 2010 increased by $16.4 million compared to the same period in 2009, due primarily to increased interest expense related to our convertible notes. We expect to see the impact of a full quarter of interest expense related to these convertible notes in the fourth quarter of 2010.

As of September 30, 2010, we have used a portion of the net proceeds from the issuance of the convertible notes to repurchase $1.18 billion of our common stock and repay the $500.0 million borrowed under our credit facility. The remaining proceeds will be used to fund additional repurchases of our common stock and repay existing indebtedness.

Healthcare Reform

In March 2010, healthcare reform legislation was adopted in the United States. As a result, we are required to further rebate or discount products reimbursed or paid for by various public payers, including Medicaid and other entities eligible to purchase discounted products through the 340B Drug Pricing Program under the Public Health Service Act, such as ADAPs. The discounts, rebates and fees in the legislation that will impact us include:

 

   

effective January 1, 2010, our minimum base rebate amount owed to Medicaid on products reimbursed by Medicaid has been increased by 8%, and the discounts or rebates we owe to ADAPs and other PHS entities which reimburse or purchase our products have also been increased by 8%;

 

   

effective March 23, 2010, we are required to extend rebates to patients receiving our products through Medicaid managed care organizations;

 

   

effective January 1, 2011, we will be required to provide a 50% discount on products sold to patients while they are in the Medicare Part D “donut hole;” and

 

   

effective 2011, we, along with other pharmaceutical manufacturers of branded drug products, will be required to pay a portion of a new industry fee (also known as the pharmaceutical excise tax), calculated based on select government sales during the 2010 calendar year as a percentage of total industry government sales.

Starting in 2014, as the number of people with access to healthcare coverage is expected to increase, we could experience a positive impact on the sales of our products. Further, the expansion of healthcare coverage may decrease the reliance of patients on state ADAPs that currently rely on the availability of federal and state funding.

 

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We estimate that the full impact of healthcare reform for 2010 will be a reduction of approximately $200 million in U.S. net product sales, and that the majority of this impact began in the third quarter and will continue throughout the fourth quarter of 2010 since some of the new discount and rebate requirements take two quarters to fully implement. For 2011, excluding the impact of the new pharmaceutical excise tax, we estimate that the impact of healthcare reform on product sales will be similar to 2010 as a percentage of our U.S. net product sales.

Many of the specific determinations necessary to implement the healthcare reform legislation have yet to be decided and communicated by the federal government. For example, we do not know how many or how quickly patients receiving our product under the Medicare Part D program will reach the “donut hole” or how the pharmaceutical excise tax will be calculated and reflected in our financial results. Based on the information that we have to date, we estimate the 2011 impact of the pharmaceutical excise tax to be less than $50 million, which will be classified as SG&A expense. The excise tax is not tax deductible. In calculating the anticipated financial impacts of healthcare reform described above, we have made several estimates and assumptions with respect to our expected payer mix, how the reforms will be implemented and the timing for implementing the various discounts, rebates and fees contained in the legislation.

Critical Accounting Policies, Estimates and Judgments

There have been no material changes in our critical accounting policies, estimates and judgments during the nine months ended September 30, 2010 compared to the disclosures in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2009.

Results of Operations

Total Revenues

Total revenues for the three months ended September 30, 2010 were $1.94 billion, compared to $1.80 billion for the same period in 2009. Total revenues for the nine months ended September 30, 2010 were $5.95 billion, compared to $4.98 billion for the same period in 2009. Included in total revenues were product sales, royalty revenues and contract and other revenues. A significant percentage of our product sales continued to be denominated in foreign currencies and we face exposure to adverse movements in foreign currency exchange rates. We used foreign currency exchange forward and option contracts to hedge a percentage of our forecasted international sales, primarily those denominated in Euro. Foreign currency exchange had an unfavorable impact of $44.2 million on our third quarter 2010 revenues compared to the third quarter of 2009.

Product Sales

The following table summarizes the period over period changes in our product sales (in thousands):

 

     Three Months Ended
September 30,
           Nine Months Ended
September 30,
        
     2010      2009      Change     2010      2009      Change  

Antiviral products:

                

Atripla

   $ 742,692       $ 605,299         23   $ 2,151,368       $ 1,684,324         28

Truvada

     668,741         620,564         8     1,968,222         1,818,996         8

Viread

     184,263         169,711         9     541,121         489,241         11

Hepsera

     47,519         67,928         (30 )%      156,977         207,716         (24 )% 

Emtriva

     6,696         6,729         0     20,597         21,001         (2 )% 
                                        

Total antiviral products

     1,649,911         1,470,231         12     4,838,285         4,221,278         15

AmBisome

     75,132         77,064         (3 )%      230,355         214,645         7

Letairis

     60,446         48,073         26     176,293         131,781         34

Ranexa

     60,312         49,005         23     172,015         85,070         102

Other products

     19,758         4,582         331     42,735         12,139         252
                                        

Total product sales

   $ 1,865,559       $ 1,648,955         13   $ 5,459,683       $ 4,664,913         17
                                        

 

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Total product sales increased by 13% and 17% for the three and nine months ended September 30, 2010, respectively, compared to the same periods in 2009. This increase was due primarily to the strong growth of Atripla sales.

Antiviral Products

Antiviral product sales increased by 12% and 15% for the three and nine months ended September 30, 2010, respectively, compared to the same periods in 2009.

 

   

Atripla

Atripla sales increased by 23% and 28% for the three and nine months ended September 30, 2010, respectively, compared to the same periods in 2009, driven primarily by sales volume growth in the United States and Europe. Atripla sales include the efavirenz component which has a gross margin of zero. The efavirenz portion of our Atripla sales was approximately $273.5 million and $791.9 million for the three and nine months ended September 30, 2010, respectively and approximately $221.6 million and $617.1 million for the three and nine months ended September 30, 2009, respectively. Atripla sales accounted for 45% and 44% of our total antiviral product sales for the three and nine months ended September 30, 2010, respectively.

 

   

Truvada

Truvada sales increased by 8% for both the three and nine months ended September 30, 2010, compared to the same periods in 2009, driven primarily by sales volume growth in the United States and Europe. Truvada sales accounted for 41% of our total antiviral product sales for both the three and nine months ended September 30, 2010.

 

   

Other Antiviral Products

Other antiviral product sales, which include product sales of Viread, Hepsera and Emtriva, were relatively flat for the three and nine months ended September 30, 2010, compared to the same periods in 2009, due primarily to higher Viread sales offset by sales volume decreases in Hepsera.

AmBisome

Sales of AmBisome decreased by 3% and increased by 7% for the three and nine months ended September 30, 2010, respectively, compared to the same periods in 2009. The decrease for the three months ended September 30, 2010 was due primarily to decreased pricing outside of the United States and foreign currency exchange fluctuations, partially offset by sales volume increases in certain markets outside of the United States. The increase in AmBisome sales for the nine months ended September 30, 2010 was driven primarily by sales volume growth in certain markets outside of the United States. AmBisome product sales in the United States and Canada relate solely to our sales of AmBisome to Astellas Pharma US, Inc. which are recorded at our manufacturing cost.

Letairis

Sales of Letairis increased by 26% and 34% for the three and nine months ended September 30, 2010, respectively, compared to the same periods in 2009, driven primarily by sales volume growth in the United States.

Ranexa

Sales of Ranexa increased by 23% and 102% for the three and nine months ended September 30, 2010, respectively, compared to the same periods in 2009, driven primarily by sales volume growth in the United States. Ranexa sales began on April 15, 2009, the date Gilead acquired CV Therapeutics.

 

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Royalty Revenues

The following table summarizes the period over period changes in our royalty revenues (in thousands):

 

     Three Months Ended
September 30,
           Nine Months Ended
September 30,
        
     2010      2009      Change     2010      2009      Change  

Royalty revenues

   $ 69,358       $ 142,133         (51 )%    $ 480,829       $ 269,070         79

Our most significant source of royalty revenues for the three and nine months ended September 30, 2010 and 2009 was from sales of Tamiflu by Roche. We recognize royalties on Tamiflu sales by Roche in the quarter following the quarter in which Tamiflu is sold.

Royalty revenues for the three months ended September 30, 2010 were $69.4 million, a decrease of 51% or $72.8 million compared to the same period in 2009, primarily due to lower Tamiflu royalties from Roche of $34.5 million in the three months ended September 30, 2010, compared to Tamiflu royalties from Roche of $113.5 million in the same period in 2009. Compared to the second quarter of 2010, Tamiflu royalties decreased by $49.3 million in the three months ended September 30, 2010 due to the fulfillment of many of the existing pandemic orders from governments and corporations.

Royalty revenues for the nine months ended September 30, 2010 were $480.8 million, an increase of 79% or $211.8 million compared to the same period in 2009, driven primarily by higher Tamiflu royalties from Roche of $364.6 million in the nine months ended September 30, 2010, compared to Tamiflu royalties from Roche of $198.6 million in the same period in 2009. These increases were primarily driven by increased Tamiflu royalties in the first quarter of 2010 related to influenza pandemic planning initiatives worldwide.

Cost of Goods Sold and Product Gross Margin

The following table summarizes the period over period changes in our product sales (in thousands), cost of goods sold (in thousands) and product gross margin:

 

     Three Months Ended
September 30,
          Nine Months Ended
September 30,
       
     2010     2009     Change     2010     2009     Change  

Total product sales

   $ 1,865,559      $ 1,648,955        13   $ 5,459,683      $ 4,664,913        17

Cost of goods sold

   $ 477,584      $ 409,700        17   $ 1,373,539      $ 1,122,159        22

Product gross margin

     74     75       75     76  

Our product gross margin for the three months ended September 30, 2010 was 74% compared to 75% for the same period in 2009. Our product gross margin for the nine months ended September 30, 2010 was 75% compared to 76% for the same period in 2009. The lower product gross margin for the three and nine months ended September 30, 2010 compared to the same periods in 2009 was due primarily to the higher proportion of Atripla sales, which has a gross margin of zero for the efavirenz component. For the nine months ended September 30, 2010, the decrease in product gross margin was partially offset by favorable product mix.

Restructuring

During the second quarter of 2010, we approved and communicated a plan to close our operations in Durham, North Carolina and consolidate our liver disease work in Foster City, California. We believe this plan will allow our employees across R&D to collaborate more effectively and further advance our programs in the liver disease area. We expect to close our operations in Durham by the end of December 2010. For the three months ended September 30, 2010, we recorded $1.1 million and $5.6 million in SG&A expenses and R&D expenses, respectively, related to employee severance and facilities-related expenses. For the nine months ended

 

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September 30, 2010, we recorded $1.4 million and $7.0 million of restructuring expenses in SG&A expenses and R&D expenses, respectively, related to employee severance and facilities-related expenses. We expect to incur an additional $13.5 million in the fourth quarter of 2010, bringing the total amount to be incurred in connection with our restructuring plan to approximately $11.6 million for employee severance and $10.3 million for facilities-related expenses.

During the second quarter of 2009, we approved a plan to realize certain synergies between CV Therapeutics and us, re-align our cardiovascular operations and eliminate certain redundancies. For the three months ended September 30, 2010, we recorded $0.4 million of restructuring expenses in R&D expenses related to relocation and employee severance costs. For the nine months ended September 30, 2010 we recorded $13.2 million and $3.2 million of restructuring expenses in SG&A expenses and R&D expenses, respectively, related to lease termination costs, other facilities-related expenses, relocation and employee severance costs. As of September 30, 2010, we recorded approximately $39.4 million and $28.9 million in SG&A expenses and R&D expenses, respectively, related to employee severance, relocation, lease termination costs and other facilities-related expenses. We expect to incur an additional $0.4 million in the fourth quarter of 2010, bringing the total amount to be incurred in connection with this restructuring plan to approximately $36.3 million for employee severance and relocation and $32.4 million for facilities-related expenses.

Research and Development Expenses

The following table summarizes the period over period changes in our R&D expenses (in thousands):

 

     Three Months Ended
September 30,
           Nine Months Ended
September 30,
        
     2010      2009      Change     2010      2009      Change  

Research and development

   $ 230,440       $ 269,856         (15 )%    $ 680,170       $ 700,273         (3 )% 

R&D expenses consist primarily of personnel costs, including salaries, benefits and stock-based compensation, clinical studies performed by contract research organizations, materials and supplies, licenses and fees and overhead allocations consisting of various support and facilities-related costs.

R&D expenses for the three months ended September 30, 2010 decreased by $39.4 million, or 15%, compared to the same period in 2009, due primarily to a decrease of $46.3 million in R&D expense reimbursements related to our collaboration with Tibotec.

R&D expenses for the nine months ended September 30, 2010 decreased by $20.1 million, or 3%, compared to the same period in 2009, due primarily to a decrease of $30.6 million in R&D expense reimbursements related to our collaboration with Tibotec, partially offset by increases in various other R&D expenses.

Selling, General and Administrative Expenses

The following table summarizes the period over period changes in our SG&A expenses (in thousands):

 

     Three Months Ended
September 30,
           Nine Months Ended
September 30,
     Change  
     2010      2009      Change     2010      2009     

Selling, general and administrative

   $ 250,559       $ 227,427         10   $ 764,183       $ 692,789         10

SG&A expenses for the three months ended September 30, 2010 increased by $23.1 million, or 10%, compared to the same period in 2009. This was due primarily to increased compensation and benefits expenses of $14.6 million as a result of higher headcount to support our expanding commercial activities.

 

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SG&A expenses for the nine months ended September 30, 2010 increased by $71.4 million, or 10%, compared to the same period in 2009, due primarily to increased compensation and benefits expenses of $20.2 million, increased promotional expenses of $19.0 million driven primarily by our expanding sales and marketing activities and facilities-related expenses of $18.9 million related primarily to lease termination costs associated with our restructuring activities.

Interest and Other Income, Net

Interest and other income, net for the three and nine months ended September 30, 2010 increased by $1.6 million and $18.4 million, respectively, compared to the same periods in 2009, due primarily to decreased costs related to our hedging activities.

Interest Expense

Interest expense for the three and nine months ended September 30, 2010 increased by $16.4 million and $16.0 million, respectively, compared to the same periods in 2009, due primarily to increased interest expense related to our convertible notes issued in July 2010.

Provision for Income Taxes

Our provision for income taxes was $258.9 million and $850.6 million for the three and nine months ended September 30, 2010, respectively, compared to $220.7 million and $616.3 million for the three and nine months ended September 30, 2009, respectively. Our effective tax rate was 26.9% and 27.3% for the three and nine months ended September 30, 2010, respectively, compared to our effective tax rate of 24.8% and 25.2% for the three and nine months ended September 30, 2009, respectively. The effective tax rates for the three and nine months ended September 30, 2010 were higher than the effective tax rates for the three and nine months ended September 30, 2009 as a result of lower earnings from non-U.S. subsidiaries that are considered indefinitely invested outside the United States as a percentage of total earnings, the expiration of the federal research tax credit as of December 31, 2009 and the resolution of certain tax positions with tax authorities in 2009.

The effective tax rate for the three and nine months ended September 30, 2010 differed from the U.S. federal statutory rate of 35% due primarily to certain operating earnings from non-U.S. subsidiaries that are considered indefinitely invested outside the United States, partially offset by state taxes. We do not provide for U.S. income taxes on undistributed earnings of our foreign operations that are intended to be permanently reinvested.

Liquidity and Capital Resources

The following table summarizes our cash, cash equivalents and marketable securities, our working capital and our cash flow activities as of the end of, and for each of, the periods presented (in thousands):

 

     As of
September 30,
    As of
December 31,
 
     2010     2009