Alexion Pharmaceuticals, Inc.
ALEXION PHARMACEUTICALS INC (Form: 10-Q, Received: 10/26/2017 16:18:50)
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, 2017
or
¨
Transition report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934
For the transition period from              to             
Commission file number: 0-27756
 
ALEXION PHARMACEUTICALS, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware
13-3648318
(State or Other Jurisdiction of Incorporation or Organization)
(I.R.S. Employer Identification No.)
 

100 College Street, New Haven Connecticut 06510
(Address of Principal Executive Offices) (Zip Code)
475-230-2596
(Registrant’s telephone number, including area code)
N/A
(Former name, former address, and former fiscal year, if changed since last report)

 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x     No   ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   x    No   ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company”, and "emerging growth company" in Rule 12b-2 of the Exchange Act. Check One:
Large accelerated filer   x    Accelerated filer   ¨     Non-accelerated filer   ¨ (Do not check if a smaller reporting company)
Smaller reporting company   ¨ Emerging growth company   ¨ If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨     No   x
Common Stock, $0.0001 par value
223,409,644
Class
Outstanding as of October 23, 2017










 
Alexion Pharmaceuticals, Inc.
Contents

 
PART I.
FINANCIAL INFORMATION
Page
 
Item 1.
Condensed Consolidated Financial Statements (Unaudited)
 
 
 

 
 
 
 
 
 
 
 
 
Item 2.
 
Item 3.
 
Item 4.
PART II.
 
Item 1.
 
Item 1A.
 
Item 2.
 
Item 5.
 
Item 6.
SIGNATURES
 
 



Alexion Pharmaceuticals, Inc.
Condensed Consolidated Balance Sheets
(unaudited)
(amounts in millions, except per share amounts)
 
 
September 30,

December 31,
 
2017

2016
Assets



Current Assets:



Cash and cash equivalents
$
550

 
$
966

Marketable securities
979

 
327

Trade accounts receivable, net
705

 
650

Inventories
441

 
375

Prepaid expenses and other current assets
207

 
260

Total current assets
2,882

 
2,578

Property, plant and equipment, net
1,354

 
1,036

Intangible assets, net
4,032

 
4,303

Goodwill
5,037

 
5,037

Other assets
338

 
299

Total assets
$
13,643

 
$
13,253

Liabilities and Stockholders' Equity



Current Liabilities:



Accounts payable
$
35


$
64

Accrued expenses
703


508

Deferred revenue
18


37

Current portion of long-term debt
167


167

Current portion of contingent consideration


24

Other current liabilities
49


23

Total current liabilities
972


823

Long-term debt, less current portion
2,763


2,888

Contingent consideration
160


129

Facility lease obligation
333


233

Deferred tax liabilities
353


396

Other liabilities
118


90

Total liabilities
4,699


4,559

Commitments and contingencies (Note 16)



Stockholders' Equity:



Common stock, $0.0001 par value; 290 shares authorized; 234 and 232 shares issued at September 30, 2017 and December 31, 2016, respectively



Additional paid-in capital
8,209


7,957

Treasury stock, at cost, 11 and 8 shares at September 30, 2017 and December 31, 2016, respectively
(1,440
)

(1,141
)
Accumulated other comprehensive (loss) income
(37
)

60

Retained earnings
2,212


1,818

Total stockholders' equity
8,944


8,694

Total liabilities and stockholders' equity
$
13,643


$
13,253


The accompanying notes are an integral part of these condensed consolidated financial statements.

2


Alexion Pharmaceuticals, Inc.
Condensed Consolidated Statements of Operations
(unaudited)
(amounts in millions, except per share amounts)
 
 
Three Months Ended September 30,

Nine Months Ended September 30,
 
2017
 
2016

2017
 
2016
Net product sales
$
859


$
798


$
2,640


$
2,251

Other revenue


1


1


2

Total revenues
859


799


2,641


2,253

Cost of sales
157


71


310


190

Operating expenses:







Research and development
195


195


613


551

Selling, general and administrative
271


230


798


695

Amortization of purchased intangible assets
80


82


240


242

Change in fair value of contingent consideration
4


41


32


31

Acquisition-related costs






2

Restructuring expenses
72


1


99


2

Impairment of intangible assets

 

 
31

 

Total operating expenses
622


549


1,813


1,523

Operating income
80


179


518


540

Other income and expense:







Investment income
5


5


13


8

Interest expense
(25
)

(24
)

(73
)

(72
)
Other expense
(2
)

(1
)



(4
)
Income before income taxes
58


159


458


472

Income tax (benefit) expense
(20
)

65


45


166

Net income
$
78


$
94


$
413


$
306

Earnings per common share







Basic
$
0.35


$
0.42


$
1.84


$
1.37

Diluted
$
0.35


$
0.42


$
1.83


$
1.35

Shares used in computing earnings per common share







Basic
223


224


224


224

Diluted
225


226


226


226


 
 
 
 
 
 
 

The accompanying notes are an integral part of these condensed consolidated financial statements.

3


Alexion Pharmaceuticals, Inc.
Condensed Consolidated Statements of Comprehensive Income
(unaudited)
(amounts in millions)

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Net income
$
78

 
$
94

 
$
413

 
$
306

Other comprehensive loss, net of tax:
 
 
 
 
 
 
 
Foreign currency translation
2

 
1

 
9

 
3

Unrealized (losses) gains on marketable securities

 
(1
)
 
1

 
2

Unrealized gains on pension obligation

 

 

 
1

Unrealized losses on hedging activities, net of tax of $(14), $(9), $(59) and $(46), respectively
(25
)
 
(16
)
 
(107
)
 
(84
)
Other comprehensive loss, net of tax
(23
)
 
(16
)
 
(97
)
 
(78
)
Comprehensive income
$
55

 
$
78

 
$
316

 
$
228


The accompanying notes are an integral part of these condensed consolidated financial statements.


4


Alexion Pharmaceuticals, Inc.
Condensed Consolidated Statements of Cash Flows
(unaudited)
(amounts in millions)
 
 
Nine Months Ended September 30,
 
2017
 
2016
Cash flows from operating activities:
 
 
 
Net income
$
413

 
$
306

Adjustments to reconcile net income to net cash flows from operating activities:
 
 
 
Depreciation and amortization
311

 
295

Impairment of assets
113

 

Change in fair value of contingent consideration
32

 
31

Payments of contingent consideration
(18
)
 

Share-based compensation expense
172

 
151

Deferred taxes
(57
)
 
96

Unrealized loss on forward contracts
8

 
11

Other
(1
)
 
(1
)
Changes in operating assets and liabilities, excluding the effect of acquisitions:
 
 
 
Accounts receivable
(35
)
 
(130
)
Inventories
(69
)
 
(72
)
Prepaid expenses and other assets
(94
)
 
(120
)
Accounts payable, accrued expenses and other liabilities
102

 
93

Deferred revenue
(19
)
 
43

Net cash provided by operating activities
858

 
703

Cash flows from investing activities:
 
 
 
Purchases of available-for-sale securities
(1,580
)
 
(656
)
Proceeds from maturity or sale of available-for-sale securities
932

 
485

Purchases of trading securities
(8
)
 
(6
)
Purchases of property, plant and equipment
(269
)
 
(226
)
Other
6

 
1

Net cash used in investing activities
(919
)
 
(402
)
Cash flows from financing activities:
 
 
 
Payments on term loan
(131
)
 
(175
)
Repurchases of common stock
(299
)
 
(400
)
Net proceeds from issuance of common stock under share-based compensation arrangements
76

 
28

Payments of contingent consideration
(7
)
 

Payments on facility lease obligations
(10
)
 
(5
)
Net cash used in financing activities
(371
)
 
(552
)
Effect of exchange rate changes on cash
16

 
3

Net change in cash and cash equivalents
(416
)
 
(248
)
Cash and cash equivalents at beginning of period
966

 
1,010

Cash and cash equivalents at end of period
$
550

 
$
762

 
 
 
 
Supplemental cash flow disclosures from investing and financing activities:
 
 
 
Capitalization of construction costs related to facility lease obligations
$
110

 
$
85

Accrued expenses for purchases of property, plant and equipment
$
33

 
$
23

The accompanying notes are an integral part of these condensed consolidated financial statements.

5

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






1.
Business
Alexion Pharmaceuticals, Inc. (Alexion, the Company, we, our or us) is a global biopharmaceutical company focused on serving patients and families affected by rare diseases through the innovation, development and commercialization of life-changing therapies.
We are the global leader in complement inhibition and have developed and commercialize the first and only approved complement inhibitor to treat patients with paroxysmal nocturnal hemoglobinuria (PNH), atypical hemolytic uremic syndrome (aHUS), and anti-acetylcholine receptor (AChR) antibody-positive generalized myasthenia gravis (gMG).  In addition, Alexion has two highly innovative enzyme replacement therapies for patients with life-threatening and ultra-rare metabolic disorders, hypophosphatasia (HPP) and lysosomal acid lipase deficiency (LAL-D).
As the leader in complement biology for over 20 years, Alexion focuses its research efforts on novel molecules and targets in the complement cascade, and its development efforts on the core therapeutic areas of hematology, nephrology, neurology, and metabolic disorders.

2.
Basis of Presentation and Principles of Consolidation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. These accounting principles were applied on a basis consistent with those of the consolidated financial statements contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2016 . In our opinion, the accompanying unaudited consolidated financial statements include all adjustments, consisting of normal recurring accruals, necessary for a fair statement of our financial statements for interim periods in accordance with accounting principles generally accepted in the United States. The condensed consolidated balance sheet data as of December 31, 2016 was derived from audited financial statements but does not include all disclosures required by accounting principles generally accepted in the United States. These interim financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2016 included in our Annual Report on Form 10-K. The results of operations for the three and nine months ended September 30, 2017 are not necessarily indicative of the results to be expected for the full year.
The financial statements of our subsidiaries with functional currencies other than the U.S. dollar are translated into U.S. dollars using period-end exchange rates for assets and liabilities, historical exchange rates for stockholders' equity and weighted average exchange rates for operating results. Translation gains and losses are included in accumulated other comprehensive income (loss), net of tax, in stockholders' equity. Foreign currency transaction gains and losses are included in the results of operations in other income and expense.
The accompanying unaudited condensed consolidated financial statements include the accounts of Alexion Pharmaceuticals, Inc. and its subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Our significant accounting policies are described in Note 1 of the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2016 .
Change in Accounting Estimates
We have historically deferred revenue recognition for sales to certain international customers, mainly distributors, until the product was received by the end customer due to various factors, including our inability to estimate product returns. On a regular basis, we review revenue arrangements, including our distributor relationships, to determine whether any changes in these arrangements or historical experience with these customers have an impact on revenue recognition. In the first quarter 2017, we determined that we had sufficient sales experience with certain customers to estimate product returns from such customers. We accounted for this prospectively as a change in estimate and began to recognize revenue for these customers when title to the product and the associated risk of loss passed to the customer. Some customers purchase larger quantities of product less frequently, which may result in revenue fluctuations from quarter to quarter. We do not believe these buying patterns increase the risk of product returns or our ability to estimate such returns.

New Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (FASB) issued a comprehensive new standard which amends revenue recognition principles and provides a single set of criteria for revenue recognition among all industries. The new

6

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





standard provides a five step framework whereby revenue is recognized when promised goods or services are transferred to a customer at an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard also requires enhanced disclosures pertaining to revenue recognition in both interim and annual periods. The standard is effective for interim and annual periods beginning after December 15, 2017 and allows for adoption using a full retrospective method, or a modified retrospective method. Entities may elect to early adopt the standard for annual periods beginning after December 15, 2016. We plan to adopt the new standard in the first quarter 2018 using the modified retrospective method. We have performed a review of the new standard compared to our current accounting policies and we have not identified any accounting changes that would materially impact the recognition of our net product sales. We have completed our review of customer contracts and we plan to finalize our analysis of these contracts in the fourth quarter 2017 to determine the impact that this standard may have on our financial position, results of operations and disclosures.
In February 2016, the FASB issued a new standard requiring that the rights and obligations arising from leases be recognized on the balance sheet by recording a right-of-use asset and corresponding lease liability. The new standard also requires qualitative and quantitative disclosures to understand the amount, timing, and uncertainty of cash flows arising from leases, as well as significant management estimates utilized. The standard is effective for interim and annual periods beginning after December 15, 2018 and requires a modified retrospective adoption. We are currently assessing the impact of this standard on our financial condition and results of operations.
In March 2016, the FASB issued a new standard intended to simplify certain aspects of the accounting for employee share-based payments. One aspect of the standard requires an entity to recognize all excess tax benefits and deficiencies associated with stock-based compensation as a reduction or increase to tax expense in the income statement. Previously, such amounts were recognized in additional paid-in capital. The amendments also require recognition of excess tax benefits regardless of whether the benefit reduces taxes payable in the current period. Furthermore, the amendment requires that excess tax benefits be classified as an operating activity in the statement of cash flows instead of a financing activity. We elected to early adopt this standard in the third quarter of 2016. We also elected to continue to estimate the impact of forfeitures when determining the amount of compensation cost to be recognized each period rather than account for forfeitures as they occur.
In October 2016, the FASB issued a new income tax standard that eliminates the exception for an intra-entity asset transfer other than inventory. Under the new standard, entities should recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. Any deferred tax asset that arises in the buyer's jurisdiction would also be recognized at the time of the transfer. We elected to early adopt this standard in the first quarter 2017. As a result of the adoption, in the first quarter of 2017, we recorded a $19 decrease in retained earnings, primarily resulting from the elimination of previously recorded prepaid tax assets.
In January 2017, the FASB issued a new standard that clarifies the definition of a business and determines when an integrated set of assets and activities is not a business. This framework requires that if substantially all of the fair value of gross assets acquired or disposed of is concentrated in a single asset or group of similar identifiable assets, the assets would not represent a business. The standard is effective for interim and annual periods beginning after December 15, 2017 with early adoption permitted. We anticipate that the adoption of this new standard will result in more transactions being accounted for as asset acquisitions.
In August 2017, the FASB issued a new standard intended to improve and simplify certain aspects of the accounting for hedges. The new standard is intended to more closely align hedge accounting with companies’ risk management strategies, simplify the application of hedge accounting, and increase transparency as to the scope and results of hedging programs. It also amends the presentation and disclosure requirements and changes how companies assess effectiveness. The standard is effective for interim and annual periods beginning after December 15, 2018 with early adoption permitted. We are currently assessing the impact of this standard on our financial condition and results of operations.


7

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





3.
Inventories
Inventories are stated at the lower of cost or estimated realizable value. We determine the cost of inventory on a standard cost basis, which approximates average costs.
The components of inventory are as follows:
 
September 30,
 
December 31,
 
2017
 
2016
Raw materials
$
12

 
$
17

Work-in-process
150

 
143

Finished goods
279

 
215

 
$
441

 
$
375



4.
Intangible Assets and Goodwill
The following table summarizes the carrying amount of our intangible assets and goodwill, net of accumulated amortization:  
 
 
 
September 30, 2017
 
December 31, 2016
 
Estimated
Life (years)
 
Cost
 
Accumulated
Amortization
 
Net
 
Cost
 
Accumulated
Amortization
 
Net
Licenses
6-8
 
$
29

 
$
(29
)
 
$

 
$
29

 
$
(29
)
 
$

Patents
7
 
11

 
(11
)
 

 
11

 
(11
)
 

Purchased technology
6-16
 
4,711

 
(679
)
 
4,032

 
4,711

 
(439
)
 
4,272

Acquired IPR&D
Indefinite
 

 

 

 
31

 

 
31

Total
 
 
$
4,751

 
$
(719
)
 
$
4,032

 
$
4,782

 
$
(479
)
 
$
4,303

Goodwill
Indefinite
 
$
5,040

 
$
(3
)
 
$
5,037

 
$
5,040

 
$
(3
)
 
$
5,037

In the second quarter 2017, we recognized an impairment charge of $31 related to our SBC-103 acquired in-process research and development asset due to clinical results.
Amortization expense was $80 and $82 for the three months ended September 30, 2017 and 2016 , respectively, and $240 and $242 for the nine months ended September 30, 2017 and 2016 , respectively. Assuming no changes in the gross cost basis of intangible assets, the total estimated amortization expense for finite-lived intangible assets is $80 for the three months ending December 31, 2017 , and $320 for each of the years ending December 31, 2018 through December 31, 2022 .

5.
Debt
On June 22, 2015, Alexion entered into a credit agreement (Credit Agreement) with a syndicate of banks, which provides for a $3,500 term loan facility and a $500 revolving credit facility maturing in five years. Borrowings under the term loan are payable in quarterly installments equal to 1.25% of the original loan amount, beginning December 31, 2015. Final repayment of the term loan and revolving credit loans are due on June 22, 2020. In addition to borrowings in which prior notice is required, the revolving credit facility includes a sublimit of $100 in the form of letters of credit and borrowings on same-day notice, referred to as swingline loans, of up to $25 . Borrowings can be used for working capital requirements, acquisitions and other general corporate purposes. With the consent of the lenders and the administrative agent, and subject to satisfaction of certain conditions, we may increase the term loan facility and/or the revolving credit facility in an amount that does not cause our consolidated net leverage ratio to exceed the maximum allowable amount.
In connection with entering into the Credit Agreement, we paid $45 in financing costs which are being amortized as interest expense over the life of the debt. Amortization expense associated with deferred financing costs for each of the three and nine months ended September 30, 2017 and 2016 was $2 and $7 , respectively.
We made principal payments of $131 during the nine months ended September 30, 2017 . As of September 30, 2017 , $2,950 remained outstanding on the term loan. As of September 30, 2017 , we had open letters of credit of $4 , and our borrowing availability under the revolving facility was $496 .

8

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





The fair value of our long term debt, which is measured using Level 2 inputs, approximates book value.

6.
Earnings Per Common Share
Basic earnings per common share (EPS) is computed by dividing net income by the weighted-average number of shares of common stock outstanding. For purposes of calculating diluted EPS, the denominator reflects the potential dilution that could occur if stock options, unvested restricted stock, unvested restricted stock units or other contracts to issue common stock were exercised or converted into common stock, using the treasury stock method.
The following table summarizes the calculation of basic and diluted EPS for the three and nine months ended September 30, 2017 and 2016 :
 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2017
 
2016
 
2017
 
2016
Net income used for basic and diluted calculation
$
78

 
$
94

 
$
413

 
$
306

Shares used in computing earnings per common share—basic
223

 
224

 
224

 
224

Weighted-average effect of dilutive securities:
 
 
 
 
 
 
 
Stock awards
2

 
2

 
2

 
2

Shares used in computing earnings per common share—diluted
225

 
226

 
226

 
226

Earnings per common share:
 
 
 
 
 
 
 
Basic
$
0.35

 
$
0.42

 
$
1.84

 
$
1.37

Diluted
$
0.35

 
$
0.42

 
$
1.83

 
$
1.35

We exclude from EPS the weighted-average number of securities whose effect is anti-dilutive. Excluded from the calculation of EPS for each of the three months ended September 30, 2017 and 2016 were 4 and 5 shares of common stock because their effect was anti-dilutive. Similarly, we excluded from the calculation of EPS for each of the nine months ended September 30, 2017 and 2016 were 4 shares of common stock because their effect was anti-dilutive.
 
7.
Marketable Securities

The amortized cost, gross unrealized holding gains, gross unrealized holding losses and fair value of available-for-sale investments by type of security as of September 30, 2017 and December 31, 2016 were as follows:
 
 
September 30, 2017
 
 
Amortized Cost
 
Gross Unrealized Holding Gains
 
Gross Unrealized Holding Losses
 
Fair Value
Commercial paper
 
$
33

 
$

 
$

 
$
33

Corporate bonds
 
471

 
1

 

 
472

Other government-related obligations:
 
 
 
 
 
 
 
 
U.S.
 
5

 

 

 
5

Foreign
 
449

 

 

 
449

Bank certificates of deposit
 
27

 

 

 
27

Total available-for-sale debt securities
 
$
985

 
$
1

 
$

 
$
986

Equity securities
 

 
1

 

 
1

Total available-for-sale securities
 
$
985

 
$
2

 
$

 
$
987


9

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






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

 
$

 
$

 
$
114

Corporate bonds
 
124

 

 
(1
)
 
123

Municipal bonds
 
91

 

 

 
91

Other government-related obligations:
 
 
 
 
 
 
 
 
U.S.
 
28

 

 

 
28

Foreign
 
73

 

 
(1
)
 
72

Bank certificates of deposit
 
5

 

 

 
5

Total available-for-sale debt securities
 
$
435

 
$

 
$
(2
)
 
$
433

Equity securities
 

 
1

 

 
1

Total available-for-sale securities
 
$
435

 
$
1

 
$
(2
)
 
$
434


The aggregate fair value of available-for-sale securities in an unrealized loss position as of September 30, 2017 and December 31, 2016 was $361 and $265 , respectively. Investments that have been in a continuous unrealized loss position for more than 12 months were $12 as of September 30, 2017 and zero as of December 31, 2016 . As of September 30, 2017 , we believe that the cost basis of our available-for-sale investments is recoverable.
The fair values of available-for-sale securities by classification in the condensed consolidated balance sheet were as follows:
 
September 30, 2017
 
December 31, 2016
Cash and cash equivalents
$
26

 
$
120

Marketable securities
961

 
314

 
$
987

 
$
434


The fair values of available-for-sale debt securities as of September 30, 2017 , by contractual maturity, are summarized as follows:
 
September 30, 2017
Due in one year or less
$
493

Due after one year through three years
493

 
$
986


As of September 30, 2017 and December 31, 2016 , the fair value of our trading securities was $18 and $13 , respectively.
We utilize the specific identification method in computing realized gains and losses. Realized gains and losses on our available-for-sale and trading securities were not material for the three and nine months ended September 30, 2017 and 2016 .
8.
Derivative Instruments and Hedging Activities
We operate internationally and, in the normal course of business, are exposed to fluctuations in foreign currency exchange rates. The exposures result from portions of our revenues, as well as the related receivables, and expenses that are denominated in currencies other than the U.S. dollar, primarily the Euro and Japanese Yen. We are also exposed to fluctuations in interest rates on our outstanding term loan debt. We manage these exposures within specified guidelines through the use of derivatives. All of our derivative instruments are utilized for risk management purposes, and we do not use derivatives for speculative trading purposes.

10

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





We enter into foreign exchange forward contracts, with durations of up to 60 months, to hedge exposures resulting from portions of our forecasted revenues, including intercompany revenues, and certain forecasted expenses that are denominated in currencies other than the U.S. dollar. The purpose of these hedges is to reduce the volatility of exchange rate fluctuations on our operating results. These hedges are designated as cash flow hedges upon contract inception. As of September 30, 2017 , we had open revenue related foreign exchange forward contracts with notional amounts totaling $1,576 that qualified for hedge accounting. As of September 30, 2017 , we had open expense related foreign exchange forward contracts with notional amounts totaling $28 that qualified for hedge accounting.
To achieve a desired mix of floating and fixed interest rates on our term loan, we enter into interest rate swap agreements that qualify for and are designated as cash flow hedges. These contracts convert the floating interest rate on a portion of our debt to a fixed rate, plus a borrowing spread. As of September 30, 2017 we are party to interest rate swap agreements with a total notional amount of $2,331 that convert the floating rate on a portion of our term loan to fixed rates ranging from 0.98% to 2.08% , plus borrowing spreads. These agreements cover periods through December 31, 2019 .
The following tables summarize the total interest rate swap contracts executed as of September 30, 2017 :
Type of Interest Rate Swap
 
Notional Amount
 
Effective Date
 
Termination Date
 
Fixed Interest Rate
Floating to Fixed
 
656
 
December 31, 2016
 
December 31, 2019
 
0.98%
Floating to Fixed
 
300
 
January 31, 2017
 
December 31, 2018
 
1.29%
Floating to Fixed
 
300
 
January 2, 2019
 
December 31, 2019
 
2.08%
Floating to Fixed
 
200
 
March 31, 2017
 
December 31, 2019
 
1.62%
Floating to Fixed
 
200
 
March 31, 2017
 
December 31, 2018
 
1.40%
Floating to Fixed
 
200
 
June 30, 2017
 
December 31, 2019
 
1.53%
Floating to Fixed
 
100
 
June 30, 2017
 
December 31, 2019
 
1.50%
Floating to Fixed
 
100
 
June 30, 2017
 
December 31, 2019
 
1.52%
Floating to Fixed
 
200
 
June 30, 2017
 
December 31, 2019
 
1.57%
Floating to Fixed
 
75
 
January 1, 2018
 
December 31, 2019
 
1.58%
The impact on accumulated other comprehensive income (AOCI) and earnings from foreign exchange and interest rate swap contracts that qualified as cash flow hedges, for the three and nine months ended September 30, 2017 and 2016 were as follows:
 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2017
 
2016
 
2017
 
2016
Foreign Exchange Contracts:
 
 
 
 
 
 
 
Loss recognized in AOCI, net of tax
$
(27
)
 
$
(10
)
 
$
(88
)
 
$
(50
)
(Loss) gain reclassified from AOCI to net product sales (effective portion), net of tax
$
(1
)
 
$
8

 
$
20

 
$
33

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

 
$
2

 
$


$
(1
)
Loss reclassified from AOCI to interest expense, net of tax
$

 
$

 
$
(1
)

$

Assuming no change in foreign exchange rates from market rates at September 30, 2017 , $15 of losses recognized in AOCI will be reclassified to revenue over the next 12 months. Assuming no change in LIBOR-based interest rates from market rates at September 30, 2017 , $3 of gains recognized in AOCI will be reclassified to interest expense over the next 12 months.
We enter into foreign exchange forward contracts, with durations up to 180 days, designed to limit the balance sheet exposure of monetary assets and liabilities. We enter into these hedges to reduce the impact of fluctuating exchange rates on our operating results. Hedge accounting is not applied to these derivative instruments as gains and losses on these hedge transactions are designed to offset gains and losses on underlying balance sheet exposures. As of September 30, 2017 , the notional amount of foreign exchange contracts where hedge accounting is not applied was $599 .
We recognized a loss of $3 in other income and expense for the three months ended September 30, 2017 and 2016 , and

11

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





$12 and $21 , for the nine months ended September 30, 2017 and 2016 , respectively, associated with the foreign exchange contracts not designated as hedging instruments. These amounts were partially offset by gains or losses on monetary assets and liabilities.
The following tables summarize the fair value of outstanding derivatives at September 30, 2017 and December 31, 2016 :  

 
September 30, 2017
 
Asset Derivatives
 
Liability Derivatives
 
Balance Sheet
Location
 
Fair
Value
 
Balance Sheet
Location
 
Fair
Value
Derivatives designated as hedging instruments:

 
 
 
 
 
 
Foreign exchange forward contracts
Prepaid expenses and other current assets
 
$
17

 
Other current liabilities
 
$
32

Foreign exchange forward contracts
Other assets
 
7

 
Other liabilities
 
28

Interest rate contracts
Prepaid expenses and other current assets
 
4

 
Other current liabilities
 
1

Interest rate contracts
Other assets
 
10

 
Other liabilities
 
1

Derivatives not designated as hedging instruments:

 
 
 

 

Foreign exchange forward contracts
Prepaid expenses and other current assets
 
4

 
Other current liabilities
 
5

Total fair value of derivative instruments
 
 
$
42

 
 
 
$
67



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

 
Other current liabilities
 
$
2

Foreign exchange forward contracts
Other assets
 
59

 
Other liabilities
 
4

Interest rate contracts
Prepaid expenses and other current assets
 

 
Other current liabilities
 

Interest rate contracts
Other assets
 
10

 
Other liabilities
 

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

 
Other current liabilities
 
10

Total fair value of derivative instruments
 
 
$
166

 
 
 
$
16





12

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





Although we do not offset derivative assets and liabilities within our condensed consolidated balance sheets, our International Swap and Derivatives Association agreements provide for net settlement of transactions that are due to or from the same counterparty upon early termination of the agreement due to an event of default or other termination event. The following tables summarize the potential effect on our condensed consolidated balance sheets of offsetting our foreign exchange forward contracts and interest rate contracts subject to such provisions:
 
 
September 30, 2017
 
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Condensed Consolidated Balance Sheet
 
 
Description
 
Gross Amounts of Recognized Assets/Liabilities
 
Gross Amounts Offset in the Condensed Consolidated Balance Sheet
 
Net Amounts of Assets/Liabilities Presented in the Condensed Consolidated Balance Sheet
 
Derivative Financial Instruments
 
Cash Collateral Received (Pledged)
 
Net Amount
Derivative assets
 
$
42

 
$

 
$
42

 
$
(27
)
 
$

 
$
15

Derivative liabilities
 
(67
)
 

 
(67
)
 
27

 

 
(40
)


 
 
December 31, 2016
 
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Condensed Consolidated Balance Sheet
 
 
Description
 
Gross Amounts of Recognized Assets/Liabilities
 
Gross Amounts Offset in the Condensed Consolidated Balance Sheet
 
Net Amounts of Assets/Liabilities Presented in the Condensed Consolidated Balance Sheet
 
Derivative Financial Instruments
 
Cash Collateral Received (Pledged)
 
Net Amount
Derivative assets
 
$
166

 
$

 
$
166

 
$
(16
)
 
$

 
$
150

Derivative liabilities
 
(16
)
 

 
(16
)
 
16

 

 


9.
Other Investments
Other investments include our investment of $38 in the preferred stock of Moderna Therapeutics, Inc. Our investment is recorded at cost within other assets in our condensed consolidated balance sheets. The carrying value of this investment was not impaired as of September 30, 2017 .


10.
Stockholders' Equity
In November 2012, our Board of Directors authorized a share repurchase program. The repurchase program does not have an expiration date, and we are not obligated to acquire a particular number of shares. The repurchase program may be discontinued at any time at the Company's discretion. In February 2017, our Board of Directors increased the authorization to acquire shares with an aggregate value of up to $1,000 for future purchases under the repurchase program, which superseded all prior repurchase programs. Under the program, for each of the three months ended September 30, 2017 and 2016 we repurchased 1 shares of our common stock at a cost of $60 and $69 , respectively. During each of the nine months ended September 30, 2017 and 2016 we repurchased 3 shares of our common stock at a cost of $299 and $400 , respectively.


13

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





11.
Other Comprehensive Income and Accumulated Other Comprehensive Income

The following tables summarize the changes in AOCI, by component, for the nine months ended September 30, 2017 and 2016 :

 
Defined Benefit Pension Plans
 
Unrealized Gains (Losses) from Marketable Securities
 
Unrealized Gains (Losses) from Hedging Activities
 
Foreign Currency Translation Adjustment
 
Total Accumulated Other Comprehensive Income (Loss)
Balances, December 31, 2016
$
(7
)
 
$
(1
)
 
$
92

 
$
(24
)
 
$
60

Other comprehensive income before reclassifications

 

 
(88
)
 
9

 
(79
)
Amounts reclassified from other comprehensive income

 
1

 
(19
)
 

 
(18
)
Net other comprehensive income (loss)

 
1

 
(107
)
 
9

 
(97
)
Balances, September 30, 2017
$
(7
)
 
$

 
$
(15
)
 
$
(15
)
 
$
(37
)

 
Defined Benefit Pension Plans
 
Unrealized Gains (Losses) from Marketable Securities
 
Unrealized Gains (Losses) from Hedging Activities
 
Foreign Currency Translation Adjustment
 
Total Accumulated Other Comprehensive Income (Loss)
Balances, December 31, 2015
$
(10
)
 
$
(1
)
 
$
93

 
$
(20
)
 
$
62

Other comprehensive income before reclassifications
1

 
2

 
(51
)
 
3

 
(45
)
Amounts reclassified from other comprehensive income

 

 
(33
)
 

 
(33
)
Net other comprehensive income (loss)
1

 
2

 
(84
)
 
3

 
(78
)
Balances, September 30, 2016
$
(9
)
 
$
1

 
$
9

 
$
(17
)
 
$
(16
)


The table below provides details regarding significant reclassifications from AOCI during the three and nine months ended September 30, 2017 and 2016 :
Details about Accumulated Other Comprehensive Income Components
 
Amount Reclassified From Accumulated Other Comprehensive Income during the three months ended September 30,
 
Amount Reclassified From Accumulated Other Comprehensive Income during the nine months ended September 30,
 
Affected Line Item in the Condensed Consolidated Statements of Operations
 
2017
2016
 
2017
2016
 
Unrealized Gains (Losses) from Hedging Activity
 
 
 
 
 
 
 
 
Effective portion of foreign exchange contracts
 
$
(1
)
$
13

 
$
31

$
51

 
Net product sales
Effective portion of interest rate swap contracts
 


 
(1
)

 
Other expense
 
 
(1
)
13

 
30

51

 
 
 
 

(5
)
 
(11
)
(18
)
 
Income tax (benefit) expense
 
 
$
(1
)
$
8

 
$
19

$
33

 
 



14

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





12.
Fair Value Measurement
Authoritative guidance establishes a valuation hierarchy for disclosure of the inputs to the valuation used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument. Level 3 inputs are unobservable inputs based on our own assumptions used to measure assets and liabilities at fair value.
The following tables present information about our assets and liabilities that are measured at fair value on a recurring basis as of September 30, 2017 and December 31, 2016 , and indicate the fair value hierarchy of the valuation techniques we utilized to determine such fair value.  
 
 
Fair Value Measurement at
September 30, 2017
Balance Sheet
Classification
Type of Instrument
Total
 
Level 1
 
Level 2
 
Level 3
Cash equivalents
Commercial paper
$
15

 
$

 
$
15

 
$

Cash equivalents
Corporate bonds
$
8

 
$

 
$
8

 
$

Cash equivalents
Bank certificates of deposit
$
3

 
$

 
$
3

 
$

Marketable securities
Mutual funds
$
18

 
$
18

 
$

 
$

Marketable securities
Commercial paper
$
18

 
$

 
$
18

 
$

Marketable securities
Corporate bonds
$
464

 
$

 
$
464

 
$

Marketable securities
Other government-related obligations
$
454

 
$

 
$
454

 
$

Marketable securities
Bank certificates of deposit
$
24

 
$

 
$
24

 
$

Marketable securities
Equity securities
$
1

 
$
1

 
$

 
$

Prepaid expenses and other current assets
Foreign exchange forward contracts
$
21

 
$

 
$
21

 
$

Other assets
Foreign exchange forward contracts
$
7

 
$

 
$
7

 
$

Other current liabilities
Foreign exchange forward contracts
$
37

 
$

 
$
37

 
$

Other liabilities
Foreign exchange forward contracts
$
28

 
$

 
$
28

 
$

Prepaid expenses and other current assets
Interest rate contracts
$
4

 
$

 
$
4

 
$

Other assets
Interest rate contracts
$
10

 
$

 
$
10

 
$

Other current liabilities
Interest rate contracts
$
1

 
$

 
$
1

 
$

Other liabilities
Interest rate contracts
$
1

 
$

 
$
1

 
$

Contingent consideration
Acquisition-related contingent consideration
$
160

 
$

 
$

 
$
160

 

15

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





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

 
$

 
$
266

 
$

Cash equivalents
Commercial paper
$
70

 
$

 
$
70

 
$

Cash equivalents
Corporate bonds
$
10

 
$

 
$
10

 
$

Cash equivalents
Municipal bonds
$
40

 
$

 
$
40

 
$

Marketable securities
Mutual funds
$
13

 
$
13

 
$

 
$

Marketable securities
Commercial paper
$
44

 
$

 
$
44

 
$

Marketable securities
Corporate bonds
$
113

 
$

 
$
113

 
$

Marketable securities
Municipal bonds
$
51

 
$

 
$
51

 
$

Marketable securities
Other government-related obligations
$
100

 
$

 
$
100

 
$

Marketable securities
Bank certificates of deposit
$
5


$


$
5


$

Marketable securities
Equity securities
$
1


$
1


$


$

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

 
$

 
$
97

 
$

Other assets
Foreign exchange forward contracts
$
59

 
$

 
$
59

 
$

Other current liabilities
Foreign exchange forward contracts
$
12

 
$

 
$
12

 
$

Other liabilities
Foreign exchange forward contracts
$
4

 
$

 
$
4

 
$

Other assets
Interest rate contracts
$
10


$


$
10


$

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

 
$

 
$

 
$
24

Contingent consideration
Acquisition-related contingent consideration
$
129

 
$

 
$

 
$
129


There were no securities transferred between Level 1, 2 and 3 during the nine months ended September 30, 2017 .

Valuation Techniques
We classify mutual fund investments and equity securities, which are valued based on quoted market prices in active markets with no valuation adjustment, as Level 1 assets within the fair value hierarchy.
Cash equivalents and marketable securities classified as Level 2 within the valuation hierarchy consist of money market funds, commercial paper, municipal bonds, U.S. and foreign government-related debt, corporate debt securities and certificates of deposit. We estimate the fair values of these marketable securities by taking into consideration valuations obtained from third-party pricing sources. These pricing sources utilize industry standard valuation models, including both income and market-based approaches, for which all significant inputs are observable, either directly or indirectly, to estimate fair value. These inputs include market pricing based on real-time trade data for the same or similar securities, issuer credit spreads, benchmark yields, and other observable inputs. We validate the prices provided by our third-party pricing sources by understanding the models used, obtaining market values from other pricing sources and analyzing pricing data in certain instances.
Our derivative assets and liabilities include foreign exchange and interest rate derivatives that are measured at fair value using observable market inputs such as forward rates, interest rates, our own credit risk as well as an evaluation of our counterparties’ credit risks. Based on these inputs, the derivative assets and liabilities are classified within Level 2 of the valuation hierarchy.
Contingent consideration liabilities related to acquisitions are classified as Level 3 within the valuation hierarchy and are valued based on various estimates, including probability of success, discount rates and amount of time until the conditions of the milestone payments are met.

16

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





As of September 30, 2017 , there has not been any impact to the fair value of our derivative liabilities due to our own credit risk. Similarly, there has not been any significant adverse impact to our derivative assets based on our evaluation of our counterparties’ credit risks.

Contingent Consideration
In connection with prior acquisitions, we may be required to pay future consideration that is contingent upon the achievement of specified development, regulatory approvals or sales-based milestone events. We determine the fair value of these obligations on the acquisition date using various estimates that are not observable in the market and represent a Level 3 measurement within the fair value hierarchy. The resulting probability-weighted cash flows were discounted using a cost of debt of 4.7% for developmental milestones and a weighted average cost of capital ranging from 10% to 21% for sales-based milestones.
Each reporting period, we adjust the contingent consideration to fair value with changes in fair value recognized in operating earnings. Changes in fair values reflect new information about the probability and timing of meeting the conditions of the milestone payments. In the absence of new information, changes in fair value will only reflect the interest component of contingent consideration related to the passage of time.
Estimated future contingent milestone payments related to prior business combinations range from zero if no milestone events are achieved, to a maximum of $741 if all development, regulatory and sales-based milestones are reached. As of September 30, 2017 , the fair value of acquisition-related contingent consideration was $160 . The following table represents a roll-forward of our acquisition-related contingent consideration:
 
Nine months ended
 
September 30, 2017
Balance at December 31, 2016
$
(153
)
Milestone payments
25

Changes in fair value
(32
)
Balance at September 30, 2017
$
(160
)

In the second quarter 2017, a sales-based milestone associated with our acquisition of Enobia Pharma Corp was achieved. In connection with such achievement, we made a $25 milestone payment in the third quarter 2017.

13.
Income Taxes
The following table provides a comparative summary of our income tax expense and effective income tax rate for the three and nine months ended September 30, 2017 and 2016 :
 
 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2017
 
2016
 
2017
 
2016
Income tax (benefit) expense
$
(20
)
 
$
65

 
$
45

 
$
166

Effective tax rate
(34.5
)%
 
40.9
%
 
9.8
%
 
35.2
%

The income tax expense for the three and nine months ended September 30, 2017 and 2016 is attributable to the U.S. federal, state and foreign income taxes on our profitable operations. The decrease in the effective tax rate for the three and nine months ended September 30, 2017 as compared to the same period in the prior year is primarily attributable to the deferred tax cost associated with the distribution of earnings from our captive foreign partnership in 2016 and conclusion of the Internal Revenue Service (IRS) examination of our 2013 and 2014 tax years in 2017. The 2016 distribution increased the effective tax rate for the three and nine months ended September 30, 2016 by approximately 22% . Conclusion of the IRS examination resulted in a decrease to our 2017 effective tax rate for the three and nine months ended September 30, 2017 of approximately 65% and 8% , respectively.
We continue to maintain a valuation allowance against certain deferred tax assets where realization is not certain.


17

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





14.
Defined Benefit Plans
We maintain defined benefit plans for employees in certain countries outside the U.S., including retirement benefit plans required by applicable local law. The plans are valued by independent actuaries using the projected unit credit method. The liabilities correspond to the projected benefit obligations of which the discounted net present value is calculated based on years of employment, expected salary increases, and pension adjustments. The total net periodic benefit cost for each of the three and nine months ended September 30, 2017 and 2016 was $2 and $5 , respectively, primarily related to service costs.

15.
Facility Lease Obligations
New Haven Facility Lease Obligation
In November 2012, we entered into a lease agreement for office and laboratory space to be constructed in New Haven, Connecticut. The term of the lease commenced in 2015 and will expire in 2030, with a renewal option of ten years. Although we do not legally own the premises, we are deemed to be the owner of the building due to the substantial improvements directly funded by us during the construction period based on applicable accounting guidance for build-to-suit leases. Accordingly, the landlord's costs of constructing the facility during construction period are required to be capitalized, as a non-cash transaction, offset by a corresponding facility lease obligation in our consolidated balance sheet.
Construction of the facility was completed and the building was placed into service in the first quarter 2016. Associated with this arrangement we recognized interest expense of $4 for each of the three months ended September 30, 2017 and 2016 , and $11 and $10 for the nine months ended September 30, 2017 and 2016 , respectively. As of September 30, 2017 and December 31, 2016 , our total facility lease obligation was $135 and $136 , respectively, recorded within other current liabilities and facility lease obligation on our condensed consolidated balance sheets.
Lonza Facility Lease Obligation
During the third quarter 2015, we entered into a new agreement with Lonza Group AG and its affiliates (Lonza) whereby Lonza will construct a new manufacturing facility dedicated to Alexion at one of its existing facilities. The agreement requires us to make certain payments during the construction of the new manufacturing facility and annual payments for ten years thereafter. As a result of our contractual right to full capacity of the new manufacturing facility, a portion of the payments under the agreement are considered to be lease payments and a portion as payment for the supply of inventory. Although we will not legally own the premises, we are deemed to be the owner of the manufacturing facility during the construction period based on applicable accounting guidance for build-to-suit leases due to our involvement during the construction period. As of September 30, 2017 and December 31, 2016 , we recorded a construction-in-process asset of $176 and $118 , respectively, and an offsetting facility lease obligation of $157 and $107 , respectively, associated with the manufacturing facility.
Payments to Lonza under the agreement are allocated to the purchases of inventory and the repayment of the facility lease obligation on a relative fair value basis. In 2017 , we incurred $52 of payments to Lonza under this agreement, of which $7 was applied against the outstanding facility lease obligation and $45 was recognized as a prepayment of inventory. See Note 16 for minimum fixed payments due under Lonza agreements.
Boston Facility Lease Obligation
In September 2017, we entered into a lease agreement for six floors of office space that is currently being constructed in Boston, Massachusetts. The term of the lease will commence upon the landlord's substantial completion of our premises and will expire on the thirteenth anniversary of commencement, with an option to renew for up to an additional ten years. Although we will not legally own the premises, due to our involvement during the construction period, we are deemed to be the owner of the portion of the building that we will lease based on applicable accounting guidance for build-to-suit leases. Accordingly, the landlord's costs of constructing the facility during the construction period are required to be capitalized, as a non-cash transaction, offset by a corresponding facility lease obligation in our consolidated balance sheet.
The landlord's construction of the building is in process and is expected to be completed during the first half of 2018. As of September 30, 2017, we recorded a construction-in-process asset and an offsetting facility lease obligation of $52 associated with our relative portion of the building.


18

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





16.
Commitments and Contingencies
Commitments
License Agreements
We have entered into a number of license agreements in order to advance and obtain technologies and services related to our business. License agreements generally require us to pay an initial fee and certain agreements call for future payments upon the attainment of agreed upon development and/or commercial milestones. These agreements may also require minimum royalty payments based on sales of products developed from the applicable technologies, if any.
Manufacturing Agreements
We have various manufacturing development and license agreements to support our clinical and commercial product needs.
We rely on Lonza, a third party manufacturer, to produce a portion of commercial and clinical quantities of Soliris and Strensiq. We have various manufacturing and license agreements with Lonza, with remaining total non-cancellable future commitments of approximately $1,188 . If we terminate certain supply agreements with Lonza without cause, we will be required to pay for product scheduled for manufacture under our arrangement. Under an existing arrangement with Lonza, we also pay Lonza a royalty on sales of Soliris manufactured at Alexion Rhode Island Manufacturing Facility (ARIMF) and a payment with respect to sales of Soliris manufactured at Lonza facilities.
In addition to Lonza, we have non-cancellable commitments of approximately $20 with other third party manufacturers.

Contingent Liabilities
We are currently involved in various claims, lawsuits and legal proceedings. On a quarterly basis, we review the status of each significant matter and assess its potential financial exposure. If the potential loss from any claim, asserted or unasserted, or legal proceeding is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. Because of uncertainties related to claims and litigation, accruals are based on our best estimates based on available information. On a periodic basis, as additional information becomes available, or based on specific events such as the outcome of litigation or settlement of claims, we may reassess the potential liability related to these matters and may revise these estimates, which could result in a material adverse adjustment to our operating results.
We have in the past received, and may in the future receive, notices from third parties claiming that their patents may be infringed by the development, manufacture or sale of our products. Under the guidance of ASC 450, Contingencies , we record a royalty accrual based on our best estimate of the fair value percent of net sales of our products that we could be required to pay the owners of patents for technology used in the manufacture and sale of our products. A costly license, or inability to obtain a necessary license, could have a material adverse effect on our financial results.
In May 2015, we received a subpoena in connection with an investigation by the Enforcement Division of the SEC requesting information related to our grant-making activities and compliance with the U.S. Foreign Corrupt Practices Act (FCPA) in various countries. In addition, in October 2015, we received a request from the DOJ for the voluntary production of documents and other information pertaining to Alexion's compliance with FCPA. The SEC and DOJ also seek information related to Alexion’s recalls of specific lots of Soliris and related securities disclosures. Alexion is cooperating with these investigations.
The investigations have focused on operations in various countries, including Brazil, Colombia, Japan, Russia and Turkey, and Alexion's compliance with the FCPA and other applicable laws.
At this time, Alexion is unable to predict the duration, scope or outcome of these investigations. While it is possible that a loss related to these matters may be incurred, given the ongoing nature of these investigations, management cannot reasonably estimate the potential magnitude of any such loss or range of loss, or the cost of the ongoing investigation. Any determination that our operations or activities are not in compliance with existing laws or regulations could result in the imposition of fines, civil and criminal penalties, equitable remedies, including disgorgement, injunctive relief, and/or other sanctions against us, and remediation of any such findings could have an adverse effect on our business operations.
Alexion is committed to strengthening its compliance program and has initiated a comprehensive company-wide transformation plan to enhance and remediate its business processes, structures, controls, training, talent and systems across Alexion’s global operations. For information concerning the risks associated with the investigation, see our Risk Factor - "If

19

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





we fail to comply with laws or regulations, we may be subject to investigations and civil or criminal penalties and our business could be adversely affected."
As previously reported, on December 29, 2016, a shareholder filed a putative class action against the Company and certain former employees in the U.S. District Court for the District of Connecticut, alleging that defendants made misrepresentations and omissions about Soliris. On April 12, 2017, the court appointed lead plaintiff. On July 14, 2017, lead plaintiff filed an amended putative class action complaint against the Company and seven current or former employees. The complaint alleges that defendants made misrepresentations and omissions about Soliris, including alleged misrepresentations regarding sales practices, management changes, and related investigations, between January 30, 2014 and May 26, 2017, and that the Company's stock price dropped upon the purported disclosure of the misrepresentations. Defendant's moved to dismiss the Amended Complaint on September 12, 2017. Given the early stages of this litigation, management does not currently believe that a loss related to this matter is probable or that the potential magnitude of such loss or range of loss, if any, can be reasonably estimated.
In December 2016, we received a subpoena from the U.S. Attorney's Office for the District of Massachusetts requesting documents relating generally to our support of 501(c)(3) organizations that provide financial assistance to Medicare patients taking drugs sold by Alexion, Alexion’s provision of free drug to Medicare patients, and Alexion compliance policies and training materials concerning the anti-kickback statute or payments to any 501(c)(3) organization that provides financial assistance to Medicare patients. We understand that the U.S. Attorney’s Office is coordinating with the Office of Inspector General (OIG) of the U.S. Department of Health and Human Services. Other companies have disclosed similar inquiries. We are cooperating with this inquiry.
In May 2017, Brazilian authorities seized records and data from our Sao Paulo, Brazil offices as part of an investigation being conducted into Alexion’s Brazilian operations. We are cooperating with this inquiry.
In June 2017, we received a demand to inspect certain Company books and records pursuant to Section 220 of the General Corporation Law of the State of Delaware on behalf of a purported stockholder. Among other things, the demand seeks to determine whether to institute a derivative lawsuit against certain of the Company’s directors and officers in relation to the investigation by our Audit and Finance Committee announced in November 2016 and the investigations instituted by the SEC, DOJ, U.S. Attorney’s Office for the District of Massachusetts, and Brazilian law enforcement officials that are described above. The Company is currently in the process of responding to the demand. Given the early stages of this matter, management does not currently believe that a loss related to this matter is probable or that the potential magnitude of such loss or range of loss, if any, can be reasonably estimated.
In March 2013, we received a Warning Letter (Warning Letter) from the U.S. Food and Drug Administration (FDA) regarding compliance with current Good Manufacturing Practices (cGMP) at ARIMF.  In October 2017, Alexion received a notification from the FDA that the Warning Letter has been resolved.  As previously announced, we plan to close ARIMF to align our manufacturing facilities with our ongoing multi-product network manufacturing strategy, which utilizes manufacturing operations in the U.S. and Ireland, and manufacturing capacity through manufacturing partners.
On September 22, 2017, a shareholder filed a suit, derivatively on behalf of the Company, in the U.S. District Court for the District of Delaware against eighteen current and former employees and members of the Board of Directors, naming the Company as a nominal defendant.  The complaint, which asserts federal and state law claims, alleges that between January 30, 2014 and September 22, 2017 defendants made misrepresentations and omissions about Soliris-including alleged misrepresentations regarding sales practices, management changes, and related investigations-in violation of federal securities law and in breach of their fiduciary duties to the Company.  The litigation is in the early stages, and defendants have not yet responded to the complaint.
On September 27, 2017, a hearing panel of the Canadian Patented Medicine Prices Review Board (PMPRB) issued a decision in a previously pending administrative pricing matter that Alexion had excessively priced Soliris in a manner inconsistent with the Canadian pricing rules and guidelines. In its decision, the PMPRB ordered Alexion to decrease the price of Soliris to an upper limit based upon pricing in certain other countries, and to forfeit excess revenues for the period between 2009 and 2017, in an amount to be determined by mutual agreement of the parties, or further ruling by the PMPRB, based upon the PMPRB’s Guidelines. We estimate that such amounts under the PMPRB’s order will not be material. In October 2017, Alexion filed an application for judicial review of the PMPRB’s decision in the Federal Court of Canada. At this time, we cannot predict the duration, scope or outcome of these judicial review proceedings or any appeals that may follow and cannot reasonably estimate the amount of any potential impact to Soliris revenues in Canada relating to any potential future price reduction.

20

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





In the second quarter 2017 , we recorded an immaterial out of period adjustment of approximately $6 for distribution fees related to importation expenses. These fees were recorded as accrued expenses in our consolidated balance sheet as of September 30, 2017 .

17.
Restructuring
In the first quarter of 2017, we initiated a company-wide restructuring designed to help position the Company for sustainable, long-term growth that we believe will further allow us to fulfill our mission of serving patients and families with rare diseases. The initial restructuring activities primarily focused on a reduction of the Company's global workforce. In September 2017, we committed to an operational plan to re-align the global organization with its refocused corporate strategy. The re-alignment focuses investments in priority growth areas to maximize leadership in complement and grow the rare disease business. The re-alignment also includes the relocation of the Company's headquarters to Boston, Massachusetts in 2018. Our New Haven, Connecticut site will continue to support employees working in the research and process development laboratories, the clinical supply and quality teams, nurse case management and a number of important enterprise business services. The plan is expected to further reduce the Company's global workforce by approximately 20% . The restructuring will achieve cost savings by focusing the development portfolio, simplifying business structures and processes across the Company's global operations, and closing of multiple Alexion sites, including ARIMF and certain regional and country-based offices.
For the three and nine months ended September 30, 2017 we recorded restructuring and related expenses of $164 and $191 , respectively. We expect to pay substantially all accrued amounts related to the 2017 restructuring activities by the end of 2018. We currently estimate incurring additional restructuring and related expenses of approximately $176 to $236 related to the 2017 restructuring activities.
The following table summarizes the total expenses recorded related to the 2017 restructuring activities by type of activity and the locations recognized within the consolidated statements of operations:
 
Three months ended September 30,
 
Nine months ended September 30,
 
2017
 
2017
 
Employee Separation Costs
 
Asset-Related Charges
 
Other
 
Total
 
Employee Separation Costs
 
Asset-Related Charges
 
Other
 
Total
Cost of sales
$

 
$
83

 
$

 
$
83

 
$

 
$
83

 
$

 
$
83

Research and development

 
1

 

 
1

 

 
1

 

 
1

Selling, general and administrative

 
6

 

 
6

 

 
6

 

 
6

Restructuring expenses
66

 

 
6

 
72

 
87

 

 
12

 
99

Other expense

 

 
2

 
2

 

 

 
2

 
2

 
$
66

 
$
90

 
$
8

 
$
164

 
$
87

 
$
90

 
$
14

 
$
191

Employee separation costs are associated with headcount reductions, as well as corporate employees not relocating with the Company's headquarters in 2018.
Asset-related charges consist of accelerated depreciation costs and asset impairment charges. Accelerated depreciation costs primarily relates to site closures, including ARIMF. Accelerated depreciation costs represent the difference between the depreciation expense recognized over the revised useful life of the asset, based upon the anticipated date the site closure and the depreciation expense as determined using the useful life prior to the restructuring activities. Asset impairment charges primarily related to manufacturing assets that will no longer be utilized due to the restructuring activities.

21

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





The following table presents a reconciliation of the restructuring reserve recorded within accrued expenses on the Company's condensed consolidated balance sheet for the three and nine months ended September 30, 2017 :
 
Three months ended September 30,
 
Nine months ended September 30,
 
2017
 
2017
 
Employee Separation Costs
 
Asset-Related Charges
 
Other
 
Total
 
Employee Separation Costs
 
Asset-Related Charges
 
Other
 
Total
Liability, beginning of period
$
11

 
$

 
$
1

 
$
12

 
$

 
$

 
$

 
$

Charges
67

 
90

 
9

 
166

 
88

 
90

 
15

 
193

Settlements
(8
)
 

 
(2
)
 
(10
)
 
(18
)
 

 
(4
)
 
(22
)
Adjustments to previous estimates
(1
)
 

 
(1
)
 
(2
)
 
(1
)
 

 
(1
)
 
(2
)
Non cash activity

 
(90
)
 

 
(90
)
 

 
(90
)
 
(3
)
 
(93
)
Liability, end of period
$
69

 
$

 
$
7

 
$
76

 
$
69

 
$

 
$
7

 
$
76


The restructuring reserve of $76 is recorded in accrued expenses on the Company's condensed consolidated balance sheet as of September 30, 2017 .
As a result of the planned relocation of our corporate headquarters to Boston, Massachusetts, we will be required to repay a forgivable loan and grant that were provided by the State of Connecticut Department of Economic Community Development in 2015 in connection with the construction of our current headquarters in New Haven, Connecticut. The loan and grant totaled $ 26 and were recognized, upon receipt, as a reduction in the cost of our New Haven facility-related fixed assets. As a result, the $ 26 repayment obligation was recorded in the third quarter 2017 with an offsetting increase in the carrying value of the related assets. We could also be required to repay income tax credits and sales tax credits of up to $ 7 to the state of Connecticut in connection with the relocation of our corporate headquarters.