1. Description of business and basis of presentation

The accompanying unaudited condensed consolidated financial statements of MannKind Corporation and its subsidiaries (the “Company”), have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission (the “SEC”). Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. These statements should be read in conjunction with the financial statements and notes thereto included in the Company’s latest audited annual financial statements. The audited statements for the year ended December 31, 2012 are included in the Company’s annual report on Form 10-K for the fiscal year ended December 31, 2012 filed with the SEC on March 18, 2013 (the “Annual Report”).

In the opinion of management, all adjustments, consisting only of normal, recurring adjustments, considered necessary for a fair presentation of the results of these interim periods have been included. The results of operations for the six months ended June 30, 2013 may not be indicative of the results that may be expected for the full year.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates or assumptions. The more significant estimates reflected in these accompanying financial statements involve assessing long-lived assets for impairment, accrued expenses, including clinical trial expenses, valuation of forward purchase contracts, valuation of stock-based compensation and the determination of the provision for income taxes and corresponding deferred tax assets and liabilities and any valuation allowance recorded against net deferred tax assets.

Business — The Company is a biopharmaceutical company focused on the discovery and development of therapeutic products for diseases such as diabetes. The Company’s lead product candidate, AFREZZA (insulin human [rDNA origin]) inhalation powder, is an ultra rapid-acting insulin therapy in late-stage clinical investigation for the treatment of adults with type 1 or type 2 diabetes for the control of hyperglycemia.

Basis of Presentation — The Company is considered to be in the development stage as its primary activities since incorporation have been establishing its facilities, recruiting personnel, conducting research and development, business development, business and financial planning, and raising capital. It is costly to develop therapeutic products and conduct clinical trials for these products. Since its inception through June 30, 2013 the Company has reported accumulated net losses of $2.2 billion, which include a goodwill impairment charge of $151.4 million, and cumulative negative cash flow from operations of $1.7 billion. On December 15, 2013, $115.0 million of aggregate principal under the 3.75% Senior Convertible Notes (the “2013 notes”) will mature (see Note 10 — Senior convertible notes), and on January 1, 2014, the Company’s borrowings under the amended and restated promissory note with The Mann Group will mature though The Mann Group’s right to repayment under the promissory note is subject to a subordination agreement between The Mann Group and affiliates of Deerfield Management Company L.P. (“Deerfield”), pursuant to which The Mann Group has agreed not to accept repayment under the note until the Company’s borrowings under its debt facility with Deerfield are repaid. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of these uncertainties. At June 30, 2013, the Company’s capital resources consisted of cash and cash equivalents of $28.5 million and $125.4 million of available borrowings through September 30, 2013 under the loan agreement with an entity controlled by the Company’s principal stockholder, The Mann Group, LLC (“The Mann Group”) (see Note 9 — Related-party arrangements). Based upon the Company’s current expectations, management believes the Company’s existing capital resources, including the available borrowings under the loan arrangement with The Mann Group and proceeds received on July 1, 2013 from the first tranche of the debt facility as described below, will enable it to continue planned operations into the fourth quarter of 2013. As described below, the Company previously issued certain public offering warrants that expire in October 2013. If these warrants are exercised prior to their expiration, the Company would receive cash proceeds of $64.6 million, which it believes, when combined with the cash resources and available borrowings discussed above, would provide sufficient capital resources to continue planned operations at least through the end of 2013. However, the Company cannot provide assurances that the warrants will be exercised, that its plans will not change or that changed circumstances will not result in the depletion of its capital resources more rapidly than it currently anticipates.

Capital resources potentially available to the Company include proceeds from the exercise of warrants, at-the-market agreements and issuance of additional 2019 notes as follows:

In October 2012, we sold in an underwritten public offering common stock and warrants resulting in net proceeds of $86.3 million and concurrently issued common stock and warrants to The Mann Group in exchange for cancellation of indebtedness under the amended and restated promissory note with The Mann Group (see Note 7 — Common and preferred stock and Note 9 — Related-party arrangements). To the extent that the trading price of our common stock exceeds the exercise price of the warrants on or about the expiration date of the public offering warrants and The Mann Group Warrants issued in October 2012, the warrant holders may potentially exercise all warrants prior to their expiration in the fourth quarter of 2013 making available $89.7 million in gross proceeds from the exercise of public offering warrants and The Mann Group warrant exercise could be settled in exchange for cancellation of indebtedness of $78.0 million. As of June 30, 2013, we have received $25.1 million in proceeds from the exercise of the public offering warrants with $64.6 million remaining unexercised. The Mann Group warrants remained unexercised as of June 30, 2013. There can be no assurances that the trading price of our common stock will be greater than the exercise price of the warrants on or about the expiration date of the warrants due to a variety of factors. There can be no assurances that the remaining warrants will be exercised or that we will receive any additional proceeds from the exercise of the warrants.

On March 18, 2013, we entered into at-the-market issuance sales agreements (the “ATM Agreements”) with two sales agents, under which we may issue and sell shares of our common stock having an aggregate offering price of up to $50.0 million under each ATM Agreement (provided that in no event may we issue and sell more than $50.0 million of shares of our common stock under both ATM Agreements in the aggregate) from time to time through either of the sales agents. Neither we nor either of the sales agents has any obligation to sell shares of our common stock under the ATM Agreements. Any sales of common stock made under the ATM Agreements will be made in “at the market” offerings as defined in Rule 415 of the Securities Act of 1933, as amended (the “Securities Act”). We have not yet issued any shares of our common stock under the ATM Agreements. There can be no assurance that we will be able to access capital through the ATM Agreements on a timely basis, or at all.

On July 1, 2013, we entered into a facility agreement (the “Facility Agreement”) with Deerfield, pursuant to which Deerfield has purchased $40.0 million aggregate principal amount of 9.75% senior secured convertible notes due 2019 (the “2019 notes”) and has committed to purchasing up to an additional $120.0 million aggregate principal amount of 2019 notes upon the satisfaction of certain conditions (see Note 12 — Subsequent Event). There can be no assurance that the conditions required for the additional $120 million of borrowings will be met or met in a timeframe necessary to support our liquidity needs.

The Company will need to raise additional capital through the resources identified above or, through the sale of equity or debt securities, a strategic business collaboration with a pharmaceutical company, the establishment of other funding facilities, licensing arrangements, assets sales or other means, in order to continue the development and commercialization of AFREZZA and other product candidates and to support its other ongoing activities. However, the Company cannot provide assurances that such additional capital will be available through any such sources or other sources.

Fair Value of Financial Instruments — The carrying amounts of financial instruments, which include cash equivalents and accounts payable, approximate their fair values due to their relatively short maturities. The fair value of the note payable to related party cannot be reasonably estimated as the Company would not be able to obtain a similar credit arrangement in the current economic environment.

Cash equivalents consist of highly liquid investments with original or remaining maturities of 90 days or less at the time of purchase, that are readily convertible into cash. As of June 30, 2013 and December 31, 2012, the Company held $28.5 million and $61.8 million, respectively of cash and cash equivalents, consisting primarily of money market funds of $25.9 million and $60.8 million, respectively, and the remaining in non-interest bearing checking accounts. The fair value of these money market funds was determined by using quoted prices for identical investments in an active market (Level 1 in the fair value hierarchy).

The following is a summary of the carrying values and estimated fair values of the 2013 notes and the Company’s senior convertible notes due in 2015 (the “2015 notes”) (in millions).


	June 30, 2013				December 31, 2012
	Carrying value		Estimated fair value		Carrying value		Estimated fair value
Notes due 2013	$	114.7	$	113.3	$	114.4	$	81.9
Notes due 2015	$	98.0	$	109.9	$	97.6	$	63.2

The estimated fair value of the 2013 notes was calculated based on quoted prices in an active market (Level 1 in the fair value hierarchy). The estimated fair value of the 2015 notes was calculated based on model-derived valuations whose inputs were observable, such as the Company’s stock price, and non-observable, such as the Company’s longer-term historical volatility (Level 3 in the fair value hierarchy). As there is no current observable market for the 2015 notes, the Company determined the estimated fair value using a convertible bond valuation model within a lattice framework. The convertible bond valuation model combined expected cash outflows with market-based assumptions regarding risk-adjusted yields, stock price volatility and recent price quotes and trading information regarding Company issued debt instruments and shares of common stock into which the notes are convertible.

The Company concluded its Common Stock Purchase Agreement with The Mann Group entered into in February 2012 (“The Mann Group Common Stock Purchase Agreement”) (see Note 7 — Common and preferred stock) represented a contingent forward purchase contract that met the definition of a derivative instrument in accordance with ASC 815 Derivatives and Hedging (“ASC 815”). Of the 31,250,000 shares issuable pursuant to The Mann Group Common Stock Purchase Agreement, the portion of the derivative instrument representing 14.7 million shares were recorded as equity (“Equity Portion”) as they met the criteria for equity classification under ASC 815-40 Derivatives and Hedging, Contracts in an Entity’s Own Stock. The remaining 16.5 million shares (“Non-Equity Portion”) required classification outside of equity as the Company did not have sufficient available shares at the time of issuance. The Company revalued the Non-Equity Portion of the forward purchase contract at each reporting date and recorded a fair value adjustment within “Other income (expense)”. The estimated fair value of The Mann Group Common Stock Purchase Agreement was based on a forward purchase contract valuation (Level 3 in the fair value hierarchy). The fair value of the forward purchase contract is highly sensitive to the discount applied for lack of marketability and the stock price, and changes in this discount and/or the stock price caused the value of the forward purchase contract to change significantly. The Company recognized the change in fair value of $(336,000) in “Other income (expense)” for the three months ended March 31, 2012. The Company revalued the Non-Equity Portion using a forward contract valuation formula, in which the forward contract was estimated to be equal to the valuation date stock price minus the strike price discounted to the valuation date using a risk-free rate of 0.08% at issuance and 0.06% at March 31, 2012. As the shares which would be received upon settlement were unregistered, the Company applied a discount for lack of marketability of 2.57% at issuance and 1.64% at March 31, 2012 based on quantitative put models, adjusted to take into account qualitative factors, including the fact that the Company’s stock was publicly traded and the fact that there was no contractual restriction on the unregistered shares being registered. As of and for the six months ended June 30, 2012, the Company recognized the change in fair value of $12.0 million in “Other income.” The Company revalued the Non-Equity Portion using a forward contract valuation formula, in which the forward contract is estimated to be equal to the valuation date stock price of $2.40 at issuance and $1.69 at May 17, 2012 minus the strike price discounted to the valuation date using a risk-free rate of 0.08% at issuance and 0.18% at May 17, 2012. As the shares which would be received upon settlement are currently unregistered, the Company applied a discount for lack of marketability of 10.27% at issuance and 1.67% at May 17, 2012 based on quantitative put models, adjusted to take into account qualitative factors, including the fact that the Company’s stock is publicly traded and the fact that there is no contractual restriction on the unregistered shares being registered.

The following roll-forward provides a summary of changes in fair value of the Company’s Level 3 forward purchase contract (in thousands):


	Three months ended June 30, 2012			Six months ended June 30, 2012
	Forward Purchase Contract			Forward Purchase Contract
Beginning Balance	$	744		$	—
Issuance		—			1,080
Adjustments to fair value included in other income		12,347			12,011
Transfers to additional paid-in-capital		(13,091	)		(13,091	)

Ending Balance	$	—		$	—

Recently Issued Accounting Standards — In February 2013, the FASB issued ASU 2013-02, Comprehensive Income (Topic 220) – Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. These amendments do not change the current requirements for reporting net income or other comprehensive income in the financial statements. These amendments provide for additional disclosure requirements for amounts reclassified out of accumulated other comprehensive income. These amendments are effective prospectively for interim and annual periods beginning after December 15, 2012. Early adoption is permitted. Effective January 1, 2013, the Company adopted the new requirements as set forth in ASU 2013-02 in the disclosure of comprehensive income on the Company’s consolidated financial statements. The adoption of the new requirements did not have a significant impact on the Company’s consolidated financial statements.

In July, 2013, the FASB ASU 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit when a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (a consensus of the FASB Emerging Issues Task Force). The amendments in this ASU provide guidance on the financial statements presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. An unrecognized tax benefit should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward with certain exceptions, in which case such an unrecognized tax benefit should be presented in the financial statements as a liability. The amendments in this ASU do not require new recurring disclosures. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The Company is evaluating the impact, if any, of the adoption of ASU 2013-11 will have on the Company’s consolidated financial statements.