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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

 

FORM 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011

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: 000-50651

 

 

SANTARUS, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   33-0734433

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

3721 Valley Centre Drive, Suite 400,

San Diego, CA

  92130
(Address of principal executive offices)   (Zip Code)

(858) 314-5700

(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.    x  Yes    ¨  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   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    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    x  No

The number of outstanding shares of the registrant’s common stock, par value $0.0001 per share, as of October 28, 2011 was 60,871,908.

 

 

 


Table of Contents

SANTARUS, INC.

FORM 10-Q — QUARTERLY REPORT

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2011

TABLE OF CONTENTS

 

     Page No.  
PART I – FINANCIAL INFORMATION   

Item 1. Financial Statements

     1   

Consolidated Balance Sheets as of September 30, 2011 (unaudited) and December 31, 2010

     1   

Consolidated Statements of Operations (unaudited) for the three and nine months ended September  30, 2011 and 2010

     2   

Consolidated Statements of Cash Flows (unaudited) for the nine months ended September  30, 2011 and 2010

     3   

Notes to Unaudited Consolidated Financial Statements

     4   

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     15   

Item 3. Quantitative and Qualitative Disclosures about Market Risk

     30   

Item 4. Controls and Procedures

     31   
PART II – OTHER INFORMATION   

Item 1. Legal Proceedings

     32   

Item 1A. Risk Factors

     33   

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

     61   

 

i


Table of Contents

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

Santarus, Inc.

Consolidated Balance Sheets

(in thousands, except share and per share amounts)

(unaudited)

 

     September 30,
2011
    December 31,
2010
 

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 54,375      $ 56,692   

Short-term investments

     4,365        4,105   

Accounts receivable, net

     15,388        7,156   

Inventories, net

     6,008        3,025   

Prepaid expenses and other current assets

     3,483        6,092   
  

 

 

   

 

 

 

Total current assets

     83,619        77,070   

Long-term restricted cash

     1,050        1,300   

Property and equipment, net

     645        774   

Intangible assets, net

     12,021        13,980   

Goodwill

     2,913        2,913   
  

 

 

   

 

 

 

Total assets

   $ 100,248      $ 96,037   
  

 

 

   

 

 

 

Liabilities and stockholders’ equity

    

Current liabilities:

    

Accounts payable and accrued liabilities

   $ 27,481      $ 29,310   

Allowance for product returns

     11,809        13,450   
  

 

 

   

 

 

 

Total current liabilities

     39,290        42,760   

Deferred revenue

     2,311        2,635   

Long-term debt

     10,000        10,000   

Other long-term liabilities

     2,396        2,659   

Commitments and contingencies

    

Stockholders’ equity:

    

Preferred stock, $0.0001 par value; 10,000,000 shares authorized at September 30, 2011 and December 31, 2010; no shares issued and outstanding at September 30, 2011 and December 31, 2010

     —          —     

Common stock, $0.0001 par value; 100,000,000 shares authorized at September 30, 2011 and December 31, 2010; 60,847,959 and 60,008,836 shares issued and outstanding at September 30, 2011 and December 31, 2010, respectively

     6        6   

Additional paid-in capital

     352,367        346,852   

Accumulated deficit

     (306,122     (308,875
  

 

 

   

 

 

 

Total stockholders’ equity

     46,251        37,983   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 100,248      $ 96,037   
  

 

 

   

 

 

 

See accompanying notes.

 

1


Table of Contents

Santarus, Inc.

Consolidated Statements of Operations

(in thousands, except share and per share amounts)

(unaudited)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2011     2010     2011     2010  

Revenues:

        

Product sales, net

   $ 19,813      $ 10,972      $ 46,488      $ 72,848   

Promotion revenue

     6,022        6,791        27,339        23,715   

Royalty revenue

     979        311        2,408        2,689   

Other license revenue

     —          —          —          245   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     26,814        18,074        76,235        99,497   

Costs and expenses:

        

Cost of product sales

     2,232        1,189        5,597        6,555   

License fees and royalties

     3,739        16,046        7,621        21,304   

Research and development

     3,825        4,427        10,963        13,984   

Selling, general and administrative

     16,152        14,997        48,746        66,464   

Restructuring charges

     —          7,258        —          7,258   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

     25,948        43,917        72,927        115,565   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

     866        (25,843     3,308        (16,068

Other income (expense):

        

Interest income

     2        22        16        68   

Interest expense

     (116     (116     (342     (345
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other income (expense)

     (114     (94     (326     (277
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     752        (25,937     2,982        (16,345

Income tax expense

     189        (191     229        65   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 563      $ (25,746   $ 2,753      $ (16,410
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) per share:

        

Basic

   $ 0.01      $ (0.44   $ 0.05      $ (0.28
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ 0.01      $ (0.44   $ 0.04      $ (0.28
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding used to calculate net income (loss) per share:

        

Basic

     60,630,297        58,622,206        60,392,956        58,480,222   

Diluted

     63,111,407        58,622,206        62,660,557        58,480,222   

See accompanying notes.

 

2


Table of Contents

Santarus, Inc.

Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

 

     Nine Months Ended
September 30,
 
     2011     2010  

Operating activities

    

Net income (loss)

   $ 2,753      $ (16,410

Adjustments to reconcile net income (loss) to net cash used in operating activities:

    

Depreciation and amortization

     2,265        1,506   

Unrealized gain on trading securities, net

     —          (2

Gain on contingent consideration

     (109     —     

Stock-based compensation

     3,917        4,153   

Issuance of common stock for technology license agreement

     —          150   

Changes in operating assets and liabilities:

    

Accounts receivable, net

     (8,232     9,019   

Inventories, net

     795        2,895   

Prepaid expenses and other current assets

     2,609        (1,572

Accounts payable and accrued liabilities

     (5,761     (23,375

Allowance for product returns

     (1,641     636   

Deferred revenue

     (324     (289
  

 

 

   

 

 

 

Net cash used in operating activities

     (3,728     (23,289

Investing activities

    

Purchases of short-term investments

     (9,816     (14,243

Sales and maturities of short-term investments

     9,809        14,231   

Redemption of investments

     —          3,850   

Purchases of property and equipment

     (180     (269

Acquisition of intangible assets

     —          (5,000

Net cash paid for business combination

     —          (842
  

 

 

   

 

 

 

Net cash used in investing activities

     (187     (2,273

Financing activities

    

Exercise of stock options

     1,332        212   

Issuance of common stock, net

     266        325   
  

 

 

   

 

 

 

Net cash provided by financing activities

     1,598        537   
  

 

 

   

 

 

 

Decrease in cash and cash equivalents

     (2,317     (25,025

Cash and cash equivalents at beginning of the period

     56,692        86,129   
  

 

 

   

 

 

 

Cash and cash equivalents at end of the period

   $ 54,375      $ 61,104   
  

 

 

   

 

 

 

See accompanying notes.

 

3


Table of Contents

Santarus, Inc.

Notes to Consolidated Financial Statements

(unaudited)

 

1. Organization and Business

Santarus, Inc. (“Santarus” or the “Company”) is a specialty biopharmaceutical company focused on acquiring, developing and commercializing proprietary products that address the needs of patients treated by physician specialists. Santarus was incorporated on December 6, 1996 as a California corporation and did not commence significant business activities until late 1998. On July 9, 2002, the Company reincorporated in the State of Delaware.

 

2. Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) related to the preparation of interim financial statements and the rules and regulations of the U.S. Securities and Exchange Commission related to a quarterly report on Form 10-Q. Accordingly, they do not include all of the information and disclosures required by GAAP for complete financial statements. The consolidated balance sheet at December 31, 2010 has been derived from the audited consolidated financial statements at that date but does not include all information and disclosures required by GAAP for complete financial statements. The interim consolidated financial statements reflect all adjustments which, in the opinion of management, are necessary for a fair presentation of the financial condition and results of operations for the periods presented. Except as otherwise disclosed, all such adjustments are of a normal recurring nature.

Operating results for the three and nine months ended September 30, 2011 are not necessarily indicative of the results that may be expected for any future periods. For further information, please see the consolidated financial statements and related disclosures included in the Company’s annual report on Form 10-K for the year ended December 31, 2010.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as well as disclosures of contingent assets and liabilities at the date of the financial statements. Estimates also affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Certain reclassifications have been made to the prior period consolidated balance sheet to conform to the current period presentation.

 

3. Principles of Consolidation

The unaudited interim consolidated financial statements of the Company include the accounts of Santarus, Inc. and its wholly owned subsidiary, Covella Pharmaceuticals, Inc. (“Covella”). The Company does not have any interest in variable interest entities. All material intercompany transactions and balances have been eliminated in consolidation.

 

4. Revenue Recognition

The Company recognizes revenue when there is persuasive evidence that an arrangement exists, title has passed, the price is fixed or determinable, and collectability is reasonably assured.

Product Sales, Net. The Company sells its Glumetza® (metformin hydrochloride extended release tablets), Cycloset® (bromocriptine mesylate) tablets and Zegerid® (omeprazole/sodium bicarbonate) products primarily to pharmaceutical wholesale distributors. The Company is obligated to accept from customers products that are returned within six months of their expiration date or up to 12 months beyond their expiration date. The shelf life of the Company’s products from the date of manufacture is as follows: Glumetza (24 to 48 months); Zegerid (36 months); and Cycloset (18 months). The Company authorizes returns for expired or damaged products in accordance with its return goods policy and procedures. The Company issues credit to the customer for expired or damaged returned product. The Company rarely exchanges product from inventory for returned product. At the time of sale, the Company records its estimates for product returns as a reduction to revenue at full sales value with a corresponding increase in the allowance for product returns liability. Actual returns are recorded as a reduction to the allowance for product returns liability at sales value with a corresponding decrease in accounts receivable for credit issued to the customer.

 

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Table of Contents

The Company recognizes product sales net of estimated allowances for product returns, estimated rebates in connection with contracts relating to managed care, Medicare, and patient coupons and voucher programs, and estimated chargebacks from distributors, wholesaler fees and prompt payment and other discounts. The Company establishes allowances for estimated product returns, rebates and chargebacks based primarily on the following qualitative and quantitative factors:

 

   

the number of and specific contractual terms of agreements with customers;

 

   

estimated levels of inventory in the distribution channel;

 

   

estimated remaining shelf life of products;

 

   

analysis of prescription data gathered by a third-party prescription data provider;

 

   

direct communication with customers;

 

   

historical product returns, rebates and chargebacks;

 

   

anticipated introduction of competitive products or generics;

 

   

anticipated pricing strategy changes by the Company and/or its competitors; and

 

   

the impact of state and federal regulations.

In its analyses, the Company utilizes prescription data purchased from a third-party data provider to develop estimates of historical inventory channel pull-through. The Company utilizes a separate analysis which compares historical product shipments less returns to estimated historical prescriptions written. Based on that analysis, the Company develops an estimate of the quantity of product in the distribution channel which may be subject to various product return, rebate and chargeback exposures.

The Company’s estimates of product returns, rebates and chargebacks require its most subjective and complex judgment due to the need to make estimates about matters that are inherently uncertain. If actual future payments for returns, rebates, chargebacks and other discounts exceed the estimates the Company made at the time of sale, its financial position, results of operations and cash flows would be negatively impacted.

The Company’s allowance for product returns was $11.8 million as of September 30, 2011 and $13.5 million as of December 31, 2010. The Company recognizes product sales at the time title passes to its customers, and the Company provides for an estimate of future product returns at that time based upon historical product returns trends, analysis of product expiration dating and estimated inventory levels in the distribution channel, review of returns trends for similar products, if available, and the other factors discussed above. Due to the lengthy shelf life of the Company’s products and the terms of the Company’s returns policy, there may be a significant time lag between the date the Company determines the estimated allowance and when the Company receives the product return and issues credit to a customer. Therefore, the amount of returns processed against the allowance in a particular year generally has no direct correlation to the product sales in the same year, and the Company may record adjustments to its estimated allowance over several periods, which can result in a net increase or a net decrease in its operating results in those periods.

The Company has been tracking its Zegerid product returns history by individual production batches from the time of its first commercial product launch of Zegerid Powder for Oral Suspension 20 mg in late 2004, taking into consideration product expiration dating and estimated inventory levels in the distribution channel. The Company launched Cycloset in November 2010 and has not experienced any returns through September 30, 2011. The Company has provided for an estimate of Cycloset product returns based upon its review of returns trends for similar products and taking into consideration the effect of a product’s shelf life on its returns history. Under a new commercialization agreement with Depomed, Inc. (“Depomed”), the Company began distributing and recording product sales for Glumetza in September 2011. The Company has provided for an estimate of Glumetza product returns based upon the Glumetza product returns history and taking into consideration the effect of a product’s shelf life on its returns history.

The Company’s allowance for rebates, chargebacks and other discounts was $10.1 million as of September 30, 2011 and $13.7 million as of December 31, 2010. These allowances reflect an estimate of the Company’s liability for rebates due to managed care organizations under specific contracts, rebates due to various organizations under Medicare contracts and regulations, chargebacks due to various organizations purchasing the Company’s products through federal contracts and/or group purchasing agreements, and other rebates and customer discounts due in connection with wholesaler fees and prompt

 

5


Table of Contents

payment and other discounts. The Company estimates its liability for rebates and chargebacks at each reporting period based on a combination of the qualitative and quantitative assumptions listed above. In each reporting period, the Company evaluates its outstanding contracts and applies the contractual discounts to the invoiced price of wholesaler shipments recognized. Although the total invoiced price of shipments to wholesalers for the reporting period and the contractual terms are known during the reporting period, the Company projects the ultimate disposition of the sale (e.g. future utilization rates of cash payors, managed care, Medicare or other contracted organizations). This estimate is based on historical trends adjusted for anticipated changes based on specific contractual terms of new agreements with customers, anticipated pricing strategy changes by the Company and/or its competitors and the other qualitative and quantitative factors described above. There may be a significant time lag between the date the Company determines the estimated allowance and when the Company makes the contractual payment or issues credit to a customer. Due to this time lag, the Company records adjustments to its estimated allowance over several periods, which can result in a net increase or a net decrease in its operating results in those periods.

In late June 2010, the Company began selling an authorized generic version of its prescription Zegerid Capsules under a distribution and supply agreement with Prasco, LLC (“Prasco”). Prasco has agreed to purchase all of its authorized generic product requirements from the Company and pays a specified invoice supply price for such products. The Company recognizes revenue from shipments to Prasco at the invoice supply price and the related cost of product sales when title transfers, which is generally at the time of shipment. The Company is also entitled to receive a percentage of the gross margin on sales of the authorized generic products by Prasco, which the Company recognizes as an addition to product sales, net when Prasco reports to the Company the gross margin from the ultimate sale of the products. Any adjustments to the gross margin related to Prasco’s estimated sales discounts and other deductions are recognized in the period Prasco reports the amounts to the Company.

Promotion, Royalty and Other License Revenue. The Company analyzes each element of its promotion and licensing agreements to determine the appropriate revenue recognition. Effective January 1, 2011, the Company adopted the authoritative guidance for revenue arrangements with multiple deliverables. Under this guidance, the Company identifies the deliverables included within the agreement and evaluates which deliverables represent separate units of accounting. Upfront license fees are generally recognized upon delivery of the license if the facts and circumstances dictate that the license has standalone value from any undelivered items, the relative selling price allocation of the license is equal to or exceeds the upfront license fees, persuasive evidence of an arrangement exists, the Company’s price to the partner is fixed or determinable and collectability is reasonably assured. Upfront license fees are deferred if facts and circumstances dictate that the license does not have standalone value. The determination of the length of the period over which to defer revenue is subject to judgment and estimation and can have an impact on the amount of revenue recognized in a given period.

Effective January 1, 2011, the Company adopted prospectively, the authoritative guidance that offers an alternative method of revenue recognition for milestone payments. Under the milestone method guidance, the Company recognizes payment that is contingent upon the achievement of a substantive milestone, as defined in the guidance, in its entirety in the period in which the milestone is achieved. Other milestones that do not fall under the definition of a milestone under the milestone method are recognized under the authoritative guidance concerning revenue recognition. Sales milestones, royalties and promotion fees are based on sales and/or gross margin information, which may include estimates of sales discounts and other deductions, received from the relevant alliance agreement partner. Sales milestones, royalties and promotion fees are recognized as revenue when earned under the agreements, and any adjustments related to estimated sales discounts and other deductions are recognized in the period the alliance agreement partner reports the amounts to the Company.

 

5. Stock-Based Compensation

For the three months ended September 30, 2011 and 2010 and the nine months ended September 30, 2011 and 2010, the Company recognized approximately $1.5 million, $1.7 million, $3.9 million and $4.2 million of total stock-based compensation, respectively. For the three and nine months ended September 30, 2010, stock-based compensation included approximately $352,000 related to the Company’s corporate restructuring implemented in the third quarter of 2010. The Company offered to accelerate the vesting of stock options by six months and extend the period for exercising vested stock options by twelve months from each affected employee’s termination date. In March 2011, the Company granted options to purchase an aggregate of 1,430,723 shares of its common stock in connection with annual option grants to all eligible employees. Also in March 2011, the Company granted options to purchase an aggregate of 1,630,613 shares of its common stock in connection with special option grants to all eligible employees. These stock options vest over a four-year period

 

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Table of Contents

from the date of grant. In addition, in March 2011 and June 2011, the Company granted options to purchase an aggregate of 406,500 shares of its common stock to non-employee directors of the Company, which vest over a one-year period from the date of grant. As of September 30, 2011, total unrecognized compensation cost related to stock options and employee stock purchase plan rights was approximately $11.9 million, and the weighted average period over which it was expected to be recognized was 2.7 years.

 

6. Comprehensive Income (Loss)

Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) includes certain changes in stockholders’ equity that are excluded from net income (loss), specifically unrealized gains and losses on securities available-for-sale. Comprehensive income (loss) consists of the following (in thousands):

 

     Three Months  Ended
September 30,
    Nine Months Ended
September 30,
 
     2011     2010     2011      2010  

Net income (loss)

   $ 563      $ (25,746   $ 2,753       $ (16,410

Unrealized gain (loss) on investments

     (1     (1     —           1   
  

 

 

   

 

 

   

 

 

    

 

 

 

Comprehensive income (loss)

   $ 562      $ (25,747   $ 2,753       $ (16,409
  

 

 

   

 

 

   

 

 

    

 

 

 

 

7. Net Income (Loss) Per Share

Basic income (loss) per share is calculated by dividing the net income (loss) by the weighted average number of common shares outstanding for the period, without consideration for common stock equivalents. Diluted income (loss) per share is computed by dividing the net income (loss) by the weighted average number of common share equivalents outstanding for the period determined using the treasury-stock method. For purposes of this calculation, common stock subject to repurchase by the Company, contingently issuable shares, options and warrants are considered to be common stock equivalents and are only included in the calculation of diluted income (loss) per share when their effect is dilutive. Potentially dilutive securities totaling 12.4 million shares and 17.6 million shares for the three months ended September 30, 2011 and 2010, and 12.5 million shares and 16.9 million shares for the nine months ended September 30, 2011 and 2010, respectively, were excluded from the calculation of diluted income (loss) per share because of their anti-dilutive effect.

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2011      2010     2011      2010  

Numerator:

          

Net income (loss) (in thousands)

   $ 563       $ (25,746   $ 2,753       $ (16,410

Denominator:

          

Weighted average common shares outstanding for basic net income (loss) per share

     60,630,297         58,622,206        60,392,956         58,408,222   

Net effect of dilutive common stock equivalents

     2,481,110         —          2,267,601         —     
  

 

 

    

 

 

   

 

 

    

 

 

 

Denominator for diluted net income (loss) per share

     63,111,407         58,622,206        62,660,557         58,480,222   
  

 

 

    

 

 

   

 

 

    

 

 

 

Net income (loss) per share

          

Basic

   $ 0.01       $ (0.44   $ 0.05       $ (0.28
  

 

 

    

 

 

   

 

 

    

 

 

 

Diluted

   $ 0.01       $ (0.44   $ 0.04       $ (0.28
  

 

 

    

 

 

   

 

 

    

 

 

 

 

8. Segment Reporting

Management has determined that the Company operates in one business segment which is the acquisition, development and commercialization of pharmaceutical products.

 

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9. Available-for-Sale Securities

The Company has classified its debt securities as available-for-sale and, accordingly, carries these investments at fair value, and unrealized holding gains or losses on these securities are carried as a separate component of stockholders’ equity. The cost of debt securities is adjusted for amortization of premiums or accretion of discounts to maturity, and such amortization is included in interest income. Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities are included in interest income. The cost of securities sold is based on the specific identification method.

The following is a summary of the Company’s available-for-sale investment securities as of September 30, 2011 and December 31, 2010 (in thousands). All available-for-sale securities held as of September 30, 2011 and December 31, 2010 have contractual maturities within one year. There were no material gross realized gains or losses on sales of available-for-sale securities for the three and nine months ended September 30, 2011 and the year ended December 31, 2010.

 

     Amortized
Cost
     Market
Value
     Unrealized
Gain
 

September 30, 2011:

        

U.S. government sponsored enterprise securities

   $ 5,415       $ 5,415       $ —     
  

 

 

    

 

 

    

 

 

 

December 31, 2010:

        

U.S. government sponsored enterprise securities

   $ 5,405       $ 5,405       $ —     
  

 

 

    

 

 

    

 

 

 

The classification of available-for-sale securities in the Company’s consolidated balance sheets is as follows (in thousands):

 

     September 30,
2011
     December 31,
2010
 

Short-term investments

   $ 4,365       $ 4,105   

Restricted cash

     1,050         1,300   
  

 

 

    

 

 

 
   $ 5,415       $ 5,405   
  

 

 

    

 

 

 

 

10. Fair Value Measurements

The carrying values of the Company’s financial instruments, including cash, cash equivalents, accounts payable and accrued liabilities and the Company’s revolving credit facility approximate fair value due to the relative short-term nature of these instruments.

The authoritative guidance for fair value measurements establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

 

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The Company’s assets and liabilities measured at fair value on a recurring basis at September 30, 2011 and December 31, 2010 are as follows (in thousands):

 

     Fair Value Measurements at Reporting Date Using  
     Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
     Total  

September 30, 2011:

           

Assets

           

Money market funds

   $ 41,476       $ —         $ —         $ 41,476   

U.S. government sponsored enterprise securities

     —           18,314         —           18,314   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 41,476       $ 18,314       $ —         $ 59,790   
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

           

Contingent consideration

   $ —         $ —         $ 1,948       $ 1,948   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ —         $ —         $ 1,948       $ 1,948   
  

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2010:

           

Assets

           

Money market funds

   $ 16,729       $ —         $ —         $ 16,729   

U.S. government sponsored enterprise securities

     —           45,368         —           45,368   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 16,729       $ 45,368       $ —         $ 62,097   
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

           

Contingent consideration

   $ —         $ —         $ 2,057       $ 2,057   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ —         $ —         $ 2,057       $ 2,057   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table provides a summary of changes in fair value of the Company’s Level 3 assets and liabilities for the three and nine months ended September 30, 2011 and 2010 (in thousands):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
   2011     2010     2011     2010  

Auction Rate Securities and Rights:

        

Beginning balance

   $ —        $ 1,750      $ —        $ 3,848   

Redemptions and sales, at par

     —          (1,750     —          (3,850

Net unrealized gain included in net loss

     —          —          —          2   
  

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ —        $ —        $ —        $ —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Contingent Consideration:

        

Beginning balance

   $ 2,278      $ —        $ 2,057      $ —     

Transfers in from business combination

     —          1,900        —          1,900   

Change in fair value recorded in operating expenses

     (330     —          (109     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 1,948      $ 1,900      $ 1,948      $ 1,900   
  

 

 

   

 

 

   

 

 

   

 

 

 

Level 3 assets included auction rate securities (“ARS”) and auction rate securities rights (“ARS Rights”). Due to conditions in the global credit markets, these securities had insufficient demand resulting in multiple failed auctions since early 2008. As a result, these affected securities were not liquid. In October 2008, the Company received an offer of ARS Rights from UBS Financial Services, Inc., a subsidiary of UBS AG (“UBS”), and in November 2008, the Company accepted the ARS Rights offer. The ARS Rights permitted the Company to require UBS to purchase the Company’s ARS at par value at any time during the period of June 30, 2010 through July 2, 2012. As a condition to accepting the offer of ARS Rights, the Company released UBS from all claims except claims for consequential damages relating to its marketing and sales of ARS. The Company also agreed not to serve as a class representative or receive benefits under any class action settlement or investor fund. In July 2010, the Company exercised its ARS Rights, and UBS purchased all of the Company’s remaining outstanding ARS at par value totaling approximately $1.8 million.

 

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Level 3 liabilities include contingent milestone and royalty obligations the Company may pay related to the acquisition of Covella in September 2010. The fair value of the contingent consideration has been determined using a probability-weighted discounted cash flow model. The key assumptions in applying this approach are the discount rate and the probability assigned to the milestone or royalty being achieved. Management remeasures the fair value of the contingent consideration at each reporting period, with any change in its fair value resulting from either the passage of time or events occurring after the acquisition date, such as changes in the estimated probability or timing of achieving the milestone or royalty, being recorded in the current period’s statement of operations. The Company recorded decreases in the fair value of contingent consideration of $330,000 and $109,000 for the three and nine months ended September 30, 2011, respectively, resulting primarily from changes in the estimated timing of achieving certain milestones and royalties and the passage of time.

 

11. Balance Sheet Details

Inventories, net consist of the following (in thousands):

 

     September 30,
2011
    December 31,
2010
 

Raw materials

   $ 817      $ 797   

Finished goods

     6,572        4,418   
  

 

 

   

 

 

 
     7,389        5,215   

Allowance for excess and obsolete inventory

     (1,381     (2,190
  

 

 

   

 

 

 
   $ 6,008      $ 3,025   
  

 

 

   

 

 

 

Inventories are stated at the lower of cost or market (net realizable value). Cost is determined by the first-in, first-out method. Inventories consist of finished goods and raw materials used in the manufacture of Cycloset tablets, Zegerid Capsules and the related authorized generic product, and Zegerid Powder for Oral Suspension. As of September 30, 2011, inventories also consisted of Glumetza tablets which the Company began distributing in September 2011. The Company provides reserves for potentially excess, dated or obsolete inventories based on an analysis of inventory on hand and on firm purchase commitments, compared to forecasts of future sales.

Accounts payable and accrued liabilities consist of the following (in thousands):

 

     September 30,
2011
     December 31,
2010
 

Accounts payable

   $ 5,308       $ 1,716   

Accrued compensation and benefits

     4,780         5,017   

Accrued rebates

     7,818         12,322   

Accrued license fees and royalties

     3,654         4,471   

Accrued research and development expenses

     2,010         2,862   

Income taxes payable

     489         332   

Other accrued liabilities

     3,422         2,590   
  

 

 

    

 

 

 
   $ 27,481       $ 29,310   
  

 

 

    

 

 

 

 

12. Long-Term Debt

On July 11, 2008, the Company entered into an Amended and Restated Loan and Security Agreement (the “Amended Loan Agreement”) with Comerica Bank (“Comerica”). The Amended Loan Agreement amends and restates the terms of the original Loan and Security Agreement entered into between the Company and Comerica in July 2006. In December 2008, the Company drew down $10.0 million under the Amended Loan Agreement. The credit facility under the Amended Loan Agreement consists of a revolving line of credit, pursuant to which the Company may request advances in an aggregate outstanding amount not to exceed $25.0 million. Under the Amended Loan Agreement, the revolving loan bears interest, as selected by the Company, at either the variable rate of interest, per annum, most recently announced by Comerica as its “prime rate” plus 0.50% or the LIBOR rate (as computed in the Amended and Restated LIBOR Addendum to the Amended Loan Agreement) plus 3.00%. The Company has selected the “prime rate” plus 0.50% interest rate option, which as of September 30, 2011 was 3.75%. Interest payments on advances made under the Amended Loan Agreement are due and

 

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payable in arrears on the first calendar day of each month during the term of the Amended Loan Agreement. On August 27, 2010, the Company entered into an amendment to the Amended Loan Agreement with Comerica that extends the maturity date of the revolving line of credit from July 11, 2011 to July 11, 2013. Amounts borrowed under the Amended Loan Agreement may be repaid and re-borrowed at any time prior to July 11, 2013, and any outstanding principal drawn during the term of the loan facility is due and payable on July 11, 2013. There is a non-refundable unused commitment fee equal to 0.50% per annum on the difference between the amount of the revolving line and the average daily balance outstanding thereunder during the term of the Amended Loan Agreement, payable quarterly in arrears. The Amended Loan Agreement will remain in full force and effect for so long as any obligations remain outstanding or Comerica has any obligation to make credit extensions under the Amended Loan Agreement.

Amounts borrowed under the Amended Loan Agreement are secured by substantially all of the Company’s personal property, excluding intellectual property. Under the Amended Loan Agreement, the Company is subject to certain affirmative and negative covenants, including limitations on the Company’s ability to: undergo certain change of control events; convey, sell, lease, license, transfer or otherwise dispose of assets; create, incur, assume, guarantee or be liable with respect to certain indebtedness; grant liens; pay dividends and make certain other restricted payments; and make investments. In addition, under the Amended Loan Agreement the Company is required to maintain a cash balance with Comerica in an amount of not less than $4.0 million and to maintain any other cash balances with either Comerica or another financial institution covered by a control agreement for the benefit of Comerica. The Company is also subject to specified financial covenants with respect to a minimum liquidity ratio and, in specified limited circumstances, minimum EBITDA requirements as defined in the Amended Loan Agreement. The Company believes it has currently met all of its obligations under the Amended Loan Agreement.

 

13. Agreements with Depomed

Under the Company’s promotion agreement with Depomed entered into in July 2008, the Company paid Depomed a $3.0 million sales milestone in March 2011 based on having achieved Glumetza net product sales in excess of $50.0 million during the 13-month period ended January 31, 2011.

In August 2011, the Company entered into a new commercialization agreement with Depomed granting the Company exclusive rights to manufacture and commercialize Depomed’s Glumetza prescription products in the U.S., including its territories and possessions and Puerto Rico. The commercialization agreement replaced the existing promotion agreement between the parties dated July 21, 2008 pursuant to which the Company has promoted Glumetza in the U.S.

Under the commercialization agreement, the parties will transition to the Company responsibility for manufacturing, distribution, pharmacovigilance and regulatory affairs. The Company continues to be responsible for advertising and promotional activities for Glumetza in the U.S. In connection with the commercialization agreement, the parties have eliminated the prior joint commercialization committee and the Company has assumed sole decision-making authority on pricing, contracting and promotion for Glumetza. The Company began distributing and recording product sales for Glumetza in September 2011.

The Company is required to pay to Depomed royalties on Glumetza net product sales in the U.S. of 26.5% in 2011; 29.5% in 2012; 32.0% in 2013 and 2014; and 34.5% in 2015 and beyond prior to generic entry of a Glumetza product. In the event of generic entry of a Glumetza product in the U.S., the parties will equally share proceeds based on a gross margin split. The Company has the exclusive right to commercialize authorized generic versions of the Glumetza products. The Company will pay no additional sales milestones to Depomed as was required under the prior promotion agreement.

Starting in 2012, the Company will have reduced minimum marketing expenditures and sales force promotion obligations during the term of the agreement until such time as a generic to Glumetza enters the market.

Pursuant to the terms of the commercialization agreement, Depomed has the option to co-promote Glumetza products to physicians other than those called on by the Company, subject to certain limitations. Depomed will be entitled to receive a royalty equal to 70% of net sales attributable to prescriptions generated by its called on physicians over a pre-established baseline.

 

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During the term, Depomed will continue to manage the ongoing patent infringement lawsuits against Lupin Limited and its wholly owned subsidiary, Lupin Pharmaceutical, Inc. (collectively “Lupin”) and Sun Pharma Global FZE, Sun Pharmaceutical Industries Ltd. and Sun Pharmaceutical Industries Inc. (collectively “Sun”) subject to certain consent rights in favor of the Company, including with regard to any proposed settlements. The Company is responsible for 70% of the future out-of-pocket costs related to the existing infringement cases.

Depomed is financially responsible for returns of Glumetza distributed by Depomed, up to the amount of its product returns reserve account for Glumetza product returns on August 31, 2011, the date immediately before Santarus began distributing Glumetza. Depomed is also financially responsible for Glumetza rebates and chargebacks up to the amount of its reserve account as of August 31, 2011 for those items. In connection with the Company’s assumption of distribution and sales responsibility, the Company is responsible for all other Glumetza returns, rebates and chargebacks.

Under the revised authoritative guidance for business combinations, the commercialization agreement with Depomed was determined to be a business combination and was accounted for using the acquisition method of accounting. Neither separate financial statements nor pro forma results of operations have been presented because the acquisition transaction does not meet the qualitative or quantitative materiality tests under Regulation S-X. Transaction-related costs of approximately $137,000 were included in selling, general and administrative expenses for the three and nine months ended September 30, 2011.

The purchase price was approximately $3.8 million and represents the amount that the Company is required to pay Depomed in cash for the purchase of Depomed’s existing inventory of Glumetza and bulk metformin hydrochloride. The entire purchase price of $3.8 million was allocated to inventory, as cost approximated fair value, and no other assets were acquired and no liabilities were assumed in the transaction. The royalties payable to Depomed based on Glumetza net product sales beginning in September 2011 are being expensed as incurred as the Company determined that the royalty rates reflect reasonable market rates for the manufacturing and commercialization rights the Company was granted under the commercialization agreement.

 

14. Recent Accounting Pronouncements

Adoption of Recent Accounting Pronouncements

In December 2010, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance concerning the recognition and classification of the new annual fee payable by branded prescription drug manufacturers and importers on branded prescription drugs which was mandated under the health care reform legislation enacted in the U.S. in March 2010. Under this new authoritative guidance, the annual fee should be estimated and recognized in full as a liability upon the first qualifying commercial sale with a corresponding deferred cost that is amortized to operating expenses using a straight-line method unless another method better allocates the fee over the calendar year in which it is payable. This new guidance is effective for calendar years beginning on or after December 31, 2010, when the fee initially became effective. Upon adoption, this guidance did not have a material impact on the Company’s consolidated financial statements.

In March 2010, the FASB ratified the final consensus that offers an alternative method of revenue recognition for milestone payments. The guidance states that an entity can make an accounting policy election to recognize a payment that is contingent upon the achievement of a substantive milestone, as defined in the guidance, in its entirety in the period in which the milestone is achieved. The guidance is effective for fiscal years, and interim periods within those years, beginning on or after June 15, 2010 with early adoption permitted, provided that the revised guidance is applied retrospectively to the beginning of the year of adoption. The Company elected to adopt this guidance prospectively, effective for the Company’s fiscal year beginning January 1, 2011. Upon adoption, the guidance did not have a material impact on the Company’s consolidated financial statements and is not expected to have a material impact on its future operating results.

In September 2009, the FASB revised the authoritative guidance for revenue arrangements with multiple deliverables. The guidance addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting and how the arrangement consideration should be allocated among the separate units of accounting. The guidance may be applied retrospectively or prospectively for new or materially modified arrangements. The Company elected to adopt this guidance prospectively, effective for the Company’s fiscal year beginning January 1, 2011. Upon adoption, the guidance did not have a material impact on the Company’s consolidated financial statements and is not expected to have a material impact on its future operating results.

 

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Pending Adoption of Recent Accounting Pronouncements

In September 2011, the FASB issued an update to the authoritative guidance on performing goodwill impairment testing. Under the revised guidance, entities testing goodwill for impairment have the option of performing a qualitative assessment before calculating the fair value of the reporting unit (step 1 of the goodwill impairment test). If entities determine, on the basis of qualitative factors, that the fair value of the reporting unit is more likely than not less than the carrying amount, the two-step impairment test would be required; otherwise, no further testing is required. The revised guidance does not change how goodwill is calculated or assigned to reporting units, does not revise the requirement to test goodwill annually for impairment, and does not amend the requirement to test goodwill for impairment between annual tests if events and circumstances warrant. The revised authoritative guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted. The Company is currently evaluating the potential impact the early adoption of this statement may have on its financial position and results of operations.

 

15. Contingencies

Glumetza Patent Litigation

In November 2009, Depomed filed a lawsuit in the United States District Court for the Northern District of California against Lupin for infringement of the following patents listed in the Orange Book for Glumetza (U.S. Patent Nos. 6,340,475; 6,635,280; and 6,488,962). The lawsuit was filed in response to an abbreviated new drug application (“ANDA”) and paragraph IV certification filed with the U.S. Food and Drug Administration (“FDA”) by Lupin regarding Lupin’s intent to market generic versions of 500 mg and 1000 mg tablets for Glumetza prior to the expiration of the asserted patents. Depomed commenced the lawsuit within the requisite 45 day time period, resulting in an FDA stay on the approval of Lupin’s proposed products for 30 months or until a decision is rendered by the District Court, which is adverse to the asserted patents, whichever may occur earlier. Absent a court decision, the 30-month stay is expected to expire in May 2012. Lupin has filed an answer in the case that asserts, among other things, non-infringement and invalidity of the asserted patents, and has also filed counterclaims. A hearing for claim construction, or Markman hearing, was held in January 2011. Following the hearing, the court principally adopted the patent term constructions Depomed proposed. The discovery phase of the lawsuit is continuing, and a trial date has been scheduled in August 2012.

In June 2011, Depomed filed a lawsuit in the United States District Court for the Northern District of New Jersey against Sun for infringement of the patents listed in the Orange Book for Glumetza (U.S. Patent Nos. 6,723,340; 6,635,280; 6,488,962; 6,340,475; and 7,780,987), as well as U.S. Patent No. 7,736,667. The lawsuit was filed in response to an ANDA and paragraph IV certification filed with the FDA by Sun regarding Sun’s intent to market generic versions of 500 mg and 1000 mg tablets for Glumetza prior to the expiration of the asserted patents. Depomed commenced the lawsuit within the requisite 45 day time period, resulting in an FDA stay on the approval of Sun’s proposed products for 30 months or until a decision is rendered by the District Court, which is adverse to the asserted patents, whichever may occur earlier. Absent a court decision, the 30-month stay is expected to expire in November 2013. Sun has filed an answer in the case that asserts, among other things, non-infringement and invalidity of the asserted patents, and has also filed counterclaims. Briefing for the Markman hearing is scheduled for the first half of 2012, and a trial date has not yet been scheduled.

Under the terms of the Company’s commercialization agreement with Depomed, Depomed will continue to manage the ongoing patent infringement lawsuits against Sun and Lupin, subject to certain consent rights in favor of the Company, including with regard to any proposed settlements. The Company will reimburse Depomed for 70% of its future out-of-pocket costs, and Depomed will reimburse the Company for 30% of its future out-of-pocket costs, related to the existing infringement cases. Although Depomed has indicated that it intends to vigorously defend and enforce its patent rights, the Company is not able to predict the timing or outcome of these actions. Any adverse outcome in the actions described above would adversely impact the Company’s revenues and business. At this time the Company is unable to estimate possible losses or ranges of losses for these actions.

Zegerid and Zegerid OTC® Patent Litigation

In April 2010, the U.S. District Court for the District of Delaware ruled that five patents covering Zegerid Capsules and Zegerid Powder for Oral Suspension (U.S. Patent Nos. 6,489,346; 6,645,988; 6,699,885; 6,780,882; and 7,399,772) were invalid due to obviousness. These patents were the subject of lawsuits the Company filed in 2007 in response to ANDAs

 

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filed by Par Pharmaceutical Inc. (“Par”) with the FDA. In May 2010, the Company filed an appeal of the District Court’s ruling to the U.S. Court of Appeals for the Federal Circuit. Oral arguments in the appeal were held on May 2, 2011, and the Company expects a decision on the appeal in the second half of 2011, although the decision could be issued later than the Company expects. Although the Company intends to vigorously defend and enforce its patent rights, the Company is not able to predict the timing or outcome of the appeal.

In September 2010, Schering-Plough HealthCare Products, Inc., a subsidiary of Merck & Co., Inc. (“Merck”) filed lawsuits in the U.S. District Court for the District of New Jersey against each of Par and Perrigo Research and Development Company (“Perrigo”) for infringement of the patents listed in the Orange Book for Zegerid OTC (U.S. Patent Nos. 6,489,346; 6,645,988; 6,699,885; and 7,399,772). The Company and the University of Missouri, licensors of the listed patents, are joined in the lawsuits as co-plaintiffs. Par and Perrigo had filed ANDAs with the FDA regarding each company’s intent to market a generic version of Zegerid OTC prior to the expiration of the listed patents. The parties in each of these lawsuits have agreed to stay the court proceedings until the earlier of the outcome of the pending appeal related to the Zegerid prescription product litigation or receipt of tentative regulatory approval for the proposed generic Zegerid OTC products. The Company is not able to predict the timing or outcome of these lawsuits.

Any adverse outcome in the litigation described above would adversely impact the Company’s Zegerid and Zegerid OTC business, including the amount of, or the Company’s ability to receive, milestone payments and royalties under its agreement with Merck. For example, the royalties payable to the Company under its license agreement with Merck are subject to reduction in the event it is ultimately determined by the courts (with the decision being unappealable or unappealed within the time allowed for appeal) that there is no valid claim of the licensed patents covering the manufacture, use or sale of the Zegerid OTC product and third parties have received marketing approval for, and are conducting bona fide ongoing commercial sales of, generic versions of the licensed products. The ruling may also negatively impact the patent protection for the products being commercialized pursuant to the Company’s ex-US licenses with Glaxo Group Limited, an affiliate of GlaxoSmithKline, plc, and Norgine B.V. Although the U.S. ruling is not binding in countries outside the U.S., similar challenges to those raised in the U.S. litigation may be raised in territories outside the U.S.

Regardless of how these litigation matters are ultimately resolved, the litigation has been and will continue to be costly, time-consuming and distracting to management, which could have a material adverse effect on the Company. At this time, the Company is unable to estimate possible losses or ranges of losses for these matters.

Wage and Hour Putative Class Action Litigation

In December 2010, a complaint styled as a putative class action was filed against the Company in the U.S. District Court for the Southern District of New York by a person employed at the time by the Company as a sales representative and on behalf of a class of similarly situated current and former employees. The complaint seeks damages for alleged violations of the New York Labor Law 650 §§ et seq. and the federal Fair Labor Standards Act. The alleged violations include failure to pay for overtime work. The complaint seeks an unspecified amount for unpaid wages and overtime wages, liquidated and/or punitive damages, attorneys’ fees and other damages. The Company denies all claims asserted in the complaint. In April 2011, the Company filed a motion to transfer the case to the United States District Court for the Southern District of California. In August 2011, the Company’s motion to transfer was denied, and the action will proceed in the New York district court. Over the last few years, similar class action lawsuits have been filed against other pharmaceutical companies alleging that the companies’ sales representatives have been misclassified as exempt employees under the Federal Fair Labor Standards Act and applicable state laws. At this time, the Company is unable to estimate possible losses or ranges of losses for this action. There have been varying outcomes in these cases to date, and it is too early to predict an outcome in the Company’s matter at this time.

Although the Company intends to vigorously defend against the litigation filed against it, litigation often is expensive and diverts management’s attention and resources, which could adversely affect the Company regardless of the outcome.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion contains forward-looking statements, which involve risks and uncertainties. As used herein, the terms “we,” “us,” “our” or the “Company” refer to Santarus, Inc., a Delaware corporation, and its wholly owned subsidiary Covella. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth below under the caption “Risk Factors.” The interim consolidated financial statements and this Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2010 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our Annual Report on Form 10-K for the year ended December 31, 2010.

Overview

We are a specialty biopharmaceutical company focused on acquiring, developing and commercializing proprietary products that address the needs of patients treated by physician specialists.

Our commercial organization currently promotes Glumetza® (metformin hydrochloride extended release tablets) 500 mg and 1000 mg in the U.S. We commenced promotion of Glumetza in October 2008, and we currently promote Glumetza under a commercialization agreement that we entered into with Depomed, Inc., or Depomed, in August 2011. The commercialization agreement replaced an existing promotion agreement entered into in July 2008. Our commercial organization also began promotion of Cycloset® (bromocriptine mesylate) 0.8 mg tablets in the U.S. in November 2010 under a distribution and license agreement with S2 Therapeutics, Inc., or S2, and VeroScience, LLC, or VeroScience. Both Glumetza and Cycloset are prescription products indicated to improve glycemic control in adult patients with type 2 diabetes.

We also sell but do not promote Zegerid® (omeprazole/sodium bicarbonate) 20 mg and 40 mg prescription products in the U.S., which are immediate-release formulations of the proton pump inhibitor, or PPI, omeprazole. In addition, we receive a percentage of the gross margin on sales of an authorized generic version of our Zegerid Capsules product under a distribution and supply agreement with Prasco LLC, or Prasco.

In addition to our commercial products, we are focused on advancing the following development-stage products to commercialization:

 

   

Uceris™ (budesonide) tablets is a corticosteroid in a novel oral tablet formulation, dosed one tablet once a day, which utilizes proprietary multi-matrix (MMX®) colonic delivery technology and is being developed for the treatment of ulcerative colitis. We have announced statistically significant top-line results according to our statistical analysis plan from two phase III clinical studies, which evaluated Uceris 9 mg for the induction of remission of mild or moderate active ulcerative colitis. Additionally, we announced top-line safety data from a 12-month, double-blind, extended use study. We plan to submit a new drug application, or NDA, to the U.S. Food and Drug Administration, or FDA, by the end of 2011. In connection with the ongoing development and potential future commercialization of Uceris, we are also planning to initiate a phase IIIb multicenter, randomized, double-blind placebo-controlled clinical study to evaluate Uceris 9 mg as an add-on therapy to current oral 5-ASA drugs, such as Asacol® or Lialda®, for induction of remission of active ulcerative colitis. We have rights to Uceris in the U.S. under a strategic collaboration with Cosmo Technologies Limited, or Cosmo.

 

   

Rhucin® (recombinant human C1 inhibitor) is a recombinant version of the human protein C1 inhibitor, which is produced using proprietary transgenic technology. Rhucin is currently being evaluated in a phase III clinical study at a 50 U/kg dose for the treatment of acute attacks of hereditary angioedema, or HAE, an orphan disease. We have rights to Rhucin in the U.S., Canada and Mexico under our license and supply agreements with Pharming.

 

   

Rifamycin SV MMX® is a broad spectrum, semi-synthetic antibiotic in a novel oral tablet formulation, which utilizes proprietary MMX colonic delivery technology and is being developed for the treatment of patients with travelers’ diarrhea and potentially for other diseases that have an infectious component in the intestine. Rifamycin SV MMX 200 mg oral tablets taken twice daily (2 times 200 mg per dose, 800 mg total daily dose) is currently being investigated in a phase III clinical program in patients with travelers’ diarrhea. We have rights to rifamycin SV MMX in the U.S. under a strategic collaboration with Cosmo.

 

   

SAN-300 (anti-VLA-1 antibody) is a novel early stage anti-VLA-1 monoclonal antibody, or mAb, development compound that we initially expect to develop for the treatment of rheumatoid arthritis. We initiated a single-center, randomized, placebo-controlled, single-dose, dose-escalation phase I clinical study with SAN-300 in March 2011, which study we expect to be completed in the first half of 2012. We have worldwide rights to SAN-300 under a license agreement with Biogen Idec MA, or Biogen, and in connection with our acquisition of Covella Pharmaceuticals, Inc., or Covella.

 

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To leverage our PPI technology and diversify our sources of revenue, we have licensed certain exclusive rights to Schering-Plough HealthCare Products, Inc., a subsidiary of Merck & Co., Inc., or Merck, to develop, manufacture and sell Zegerid OTC® products in the U.S. and Canada. We have also licensed certain exclusive rights to Glaxo Group Limited, an affiliate of GlaxoSmithKline, plc, or GSK, to develop, manufacture and commercialize prescription and over-the-counter, or OTC, immediate-release omeprazole products in up to 114 specified countries (including markets within Africa, Asia, the Middle-East, and Central and South America). In addition, we have licensed certain exclusive rights to Norgine B.V., or Norgine, to develop, manufacture and commercialize prescription immediate-release omeprazole products in specified markets in Europe and in Israel.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based on our unaudited interim consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. We review our estimates on an on-going basis. We base our estimates on historical experience and on various other 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. Actual results may differ from these estimates under different assumptions or conditions. We believe the following accounting policies to be critical to the judgments and estimates used in the preparation of our financial statements.

Principles of Consolidation

Our unaudited interim consolidated financial statements include the accounts of Santarus and its wholly owned subsidiary, Covella. We do not have any interest in variable interest entities. All material intercompany transactions and balances have been eliminated in consolidation.

Business Combinations

The revised authoritative guidance for business combinations establishes principles and requirements for recognizing and measuring the total consideration transferred to and the assets acquired and liabilities assumed in the acquired target in a business combination.

We accounted for the acquisition of Covella in September 2010 in accordance with the revised authoritative guidance for business combinations. The consideration paid to acquire Covella was required to be measured at fair value and included cash consideration, the issuance of our common stock and contingent consideration, which includes our obligation to make clinical and regulatory milestone payments based on success in developing product candidates in addition to a royalty on net sales of any commercial products resulting from the anti-VLA-1 mAb technology. After the total consideration transferred was calculated by determining the fair value of the contingent consideration plus the upfront cash and stock consideration, we assigned the purchase price of Covella to the fair value of the assets acquired and liabilities assumed. This allocation of the purchase price resulted in recognition of intangible assets related to in-process research and development, or IPR&D, and goodwill.

We accounted for the commercialization agreement with Depomed entered into in August 2011 in accordance with the revised authoritative guidance for business combinations. The purchase consideration was comprised of cash payments for the purchase of existing inventory, and the entire purchase price was allocated to inventory, as cost approximated fair value, and no other assets were acquired and no liabilities were assumed in the transaction. Under the commercialization agreement, we have an obligation to pay royalties to Depomed based on Glumetza net product sales. These royalties are being expensed as incurred as we determined that the royalty rates reflect reasonable market rates for the manufacturing and commercialization rights we were granted under the commercialization agreement.

The determination and allocation of consideration transferred in a business combination requires us to make significant estimates and assumptions, especially at the acquisition date with respect to the fair value of the contingent consideration.

 

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The key assumptions in determining the fair value are the discount rate and the probability assigned to the potential milestone or royalty being achieved. We remeasure the fair value of the contingent consideration at each reporting period, with any change in fair value being recorded in the current period’s operating expenses. Changes in the fair value may result from either the passage of time or events occurring after the acquisition date, such as changes in the estimated probability or timing of achieving the milestone or royalty.

Intangible Assets and Goodwill

Our intangible assets are comprised primarily of acquired IPR&D and license agreements. Goodwill represents the excess of the cost over the fair value of net assets acquired from business combinations. We periodically assess the carrying value of our intangible assets and goodwill, which requires us to make assumptions and judgments regarding the future cash flows of these assets. The assets are considered to be impaired if we determine that the carrying value may not be recoverable based upon our assessment of the following events or changes in circumstances:

 

   

the asset’s ability to generate income from operations and positive cash flow in future periods;

 

   

loss of legal ownership or title to the asset;

 

   

significant changes in our strategic business objectives and utilization of the asset(s); and

 

   

the impact of significant negative industry, regulatory or economic trends.

IPR&D will not be amortized until the related development process is complete and goodwill is not amortized. License agreements and other intangible assets are amortized over their estimated useful lives. If the assets are considered to be impaired, the impairment we recognize is the amount by which the carrying value of the assets exceeds the fair value of the assets. Fair value is determined by a combination of third-party sources and forecasted discounted cash flows. In addition, we base the useful lives and related amortization expense on our estimate of the period that the assets will generate revenues or otherwise be used. We also periodically review the lives assigned to our intangible assets to ensure that our initial estimates do not exceed any revised estimated periods from which we expect to realize cash flows from the technologies. A change in any of the above-mentioned factors or estimates could result in an impairment charge which could negatively impact our results of operations. We have not recognized any impairment charges on our intangible assets or goodwill through September 30, 2011.

Inventories and Related Reserves

Inventories are stated at the lower of cost or market (net realizable value). Cost is determined by the first-in, first-out method. Inventories consist of finished goods and raw materials used in the manufacture of Glumetza tablets, Cycloset tablets, Zegerid Capsules and the related authorized generic product and Zegerid Powder for Oral Suspension. We provide reserves for potentially excess, dated or obsolete inventories based on an analysis of inventory on hand and on firm purchase commitments compared to forecasts of future sales.

Revenue Recognition

We recognize revenue when there is persuasive evidence that an arrangement exists, title has passed, the price is fixed or determinable, and collectability is reasonably assured.

Product Sales, Net. We sell our Glumetza, Cycloset and Zegerid products primarily to pharmaceutical wholesale distributors. We are obligated to accept from customers products that are returned within six months of their expiration date or up to 12 months beyond their expiration date. The shelf life of our products from the date of manufacture is as follows: Glumetza (24 to 48 months); Zegerid (36 months); and Cycloset (18 months). We authorize returns for expired or damaged products in accordance with our return goods policy and procedures. We issue credit to the customer for expired or damaged returned product. We rarely exchange product from inventory for returned product. At the time of sale, we record our estimates for product returns as a reduction to revenue at full sales value with a corresponding increase in the allowance for product returns liability. Actual returns are recorded as a reduction to the allowance for product returns liability at sales value with a corresponding decrease in accounts receivable for credit issued to the customer.

 

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We recognize product sales net of estimated allowances for product returns, estimated rebates in connection with contracts relating to managed care, Medicare, and patient coupons and voucher programs, and estimated chargebacks from distributors, wholesaler fees and prompt payment and other discounts. We establish allowances for estimated product returns, rebates and chargebacks based primarily on the following qualitative and quantitative factors:

 

   

the number of and specific contractual terms of agreements with customers;

 

   

estimated levels of inventory in the distribution channel;

 

   

estimated remaining shelf life of products;

 

   

analysis of prescription data gathered by a third-party prescription data provider;

 

   

direct communication with customers;

 

   

historical product returns, rebates and chargebacks;

 

   

anticipated introduction of competitive products or generics;

 

   

anticipated pricing strategy changes by us and/or our competitors; and

 

   

the impact of state and federal regulations.

In our analyses, we utilize prescription data purchased from a third-party data provider to develop estimates of historical inventory channel pull-through. We utilize a separate analysis which compares historical product shipments less returns to estimated historical prescriptions written. Based on that analysis, we develop an estimate of the quantity of product in the distribution channel which may be subject to various product return, rebate and chargeback exposures.

Our estimates of product returns, rebates and chargebacks require our most subjective and complex judgment due to the need to make estimates about matters that are inherently uncertain. If actual future payments for returns, rebates, chargebacks and other discounts exceed the estimates we made at the time of sale, our financial position, results of operations and cash flows would be negatively impacted.

Our allowance for product returns was $11.8 million as of September 30, 2011 and $13.5 million as of December 31, 2010. We recognize product sales at the time title passes to our customers, and we provide for an estimate of future product returns at that time based upon historical product returns trends, analysis of product expiration dating and estimated inventory levels in the distribution channel, review of returns trends for similar products, if available, and the other factors discussed above. Due to the lengthy shelf life of our products and the terms of our returns policy, there may be a significant time lag between the date we determine the estimated allowance and when we receive the product return and issue credit to a customer. Therefore, the amount of returns processed against the allowance in a particular year generally has no direct correlation to the product sales in the same year, and we may record adjustments to our estimated allowance over several periods, which can result in a net increase or a net decrease in our operating results in those periods.

We have been tracking our Zegerid product returns history by individual production batches from the time of our first commercial product launch of Zegerid Powder for Oral Suspension 20 mg in late 2004, taking into consideration product expiration dating and estimated inventory levels in the distribution channel. We launched Cycloset in November 2010 and have not experienced any returns through September 30, 2011. We have provided for an estimate of Cycloset product returns based upon our review of returns trends for similar products and taking into consideration the effect of a product’s shelf life on its returns history. Under a new commercialization agreement with Depomed, we began distributing and recording product sales for Glumetza in September 2011. We have provided for an estimate of Glumetza product returns based upon the Glumetza product returns history and taking into consideration the effect of a product’s shelf life on its returns history.

Our allowance for rebates, chargebacks and other discounts was $10.1 million as of September 30, 2011 and $13.7 million as of December 31, 2010. These allowances reflect an estimate of our liability for rebates due to managed care organizations under specific contracts, rebates due to various organizations under Medicare contracts and regulations, chargebacks due to various organizations purchasing our products through federal contracts and/or group purchasing agreements, and other rebates and customer discounts due in connection with wholesaler fees and prompt payment and other discounts. We estimate our liability for rebates and chargebacks at each reporting period based on a combination of the qualitative and quantitative assumptions listed above. In each reporting period, we evaluate our outstanding contracts and apply the contractual discounts to the invoiced price of wholesaler shipments recognized. Although the total invoiced price of shipments to wholesalers for the reporting period and the contractual terms are known during the reporting period, we project the ultimate disposition of the sale (e.g. future utilization rates of cash payors, managed care, Medicare or other contracted organizations). This estimate is based on historical trends adjusted for anticipated changes based on specific contractual terms of new agreements with customers, anticipated pricing strategy changes by us and/or our competitors and

 

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the other qualitative and quantitative factors described above. There may be a significant time lag between the date the we determine the estimated allowance and when we make the contractual payment or issues credit to a customer. Due to this time lag, we record adjustments to our estimated allowance over several periods, which can result in a net increase or a net decrease in our operating results in those periods. For the nine months ended September 30, 2011, we recorded a decrease in our estimated allowance for accrued rebates associated with product sales in prior periods of $1.4 million due to decreased utilization under, as well as the termination of, certain of our managed care and other contracts associated with our Zegerid products. Our estimate for accrued rebates was impacted by reduced sales volumes resulting from Par Pharmaceutical Inc.’s, or Par’s, commencement of its commercial sale of a generic version of Zegerid Capsules prescription products in late June 2010 and our decision to cease promotion of our Zegerid prescription products at that time. Absent this discrete event, actual results were not materially different from our estimates for the nine months ended September 30, 2011. For the nine months ended September 30, 2010, actual results were not materially different from our estimates.

In late June 2010, we began selling an authorized generic version of our prescription Zegerid Capsules under a distribution and supply agreement with Prasco. Prasco has agreed to purchase all of its authorized generic product requirements from us and pays a specified invoice supply price for such products. We recognize revenue from shipments to Prasco at the invoice supply price and the related cost of product sales when title transfers, which is generally at the time of shipment. We are also entitled to receive a percentage of the gross margin on sales of the authorized generic products by Prasco, which we recognize as an addition to product sales, net when Prasco reports to us the gross margin from the ultimate sale of the products. Any adjustments to the gross margin related to Prasco’s estimated sales discounts and other deductions are recognized in the period Prasco reports the amounts to us.

Promotion, Royalty and Other License Revenue. We analyze each element of our promotion and licensing agreements to determine the appropriate revenue recognition. Effective January 1, 2011, we adopted the authoritative guidance for revenue arrangements with multiple deliverables. Under this guidance, we identify the deliverables included within the agreement and evaluate which deliverables represent separate units of accounting. Upfront license fees are generally recognized upon delivery of the license if the facts and circumstances dictate that the license has standalone value from any undelivered items, the relative selling price allocation of the license is equal to or exceeds the upfront license fees, persuasive evidence of an arrangement exists, our price to the partner is fixed or determinable and collectability is reasonably assured. Upfront license fees are deferred if facts and circumstances dictate that the license does not have standalone value. The determination of the length of the period over which to defer revenue is subject to judgment and estimation and can have an impact on the amount of revenue recognized in a given period.

Effective January 1, 2011, we adopted prospectively, the authoritative guidance that offers an alternative method of revenue recognition for milestone payments. Under the milestone method guidance, we recognize payment that is contingent upon the achievement of a substantive milestone, as defined in the guidance, in its entirety in the period in which the milestone is achieved. Other milestones that do not fall under the definition of a milestone under the milestone method are recognized under the authoritative guidance concerning revenue recognition. Sales milestones, royalties and promotion fees are based on sales and/or gross margin information, which may include estimates of sales discounts and other deductions, received from the relevant alliance agreement partner. Sales milestones, royalties and promotion fees are recognized as revenue when earned under the agreements, and any adjustments related to estimated sales discounts and other deductions are recognized in the period the alliance agreement partner reports the amounts to us.

Stock-Based Compensation

We estimate the fair value of stock options and employee stock purchase plan rights granted using the Black-Scholes valuation model. This estimate is affected by our stock price, as well as assumptions regarding a number of complex and subjective variables. These variables include the expected volatility of our stock price, the expected term of the stock option, the risk-free interest rate and expected dividends. In determining our volatility factor, we perform an analysis of our historical volatility since our initial public offering in April 2004. In addition, we consider the expected volatility of similar entities. In evaluating similar entities, we consider factors such as industry, stage of development, size and financial leverage. In determining the expected life of the options, we use the “simplified” method. Under this method, the expected life is presumed to be the mid-point between the vesting date and the end of the contractual term. We will continue to use the “simplified” method until we have sufficient historical exercise data to estimate the expected life of the options.

The fair value of options granted is amortized on a straight-line basis over the requisite service period of the awards, which is generally the vesting period ranging from one to four years. Pre-vesting forfeitures were estimated to be

 

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approximately 0% for the three and nine months ended September 30, 2011 and 2010 as the majority of options granted contain monthly vesting terms.

The following table includes stock-based compensation recognized in our consolidated statements of operations (in thousands):

 

     Three Months  Ended
September 30,
     Nine Months Ended
September 30,
 
     2011      2010      2011      2010  

Cost of product sales

   $ 41       $ 52       $ 107       $ 107   

Research and development

     243         190         623         527   

Selling, general and administrative

     1,175         1,071         3,187         3,167   

Restructuring charges

     —           352         —           352   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,459       $ 1,665       $ 3,917       $ 4,153   
  

 

 

    

 

 

    

 

 

    

 

 

 

As of September 30, 2011, total unrecognized compensation cost related to stock options was approximately $11.9 million, and the weighted average period over which it was expected to be recognized was 2.7 years.

Income Taxes

We provide for income taxes under the liability method. This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of differences between the tax basis of assets or liabilities and their carrying amounts in the financial statements. We provide a valuation allowance for deferred tax assets if it is more likely than not that these items will either expire before we are able to realize their benefit or if future deductibility is uncertain.

We follow the authoritative guidance relating to accounting for uncertainty in income taxes. This guidance clarifies the recognition threshold and measurement attributes for financial statement disclosure of tax positions taken or expected to be taken on a tax return. The impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more likely than not to be sustained upon audit by the relevant taxing authority. An uncertain tax position will not be recognized if it has less than a 50% likelihood of being sustained.

The above listing is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP. There are also areas in which our management’s judgment in selecting any available alternative would not produce a materially different result. Please see our audited consolidated financial statements and notes thereto included in our annual report on Form 10-K, which contain accounting policies and other disclosures required by GAAP.

Recent Accounting Pronouncements

Adoption of Recent Accounting Pronouncements

In December 2010, the Financial Accounting Standards Board, or FASB, issued authoritative guidance concerning the recognition and classification of the new annual fee payable by branded prescription drug manufacturers and importers on branded prescription drugs which was mandated under the health care reform legislation enacted in the U.S. in March 2010. Under this new authoritative guidance, the annual fee should be estimated and recognized in full as a liability upon the first qualifying commercial sale with a corresponding deferred cost that is amortized to operating expenses using a straight-line method unless another method better allocates the fee over the calendar year in which it is payable. This new guidance is effective for calendar years beginning on or after December 31, 2010, when the fee initially became effective. Upon adoption, this guidance did not have a material impact on our consolidated financial statements.

In March 2010, the FASB ratified the final consensus that offers an alternative method of revenue recognition for milestone payments. The guidance states that an entity can make an accounting policy election to recognize a payment that is contingent upon the achievement of a substantive milestone, as defined in the guidance, in its entirety in the period in which the milestone is achieved. The guidance is effective for fiscal years, and interim periods within those years, beginning on or after June 15, 2010 with early adoption permitted, provided that the revised guidance is applied retrospectively to the beginning of the year of adoption. We elected to adopt this guidance prospectively, effective for our fiscal year beginning January 1, 2011. Upon adoption, the guidance did not have a material impact on our consolidated financial statements and is not expected to have a material impact on our future operating results.

 

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In September 2009, the FASB revised the authoritative guidance for revenue arrangements with multiple deliverables. The guidance addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting and how the arrangement consideration should be allocated among the separate units of accounting. The guidance may be applied retrospectively or prospectively for new or materially modified arrangements. We elected to adopt this guidance prospectively, effective for our fiscal year beginning January 1, 2011. Upon adoption, the guidance did not have a material impact on our consolidated financial statements and is not expected to have a material impact on our future operating results.

Pending Adoption of Recent Accounting Pronouncements

In September 2011, the FASB issued an update to the authoritative guidance on performing goodwill impairment testing. Under the revised guidance, entities testing goodwill for impairment have the option of performing a qualitative assessment before calculating the fair value of the reporting unit (step 1 of the goodwill impairment test). If entities determine, on the basis of qualitative factors, that the fair value of the reporting unit is more likely than not less than the carrying amount, the two-step impairment test would be required; otherwise, no further testing is required. The revised guidance does not change how goodwill is calculated or assigned to reporting units, does not revise the requirement to test goodwill annually for impairment, and does not amend the requirement to test goodwill for impairment between annual tests if events and circumstances warrant. The revised authoritative guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted. We are currently evaluating the potential impact the early adoption of this statement may have on our financial position and results of operations.

Results of Operations

Comparison of Three Months Ended September 30, 2011 and 2010

Product Sales, Net. Product sales, net were $19.8 million for the three months ended September 30, 2011 and $11.0 million for the three months ended September 30, 2010 and consisted of sales of Zegerid Capsules and Zegerid Powder for Oral Suspension as well as sales of the authorized generic version of Zegerid Capsules under our distribution and supply agreement with Prasco. In the three months ended September 30, 2011, product sales, net also consisted of sales of Cycloset which we launched in November 2010 and Glumetza which we began distributing in September 2011. The $8.8 million increase in product sales, net included approximately $7.8 million in sales of Glumetza and approximately $2.1 million in sales of Cycloset. In September 2011, we implemented an eVoucher program designed to reduce co-pay costs for patients using Glumetza and increase overall Glumetza usage. We recorded eVoucher discounts of approximately $1.1 million in the three months ended September 2011, of which approximately $371,000 related to our September 2011 shipments of Glumetza and approximately $687,000 related to potential eVoucher redemptions on shipments of Glumetza prior to September 2011. These increases were offset in part by a decrease in net sales of our Zegerid products as well as the authorized generic version of Zegerid Capsules.

Promotion Revenue. Promotion revenue was $6.0 million for the three months ended September 30, 2011 and $6.8 million for the three months ended September 30, 2010. Promotion revenue included fees earned under our promotion agreement with Depomed for the promotion of Glumetza prescription products. Promotion revenue for the three months ended September 30, 2011 was based on Glumetza sales recorded by Depomed for July and August 2011 and which sales were impacted by an increase of $3.5 million in Depomed’s allowance for product returns related to a Glumetza pricing action taken in August 2011. The promotion agreement was replaced by a new commercialization agreement with Depomed under which we began distributing and recording product sales for Glumetza in September 2011. Glumetza 500 mg was the subject of a voluntary recall and supply interruption which resulted in the unavailability of this dosage strength from June 2010 through early January 2011. Shipments of Glumetza 500 mg resumed in January 2011.

Royalty Revenue. Royalty revenue was $979,000 for the three months ended September 30, 2011 and $311,000 for the three months ended September 30, 2010 and was comprised of royalty revenue earned under our license agreement with Merck for Zegerid OTC and our license agreement with GSK for prescription and OTC immediate-release omeprazole products in specified countries outside the U.S. Merck commenced commercial sales of Zegerid OTC in the first quarter of 2010 and GSK commenced commercial sales in Mexico in the second quarter of 2011.

 

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Cost of Product Sales. Cost of product sales was $2.2 million for the three months ended September 30, 2011 and $1.2 million for the three months ended September 30, 2010, or approximately 11% of net product sales in each period. Cost of product sales consists primarily of raw materials, third-party manufacturing costs, freight and indirect personnel and other overhead costs associated with the sales of our Glumetza, Cycloset and Zegerid prescription products as well as shipments to Prasco of the authorized generic version of Zegerid Capsules. Cost of product sales also includes reserves for excess, dated or obsolete commercial inventories based on an analysis of inventory on hand and on firm purchase commitments compared to forecasts of future sales.

License Fees and Royalties. License fees and royalties were $3.7 million for the three months ended September 30, 2011 and $16.0 million for the three months ended September 30, 2010. License fees and royalties consist of royalties due to the University of Missouri based upon net product sales of our Zegerid prescription products, sales of Zegerid OTC by Merck under our license agreement and products sold by GSK under our license agreement, and royalties due to Depomed under our commercialization agreement based upon net product sales of Glumetza. In addition, license fees and royalties include milestone payments and upfront fees expensed or amortized under license agreements, as well as amounts payable to S2 and VeroScience based on a percentage of the gross margin associated with net sales of Cycloset. License fees and royalties also include changes in the fair value of contingent consideration related to business combinations. The $12.3 million decrease in license fees and royalties was primarily due to the $15.0 million upfront fee we paid to Pharming in September 2010 under our license and supply agreements. This decrease was offset in part by royalties due to Depomed based upon net product sales of Glumetza, which commenced in September 2011 under our commercialization agreement entered into in August 2011.

Research and Development. Research and development expenses were $3.8 million for the three months ended September 30, 2011 and $4.4 million for the three months ended September 30, 2010. The $602,000 decrease in our research and development expenses was primarily attributable to a decrease in costs associated with our Uceris phase III clinical program.

Selling, General and Administrative. Selling, general and administrative expenses were $16.2 million for the three months ended September 30, 2011 and $15.0 million for the three months ended September 30, 2010. The $1.2 million increase in our selling, general and administrative expenses was primarily attributable to an increase in promotional spending related to our Glumetza and Cycloset products.

Interest Income. Interest income was $2,000 for the three months ended September 30, 2011 and $22,000 for the three months ended September 30, 2010.

Interest Expense. Interest expense was $116,000 for both the three months ended September 30, 2011 and 2010. Interest expense was comprised primarily of interest due in connection with our revolving credit facility with Comerica Bank, or Comerica.

Income Tax Expense. Income tax expense was $189,000 for the three months ended September 30, 2011 and $(191,000) for the three months ended September 30, 2010. The provision for income taxes reflects our estimate of the effective tax rate expected to be applicable for the full fiscal year. Our effective tax rate for the three months ended September 30, 2011 and September 30, 2010 is impacted by anticipated utilization of Federal and state income tax net operating loss carryforwards.

Comparison of Nine Months Ended September 30, 2011 and 2010

Product Sales, Net. Product sales, net were $46.5 million for the nine months ended September 30, 2011 and $72.8 million for the nine months ended September 30, 2010 and consisted of sales of Zegerid Capsules and Zegerid Powder for Oral Suspension as well as sales of the authorized generic version of Zegerid Capsules under our distribution and supply agreement with Prasco. In the nine months ended September 30, 2011, product sales, net also consisted of sales of Cycloset which we launched in November 2010 and Glumetza which we began distributing in September 2011. The $26.3 million decrease in product sales, net was comprised of approximately $38.9 million related to a decrease in sales of our Zegerid products, including the authorized generic products, partially offset by approximately $7.8 million in sales of

 

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Glumetza and approximately $4.8 million in sales of Cycloset. In September 2011, we implemented an eVoucher program designed to reduce co-pay costs for patients using Glumetza and increase overall Glumetza usage. We recorded eVoucher discounts of approximately $1.1 million in the nine months ended September 2011, of which approximately $371,000 related to our September 2011 shipments of Glumetza and approximately $687,000 related to potential eVoucher redemptions on shipments of Glumetza prior to September 2011. The decrease in Zegerid sales volume resulted from Par’s commencement of commercial sale of its generic version of our Zegerid Capsules prescription products in late June 2010.

Promotion Revenue. Promotion revenue was $27.3 million for the nine months ended September 30, 2011 and $23.7 million for the nine months ended September 30, 2010. Promotion revenue included fees earned under our promotion agreement with Depomed for the promotion of Glumetza prescription products. Promotion revenue for the nine months ended September 30, 2011 was based on Glumetza sales recorded by Depomed for January through August 2011 and which sales were impacted by an increase of $3.5 million in Depomed’s allowance for product returns related to a Glumetza pricing action taken in August 2011. The promotion agreement was replaced by a new commercialization agreement with Depomed under which we began distributing and recording product sales for Glumetza in September 2011. Glumetza 500 mg was the subject of a voluntary recall and supply interruption which resulted in the unavailability of this dosage strength from June 2010 through early January 2011. Shipments of Glumetza 500 mg resumed in January 2011.

Royalty Revenue. Royalty revenue was $2.4 million for the nine months ended September 30, 2011 and $2.7 million for the nine months ended September 30, 2010 and was comprised primarily of royalty revenue earned under our license agreement with Merck for Zegerid OTC and our license agreement with GSK for prescription and OTC immediate-release omeprazole products in specified countries outside the U.S. Merck commenced commercial sales of Zegerid OTC products in the first quarter of 2010 and GSK commenced commercial sales in Mexico in the second quarter of 2011.

Other License Revenue. Other license revenue was $245,000 for the nine months ended September 30, 2010 and was comprised of the remaining amortization of the upfront payment we received in October 2009 in connection with our license agreement with Norgine. There was no other license revenue in the nine months ended September 30, 2011.

Cost of Product Sales. Cost of product sales was $5.6 million for the nine months ended September 30, 2011 and $6.6 million for the nine months ended September 30, 2010, or approximately 12% and 9% of net product sales, respectively. Cost of product sales consists primarily of raw materials, third-party manufacturing costs, freight and indirect personnel and other overhead costs associated with the sales of our Glumetza, Cycloset and Zegerid prescription products as well as shipments to Prasco of the authorized generic version of Zegerid Capsules. Cost of product sales also includes reserves for excess, dated or obsolete commercial inventories based on an analysis of inventory on hand and on firm purchase commitments compared to forecasts of future sales. The increase in our cost of product sales as a percentage of net product sales was primarily attributable to certain fixed costs being applied to decreased sales volumes and higher manufacturing costs associated with Cycloset.

License Fees and Royalties. License fees and royalties were $7.6 million for the nine months ended September 30, 2011 and $21.3 million for the nine months ended September 30, 2010. License fees and royalties consist of royalties due to the University of Missouri based upon net product sales of our Zegerid prescription products, sales of Zegerid OTC by Merck under our license agreement and products sold by GSK under our license agreement, and royalties due to Depomed under our commercialization agreement based upon net product sales of Glumetza. In addition, license fees and royalties include milestone payments and upfront fees expensed or amortized under license agreements, as well as amounts payable to S2 and VeroScience based on a percentage of the gross margin associated with net sales of Cycloset. License fees and royalties also include changes in the fair value of contingent consideration related to business combinations. The $13.7 million decrease in license fees and royalties was primarily due to the $15.0 million upfront fee we paid to Pharming in September 2010 under our license and supply agreements and to a decrease in royalties due to the University of Missouri based on decreased sales of Zegerid prescription products. These decreases were offset in part by the product royalty payable to S2 and VeroScience based on the gross margin associated with net sales of Cycloset and the royalties due to Depomed based upon net product sales of Glumetza, which commenced in September 2011 under our commercialization agreement entered into in August 2011.

Research and Development. Research and development expenses were $11.0 million for the nine months ended September 30, 2011 and $14.0 million for the nine months ended September 30, 2010. The $3.0 million decrease in our research and development expenses was primarily attributable to a decrease in costs associated with our Uceris and rifamycin SV MMX phase III clinical programs partially offset by costs associated with our phase I clinical study with SAN-300.

 

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In connection with our strategic collaboration with Cosmo entered into in December 2008, we are developing two product candidates targeting gastrointestinal, or GI, conditions. Uceris is a corticosteroid in a novel oral tablet formulation, dosed one tablet once a day, which utilizes proprietary MMX colonic delivery technology and is being developed for the treatment of ulcerative colitis. We have announced statistically significant top-line results according to our statistical analysis plan from two phase III clinical studies which evaluated Uceris 9 mg for the induction of remission of mild or moderate active ulcerative colitis. Additionally, we announced top-line safety data from a 12-month, double-blind, extended use study. We plan to submit an NDA for Uceris to the FDA by the end of 2011. In connection with the ongoing development and potential future commercialization of Uceris, we are also planning to initiate a phase IIIb multicenter, randomized, double-blind placebo-controlled clinical study to evaluate Uceris 9 mg as an add-on therapy to current oral 5-ASA drugs, such as Asacol or Lialda, for induction of remission of active ulcerative colitis. Rifamycin SV MMX is a broad spectrum, semi-synthetic antibiotic in a novel oral tablet formulation, which utilizes proprietary MMX colonic delivery technology and is being developed for the treatment of patients with travelers’ diarrhea and potentially for other diseases that have an infectious component in the intestine. Rifamycin SV MMX 200 mg oral tablets taken twice daily (2 times 200 mg per dose, 800 mg total daily dose) is currently being investigated in a phase III clinical program in patients with travelers’ diarrhea.

We have acquired rights to Rhucin under license and supply agreements with Pharming. Rhucin is a recombinant version of the human protein C1 inhibitor, which is produced using proprietary transgenic technology. Rhucin is currently being evaluated in a phase III clinical study at a 50 U/kg dose for the treatment of acute attacks of HAE, an orphan disease.

We have acquired the exclusive worldwide rights to SAN-300 through the acquisition of Covella and a related license agreement with Biogen. SAN-300 is an inhibitor of VLA-1, also known as a1ß1 integrin, and has shown activity in multiple preclinical models of inflammatory and autoimmune diseases. We believe that SAN-300 may have potential application as a drug candidate in multiple inflammatory and autoimmune diseases, including rheumatoid arthritis, inflammatory bowel disease, psoriasis and organ transplantation. We initiated a single-dose, dose-escalation Phase I clinical study in March 2011, which study we expect to be completed in the first half of 2012.

Research and development expenses have historically consisted primarily of costs associated with clinical studies of our products under development as well as clinical studies designed to further differentiate our products from those of our competitors, development of and preparation for commercial manufacturing of our products, compensation and other expenses related to research and development personnel and facilities expenses.

A substantial portion of our external research and development costs is tracked on a direct project basis. However, because our internal research and development resources are used in several projects, the related indirect costs are not attributable to a specific development product candidate. For example, personnel and facility related costs are not tracked on a project basis. We have summarized the costs associated with our development programs in the following table (in thousands). Costs that are not attributable to a specific product candidate, including salaries and related personnel and facilities costs, are included in the “indirect costs” category.

 

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     Three Months  Ended
September 30,
     Nine Months Ended
September 30,
     Project to
Date
Through
September 30,
2011(1)
 
     2011      2010      2011      2010     

Direct costs:

              

Uceris

   $ 743       $ 1,533       $ 1,621       $ 5,265       $ 18,976   

Rifamycin SV MMX

     475         643         1,167         2,052         4,214   

Rhucin

     40         329         229         329         632   

SAN-300

     328         —           1,721         —           2,237   

Zegerid and other projects

     53         366         176         1,433         N/A   
  

 

 

    

 

 

    

 

 

    

 

 

    

Total direct costs

     1,639         2,871         4,914         9,079      

Indirect costs

     2,186         1,556         6,049         4,905         N/A   
  

 

 

    

 

 

    

 

 

    

 

 

    

Total research and development

   $ 3,825       $ 4,427       $ 10,963       $ 13,984      
  

 

 

    

 

 

    

 

 

    

 

 

    

 

(1) Project to date amounts are included for projects on which we are primarily focused.

In the future, we may conduct additional clinical studies to further differentiate our marketed products and products under development, as well as conduct research and development related to any future products that we may in-license or otherwise acquire. Although we are currently focused primarily on the advancement of the Uceris, Rhucin, rifamycin SV MMX and SAN-300 development-stage products, we anticipate that we will make determinations as to which development projects to pursue and how much funding to direct to each project on an ongoing basis in response to the scientific, clinical and commercial merits of each project. We are unable to estimate with any certainty the research and development costs that we may incur in the future. In addition, in connection with the approval of our NDAs for Zegerid Powder for Oral Suspension, we committed to commence clinical studies to evaluate the product in pediatric populations in 2005. We have not yet commenced any of the studies and have requested a waiver of this requirement from the FDA. We received an initial response from the FDA waiving certain of the requirements and plan to seek further clarification.

Selling, General and Administrative. Selling, general and administrative expenses were $48.7 million for the nine months ended September 30, 2011 and $66.5 million for the nine months ended September 30, 2010. The $17.8 million decrease in our selling, general and administrative expenses was primarily attributable to a decrease in compensation, benefits and related employee costs and a decrease in Zegerid promotional spending related to our decision to cease promotion of our Zegerid prescription products and implement a corporate restructuring in the third quarter of 2010. These decreases in selling, general and administrative expenses were offset in part by an increase in advertising and promotional spending associated with Cycloset.

Interest Income. Interest income was $16,000 for the nine months ended September 30, 2011 and $68,000 for the nine months ended September 30, 2010.

Interest Expense. Interest expense was $342,000 for the nine months ended September 30, 2011 and $345,000 for the nine months ended September 30, 2010. Interest expense was comprised primarily of interest due in connection with our revolving credit facility with Comerica.

Income Tax Expense. Income tax expense was $229,000 for the nine months ended September 30, 2011 and $65,000 for the nine months ended September 30, 2010. The provision for income taxes reflects our estimate of the effective tax rate expected to be applicable for the full fiscal year. Our effective tax rate for the nine months ended September 30, 2011 and September 30, 2010 is impacted by anticipated utilization of Federal and state income tax net operating loss carryforwards.

Liquidity and Capital Resources

As of September 30, 2011, cash, cash equivalents and short-term investments were $58.7 million, compared to $60.8 million as of December 31, 2010, a decrease of $2.1 million. This net decrease resulted from changes in operating assets and liabilities offset in part by our net income for the nine months ended September 30, 2011, adjusted for non-cash charges.

 

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Net cash used in operating activities was $3.7 million for the nine months ended September 30, 2011 and $23.3 million for the nine months ended September 30, 2010. The primary use of cash for the nine months ended September 30, 2011 resulted from changes in operating assets and liabilities. Significant working capital uses of cash for the nine months ended September 30, 2011 included increases in accounts receivable related to our commencement of distribution of Glumetza in September 2011 and decreases in accounts payable and accrued liabilities related to payments of a one-time $3.0 million sales milestone to Depomed, annual corporate bonuses, accrued rebates and other expenses accrued in 2010. These working capital uses of cash were offset in part by our net income for the nine months ended September 30, 2011, adjusted for non-cash charges, including $3.9 million in stock-based compensation and $2.3 million in depreciation and amortization and decreases in prepaid expenses and other current assets. The primary use of cash for the nine months ended September 30, 2010 resulted from our net loss for the period, which included the $15.0 million upfront fee we paid to Pharming in connection with the license and supply agreements we entered into in September 2010, adjusted for non-cash charges, including $4.2 million in stock-based compensation and $1.5 million in depreciation and amortization, and changes in operating assets and liabilities. Significant working capital uses of cash for the nine months ended September 30, 2010 included increases in prepaid expenses and other current assets and decreases in accounts payable and accrued liabilities related to payment of annual corporate bonuses, accrued rebates and other expenses accrued in 2009. These working capital uses of cash for the nine months ended September 30, 2010 were offset in part by decreases in inventories related to our reserves against on-hand inventories of our Zegerid products, and decreases in accounts receivable resulting from our decision to cease promotion of Zegerid and the launch of generic versions of prescription Zegerid Capsules.

Net cash used in investing activities was $187,000 for the nine months ended September 30, 2011 and $2.3 million for the nine months ended September 30, 2010. These activities included purchases and sales/maturities/redemptions of short-term investments and purchases of property and equipment. For the nine months ended September 30, 2010, net cash used in investing activities also included the $5.0 million upfront payment we made to S2 and VeroScience in connection with the acquisition of intangible assets related to Cycloset and net cash payments of $842,000 in connection with our acquisition of Covella.

Net cash provided by financing activities was $1.6 million for the nine months ended September 30, 2011 and $537,000 for the nine months ended September 30, 2010. Net cash provided by financing activities included proceeds received from the exercise of stock options and through the issuance of common stock under our employee stock purchase plan.

Contractual Obligations and Commitments

We currently rely on Patheon, Inc. as our manufacturer of Glumetza 500 mg, Cycloset and Zegerid Powder for Oral Suspension, and we currently rely on Depomed to oversee the manufacturing of Glumetza 1000 mg. We rely on Norwich Pharmaceuticals, Inc. as our manufacturer of Zegerid Capsules and the related authorized generic product. We also are required to purchase commercial quantities of certain active ingredients in our Glumetza, Cycloset and Zegerid products. At September 30, 2011, we had finished goods and raw materials inventory purchase commitments of approximately $2.0 million.

License Agreement with University of Missouri

Under our exclusive worldwide license agreement with the University of Missouri entered into in January 2001 relating to specific formulations of PPIs with antacids and other buffering agents, we are required to make milestone payments to the University of Missouri upon initial commercial sale in specified territories outside the U.S., which may total up to $3.5 million in the aggregate. We are also required to make milestone payments based on first-time achievement of significant sales thresholds, up to a maximum of $83.8 million remaining under the agreement, which includes sales by us, Prasco, Merck, GSK and Norgine. We are also obligated to pay royalties on net sales of our Zegerid prescription products and any products sold by Prasco, Merck, GSK and Norgine under our existing license and distribution agreements.

Agreements with Depomed

Under our promotion agreement with Depomed entered into in July 2008, we paid a $3.0 million sales milestone in March 2011 based on having achieved Glumetza net product sales in excess of $50.0 million during the 13-month period ending January 31, 2011. Under a new commercialization agreement with Depomed entered into in August 2011, we are required to pay to Depomed royalties on Glumetza net product sales in the U.S. of 26.5% in 2011; 29.5% in 2012; 32.0% in 2013 and 2014; and 34.5% in 2015 and beyond prior to generic entry of a Glumetza product. In the event of generic entry

 

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of a Glumetza product in the U.S., the parties will equally share proceeds based on a gross margin split. We have the exclusive right to commercialize authorized generic versions of the Glumetza products. The commercialization agreement replaces the existing promotion agreement, and we will pay no additional sales milestones to Depomed as was required under the prior promotion agreement. Under the commercialization agreement, we have certain reduced minimum marketing expenditures and sales force promotion obligations during the term of the agreement until such time as a generic to Glumetza enters the market. We are responsible for 70% of the future out-of-pocket costs related to the existing patent infringement lawsuits against Lupin Limited and its wholly owned subsidiary, Lupin Pharmaceutical, Inc., collectively Lupin, and Sun Pharma Global FZE, Sun Pharmaceutical Industries Ltd. and Sun Pharmaceutical Industries Inc., collectively Sun.

License Agreement with Cosmo

Under our license agreement, stock issuance agreement and registration rights agreement with Cosmo entered into in December 2008, Cosmo is entitled to receive up to a total of $6.0 million in clinical and regulatory milestones remaining under the agreements for the initial indications for the licensed products, including $4.0 million upon FDA acceptance of the NDA for Uceris, up to $6.0 million in clinical and regulatory milestones for a second indication for rifamycin SV MMX and up to $57.5 million in commercial milestones. The milestones may be paid in cash or through issuance of additional shares of our common stock, at Cosmo’s option, subject to certain limitations. We will be required to pay tiered royalties to Cosmo ranging from 12% to 14% on net sales of any licensed products we sell. Such royalties are subject to reduction in certain circumstances, including in the event of market launch in the U.S. of a generic version of a licensed product. We are responsible for one-half of the total out-of-pocket costs associated with the Uceris phase III clinical program associated with obtaining regulatory approval and for all of the out-of-pocket costs for the ongoing rifamycin SV MMX phase III U.S. registration study and the planned Uceris phase IIIb multicenter clinical study. In the event that additional clinical work is required to obtain U.S. regulatory approval for either of the licensed products, the parties will agree on cost sharing.

Distribution and License Agreement with S2 and VeroScience

Under the terms of our distribution and license agreement with S2 and VeroScience entered into in September 2010, we are responsible for paying a product royalty to S2 and VeroScience of 35% of the gross margin associated with net sales of Cycloset up to $100 million of cumulative total gross margin, increasing to 40% thereafter. Gross margin is defined as net sales less cost of goods sold. In the event net sales of Cycloset exceed $100 million in a calendar year, we will pay an additional 3% of the gross margin to S2 and VeroScience on incremental net sales over $100 million.

License Agreement and Supply Agreement with Pharming

Under our license agreement with Pharming entered into in September 2010, we are required to pay a $5.0 million milestone to Pharming upon FDA acceptance of a biologics license application for Rhucin. We may also be required to pay Pharming additional success-based clinical and commercial milestones totaling up to an aggregate of $30 million, including a $10 million milestone payable on successful completion of the phase III clinical study, depending upon the achievement of developmental and commercial objectives. In addition, we will be required to pay certain one-time performance milestones if we achieve certain aggregate net sales levels of Rhucin. The amount of each such milestone payment varies upon the level of net sales in a calendar year. The maximum amount of all such payments to Pharming would be $45 million, assuming net sales exceeded $500 million in a calendar year. As consideration for the licenses and rights granted under the license agreement, and as compensation for the commercial supply of Rhucin by Pharming pursuant to our supply agreement, we will pay Pharming a tiered supply price, based on a percentage of net sales of Rhucin, subject to reduction in certain events.

Acquisition of Covella

We have acquired the exclusive worldwide rights to SAN-300 through the acquisition of Covella and a related license agreement with Biogen. In connection with our acquisition of Covella, under the terms of the merger agreement, we may be required to make clinical and regulatory milestone payments totaling up to an aggregate of $37.7 million (consisting of a combination of cash and our common stock) based on success in developing product candidates (with the first such milestone being payable upon successful completion of the first Phase IIb clinical study). We may also be required to pay a royalty equal to a low single digit percentage rate of net sales of any commercial products resulting from the anti-VLA-1 mAb technology.

 

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Amended License Agreement and Amended Services and Supply Agreement with Biogen

Under our amended license agreement with Biogen, we may be obligated to make various clinical, regulatory and sales milestone payments based upon our success in developing and commercializing development-stage products (with the first such milestone being payable upon successful completion of the first Phase IIb clinical study). The amounts of the clinical and regulatory milestone payments vary depending on the type of product, the number of indications, and other specifically negotiated milestones. If SAN-300 is the first to achieve all applicable milestones for all three indications, we will be required to pay Biogen maximum aggregate clinical and regulatory milestone payments of $97.2 million. The amount of the commercial milestone payments we will be required to pay Biogen will depend on the level of net sales of a particular product in a calendar year. The maximum aggregate commercial milestone payments to Biogen total $105.5 million for SAN-300, assuming cumulative net sales of at least $5 billion of such product, and total $60.25 million for products containing certain other compositions as described in the license, assuming cumulative net sales of at least $5 billion of such products. In addition, we will be required to pay tiered royalties ranging from low single digit to low double digit percentage rates, subject to reduction in certain limited circumstances, on net sales of products developed under the amended license.

In November 2011, we amended our services and supply agreement with Biogen. Under the services and supply agreement, Biogen agreed to sell to us materials manufactured by Biogen for use in the anti-VLA-1 antibody development program. The amendment provides for a revised payment structure for such material. Under the terms of our amended services and supply agreement, there are no fees associated with the storage, delivery or usage of certain material supplied under the agreement, however, upon the achievement of the first regulatory approval as set forth in our amended license agreement, Biogen is entitled to receive a one-time milestone payment of approximately $11.7 million, which is equivalent to the cost of the materials supplied under the services and supply agreement. In the event the amended license agreement is terminated by us or Biogen prior to the achievement of the first regulatory approval as set forth in the amended license agreement, we will be required to pay Biogen a one-time termination fee of $3.0 million.

The following summarizes our long-term contractual obligations as of September 30, 2011, excluding potential clinical, regulatory and commercial milestones and royalty obligations under our agreements which are described above:

 

      Payments Due by Period  

Contractual Obligations

   Total      Less than
One  Year
     One to
Three  Years
     Four to
Five  Years
     Thereafter  
   (in thousands)  

Operating leases

   $ 2,438       $ 418       $ 2,020       $ —         $ —     

Long-term debt

     10,803         113         10,690         —           —     

Other long-term contractual obligations

     54         —           54         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 13,295       $ 531       $ 12,764       $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The amount and timing of cash requirements will depend on our ability to generate revenues from Glumetza and Cycloset, our currently promoted commercial prescription products, including our ability to maintain commercial supply for Glumetza and Cycloset, and the impact on our business of the ongoing generic competition for our Zegerid prescriptions products. In addition, our cash requirements will depend on market acceptance of any other products that we may market in the future, the success of our strategic alliances, the resources we devote to researching, developing, formulating, manufacturing, commercializing and supporting our products, and our ability to enter into third-party collaborations.

We believe that our current cash, cash equivalents and short-term investments and use of our line of credit will be sufficient to fund our current operations through at least the next twelve months; however, our projected revenue may decrease or our expenses may increase and that would lead to our cash resources being consumed earlier than we expect. Although we do not believe that we will need to raise additional funds to finance our current operations through at least the next twelve months, we may pursue raising additional funds in connection with licensing or acquisition of new products or the continued development of our product candidates. Sources of additional funds may include funds generated through equity and/or debt financings or through strategic collaborations or licensing agreements.

 

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Our existing universal shelf registration statement was declared effective in December 2008 and expires in December 2011. The universal shelf registration statement may permit us, from time to time, to offer and sell up to an additional approximately $75.0 million of equity or debt securities. However, there can be no assurance that we will be able to complete any such offerings of securities. Factors influencing the availability of additional financing include the progress of our commercial and development activities, investor perception of our prospects and the general condition of the financial markets, among others.

In July 2006, we entered into our loan agreement with Comerica, which was subsequently amended in July 2008, pursuant to which we may request advances in an aggregate outstanding amount not to exceed $25.0 million. In December 2008, we drew down $10.0 million under the loan agreement. The revolving loan bears interest at a variable rate of interest, per annum, most recently announced by Comerica as its “prime rate” plus 0.50%, which as of September 30, 2011 was 3.75%. Interest payments on advances made under the loan agreement are due and payable in arrears on the first calendar day of each month during the term of the loan agreement. On August 27, 2010, we entered into an amendment with Comerica that extends the maturity date of the revolving line from July 11, 2011 to July 11, 2013. Amounts borrowed under the loan agreement may be repaid and re-borrowed at any time prior to July 11, 2013, and any outstanding principal drawn during the term of the loan facility is due and payable on July 11, 2013. There is a non-refundable unused commitment fee equal to 0.50% per annum on the difference between the amount of the revolving line and the average daily balance outstanding thereunder during the term of the loan agreement, payable quarterly in arrears. The loan agreement will remain in full force and effect for so long as any obligations remain outstanding or Comerica has any obligation to make credit extensions under the loan agreement.

Amounts borrowed under the loan agreement are secured by substantially all of our personal property, excluding intellectual property. Under the loan agreement, we are subject to certain affirmative and negative covenants, including limitations on our ability to: undergo certain change of control events; convey, sell, lease, license, transfer or otherwise dispose of assets; create, incur, assume, guarantee or be liable with respect to certain indebtedness; grant liens; pay dividends and make certain other restricted payments; and make investments. In addition, under the loan agreement, we are required to maintain a cash balance with Comerica in an amount of not less than $4.0 million and to maintain any other cash balances with either Comerica or another financial institution covered by a control agreement for the benefit of Comerica. We are also subject to specified financial covenants with respect to a minimum liquidity ratio and, in specified limited circumstances, minimum EBITDA requirements. We believe we have currently met all of our obligations under the loan agreement.

We cannot be certain that our existing cash and marketable securities resources and use of our line of credit will be adequate to sustain our current operations. To the extent we require additional funding, we cannot be certain that such funding will be available to us on acceptable terms, or at all. To the extent that we raise additional capital by issuing equity or convertible securities, our stockholders’ ownership will be diluted. Any debt financing we enter into may involve covenants that restrict our operations. If adequate funds are not available on terms acceptable to us at that time, our ability to continue our current operations or pursue new product opportunities would be significantly limited.

In addition, our results of operations could be materially affected by economic conditions generally, both in the U.S. and elsewhere around the world. Continuing concerns over inflation, energy costs, geopolitical issues, the availability and cost of credit, the U.S. mortgage market and a declining residential real estate market in the U.S. have contributed to increased volatility and diminished expectations for the economy and the markets going forward. These factors, combined with volatile oil prices, declining business and consumer confidence and increased unemployment, have precipitated economic uncertainty. Domestic and international equity markets continue to experience heightened volatility and turmoil. These events and the continuing market upheavals may have an adverse effect on us. In the event of a continuing market downturn, our results of operations could be adversely affected by those factors in many negative ways, including making it more difficult for us to raise funds if necessary, and our stock price may further decline. In addition, we maintain significant amounts of cash and cash equivalents at one or more financial institutions that are in excess of federally insured limits. Given the current instability of financial institutions, we cannot be assured that we will not experience losses on these deposits.

In March 2010, the President signed the Patient Protection and Affordable Care Act, which makes extensive changes to the delivery of healthcare in the U.S. This act includes numerous provisions that affect pharmaceutical companies, some of which are effective immediately and others of which will be taking effect over the next several years. For example, the act seeks to expand healthcare coverage to the uninsured through private health insurance reforms and an expansion of

 

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Medicaid. The act also imposes substantial costs on pharmaceutical manufacturers, such as an increase in liability for rebates paid to Medicaid, new drug discounts that must be offered to certain enrollees in the Medicare prescription drug benefit, an annual fee imposed on all manufacturers of brand prescription drugs in the U.S., and an expansion of an existing program requiring pharmaceutical discounts to certain types of hospitals and federally subsidized clinics. The act also contains cost-containment measures that could reduce reimbursement levels for healthcare items and services generally, including pharmaceuticals. It also will require reporting and public disclosure of payments and other transfers of value provided by pharmaceutical companies to physicians and teaching hospitals. These measures could result in decreased net revenues from our pharmaceutical products and decreased potential returns from our development efforts.

As of September 30, 2011, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships.

Caution on Forward-Looking Statements

Any statements in this report and the information incorporated herein by reference about our expectations, beliefs, plans, objectives, assumptions or future events or performance that are not historical facts are forward-looking statements. You can identify these forward-looking statements by the use of words or phrases such as “believe,” “may,” “could,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “seek,” “plan,” “expect,” “should,” or “would.” Among the factors that could cause actual results to differ materially from those indicated in the forward-looking statements are risks and uncertainties inherent in our business including, without limitation: our ability to generate revenues from Glumetza® (metformin hydrochloride extended release tablets) and Cycloset® (bromocriptine mesylate) tablets, our currently promoted commercial products; our ability to ensure continued supply of our commercial products; our ability to successfully advance the development of, obtain regulatory approval for and ultimately commercialize, our development-stage products—Uceris™ (budesonide) tablets, Rhucin® (recombinant human C1 inhibitor), rifamycin SV MMX, and SAN-300 (anti-VLA-1 antibody); our ability to maintain patent protection for our products, including the difficulty in predicting the timing and outcome of the Glumetza, Zegerid® and Zegerid OTC® patent litigation; our ability to achieve continued progress under our strategic alliances, including our over-the-counter license agreement with Schering-Plough HealthCare Products, Inc., a subsidiary of Merck & Co., Inc., our license agreement with Glaxo Group Limited, an affiliate of GlaxoSmithKline plc, and our license agreement with Norgine B.V., and the potential for early termination of, or reduced payments under, these agreements; our ability to continue to generate revenues from our branded and authorized generic Zegerid (omeprazole/sodium bicarbonate) prescription products and the impact on our business and financial condition of the ongoing generic competition for our Zegerid products; adverse side effects, inadequate therapeutic efficacy or other issues related to our products or products we promote that could result in product recalls, market withdrawals or product liability claims; competition from other pharmaceutical or biotechnology companies and evolving market dynamics; our ability to further diversify our sources of revenue and product portfolio; other difficulties or delays relating to the development, testing, manufacturing and marketing of, and obtaining and maintaining regulatory approvals for, our and our strategic partners’ products; fluctuations in quarterly and annual results; our ability to obtain additional financing as needed to support our operations or future product acquisitions; the impact of healthcare reform legislation and the recent turmoil in the financial markets; and other risks detailed below under Part II — Item 1A — Risk Factors.

Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee future results, events, levels of activity, performance or achievement. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, unless required by law.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Under the terms of our loan agreement with Comerica Bank, or Comerica, the interest rate applicable to any amounts borrowed by us under the credit facility will be, at our election, indexed to either Comerica’s prime rate or the LIBOR rate. If we elect Comerica’s prime rate for all or any portion of our borrowings, the interest rate will be variable, which would expose us to the risk of increased interest expense if interest rates rise. If we elect the LIBOR rate for all or any portion of our borrowings, such LIBOR rate will remain fixed only for a specified, limited period of time after the date of our election, after which we will be required to repay the borrowed amount, or elect a new interest rate indexed to either Comerica’s

 

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prime rate or the LIBOR rate. The new rate may be higher than the earlier interest rate applicable under the loan agreement. As of September 30, 2011, the balance outstanding under the credit facility was $10.0 million, and we had elected the “prime rate” plus 0.50% interest rate option, which was 3.75% as of September 30, 2011. Under our current policies, we do not use interest rate derivative instruments to manage our exposure to interest rate changes. A hypothetical 10% increase or decrease in the interest rate under the loan agreement would not materially affect our interest expense at our current level of borrowing.

In addition to market risk related to our loan agreement with Comerica, we are exposed to market risk primarily in the area of changes in U.S. interest rates and conditions in the credit markets, particularly because the majority of our investments are in short-term marketable securities. We do not have any material foreign currency or other derivative financial instruments. Our short-term investment securities have consisted of corporate debt securities, government agency securities and U.S. Treasury securities which are classified as available-for-sale and therefore reported on the consolidated balance sheets at estimated market value.

Our results of operations could be materially affected by economic conditions generally, both in the U.S. and elsewhere around the world. Continuing concerns over inflation, energy costs, geopolitical issues, the availability and cost of credit, the U.S. mortgage market and a declining residential real estate market in the U.S. have contributed to increased volatility and diminished expectations for the economy and the markets going forward. These factors, combined with volatile oil prices, declining business and consumer confidence and increased unemployment, have precipitated economic uncertainty. Domestic and international equity markets continue to experience heightened volatility and turmoil. These events and the continuing market upheavals may have an adverse effect on us. In the event of a continuing market downturn, our results of operations could be adversely affected by those factors in many negative ways, including making it more difficult for us to raise funds if necessary, and our stock price may further decline. In addition, we maintain significant amounts of cash and cash equivalents at one or more financial institutions that are in excess of federally insured limits. Given the current instability of financial institutions, we cannot be assured that we will not experience losses on these deposits.

Item 4. Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As required by Securities and Exchange Commission Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the quarter covered by this report. Based on the foregoing, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level.

There has been no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II — OTHER INFORMATION

Item 1. Legal Proceedings

Glumetza® Patent Litigation

In November 2009, Depomed, Inc., or Depomed, filed a lawsuit in the United States District Court for the Northern District of California against Lupin Limited and its wholly owned subsidiary, Lupin Pharmaceutical, Inc., collectively referred to herein as Lupin, for infringement of the following patents listed in the Orange Book for Glumetza: U.S. Patent Nos. 6,340,475; 6,635,280; and 6,488,962. The lawsuit was filed in response to an abbreviated new drug application, or ANDA, and paragraph IV certification filed with the U.S. Food and Drug Administration, or FDA, by Lupin regarding Lupin’s intent to market generic versions of 500 mg and 1000 mg tablets for Glumetza prior to the expiration of the asserted patents. Depomed commenced the lawsuit within the requisite 45 day time period, resulting in an FDA stay on the approval of Lupin’s proposed products for 30 months or until a decision is rendered by the District Court, which is adverse to the asserted patents, whichever may occur earlier. Absent a court decision, the 30-month stay is expected to expire in May 2012. Lupin has filed an answer in the case that asserts, among other things, non-infringement and invalidity of the asserted patents, and has also filed counterclaims. A hearing for claim construction, or Markman hearing, was held in January 2011. Following the hearing, the court principally adopted the patent term constructions Depomed proposed. The discovery phase of the lawsuit is continuing, and a trial date has been scheduled in August 2012.

In June 2011, Depomed filed a lawsuit in the United States District Court for the Northern District of New Jersey against Sun Pharma Global FZE, Sun Pharmaceutical Industries Ltd. and Sun Pharmaceutical Industries Inc., collectively referred to herein as Sun, for infringement of the patents listed in the Orange Book for Glumetza (U.S. Patent Nos. 6,723,340; 6,635,280; 6,488,962; 6,340,475; and 7,780,987), as well as U.S. Patent No. 7,736,667. The lawsuit was filed in response to an ANDA and paragraph IV certification filed with the FDA by Sun regarding Sun’s intent to market generic versions of 500 mg and 1000 mg tablets for Glumetza prior to the expiration of the asserted patents. Depomed commenced the lawsuit within the requisite 45 day time period, resulting in an FDA stay on the approval of Sun’s proposed products for 30 months or until a decision is rendered by the District Court, which is adverse to the asserted patents, whichever may occur earlier. Absent a court decision, the 30-month stay is expected to expire in November 2013. Sun has filed an answer in the case that asserts, among other things, non-infringement and invalidity of the asserted patents, and has also filed counterclaims. Briefing for the Markman hearing is scheduled for the first half of 2012, and a trial date has not yet been scheduled.

Under the terms of our commercialization agreement with Depomed, Depomed will continue to manage the ongoing patent infringement lawsuits against Sun and Lupin, subject to certain consent rights in favor of us, including with regard to any proposed settlements. We will reimburse Depomed for 70% of its future out-of-pocket costs, and Depomed will reimburse us for 30% of our future out-of-pocket costs, related to the existing infringement cases. Although Depomed has indicated that it intends to vigorously defend and enforce its patent rights, we are not able to predict the timing or outcome of these actions. At this time we are unable to estimate possible losses or ranges of losses for these actions.

Any adverse outcome in the litigation described above would adversely impact our business and revenues. Regardless of how these litigation matters are ultimately resolved, the litigation will continue to be costly, time-consuming and distracting to management, which could have a material adverse effect on our business.

Zegerid® and Zegerid OTC® Patent Litigation

In April 2010, the U.S. District Court for the District of Delaware ruled that five patents covering Zegerid Capsules and Zegerid Powder for Oral Suspension (U.S. Patent Nos. 6,489,346; 6,645,988; 6,699,885; 6,780,882; and 7,399,772) were invalid due to obviousness. These patents were the subject of lawsuits we filed in 2007 in response to ANDAs filed by Par Pharmaceutical, Inc., or Par, with the FDA. In May 2010, we filed an appeal of the District Court’s ruling to the U.S. Court of Appeals for the Federal Circuit. Oral arguments in the appeal were held on May 2, 2011, and we expect a decision on the appeal in the second half of 2011, although the decision could be issued later than we expect. Although we intend to vigorously defend and enforce our patent rights, we are not able to predict the timing or outcome of the appeal.

In September 2010, Merck filed lawsuits in the U.S. District Court for the District of New Jersey against each of Par and Perrigo Research and Development Company, or Perrigo, for infringement of the patents listed in the Orange Book for Zegerid OTC (U.S. Patent Nos. 6,489,346; 6,645,988; 6,699,885; and 7,399,772). We and the University of Missouri,

 

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licensors of the listed patents, are joined in the lawsuits as co-plaintiffs. Par and Perrigo had filed ANDAs with the FDA regarding each company’s intent to market a generic version of Zegerid OTC prior to the expiration of the listed patents. The parties in each of these lawsuits have agreed to stay the court proceedings until the earlier of the outcome of the pending appeal related to the Zegerid prescription product litigation or receipt of tentative regulatory approval for the proposed generic Zegerid OTC products. We are not able to predict the timing or outcome of these lawsuits.

Any adverse outcome in the litigation described above would adversely impact our Zegerid and Zegerid OTC business, including the amount of, or our ability to receive, milestone payments and royalties under our agreement with Merck. For example, the royalties payable to us under our license agreement with Merck are subject to reduction in the event it is ultimately determined by the courts (with the decision being unappealable or unappealed within the time allowed for appeal) that there is no valid claim of the licensed patents covering the manufacture, use or sale of the Zegerid OTC product and third parties have received marketing approval for, and are conducting bona fide ongoing commercial sales of, generic versions of the licensed products. The ruling may also negatively impact the patent protection for the products being commercialized pursuant to our ex-US licenses with GSK and Norgine. Although the U.S. ruling is not binding in countries outside the U.S., similar challenges to those raised in the U.S. litigation may be raised in territories outside the U.S.

Regardless of how these litigation matters are ultimately resolved, the litigation has been and will continue to be costly, time-consuming and distracting to management, which could have a material adverse effect on our business. At this time we are unable to estimate possible losses or ranges of losses for these matters.

Wage and Hour Putative Class Action Litigation

In December 2010, a complaint styled as a putative class action was filed against us in the U.S. District Court for the Southern District of New York by a person employed at the time by us as a sales representative and on behalf of a class of similarly situated current and former employees. The complaint seeks damages for alleged violations of the New York Labor Law 650 §§ et seq. and the federal Fair Labor Standards Act. The alleged violations include failure to pay for overtime work. The complaint seeks an unspecified amount for unpaid wages and overtime wages, liquidated and/or punitive damages, attorneys’ fees and other damages. We deny all claims asserted in the complaint. In April 2011, we filed a motion to transfer the case to the United States District Court for the Southern District of California. In August 2011, our motion to transfer was denied, and the action will proceed in the New York district court. Over the last few years, similar class action lawsuits have been filed against other pharmaceutical companies alleging that the companies’ sales representatives have been misclassified as exempt employees under the federal Fair Labor Standards Act and applicable state laws. At this time, we are unable to estimate possible losses or ranges of losses for this action. There have been varying outcomes in these cases to date, and it is too early to predict an outcome in our matter at this time.

Although we intend to vigorously defend against the litigation filed against us, litigation often is expensive and diverts management’s attention and resources, which could adversely affect our business regardless of the outcome.

Item 1A. Risk Factors

Certain factors may have a material adverse effect on our business, financial condition and results of operations, and you should carefully consider them. Accordingly, in evaluating our business, we encourage you to consider the following discussion of risk factors in its entirety, in addition to other information contained in this report as well as our other public filings with the Securities and Exchange Commission, or SEC.

In the near-term, the success of our business will depend on many factors, including:

 

   

our ability to generate revenues from our two marketed products: Glumetza® (metformin hydrochloride extended release tablets) and Cycloset® (bromocriptine mesylate) tablets, both of which are indicated to treat type 2 diabetes;

 

   

our ability to successfully advance the development of, obtain regulatory approval for and ultimately commercialize, our development products: Uceris ™ (budesonide) tablets, Rhucin® (recombinant human C1 inhibitor), rifamycin SV MMX and SAN-300;

 

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our ability to maintain patent protection and regulatory exclusivity for our commercial and development-stage products, including difficulty in predicting the timing and outcome of the Glumetza, Zegerid® and Zegerid OTC® patent litigation;

 

   

our ability to continue to generate revenues from our branded and authorized generic Zegerid (omeprazole/sodium bicarbonate) prescription products and the impact on our business and financial condition of the ongoing generic competition for our Zegerid products; and

 

   

our ability to achieve continued progress under our strategic alliances, including our over-the-counter, or OTC, license agreement with Schering-Plough HealthCare Products, Inc., a subsidiary of Merck & Co., Inc., or Merck, our license agreement with Glaxo Group Limited, an affiliate of GlaxoSmithKline plc, or GSK, and our license agreement with Norgine B.V., or Norgine, and the potential for early termination of, or reduced payments under, these agreements.

Each of these factors, as well as other factors that may impact our business, are described in more detail in the following discussion. Although the factors highlighted above are among the most significant, any of the following factors could materially adversely affect our business or cause our actual results to differ materially from those contained in forward-looking statements we have made in this report and those we may make from time to time, and you should consider all of the factors described when evaluating our business.

Risks Related to Our Business and Industry

We are dependent upon our ability to generate revenues from Glumetza and Cycloset, our only promoted commercial products, and we cannot be certain that we will be successful.

Our ability to generate product revenue in the near term will depend primarily on the success of Glumetza and Cycloset. The commercial success of Glumetza and Cycloset will depend on several factors, including:

 

   

our ability to generate and increase market demand for, and sales of, Glumetza;

 

   

our ability to mitigate the impact of a prior recall and supply interruption of Glumetza 500 mg, which resulted in the unavailability of this dosage strength from June 2010 through early January 2011;

 

   

our ability to manage full operational responsibilities for Glumetza which are being transitioned to us in connection with the commercialization agreement that we signed in August 2011;

 

   

our ability to successfully generate demand for, and sales of, Cycloset, which we launched in November 2010 and have limited experience promoting;

 

   

the ability to maintain patent coverage for Glumetza and Cycloset, including whether a favorable outcome is obtained in the pending patent infringement lawsuits relating to Glumetza;

 

   

the performance of third-party manufacturers and their ability to maintain commercial manufacturing operations in accordance with regulatory and quality requirements and as necessary to meet commercial demand for the products and avoid supply interruptions;

 

   

our ability to accurately forecast manufacturing requirements and manage production and inventory levels for Cycloset during the launch period and thereafter and in light of the product’s limited expiry dating;

 

   

the occurrence of adverse side effects, inadequate therapeutic efficacy or other issues relating to the products, and any resulting product liability claims or product recalls;

 

   

the availability of adequate levels of reimbursement coverage for the products from third-party payors, particularly in light of the availability of other branded and generic competitive products; and

 

 

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our ability to effectively market Glumetza and Cycloset in accordance with the requirements of the U.S. Food and Drug Administration, or FDA.

We promote the Glumetza products under a commercialization agreement that we entered into with Depomed, Inc., or Depomed, and we promote the Cycloset products under a distribution and license agreement that we entered into with S2 Therapeutics, Inc., or S2, and VeroScience, LLC, or VeroScience. Our ability to successfully commercialize the Glumetza and Cycloset products is also subject to risks associated with these agreements, including the potential for termination of the agreements, our reliance on Depomed and VeroScience for patent protection for the products and, for Cycloset, our reliance on VeroScience to maintain regulatory responsibility.

We cannot be certain that our marketing of the Glumetza and Cycloset products will result in increased demand for, and sales of, those products. In addition, we recently announced that we have engaged Ventiv Commercial Services, LLC, d/b/a inVentiv Commercial Services, LLC, or inVentiv, to supplement our sales efforts by providing 40 contract sales representatives. We will incur significant costs to fund inVentiv’s sales efforts, and we cannot be sure that the added efforts of the contract sales force to increase Glumetza and Cycloset prescriptions will offset our expenses. If we fail to successfully commercialize these products, we may be unable to generate sufficient revenues to grow our business, and our business, financial condition and results of operations would be adversely affected.

Our development-stage products will require significant development activities and ultimately may not be approved by the FDA, and any failure or delays associated with these activities or the FDA’s approval of such products would increase our costs and time to market.

We will not be permitted to market Uceris, Rhucin, rifamycin SV MMX and SAN-300 or any other development products for which we may acquire rights in the U.S. until we complete all necessary development activities and obtain regulatory approval from the FDA.

To market a new drug in the U.S., we must submit to the FDA and obtain FDA approval of a new drug application, or NDA, or a biologics license application, or BLA. An NDA or BLA must be supported by extensive clinical and preclinical data, as well as extensive information regarding chemistry, manufacturing and controls, or CMC, to demonstrate the safety and effectiveness of the applicable product candidate. The FDA’s regulatory review of NDAs and BLAs is becoming increasingly focused on product safety attributes, and even if approved, development-stage products may not be approved for all indications requested and such approval may be subject to limitations on the indicated uses for which the drug may be marketed, restricted distribution methods or other limitations.

Failure can occur at any stage of clinical testing. The clinical study process may fail to demonstrate that our products are safe for humans or effective for their intended uses. Our clinical tests must comply with FDA and other applicable U.S. and foreign regulations, including a requirement that they be conducted in accordance with good clinical practices. We may encounter delays based on our inability to timely enroll enough patients to complete our clinical studies. We may suffer significant setbacks in advanced clinical studies, even after showing promising results in earlier studies. Based on results at any stage of clinical studies, we may decide to discontinue development of a product candidate. We or the FDA may suspend clinical studies at any time if the patients participating in the studies are exposed to unacceptable health risks or if the FDA finds deficiencies in our applications to conduct the clinical studies or in the conduct of our studies.

 

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Regulatory approval of an NDA or a BLA is difficult, time-consuming and expensive to obtain. The number and types of preclinical studies and clinical trials that will be required for NDA or BLA approval varies depending on the product candidate, the disease or the condition that the product candidate is designed to target and the regulations applicable to any particular product candidate. Despite the time and expense associated with preclinical and clinical studies, failure can occur at any stage, and we could encounter problems that cause us to repeat or perform additional preclinical studies, CMC studies or clinical studies. The FDA and similar foreign authorities could delay, limit or deny approval of a product candidate for many reasons, including because they:

 

   

may not deem a product candidate to be adequately safe and effective;

 

   

may not find the data from preclinical studies, CMC studies and clinical studies to be sufficient to support a claim of safety and efficacy;

 

   

may interpret data from preclinical studies, CMC studies and clinical studies significantly differently than we do;

 

   

may not approve the manufacturing processes or facilities utilized for our development activities or our proposed commercial manufacturing operations;

 

   

may conclude that we have not sufficiently demonstrated long-term stability of the formulation for which we are seeking marketing approval;

 

   

may change approval policies (including with respect to our development products’ class of drugs) or adopt new regulations; or

 

   

may not accept a submission due to, among other reasons, the content or formatting of the submission.

Even if we believe that data collected from our preclinical studies, CMC development program and clinical studies of our development products are promising and that our information and procedures regarding CMC are sufficient, our data may not be sufficient to support marketing approval by the FDA or any other U.S. or foreign regulatory authority, or regulatory interpretation of these data and procedures may be unfavorable. In addition, before the FDA approves one of our development products, the FDA may choose to conduct an inspection of one or more clinical or manufacturing sites. These inspections may be conducted by the FDA both at U.S. sites as well as overseas. Any restrictions on the ability of FDA investigators to travel overseas to conduct such inspections, either because of financial or other reasons including political unrest, disease outbreaks or terrorism, could delay the inspection of overseas sites and consequently delay FDA approval of our development products.

Our product development costs will increase and our product revenues will be delayed if we experience delays or setbacks for any reason. In addition, such failures could cause us to abandon a product candidate entirely. If we fail to take any current or future product candidate from the development stage to market, we will have incurred significant expenses without the possibility of generating revenues, and our business will be adversely affected.

To market any drugs outside of the U.S., we and current or future collaborators must comply with numerous and varying regulatory requirements of other countries. Approval procedures vary among countries and can involve additional product testing and additional administrative review periods, including obtaining reimbursement approval in select markets. Regulatory approval in one country does not ensure regulatory approval in another, but a failure or delay in obtaining regulatory approval in one country may negatively impact the regulatory process in others.

In addition to the general development and regulatory risks described above, each of our development products is subject to the following additional risks:

Uceris (budesonide)

Uceris is being studied for the treatment of ulcerative colitis in a phase III clinical program pursuant to our strategic collaboration with Cosmo Technologies Limited, or Cosmo. We have announced statistically significant top-line results from the U.S. and European phase III clinical studies, both of which are intended to support U.S. regulatory approval. Additionally, we announced top-line safety data from a 12-month, double-blind, extended use study. We plan to submit an NDA for Uceris to the FDA by the end of 2011.

Although the top-line results in the U.S. and European phase III studies showed that Uceris 9 mg taken once daily met the primary endpoint of superiority to placebo in achieving clinical remission as measured by the ulcerative colitis disease activity index score after eight weeks of treatment, we cannot be sure that the FDA will concur with our clinical interpretation of the results, our statistical analysis plan (including our definition of the intent-to-treat population) or the conduct of the studies. It is also possible that the extended use study, which evaluated Uceris 6 mg, will not provide adequate data to support approval of Uceris 9 mg and that an additional study with the 9 mg dose might be required.

 

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In connection with the ongoing development and potential future commercialization of Uceris, we are also planning to initiate a phase IIIb multicenter, randomized, double-blind placebo-controlled clinical study to evaluate Uceris 9 mg as an add-on therapy to current oral 5-ASA drugs, such as Asacol® or Lialda®, for induction of remission of active ulcerative colitis. We expect to initiate this clinical study in late 2011 or early 2012 and expect to enroll approximately 500 patients at clinical sites in the U.S., Canada and Europe. We may not be able to initiate or complete this trial as expected, and we cannot be certain that the results of the trial will be positive.

Once we submit our NDA, the FDA may refuse to accept the NDA for filing. Alternatively, the FDA may accept the NDA for filing but may ultimately conclude that we have not demonstrated sufficient safety or efficacy to approve an NDA filing for this development product or may require additional clinical studies or other development programs before approving Uceris. The costs of any additional clinical studies and development programs could be significant, and we may not have sufficient resources to complete any additional development requirements in a prompt manner or at all.

In addition, we anticipate that we will be filing our NDA for Uceris as a section 505(b)(2) NDA, referencing pre-clinical data generated for Entocort® EC (budesonide). As a result, we will be required to certify with regard to any unexpired patents listed in the Orange Book for Entocort EC that Uceris does not infringe such patents or that the patents are invalid. Based on current Orange Book listings, we anticipate there will be one unexpired patent listed for Entocort EC at the time we submit our NDA for Uceris. Although we believe that we have meritorious non-infringement and/or invalidity positions with regard to such patent, it is possible that following our certification, the NDA and patent holder for Entocort EC could elect to file suit against us, which in turn could result in a delay of approval for up to 30 months or longer. The outcome of any such litigation could be uncertain and defending such litigation could be expensive, time-consuming and distracting to management.

Rhucin (recombinant human C1 inhibitor)

We have licensed rights to develop and commercialize Rhucin pursuant to license and supply agreements with Pharming Group NV, or Pharming. In December 2010, Pharming submitted a BLA for Rhucin to the FDA seeking approval to market Rhucin for the treatment of acute angioedema attacks in patients with hereditary angioedema, or HAE. In February 2011, based on prior discussions with the FDA, Pharming initiated a placebo-controlled, double-blind clinical study with approximately 50 patients to provide additional data in support of the 50 U/kg dose of Rhucin for the treatment of HAE.

Also in February 2011 and after the initiation of the additional study, Pharming announced receipt of a refusal to file letter from the FDA for the Rhucin BLA. In the letter, the FDA indicated that the BLA was not sufficiently complete to enable a critical medical review. In reaching its conclusion, the FDA indicated that the previously conducted studies evaluating Rhucin for the treatment of acute attacks of HAE did not provide data for a sufficient number of subjects to support the proposed dose of 50 U/kg and lacked prospective validation of the visual analog scale used in measuring the clinical effects of Rhucin. The FDA also provided other comments on the prior clinical studies and indicated that the FDA would provide additional feedback on the design of the ongoing clinical study. In addition, the FDA requested that the results of the ongoing clinical study be included in any future BLA submission for Rhucin.

In late March 2011, we and Pharming met with the FDA to discuss the FDA refusal to file letter and to gain further clarification on the protocol for the ongoing study. Based on input from the FDA, as well as our and Pharming’s review of the FDA meeting minutes, we and Pharming submitted an amendment to the protocol for the study. In August 2011, we and Pharming reached an agreement with the FDA on the protocol for the study through the Special Protocol Assessment, or SPA, process, which included an increase of the number of patients to approximately 75 and a modification of the manner in which the primary endpoint will be assessed. We still plan to include in the study an open-label extension to further evaluate the efficacy, safety and immunogenicity of Rhucin at 50 U/kg for the repeated treatment of acute HAE attacks.

The companies currently expect that the phase III study will be completed by the third quarter of 2012. However, the timing estimate is dependent on the rate of enrollment, as well as other general risks associated with the conduct of the study.

We cannot be certain that Pharming will complete the phase III clinical study in a timely or successful manner. In addition, we cannot be certain that the FDA will accept a future BLA submission for Rhucin and ultimately approve Rhucin

 

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in a timely manner or at all. The FDA may require additional clinical studies or other development programs beyond the ongoing phase III study prior to approving Rhucin. The costs of any additional clinical studies and development programs could be significant, and we and Pharming may not have sufficient resources to complete any additional development requirements in a prompt manner or at all.

In addition, Pharming has initiated a phase II proof of concept study to evaluate recombinant human C1 inhibitor for the treatment of antibody mediated rejection, or AMR, in renal transplant patients. Given that this study is a proof of concept study, there is no assurance that recombinant human C1 inhibitor will be safe or effective for this particular indication. We cannot be certain that the clinical testing will be timely or successful, and there are many significant risks for this development program.

Moreover, Rhucin utilizes Pharming’s transgenic technology platform for the production of recombinant human proteins, and to date there has been only one other prescription product approved by the FDA that utilizes transgenic technology. As a result, the Rhucin development product is subject to risks related to the novelty of its technology platform as well as other general development risks, any of which may result in additional costs and delays prior to our ability to obtain U.S. regulatory approval for, and commercialize, Rhucin.

Rifamycin SV MMX

In June 2010, we initiated a phase III clinical study evaluating rifamycin SV MMX in patients with travelers’ diarrhea pursuant to our strategic collaboration with Cosmo, and we anticipate that the study will be completed in the second half of 2012. Our ongoing phase III clinical study is being conducted in Mexico and Guatemala, and to date, enrollment has been slower than anticipated due to a variety of circumstances, including a decrease in tourism and student travel in these countries. Cosmo’s European partner Dr. Falk Pharma GmbH, or Dr. Falk, initiated its phase III clinical study in October 2010. Given the delays in enrollment, among other potential risks, we cannot be certain that we and Dr. Falk will be able to complete our respective planned studies in a timely and successful manner.

SAN-300 (anti-VLA-1antibody)

We have acquired the exclusive worldwide rights to a humanized anti-VLA-1 monoclonal antibody, or mAb, development program, through the acquisition of Covella Pharmaceuticals, Inc., or Covella, and a related license agreement with Biogen Idec MA Inc., or Biogen. SAN-300, our anti-VLA-1 mAb, is an inhibitor of VLA-1, also known as a1ß1 integrin, and has shown activity in multiple preclinical models of inflammatory and autoimmune diseases. We initially expect to develop SAN-300 for the treatment of rheumatoid arthritis, or RA. We initiated a single-dose, dose-escalation phase I clinical study in March 2011, which study we expect to be completed in the first half of 2012.

Although SAN-300 has shown activity in pre-clinical models, it is at a very early stage of development, and has just begun being tested in human clinical trials. As a result, we cannot be certain that the initial clinical testing and any necessary additional pre-clinical testing will be timely or successful, and there are many significant risks for this early-stage development program.

Our commercialization efforts and revenues have been negatively impacted by the prior recall and supply interruption of Glumetza 500 mg.

In June 2010, Depomed temporarily suspended product shipments of Glumetza 500 mg to its customers in connection with Depomed’s voluntary, wholesaler-level recall of 52 lots of Glumetza 500 mg due to the presence of trace amounts of a chemical called 2,4,6-tribromoanisole, or TBA, in bottles containing the 500 mg formulation of Glumetza. The 1000 mg formulation of Glumetza was not subject to the recall. Following implementation of various corrective actions by Depomed’s supplier, Depomed resumed shipments of Glumetza 500 mg in early January 2011. This recall and supply interruption resulted in the unavailability of this dosage strength for over six months and adversely impacted our Glumetza promotion revenues in the second, third and fourth quarters of 2010. Although we have resumed the promotion and supply of Glumetza 500 mg, many of the patients who were previously prescribed Glumetza may be taking other prescription metformin products, and we may never be able to regain the lost share of the business caused by the recall.

We entered into a commercialization agreement with Depomed in August 2011 pursuant to which we now have responsibility for manufacturing, distribution, pharmacovigilance and regulatory affairs. However, similar recall and supply interruptions may occur again in the future and may affect our Glumetza products or other products. Any further recall or supply interruption could result in damage to our reputation and product liability claims.

 

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Our reliance on our strategic partners, third-party clinical investigators and clinical research organizations may result in delays in completing, or a failure to complete, clinical studies or we may be unable to use the clinical data gathered if they fail to comply with our patient enrollment criteria, our clinical protocols or regulatory requirements, or otherwise fail to perform under our agreements with them.

As an integral component of our clinical development programs, we engage clinical investigators and clinical research organizations, or CROs, to enroll patients and conduct and manage our clinical studies, including CROs located both within and outside the U.S. In addition, it is anticipated that U.S. regulatory approval for each of the Uceris, Rhucin and rifamycin SV MMX development products will be supported in part by clinical studies being conducted by our strategic partners in connection with CROs or other third parties. As a result, many key aspects of this process have been and will be out of our direct control and are impacted by general conditions both within and outside the U.S. If the CROs and other third parties that we rely on for patient enrollment and other portions of our clinical studies fail to perform the clinical studies in a timely and satisfactory manner and in compliance with applicable U.S. and foreign regulations, including the FDA’s regulations relating to good clinical practices, we could face significant delays in completing our clinical studies or we may be unable to rely in the future on the clinical data generated. If these CROs or other third parties do not carry out their contractual duties or obligations or fail to meet expected deadlines, or if the quality or accuracy of the clinical data they obtain is compromised due to their failure to adhere to our patient enrollment criteria, our clinical protocols, regulatory requirements or for other reasons, our clinical studies may be extended, delayed or terminated, we may be required to repeat one or more of our clinical studies and we may be unable to obtain or maintain regulatory approval for or successfully commercialize our products.

Due to Par’s decision to launch its generic product, we expect future sales of our Zegerid brand and authorized generic prescription products to be significantly less than historical sales, which will continue to negatively impact our overall financial results.

In April 2010, the U.S. District Court for the District of Delaware ruled that certain patents covering our Zegerid prescription products were invalid due to obviousness. These patents were the subject of lawsuits we filed in 2007 in response to abbreviated new drug applications, or ANDAs, filed by Par Pharmaceutical, Inc., or Par, with the FDA. In May 2010, we filed an appeal of the District Court’s ruling to the U.S. Court of Appeals for the Federal Circuit. Oral arguments in the appeal were held on May 2, 2011, and we expect a decision on the appeal in the second half of 2011, although the decision could be issued later than we expect. Although we intend to vigorously defend and enforce our patent rights, we are not able to predict the timing or outcome of the appeal.

In late June 2010, Par commenced its commercial sale of its generic version of our Zegerid Capsules prescription product. We anticipate that Par will launch its generic version of our Zegerid Powder for Oral Suspension product once it receives FDA approval to market that product.

In late June 2010, under our distribution and supply agreement with Prasco LLC, or Prasco, and as a result of Par’s decision to launch its generic version of our Zegerid Capsules prescription product, Prasco commenced shipments of our authorized generic of prescription Zegerid Capsules in the U.S., and we ceased our commercial promotion of Zegerid prescription products. Under our distribution and supply agreement, Prasco pays us a specified invoice supply price and a percentage of the gross margin on sales of the authorized generic products. However, the amounts we receive from Prasco under this agreement are significantly less than the gross margin we previously recognized on sales of Zegerid prescription products. Furthermore, due to the availability of Par’s generic product, Prasco’s authorized generics’ market share is smaller than the previous market share for our Zegerid prescription products.

The launch of generic Zegerid Capsules prescription products has and will continue to adversely impact sales of our Zegerid brand prescription products and have a negative impact on our financial condition and results of operations, including causing a significant decrease in our revenues and cash flows. Even if physicians prescribe Zegerid products, third-party payors and pharmacists can substitute generic versions of Zegerid. In many cases, insurers and other healthcare payment organizations encourage the use of generic brands through their prescription benefits coverage and payment or reimbursement policies. Insurers and other healthcare payment organizations typically make generic alternatives more attractive to patients by providing different amounts of coverage or out-of-pocket expenses so that the net cost of the generic product to the patient is less than the net cost of the branded product.

 

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Sales of our Zegerid brand and authorized generic products may also be negatively impacted by general commercial risks, including risks relating to manufacturing and the occurrence of adverse side effects or inadequate therapeutic efficacy and any resulting product liability claims or product recalls. For example, the FDA has required proton pump inhibitor, or PPI, manufacturers to highlight the association of high-dose or long-term PPI therapy with increased risk for osteoporosis-related fractures of the hip, wrist or spine as part of the prescribing information.

Our ability to generate revenues also depends on the success of our strategic alliances with Merck, GSK and Norgine.

Our ability to generate revenues in the longer term will also depend on whether our strategic alliances with Merck, GSK and Norgine lead to the successful commercialization of additional omeprazole products, and we cannot be certain that we will receive any additional milestone payments or sales-based royalties from these alliances. Under these agreements, we depend on the efforts of Merck, GSK and Norgine, and we have limited control over their commercialization efforts. We are also subject to the risk of termination of each of these agreements.

We cannot be certain that these strategic partners will continue to devote significant resources to the sale or development of products under the agreements. Any determination by Merck, GSK or Norgine to cease promotion or development of products under our strategic alliances would limit our potential to receive additional payments under these agreements, and adversely affect our ability to generate sufficient revenues to grow our business.

See also “Risks Related to Our Intellectual Property” for a description of the Zegerid and Zegerid OTC patent litigation and the potential impact on our strategic alliances.

Our business experienced significant change in 2010, and we may not be successful in integrating our new products into our existing operations or in achieving the planned results from our expanded product portfolio and pipeline.

In late June 2010, as a result of Par’s decision to launch its generic version of our Zegerid Capsules prescription product, we ceased promotion of our Zegerid prescription products and announced a corporate restructuring, including a substantial workforce reduction. Shortly thereafter, in September 2010, we completed several product related transactions, including:

 

   

a distribution and license arrangement with S2 and VeroScience granting us exclusive rights to manufacture and commercialize Cycloset prescription products in the U.S.;

 

   

an exclusive license and supply arrangement with Pharming, granting us the right to commercialize Rhucin, a late-stage development product, in North America; and

 

   

an acquisition of Covella, in which we obtained the exclusive worldwide rights to SAN-300, an early-stage development product.

We will need to overcome significant challenges in order to realize any benefits or synergies from these transactions. These challenges include the timely, efficient and successful execution of a number of tasks, including the following:

 

   

integrating Cycloset into our existing operations and managing the on-going manufacturing and commercial activities associated with this product;

 

   

mitigating the impact of a prior recall and supply interruption of Glumetza 500 mg, which resulted in the unavailability of this dosage strength from June 2010 through early January 2011, and assuming full operational responsibilities for this product going forward;

 

   

integrating our new development products and successfully managing the development and regulatory approval processes;

 

   

coordinating with our strategic partners and licensors concerning the development, manufacturing, regulatory and intellectual property protection strategies for these new products and development products; and

 

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managing compliance with the in-license, acquisition, distribution, supply and other agreements associated with each of these transactions.

In addition, we rely on our strategic partners and licensors for many aspects of our development and commercialization activities, and we are subject to risks related to their financial stability and solvency.

We may not succeed in addressing these risks or any other problems encountered in connection with these transactions. These changes will require us to expend substantial resources on the promotion of a new product and the management of development programs for additional product candidates. Even if we successfully integrate these new programs into our operations, we will be subject to the continuing risk of early termination of a number of license and similar agreements, as well as the other risks described herein. We may be unable to generate sufficient revenues from our commercial-stage products or our existing collaborations, and may be unsuccessful in raising additional capital to continue to advance our development-stage products. The occurrence of any of these risks could have a material adverse effect on our business, results of operations and prospects.

In addition, other companies who have shifted focus to new products and additional development programs have been the target of unsolicited public proposals from activist stockholders. The public proposals can result in significant uncertainty for current and potential licensors, suppliers and other business partners, and can cause these business partners to change or terminate their business relationships with the targeted company. Companies targeted by these unsolicited proposals from activist stockholders may not be able to attract and retain key personnel as a result of the related uncertainty. Moreover, the review and consideration of an unsolicited proposal can be a significant distraction for management and employees, and may require the expenditure of significant time, costs and other resources.

The markets in which we compete are intensely competitive and many of our competitors have significantly more resources and experience, which may limit our commercial opportunity.

The pharmaceutical and biotechnology industries are intensely competitive in the markets in which our commercial products compete and development products may compete, and there are many other currently marketed products that are well-established and successful, as well as development programs underway. In addition, many of our competitors are large, well-established companies in the pharmaceutical and biotechnology fields with significantly greater expertise.

Many of these companies with which we compete also have significantly greater financial and other resources than we do. Larger pharmaceutical and biotechnology companies typically have significantly larger field sales force organizations and invest significant amounts in advertising and marketing their products. As a result, these larger companies are able to reach a greater number of physicians and consumers and reach them more frequently than we can with our smaller sales organization.

If we are unable to compete successfully, our business, financial condition and results of operations will be materially adversely affected.

Our Glumetza and Cycloset prescription products currently compete with many other drug products.

The Glumetza prescription products compete with many other products, including:

 

   

other branded immediate-release and extended-release metformin products (such as Fortamet®, Glucophage® and Glucophage XR®);

 

   

generic immediate-release and extended-release metformin products; and

 

   

other prescription diabetes treatments.

In addition, various companies are developing new products that may compete with the Glumetza products in the future. For example, Depomed has licensed rights to use its extended-release technology in combination with sitagliptin, the active ingredient in Merck’s Januvia® product, and with canagliflozin, a sodium-glucose transporter-2, or SGLT2, compound being developed by Janssen. Depomed has also licensed rights to use its extended-release metformin technology to Boehringer Ingelheim for use with certain of its proprietary compounds. The Glumetza prescription products are also the subject of two pending ANDAs and related patent infringement litigation. If the litigation is resolved unfavorably to our licensor, Depomed, we may face competition from generic versions of 500 mg and 1000 mg dosage strengths of Glumetza prior to patent expiry.

 

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Like Glumetza, our Cycloset prescription product competes with many other products, including:

 

   

dipeptidyl peptidase IV inhibitors, or DPP-4, products (such as Januvia® and Onglyza™);

 

   

glucagon-like peptide 1, or GLP-1, receptor agonist products (such as Byetta® and Victoza®);

 

   

thiazolidinedione, or TZD, products (such as Avandia® and Actos®);

 

   

sulfonylureas products (such as Amaryl® and Glynase®); and

 

   

branded and generic metformin products.

In addition, various companies are developing new products that may compete with the Cycloset product in the future. For example, SGLT2 and new DPP-4 inhibitor products in development could compete with Cycloset in treating type 2 diabetes patients in the future. In addition, companies could develop combination products that include bromocriptine mesylate as one of the active ingredients for the treatment of type 2 diabetes.

We or our strategic partners may also face competition for our products from lower-priced products from foreign countries that have placed price controls on pharmaceutical products. Proposed federal legislative changes may expand consumers’ ability to import lower-priced versions of our products and competing products from Canada and other developed countries. Further, several states and local governments have implemented importation schemes for their citizens and, in the absence of federal action to curtail such activities, we expect other states and local governments to launch importation efforts. The importation of foreign products that compete with our own products could negatively impact our business and prospects.

The existence of numerous competitive products may put downward pressure on pricing and market share, which in turn may adversely affect our business, financial condition and results of operations.

In addition, if approved, our development-stage products will compete with many other drug and biologic products that are already entrenched in the marketplace, as well as face competition from other product candidates currently under development.

We do not currently have any manufacturing facilities and instead rely on third-party manufacturers and our strategic partners for supply.

We rely on third-party manufacturers and our strategic partners to provide us with an adequate and reliable supply of our products on a timely basis, and we do not currently have any of our own manufacturing or distribution facilities. Our manufacturers must comply with U.S. regulations, including the FDA’s current good manufacturing practices, applicable to the manufacturing processes related to pharmaceutical products, and their facilities must be inspected and approved by the FDA and other regulatory agencies on an ongoing basis as part of their business. In addition, because several of our key manufacturers are located outside of the U.S., they must also comply with applicable foreign laws and regulations.

We have limited control over our third-party manufacturers and strategic partners, including with respect to regulatory compliance and quality assurance matters. Any delay or interruption of supply related to a failure to comply with regulatory or other requirements, or in connection with transfer of manufacturing activities to alternate facilities, would limit our ability to sell our products. Any manufacturing defect or error discovered after products have been produced and distributed could result in even more significant consequences, including costly recall procedures, re-stocking costs, damage to our reputation and potential for product liability claims. With respect to any future products under development, if the FDA finds significant issues with any of our manufacturers during the pre-approval inspection process, the approval of those products could be delayed while the manufacturer addresses the FDA’s concerns, or we may be required to identify and obtain the FDA’s approval of a new supplier. This could result in significant delays before manufacturing of our products can begin, which in turn would delay commercialization of our products. In addition, the importation of pharmaceutical products into the U.S. is subject to regulation by the FDA, and the FDA can refuse to allow an imported product into the U.S. if it is not satisfied that the product complies with applicable laws or regulations.

In connection with the license of rights to Cycloset, we assumed a manufacturing services agreement with Patheon, Inc., or Patheon, and, accordingly, we rely on a Patheon facility located in Ohio as the sole third-party manufacturer for Cycloset.

 

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For Glumetza 500 mg, we assumed from Depomed a commercial manufacturing agreement with Patheon, and, accordingly, we rely on a Patheon facility located in Puerto Rico to manufacture Glumetza 500 mg. We are in the process of moving the Glumetza 500 mg manufacturing to an alternate Patheon facility also located in Puerto Rico. We currently rely on Depomed to oversee product manufacturing and supply of Glumetza 1000 mg but we will also ultimately assume these obligations from Depomed. In turn, Depomed relies on a Valeant Pharmaceuticals International, Inc. facility located in Canada to manufacture Glumetza 1000 mg.

For our Zegerid Capsules prescription product, we currently rely on Norwich Pharmaceuticals, Inc., located in New York, as the sole third-party manufacturer of the brand and related authorized generic product. In addition, we rely on a Patheon facility located in Canada for the supply of Zegerid Powder for Oral Suspension.

For our Uceris and rifamycin SV MMX development-stage products, we rely on Cosmo, located in Italy, to manufacture and supply all of our drug product requirements.

For our Rhucin development-stage product, we rely on Pharming to oversee product manufacturing and supply. In turn, Pharming utilizes certain of its own facilities as well as third-party manufacturing facilities for supply, all of which are located in Europe.

For our SAN-300 development-stage product, we are utilizing clinical trial material previously manufactured by Biogen. In the future, Biogen has a right of first offer to supply our product requirements.

We and our strategic partners also rely in many cases on sole source suppliers for active ingredients and other product materials and components. Any significant problem that our strategic partners or the third-party manufacturers or suppliers experience could result in a delay or interruption in the supply until the problem is cured or until we or our partners locate an alternative source of supply. In addition, because these sole source manufacturers and suppliers in many cases provide services to a number of other pharmaceutical companies, they may experience capacity constraints or choose to prioritize one or more of their other customers.

Although alternative sources of supply exist, the number of third-party manufacturers with the manufacturing and regulatory expertise and facilities necessary to manufacture the finished forms of our pharmaceutical products or the key ingredients in our products is limited, and it would take a significant amount of time to arrange for alternative manufacturers. Any new supplier of products or key ingredients would be required to qualify under applicable regulatory requirements and would need to have sufficient rights under applicable intellectual property laws to the method of manufacturing such products or ingredients. The FDA may require us to conduct additional clinical studies, collect stability data and provide additional information concerning any new supplier before we could distribute products from that supplier. Obtaining the necessary FDA approvals or other qualifications under applicable regulatory requirements and ensuring non-infringement of third-party intellectual property rights could result in a significant interruption of supply and could require the new supplier to bear significant additional costs which may be passed on to us.

Our reporting and payment obligations under governmental purchasing and rebate programs are complex and may involve subjective decisions, and any failure to comply with those obligations could subject us to penalties and sanctions, which in turn could have a material adverse effect on our business and financial condition.

As a condition of reimbursement by various federal and state healthcare programs, we must calculate and report certain pricing information to federal and state healthcare agencies. The regulations regarding reporting and payment obligations with respect to governmental programs are complex. Our calculations and methodologies are subject to review and challenge by the applicable governmental agencies, and it is possible that such reviews could result in material changes. In addition, because our processes for these calculations and the judgments involved in making these calculations involve subjective decisions and complex methodologies, these calculations are subject to the risk of errors. Any failure to comply with the government reporting and payment obligations could result in civil and/or criminal sanctions.

Regulatory approval for our currently marketed products is limited by the FDA to those specific indications and conditions for which clinical safety and efficacy have been demonstrated.

Any regulatory approval is limited to those specific diseases and indications for which our products are deemed to be

 

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safe and effective by the FDA. In addition to the FDA approval required for new formulations, any new indication for an approved product also requires FDA approval. If we are not able to obtain FDA approval for any desired future indications for our products, our ability to effectively market and sell our products may be reduced and our business may be adversely affected.

While physicians may choose to prescribe drugs for uses that are not described in the product’s labeling and for uses that differ from those tested in clinical studies and approved by the regulatory authorities, our ability to promote the products is limited to those indications that are specifically approved by the FDA. These “off-label” uses are common across medical specialties and may constitute an appropriate treatment for many patients in varied circumstances. Regulatory authorities in the U.S. generally do not regulate the behavior of physicians in their choice of treatments. Regulatory authorities do, however, restrict communications by pharmaceutical companies on the subject of off-label use. If our promotional activities fail to comply with these regulations or guidelines, we may be subject to warnings from, or enforcement action by, these authorities. In addition, our failure to follow FDA rules and guidelines relating to promotion and advertising may cause the FDA to delay its approval or refuse to approve a product, the suspension or withdrawal of an approved product from the market, recalls, fines, disgorgement of money, operating restrictions, injunctions or criminal prosecution, any of which could harm our business.

We are subject to ongoing regulatory review of our currently marketed products.

Following receipt of regulatory approval, any products that we market continue to be subject to extensive regulation. These regulations impact many aspects of our operations, including the manufacture, labeling, packaging, adverse event reporting, storage, distribution, advertising, promotion and record keeping related to the products. The FDA also frequently requires post-marketing testing and surveillance to monitor the effects of approved products or place conditions on any approvals that could restrict the commercial applications of these products. For example, in connection with the approval of our NDAs for Zegerid Powder for Oral Suspension, we committed to commence clinical studies to evaluate the product in pediatric populations in 2005. We have not yet commenced any of the studies and have requested a waiver of this requirement from the FDA. We received an initial response from the FDA waiving certain of the requirements and plan to seek further clarification. If we fail to comply with applicable regulatory requirements, we may be subject to fines, suspension or withdrawal of regulatory approvals, product recalls, seizure of products, disgorgement of money, operating restrictions and criminal prosecution.

In addition to FDA restrictions on marketing of pharmaceutical products, several other types of state and federal laws have been applied to restrict certain marketing practices in the pharmaceutical industry in recent years. These laws include anti-kickback statutes and false claims statutes. The federal healthcare program anti-kickback statute prohibits, among other things, knowingly and willfully offering, paying, soliciting or receiving remuneration to induce or in return for purchasing, leasing, ordering or arranging for the purchase, lease or order of any healthcare item or service reimbursable under Medicare, Medicaid or other federally financed healthcare programs. This statute has been interpreted to apply to arrangements between pharmaceutical manufacturers on the one hand and prescribers, purchasers and formulary managers on the other. Violations of the anti-kickback statute are punishable by imprisonment, criminal fines, civil monetary penalties and exclusion from participation in federal healthcare programs. Although there are a number of statutory exemptions and regulatory safe harbors protecting certain common activities from prosecution or other regulatory sanctions, the exemptions and safe harbors are drawn narrowly, and practices that involve remuneration intended to induce prescribing, purchases or recommendations may be subject to scrutiny if they do not qualify for an exemption or safe harbor. Our practices may not in all cases meet all of the criteria for safe harbor protection from anti-kickback liability.

Federal false claims laws prohibit any person from knowingly presenting, or causing to be presented, a false claim for payment to the federal government, or knowingly making, or causing to be made, a false statement to have a false claim paid. Recently, several pharmaceutical and other healthcare companies have been prosecuted under these laws for allegedly inflating drug prices they report to pricing services, which in turn are used by the government to set Medicare and Medicaid reimbursement rates, and for allegedly providing free product to customers with the expectation that the customers would bill federal programs for the product. In addition, certain marketing practices, including off-label promotion, may also violate false claims laws. The majority of states also have statutes or regulations similar to the federal anti-kickback law and false claims laws, which apply to items and services reimbursed under Medicaid and other state programs, or, in several states, apply regardless of the payor. Sanctions under these federal and state laws may include civil monetary penalties, exclusion of a manufacturer’s products from reimbursement under government programs, criminal fines and imprisonment.

 

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The Patient Protection and Affordable Care Act, enacted in 2010, imposes new reporting and disclosure requirements for pharmaceutical and device manufacturers with regard to payments or other transfers of value, including samples, made to physicians and teaching hospitals. We will need to start capturing such data starting in 2012, with reporting requirements effective in 2013. In addition, pharmaceutical and device manufacturers will also be required to report and disclose investment interests held by physicians and their immediate family members during the preceding calendar year. There is some uncertainty as to the exact extent of the requirements and definitive guidance has not yet been provided by the government. Failure to submit required information may result in civil monetary penalties for payments, transfers of value or ownership or investment interests not reported in an annual submission.

If not preempted by this federal law, several states require pharmaceutical companies to report expenses relating to the marketing and promotion of pharmaceutical products and to report gifts and payments to individual physicians in the states. Other states prohibit providing various other marketing related activities. Still other states require the posting of information relating to clinical studies and their outcomes. In addition, certain states require pharmaceutical companies to implement compliance programs or marketing codes. Currently, several additional states are considering similar proposals. Compliance with these laws is difficult and time consuming, and companies that do not comply with these state laws face civil penalties. Because of the breadth of these laws and the narrowness of the safe harbors, it is possible that some of our business activities could be subject to challenge under one or more of such laws. Such a challenge could have a material adverse effect on our business, financial condition, results of operations and growth prospects.

In addition, as part of the sales and marketing process, pharmaceutical companies frequently provide samples of approved drugs to physicians. This practice is regulated by the FDA and other governmental authorities, including, in particular, requirements concerning record keeping and control procedures. Any failure to comply with the regulations may result in significant criminal and civil penalties as well as damage to our credibility in the marketplace.

We are subject to new legislation, regulatory proposals and managed care initiatives that may increase our costs and adversely affect our ability to market our products.

In March 2010, the President signed the Patient Protection and Affordable Care Act, which makes extensive changes to the delivery of healthcare in the U.S. This act includes numerous provisions that affect pharmaceutical companies, some of which are effective immediately and others of which will be taking effect over the next several years. For example, the act seeks to expand healthcare coverage to the uninsured through private health insurance reforms and an expansion of Medicaid. The act also imposes substantial costs on pharmaceutical manufacturers, such as an increase in liability for rebates paid to Medicaid, new drug discounts that must be offered to certain enrollees in the Medicare prescription drug benefit, an annual fee imposed on all manufacturers of brand prescription drugs in the U.S., increased disclosure obligations and an expansion of an existing program requiring pharmaceutical discounts to certain types of hospitals and federally subsidized clinics. The act also contains cost-containment measures that could reduce reimbursement levels for healthcare items and services generally, including pharmaceuticals. It also will require reporting and public disclosure of payments and other transfers of value provided by pharmaceutical companies to physicians and teaching hospitals. These measures could result in decreased net revenues from our pharmaceutical products and decreased potential returns from our development efforts.

In addition, there have been a number of other legislative and regulatory proposals aimed at changing the pharmaceutical industry. These include proposals to permit reimportation of pharmaceutical products from other countries and proposals concerning safety matters. For example, in an attempt to protect against counterfeiting and diversion of drugs, a bill was introduced in a previous Congress that would establish an electronic drug pedigree and track-and-trace system capable of electronically recording and authenticating every sale of a drug unit throughout the distribution chain. This bill or a similar bill may be introduced in Congress in the future. California has already enacted legislation that requires development of an electronic pedigree to track and trace each prescription drug at the saleable unit level through the distribution system. California’s electronic pedigree requirement is scheduled to take effect beginning in January 2015. Compliance with California and any future federal or state electronic pedigree requirements will likely require an increase in our operational expenses and will likely be administratively burdensome. As a result of these and other new proposals, we may determine to change our current manner of operation, provide additional benefits or change our contract arrangements, any of which could have a material adverse effect on our business, financial condition and results of operations.

 

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We face a risk of product liability claims and may not be able to obtain adequate insurance.

Our business exposes us to potential liability risks that may arise from the clinical testing, manufacture and sale of our marketed products and development-stage products. These risks exist even if a product is approved for commercial sale by the FDA and manufactured in facilities licensed and regulated by the FDA. Any product liability claim or series of claims brought against us could significantly harm our business by, among other things, reducing demand for our products, injuring our reputation and creating significant adverse media attention and costly litigation. Plaintiffs have received substantial damage awards in some jurisdictions against pharmaceutical companies based upon claims for injuries allegedly caused by the use of their products. Any judgment against us that is in excess of our insurance policy limits would have to be paid from our cash reserves, which would reduce our capital resources. Although we have product and clinical study liability insurance with a coverage limit of $15.0 million, this coverage may prove to be inadequate. Furthermore, we cannot be certain that our current insurance coverage will continue to be available for our commercial or clinical study activities on reasonable terms, if at all. Further, we may not have sufficient capital resources to pay a judgment, in which case our creditors could levy against our assets, including our intellectual property.

If we are unable to retain key personnel, our business will suffer.

We are a small company and, as of September 30, 2011, had 229 employees. As a result of Par’s decision to launch a generic version of our Zegerid Capsules prescription product, in late June 2010, we determined to cease promotion of our Zegerid prescription products, launch an authorized generic version of our Zegerid Capsules prescription product and announced a corporate restructuring, including a significant workforce reduction in our commercial organization and other selected operations.

Our success depends on our continued ability to retain and motivate highly qualified management, clinical, regulatory, manufacturing, product development, business development and sales and marketing personnel. We may not be able to recruit and retain qualified personnel in the future, due to competition for personnel among pharmaceutical businesses, and the failure to do so could have a significant negative impact on our future product revenues and business results.

Our success also depends on a number of key senior management personnel, particularly Gerald T. Proehl, our President and Chief Executive Officer. Although we have employment agreements with our executive officers, these agreements are terminable at will at any time with or without notice and, therefore, we cannot be certain that we will be able to retain their services. In addition, although we have a “key person” insurance policy on Mr. Proehl, we do not have “key person” insurance policies on any of our other employees that would compensate us for the loss of their services. If we lose the services of one or more of these individuals, replacement could be difficult and may take an extended period of time and could impede significantly the achievement of our business objectives.

Our future growth may depend on our ability to identify and in-license or acquire additional products, and if we do not successfully do so, or otherwise fail to integrate any new products into our operations, we may have limited growth opportunities.

We are continuing to seek to acquire or in-license products, businesses or technologies that we believe are a strategic fit with our business strategy. Future in-licenses or acquisitions, however, may entail numerous operational and financial risks, including:

 

   

exposure to unknown liabilities;

 

   

disruption of our business and diversion of our management’s time and attention to develop acquired products or technologies;

 

   

a reduction of our current financial resources;

 

   

difficulty or inability to secure financing to fund development activities for such acquired or in-licensed technologies;

 

   

incurrence of substantial debt or dilutive issuances of securities to pay for acquisitions; and

 

 

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higher than expected acquisition and integration costs.

We may not have sufficient resources to identify and execute the acquisition or in-licensing of third-party products, businesses and technologies and integrate them into our current infrastructure. In particular, we may compete with larger pharmaceutical companies and other competitors in our efforts to establish new collaborations and in-licensing opportunities. These competitors likely will have access to greater financial resources than us and may have greater expertise in identifying and evaluating new opportunities. Moreover, we may devote resources to potential acquisitions or in-licensing opportunities that are never completed, or we may fail to realize the anticipated benefits of such efforts.

Risks Related to Our Intellectual Property

The protection of our intellectual property rights is critical to our success and any failure on our part to adequately maintain such rights would materially affect our business.

We regard the protection of patents, trademarks and other proprietary rights that we own or license as critical to our success and competitive position. Laws and contractual restrictions, however, may not be sufficient to prevent unauthorized use or misappropriation of our technology or deter others from independently developing products that are substantially equivalent or superior to our products.

Patents

Our commercial success will depend in part on the patent rights we have licensed or will license and on patent protection for our own inventions related to the products that we market and intend to market. Our success also depends on maintaining these patent rights against third-party challenges to their validity, scope or enforceability. Our patent position is subject to uncertainties similar to other biotechnology and pharmaceutical companies. For example, the U.S. Patent and Trademark Office, or PTO, or the courts may deny, narrow or invalidate patent claims, particularly those that concern biotechnology and pharmaceutical inventions.

We may not be successful in securing or maintaining proprietary or patent protection for our products, and protection that we have and do secure may be challenged and possibly lost. In addition, our competitors may develop products similar to ours using methods and technologies that are beyond the scope of our intellectual property rights. Other drug companies may challenge the scope, validity and enforceability of our patent claims and may be able to develop generic versions of our products if we are unable to maintain our proprietary rights. We also may not be able to protect our intellectual property rights against third-party infringement, which may be difficult to detect.

We have licensed the primary patent rights for each of our products and development-stage products. Although we consult with our strategic partners and licensors concerning our licensed patent rights, in most cases those partners remain primarily responsible for prosecution activities. We cannot control the amount or timing of resources that our strategic partners and licensors devote to these activities. As a result of this lack of control and general uncertainties in the patent prosecution process, we cannot be sure that any additional patents will ever be issued or that the issued patents will be properly maintained. In addition, we are subject to the risk that one or more of our licenses could be terminated and any loss of our license rights would negatively impact our ability to develop, manufacture and commercialize our products and development-stage products.

Glumetza and Pending Patent Litigation

We have exclusive rights to manufacture and commercialize the Glumetza products in the U.S., including its territories and possessions and Puerto Rico, under our commercialization agreement with Depomed. Currently, there are four issued U.S. patents that are owned or licensed by Depomed that we believe provide coverage for the Glumetza 500 mg dose product (U.S. Patent Nos. 6,340,475; 6,635,280; 6,488,962; and 6,723,340), with expiration dates in 2016, 2020 and 2021. There are two issued U.S. patents that are owned or licensed by Depomed that we believe provide coverage for the Glumetza 1000 mg dose product (U.S. Patent Nos. 6,488,962 and 7,780,987), with expiration dates in 2020 and 2025.

Depomed, Inc. – Glumetza Patent Litigation

In November 2009, Depomed filed a lawsuit in the United States District Court for the Northern District of California

 

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against Lupin Limited and its wholly owned subsidiary, Lupin Pharmaceutical, Inc., collectively referred to herein as Lupin, for infringement of the following patents listed in the Orange Book for Glumetza: U.S. Patent Nos. 6,340,475; 6,635,280; and 6,488,962. The lawsuit was filed in response to an ANDA and paragraph IV certification filed with the FDA by Lupin regarding Lupin’s intent to market generic versions of 500 mg and 1000 mg tablets for Glumetza prior to the expiration of the asserted patents. Depomed commenced the lawsuit within the requisite 45 day time period, resulting in an FDA stay on the approval of Lupin’s proposed products for 30 months or until a decision is rendered by the District Court, which is adverse to the asserted patents, whichever may occur earlier. Absent a court decision, the 30-month stay is expected to expire in May 2012. Lupin has filed an answer in the case that asserts, among other things, non-infringement and invalidity of the asserted patents, and has also filed counterclaims. A hearing for claim construction, or Markman hearing, was held in January 2011. Following the hearing, the court principally adopted the patent term constructions Depomed proposed. The discovery phase of the lawsuit is continuing, and a trial date has been scheduled in August 2012.

In June 2011, Depomed filed a lawsuit in the United States District Court for the Northern District of New Jersey against Sun Pharma Global FZE, Sun Pharmaceutical Industries Ltd. and Sun Pharmaceutical Industries Inc., collectively referred to herein as Sun, for infringement of the patents listed in the Orange Book for Glumetza (U.S. Patent Nos. 6,723,340; 6,635,280; 6,488,962; 6,340,475; and 7,780,987), as well as U.S. Patent No. 7,736,667. The lawsuit was filed in response to an ANDA and paragraph IV certification filed with the FDA by Sun regarding Sun’s intent to market generic versions of 500 mg and 1000 mg tablets for Glumetza prior to the expiration of the asserted patents. Depomed commenced the lawsuit within the requisite 45 day time period, resulting in an FDA stay on the approval of Sun’s proposed products for 30 months or until a decision is rendered by the District Court, which is adverse to the asserted patents, whichever may occur earlier. Absent a court decision, the 30-month stay is expected to expire in November 2013. Sun has filed an answer in the case that asserts, among other things, non-infringement and invalidity of the asserted patents, and has also filed counterclaims. Briefing for the Markman hearing is scheduled for the first half of 2012, and a trial date has not yet been scheduled.

Under the terms of our commercialization agreement with Depomed, Depomed will continue to manage the ongoing patent infringement lawsuits against Sun and Lupin, subject to certain consent rights in favor of us, including with regard to any proposed settlements. We are responsible for 70% of the future out-of-pocket costs, and Depomed is responsible for 30% of the future out-of-pocket costs, related to the existing infringement cases. Although Depomed has indicated that it intends to vigorously defend and enforce its patent rights, we are not able to predict the timing or outcome of these actions. At this time we are unable to estimate possible losses or ranges of losses for these actions.

Any adverse outcome in the litigation described above would adversely impact our business and revenues. Regardless of how these litigation matters are ultimately resolved, the litigation will continue to be costly, time-consuming and distracting to management, which could have a material adverse effect on our business.

Cycloset

We have exclusive rights to manufacture and commercialize Cycloset in the U.S. under our distribution and license agreement with S2 and VeroScience. Currently, there are five issued U.S. patents that we have licensed from S2 and VeroScience that we believe provide coverage for Cycloset (U.S. Patent Nos. 5,468,755; 5,679,685; 5,716,957; 5,756,513; and 5,866,584), with expiration dates in 2012, 2014 and 2015.

Uceris

We have exclusive rights to develop and commercialize the Uceris development-stage product in the U.S. under our strategic collaboration with Cosmo. Currently, there are three issued U.S. patents that are owned by Cosmo and licensed to us that we believe provide coverage for Uceris (U.S. Patent Nos. 7,431,943, 7,410,651 and 8,029,823), each of which expires in 2020.

Rhucin

We have exclusive rights to develop and commercialize the Rhucin development-stage product in the U.S., Canada and Mexico under our license and supply agreements with Pharming. Currently, there are two issued U.S. patents that are owned by Pharming and licensed to us that we believe provide coverage for Rhucin (U.S. Patent Nos. 7,067,713 and 7,544,853), which expire in 2022 and 2024. In addition, we believe Rhucin, as a biological product, is entitled under current legislation to a period of 12 years of regulatory exclusivity in the U.S.

 

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In June 2011, Pharming filed with the PTO an application to reissue U.S. Patent No. 7,544,853, or the ‘853 patent, a method of treatment patent. We, together with Pharming, intend to vigorously prosecute the reissue application; however, it is not feasible to predict the impact that the reissue proceeding may have on the scope and validity of the ‘853 patent claims. If the claims of the ‘853 patent ultimately are narrowed substantially or invalidated by the PTO, the extent of the patent coverage afforded to the Rhucin development-stage product could be impaired, which could potentially harm our business and operating results.

Rifamycin SV MMX

We have exclusive rights to develop and commercialize the rifamycin SV MMX development-stage product in the U.S. under our strategic collaboration with Cosmo. Currently, there is one issued U.S. patent that is owned by Cosmo and licensed to us that we believe provides coverage for rifamycin SV MMX (U.S. Patent No. 7,431,943), which expires in June 2020.

SAN-300

We acquired worldwide rights to develop and commercialize the SAN-300 development-stage product in connection with our acquisition of Covella. Currently, there are five issued U.S. patents that are owned by Biogen and licensed to us that we believe provide coverage for SAN-300 (U.S. Patent Nos. 7,358,054; 7,462,353; 6,955,810; 7,723,073; and 7,910,099), which expire in 2020 and 2022. In addition, we believe SAN-300, as a biological product, is entitled under current legislation to a period of 12 years of regulatory exclusivity in the U.S.

Zegerid, Related PPI Technology and Pending Patent Litigation

We have entered into an exclusive, worldwide license agreement with the University of Missouri for patents and pending patent applications relating to specific formulations of PPIs with antacids and other buffering agents and methods of using these formulations. Currently, there are six issued U.S. patents that have provided coverage for our Zegerid products (U.S. Patent Nos. 5,840,737; 6,489,346; 6,645,988; 6,699,885; 6,780,882; and 7,399,772), all of which are subject to the University of Missouri license agreement. Five of these patents were asserted in our patent litigation against Par and were found to be invalid by ruling of the U.S. District Court for the District of Delaware, which ruling is being appealed, as further described below. In addition to the issued U.S. patent coverage described above, several international patents have been issued.

Zegerid and Zegerid OTC® Patent Litigation

In April 2010, the U.S. District Court for the District of Delaware ruled that five patents covering Zegerid Capsules and Zegerid Powder for Oral Suspension (U.S. Patent Nos. 6,489,346; 6,645,988; 6,699,885; 6,780,882; and 7,399,772) were invalid due to obviousness. These patents were the subject of lawsuits we filed in 2007 in response to ANDAs filed by Par with the FDA. In May 2010, we filed an appeal of the District Court’s ruling to the U.S. Court of Appeals for the Federal Circuit. Oral arguments in the appeal were held on May 2, 2011, and we expect a decision on the appeal in the second half of 2011, although the decision could be issued later than we expect. Although we intend to vigorously defend and enforce our patent rights, we are not able to predict the timing or outcome of the appeal.

In September 2010, Merck filed lawsuits in the U.S. District Court for the District of New Jersey against each of Par and Perrigo Research and Development Company, or Perrigo, for infringement of the patents listed in the Orange Book for Zegerid OTC (U.S. Patent Nos. 6,489,346; 6,645,988; 6,699,885; and 7,399,772). We and the University of Missouri, licensors of the listed patents, are joined in the lawsuits as co-plaintiffs. Par and Perrigo had filed ANDAs with the FDA regarding each company’s intent to market a generic version of Zegerid OTC prior to the expiration of the listed patents. The parties in each of these lawsuits have agreed to stay the court proceedings until the earlier of the outcome of the pending appeal related to the Zegerid prescription product litigation or receipt of tentative regulatory approval for the proposed generic Zegerid OTC products. We are not able to predict the timing or outcome of these lawsuits.

Any adverse outcome in the litigation described above would adversely impact our Zegerid and Zegerid OTC business, including the amount of, or our ability to receive, milestone payments and royalties under our agreement with Merck. For

 

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example, the royalties payable to us under our license agreement with Merck are subject to reduction in the event it is ultimately determined by the courts (with the decision being unappealable or unappealed within the time allowed for appeal) that there is no valid claim of the licensed patents covering the manufacture, use or sale of the Zegerid OTC product and third parties have received marketing approval for, and are conducting bona fide ongoing commercial sales of, generic versions of the licensed products. The ruling may also negatively impact the patent protection for the products being commercialized pursuant to our ex-US licenses with GSK and Norgine. Although the U.S. ruling is not binding in countries outside the U.S., similar challenges to those raised in the U.S. litigation may be raised in territories outside the U.S.

Regardless of how these litigation matters are ultimately resolved, the litigation has been and will continue to be costly, time-consuming and distracting to management, which could have a material adverse effect on our business. At this time we are unable to estimate possible losses or ranges of losses for these matters.

Exclusive License Agreement with the University of Missouri

In January 2001, we entered into an exclusive, worldwide license agreement with the University of Missouri for patents and pending patent applications relating to specific formulations of PPIs with antacids and other buffering agents and methods of using these formulations. Pursuant to the terms of the license agreement, we paid the University of Missouri an upfront licensing fee of $1.0 million in 2001, a one-time $1.0 million milestone fee in 2003 following the filing of our first NDA and a one-time $5.0 million milestone fee in July 2004 following the FDA’s approval of Zegerid Powder for Oral Suspension 20 mg. We are required to make additional milestone payments to the University of Missouri upon initial commercial sale in specified territories outside the U.S., which may total up to $3.5 million in the aggregate. We are also required to make milestone payments based on first-time achievement of significant sales thresholds, up to a maximum of $86.3 million, the first of which was a one-time $2.5 million milestone payment upon initial achievement of $100.0 million in annual calendar year net product sales, which was paid to the University of Missouri in the first quarter of 2009. We are also obligated to pay royalties to the University of Missouri on net sales of our products and any products commercialized by GSK, Merck and Norgine under our existing license and distribution agreements. In addition, we are required to bear the costs of prosecuting and maintaining the licensed patents, but the University of Missouri remains responsible for prosecution of any applications. Under the license agreement, we are also required to carry occurrence-based liability insurance with policy limits of at least $5.0 million per occurrence and a $10.0 million annual aggregate.

The license from the University of Missouri expires in each country when the last patent for licensed technology expires in that country and the last patent application for licensed technology in that country is abandoned, provided that our obligation to pay certain minimum royalties in countries in which there are no pending patent applications or existing patents terminates on a country-by-country basis on the 15th anniversary of our first commercial sale in such country. If we fail to meet certain diligence obligations following commercialization in specified countries, the University of Missouri can terminate our license or render it non-exclusive with respect to those countries. Our rights under this license are also generally subject to early termination under specified circumstances, including our material and uncured breach or our bankruptcy or insolvency. To date, we believe we have met all of our obligations under the license. We can terminate the license at any time, in whole or in part, with 60 days written notice.

Trade Secrets and Proprietary Know-how

We also rely upon unpatented proprietary know-how and continuing technological innovation in developing our products. Although we require our employees, consultants, advisors and current and prospective business partners to enter into confidentiality agreements prohibiting them from disclosing or taking our proprietary information and technology, these agreements may not provide meaningful protection for our trade secrets and proprietary know-how. Further, people who are not parties to confidentiality agreements may obtain access to our trade secrets or know-how. Others may independently develop similar or equivalent trade secrets or know-how. If our confidential, proprietary information is divulged to third parties, including our competitors, our competitive position in the marketplace will be harmed and our ability to successfully penetrate our target markets could be severely compromised.

Trademarks

The trademarks and trademark applications we own and license are important to our success and competitive position. Any objections we receive from the PTO, foreign trademark authorities or third parties relating to our registered trademarks

 

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and pending applications could require us to incur significant expense in defending the objections or establishing alternative names. There is no guarantee we will be able to secure any of our pending trademark applications with the PTO or comparable foreign authorities.

If we do not adequately protect our rights in our various trademarks from infringement, any goodwill that has been developed in those marks would be lost or impaired. We could also be forced to cease using any of our trademarks that are found to infringe upon or otherwise violate the trademark or service mark rights of another company, and, as a result, we could lose all the goodwill which has been developed in those marks and could be liable for damages caused by any such infringement or violation.

Third parties may choose to file patent infringement claims against us, which litigation would be costly, time-consuming and distracting to management and could be materially adverse to our business.

The products we currently market, and those we may market in the future, may infringe patent and other rights of third parties. In addition, our competitors, many of which have substantially greater resources than us and have made significant investments in competing technologies or products, may seek to apply for and obtain patents that will prevent, limit or interfere with our ability to make, use and sell products either in the U.S. or international markets. Intellectual property litigation in the pharmaceutical industry is common, and we expect this to continue. Any third party patent infringement litigation may result in a loss of rights and would be time-consuming and costly. In addition, we may be required to negotiate licenses with one or more third parties with terms that may or may not be favorable to us.

Risks Related to Our Financial Results and Need for Financing

We may incur operating losses in the future and may not be able to sustain profitability.

The extent of our future operating losses and our ability to sustain profitability are highly uncertain. We have been engaged in developing and commercializing drugs and have generated significant operating losses since our inception in December 1996. Our commercial activities and continued product development and clinical activities will require significant expenditures. For the nine months ended September 30, 2011, we recognized $76.2 million in total revenues, and, as of September 30, 2011, we had an accumulated deficit of $306.1 million.

We may incur additional operating losses and capital expenditures as we support the continued marketing of the Glumetza and Cycloset products and the development of our Uceris, Rhucin, rifamycin SV MMX and SAN-300 development products and any other products or development products that we acquire or in-license.

Our quarterly financial results are likely to fluctuate significantly due to uncertainties about future sales levels for our currently marketed products and future costs associated with our development-stage products.

Our quarterly operating results are difficult to predict and may fluctuate significantly from period to period, particularly because the commercial success of, and demand for, currently marketed products, as well as the success and costs of our development programs are uncertain and therefore our future prospects are uncertain. The level of our revenues and results of operations at any given time will be based primarily on the following factors:

 

   

commercial success of the Glumetza and Cycloset prescription products;

 

   

results of clinical studies and other development programs, including the ongoing and planned clinical programs for the Uceris, Rhucin, rifamycin SV MMX and SAN-300 development products;

 

   

our ability to obtain regulatory approval for our development products and any future products we develop or in-license;

 

   

potential to receive revenue from Zegerid brand and authorized generic products;

 

   

whether we are able to maintain patent protection for our products, including whether favorable outcomes are obtained in our pending appeal relating to our Zegerid prescription products and the pending patent infringement lawsuits relating to our Glumetza prescription product and Zegerid OTC;

 

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interruption in the manufacturing or distribution of our products;

 

   

progress under our strategic alliances with Merck, GSK and Norgine, including the impact on these alliances from generic competition and the potential for early termination of, or reduced payments under, the related agreements;

 

   

timing of new product offerings, acquisitions, licenses or other significant events by us, our strategic partners or our competitors; and

 

   

legislative changes, including healthcare reform, affecting the products we may offer or those of our competitors.

Because of these factors, our operating results in one or more future quarters may fail to meet the expectations of securities analysts or investors, which could cause our stock price to decline significantly.

To the extent we need to raise additional funds in connection with the licensing or acquisition of new products or to continue our operations, we may be unable to raise capital when needed.

We believe that our current cash, cash equivalents and short-term investments and use of our line of credit will be sufficient to fund our current operations through at least the next twelve months; however, our projected revenue may decrease or our expenses may increase and that would lead to our cash resources being consumed earlier than we expect. Although we do not believe that we will need to raise additional funds to finance our current operations through at least the next twelve months, we may pursue raising additional funds in connection with licensing or acquisition of new products or the continued development of our product candidates. Sources of additional funds may include funds generated through equity and/or debt financing or through strategic collaborations or licensing agreements.

Our existing universal shelf registration statement was declared effective in December 2008 and expires in December 2011. The shelf registration statement may permit us, from time to time, to offer and sell up to approximately $75.0 million of equity or debt securities. However, there can be no assurance that we will be able to complete any such offerings of securities. Factors influencing the availability of additional financing include the progress of our commercial and development activities, investor perception of our prospects and the general condition of the financial markets, among others.

In addition, our ability to borrow additional amounts under our loan agreement with Comerica Bank, or Comerica, depends upon a number of conditions and restrictions, and we cannot be certain that we will satisfy all borrowing conditions at a time when we desire to borrow such amounts under the loan agreement. For example, we are subject to a number of affirmative and negative covenants, each of which must be satisfied at the time of any proposed borrowing. If we have not satisfied these various conditions, or an event of default otherwise has occurred, we may be unable to borrow additional amounts under the loan agreement, and may be required to repay any amounts previously borrowed.

We cannot be certain that our existing cash and marketable securities resources will be adequate to sustain our current operations. To the extent we require additional funding, we cannot be certain that such funding will be available to us on acceptable terms, or at all. If adequate funds are not available on terms acceptable to us at that time, our ability to continue our current operations or pursue new product opportunities would be significantly limited.

Our current and any future indebtedness under our loan agreement with Comerica could adversely affect our financial health.

Under our loan agreement with Comerica, we may incur a significant amount of indebtedness. Such indebtedness could have important consequences. For example, it could:

 

   

impair our ability to obtain additional financing in the future for working capital needs, capital expenditures and general corporate purposes;

 

   

increase our vulnerability to general adverse economic and industry conditions;

 

   

make it more difficult for us to satisfy other debt obligations we may incur in the future;

 

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require us to dedicate a substantial portion of our cash flows from operations to the payment of principal and interest on our indebtedness, thereby reducing the availability of our cash flows to fund working capital needs, capital expenditures and other general corporate purposes; and

 

   

expose us to higher interest expense in the event of increases in interest rates because our indebtedness under the loan agreement with Comerica bears interest at a variable rate.

If an event of default occurs under the loan agreement, we may be unable to borrow additional amounts, and may be required to repay any amounts previously borrowed. The events of default under the loan agreement include, among other things, a material adverse effect on (i) our business operations, condition (financial or otherwise) or prospects, (ii) our ability to repay the obligations under the loan agreement or otherwise perform our obligations under the loan agreement, or (iii) our interest in, or the value, perfection or priority of Comerica’s security interest in the collateral, which generally includes all of our cash and accounts receivable, but excludes intellectual property. For a description of the loan agreement, see Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.

Covenants in our loan agreement with Comerica may limit our ability to operate our business.

Under our loan agreement with Comerica, we are subject to specified affirmative and negative covenants, including limitations on our ability: to undergo certain change of control events; to convey, sell, lease, license, transfer or otherwise dispose of assets; to create, incur, assume, guarantee or be liable with respect to certain indebtedness; to grant liens; to pay dividends and make certain other restricted payments; and to make investments. In addition, under the loan agreement we are required to maintain a balance of cash with Comerica in an amount of not less than $4.0 million and to maintain any other cash balances with either Comerica or another financial institution covered by a control agreement for the benefit of Comerica. We are also subject to specified financial covenants with respect to a minimum liquidity ratio and, in specified limited circumstances, minimum EBITDA requirements, as defined in the loan agreement. Our subsidiary must also guarantee our obligations under the loan agreement, and we are required to pledge the stock of our subsidiary to the lender to secure our obligations under the loan agreement.

If we default under the loan agreement because of a covenant breach or otherwise, all outstanding amounts could become immediately due and payable, which would negatively impact our liquidity and reduce the availability of our cash flows to fund working capital needs, capital expenditures and other general corporate purposes.

Our ability to use our net operating losses to offset taxes that would otherwise be due could be limited or lost entirely if we do not continue to generate taxable income in a timely manner or if we trigger an “ownership change” pursuant to Section 382 of the Internal Revenue Code which, if we continue to generate taxable income, could materially and adversely affect our business, financial condition, and results of operations.

As of December 31, 2010, we had Federal and state income tax net operating loss carryforwards, or NOLs, of approximately $173.3 million and $155.5 million, respectively. Our ability to use our NOLs to offset taxes that would otherwise be due is dependent upon our generation of future taxable income before the expiration dates of the NOLs, and we cannot predict with certainty whether we will be able to generate future taxable income. In addition, even if we generate taxable income, realization of our NOLs to offset taxes that would otherwise be due could be restricted by annual limitations on use of NOLs triggered by an “ownership change” under Section 382 of the Internal Revenue Code and similar state provisions. An “ownership change” may occur when there is a 50% or greater change in total ownership of our company by one or more 5% shareholders within a three-year period. The loss of some or all of our NOLs could materially and adversely affect our business, financial condition and results of operations. In addition, California and certain states have suspended use of NOLs for certain taxable years, and other states may consider similar measures. As a result, we may incur higher state income tax expense in the future. Depending on our future tax position, continued suspension of our ability to use NOLs in states in which we are subject to income tax could have an adverse impact on our operating results and financial condition.

 

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Our results of operations and liquidity needs could be materially negatively affected by market fluctuations and economic downturn.

Our results of operations could be materially negatively affected by economic conditions generally, both in the U.S. and elsewhere around the world. Continuing concerns over inflation, energy costs, geopolitical issues, the availability and cost of credit, the U.S. mortgage market and a difficult residential real estate market in the U.S. have contributed to increased volatility and diminished expectations for the economy and the markets going forward.

These factors, combined with volatile oil prices, declining business and consumer confidence and continued unemployment concerns, have precipitated economic uncertainty. Domestic and international equity markets continue to experience heightened volatility and turmoil. These events and the continuing market upheavals may have an adverse effect on us. In the event of a continuing market downturn, our results of operations could be adversely affected by those factors in many ways, including making it more difficult for us to raise funds if necessary, and our stock price may decline. In addition, we maintain significant amounts of cash and cash equivalents at one or more financial institutions that are in excess of federally insured limits. Given the current instability of financial institutions, we cannot be assured that we will not experience losses on these deposits.

In addition, concern about the stability of markets generally and the strength of counterparties specifically has led many lenders and institutional investors to reduce, and in some cases, cease to provide credit to businesses and consumers.

In connection with the reporting of our financial condition and results of operations, we are required to make estimates and judgments which involve uncertainties, and any significant differences between our estimates and actual results could have an adverse impact on our financial position, results of operations and cash flows.

Our discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. In particular, as part of our revenue recognition policy, our estimates of product returns, rebates and chargebacks require our most subjective and complex judgment due to the need to make estimates about matters that are inherently uncertain. Any significant differences between our actual results and our estimates under different assumptions or conditions could negatively impact our financial position, results of operations and cash flows.

Risks Related to the Securities Markets and Ownership of Our Common Stock

Our stock price has been and may continue to be volatile, and our stockholders may not be able to sell their shares at attractive prices.

The market prices for securities of specialty biopharmaceutical companies in general have been highly volatile and may continue to be highly volatile in the future. For example, during the year ended December 31, 2010, the trading prices for our common stock ranged from a high of $5.67 to a low of $2.09, and on September 30, 2011, the closing trading price for our common stock was $2.79. In addition, we have not paid cash dividends since our inception and do not intend to pay cash dividends in the foreseeable future. Furthermore, our loan agreement with Comerica prohibits us from paying dividends. Therefore, investors will have to rely on appreciation in our stock price and a liquid trading market in order to achieve a gain on their investment.

 

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The trading price of our common stock may continue to fluctuate substantially as a result of one or more of the following factors:

 

   

announcements concerning our commercial progress and activities, including sales and revenue trends for the Glumetza and Cycloset products we promote and the status of the patent litigation relating to Glumetza;

 

   

announcements concerning our products or competitive products, including progress under development programs, results of clinical studies or status of regulatory submissions;

 

   

the status of the generic versions of our Zegerid prescription products offered by Par and Prasco, and any additional generic products that may be offered in the future, as well as developments in the pending appeal relating to our Zegerid prescription products and the pending litigation concerning Zegerid OTC;

 

   

announcements concerning any recalls or supply interruptions caused by manufacturing issues or otherwise;

 

   

developments, including announcements concerning progress, delays or terminations, pursuant to our strategic alliances with Merck, GSK and Norgine;

 

   

announcements made by our strategic partners concerning their business or the products they develop or promote;

 

   

other disputes or developments concerning proprietary rights, including patents and trade secrets, litigation matters, and our ability to patent or otherwise protect our products and technologies;

 

   

conditions or trends in the pharmaceutical and biotechnology industries, including the impact of healthcare reform;

 

   

fluctuations in stock market prices and trading volumes of similar companies or of the markets generally;

 

   

changes in, or our failure to meet or exceed, investors’ and securities analysts’ expectations;

 

   

announcements concerning borrowings under our loan agreement, takedowns under our existing universal shelf registration statement or other developments relating to the loan agreement, universal shelf registration statement or our other financing activities;

 

   

acquisition of products or businesses by us or our competitors;

 

   

litigation and government inquiries, including the results of a putative class action filed against us relating to alleged violations of certain labor laws seeking an unspecified amount for unpaid wages and overtime wages, liquidated and/or punitive damages, attorneys’ fees and other damages; or

 

   

economic and political factors, including sovereign debt uncertainty, wars, terrorism and political unrest.

Our stock price could decline and our stockholders may suffer dilution in connection with future issuances of equity or debt securities.

Although we believe that our current cash, cash equivalents and short-term investments and use of our line of credit will be sufficient to fund our current operations through at least the next twelve months, we may pursue raising additional funds in connection with licensing or acquisition of new products or the continued development of our product candidates. Sources of additional funds may include funds generated through equity and/or debt financing, or through strategic collaborations or licensing agreements. To the extent we conduct substantial future offerings of equity or debt securities, such offerings could cause our stock price to decline. For example, we may issue securities under our existing universal shelf registration statement or we may pursue alternative financing arrangements.

The exercise of outstanding options and warrants and future equity issuances, including future public offerings or future private placements of equity securities and any additional shares issued in connection with licenses or acquisitions, will also result in dilution to investors. The market price of our common stock could fall as a result of resales of any of these shares of common stock due to an increased number of shares available for sale in the market.

 

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Future sales of our common stock by our stockholders may depress our stock price.

A concentrated number of stockholders hold significant blocks of our outstanding common stock. Sales by our current stockholders of a substantial number of shares, or the expectation that such sales may occur, could significantly reduce the market price of our common stock. In addition, certain of our executive officers have from time to time established programmed selling plans under Rule 10b5-1 of the Securities Exchange Act of 1934, as amended, for the purpose of effecting sales of common stock, and other employees and affiliates, including our directors and executive officers, may choose to establish similar plans in the future. If any of our stockholders cause securities to be sold in the public market, the sales could reduce the trading price of our common stock. These sales also could impede our ability to raise future capital.

We may become involved in securities or other class action litigation that could divert management’s attention and harm our business.

The stock market has from time to time experienced significant price and volume fluctuations that have affected the market prices for the common stock of pharmaceutical and biotechnology companies. These broad market fluctuations may cause the market price of our common stock to decline. In the past, following periods of volatility in the market price of a particular company’s securities, securities class action litigation has often been brought against that company.

In December 2010, a complaint styled as a putative class action was filed against us in the U.S. District Court for the Southern District of New York by a person employed at the time by us as a sales representative and on behalf of a class of similarly situated current and former employees. The complaint seeks damages for alleged violations of the New York Labor Law 650 §§ et seq. and the federal Fair Labor Standards Act. The alleged violations include failure to pay for overtime work. The complaint seeks an unspecified amount for unpaid wages and overtime wages, liquidated and/or punitive damages, attorneys’ fees and other damages. We deny all claims asserted in the complaint. In April 2011, we filed a motion to transfer the case to the United States District Court for the Southern District of California. In August 2011, our motion to transfer was denied, and the action will proceed in the New York district court. Over the last few years, similar class action lawsuits have been filed against other pharmaceutical companies alleging that the companies’ sales representatives have been misclassified as exempt employees under the federal Fair Labor Standards Act and applicable state laws. At this time, we are unable to estimate possible losses or ranges of losses for this action. There have been varying outcomes in these cases to date, and it is too early to predict an outcome in our matter at this time. Although we intend to vigorously defend against the litigation filed against us, litigation often is expensive and diverts management’s attention and resources, which could adversely affect our business regardless of the outcome.

Anti-takeover provisions in our organizational documents and Delaware law may discourage or prevent a change in control, even if an acquisition would be beneficial to our stockholders, which could adversely affect our stock price and prevent attempts by our stockholders to replace or remove our current management.

Our certificate of incorporation and bylaws contain provisions that may delay or prevent a change in control, discourage bids at a premium over the market price of our common stock and adversely affect the market price of our common stock and the voting and other rights of the holders of our common stock.

These provisions include:

 

   

dividing our board of directors into three classes serving staggered three-year terms;

 

   

prohibiting our stockholders from calling a special meeting of stockholders;

 

   

permitting the issuance of additional shares of our common stock or preferred stock without stockholder approval;

 

   

prohibiting our stockholders from making certain changes to our certificate of incorporation or bylaws except with 66 2/3% stockholder approval; and

 

   

requiring advance notice for raising business matters or nominating directors at stockholders’ meetings.

 

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We are also subject to provisions of the Delaware corporation law that, in general, prohibit any business combination with a beneficial owner of 15% or more of our common stock for five years unless the holder’s acquisition of our stock was approved in advance by our board of directors. Together, these charter and statutory provisions could make the removal of management more difficult and may discourage transactions that otherwise could involve payment of a premium over prevailing market prices for our common stock.

In addition, we have adopted a stockholder rights plan. Although the rights plan will not prevent a takeover, it is intended to encourage anyone seeking to acquire our company to negotiate with our board prior to attempting a takeover by potentially significantly diluting an acquirer’s ownership interest in our outstanding capital stock. The existence of the rights plan may also discourage transactions that otherwise could involve payment of a premium over prevailing market prices for our common stock.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Unregistered Sales of Equity Securities

Not applicable.

Issuer Purchases of Equity Securities

Not applicable.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Removed and Reserved

Item 5. Other Information

On November 4, 2011, we and our wholly owned subsidiary, Covella Pharmaceuticals, Inc., or Covella, entered into an amendment, or the First Amendment, with Biogen Idec MA Inc., or Biogen Idec, amending the Amended and Restated Services and Supply Agreement, or the Services and Supply Agreement, dated September 10, 2010 among us, Covella and Biogen Idec.

The Services and Supply Agreement was entered into in connection with the License Agreement, dated January 22, 2009 between Covella and Biogen Idec, as amended by the Amendment to License Agreement, dated September 10, 2010, or collectively, the Amended License. Under the terms of the Amended License, Biogen Idec granted Covella an exclusive, worldwide license to patents and certain know-how and other intellectual property owned and controlled by Biogen Idec relating to the anti-VLA-1 antibody development program.

Under the Services and Supply Agreement, Biogen Idec agreed to sell to Covella materials manufactured by Biogen Idec for use in the anti-VLA-1 antibody development program. The First Amendment provides for a revised payment structure for such materials. Pursuant to the First Amendment, there shall be no fee for storage, delivery or usage of certain materials supplied under the Services and Supply Agreement. However, upon Covella’s (or its affiliates’ or sublicensees’) achievement of the first regulatory approval set forth in the Amended License, Biogen Idec shall be entitled to receive a one-time milestone payment equal to $11,742,000, which is equivalent to the cost of the materials supplied under the Services and Supply Agreement. In the event the Amended License is terminated by either Covella or Biogen Idec prior to Covella’s (or its affiliates’ or sublicensees’) achievement of the first regulatory approval set forth in the Amended License, Covella shall be required to pay Biogen Idec a one-time termination fee of $3,000,000.

The foregoing descriptions of the terms of the First Amendment and the Services and Supply Agreement are each qualified in their entirety by reference to the provisions of the First Amendment and the Services and Supply Agreement, respectively, which will be filed as exhibits to Santarus’ Annual Report on Form 10-K for the year ending December 31, 2011.

 

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The foregoing descriptions of the terms of the License Agreement and the Amendment to License Agreement are each qualified in their entirety by reference to the provisions of the License Agreement and Amendment to License Agreement, respectively, which were filed as exhibits 10.8 and 10.9, respectively, to Santarus’ Quarterly Report on Form 10-Q/A for the quarter ending September 30, 2010.

Item 6. Exhibits

 

Exhibit
Number

 

Description

  2.1(1)*   Agreement and Plan of Merger, dated September 10, 2010, among us, SAN Acquisition Corp., Covella Pharmaceuticals, Inc. and Lawrence C. Fritz, as the Stockholder Representative
  3.1(2)   Amended and Restated Certificate of Incorporation
  3.2(3)   Amended and Restated Bylaws
  3.3(4)   Certificate of Designations for Series A Junior Participating Preferred Stock
  4.1(4)   Form of Common Stock Certificate
  4.2(5)   Amended and Restated Investors’ Rights Agreement, dated April 30, 2003, among us and the parties named therein
  4.3(5)   Amendment No. 1 to Amended and Restated Investors’ Rights Agreement, dated May 19, 2003, among us and the parties named therein
  4.4(5)*   Stock Restriction and Registration Rights Agreement, dated January 26, 2001, between us and The Curators of the University of Missouri
  4.5(5)   Form of Common Stock Purchase Warrant
  4.6(4)   Rights Agreement, dated as of November 12, 2004, between us and American Stock Transfer & Trust Company, which includes the form of Certificate of Designations of the Series A Junior Participating Preferred Stock of Santarus, Inc. as Exhibit A, the form of Right Certificate as Exhibit B and the Summary of Rights to Purchase Preferred Shares as Exhibit C
  4.7(6)   First Amendment to Rights Agreement, dated as of April 19, 2006, between us and American Stock Transfer & Trust Company
  4.8(7)   Second Amendment to Rights Agreement, dated December 10, 2008, between us and American Stock Transfer & Trust Company
  4.9(8)   Warrant to Purchase Shares of Common Stock, dated February 3, 2006, issued by us to Kingsbridge Capital Limited
  4.10(8)   Registration Rights Agreement, dated February 3, 2006, between us and Kingsbridge Capital Limited
  4.11(9)   Registration Rights Agreement, dated December 10, 2008, between us and Cosmo Technologies Limited
  4.12(9)   Amendment No. 1 to Registration Rights Agreement, dated April 23, 2009, between us and Cosmo Technologies Limited
10.1   First Amendment to Sublease, dated August 5, 2011, between us and Avnet, Inc.
10.2+   Commercialization Agreement, dated August 22, 2011, between us and Depomed, Inc.

 

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  10.3    Amendment No. 4 to OTC License Agreement, dated September 23, 2011, between us and MSD Consumer Care, Inc. (formerly known as Schering-Plough Healthcare Products, Inc.)
  31.1    Certification of Chief Executive Officer pursuant to Rules 13a-14 and 15d-14 promulgated under the Securities Exchange Act of 1934
  31.2    Certification of Chief Financial Officer pursuant to Rules 13a-14 and 15d-14 promulgated under the Securities Exchange Act of 1934
  32#    Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS†    XBRL Instance Document
101.SCH†    XBRL Taxonomy Extension Schema Document
101.CAL†    XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB†    XBRL Taxonomy Extension Label Linkbase Document
101.PRE†    XBRL Taxonomy Extension Presentation Linkbase Document

 

(1) Incorporated by reference to the Quarterly Report on Form 10-Q of Santarus, Inc. for the quarter ended September 30, 2010, filed with the Securities and Exchange Commission on November 9, 2010.
(2) Incorporated by reference to the Quarterly Report on Form 10-Q of Santarus, Inc. for the quarter ended March 31, 2004, filed with the Securities and Exchange Commission on May 13, 2004.
(3) Incorporated by reference to the Current Report on Form 8-K of Santarus, Inc., filed with the Securities and Exchange Commission on December 5, 2008.
(4) Incorporated by reference to the Current Report on Form 8-K of Santarus, Inc., filed with the Securities and Exchange Commission on November 17, 2004.
(5) Incorporated by reference to the Registration Statement on Form S-1 of Santarus, Inc. (Registration No. 333-111515), filed with the Securities and Exchange Commission on December 23, 2003, as amended.
(6) Incorporated by reference to the Current Report on Form 8-K of Santarus, Inc., filed with the Securities and Exchange Commission on April 21, 2006.
(7) Incorporated by reference to our Current Report on Form 8-K, filed with the Securities and Exchange Commission on December 15, 2008.
(8) Incorporated by reference to the Current Report on Form 8-K of Santarus, Inc., filed with the Securities and Exchange Commission on February 3, 2006.
(9) Incorporated by reference to the Registration Statement on Form S-3 of Santarus, Inc. (Registration No. 333-156806), filed with the Securities and Exchange Commission on January 20, 2009, as amended.
* Santarus, Inc. has been granted confidential treatment with respect to certain portions of this exhibit (indicated by asterisks), which portions have been omitted and filed separately with the Securities and Exchange Commission.
+ Application has been made to the Securities and Exchange Commission to seek confidential treatment of certain provisions. Omitted material for which confidential treatment has been requested has been filed separately with the Securities and Exchange Commission.

 

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# These certifications are being furnished solely to accompany this quarterly report pursuant to 18 U.S.C. Section 1350, and are not being filed for purposes of Section 18 of the Securities Exchange Act of 1934 and are not to be incorporated by reference into any filing of Santarus, Inc., whether made before or after the date hereof, regardless of any general incorporation language in such filing.
Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Section 11 or 12 of the Securities Act, are deemed not filed for purposes of Section 18 of the Exchange Act, and otherwise are not subject to liability under these sections.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Dated: November 7, 2011

 

/s/ Debra P. Crawford

Debra P. Crawford,

Senior Vice President and Chief Financial Officer

(Duly Authorized Officer and Principal Financial Officer)

 

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